"Traveling steerage. Unloading cattle from ocean steamer Julia"
Ilargi: We have sort of a double bill for you today. First, Stoneleigh’s latest interview with Jim Puplava. Then, Ashvin Pandurangi's "Vonnegutesque" take on the world of finance.
Nicole Foss- Preparing for the next Tsunami
The Peaking of Oil Prices and the Coming Depression. Resource Wars to follow.
James J Puplava CFP interviews Nicole M Foss
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On the Financial Sense Newshour this week, Jim Puplava is pleased to welcome back Nicole Foss. Nicole M. Foss is senior editor of The Automatic Earth, where she writes under the name Stoneleigh. She and her writing partner have been chronicling and interpreting the on-going credit crunch as the most pressing aspect of our current multi-faceted predicament. The site integrates finance, energy, environment, psychology, population and real politik in order to explain why we find ourselves in a state of crisis and what we can do about it. Prior to the establishment of TAE, she was editor of The Oil Drum Canada, where she wrote on peak oil and finance.
Foss also ran the Agri-Energy Producers' Association of Ontario, where she focused on farm-based biogas projects and grid connections for renewable energy. While living in the UK she was a Research Fellow at the Oxford Institute for Energy Studies, where she specialized in nuclear safety in Eastern Europe and the Former Soviet Union, and conducted research into electricity policy at the EU level.
Her academic qualifications include a BSc in biology from Carleton University in Canada (where she focused primarily on neuroscience and psychology), a post-graduate diploma in air and water pollution control, the common professional examination in law and an LLM in international law in development from the University of Warwick in the UK. She was granted the University Medal for the top science graduate in 1988 and the law school prize for the top law school graduate in 1997.
This week in her discussions with Jim Puplava, Nicole believes we will see the peaking of oil prices, the next bout of deflation and a looming depression. She sees resource wars as inevitable, given this deflationary scenario.
"There are no characters in this story and almost no dramatic confrontations, because most of the people in it are so sick and so much the listless playthings of enormous forces."
– Kurt Vonnegut, Slaughterhouse-Five
Hardly a day goes by without an excellent analysis of hard facts and data being followed by a surprisingly disconnected conclusion. Over the weekend, it appeared to be Zero Hedge's analysis of a video report by Eric deCarbonnel of Market Skeptics, which concluded that the Federal Reserve, U.S. Treasury market, and U.S. dollar may all be on the verge of imminent implosion due to the Fed's AIG-esque policy of selling large amounts of protection against an increase in Treasury bond rates. A rebuttal to this view was provided the next day on The Automatic Earth, in a piece entitled Bailing Out The Thimble With The Titanic.
In this piece, it was essentially argued that the U.S. dollar and Treasury market are symbolic of the Fed and the financial elite class, as partly confirmed by deCarbonnel's report, and these elite institutions have been engineering a successful bailout of those markets over the last few years, in tandem with natural financial dynamics and at the expense of everyone else. The bailout was "successful" in the sense that those markets will most likely remain stable in value for at least the next 2-3 years. On April 19 we were provided an excellent report by Chris Martenson, entitled The Breakdown Draws Near, but, as usual, all roads lead to financial chaos in Washington, D.C.
The "excellent" part of the report comes from the thorough data it provides regarding global liabilities that are maturing for banks and governments over the next few years. First, we are given a reference to the IMF's conclusions regarding global bank liabilities maturing in the near-term, with a stern eye locked on Europe :
The world's banks face a $3.6 trillion "wall of maturing debt" in the next two years and must compete with debt-laden governments to secure financing. Many European banks need bigger capital cushions to restore market confidence and assure they can borrow, and some weak players will need to be closed, the International Monetary Fund said in its Global Financial Stability Report.
The debt rollover requirements are most acute for Irish and German banks, with as much as half of their outstanding debt coming due over the next two years, the fund said.
The IMF basically tells us what has become painfully obvious by now - European banks and governments are both struggling to acquire the capital necessary to service their existing and/or refinance maturing debts, and there isn't nearly enough to satisfy them both. The latter fact is especially true when factoring in the maturing liabilities of banks and governments in other parts of the world, which is something that Martenson focuses on in the remainder of his analysis.
It is important, however, to note the added twist in the IMF's statement, in which it says that "some weak players will need to be closed". While it is specifically referring to European banks, the logic can be applied just as well to banks and governments all around the world, but we will return to that point later. In the rest of Martenson's report, we find out that Spain is actually pinning a significant portion of its private financing hopes on China, which, in turn, is facing its own imminent financial crisis due to an imploding real estate bubble.
But it is Spain that is first in the firing line and its 10-year bond premium in the secondary market widened 14 basis points to 194 bps. Madrid is hoping for support from China for its efforts to recapitalise a struggling banking sector... 
Prices of new homes in China's capital plunged 26.7% month-on-month in March, the Beijing News reported Tuesday, citing data from the city's Housing and Urban-Rural Development Commission. .
We can also expect that housing bubbles in countries such as Australia and Canada will start to implode in lockstep with China, as their economies are both highly dependent on Chinese import demand for natural resources. A renewed round of real estate busts, combined with the ongoing slump in Europe and the U.S. and less aggressive monetary policy (-temporary- winding down of QE), will also feed off of and into a collapse in global equity and commodity values. That collapse will wipe out large swaths of imaginary capital existing on the books of major institutions. All of that leads us to Martenson's seminal question, "Who Will Buy All of the Bonds?", specifically meaning the public bonds of Europe and the U.S.
Martenson refers to the Treasury International Capital (TIC) Report in his piece, which indicated that there was a "lower-than-trend" net inflow of foreign capital ($26.9B) into long-term securities for the month of February, which includes those going into long-term Treasury bonds. When including short-term securities, we see that there was a healthy net inflow of $97.7B into U.S. bond markets from foreign investors. . What this data indicates is that, during the month of February, there was significant foreign investment in U.S. bonds, but 72% of that was into short-term securities (which do not include 10 or 30-year Treasury bonds).
He goes on to conclude that this inflow dynamic will get worse as Japanese purchases drop off in the next few months, and that the proposed "spending cuts" for a few federal programs will hardly do anything to reduce the supply of Treasury bonds over this same time period. I agree that there is a strong possibility of reduced purchases by the Japanese government in the short-term, as well as the governments of China and the UK. In addition, the minuscule spending cuts will indeed be irrelevant to the overall size of the 2011-12 federal budget deficits.
To go from there to the conclusion that the U.S. Treasury faces an imminent funding crisis, however, requires a few major and unlikely assumptions; the classic hallmark of those fretting over hyperinflation of the dollar in the short-term. As briefly discussed above, a slowdown in foreign government purchases of U.S. Treasury bonds could be significantly offset by an increase of inflows from private foreign investors fleeing the equity, commodity, government agency and mortgage-related investments of other regions, as well as domestic investors fleeing those same risky investments.
And that's where we return to the IMF's little "hint" in its report from last week. The financial elites do not need anyone to buy ALL of the bonds, only those that are most important to maintaining their wealth extraction operations. The weak players? Well, they can all fight over the scraps and devour themselves in the financial marketplace. The truly significant capital will be transported towards a few central locations by natural forces and by human design, like lambs to the inevitable slaughter. Of these locations, the most critical are surely the U.S. Treasury market, which can be used to support major U.S. banks, and the U.S. currency market.
What are the chances that the majority of people who find themselves invested in U.S. government bonds and the dollar will get anything close to a return on their investment over 10, 20 or 30 years? The answer to that is probably a massively negative percentage, because the psychological pain of holding on for that long will be even worse than the total wipe out itself. However, the herd typically doesn't figure out how close they were to the edge of the cliff until after they are tumbling down the other side.
Stoneleigh at The Automatic Earth has repeatedly pointed out that people in such fearful environments tend to discount the future by an increasing rate, which means they care less and less about what will happen several decades, years or even months from the present time. The discount situation of financial elites is similar because they know how precarious the dollar-based financial markets are, so their concern is over whether they can corral all of the lambs into one or two places over a relatively short time period. So far, most of the evidence says that not only is it possible, but the process is already well under way.
Another unlikely assumption contained in Martenson’s report is the following [emphasis mine]:
With the Fed potentially backing away from the quantitative easing (QE) programs in June, the US government will need someone to buy roughly $130 billion of new bonds each month for the next year. So the question is, "Who will buy them all?"
I say the above question is an unlikely assumption because it seems to imply that the Fed may stop QE for another whole year after the QE-lite and QE2 programs wind down. If recent history has taught us anything, it's that a fearful deflationary environment is the perfect justification for the Fed to resume QE, and perhaps at an even larger scale than it has "monetized" in the past. Will the American people be up in arms about monetization of the federal debt or an indirect link to sociopolitical unrest, when their own finances, homes and careers are once again being beaten down by the unrelenting force of debt deflation? I really doubt they will be.
In the next section of his article, Martenson himself refers to how significant QE has been when talking about proposed budget cuts [emphasis mine]:
For the record, these 'cuts' work out to ~$3 billion less in spending each month, or less than the amount the Fed has been pouring into the Treasury market each business day for the past five months.
