Is Sovereign Debt Crisis Contained to Subprime?
Those who believe rates will never rise as long as the Fed remains accommodative, or that inflation will not flare up as long as unemployment remains high, are just as foolish as those who assured us that the mortgage market was sound because national real estate prices could never fall.
As Americans observe the chaos in Greece, most assume that the strength of our currency, the credit worthiness of our government, and the vast expanse of two oceans, will prevent a similar scene from playing out in our streets. I believe these protections to be illusory.
Once again the vast majority fails to see a crisis in the making, even as it stares at them from close range. Just as market observers in 2007 told us that the credit crisis would be confined to the subprime mortgage market, current analysts tell us that sovereign debt problems are confined to Greece, Spain, Portugal, and perhaps Italy. They were wrong then, and I believe that they're wrong now.
During the housing boom, subprime and prime borrowers made many of the same mistakes. Both groups overpaid for their homes, bought with low or no down payments, financed using ARMs instead of fixed rate mortgages, and repeatedly cashed out appreciated home equity through re-financings. The market largely overlooked the glaring similarities, and instead merely focused on FICO scores. Yes, prime borrowers had better credit, but their losses on underwater properties were no less devastating. As the magnitude of home price declines intensified, prime borrowers defaulted in levels that were almost as high as the subprime crowd.
So when mortgage backed securities started to go bad, it wasn't as if the problems emanated in subprime and subsequently "contaminated" the rest of the market. All borrowers were infected with the same disease, but the symptoms merely expressed themselves sooner in subprime. The same is true on a national level, whereby Greece plays the part of the subprime borrower. Though the U.S. is considered to be the highest order of "prime" borrower, based on historic precedent, our debt to GDP levels are at crisis levels, and are not that much lower than Portugal or Spain. When off-budget and contingency liabilities are properly accounted for, one could argue that we are already in worse financial shape than Greece.
Most importantly, like Greece (and homeowners who relied on adjustable rate mortgages), we have a high percentage of short-term debt that is vulnerable to rising rates. The one key difference is that while Greece borrows in euros, a currency it cannot print, America borrows in dollars, which we can print endlessly. In reality however, this is a distinction with very little substantive difference.
What if Greece had not been a member of the euro zone and had instead borrowed in their former currency, the drachma? First, given its past history of fiscal shortfalls, Greece would not have been able to borrow nearly as much as it had (They may well have been forced to borrow in euros anyway). Under those circumstances, creditors would have been more reluctant to lend without the possibility of a German led bailout. Had Greece never adopted the euro as its currency, but nevertheless borrowed in euros, it would now face the same difficult choices, but would not be offered the carrots or sticks provided by other euro zone nations that are worried about the integrity of their currency. The IMF would have been Greece's only possible savior.
Many of our top economists now argue that all would be well in Greece if the country was in charge of its own currency. In such a scenario, Greece would indeed have had no problems printing as many drachmas needed to pay its debts. However, would this really be a "get out of debt free" card for Greece?
The main reason the Greeks are protesting in the streets is that they do not want their benefits reduced or taxes raised to repay foreign creditors. But despite the likely domestic popularity of a drachma-printing policy, would it really get the Greeks off the hook? They would stiff their creditors by repaying them in currency of diminished value. But the same result could be achieved through an honest debt restructuring, which would involve "haircuts" for all creditors. In a restructuring, the pain falls most squarely on those who foolishly lent money to a "subprime" borrower.
But with inflation it's not just foreign creditors who would suffer. Every Greek citizen who has savings in drachma would suffer. Every Greek citizen who works for wages would suffer. Sure nominal benefits are preserved and taxes are not raised, but real purchasing power is destroyed. If the cost of living goes up, the reduction in the value of government benefits is just as real.
Of course, the negative effects on the economy of run-a-way inflation and skyrocketing interest rates are worse than what otherwise might result from an honest restructuring or even out right default. It is just amazing how few economists understand this simple fact.
Just because we can inflate does not mean we can escape the consequences of our actions. One way or another the piper must be paid. Either benefits will be cut or the real value of those benefits will be reduced. In fact, it is precisely because we can inflate our problems away that they now loom so large. With no one forcing us to make the hard choices, we constantly take the easy way out.
When creditors ultimately decide to curtail loans to America, U.S. interest rates will finally spike, and we will be confronted with even more difficult choices than those now facing Greece. Given the short maturity of our national debt, a jump in short-term rates would either result in default or massive austerity. If we choose neither, and opt to print money instead, the run-a-way inflation that will ensue will produce an even greater austerity than the one our leaders lacked the courage to impose. Those who believe rates will never rise as long as the Fed remains accommodative, or that inflation will not flare up as long as unemployment remains high, are just as foolish as those who assured us that the mortgage market was sound because national real estate prices could never fall.
Freddie Finances Scarier.........
Freddie Finances Scarier Than Bad Slasher Flick: Kevin Hassett
Commentary by Kevin Hassett
May 10 (Bloomberg) -- Freddie Mac’s disclosure that it lost $6.7 billion of taxpayer dollars in the first quarter of 2010, and that bigger losses may follow, suggests the Congressional Budget Office may have been kind in estimating that Freddie and Fannie Mae could gobble up $389 billion in U.S. aid by 2019.
The carnage of America’s government-sponsored housing agencies continues. It’s a remake of “A Nightmare on Elm Street,” only Freddy Krueger now goes by Freddie. The hapless victims are played by taxpayers.
The worst financial crisis in generations was set off by a massive government effort, led by the two mortgage giants, to make loans to homebuyers no matter whether they could make the payments. Lenders were willing to lend money to just about all comers, no matter how low their income. Why? Because the lenders knew Fannie and Freddie would purchase the loans from them for a high price before bundling them into securities to sell to investors.
Given that lenders didn’t have to keep skin in the game, they made loans that were as big as possible as fast as possible to people who, in some cases, were as unqualified as possible. That lending frenzy created the housing bubble, leaving us all holding the check.
At least we know that now. Given everything that happened, surely Fannie and Freddie have stopped adding to the problem, right?
Think again. Even after all of the bailouts, those idiotic loans are continuing.
Worst Practices
The two mortgage giants that largely created this mess chug along enthusiastically, not even bothering to change key practices that led to the worst real-estate crisis in U.S. history. Not only have Democrats failed to address Fannie and Freddie in their financial reform, they are standing back and allowing the worst practices to go on.
And while the rest of the economy has turned the corner, the bleeding is getting worse at the government housing agencies.
How did so much of our money get wasted? Peter Wallison, my colleague at the American Enterprise Institute, recapped the plot in gory detail in a November 2008 article.
The housing crisis built up gradually, accelerating to an outright calamity near the end of the last decade. It began when do-gooders figured out that they could subsidize the purchases of low-income housing by requiring Fannie and Freddie to make risky loans to low-income individuals.
Too Creative
Wallison cites the 1994 National Homeownership Strategy developed by President Bill Clinton’s administration that pushed “financing strategies, fueled by the creativity and resources of the private and public sectors, to help homeowners that lack cash to buy a home or to make the payments.”
