Nobel gurus warn Britain on fiscal overkill and Fed on monetary overkill

Professor Edmund Phelps said rich states all need to bring ballooning debts under control, but at a calibrated pace Photo: Alamy

"Britain has jumped on the band-wagon of fiscal tightening in a big way," said Professor Edmund Phelps from New York's Columbia University.

"I have some sympathy with that but I'm not sure it is being implemented as deftly as it should be. If you slam on the brakes too hard you risk throwing the infant through the windscreen," he told The Telegraph at a forum of Nobel laureates on Lake Constance.

Unlike many Left-leaning critics of the Government's policies, Professor Phelps is in the free-market camp and director of Columbia's Centre on Capitalism and Society. He made his name refuting the "Phillips Curve" assumptions of the 1960s that policy-makers could exploit an easy Keynesian trade-off between inflation and unemployment.

His warning echoes arguments made by Shadow Chancellor Ed Balls and may cause some discomfort in Downing Street, especially after CBI data for early August showed the sharpest drop in retail sales for a year.

Professor Phelps said the rich states all need to bring ballooning debts under control, but at a calibrated pace. The US has been too timid. "To do just $100bn of tightening this year is nothing. The US is in a complete mess and it must move to a budget surplus in absolute terms," he said.

He compared the US task with Britain's plight in the late 1940s. "The question is how to pay for the 'war', which is what Keynes worried about, except this time the war was our own housing market."

Like other Nobel laureates in Lindau, he warned against a third blast of quantitative easing (QE) by the Federal Reserve now that US core inflation is creeping back up to 2pc.

"I was a supporter of QE2 to prevent deflation but that potential justification is no longer there. The Fed should remain very watchful and keep its finger on the trigger. If we get a cyclical contraction on top of a slump, it could be serious."

Myron Scholes, who won the Nobel Prize for theories on derivatives, said QE is a misguided attempt to disguise both a bank bailout and dollar devaluation.

"Ben Bernanke knows his pistol is close to blanks. He is trying to weaken the dollar but it is only so long before Japan, Switzerland and others figure out how to retaliate, and if there is QE3 they will start arming themselves," he told the Telegraph.

"The question is how unconventional will Bernanke be. Will he buy equities, or real estate, until the Fed owns everything? The more illiquid assets they buy, the more difficult it will be to unwind.

"I wonder whether Bernanke might not say that 'the Europeans are our friends, and we know that the European Central Bank 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.

Mr Bernanke hinted at this during a 2002 speech on deflation that is widely view as his policy "road map" for in extremis. Buying EMU bonds would allow the Fed to drive down the dollar and stabilise Europe's debt crisis at the same time.

Professor Scholes said the eurozone has squandered its chance of making the system work. "They had the opportunity from 1997 to 2010 to think about how to make the euro work and create a fiscal union. They did nothing," he said.

"For a common area to work it has to be 'socialised' with common taxation and fiscal transfers. People have to think that Italians are the same as Germans, and can work in each other's country. There has to be a homogeneity of beliefs."

He said the West risks repeating the errors of Japan the longer it refuses to confront the mountain of bad debts and fails to clears the way for a new cycle of growth. "I think it would have been better to get it over right away, even though it would have been a huge shock to the system. We had this heart attack and they keep treating every other part of the body, the hands, the feet, or the ankles," he said.

Mr Scholes, known to many as the guru behind the LTCM hedge fund that came to grief in 1998, said the apparent calm induced by global policy makers and central banks during the bubble created a massive risk free illusion and primed the system for disaster. "If things can be too calm, and volatility too low, people stop worrying. The tiger looked caged, but the cage door was open."

View the original article here

Global bond rout deepens on US fiscal worries

Fedderal Reserve chairman Ben Bernanke has stated that the explicit purpose of the policy, which he calls 'credit easing', is to bring down yields Photo: Getty Images

The yield on 10-year Treasuries – the benchmark price of money worldwide and the key driver of US mortgages rates – has rocketed to 3.3pc, up 35 basis points since President Barack Obama agreed on Monday to compromise with Senate Republicans on tax cuts.

The Treasury sell-off has ricocheted through the global system, triggering bond sell-offs in Asia, Europe and Latin America. Japan's finance ministry braced as borrowing costs on seven-year debt jumped by a sixth in one trading session, while German Bunds punched through 3pc.

The White House deal with Congress will renew the Bush tax cuts for rich and poor alike for two years, as well as adding a further a 2pc cut in payroll taxes and an extension of unemployment aid.

David Bloom, currency chief at HSBC, said it is hard to disentangle whether investors are shunning bonds because they expect US stimulus to boost growth next year, or whether they are losing patience with profligacy in Washington.

"If this is all about growth, that's brilliant. But if yields are rising because people think Amirca's fiscal situation is unsustainable, then its armaggedon," he said.

"The US can get away with this only because it is the world's reserve currency. This would be totally unacceptable in any other country. We think these problems will start to crystallise for the US in the second half of 2011, once the European debt crisis has stabilised," he said.

The warnings were echoed by Li Daokui, a rate-setter for China's central bank. "The focus of the market is still in Europe, but we must be aware that the US fiscal situation is much worse than in Europe," he said.