In addition, as discussed in Bailing Out The Thimble With The Titanic, the Fed may also be using Treasury put options to help them exert more control over long-term rates that cannot be reached as easily by QE programs. With regards to the latter, the following table is the Fed's "liquidity injection" schedule for the next month, which is certainly winding down, but still towers over any notional amount that has been "negotiated" by the politicians on Capitol Hill in their budget talks :
The other major assumption involved here is that interest rates will start to rise along the curve, and this will make sovereign default much more likely, since a significant portion of Treasury debt is in notes with relatively short-term maturities. This logic is circular at best, since it relies on the fact that sovereign default and/or inflation concerns will drive short-term interest rates up in order to posit the argument that increased short-term interest burdens will lead investors to be more concerned about sovereign default or inflation (from printing). There is certainly a positive feedback involved in such dynamics, but the feedback must be rooted in some initial economic or political trigger.
As mentioned earlier in this piece, and many other times on The Automatic Earth, the dominant and natural economic trend is debt deflation, while the dominant (and natural) political trend is aggressive fiscal and monetary policies that are crafted to funnel money into major banks, rather than the productive economy. There are very few reasons to think that either of these trends will reverse in the short-term, either by design of the financial elite class or by the inadvertent consequences of their actions. They have no doubt painted themselves into a corner, but their corner is significantly larger than the concentration camps built to imprison a large majority of the global population. The latter fact is clearly evidenced by the perpetual taxpayer subsidies given to financial institutions in the sullied names of "economic recovery" and "austerity".
The cities of Greece continue to erupt in violence as its citizens are forced to bail out European banks, and, meanwhile, Americans continue to mistake their own reflections in the global mirror. Earlier this year, Standard & Poor's rating agency downgraded the outlook for the triple-A rated status of Treasury bonds (from "stable" to "negative"), in what was nothing less than an act of aiding and abetting the politicians, bankers and major corporate executives who strive for the imposition of austerity on everyone but themselves. The only difference between Greece and the U.S. is that the latter is not a "weak player" in the eyes of elite institutions, such as the IMF. Which means that, while the Greek taxpayers may soon be put out of their misery, we will die a much slower death, choking on our own debt for years to come.
"He kept silent until the lights went out at night, and then, when there had been a long silence containing nothing to echo, he said to Rumfoord, "I was in Dresden when it was bombed. I was a prisoner of war."
- Kurt Vonnegut Slaughterhouse-Five
Faltering in a stormy sea of debt
by Martin Wolf - Financial Times
It is astonishing that Standard & Poor’s can say anything about the best-known debt class in the world that is deemed to add value. This business is, after all, one of a class whose failures contributed mightily to the financial crisis. Nevertheless, the announcement that it was shifting its long-term rating on US federal debt from stable to negative reminded us all of something vital: the world economy is not on a stable path. On the contrary, to adopt a phrase often applied by the Chinese premier Wen Jiabao to his country, the world economy is "unsteady, unbalanced, unco-ordinated and unsustainable". The US fiscal position is just one of a number of risks – and far from the biggest.
This may not seem so clear from the forecasts in the latest World Economic Outlook of the International Monetary Fund. At the global level its forecasts are the same as in January: a healthy 4.4 per cent growth in 2011 and 4.5 per cent in 2012. Even at market exchange rates, growth is forecast at 3.5 per cent and 3.7 per cent, respectively. The volume of world trade is forecast to expand 7.4 per cent this year and 6.9 per cent in 2012, after the post-crisis recovery of 12.4 per cent in 2010. Inflation, too, is forecast to be reasonably under control, with consumer prices rising 2.2 per cent in 2011 and 1.7 per cent in 2012 in advanced economies. Even in emerging countries, inflation is forecast to fall from 6.9 per cent this year to 5.3 per cent in 2012.
The WEO also lays out the pattern of divergent growth. Advanced countries are forecast to experience a moderate recovery, with growth of 2.4 per cent in 2011 and 2.6 per cent in 2012. Meanwhile, emerging and developing economies are forecast to expand 6.5 per cent in both years, with developing Asia, led yet again by China and India, forecast to grow 8.4 per cent in both years.
This is a world-transforming. But it is also a time of great uncertainty. The IMF’s Global Financial Stability Report opens with the bold view that "risks to global financial stability have declined" since October 2010. Confidence has indeed improved. But reality is quite another matter.
First, the advanced countries are in no sense back to normality: fiscal deficits remain exceptional; monetary policy is hugely accommodative; the financial sector is fragile, particularly in the eurozone; credit growth has been remarkably slow in the US and eurozone; households of several countries, including the US and UK, remain highly indebted; and there exists the possibility of sovereign defaults, bank failures or both within the eurozone. Moreover, despite the scale of the monetary and fiscal stimuli applied, the recovery in these countries is still expected to be anaemic (see chart).
Second, while advanced countries are in the doldrums, several emerging economies are suffering from excessive credit expansion and overheating. In many countries, particularly in developing Asia and Latin America, output is well above the pre-crisis trends. Particularly disturbing are the positions of Argentina, Brazil, India and Indonesia. "In many of these economies," notes the IMF, "both headline and core inflation either are rising from low levels or are fairly high already." The IMF picks out Brazil, Colombia, India, Indonesia and Turkey; over the past five years, credit per head has almost doubled in these economies, in real terms. Much of this flows into real estate. The IMF adds that "such expansions are close to those experienced before previous credit booms and busts".
Third, complex and disturbing interactions occur between the two sides of our divided world economy.
One of these comes via the emergence of a commodity price boom (see chart). The IMF commodity price index rose 32 per cent between June 2010 and February 2011. Behind this surge lies strong demand in fast-growing emerging economies, particularly China, adverse supply conditions, particularly for food, and political instability in certain oil-producing countries. Some argue that monetary policy is responsible. This is unpersuasive. But ultra-low interest rates lower the cost of financing inventories, while the decline in the US dollar raises the dollar prices.
Rapidly rising commodity prices help cause high inflation in emerging economies and stagflation in advanced countries. The result is pressure for monetary tightening. A global central bank might be tightening monetary policy sharply, even though such a response to a shift in relative prices would compel other prices, including wages, to fall in nominal terms. Certainly, rising commodity prices create challenges for monetary policy everywhere.
Another interaction comes via capital inflows and consequent upward pressure on exchange-rates in emerging countries. Monetary tightening exacerbates the pressure. But exchange rate pressure does not fall evenly, since China manages its exchange rate so effectively. Many countries are concerned that allowing appreciation and large current account deficits makes their economies vulnerable to shifts in US monetary policy. The IMF suggests that "capital controls may be the only instrument available to the authorities in the short term". But whether open economies can wield them as well as China is doubtful.
Last, but not least, we have the related issue of rebalancing of global demand. Despite overheating in a number of emerging countries, the IMF concludes that rebalancing has stalled. As it also notes, the adverse demand consequences of fiscal rebalancing in the high-income countries need to be partly offset by rising net exports. Unfortunately, it notes, "a disproportionate burden of demand rebalancing since the beginning of the crisis has been borne by economies that do not have large current account surpluses but attract flows because of the openness and depth of their capital markets". Such rebalancing – both limited and malign – greatly increases the risks of more financial shocks.
In all, policymakers confront a host of complex and interlocking challenges: fiscal and monetary normalisation in advanced countries; fixing the overhang of excess debt and financial fragility in those economies; managing the overheating in emerging economies; adjusting to big shifts in relative prices; and rebalancing the entire pattern of global demand. Nothing that is now happening suggests any of this will be managed competently, let alone smoothly. In short, those who think we are now looking at the sunlit uplands are fooling themselves. Much disruption lies ahead.
Geithner Downgrades His Credibility to Junk
by Jonathan Weil - Bloomberg
Fox Business reporter Peter Barnes began his televised interview with Treasury Secretary Tim Geithner two days ago with this question: "Is there a risk that the United States could lose its AAA credit rating? Yes or no?"
Geithner’s response: "No risk of that."
"No risk?" Barnes asked.
"No risk," Geithner said.
It’s enough to make you wonder: How could Geithner know this to be true? The short answer is he couldn’t. All you have to do is read the research report Standard & Poor’s published on April 18 about its sovereign-credit rating for the U.S., and you will see it estimated the risk of a downgrade quite succinctly. "We believe there is at least a one-in-three likelihood that we could lower our long-term rating on the U.S. within two years," said S&P, which reduced its outlook on the government’s debt to "negative" from "stable."
There you have it: Geithner says the chance of a downgrade is zero. S&P says the odds it will cut its rating might be greater than one out of three. So who are you going to believe? Geithner? Or the people at S&P who actually will be deciding what S&P will do about S&P’s own rating of U.S. sovereign debt?
It would be one thing to express the view that a downgrade would be unwarranted, or that the chance of it happening is remote. Either of these positions would be defensible. Geithner went beyond that and staked out an absolutist stance that reeks of raw arrogance: There is no risk a rating cut will occur. He left no room for a trace of a possibility, ever.
The mystery is why Geithner would say such a thing. What’s he going to do if S&P or some other rating company winds up disagreeing with him? Send Barney Frank to beat them up? The problem for leaders who make indefensible claims like this one is that, after a while, nobody knows whether to believe anything they say. Just remember all those government officials in Greece, Ireland and Portugal who kept saying their countries didn’t need bailouts, long after it became clear they did.
This was the same answer Geithner gave during an ABC News interview in February 2010, when asked if the U.S. might lose its AAA rating. "Absolutely not," he said. "That will never happen to this country." So, an asteroid could destroy the entire Eastern seaboard 100 years from now. And, in the world according to Geithner, we’re supposed to believe America’s top rating would be safe.
Perhaps Geithner would be well-positioned to make such assessments if he were the only person on the planet with the authority to grade sovereign debt -- and if there were zero risk that he would ever die. Not only is Geithner mortal, he doesn’t even work for a nationally recognized statistical rating organization.