Over time, with housing prices rising year after year, it looked like a free lunch. Taxpayers increasingly were placed on the hook for questionable loans, with low- and very low-income individuals accounting for a whopping 25 percent of loans purchased by Fannie and Freddie in 2007.
Incredibly, the Obama administration has done nothing to stop Fannie and Freddie from engaging in these dangerous practices. Quite the opposite.
In February, the Federal Housing Finance Agency proposed a rule setting goals for Fannie and Freddie for 2010 and 2011. One goal is that 27 percent of mortgages acquired by Fannie and Freddie “meet the low-income standard.”
Horror Continues
In other words, not only are your tax dollars going to bail out the horrifying loans that Fannie and Freddie encouraged during the real-estate bubble, they are also being used to guarantee new loans to borrowers who would not qualify absent government intervention.
The Democrats have put off dealing with Fannie and Freddie for a simple reason: Reform will require a conversation on how the two organizations contributed to the financial crisis.
Such a discussion is inconsistent with the Democratic story that Republican deregulation created the mess. It’s especially painful for President Barack Obama, who was a strong advocate for the two mortgage giants and helped obstruct efforts to rein them in. As of 2008, Obama trailed only Senator Christopher Dodd of Connecticut, chairman of the Senate Banking Committee, in collecting political donations from Fannie and Freddie’s employees and political action committees.
My guess is that Democrats will continue to avoid doing anything about Fannie and Freddie. The two leaking organizations will be cut into pieces and sent to the bottom of the ocean only after Republicans recapture Congress. Dire financial reports, such as Freddie’s last week, may hasten that transfer of power.
Greek Contagion Myth Masks Real Europe Crisis
Greek Contagion Myth Masks Real Europe Crisis: Caroline Baum
Commentary by Caroline Baum
May 10 (Bloomberg) -- Greece sneezes and Portugal catches a cold. Portugal coughs and Spain falls ill. Spain runs a fever and Italy comes down with the flu.
Contagion, or contagion theory, is sweeping the euro zone, where Greece’s debt crisis is infecting neighboring countries and threatening to make its way across the Atlantic to U.S. shores.
At least that’s what we’re told on a daily basis. European Central Bank council member Axel Weber warned last week of “grave contagion effects” for countries that have adopted the euro. “Greece Fuels Fears of Contagion in the U.S.,” trumpeted a May 6 Wall Street Journal headline.
I hate to pour cold water on that theory, but healthy countries aren’t susceptible to Greece’s disease. The sick ones, already plagued with high debt levels and bloated state budgets, don’t need a carrier. Capital flight from these countries “is not evidence of contagion,” said economist and author Anna Schwartz.
Of course, Schwartz said that in 1998 following the Asian financial crisis. In “International Financial Crises: Myths and Realities” (the Cato Journal, Vol. 17 No. 3), Schwartz punctured the notion that financial crises spread from the initial source to innocent victims. Nations are vulnerable because of their “home grown economic problems,” she said.
Schwartz’s insights are equally valid today. Capital isn’t fleeing sovereign debt markets in Spain and Portugal because Greece can’t pay its bills. Bond yields are rising because of an increased risk those countries may find themselves in the same boat as Greece: unable to meet their debt obligations.
Chronic Defaulter
OK, maybe not quite as leaky a boat. It would be hard to match Greece’s record of spending half the years since its independence in 1829 in default or rescheduling its debt, according to economists Carmen Reinhart and Ken Rogoff, authors of “This Time is Different.”
A single currency, it turns out, isn’t a panacea for everything that ails Europe. The 11 nations that scrapped their sovereign currencies and adopted the euro in 1999 never constituted an optimum currency area as envisioned by economist and Nobel Laureate Robert Mundell, the father of the euro.
“They don’t have a mechanism to deal with crises when they come up,” says Michael Bordo, professor of economics at Rutgers University and author of a book on the history of monetary unions. Europeans knew if they ceded domestic monetary policy to a centralized European Central Bank they would need “labor mobility and/or transfers from healthy states to weaker ones to deal with asymmetric shocks,” he says.
Fiscal Transfers
Europe has neither. Political union is still a dream. Germans are still Germans, and Greeks are still Greeks. The man on the street in Dusseldorf probably doesn’t understand why the German government has to fork over what could be his pension to a country for whom default is a way of life.
Political union isn’t a prerequisite for dealing with a sovereign debt crisis. What’s needed is some kind of a priori agreement on how fiscal transfers are to be carried out, says William White, chairman of the Economic Development and Review Committee at the Organization for Economic Cooperation and Development. In the case of the euro zone, “they were short of a few fiscal elements,” he says.
It’s far from clear the German public would have supported such transfers from strong to weak countries, White says. Especially if it’s the same profligate nations, such as Greece, that keep feeding at the trough.
Wake-Up Call
That said, European leaders have invested too much political capital in a united Europe to turn back now. Germany’s Parliament approved a package of loans to Greece on Friday, part of a 110 billion euro ($142 billion) package from the International Monetary Fund and European Union. Greece approved an austerity plan in exchange for the bailout.
“This should be a wake-up call to design mechanisms to deal with crises and enforce the rules” on debt and deficits, Bordo says.
The 1992 Maastricht Treaty outlined four convergence criteria for joining the European Monetary Union, including a maximum deficit-to-GDP ratio of 3 percent and debt-to-GDP of 60 percent. Last year Greece’s deficit and debt were 13.6 percent and 115 percent, respectively, as a share of the economy. All of the infected countries, and a few that haven’t caught the disease yet, are well in excess of those limits. The U.K., for instance, which is benefiting from capital flight out of Europe’s Club Med countries, ran a deficit last year that was 11.5 percent of GDP.
Investors may flee the U.K. at some point, but it won’t be because it caught anything from Greece.
Incubation Period
There is no question we live in an interconnected world. Subprime mortgage defaults by homeowners in Irvine, California, infected banks in Europe and Asia, thanks to the miracle of securitization.
So yes, European banks that hold Greek debt are vulnerable to losses. The interbank lending market is showing signs of stress. And the austerity measures required in Europe’s peripheral countries may spill over into reduced U.S. exports. That’s not the kind of contagion we keep hearing about.
On the other hand, it would be a mistake to interpret the flight-to-quality into U.S. Treasuries last week as a sign of immunity. The U.S. is already infected with the debt virus. It’s still in its incubation period.
Fed Restarts Currency Swaps
Fed Restarts Currency Swaps as EU Debt Crisis Flares (Update3)
By Scott Lanman and Craig Torres
May 10 (Bloomberg) -- The U.S. Federal Reserve will restart its emergency currency-swap tool by providing as many dollars as needed to European central banks to keep the continent’s sovereign-debt crisis from spreading.
The swaps with the European Central Bank, Bank of England and Swiss central bank, as well as the Bank of Japan, will allow them to provide the “full allotment” of U.S. dollars as needed, the Fed said late yesterday and today in statements in Washington. A separate swap line with the Bank of Canada will support as much as $30 billion, the Fed said. The swaps were authorized through January 2011.
