Trichet says crisis continues
In his most important recent interview yet, Jean-Claude Trichet told the BBC that we have an “ongoing, very significant market correction”, a blunt contradiction to the recently expressed optimism by the Bank of England, which implied that the worst was now over. He also warned that central banks should resist the temptation to cut interest rates now. He said Europe’s failure to digest tighter monetary policy in the 1970s caused higher wages that undermined the region's ability to compete, leading to mass unemployment. He said high unemployment was a legacy of policy mistakes during that era. In respect of interest rates, the BBC said, Mr Trichet’s comments implied a rate cut was not on the cards, though he also said high inflation would not last forever.
With his view on the crisis Trichet is in good company. Below are quotes from Warren Buffett and Myron Scholes, who all agree that the worst is still ahead.
This is what Warren Buffett has to say, according to Bloomberg, hat tip Naked Capitalism: “I don't necessarily think we're halfway through or necessarily a quarter of the way through the effects throughout the general economy…The initial effects are felt by the people who really did the silliest things, but you can have a whole bunch of domino-type effects that eventually can get to people who are doing fairly sound things.”
And this is what Myron Scholes (as in Black-Scholes), had to say, according to the Big Picture blog: “From my perspective, I think that we don't know if the storm has passed or if we are still in the eye of the storm. Are there other shoes to drop and new events or new shocks that will come to the fore?' In my view, this is probably as bad or worse than the 1989-1990 crisis and may even rival the worst crisis we've seen since the end of the Second World War.”
Credit cards and boats are next categories to hit trouble
We knew about credit cards, but boat mortgages were also securitised, and defaults are rising here to. See the Calculated Risk blog for an individual tale of a distressed boat borrower, and Naked Capitalism, which has a wider analysis of the credit card and boat problem, a signal of ongoing consumer stress in the US. The Naked Capitalism blog also makes the point that American Express, among the more conservative card companies, has cut credit lines for many cardholders, which suggests that the situation is not rosy.
Fillon to press ahead with next wave of French reforms
Francois Fillon started preparations for the next wave of reforms by calling an informal governmental meeting last Sunday, reports Le Monde. Fillon said that the primary objective of his government is a balanced budget by 2012. Sarkozy even envisages a balanced budget rule in the constitution (Le Monde), a concession to Nouveau Centre, the allied centrist party, in return for their vote on his constitutional reforms. Fillon said that half of Sarkozy’s reform agenda is already realised or are about to be implemented. Le Monde writes that this resulted in only €7bn of savings so far implying that the worst reforms are still to come. On the agenda for the next reform wave are health insurance, social minima, defense, employment and housing. Trade unions already prepare for mobilization.
Euro Area closes growth gap with the US
The Bundesbank, in its monthly report, concluded that the euro area has almost closed the growth gap with the US, Frankfurter Allgemeine reports. This is not a cyclical observation, but a structural shift, due to the erosion of the technological boost, the US received in the 1990s. The US potential growth has since fallen from 3.5 to 2.5% per annum, while the euro area’s has remained unchanged at 2%. On the Bundesbank’s purchasing power adjustment, US net incomes are still 30% above the euro area’s, but the smaller gap in potential growth is likely to lead to a small income gap in the future.
Some optimism about Italy
You don’t hear this a lot, so we report it here. FT Deutschland has a comment expressing optimism about the Berlusconi administration, on the grounds that, first, Mr Berlusconi has a solid majority, that, second, Berlusconi appears more determined to undertake reforms than he did last time, and that third, both he and Veltroni appear more minded to co-operate than they used to. The main point is that some of the previous extremism has come out of Italian politics.
Philip Lane on Ireland in EMU
Philip Lane, writing in the Sunday Business Post, and reprinted in Europe Economonitor, says that Ireland has not yet fully adjusted to membership of EMU. He said the experience of other member countries, such as Portugal, is that adjustment in an economy where wages have grown too fast requires a prolonged period of below-trend growth. Judicious wage moderation is thus the best response to avoid a slump. He makes the point that this was also the lesson of Ireland’s own macroeconomic history – given its de-facto monetary union with the UK until 1979. The appropriate fiscal response is also clear. No generous public sector wage increases, but a vigorous capital expenditure programme. He concludes that the current social partnership talks provides an opportunity for a deal on public sector reform.