In one of the great errors of financial history, the U.S. long ago bestowed that vaunted designation on the likes of S&P and Moody’s Investors Service. The raters showed they could be corrupted when they put their AAA marks on countless subprime mortgage bonds that quickly turned sour. Unlike the companies that bought those labels, though, the U.S. government didn’t solicit S&P’s ranking of its debt. Trying to predict with certainty what the raters may do next is a fool’s game.
Sure, it’s conceivable the government might threaten to strip the raters of their officially recognized franchise as retaliation if they dared to downgrade the U.S. We can only hope this isn’t what Geithner had in mind when he made his bold prediction. A move like that would risk a major scandal, and it might not even work.
Nothing the raters say should matter, of course. The markets are well aware the U.S. debt is on its way to surpassing the country’s annual gross domestic product, and that few leaders in Washington are willing to get federal spending under control again. The least Geithner could have done was take a page from Lloyd Blankfein, the chairman and chief executive officer of Goldman Sachs Group Inc., and throw in a wiggle word or two.
Testifying last year at a hearing led by Democratic Senator Carl Levin of Michigan, Blankfein said "we didn’t have a massive short against the housing market," notwithstanding that Goldman made about $500 million shorting the housing market in 2007. Levin says he wants to refer the matter to the Justice Department for a perjury investigation. Blankfein, of course, included the word "massive" in his statement, whatever that’s supposed to mean.
Geithner could have done something similar. Yet for some inexplicable reason he didn’t, which, if nothing else, should tell us he probably wouldn’t have much of a future as a top executive at Goldman Sachs. No risk at all? If Geithner is really as smart as his friends say he is, he doesn’t believe it either.
The 'other' housing market, where house prices have regressed 60%
by Jeremy Warner - Telegraph
Even the row of terraced houses in North West London where I live has managed to put the housing crash behind it; these relatively modest late Victorian properties again sell at record prices. Yet stray beyond London and the South East, and you see an altogether different picture, one that goes largely unrecorded by the established indices for measuring the UK housing market – Halifax, Nationwide, Rightmove and so on.
To see this "other" housing market, I've been to Newcastle and its surrounding areas in the North East, the region that gave birth to the folly of Northern Rock. Like all property markets, prices in the region are highly calibrated. There remain sizeable pockets of prosperity, where values, though still significantly off, have held up reasonably well. As in many parts of London, it's easy to imagine from these relatively well to do districts that there never was much of a housing crash.
Unfortunately, they are more the exception than the rule. Little more than a stone's throw from these posher areas lies a tale of catastrophic decline and value destruction to match the very worst the sub-prime crisis has managed to produce in the US. Tens of thousands of houses in the North East alone will have fallen in value by 30-60pc since the peak, and by the look of it, still have further to go.
Many can neither be sold nor let. You've heard about Britain's chronic shortage of housing stock, one of the factors which allegedly underpins the value of domestic property in the UK. Well, there's little sign of it here in Newcastle and the rest of the North East. Row upon row of properties that used to house workers in the region's once proud industrial tradition of shipbuilding, coal and steel lie half boarded up or otherwise derelict.
Yet believe it or not, these very same houses and flats were until three years ago as much a part of the British property bubble as everywhere else – perhaps more so in some cases. Over a seven year period, prices for a typical two to three bed house or flat were chased all the way up from the low teens to well in excess of £60,000. New build subject to mortgage fraud would fetch £125,000 or more. Today you'd be lucky to get half. Prices are fast regressing all the way back to where they came from before the bubble began.
Typical of this phenomenon is Benwell, located on the hillside that tumbles down to the Tyne in Newcastle's West end. A scene of grim degradation, it stands as a lasting reminder of the policy failures and illusory prosperity of Brown's Britain. Pumped up on a sea of credit, make work public expenditure and benefit payments, prices rocketed from 2000 onwards. First came the local money, chasing the apparently mouth watering yields that housing benefit could offer to buy-to-let landlords. Then having exhausted the possibilities down south, in came the London investors. In the final hurrah came the Irish, their pockets overflowing with loans from their now hopelessly bust banking system.
Many of these investors will already be in substantial negative equity, but still they refuse to adjust their price expectations to the all too dire reality. So they hold on in the hope they can find the tenants to pay the mortgage and that prices will eventually recover. Denial is the order of the day.
London is always first in and out of any housing market downturn. The trend then ripples out from the capital, with regions such as the North East lagging London by a year or two. If that relationship holds, then you would indeed expect prices in the regions soon to be chasing London higher again. Regrettably, it's more than likely broken. Even if the banks were prepared to fund another rip-roaring property boom – they are still scarcely in any condition to do so – the fundamentals in regions such as the North East are most unlikely to support it.
Highly dependent on public sector employment and handouts – which are being severely cut – there appears nothing to stop the free fall in prices. Ever optimistic, one estate agent in Blyth, on the coast south of Newcastle, insists that with the advent of the prime Easter selling season, things are picking up. Buy-to-let investors from London are back, he says, in part because low interest rates are driving them into riskier assets in the search for income and capital gain. "They know a bargain when they see one", he says, pointing to the recent sale of a property at half its bubble peak. In the real world, prices have in fact taken a further lurch downwards.
A little further south still, at Dean Bank, Ferryhill, it's the same depressing scene of boarded up housing and decline. Even the warm spring sunshine fails to make a dent in the oppressiveness of it all. A woman is grilling meat on a disposable barbecue in her front door porch. "I've been in this town a long time. It always was s*** and it still is. But my mortgage broker is a good man. He'll look after me", she says, generously offering a sausage sandwich. Somehow I doubt it.
But let's not single out the North East. To a greater or lesser extent, you find much the same story around all the major regional cities of Northern England. It's still the same rubbish property with the same down at heel tenants, but in the past ten years the prices have been up like a rocket and now they are falling back down again like a spent stick. It's hard to know what's going to rescue districts like these. With the anaesthetic of abundant credit and public money now largely gone, many areas of Britain are simply returning to the way they were before the New Labour boom began. It's as if it never happened at all.
George Osborne's hoped for private sector recovery threatens entirely to bypass areas like these. For the North East, the somewhat underwhelming programme of supply side reforms he announced in the Budget is unlikely to make any significant difference. Better education and training may lift things in time, but it all costs money, which is in short supply. Eventually, incomes might slip to levels that make the region competitive with emerging markets, but that's hardly an outcome to aspire to.
Everywhere's hurting right now, yet few places are hurting more than the North East. The collapse in low end property prices is only one outward sign of it. Public policy must focus like a lazer on these forgotten badlands, or risk permanently entrenching an ever more divided society.
The world’s hottest real-estate market?
by Brett Arends, MarketWatch - MarketWatch
I hesitate to use the overplayed word "bubble." But in the case of London property, it’s hard to avoid. What’s happening here is absolutely ridiculous. Look in the window of any real-estate agent here and you think people have gone crazy — and then you realize that the prices are in British pounds, and that to convert to dollars you have to add another 60%.
Half a million pounds ($800,000) for a one-bedroom condo with a small garden on the southern, unfashionable side of the river Thames? Really? And $2 million for a modest two-bedroom condo in Chelsea? As John McEnroe used to say at Wimbledon, you cannot be serious.
While the rest of Britain grapples with austerity, falling real wages and budget cuts, London real estate — super-prime London real estate, the best of the best — is back in the grip of another mania. According to an index maintained by high-end real-estate firm Knight Frank, prime central London prices are nearing and may even be surpassing the giddy levels seen at the peak a few years ago. The brokers’ windows tell the same story. It’s like that whole Lehman thing never even happened.
What’s going on? "London property is the ‘Swiss bank account’ of the 21st century," Robin Hardy, an analyst at London investment firm Peel Hunt, explained to me. Rich people in places like Egypt, Syria and southern Europe are rushing to get their money away from the turmoil, and for want of a better alternative, they are plunking it down in the "millionaire’s playground" of central London. "It’s seen as a relatively safe place to put your money if your objective is capital preservation," he said. They think money is "safer invested in an apartment in Sloane Street than in a bank account in Damascus."
Foxtons, a high-end real-estate agency, told me that 80% of its sales this year at its Sloane Square branch have come from overseas buyers. This is just the latest twist to a story that’s been running for some time. Gulf sheikhs. Russian oligarchs. Newly rich Indian and Chinese tycoons. London has become a magnate for the international super-rich: a millionaire’s playground. Russian money has been flooding in for at least a decade. One hedge-fund manager here told me London property was a "laundromat for Russian money."
You can see it in the fanciest shopping districts, from Jermyn Street and Old Bond Street. The booms in oil and emerging markets have been very good for prices here for at least a decade. Great Britain, through generous tax treatment of foreign nationals, has cleverly encouraged the trend.
A friend of mine a few years ago described how a Gulf sheikh was steadily buying up more and more of her condo development just north of Hyde Park. The sheikh liked to come to London for two months every summer to escape the Gulf heat, and he liked to bring his extended family and entourage. He didn’t care much about price, and he wanted as many condos as he could get.
There are other factors at work. London has become the financial capital of Europe. The giant money machine has spread far beyond the old financial district of the City of London. High-powered hedge funds and secretive commodity firms crowd the alleys and lanes of Mayfair and the towers of redeveloped Docklands. The windfalls have long been seen as a major driver of property prices.
Housing supply is limited, especially in the best areas. London has tough zoning laws, so there is very little new development. And you can also throw into the mix low interest rates. A friend explained how his grossly overpriced home cost him very little every year, because he is paying just 1% interest on a flexible mortgage.