The Fed action was a complement to European policy makers’ announcement of an unprecedented loan package worth almost $1 trillion to stop a crisis that threatened to shatter confidence in the euro. The U.S. central bank on Feb. 1 had closed all swap lines opened during the last crisis, triggered by the subprime- mortgage meltdown in 2007.
“If there is one thing the Fed doesn’t like, it is systemic risk,” said Torsten Slok, an economist at Deutsche Bank AG in New York. “Early signs of systemic risk were brewing in the financial system last week, and if policy makers had not taken action this weekend, then this would also have been a threat to the U.S. financial system.”
Stocks surged around the world today after yesterday’s actions, with the Standard & Poor’s 500 Index rising 3.8 percent to 1,152.79 at 1:29 p.m. in New York. The euro strengthened against the dollar, gaining 0.4 percent to $1.2807 after rising as much as 2.7 percent. The euro traded at $1.5134 in November.
Stress Sign
In a swap, central banks exchange foreign currency with an agreement to reverse the transaction at a later date. The central banks will then lend the dollars at fixed rates to firms in their countries. Dollar liquidity tightened in London last week amid concern financial institutions are holding too many assets of Europe’s most-indebted nations.
“My concern was whether or not the financial concerns for financial institutions in Europe would spill over into the United States and affect our incipient recovery,” Philadelphia Fed President Charles Plosser said today in an interview on CNBC. “Hopefully the actions that have been taken will prevent that from happening, and the Fed’s role in this, in renewing the swap lines, was an effort to help ensure that that didn’t happen.”
Libor Fell
The London interbank offered rate, or Libor, for three- month loans slipped to 0.421 percent today, from 0.428 percent on May 7, the highest since Aug. 17, according to the British Bankers’ Association.
Plosser said his U.S. economic outlook is “still pretty upbeat” and projected average job growth of about 250,000 to 300,000 positions a month for the rest of the year.
Fed officials aren’t sure what the immediate demand will be for dollars or how much the U.S. central bank’s balance sheet will grow from its current level of $2.33 trillion. The ECB said its first offering will take place tomorrow. The prior incarnation of the swaps peaked at $583.1 billion in December 2008, with deals encompassing 14 other central banks.
“We have a banking system that is fragile, and those banks are exposed to European banks,” said David Kotok, chairman and chief investment officer at Cumberland Advisors Inc., which manages about $1.4 billion in Vineland, New Jersey. Further volatility in Europe would “impact us as well,” he said.
Rising Costs
Rising costs in the market for dollar loans between banks began to show “distrust” in the financial system, Kotok said. “As soon as you see that, you know you have systemic risk.”
This time, the Fed’s swaps come amid increasing political scrutiny. Congress could ask why the U.S. central bank is expanding the supply of dollars to help smooth disruptions caused by fiscal imbalances in Europe.
Senator Bernard Sanders, a Vermont independent, wants the Government Accountability Office to look into Fed lending facilities during the crisis, including swap lines with foreign central banks, such as the $20 billion facility the Fed opened with the ECB in December 2007.
A vote on the Sanders amendment could come as soon as May 11 as Congress proceeds with the most sweeping overhaul of financial regulations since the Great Depression.
“Many members of Congress are deeply suspicious of the Fed’s interventionist instincts,” said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. “Bailing out Wall Street caused enough resentment; appearing to bail out Greece would be even more problematic.”
‘Rile Up’
“The Fed cannot afford to rile up its congressional critics while the financial reform bill is still in play,” Crandall said before tonight’s announcement.
The Fed said today it’s not at risk of any losses on the swaps, because the ECB is obligated to repay the dollars the Fed provides at the same exchange rate.
The weekend’s events had echoes of the financial crisis in 2008. Fed policy makers acted after getting formal requests from the other central banks late on May 8, a Saturday, following informal requests toward the end of last week. The FOMC convened a meeting around midday yesterday and delegated authority, with conditions, for Chairman Ben S. Bernanke to approve the swaps. The vote of Fed policy makers was unanimous.
Fed officials considered possible political consequences of their decision at their weekend meeting. Bernanke told his colleagues that the Fed had to do what is right for the U.S. economy, while providing more transparency to Congress. The Fed said it will publish weekly reports on the swaps and will “shortly” release the contracts with the other central banks.
Many Risks
Officials at the Fed saw multiple risks to the U.S. expansion from continued turmoil in Europe, such as crimped trade, declining confidence, and financial volatility.
The Fed’s move may pale next to the agreement by the 16 euro nations to offer financial assistance worth as much as 750 billion euros ($971 billion) to countries under attack from speculators. The ECB said it will counter “severe tensions” in “certain” markets by purchasing government and private debt.
“The Fed action is a fringe development here,” said Axel Merk, president and chief investment officer of Merk Investments LLC in Palo Alto, California. The more important development is that “Europe is getting its act together,” he said.
Oil, Copper, Nickel Jump
Oil, Copper, Nickel Jump on European Bailout Plan; Gold Drops
By Chanyaporn Chanjaroen and Millie Munshi
May 10 (Bloomberg) -- Crude oil rose from a 12-week low and copper gained the most in six weeks after European policy makers approved almost $1 trillion in loans to ease a debt crisis that has been jeopardizing global growth.
Oil jumped as much as 4.5 percent to $78.51 a barrel, the biggest intraday increase since Sept. 30. Copper added 2.7 percent to $3.228 a pound in New York, while nickel increased 2 percent to $22,943 a metric ton on the London Metal Exchange. The Reuters/Jefferies CRB Index of 19 raw materials gained 1.3 percent to 264.65, heading for its biggest gain since March 29.
The CRB gauge plunged 5.9 percent last week, the most since Dec. 5, 2008, on concerns the Greek debt problems would spread. The declines in commodity prices presented a “buying opportunity,” Goldman Sachs Group Inc.’s analysts said in a report today.
“We remain most constructive on crude oil, copper and precious metals, with copper in particular looking attractive post the recent severe sell-off,” Goldman said in the report led by Jeff Currie in London.
The 16 euro nations agreed to lend as much as 750 billion euros ($962 billion) to countries they said are under attack from speculators. The European Central Bank said it will buy government and private debt.
“In the next few days there will be some recovery of risky assets including commodities,” said Charles Morris, who manages $2.5 billion at HSBC Global Asset Management’s Absolute Return fund in London.
Fifteen of the 19 commodities in the CRB index gained.
Gold Slumps
Gold fell for the first time in four sessions, losing as much as 2.1 percent, as the European loan package reduced demand for the metal as a haven. Prices were up 10 percent this year before today on demand for the precious metal as an alternative to currencies.
“You’re seeing commodities trade like equities today as traders are excited about this huge $1 trillion package and the prospects for growth,” said Scott Carter, executive vice president of Goldline International Inc.
“Gold investors are taking some profit and maybe moving into the other markets,” Carter said. “The easy money and new fiscal stimulus will eventually create inflation, and I wouldn’t be surprised to see gold rebound.”
Stocks, Commodities, Greek Bonds Rally on European Loan Package
Stocks, Commodities, Greek Bonds Rally on European Loan Package
By Rita Nazareth and Gavin Serkin
May 10 (Bloomberg) -- Stocks rallied around the world, sending the MSCI World Index up the most in 13 months, while Greek, Spanish and Portuguese bonds soared after European policy makers announced an almost $1 trillion loan package to end the region’s sovereign-debt crisis. The euro pared an earlier rally.