The US tax deal adds $1 trillion of stimulus over two years, according to BNP Paribas. America's budget deficit will remain stuck near 10pc of GDP, not just in 2011 but also in 2012. This will push gross public debt to 110pc of GDP under the IMF definition, near the brink of a debt compound spiral. The contrast with fiscal tightening in Europe has become starkly evident.

Both Moody's and Fitch warned that the US must map out a credible strategy to control spending. "We have long-term concerns about the US rating outlook and they're not yet being addressed," said Stephen Hess, chief US analyst for Moody's.

Stephen Lewis, from Monument Securities, said the bond rout is a sign that Washington can no longer take global markets for granted. "We have reached the limits of tolerance for budget deficits. There is a feeling around the world that nobody in Washington is paying any attention to the implications of what they are doing, but there is a very real risk that this will backfire if it causes mortgage rates to keep going up," he said.

"At the same time we've seen a loss of confidence in Fed strategy. There is a feeling that the Fed doesn't care about inflation – in fact, wants more of it – and that is certainly not in the interest of bondholders," he said.

The standard rate for 30-year mortgages in US has moved up in tandem with Treasury yields. The rate has been creeping up ever since the US Federal Reserve first signalled plans for a fresh blast of quantitative easing, rising 85 basis points in three months.

The housing squeeze raises serious doubts about the Fed's plan to purchase a further $600bn in Treasuries over coming months, or QE2 as it is known. Fed chair Ben Bernanke stated on Sunday that the explicit purpose of the policy – which he calls "credit easing" – is to bring down yields.

"We're not printing money. What we're doing is lowering interest rates by buying Treasury securities. And by lowering interest rates, we hope to stimulate the economy to grow faster," he said.

US data on foreign holdings of Treasuries and agency bonds are published with a delay, but monthly figures show that China sold a net $24bn in September and Russia sold $10bn. The concern is that investor flight from US debt will overpower the monthly purchases of $100bn by the Fed, making it ever harder for Washington to raise the $1.4 trillion needed next year to cover the deficit.

The rise in yields risks becoming a textbook case of a central bank losing control over long-term rates. The danger is that market fears of future bond losses – whether from inflation or higher default premiums – will neutralise the stimulus, or lead to stagflation.

Tom Porcelli, from RBC Capital Markets, said the Fed rates might be nearer 4pc by now if the Fed had not acted. However, he said there was no justification for QE2 at a time when the economy is growing at more than 2pc, and core inflation – though the lowest since the 1960s – is positive at 1pc. "Nobody believes that we're slipping into deflation anymore. That phase has passed," he said.

View the original article here

This post was made using the Auto Blogging Software from WebMagnates.org This line will not appear when posts are made after activating the software to full version.

IMF chides US for fiscal folly

 The IMF said the US economy was enjoying a short-term spike as a result of quantitative easing by the US Federal Reserve Photo: Getty Images

The IMF said the US economy was enjoying a short-term spike as a result of quantitative easing by the US Federal Reserve and the fiscal package agreed by Congress and the White House late last year, but expressed reservations about the side-effects of these policies.

"Although some targeted measures in the US are justifiable at this juncture given the still weak labour and housing markets, the recently implemented stimulus is expected to deliver only a relatively small growth dividend [given its size] at a considerable fiscal cost," the IMF said in its update to the World Economic Outlook.

The IMF said the deficit would remain stuck at 10.75pc of GDP in 2011, with public debt exceeding 110pc of GDP in 2016.

"The absence of a credible, medium-term fiscal strategy would eventually drive up US interest rates, which could prove disruptive for global financial markets and for the world economy," it said. The report called for an assault on America's entitlements behemoth, and caps on discretionary spending.

The deal between President Barack Obama and Capitol Hill extended the Bush tax cuts for rich and poor alike, and added fresh spending, angering the Tea Party hard-liners. "We are much closer to the Greece-Ireland-Spain precipice than any of us would like to believe," said Congressman John Campbell.

While the US has been the most complacent about fiscal slippage, the Fund called for "urgent" action to rein in spending across the industrial world.

"Problems in Greece, and now Ireland, have reignited questions about sovereign debt sustainability and banking sector health in a broader set of euro area countries and possibly beyond. Market pressures could result in serious funding pressures for major banks and sovereigns, increasing the likelihood that problems spill over to core countries."

The Fund said investors have "not been assuaged by stress tests conducted to date" on eurozone banks. It called for more "realistic, thorough and stringent" tests to build confidence, backed by rapid moves to recapitalise crippled lenders.

The report said the EU's €440bn (£380bn) bail-out fund "must have the ability to raise sufficient resources and deploy them in a flexible manner", throwing its weight behind demands from Brussels for a doubling of the rescue machinery.

Although the IMF has raised its forecast of global growth for 2011 from 4.2pc to 4.4pc, the report says recovery remains fragile and overly dependent on government stimulus, effectively stealing growth from the future.

The Fund supports ultra-easy monetary policy in the West but acknowledged that liquidity has leaked into the emerging world and pushed up raw material costs. Non-oil commodity prices are expected to rise 11pc this year.

The IMF said credit growth is nearing danger levels in some emerging economies. "Key risks relate to overheating, a rapid rise of inflation pressures, and the possibility of a hard landing."

View the original article here

This post was made using the Auto Blogging Software from WebMagnates.org This line will not appear when posts are made after activating the software to full version.