To hear people tell it here, this miracle will go on indefinitely. Prices will keep rising skyward. You no longer encounter many bears of London property. Most have given up. But there are a couple of wrinkles that should give people pause.
First, you see more and more dark windows. On Sunday I went to a pub with one of my oldest friends. He described how more and more properties in central London were simply unused most of the year. You’d look up at the windows as you walked down the street, and very few were lit up. A recent study by Knight Frank found that one of the top reasons the international elite gave for selling a London home was simply that it was surplus to their needs.
The second concern is that more and more actual British are being crowded out of the city. Over dinners in the past 10 days, both a London member of Parliament and a top executive at a fund firm here have bemoaned the fact that young people can no longer afford to move into the usual London neighborhoods when they start their careers here. They’ve been priced out. Many of the middle-class are suffering the same fate. Ultimately, this simply becomes unsustainable. It will strangle the city’s vitality.
The third problem is that 1% interest rates will not last forever. Sooner or later they will have to rise, and when they do, a lot of home loans will become unmanageable as well as unrepayable. Happy times.
The fourth issue is one that often gets forgotten. In the age of the Internet and modern technology, the comparative advantages of big, expensive cities like London are actually in decline. Twenty years ago, if you wanted to run a hedge fund in the British Isles, you probably had to do it in London. That is no longer the case. It is a lot cheaper — and the quality of life much better — if you move out of town.
The fifth problem, though, is probably most ominous: the plunge in rental yields. According to Knight Frank, while prime London sales prices have doubled in the past 10 years, prime London rents have risen by less than 10%. The net result is that landowners are getting a gross yield of maybe 3.6% on average, compared to more than 6% a decade ago. Conversations I’ve had — with renters and owners — suggest some are getting even less.
Once you subtract all the costs of buying and selling a home, maintenance, taxes and condo fees, some landlords are making very little — if anything. As usual, the defenders of current prices are quick with a rebuttal: "But people aren’t investing for the yield," they say. "They are investing for the capital gains!" Alas for this argument, in a rational market, yields are the drivers of capital gains. The price of an asset goes up because the current owners are earning so much money that outsiders want in. The idea that people will keeping bidding up prices of an asset that makes no money is quixotic at best.
Will it turn? If so, when? It’s anyone’s guess. But for those living and working in Britain, the conclusions are pretty obvious. If I moved back to this country, I would avoid living and working in London if at all possible. And if I had to be in London, I’d rent.
Economy struggles for momentum, data shows
by Lucia Mutikani - Reuters
Factory activity in Middle Atlantic states braked sharply in April and the number of Americans claiming new jobless benefits fell less than expected, implying the economy was struggling to regain momentum.
Other data on Thursday showed steep declines in home prices in February, underscoring the challenges confronting the economy, but the recovery is expected to remain on track. The reports came a week before government data is expected to show growth slowed significantly in the first quarter. The economy grew at a 2.0 percent annualized rate, according to a Reuters survey, after a 3.1 percent pace in the last three months of 2010.
"The economy certainly lost some steam through the first quarter, (but) the underlying health remains sound," said Brian Levitt, an economist for OppenheimerFunds in New York. "It's an economy that is likely to grow, but out-sized growth is not on the horizon."
The Philadelphia Federal Reserve Bank's business activity index fell to 18.5 in April, pulling back from March's 27-year high of 43.4 and far exceeding economists' expectations for a drop to 37. The index covers Pennsylvania, southern New Jersey and Delaware and is an early indicator of the health of U.S. manufacturing contained in a later national report.
Separately, the Labor Department said initial claims for state unemployment benefits fell 13,000 to a seasonally adjusted 403,000 last week, well above economists' expectations for a decline to 392,000. The slowdown in economic activity comes as some policymakers at the Federal Reserve are pushing for the U.S. central bank to start considering withdrawing some of the stimulus it has provided the economy.
The Fed's policy-setting committee will meet April 26-27 to assess the economy and is expected to reaffirm a June end date for purchases of $600 billion of government bonds. Thursday's economic data curtailed stock market gains, which began with a flurry of strong corporate earnings. Treasury debt prices rose marginally, while the dollar fell against a basket of currencies.
Economists said it was possible supply disruptions in the aftermath of the devastating earthquake and tsunami in Japan could have hindered U.S. factory activity and kept initial unemployment claims elevated as some automakers idled plants.
"While affected individuals can file claims for unemployment insurance when these plants close temporarily, it is unlikely that workers were laid off for the entire payroll period, meaning they would still count as employed in the payroll survey data," said Daniel Silver, an economist at JPMorgan in New York. The claims data covered the survey period for April's nonfarm payrolls report, which will be released in early May. Employers added 216,000 jobs in March, the most in 10 months, and the unemployment rate slipped to a two-year low of 8.8 percent from 8.9 percent.
The smaller-than-expected drop in claims last week left the total above 400,000 for a second straight week. Claims below that level are usually associated with fairly solid jobs growth. A third report showing home prices fell 1.6 percent in February from January provided more evidence of the headwinds buffeting the economy. On a year-over-year basis, home prices fell 5.7 percent.
Despite the sharp pullback in April, mid-Atlantic factory activity has now expanded for seven months in a row. Economists did not view the report as a sign that manufacturing, which as led the economic recovery, was slowing.
A report last week showed a gauge of manufacturing in New York state rose in April to its highest level in a year. The Philadelphia Fed survey also showed steep declines in new orders and the employment measure, which were both the lowest since December. It also showed a surge in prices received by manufacturers, a potential warning on inflation.
"The Fed might also be concerned to see that the prices received index climbed sharply even though output growth seems to be tailing off and the prices paid index dropped back a little," said Paul Ashworth, chief U.S. economist at Capital Economics in Toronto. "It appears manufacturers are testing out their pricing power."
While the economy slowed in the first three months of 2011, it is expected to continue expanding. The Conference Board's Leading Economic Index rose 0.4 percent in March to 114.1, rising for a ninth straight month.
Bernanke to Open Up as Fed Embarks on Era of Glasnost
by Jon Hilsenrath - Wall Street Journal
Next Wednesday, Federal Reserve Chairman Ben Bernanke will do something no Fed chief has done before: Stand before a room full of journalists after officials conclude a policy meeting and answer questions about the central bank's decisions.
Washington churns out press conferences the way Kansas cranks out wheat. But this briefing will carry more import than most: Mr. Bernanke has been on a campaign since taking the helm of the Fed in 2006 to make it more transparent and consensus-driven. The financial crisis severely shook public confidence in the Fed, the economy has recovered unevenly since then, and Mr. Bernanke faces disagreement on his own policy-making committee.
Inflation is climbing, in large part due to surging food and energy prices. Unemployment remains high and economic growth disappointed in the first quarter. Mr. Bernanke seems intent on leaving the central bank's ultralow-interest-rate policy in place for now, but he faces vocal opposition in his ranks. In stepping out now, the chairman has a chance to assert his voice over the Fed's cacophonous internal debates—before any of his colleagues can get to a microphone—and reassure the public that he'll keep inflation under control.
"You can argue that the chairman of the Fed is more important than the president of the United States, but very few Americans understand what the Fed does," says Sen. Bernie Sanders, a Vermont independent who successfully pushed for the Fed to disclose more about its secretive bank lending. Addressing the press, Mr. Sanders says, will be "a step forward."
The outcome of next week's Fed board meeting isn't in doubt. It is likely to decide to allow a $600 billion program to buy Treasury bonds to run its course, as planned, in June. The debate will shift to how and when to begin raising interest rates to stem the risk of inflation.
Despite internal opposition, Mr. Bernanke and his top lieutenants—Vice Chairwoman Janet Yellen and New York Fed President William Dudley—have signaled they believe it is too soon to start raising rates. Though inflation is rising, they believe consumer-price increases will prove transient, as occurred in a 2008 run-up in food and energy prices. The press conference will give Mr. Bernanke a chance to explain this view to a sometimes skeptical public.
It is possible that this new one-man show might undercut the collegiality that Mr. Bernanke has built within the Fed, though he has won broad support to proceed among his colleagues, who see him as the voice and face of the central bank. Fed officials have been preparing carefully, according to people familiar with the process. Mr. Bernanke spent a recent weekend watching videos of European Central Bank President Jean-Claude Trichet and Bank of England chief Mervyn King, parrying reporters' questions at their regular press conferences.
In February, on the sidelines of a meeting of financial officials in Paris, Mr. Bernanke quizzed Mr. Trichet and other European central bankers on how they manage their press conferences. He'll do dress rehearsals, with staffers peppering him with questions, as the briefing nears. Mr. Bernanke's staff, meanwhile, has spent weeks scripting the mechanics of how the press conference will work.
He will hold his briefing in a big top-floor conference room at the Fed's Martin building, opposite the central bank's main cafeteria, where Mr. Bernanke can sometimes be found wandering, tray in hand, to chat with staffers. Twenty years ago, the central bank didn't even tell the public when it was changing interest rates. Well-paid Fed watchers on Wall Street had to read the tea leaves and figure it out for themselves. Mr. Bernanke's predecessor, Alan Greenspan, conducted one on-the-record television interview shortly before the 1987 stock-market crash and never did another.
The Fed started becoming more open about its interest-rate decisions on Mr. Greenspan's watch, releasing statements on rates and the economy after every meeting. The trend was accelerated by Mr. Bernanke, who thinks the Fed will be more effective and more accountable if people better understand what it is doing and why.