The MSCI World Index jumped 4.8 percent at 4 p.m. in New York and the Standard & Poor’s 500 Index rose 4.4 percent, the biggest gain since March 23, 2009, for both. Spain’s IBEX 35 Index surged a record 14 percent. The premium demanded to hold Greek 10-year bonds instead of benchmark German bunds slid by 484 basis points. Oil snapped a four day slump. Gauges of stock- market volatility slid by records while Treasuries, the dollar and gold fell as demand for safer assets decreased. The euro, which topped $1.30 earlier, traded near $1.28.
Governments of the 16 euro nations agreed today to lend as much as 750 billion euros ($959.4 billion) to the most-indebted countries. The European Central Bank said it will counter “severe tensions” in “certain” markets by purchasing government and private debt. Concerns that the Greek financial crisis will spread wiped $3.7 trillion from the value of global stock markets last week.
“I was rubbing my eyes and trying to make sure I was looking at the right numbers,” James Dunigan, chief investment officer at PNC Wealth Management in Philadelphia, which oversees $104 billion, said of early gains in stocks. “The selloff from last week is overdone. That’s why we’re rallying. If you’re able to stabilize Europe, the growth story continues to be in place in the U.S.”
Improving Economy
The emergency action may allow investors to return their focus to the improving outlook for the global economy. About 69 percent of companies on the MSCI World Index that reported quarterly earnings since April 12 have beaten analysts’ forecasts, according to Bloomberg data. Employment in the U.S. increased in April by the most in four years, the Labor Department said May 7, indicating the recovery is becoming self- sustaining.
The S&P 500 recouped about two-thirds of last week’s 6.4 percent plunge, the biggest drop in a year. Waves of electronic selling helped push the Dow Jones Industrial Average down as much as 9.2 percent on May 6, the biggest drop since the crash of 1987, before paring losses.
The biggest U.S. equity exchanges took a step toward aligning trading rules to prevent conflicting systems from worsening stock-market plunges. Executives from six securities venues, including NYSE Euronext and Nasdaq OMX Group Inc., agreed on a framework for “strengthening circuit breakers and handling erroneous trades,” according to a statement from the Securities and Exchange Commission.
Broad Rally
All 10 industry groups in the S&P 500 rallied at least 2.4 percent today, led by gains of more than 5.5 percent in gauges of industrial and financial companies. General Electric Co., Caterpillar Inc. and Bank of America Corp. jumped more than 6.8 percent to lead the Dow Jones Industrial Average up 404.71 points, or 3.9 percent, to 10,785.14.
“The rally is justified,” said David Kelly, who helps oversee $445 billion as chief market strategist for JPMorgan Funds in New York. “All the actions taken by the European governments and the commitments by central banks were steps in the right direction. The market had sold off because of the fear that this financial crisis would get out of hand. Investors have a chance to look at the economic fundamentals in the U.S. now, which are good and expanding.”
VIX’s Record Drop
The VIX, as the Chicago Board Options Exchange Volatility Index is known, fell 30 percent to 28.84 after a record weekly gain last week. The index measures the cost of using options as insurance against declines in the S&P 500. The VStoxx Index, a gauge of Euro Stoxx 50 Index options, lost 22 percent to 38.66 for the biggest drop in its 11-year history. Futures on both options indexes also fell as investors bet that stock swings will decrease.
The euro climbed 0.3 percent to $1.2793 after climbing as much as 2.7 percent. The 16-nation currency is down about 11 percent against the dollar this year.
For now, the rescue package “may be viewed as a positive and we may recover some of the losses we had in equities last week,” Oscar Pulido, a portfolio specialist at BlackRock Inc., said in a briefing in Seoul today. “In the longer-term, it’s going to be very much dependent on whether governments in these countries can truly take the measures to reduce the deficits they’ve accumulated.” BlackRock managed $3.36 trillion in assets as of March 31, according to its Web site.
Pound Gains
The pound rose amid speculation Conservative leader David Cameron may forge a coalition government with his Liberal Democrat counterpart Nick Clegg after last week’s election failed to give any one party a parliamentary majority. Sterling appreciated 0.5 percent versus the dollar and strengthened 2.2 percent compared with the yen.
The yield on the Greek 10-year bond slid 468 basis points to 7.77 percent, narrowing the extra yield, or spread, to bunds to 481 basis points, from 965 basis points at end of last week. The Portuguese 10-year yield tumbled 163 basis points to 4.65 percent and the yield premium to German debt shrank to 170 basis points from 349 basis points. The Spanish spread declined to 97 basis points from 164 basis points.
‘Mother of All Aid’
“The authorities have put in place the mother of all aid plans, in an effort to prevent further losses in confidence,” Ciaran O’Hagan, a fixed-income strategist at Societe Generale SA in Paris, wrote in a note to investors. “We are seeing standard moves in favor of risk appetite after all the announcements. Whilst the market reaction has been positive, it is still very early days.”
The cost to protect against default on corporate and government bonds declined.
Credit-default swaps on the Markit iTraxx Europe Index of 125 investment-grade companies tumbled 33 basis points to a mid- price of 99.9, with banks leading the biggest ever one-day decline, according to Markit Group Ltd. Swaps on Greece fell 358.5 basis points to 557, Portugal dropped 178 to 247 and Spain declined 82.5 to 156 basis points, according to CMA DataVision. Contracts on France, Germany and the U.K. also fell.
The Stoxx Europe 600 Index rallied 7.2 percent, the most since November 2008, with France’s CAC 40 Index jumping 9.7 percent and Germany’s DAX Index rising 5.3 percent.
Banco Santander SA, Spain’s largest lender, climbed 23 percent in Madrid, reversing last week’s 18 percent loss. BNP Paribas, the biggest French bank, advanced 21 percent in Paris while Barclays Plc gained 16 percent in London.
BP Slips
BP Plc, battling an oil spill in the Gulf of Mexico, had one of only two declines in the Stoxx 600, slipping 0.9 percent as it prepared to lower a second, smaller containment dome over the main leak point after suspending efforts to place an initial cover over the weekend.
The MSCI Asia Pacific Index climbed 1.5 percent, snapping five days of losses. Esprit Holdings Ltd., which gets 85 percent of its revenue from Europe, rose 3.7 percent in Hong Kong. Commonwealth Bank of Australia, the nation’s biggest bank by market value, gained 5.2 percent in Sydney. Bridgestone Corp. increased 4.7 percent in Tokyo after the tiremaker boosted its profit forecast.
U.S. Treasuries declined as demand for the safest assets waned. The 10-year yield jumped 12 basis points to 3.54 percent. The Dollar Index, which gauges the U.S. currency against six major trading partners, fell 0.2 percent. The dollar weakened against all 16 major counterparts except the Swiss franc and the Japanese yen. The Brazilian real and Mexican peso lead gains against the dollar, climbing more than 3 percent.