And this from Monday:
Inflation everywhere
When we return after a week long break, we found that the rise in global inflation was the dominant theme in the euro area media this morning. Some commentators were spooked. Here is a selection of news and views.
European Commission says high inflation is there to stay
Financial Times Deutschland has obtained a paper by the European Commission, to be presented on Tuesday, according to which inflation is likely to remain high for long periods. The paper says that the imbalance between strong growth demand growth, and supply constraints is likely to persists, which means continued upward pressure on inflation. The Commission also expressed concern about inflation rates in euro area accession countries.
Another Fed governor warns on inflation
There is also concern about inflation in the US. Another non-voting Fed governor has joined the growing chorus of concern about current US monetary policy. Dennis Lockhart of the Atlanta Fed made the point that the US has entered a period of slower growth, and persistently high inflation, which was becoming a growing problem – hinting apparently that the rate cutting cycle is ending, according to the Wall Street Journal’s economics blog. He also made the point that the global economy is now less dependent on the US than it used to be.
EBRD warns about rising inflation in Eastern Europe
The European Bank for Reconstruction and Development warned about the rise in inflation, and said the credit crisis was almost a non-event for growth for the region, according to Frankfurter Allgemeine. At its annual conference the EBRD forecast 2007 regional growth at 6.1% in 2007, down from 7.3% last year. In Ukraine, annual inflation is now 30%, and in the Baltic Republic it is now 15%. EBRD chief economist Erik Berglof recommended that many east European central banks should abandon the dollar peg. Today, Thomas Mirow, deputy German finance minister, is due to be voted as successor to Jean Lemmiere.
Le Monde on Trichet’s triomph
Le Monde makes the point that Jean-Claude Trichet had been right all along in his warnings about inflation. Mr Trichet’s has not scored a victory, but achieved a triumph, having been right on this issue against the advice of many experts and politicians. The article also makes the point that Nicholas Sarkozy appears to have given up on ECB bashing, though one should probably not hold one’s breath for Mr Sarkozy to admit that he was wrong.
Leijonhufvud on inflation targeting
This was posted on Vox sometime last week, but since we missed it, we make a reference here in case you missed it as well. The Swedish economist Axel Leijonhufvud makes the case that the crisis rocks two fundamental aspects of the prevailing monetary doctrine, inflation targeting and central bank independence. He says that inflation targeting is the very reason that the US is now in its predicament, as the strategy forced the Fed to cut interest rates too aggressively. The US is now facing a long period of stagflation, in which it has to make economic policy choices that can hardly be left to unelected officials.
Simon Ward on the Bank of England
Writing in the FT, Simon Ward makes the point that the Bank of England has been complacent in dismissing the rise in monetary aggregates as a purely financial sector development. After the recent rise in inflation another red letter day for Mervyn King beckons. He argues that market expectations of a further fall in interest rates are misplaced, as inflationary expectations are becoming entrenched.
Back to the 1970s
Thorsten Polleit of Barclays Capital warns that we are subject to the same inflationary trends as we were during the 1970s, and we are making exactly the same mistakes as we did then. Inflation is not caused by rising commodity price, he writes in Frankfurter Allgemeine, but by rising money supply and credit growth. He forecasts inflation to rise to a range to 5-10% wordwide – which is not yet reflected bond prices.
Buiter on Inflation
This is a few days old – we are still catching up – but it fits our theme. Willem Buiter says inflation has become a real problem. The most important point he makes is that inflation is not caused by rising in oil prices or single price. Inflation is always caused by central banks. Central banks have the means to control it, the question is only whether they are willing and able to employ it. Buiter has also reiterated his known criticism of core inflation measures, or measures that exclude house prices. On the euro area he says, that interest rates may have to go up again.