Mr. Bernanke's counterparts at the ECB, the Bank of England, the Bank of Japan and others have been holding press conferences for years. But the idea has generated resistance within the Fed in the past. "There's always the chance you'll say something you regret," says Donald Kohn, a former Fed vice chairman who served under both Mr. Greenspan and Mr. Bernanke. "For a long time, I thought the risks of holding press conferences might exceed the rewards." By the time Mr. Kohn left the Fed last year, he was for it. "It was clear we needed to do more to explain ourselves," he says, including the many programs the bank started to support the financial system during the crisis.
A Gallup Inc. survey showed the public's faith in Mr. Bernanke to do what's right for the economy hit an all-time low in April. Among 1,077 survey respondents, 42% said they had little or no confidence in him, compared with 39% who had those views a year ago and 35% the year before. Economists surveyed by The Wall Street Journal in January gave the former economics professor a 'C' grade. The decision to hold news conferences has been several years in the making. One factor that weighed on some officials was last year's raucous internal debate about the $600 billion bond-buying program, which several Fed officials openly opposed. The messy wrangling led to the creation of a communications committee chaired by Ms. Yellen, which backed the chairman's move.
Popularity doesn't mean much to the shy Fed chairman, but public faith in the Fed potentially means a lot. The central bank controls inflation primarily by managing how much money flows through the economy. If it pumps too much into the financial system, and in the process keeps interest rates too low for too long, it could set off surging consumer prices. But perceptions also matter greatly. Mr. Bernanke needs to maintain public confidence that inflation will remain low. If businesses or households doubt the Fed's ability or willingness to control inflation, they could expect higher prices, which could become a self-fulfilling prophecy. That's become a bigger challenge with food and gas prices rising.
Then-Fed Chairman Paul Volcker is widely credited with breaking the back of high inflation expectations in the early 1980s. His Fed ratcheted interest rates up into the double-digits, sent the economy into a severe recession and slowed inflation dramatically—demonstrating the Fed's power and commitment to keep prices in check. "We live on the reputation of what Paul Volcker did in the 1980s. He anchored a view that the Fed will not let inflation get out of control," said Richard Fisher, president of the Dallas Fed, in an interview. An inflation hawk who has been warning of the dangers of keeping rates too low for too long, Mr. Fisher said the Fed can't assume it will always have the benefit of the doubt.
Measures of short-term inflation expectations have picked up lately, but longer-term measures, which the Fed is watching closely, haven't gone up much. One of Mr. Bernanke's main tasks at the news conference will be to lay out the central bank's economic forecast and explain why it justifies a continuation of low-interest rate policies.
In January, the Fed's policy-making committee projected the economy would expand 3.4% to 3.9% this year and inflation would rise 1.3% to 1.7%. After a sluggish first quarter, in which high fuel prices pinched consumers and housing continued to languish, the growth forecast is likely to come down a touch and the inflation forecast is expected to go up. Mr. Bernanke is likely to point out that he and his colleagues expect inflation to move back below the Fed's 2% objective in 2012 and 2013. This means they can keep interest rates very low to encourage growth.
"As long as we're not seeing wages and salaries growing very rapidly, it's hard to see how inflation can become a sustained problem," Boston Fed President Eric Rosengren said in an interview this month, before the Fed's self-imposed, pre-meeting blackout this week, in which Fed officials stopped talking to the press. Another challenge for Mr. Bernanke: explaining the often disparate views of his colleagues. In Mr. Greenspan's day, the chairman dominated discourse. When officials disagreed with Mr. Greenspan at policy meetings, "you got the look of somebody who slurps his soup at a polite party," says Alan Blinder, a Fed vice chairman from 1994 to 1996.
Mr. Greenspan says today that the deference made him uncomfortable and he encouraged dissent. "It is not good for the Federal Reserve to have the presumption that all of these independent intellectuals are acting in unison. Something is wrong with that," he says. A 2005 paper by Mr. Blinder has become an influential ingredient in the way Mr. Bernanke runs the Fed. Mr. Blinder concluded, after a series of controlled experiments with 100 college students, that groups did a better job making decisions in monetary-policy games than individuals.
Still, the move to more openness and consensus has been accompanied by more clamor among officials, something Mr. Greenspan says might not be good for the Fed's reputation. Debate within the Fed has been especially loud and colorful lately. Mr. Fisher has warned that the U.S. could go the way of Germany's hyperinflationary Weimar Republic if the Fed finances government debt. Thomas Hoenig, president of the Kansas City Fed, has described the Fed's $600 billion bond-buying program as a "bargain with the devil." The St. Louis Fed's James Bullard has taken turns as a television commentator—co-hosting CNBC's "Squawk Box" television program from the St. Louis Fed's lobby
In the past month alone, 16 different Fed policy makers have given more than 40 formal addresses, in addition to television, newspaper and newswire interviews. They espouse different views, not only on when to reverse the Fed's easy-money policies, but how. Mr. Bullard wants to stop the bond-buying program early. Charles Plosser, president of the Philadelphia Fed, wants the Fed to move quickly to sell its bond holdings. Mr. Hoenig has been pushing for interest-rate increases for months. The dissonance is in part the result of the complexity of the situation. "We can't speak with more certitude than we have," said Mr. Rosengren.
Some traders think the Fed carefully scripts its messages with regional-bank presidents. In fact, it is often just the opposite. Some officials at the Fed board in Washington have been annoyed that regional bank presidents are staking out policy positions before the policy-making Federal Open Market Committee even meets to consider them. They also have been concerned that Fed chatter after meetings might be confusing the public about the Fed's actual plans. The Fed comprises 12 regional Fed banks and a board of governors in Washington, with five of the regional-bank presidents voting on interest-rate decisions on a rotating basis.
"A tightening cycle is the hardest thing for a central bank to do," Mr. Bullard said in an interview earlier this month. "It's tumultuous times for monetary policy, and that's why you're hearing more from the Fed." The press conference will be a chance for Mr. Bernanke to assert himself as the leader and voice of a group whose independence and assertiveness he helped create. He has developed a knack in his five years as chairman for considering the views of his colleagues—something he does when he sums up discussions at every closed-door meeting after they debate the economic outlook and policy options—as well as a knack for getting his way.
Officials, even those who don't always agree with his policies, say they are comfortable seeing Mr. Bernanke speaking out more.
Poll: Americans strongly oppose some deficit proposals
by Jon Cohen and Dan Balz – Washington Post
Despite growing concerns about the country’s long-term fiscal problems and an intensifying debate in Washington about how to deal with them, Americans strongly oppose some of the major remedies under consideration, according to a new Washington Post-ABC News poll.
The survey finds that Americans prefer to keep Medicare just the way it is. Most also oppose cuts in Medicaid and the defense budget. More than half say they are against small, across-the-board tax increases combined with modest reductions in Medicare and Social Security benefits. Only President Obama’s call to raise tax rates on the wealthiest Americans enjoys solid support.
On Monday, Standard & Poor’s, for the first time, shifted its outlook on U.S. creditworthiness to "negative" because of the nation’s accumulating debt. The announcement rattled investors and could increase pressure on both sides in Washington to work out a broader deal as part of the upcoming vote over increasing the government’s borrowing authority. The president and congressional Republicans have set out sharply differing blueprints to deal with the looming problem. Obama has called for agreement on at least a framework by early summer, which roughly coincides with the deadline for raising the nation’s debt ceiling.
Public resistance to many proposals in the competing plans could greatly complicate those discussions. Altering entitlement programs still involves political risk, the poll shows, and proponents of such changes face a substantial challenge in persuading the public that they are needed. The two sides are far apart philosophically, and neither enjoys great public confidence: Fifty-eight percent of those polled disapprove of the way the president is handling the budget deficit. Even more — 64 percent — give Republicans in Congress low marks.
The public is split about evenly on whether Obama or congressional Republicans are more trusted to find the right balance between cutting unnecessary spending and preserving priorities. On that question, public opinion is unchanged since last month, despite the recent battle over funding the government for the rest of the current fiscal year, resulting in a deal that includes $38 billion in cuts and that came barely an hour before the government was scheduled to shut down.
Congressional Republicans maintain a narrow edge over Obama when it comes to taking a "stronger leadership role" in Washington, 45 to 40 percent. And political independents side with the Republicans on tackling the burgeoning debt. But Obama maintains a key, double-digit advantage among independents when it comes to "protecting the middle class." The Republican budget plan, drafted by House Budget Committee Chairman Paul Ryan (Wis.) and approved by the House last week, calls for a major restructuring of Medicare and Medicaid, with sizable savings in future costs. Obama, in his plan, opposes the GOP’s restructuring, but he has said that future savings will be needed to keep Medicare solvent.
The Post-ABC poll finds that 78 percent oppose cutting spending on Medicare as a way to chip away at the debt. On Medicaid — the government insurance program for the poor — 69 percent disapprove of cuts. There is also broad opposition to cuts in military spending to reduce the debt, but at somewhat lower levels (56 percent).
In his speech last week, the president renewed his call to raise tax rates on family income over $250,000, and he appears to hold the high ground politically, according to the poll. At this point, 72 percent support raising taxes along those lines, with 54 percent strongly backing this approach. The proposal enjoys the support of majorities of Democrats (91 percent), independents (68 percent) and Republicans (54 percent). Only among people with annual incomes greater than $100,000 does less than a majority "strongly support" such tax increases.