Emerging Markets
Developing-nation bonds climbed, sending the spread over U.S. Treasuries down 39 basis points to 291 basis points, according to JPMorgan Chase & Co.’s EMBI+ Index.
The MSCI Emerging Markets Index climbed 4.5 percent, rebounding from a 9.1 percent drop last week that was the steepest for the equities gauge since February 2009. Hungary’s BUX Index rose 11 percent, the most since October 2008, and the forint strengthened 2.2 percent against the euro, the most in a year. Brazil’s Bovespa index rallied 4.1 percent, the most since October.
Crude oil rose from a 12-week low, climbing 2.3 percent to $76.80 a barrel in New York, and copper gained the most in six weeks. Gold fell for the first time in four sessions, losing as much as 2.1 percent, on reduced demand for the metal as a haven. Prices were up 10 percent this year before today on demand for the precious metal as an alternative to currencies.
The Reuters/Jefferies CRB Index of commodities jumped 1.6 percent, breaking a four-day slump.
The Blockade and Attempted Starvation of Germany
The Blockade and Attempted Starvation of Germany
[The Politics of Hunger: Allied Blockade of Germany, 1915-1919 • By C. Paul Vincent • Ohio University Press (1985) • 185 pages. This review was first published in the Review of Austrian Economics 3, no. 1.]
States throughout history have persisted in severely encumbering and even prohibiting international trade. Seldom, however, can the consequences of such an effort — the obvious immediate results as well as the likely long-range ones — have been as devastating as in the case of the Allied (really, British) naval blockade of Germany in the First World War. This hunger blockade belongs to the category of forgotten state atrocities of the twentieth century. (Similarly, who now remembers the tens of thousands of Biafrans starved to death during the war of independence through the policy of the Nigerian generals supported by the British government?) Thus, C. Paul Vincent, a trained historian and currently library director at Keene State College in New Hampshire, deserves our gratitude for recalling it to memory in this scholarly and balanced study.
Vincent tellingly recreates the atmosphere of jubilation that surrounded the outbreak of the war that was truly the fateful watershed of the twentieth century. While Germans were overcome by an almost mystical sense of community (the economist Emil Lederer declared that now Gesellschaft [Society] had been transformed into Gemeinschaft [Community]), the British gave themselves over to their own patented form of cant. The socialist and positivist utopian H.G. Wells, for instance, gushed: "I find myself enthusiastic for this war against Prussian militarism. … Every sword that is drawn against Germany is a sword drawn for peace." Wells later coined the mendacious slogan "the war to end war."
As the conflict continued, the state-socialist current that had been building for decades overflowed into massive government intrusions into every facet of civil society, especially the economy. The German Kriegssozialismus that became a model for the Bolsheviks on their assumption of power is well known, but, as Vincent points out: "the British achieved control over their economy unequaled by any of the other belligerent states."
Everywhere state seizure of social power was accompanied and fostered by propaganda drives unparalleled in history to that time. In this respect, the British were very much more successful than the Germans, and their masterly portrayal of the "Huns" as the diabolical enemies of civilization, perpetrators of every imaginable sort of "frightfulness,"[1] served to mask the single worst example of barbarism in the whole war, aside from the Armenian massacres.
This was what Lord Devlin frankly calls "the starvation policy" directed against the civilians of the Central Powers (particularly Germany),[2] the plan that aimed, as Winston Churchill, First Lord of the Admiralty in 1914 and one of the framers of the scheme, admitted, to "starve the whole population — men, women, and children, old and young, wounded and sound — into submission."[3]
The British policy was in contravention of international law on two major points.[4] First, in regard to the character of the blockade, it violated the Declaration of Paris of 1856, which Britain itself had signed, and which, among other things, permitted "close" but not "distant" blockades. A belligerent was allowed to station ships near the three-mile limit to stop traffic with an enemy's ports; it was not allowed simply to declare areas of the high seas comprising the approaches to the enemy's coast to be off-limits.
This is what Britain did on November 3,1914, when it announced, allegedly in response to the discovery of a German ship unloading mines off the English coast, that henceforth the whole of the North Sea was a military area, which would be mined and into which neutral ships proceeded "at their own peril." Similar measures in regard to the English Channel insured that neutral ships would be forced to put into British ports for sailing instructions or to take on British pilots. During this time they could easily be searched, obviating the requirement of searching them on the high seas.
This introduces the second and even more complex question: that of contraband. Briefly, following the lead of the Hague Conference of 1907, the Declaration of London of 1909 considered food to be "conditional contraband," that is, subject to interception and capture only when intended for the use of the enemy's military forces. This was part of the painstaking effort, extending over generations, to strip war of its most savage aspects by establishing a sharp distinction between combatants and noncombatants. Among the corollaries of this was that food not intended for military use could legitimately be transported to a neutral port, even if it ultimately found its way to the enemy's territory. The House of Lords had refused its consent to the Declaration of London, which did not, consequently, come into full force. Still, as the US government pointed out to the British at the start of the war, the declaration's provisions were in keeping "with the generally recognized principles of international law." As an indication of this, the British admiralty had incorporated the Declaration into its manuals.
The British quickly began to tighten the noose around Germany by unilaterally expanding the list of contraband and by putting pressure on neutrals (particularly the Netherlands, since Rotterdam more than any other port was the focus of British concerns over the provisioning of the Germans) to acquiesce in its violations of the rules. In the case of the major neutral, the United States, no pressure was needed. With the exception of the beleaguered secretary of state, William Jennings Bryan, who resigned in 1915, the American leaders were amazingly sympathetic to the British point of view. For example, after listening to complaints from the Austrian ambassador on the illegality of the British blockade, Colonel House, Wilson's intimate advisor on foreign affairs, noted in his diary: "He forgets to add that England is not exercising her power in an objectionable way, for it is controlled by a democracy."[5]
The Germans responded to the British attempt to starve them into submission by declaring the seas around the British Isles a "war zone." Now the British openly announced their intention of impounding any and all goods originating in or bound for Germany. Although the British measures were lent the air of reprisals for German actions, in reality the great plan was hatched and pursued independently of anything the enemy did or refrained from doing:
The War Orders given by the Admiralty on 26 August [1914] were clear enough. All food consigned to Germany through neutral ports was to be captured and all food consigned to Rotterdam was to be presumed consigned to Germany. … The British were determined on the starvation policy, whether or not it was lawful.[6]
The effects of the blockade were soon being felt by the German civilians. In June 1915, bread began to be rationed. "By 1916," Vincent states, "the German population was surviving on a meager diet of dark bread, slices of sausage without fat, an individual ration of three pounds of potatoes per week, and turnips," and that year the potato crop failed. The author's choice of telling quotations from eye witnesses helps to bring home to the reader the reality of a famine such as had not been experienced in Europe outside of Russia since Ireland's travail in the 1840s. As one German put it: "Soon the women who stood in the pallid queues before shops spoke more about their children's hunger than about the death of their husbands."