And some complacency from the US
Bloomberg – hat tip Naked Capitalism – has entry about a divergence of inflation expectation between consumers and the financial markets – as express by surveys of inflation expectations, and rates on TIPs. Consumers believe inflation will be at over 5% over the next five years, while market prices suggest that it will be 3%.
The next stage of the US housing crisis
We are not watching the US housing crisis is every minute detail. However, it appears that the crisis is now spilling over to commercial real estate (while continuing in the retail sector). The Calculated Risk blog, probably the most reliable discussion board about the US property market, quotes an economist who says that the commercial sector is hit on all fronts, retail, office, and lodging. So this crisis is long and deep.
Divergences within the EU
Le Monde offers an overview of economic divergences within the EU. While Germany is roaring ahead, Spain and Ireland are crashing, Italy and Portugal are suffered, east Europe is drowning in inflation. So this is pretty dire picture.
Dullien on Portugal
Sebastian Dullien has focused on divergences within the euro area in a recent blog post. No US state or German land has ever experienced a decline in relative competitiveness as harsh as Portugal, whose real exchange rate has gone down by 17% since the start of EMU. In his latest post, Dullien writes the latest data from Portugal suggest there is some adjustment, but this is extremely low. The process of adjustment is likely to be extremely painful and long – and as experience has shown the only way to get back to a growth path would imply fall in the real exchange rate below equilibrium level, which means that Portugal has to be improve its relative competitiveness by a lot more than that 17% number would suggest.
How reliable are German data
Robert von Heusinger, writing in the blog Herdentrieb, and who has been advocating aggressive interest rate cuts for the euro area, expresses exasperation at the latest data from the Federal Statistics Office for Germany, which show that the economy expanded by 1.5% (annualised over 6%!) during the first quarter this year, the highest rate of expansion since 1996. He says the quality of German economic data is notoriously unreliable, and this data release only serves to support the ECB’s complacency, and postpone the day of policy adjustment by another 3 months.
Quatremer on the Flemish
Jean Quatremer has an interesting blog on the Flemish outrage at the global press coverage of Belgium. The New York Times apparently recently call the Flemish non-violent fascists. Quatremer himself has written a large number of articles highlighting persistent discrimination against the French-speaking minority in Flemish communities, including the abrogation of voting rights, discrimination of children in playground, and other outrages. The Flemish believe that they have an image problem, and respond to it through a PR campaign. Quatremer makes the point that the problem is not the delivery of the message, but the message itself.
EU Commission takes on Sarkozy over Mediterranean Union
FT Deutschland has an interesting story that the European Commission is planning to destroy a key plank in Nicholas Sarkozy’s proposals for a Mediterranean Union. Angela Merkel already got Sarkozy to accept the presence of non-Mediterranean members, but Sarkozy still wants a Mediterranean Union co-presidency reserved for Mediterranean states. The Commission says this violates European law.
Harold James on the future of the euro
Economic historian Harold James argues in the FT that the US is unlikely to allow the dollar to end its reign as the global currency. The US would exert all its economic and diplomatic pressures to prevent this. Furthermore, he says, the euro area is too young for the euro to take on such a role, and there already many strains inside the monetary union that may even lead to its eventual break up.
Larry Summers: I am not a protectionist
The Economists View blog features a detailed response by Larry Summers, after criticism that he may have conceded to the forces of darkness, by advocated a change of policies on trade and globalisation. Summers says he is no protectionist, but it has to be recognition that globalisation is not a win-win game. Western blue-collar workers are the clear losers, and it is no longer sufficient for governments to do nothing, and merely compensate the losers through wealth transfers.
Buiter again
In his latest blog entry, based on a CEPR policy paper, Willem Buiter asks the question whether central banks can go bust (see also Richard Baldwin’s summery of the Buiter paper on Vox). The answer is of course, and when such a situation occurs, the tax payers is called upon to recapitalise the central bank. He says that we should be told how this would happened in the EU, where the shareholders in the ECB are 27 member states, while the eurosystem only includes currently 15 members. It would not be a good idea to resolve this question when a solvency crisis were to hit the euro area.
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