An across-the-board tax increase is decidedly less popular, at least when coupled with benefit reductions. A report by the National Commission on Fiscal Responsibility , co-chaired by former senator Alan Simpson (R-Wyo.) and former Clinton White House chief of staff Erskine Bowles, recommended "shared sacrifice." But in the poll, a slim majority — 53 percent — opposes small tax increases and minor benefit cuts for all as a way to significantly reduce the debt. Strong opposition to that kind of solution outnumbers strong support by 2 to 1.
There is broad support for keeping Medicare structured the way it has been since it was instituted in 1965: as a defined-benefit health insurance program. Just 34 percent of Americans say Medicare should be changed along the lines outlined in the Ryan budget proposal, shifting it away from a defined-benefit plan. Under that proposal, recipients would select from a group of insurance plans providing guaranteed coverage, and the government would provide a payment to the insurer, subsidizing the cost. Advocates say this approach is more sophisticated than a pure voucher plan.
In his speech last week, Obama attacked that idea, saying it could leave some Americans without adequate coverage and would end "Medicare as we know it." While the debt issue lingers, most Americans — 59 percent — do approve of the deal stitched together to avoid a government shutdown by cutting billions from this year’s budget. The telephone poll was conducted April 14 to 17 among a random national sample of 1,001 adults. The margin of sampling error is plus or minus 3.5 percentage points.
Fiscal Conservatives Dodge $10 Trillion Debt
by Simon Johnson - Bloomberg
Washington is filled with self- congratulation this week, with Republicans claiming that they have opened serious discussion of the U.S. budget deficit and President Barack Obama’s proponents arguing that his counterblast last Wednesday will win the day. The reality is that neither side has come to grips with the most basic of our harsh fiscal realities.
Start with the facts as provided by the nonpartisan Congressional Budget Office. Compare the CBO’s budget forecast for January 2008, before the outbreak of serious financial crisis in the fall of that year, with its latest version from January 2011. The relevant line is "debt held by the public at the end of the year," meaning net federal government debt held by the private sector, which excludes government agency holdings of government debt.
In early 2008, the CBO projected that debt as a percent of gross domestic product would fall from 36.8 percent to 22.6 percent at the end of 2018. In contrast, the latest CBO forecast has debt soaring to 75.3 percent of GDP in 2018. What caused this stunning reversal, which in dollar terms works out to a $10 trillion swing for end-year 2018 debt, from $5.1 trillion to $15.8 trillion?
Almost all of this increase is due to the severe recession that followed the financial crisis of late 2008. This lowered output and employment, and therefore reduced tax revenue. For example, look at the tax revenue numbers for 2011, as a percent of GDP. The earlier expectation for 2011 was that the federal government would collect revenue equal to 19.3 percent of GDP. The forecast now is for revenue of 14.8 percent of GDP.
Whatever you think about the fiscal stimulus of 2008 (at President George W. Bush’s instigation) or 2009 (from Obama), those had relatively little impact compared with the automatic stabilizers, such as unemployment benefits, that are triggered by deep recession. Why did we have a severe recession with such a crippling fiscal consequences? On this issue, most politicians from both sides of the aisle fall silent.
What isn’t in doubt is that this was a financial-sector crisis of classic proportions. In terms of the negative fiscal repercussion, it reads like an episode straight from Ken Rogoff and Carmen Reinhart’s "This Time Is Different," a history of financial crises. But the political elite that now profess to be bothered by the fiscal deficit made no serious effort to make the financial sector any safer after the events of September-October 2008.
When you press politicians and their advisers on this, you will hear three kinds of responses in candid moments.
First is the notion that banking crises are rare. This is a favorite of the Treasury Department. Perhaps that was true in the past, but our big banks have become bigger, and too-big-to- fail banks have major incentives to take on very high levels of risk. After all, the downside isn’t their problem.
Second is the idea that we fixed it with the Dodd-Frank Act, a line heard most often from Democrats on Capitol Hill. Almost no one holds to that view, including William Dudley, president of the New York Federal Reserve, and Sheila Bair, head of the Federal Deposit Insurance Corp. Both have expressed concerns that the roadmap for closing a large troubled bank remains elusive.
And the idea that new international rules will force banks to increase their capital enough to reduce the risk of systemic crisis is regarded as ludicrous, at least by leading independent finance experts, such as Anat Admati of Stanford’s Graduate School of Business. Forcing banks to raise more equity in an appropriate way would lower risk, strengthening the financial system at little or no cost to the broader economy, according to Admati.
Third, "Let the markets evolve the way the markets evolve." This was a recent quote from Anthony Santomero, former president of the Philadelphia Fed and current Citigroup Inc. director. Citigroup has blown up repeatedly in the past 30 years, not surprising for a complex and unwieldy megabank with 260,000 employees worldwide.
Each time, it was saved through some form of external assistance, usually from the government, in part because responsible policy makers feared what Citigroup’s collapse would do the broader economy. Do we really think that the next time a bank with 200 million clients worldwide gets in trouble that the U.S. will let it go bankrupt, regardless of the consequences? Is that what Vikram Pandit, the chief executive officer, or Timothy Geithner, the Treasury secretary, argued for in 2008 or will argue for next time?
The right way to think about future budget deficits is in a probability-based fashion: What is the chance something bad will happen, and how bad will that be for debt levels? The odds of another major financial calamity next year are small, but the risk over a 10- to 20-year period is high. That’s the right time horizon to use in the coming budget debate. The impact of a new financial crisis on the U.S. public balance sheet would be huge. Anyone who wants to be taken seriously as a fiscal conservative must stop dodging this issue and start proposing solutions.
Debt at 200% of GDP Dares S&P Amid Succession: William Pesek
by William Pesek - Bloomberg
So Naoto Kan is a goner.
That’s the word in traumatized Tokyo. Japan’s prime minister had a once-in-a-lifetime chance to get his mojo back in the five weeks since a record earthquake and tsunami. He failed, and pundits wonder if he will make it to his first anniversary in office in June. Kan would be the fifth to go in five years.
Investors harbor a well-honed cynicism about Japanese leaders. They come, stick around for 12 months and they’re gone before markets or foreign governments get to know them. Japan’s revolving-door politics constantly sends new finance and foreign ministers to global summits. So much for relationship-building.
Kan’s predecessor lasted only nine months. Now Kan, who cheered markets with talk of reducing Japan’s massive debt, seems to be on the way out. And the question isn’t who’s next, but does it even matter? Not without sweeping changes to the political system. Barring that, Japan’s economic future is as cloudy as the status of the radiation leaks in Fukushima.
The focus is on how the March 11 quake, tsunami and unfolding nuclear-reactor drama will affect gross domestic product this year. That makes sense when the world’s third- biggest economy is suddenly in turmoil. We also must ponder where aging, deflation-plagued Japan will be five, 10 or 20 years from now. And that’s what worries me. Japan faces a daunting Catch 22. It needs a strong, independent prime minister willing to wrest power from the entrenched bureaucrats who really run the nation. When we actually get one, the entire political establishment thwarts reform and works to oust that leader.
Kan is one of the few prime ministers in decades who didn’t descend from political royalty. His maverick streak emerged in the 1990s. As health minister, he forced bureaucrats to release documents exposing their role in allowing as many as 5,000 Japanese to contract HIV through contaminated blood products. Whistle-blowers are a rare thing in Japanese politics.
Investors were excited 10 months ago when Kan unveiled plans to yank power away from bureaucrats. We foreign journalists were overjoyed that Kan’s government moved to open press conferences to scribes outside Japan’s press-club system, which is more about control than transparency. These steps alone border on revolutionary and go a long way toward explaining why Kan efforts to bring about change are failing. Vested interests rallied to save the status quo.
One of the most corrupting forces in government is the rise of shadowy fiefdoms. The longer one stays in a job, the bigger their influence becomes and the more skewed their incentives are toward personal success and avoiding change. An added problem in Japan is the offensive practice of public servants getting cushy gigs in industries they once oversaw.
The hapless Tokyo Electric Power Co. runs the leaking Fukushima Dai-Ichi nuclear power plant. You might expect there to be strict rules about former government officials gaining lucrative employment at Tepco after retirement -- you know, just to ensure that nuclear plants are actually being watched with some semblance of objectivity.
Nope, the practice that encourages bureaucrats to look out for their future employers, not the average Japanese household, is alive and well. It’s called amakudari, which means "descent from heaven." Decades of doctored safety reports and underestimated risks at Tepco were made possible by bureaucrats looking the other way. Far from heaven, it’s made life a nightmare for farmers, fishermen and millions living around Fukushima.
Kan’s unsteady leadership these last five weeks sealed his political fate. Yet so did his failure to see through change, just as Japan’s last independent-minded leader Junichiro Koizumi fell far short in his pledge to shake things up. Koizumi was around for an extraordinarily long time, from 2001 to 2006, and had only marginal success. Though they hail from different parties and ideologies, both ran up against the same wall: Japan Inc.
We can obsess over who will succeed Kan. Many bets are on Katsuya Okada, secretary general of the ruling Democratic Party of Japan. Chief Cabinet Secretary Yukio Edano is another favorite, as are Finance Minister Yoshihiko Noda and National Strategy Minister Koichiro Gemba. Long shots include Renho Murata, a former model turned fiscal firebrand serving as conservation minister. She would be Japan’s first female premier. Unless Kan’s successor is willing to attack the status quo, to disturb Tokyo’s established political order, it won’t much matter.