An American correspondent in Berlin wrote:
Once I set out for the purpose of finding in these food-lines a face that did not show the ravages of hunger. … Four long lines were inspected with the closest scrutiny. But among the 300 applicants for food there was not one who had had enough to eat for weeks. In the case of the youngest women and children the skin was drawn hard to the bones and bloodless. Eyes had fallen deeper into the sockets. From the lips all color was gone, and the tufts of hair which fell over the parchmented faces seemed dull and famished — a sign that the nervous vigor of the body was departing with the physical strength.
Vincent places the German decision in early 1917 to resume and expand submarine warfare against merchant shipping — which provided the Wilson administration with its final pretext for entering the war — in the framework of collapsing German morale. The German U-boat campaign proved unsuccessful and, in fact, by bringing the United States into the conflict, aggravated the famine.
"Wilson ensured that every loophole left open by the Allies for the potential reprovisioning of Germany was closed … even the importation of foodstuffs by neutrals was prevented until December 1917." Rations in Germany were reduced to about one thousand calories a day. By 1918, the mortality rate among civilians was 38 percent higher than in 1913; tuberculosis was rampant, and, among children, so were rickets and edema. Yet, when the Germans surrendered in November 1918, the armistice terms, drawn up by Clemenceau, Foch, and Pétain, included the continuation of the blockade until a final peace treaty was ratified.
In December 1918, the National Health Office in Berlin calculated that 763,000 persons had died as a result of the blockade by that time; the number added to this in the first months of 1919 is unknown.[7] In some respects, the armistice saw the intensification of the suffering, since the German Baltic coast was now effectively blockaded and German fishing rights in the Baltic annulled.
One of the most notable points in Vincent's account is how the perspective of "zoological" warfare, later associated with the Nazis, began to emerge from the maelstrom of ethnic hatred engendered by the war. In September 1918, one English journalist, in an article titled "The Huns of 1940," wrote hopefully of the tens of thousands of Germans now in the wombs of famished mothers who "are destined for a life of physical inferiority."[8] The "famous founder of the Boy Scouts, Robert Baden-Powell, naively expressed his satisfaction that the German race is being ruined; though the birth rate, from the German point of view, may look satisfactory, the irreparable harm done is quite different and much more serious."
Against the genocidal wish-fantasies of such thinkers and the heartless vindictiveness of Entente politicians should be set the anguished reports from Germany by British journalists and, especially, army officers, as well as by the members of Herbert Hoover's American Relief Commission. Again and again they stressed, besides the barbarism of the continued blockade, the danger that famine might well drive the Germans to Bolshevism. Hoover was soon persuaded of the urgent need to end the blockade, but wrangling among the Allies, particularly French insistence that the German gold stock could not be used to pay for food, since it was earmarked for reparations, prevented action.
In early March 1919, General Herbert Plumer, commander of the British Army of Occupation, informed Prime Minister Lloyd George that his men were begging to be sent home; they could no longer stand the sight of "hordes of skinny and bloated children pawing over the offal" from the British camps. Finally, the Americans and British overpowered French objections, and at the end of March, the first food shipments began arriving in Hamburg. But it was only in July, after the formal German signature to the Treaty of Versailles, that the Germans were permitted to import raw materials and export manufactured goods.
Besides the direct effects of the British blockade, there are the possible indirect and much more damaging effects to consider. A German child who was ten years old in 1918, and who survived, was twenty-two in 1930. Vincent raises the question of whether the miseries and suffering from hunger in the early, formative years help account to some degree for the enthusiasm of German youth for Nazism later on. Drawing on a 1971 article by Peter Loewenberg, he argues in the affirmative.[9] Loewenberg's work, however, is a specimen of psychohistory and his conclusions are explicitly founded on psychoanalytic doctrine.
Although Vincent does not endorse them unreservedly, he leans toward explaining the later behavior of the generation of German children scarred by the war years in terms of an emotional or nervous impairment of rational thought. Thus, he refers to "the ominous amalgamation of twisted emotion and physical degradation, which was to presage considerable misery for Germany and the world" and which was produced in large part by the starvation policy.
But is such an approach necessary? It seems perfectly plausible to seek for the mediating connections between exposure to starvation (and the other torments caused by the blockade) and later fanatical and brutal behavior in commonly intelligible (though, of course, not thereby justifiable) human attitudes generated by the early experiences. These attitudes would include hatred, deep-seated bitterness and resentment, and a disregard for the value of life of "others" because the value of one's "own" life had been so ruthlessly disregarded.
A starting point for such an analysis could be Theodore Abel's 1938 work, Why Hitler Came into Power: An Answer Based on the Original Life Stories of Six Hundred of His Followers. Loewenberg's conclusion after studying this work is that "the most striking emotional affect expressed in the Abel autobiographies are the adult memories of intense hunger and privation from childhood."[10] An interpretation that would accord the hunger blockade its proper place in the setting for the rise of Nazi savagery has no particular need for a psychoanalytical or physiological underpinning.
Occasionally Vincent's views on issues marginal to his theme are distressingly stereotyped: he appears to accept an extreme Fischer-school interpretation of guilt for the origin of the war as adhering to the German government alone, and, concerning the fortunes of the Weimar Republic, he states: "That Germany lost this opportunity is one of the tragedies of the twentieth century. … Too often the old socialists seemed almost terrified of socialization."
The cliché that, if only heavy industry had been socialized in 1919, then German democracy could have been saved, was never very convincing.[11] It is proving less so as research begins to suggest that it was precisely the Weimar system of massive state intervention in the labor markets and the advanced welfare-state institutions (the most "progressive" of their time) that so weakened the German economy that it collapsed in the face of the Great Depression.[12] This collapse, particularly the staggering unemployment that accompanied it, has long been considered by scholars to have been a major cause of the Nazi rise to power in 1930–33.
These are, however, negligible points in view of the service Vincent has performed both in reclaiming from oblivion past victims of a murderous state policy and in deepening our understanding of twentieth-century European history. There has recently occurred in the Federal Republic of Germany a "fight of historians" over whether the Nazi slaughter of the European Jews should be viewed as "unique" or placed within the context of other mass murders, specifically the Stalinist atrocities against the Ukrainian peasantry.[13] Vincent's work suggests the possibility that the framework of the discussion ought to be widened more than any of the participants has so far proposed.
Should We Be Upbeat on Unemployment?
Should We Be Upbeat on Unemployment?
[Douglas French is teaching a class this summer on the bubble economy in the Mises Academy. Sign up today!]
The April jobs report was described as "upbeat," with the reported 290,000 positive job gain the best in four years. "It clearly shows that this economic recovery can no longer be seen as a jobless one," said Bart van Ark, chief economist of research firm The Conference Board. "Companies apparently are finding they can't squeeze out any more output without adding workers."
Even the increase in the headline unemployment rate to 9.9 percent because more workers re-entered the job market was spun as positive. "When you think about the force it takes to get 800,000 beaten-down people off the couch and back on the street looking for work, that's pretty significant," said Lakshman Achuthan, managing director of Economic Cycle Research Institute.
What the headlines and talking heads didn't mention was that there are still 15.3 million people lying around on the couch watching Oprah and Ellen every day and a record 46 percent of these folks have been out of work for six months or longer. The government's U-6 unemployment measurement, which includes workers unemployed less than one year and are thus termed "short-term discouraged," rose to 17.1 percent. And adding back "long-term discouraged" workers gives us an unemployment rate of 22 percent.