Standard & Poor’s regained a bit of its own mojo this week by threatening to take away the AAA credit rating for the U.S. Japan should brace for greater skepticism of its balance sheet as politicians add to a public debt that’s 200 percent of GDP. In January, S&P lowered Japan’s rating to AA-, the same level as China’s. Japan’s forthcoming borrowing binge to rebuild the quake-devastated northeast will do nothing to make it more competitive or vibrant, and its rating may pay the price. Leaders change; Japan’s dismal debt-to-GDP ratio doesn’t.
To change course, the nation’s 127 million people require a liberated and visionary leader. They just need to find one and let him or her stay in the job for a while.
Lessons from the Credit-Anstalt Collapse
by Peter Coy - BusinessWeek
In May 1931, a Viennese bank named Credit-Anstalt failed. Founded by the famous Rothschild banking family in 1855, Credit-Anstalt was one of the most important financial institutions of the Austro-Hungarian Empire, and its failure came as a shock because it was considered impregnable.
The bank not only made loans; it acquired ownership stakes in all kinds of companies throughout the sprawling empire, from sugar producers to the new automobile makers. Its headquarters city, Vienna, was a place of wealth and splendor, famous for its opera, balls, chocolate, psychoanalysis, and the extravagant architecture of the Ringstrasse. The fall of Credit-Anstalt—and the dominoes it helped topple across Continental Europe and the confidence it shredded as far away as the U.S.—wasn't just the failure of a bank: It was a failure of civilization.
Once again, Europe's banking system, and by extension its social fabric, is threatened by bad loans. What had been slow-moving fiscal disasters in Greece, Ireland, and Portugal have gathered speed in recent weeks despite rescue packages designed to calm markets and prevent spreading the contagion to Spain, Belgium, and beyond. Portugal's 10-year borrowing costs hit a record 9.3 percent on Apr. 20, up from 7.4 percent just a month before, even as authorities met in Lisbon on an €80 billion ($116 billion) financing package.
The higher that creditors drive up interest rates, the more unaffordable the debt becomes—creating the conditions for the very failure they fear. "All of the rescue packages don't really ensure that we can escape this adverse feedback loop that these countries are being trapped in," Christoph Rieger, head of fixed-income strategy at Frankfurt-based Commerzbank, told Bloomberg Television on Apr. 19.
With weak banking systems still resisting aggressive treatment, it's worth revisiting Credit-Anstalt to plumb for any applicable lessons. Long before 1931, Credit-Anstalt had begun to develop cracks that were invisible to the public. When the Austro-Hungarian Empire broke up after World War I, the bank continued to do business throughout the old empire without recognizing that the world had changed. Suddenly, more knowledgeable local lenders were getting the best deals, leaving Credit-Anstalt with the loans no one else would touch, says Aurel Schubert, an Austrian economist who wrote a 1991 book on the episode called The Credit-Anstalt Crisis of 1931. (There's a modern analogy in Greek banks' unwise loans in Bulgaria, Romania, and Serbia.)
The hyperinflation of 1921-23 that made the price of a beer rise to 4 billion marks badly damaged the finances of Credit-Anstalt as well as Austria itself. The nation was propped up by a 1923 loan from the League of Nations, the predecessor of the U.N. A Dutch citizen was appointed by the League to supervise the Austrian budget. He devised plans to raise taxes while cutting government jobs, pay, and pensions, the same prescription being urged on the weak members of the euro zone today. But Austria continued to stumble.
Bank regulation, meanwhile, was thin and getting thinner: Regulators began to demand a balance sheet just once a year, instead of every six months, says Schubert. As weaker banks failed, Credit-Anstalt took them over at regulators' insistence, becoming more bloated and less profitable with every merger. And the weakening of the economy was damaging lenders' ability to repay.
The tipping point came early in 1931 when a bank director named Zoltan Hajdu refused to sign off on Credit-Anstalt's books without a comprehensive reevaluation of the bank's assets. The bank revealed losses that it kept revising upward as the weeks passed. Depositors withdrew funds. The Austrian government stepped in to guarantee all the bank's deposits and other liabilities—but that only brought the government's own creditworthiness into question. "In today's language," says Schubert, "Credit-Anstalt was too big to fail, but too big to save."
Harold James, a British historian at Princeton University, described what happened next in his 2001 book The End of Globalization: Lessons from the Great Depression. "The Viennese panic brought down banks in Amsterdam and Warsaw. In June and July the scare spread to Germany, and from there immediately to Latvia, Turkey, and Egypt (and within a few months to England and the U.S.)." Austria got an undersized loan from the Bank for International Settlements and some help from the British branch of the Rothschild family. But French politicians rejected an international rescue without political concessions from Germany that weren't forthcoming.
Thus the failure of Credit-Anstalt accelerated the financial panic that turned a recession into a global depression. Economic distress in Austria contributed to the outbreak of violent conflict between socialists and fascists in 1934. Jews became scapegoats. In 1938, Nazi Germany occupied Austria, and Adolf Hitler was received by adoring crowds in Vienna. Albeit indirectly, the failure of Credit-Anstalt helped clear the path for some of the darkest events of the 20th century.
Today's Europe is far from a series of events resembling this tragic cascade. But the experience of the 1930s and 1940s has made European policymakers and economists hyper-aware of historical precedents. The current debate is about how to avoid a repeat. To those who believe hyperinflation was the key policy mistake in Credit-Anstalt's fall, keeping a lid on inflation is priority No. 1. Others stress the lack of international coordination, or the failure to regulate, or even the handcuffs on government policies from adherence to the gold standard—represented today by the euro zone's reliance on a common currency. As in most car crashes, the witnesses have a hard time agreeing on just what they saw.
The scariest thing about the Credit-Anstalt default is that it occurred in a small, peripheral country, just as today's worst problems are concentrated so far in Greece, Ireland, and Portugal, which combined make up just 5 percent of the 27-nation European Union's gross domestic product. "Austria is a tiny, tiny little place, and you wouldn't imagine it could set off a chain of domino reactions. But it did. I do see exactly that potential now," says James.
For that reason, German economist Holger Schmieding says Europe should do everything in its power to prevent or at least delay defaults by national governments. Schmieding, chief economist of the German private bank Joh. Berenberg Gossler, says keeping Greece and others from defaulting for as long as possible—if not forever—will give banks in Germany, France, and other nations that have lent to them the time they need to rebuild their capital so they can withstand the hit from loan losses. The Bank for International Settlements says that as of last September, German banks had over €220 billion worth of exposure to Greece, Ireland, and Portugal, and French banks had over €150 billion worth.
For all of Europe's bickering over aid to Greece, Ireland, and Portugal, the Continent is more united and financially stable now than in the interwar period. "Unlike Austria in 1931, the euro zone has the resources to bail out the threatened banks without really triggering a full-blown debt crisis," says Michael D. Bordo, a Rutgers University economic historian. The more Europe takes the lessons of Credit-Anstalt to heart, the less likely it is to make the same mistakes again.
The introduction of Schubert's book begins with the famous line of George Santayana, the Spanish philosopher, who said, "Those who cannot remember the past are condemned to repeat it." J. Bradford DeLong, an economist at the University of California at Berkeley, thinks Europe has absorbed Santayana's message—to an extent. "Because we remember the Credit-Anstalt, we will not make that mistake," DeLong says. "We will make different ones."
Papandreou slams rating agencies 'trying to shape Greece's future'
by Helena Smith and Jill Treanor - Guardian
Greek government calls in Interpol over Citigroup trader's email as restructuring speculation mounts
Greece's prime minister, George Papandreou, has launched a new attack on credit rating agencies amid mounting expectation that Greece was considering ways to restructure its debts.
On the first anniversary of the Greek bailout by the International Monetary Fund and the EU, Papandreou said on a government website that agencies were "seeking to shape our destiny and determine the future of our children".
His outburst came as the Greek authorities focused on a London trader at US bank Citigroup in their attempts to get to the bottom of rumours that the government would restructure its debt as early as this Easter weekend. In an email sent on 20 April Paul Moss, a Citigroup employee, outlined "market noise" about a possible restructuring, when rumours were rife in the markets. Shares in Greek banks fell 4.7% that day, infuriating the Greek authorities, which have called in Interpol.
Citi is adamant that neither it nor its employees have done anything wrong. Greek authorities said they were awaiting news of what they hoped would be an in-depth investigation. "Our cybercrime division has sent paperwork asking for the individual to be questioned," said a police spokeswoman.
On 20 April the Reuters news agency said 46 out of 55 economists expected Greece to have to restructure its debt in the next two years, with extending loans' maturity the most likely option. Greek newspapers later reported on 22 April that this was what the country was privately already discussing. The country's top-selling newspaper, Ta Nea, described "a velvet restructuring" that would include extending outstanding debt and a voluntary agreement to modify repayment terms. The paper said this would need to take place before 2012.
Describing the informal talks, the paper said the Greek official in charge was finance minister George Papaconstantinou, who has reiterated that a debt extension or other restructuring was out of the question. Officially, the country is planning to return to the bond market early next year – reducing the urgency for a bailout – and Papaconstantinou claimed the debt was "sustainable" even though it is expected to hit 160% of GDP in 2012. Another Greek newspaper, Isotimia, reported that the government might seek to extend the maturities of its outstanding debt by an average of five years.
In March Papandreou hit out at a downgrade by ratings agency Standard & Poor's – to BB – saying that the country was being downgraded not because of its policies but because of the EU's handling of the crisis. While Greece has never had a top-notch AAA rating it has been downgraded or warned of a downgrade eight times since January 2009, when it had an A rating. A year ago, just after the bailout, it was the first eurozone country to have its debt rating cut to junk when S&P had warned that bondholders could recover as little as 30% if the country restructured its debt.