Plus, as John Williams of Shadowstats.com fame points out, the dubious birth–death adjustment (an "unsupportable premise that jobs created by start-up companies in this downturn have more than offset jobs lost by companies going out of business"), "survives and remains a major distorting factor in monthly payroll reporting, likely adding in excess of 230,000 phantom jobs per month at present. That now could be roughly 300,000, given the unusual April data." And then there are those 66,000 census jobs, which add to the cheery numbers.
Williams reports that next month's reporting will reflect the peak in census hiring. But this temporary bump will be short lived. "Based on employment patterns for the 2000 census," writes Williams, "nearly all such gains should reverse out of the data by the end of September, with June payrolls reflecting the first outright contraction in the reversal of current hiring."
From the peak month of December 2007 to January of this year, over 8.3 million jobs were lost as the real-estate boom turned to bust. As David Wessell wrote with emphasis in the Wall Street Journal last week "one in every five men 25 to 54 isn't working."
The point Wessell clearly makes is that many of the jobs done by men during the boom — such as construction, manufacturing, and paper-pushing work in finance — when the unemployment rate bottomed at 4.4 percent aren't needed again anytime soon.
Even a law degree hasn't turned out to be a sure bet. Nathan Koppel writes in the WSJ about law grads like Fabian Ronisky, who will be moving back in with his parents and selling music and movies online after racking up $150,000 in student loans to earn a law degree from Northwestern.
Uneducated men have a tough go of it looking for work. But the question is whether they are looking very hard. According to Wessell, "On average, surveys find, the unemployed in the U.S. spend 40 minutes a day looking for work and 3 hours and 20 minutes a day watching TV." Many of these unemployed men must not realize that they will never work again, and according to Wessell, if they do it will be as greeters at Walmart or as security guards at the local mall.
Of course, lost in this discussion is the Bush administration's increase of the federal minimum-wage rate in three stages. In the summer of 2007, the minimum wage rose 70 cents to $5.85 per hour. The next summer, it automatically increased to $6.55, and last July the federal minimum was set at $7.25 per hour. So the price of unskilled labor has increased over 40 percent, while the economy has hit the ditch. It's a wonder the unemployment rate isn't higher than it is.
And in some states the minimum is even higher. Michigan, which in March had the highest unemployment rate in the nation, at 14.1 percent, has a minimum wage of $7.40 per hour. Hard-hit Nevada, with a 13.4 percent unemployment rate, will see its minimum wage increase to $8.25 per hour on July 1st for employers who don't provide health insurance. California's minimum wage is $8.00, while its unemployment rate is 12.6 percent. The state of Washington has the highest minimum wage at $8.55 per hour, with 9.5 percent of its workers unemployed.
As bad as the government's pricing unskilled labor out of the market is for men, for young people trying to get their first job, it's catastrophic. The New York Post reported last September that "the number of young Americans without a job has exploded to 53.4 percent — a post–World War II high, according to the Labor Dept." The worry is that this lack of jobs will create a lost generation, because "Studies suggest that an extended period of youthful joblessness can significantly depress lifetime income as people get stuck in jobs that are beneath their capabilities, or come to be seen by employers as damaged goods," writes BusinessWeek's Peter Coy.
With unskilled and young workers priced out of the market, chronic high unemployment rates will become common in the United States, just as in Europe. In which case, "this era of high joblessness will likely change the life course and character of a generation of young adults — and quite possibly those of the children behind them as well," Don Peck wrote in the Atlantic.
It will leave an indelible imprint on many blue-collar white men — and on white culture. It could change the nature of modern marriage, and also cripple marriage as an institution in many communities. It may already be plunging many inner cities into a kind of despair and dysfunction not seen for decades. Ultimately, it is likely to warp our politics, our culture, and the character of our society for years.
Art Carden explains what Messrs. Coy and Peck lament about in his article "The Hidden Costs of a Minimum Wage." Carden explains that wage minimums cause employers to substitute skilled for unskilled labor. So, on-the-job training is reduced, which "in the long run … must reduce the number of opportunities for those laborers to acquire valuable job skills. Far from increasing opportunities for the working poor, a minimum wage actually restricts their mobility."
Also, workers, given a raise by the government, and not necessarily on the merits of their work output, are put at odds with employers. "Encouraging the view that employment is a raw deal has created needless acrimony," Carden writes. "At the margin, this intimidates people and discourages some from becoming employers themselves."
Getting up and going to work becomes a habit — a good habit. In fact for most of us it becomes an obsession. Besides the particular job skills learned at work, young people learn responsibility, how to get along with others, how to take direction, and how to deal with difficult people. But most important, the feeling of accomplishment and the satisfaction of a job well done is never felt by those who never enter the private work force. Showing up for make-work jobs like people-counting for the government will never provide that.
Murray Rothbard described minimum-wage laws in Power and Market as compulsory unemployment. During the boom there was great pressure in Washington to raise the minimum wage after the federal government had left it alone for a decade. Of course, those who agitated for it said it would increase the living standards for marginal workers. As Rothbard explains, "the actual effect is precisely the reverse — it is to render them unemployable at legal wage rates. The higher the minimum-wage rate relative to free-market rates, the greater the resulting unemployment."
In a depression, all prices must be allowed to adjust downward. Wages are no different. First and foremost, the government's artificial wage floor should be removed. The future of a generation depends upon on it.
Cold feet
Prudential's bid for AIA
Cold feet
Britain's financial regulator shares investors' worries about the Pru's giant Asian deal
THE bankers were in Prudential's headquarters at Laurence Pountney Hill in the City of London on May 4th, poised to price a $21 billion (£14 billion) rights issue, set to be launched the next morning. Printing presses were ready to spew out the 1,000-page prospectus. Then came the bombshell: the man from the Financial Services Authority (FSA) was not happy with the man from the Pru; the rights issue was halted.
With that, a $35.5 billion deal to transform Prudential PLC, Britain’s best-known life insurer, into a dominant force in Asia was put on hold. Prudential (unrelated to the American insurer of the same name) wants to buy AIA, the Asian operations of American International Group (AIG), an insurance giant bailed out by the American government in 2008. AIA is in ten large Asian countries and the biggest life insurer in two of them; Prudential dominates in four. Together AIA and the Pru would become the leading life insurer in seven Asian countries, and the biggest foreign provider in China and India. Apart from the rights issue, Prudential is planning to raise another $10 billion in bonds, and to place $5.5 billion of its own shares with AIG.
The deal was delayed, it seems, because the FSA got cold feet. It would remain the Prudential’s lead regulator, under international rules now in the works, even though at least 60% of the insurer’s new business income would be in Asia. With blood from the global financial crisis still flowing, it makes sense that the main regulator of a far-flung conglomerate, by most measures too big to fail, would want to be sure that capital is available in London in case of need. This last-minute hitch rather thwarted the earlier regulatory due-diligence done on behalf of Prudential by lawyers Slaughter & May.
Capital rules for insurers are in a state of flux. A new European Union directive known as Solvency II, which will have global ramifications, is being thrashed through various EU bodies and is about 95% complete. But studies on its likely impact are still being done. A big concern about the Prudential deal, under Solvency II, is whether the British holding company would have ready access to capital held outside the EU. The new Prudential plans to list its shares in Hong Kong and Singapore as well as in London and New York.
The FSA’s objections may require the Pru to find yet more capital. This week’s thwarted attempt was already the biggest British rights issue ever, apart from those involving government money. And critics of the acquisition, including some of the Pru’s big shareholders, think the firm is overpaying. AIG was preparing to float AIA for up to $25 billion when Prudential stepped in with an offer $10 billion higher.
Tidjane Thiam, Prudential’s chief executive, and Mark Tucker, his predecessor, have pushed it resolutely towards Asian expansion. The potential for growth in Asia, compared with prospects in more mature markets in Europe and America, is mouth-watering on paper: life-insurance premiums gathered in India and China account for only 4% and 2.2% of GDP respectively. In Hong Kong, where life insurance took hold earlier, the ratio is 9.9% of GDP and climbing; in Britain it is 10.6%.
Yet there are those who worry, following reports that the Pru is ready to sell its British business to chase its Asian dream, that this 162-year-old insurance company is burning boats it should hang on to. On the numbers alone it may seem compelling to go flat-out for growth. But shareholders in financial institutions have seen rather too much of that strategy lately to be entirely comfortable with it.
In a report published on April 30th the OECD, a rich-country club, analyses the impact of the financial crisis on insurance. It warns supervisors to take more account of macroprudential spillover as many insurers react similarly to economic events. It may be that some such consideration prompted the FSA to slam on the brakes.
Green back
Currencies
Green back
In a world of ugly currencies, the dollar is sitting pretty
JOHN MAYNARD KEYNES once likened investing to judging a beauty contest. For today’s currency investor, however, none of the main contestants looks that fetching. “It’s more like an ugliness contest,” says one hedge-fund manager.
The dollar, for all its blemishes, is the least hideous-looking. So far this year it has risen against the other main currencies (the yen, pound and euro) that are traded internationally and held as reserves by central banks. It has risen most against the euro, which started the year at $1.43 but bought just $1.28 on May 6th (see chart). The euro has slumped in part because the Greek crisis makes it look a poor choice for reserve managers hoping to diversify their big dollar holdings. The variable quality of euro sovereign bonds is now much harder to ignore. Treasury bonds, with their liquid markets and unique issuer, look prettier.
The case for a further drop in the euro against the dollar has more than just momentum to back it. Business cycles favour it: the euro-area economy is picking up speed again, but America’s recovery is more advanced. The pressure to tighten fiscal policy in some parts of the euro area will make it hard for the European Central Bank to even consider raising interest rates. A weaker euro also addresses the deeper cause of the present crisis: a lack of export competitiveness in the south of the currency zone. It does not help Greece, Portugal and the rest compete with Germany, but it at least gives their firms a chance against imports from outside the euro bloc.
A cheaper euro hurts America, which will feel it is owed a chance for export-led growth after almost ruining itself as the world’s main consumer. By most fair-value gauges, the euro is still dear against the dollar, notwithstanding its recent slide. Even so, a weaker euro may crystallise a feeling that Europe is not doing its bit to support global demand.
Are there any beautiful currencies left? A handful had comfortably outpaced the dollar this year before the latest market tremors had investors grasping for greenbacks. Two such currencies are the Australian dollar and the Canadian dollar. Both are issued by rich countries with stable banks that have not sullied the public finances. Another is the South Korean won. Brazil’s real may over time develop as a reliable store of value. The trouble is, securities issued in these currencies are a tiny fraction of those available in the world’s four main currencies, says Stephen Jen of BlueGold Capital, a hedge fund. The lack of scale and liquidity limits their role as reserve currencies. The dollar has those plainer qualities in abundance.
Elena Kagan picked for the Supreme Court
A blog by the author of our column on American politics
Lexington's notebook
Elena Kagan picked for the Supreme Court
by Lexington
THE waiting is over. The favourite won. President Barack Obama nominated Elena Kagan to the Supreme Court today. Ms Kagan is Mr Obama's solicitor general, so he knows her well. And he appears to have forgiven her for attempting to sabotage his political career when, as a fellow law professor at the University of Chicago many years ago, she urged her bright young colleague to commit to a life in academe.
Ms Kagan "is widely regarded as one of the nation's foremost legal minds," said Mr Obama. As solicitor general, she has argued six cases before the Supreme Court, during which she more or less held her own against the court's conservative heavyweights. As dean of Harvard Law School she was popular even among conservative legal scholars, who were pleasantly surprised that she treated them fairly.
Liberals assume that she is a liberal—why else would Mr Obama pick her? But her record is difficult to attack, because she has scrupulously avoided expressing firm opinions on thorny constitutional questions for as long as anyone can remember. Conservative criticism of her will therefore focus on the few instances in which she has stuck out her neck.
The most obvious was her decision, when dean of Harvard Law School, to bar military recruiters from campus. She did this because the military's "Don't Ask, Don't Tell" policy, which forbids openly gay people from serving in uniform, violates Harvard's rules about employers who discriminate. Ms Kagan called it "a moral injustice of the first order", though she later backed down when the law school's federal funding was threatened.
This episode resonates badly in middle America. Many who think the military's ban on gays is wrong and foolish are nonetheless affronted by the idea that the nation's top law school would actively discourage its students from serving their country. It is not as if they were queueing up to do so in the first place.
Supreme Court hearings are nearly as vicious as presidential campaigns, and with good reason. The stakes are almost as high. If confirmed—as seems highly likely—Ms Kagan will enjoy a seat for life on the court that is the final arbiter of what the US constitution means. Since Ms Kagan is only 50, she could be shaping the ground rules for American public life for the next four decades. So conservatives will do all they can to make her appear out of touch. Even if they cannot prevent her from being confirmed, they can at least score points in the run-up to the mid-term elections in November.
No biographical nugget will be considered irrelevant if it serves this purpose. The Washington Post reports that Ms Kagan "is such a product of New York that she did not learn to drive until her late 20s" and that it is "a skill she has not yet mastered". Ed Whelan, a conservative court-watcher, jeers that this "nicely captures Elena Kagan’s remoteness from the lives of most Americans".
Court-watchers on the left are a little unsettled by Ms Kagan's lack of a paper trail. How can they be sure she is one of them when she has expressed so few clear opinions? Some also worry that she will be too deferential to the executive on matters of civil liberties. For example, during her confirmation hearings for the post of solicitor general, she agreed that Taliban prisoners in Afghanistan do not have due process rights under American law.
Others on the left are concerned that Ms Kagan would have to recuse herself from a huge number of cases in her first couple of years on the court, since as solicitor general she was involved in practically every case involving the federal government. That would tilt the court's balance rightwards, at least temporarily. But overall, liberals are inclined to give Mr Obama the benefit of the doubt. Nan Aron of the Alliance for Justice, a liberal pressure group, exults that Ms Kagan will "stand up for the rights of ordinary Americans" instead of "protecting corporate interests".
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