The cuts to the ratings help to push up the cost of borrowing for Greece on the international bond markets. Before the markets shut for the long Easter weekend, the yield on 10-year bonds was above 15%. Yields rise when bond prices fall. Germany, regarded as the safest borrower in the eurozone, has a yield of 3.27%.
Greeks Brace for Losses as Papandreou Debt-Cutting Odyssey Enters Year Two
by Maria Petrakis - Bloomberg
Georgios Kakaboukis, 87, has survived the Nazi occupation of Greece, a civil war, a military coup and martial law. He can deal with Prime Minister George Papandreou cutting his Easter holiday pension bonus. "Some people, these younger ones, haven’t lost anything at all," said Kakaboukis, a retired civil servant, while waiting in line to see his doctor at the state welfare office in the Athens suburb of Neos Kosmos. "Greeks have learned to yell, raising their fists in protest while the other hand is stretched out for handouts."
It’s been almost a year since Papandreou traveled to the remote island of Kastelorizo on April 23 to tell Greeks they needed to grab the financial lifeline from the European Union and International Monetary Fund. Evoking Homer’s Odyssey, the Socialist premier said he had "charted the waters" and "knows the way to Ithaca," the home of the mythological hero Odysseus.
Greeks are realizing that the journey to financial health is only just beginning. A year of spending cuts and tax increases has failed to tame the euro-region’s second-largest deficit and the government is pushing for more austerity. Record bond yields signal investors’ bets that Greece will capitulate and restructure a debt forecast to peak at 159 percent of gross domestic product next year.
With unemployment set to exceed 15 percent this year, and the country’s central bank saying the economy may shrink more than its 3 percent forecast, the third year of contraction, Greeks are girding for more losses. Last week, Finance Minister George Papaconstantinou announced cuts covering the next five years, targeting schools, hospitals, and public transit.
Wages and pensions have already been reduced for the 768,000 state workers and the bonus payments were eliminated. The deficit-cutting drive that was a condition of 110 billion euros ($160 billion) in aid has left hospitals without supplies, forcing closures. Higher public transit fares have sparked a "won’t-pay" movement on buses, trains and toll roads.
Athina Eleftheriou, 50, is fed up with Papandreou. "We should throw him in the sea and let him find his own way to Ithaca," said Eleftheriou. Sales at her central Athens store selling silks imported from India have fallen by half, as have her prices, while sales taxes have risen, she said. "Nobody asked the Greeks about this."
Yiannis Constantinidis, 57, Eleftheriou’s husband, says Papandreou’s policies are squeezing small businesses and forcing people to dodge taxes, worsening the situation. "He’s taking 45 percent of profit, 23 percent VAT and indirect taxes and there’s nothing left," he said. "He’s forcing us into a position where we can’t pay." The couple represents Greece’s fastest growing political group: the disenchanted. Polls show Greeks increasingly unhappy with both Papandreou’s Socialist Pasok party and the main opposition New Democracy led by Antonis Samaras.
Thirty percent of the 1,005 Greeks surveyed by Kapa Research between April 11 and April 14 said they were undecided about who they would vote for if elections were held now. Pasok garnered the support of 21.7 percent; New Democracy of 20.1 percent. More than half said their greatest fear was a major cut in their household income. The second-greatest was a bankruptcy of the Greek state, according to the poll.
Papandreou and Papaconstantinou are sticking to the plan, rejecting default and saying the economy needs to be overhauled to avoid wasting their efforts. "Restructuring holds huge dangers for Greece’s economy, Greek banks, households and businesses," Papaconstantinou said yesterday. "I leave out the issue of what will happen in the rest of the European Union."
The bailout was designed to give Greece room to cut a budget shortfall that soared to 15.4 percent of GDP in 2009, the EU plan foresees the country returning to markets for financing in 2012, an eventuality bond yields are signaling isn’t likely to happen. The deficit is targeted to fall to 7.4 percent this year and to within the EU’s 3 percent limit in 2014.
The yield on the country’s 10-year bond was 14.8 percent yesterday, about 600 basis points higher than when Papandreou asked for the aid a year ago. Borrowing costs for two-year Greek bonds exceed 22 percent, more than 10 times what Germany pays. Echoing the pre-bailout dynamic, ratings companies have kept up the pressure on Papandreou, lowering the country’s creditworthiness to junk status. Meantime, tax evasion, slumping growth and corruption are undermining his efforts.
Government revenue grew 5.5 percent in 2010, compared with a targeted increase of 6 percent. The government initially forecast a 13.7 percent increase and was forced to reduce the goal twice as increases in value-added taxes and levies on alcohol, tobacco and fuel failed to generate enough income. Greeks were asked to pay bribes of between 150 euros and 7,500 euros for surgery in public hospitals, with payments to doctors to facilitate the process ranging from 50 euros to 1,500 euros, according to data presented by the Greek chapter of Transparency International and posted on its website. Total bribes paid were an estimated 632 million euros last year, about 0.3 percent of the economy, the report said.
Plans to cut the state’s stakes in the phone, gambling and power companies have reignited union dissent, with the country’s biggest groups calling a general strike for May 11, days before Papandreou takes his five-year plan to parliament for approval. His majority in the legislature has fallen to 156 of the 300- seat chamber. That’s down from 160 after his election in October 2009 as lawmakers broke ranks.
As the EU pushes through legislation to toughen punishment of governments that breach the bloc’s budget-deficit and debt limits, Socialist politicians say the EU must avoid pursuing punitive policies. "The weaker economies will go through a period of blood, sweat and tears," says Udo Bullmann, a German Socialist member of the European Parliament. "The leaders there have to be able to offer something to their people. They have to be able to say ‘you get something more from Brussels than sanctions.’"
Kakaboukis, the pensioner, says Greeks are well aware of their failures, referring to bankruptcies in 1843 and 1893. Default wouldn’t be the end of the story, and would spread to other countries, he said. "Bankruptcy isn’t just a word," he said. "Bankruptcy, restructuring, these are terrible things. We will all fall in the sea together."
Euro Benefits Germany More Than Others in Zone
by Floyd Norris - New York Times
The euro has been very, very good for Germany. Other members of the zone have not fared as well.
Since the introduction of the euro at the beginning of 1999, the European Central Bank calculates that Germany has gained competitiveness, not only against other major industrial nations but against all other members of the euro zone.
Over the same period, Germany’s balance of payments has gone from a small deficit to a strong surplus, but in the euro zone as a whole the balance of payments position has deteriorated slightly. Trade balances are the largest part of the balance of payments, but other transfers — not including international investments and profits from those investments — are also included.
The loss of competitiveness has been a major problem for some other members of the euro zone, most notably Greece and Ireland, each of which has been bailed out by Europe. Portugal, the other country to seek help, has suffered a smaller loss of competitiveness. Ireland’s problems were caused largely by the collapse of its banking system, which stemmed from the collapse of a property boom that had been propelled by cheap credit and tax incentives. The loss of competitiveness was not as much of a problem for Ireland as it was for Greece and Portugal.
After the collapse, Ireland embarked on a harsh program of austerity, including wage cuts, and both its competitiveness and its balance of payments have improved. The competitiveness measure is based on currency movements and changes in unit labor costs in major industrialized countries. German competitiveness against the rest of the world was probably helped by the fact that the relatively poor performance of other members of the euro zone held down the appreciation of the euro against other currencies.
The first set of charts accompanying this article shows Germany’s performance in competitiveness, as well as the country’s balance of payments as a percentage of gross domestic product. The next set of charts shows similar measures for the other major countries of the euro zone, France, Italy and Spain. The final set shows the performance of the three countries that were forced to seek European help.
The European Central Bank does not publish a competitiveness index for Portugal based on unit labor costs, so a similar one based on overall inflation in the economy is used instead. Greek balance of payments data is not available for 1999. With the exception of Germany, each of the countries shown has lost competitiveness because unit labor costs have risen more rapidly in those countries. Absent the euro, many of the countries probably would have devalued their national currencies, but that is not possible as long as they remain in the euro zone.
Since the financial crisis intensified in mid-2008, all of the countries, including Germany, have improved their global competitive positions. Ireland has improved its position more than any other country in the euro zone, but both Greece and Portugal have continued to lose ground to Germany.
Epidemiologist, Dr. Steven Wing, Discusses Global Radiation Exposures and Consequences with Gundersen
by Fairewinds Associates
Money And Trust: Richer, More Equal Countries Are More Trusting, Study Finds
by Lila Shapiro - Huffington Post
People living in richer, more egalitarian countries trust their fellow human beings more, new data shows. Countries with high median household incomes are more trusting, generally, than countries with lower income levels. The United States is an exception to this trend.
The Organization for Economic Cooperation and Development surveyed 30 industrialized countries with the question, "Generally speaking would you say that most people can be trusted or that you need to be very careful in dealing with people?" Danes are the most trusting people and Chileans the least, according to the data.
In 2008, the United States was the 10th least trusting country, with only 48.7 percent of Americans responding that, generally speaking, most people could be trusted. But, of the countries surveyed, the U.S. ranks fourth for median household income levels.
The O.E.C.D.'s data also shows that higher levels of trust are strongly associated with lower levels of income inequality. The analysis from the O.E.C.D. does not draw definite conclusions about the cause and effect relationship between wealth and trust. "Trust may promote gainful economic activity, or trust may be a luxury affordable only by richer countries," the report notes.
Likewise, the relationship between inequality and trust is left open by the report, which surmises that income inequality may make it more difficult for people to share a sense of common purpose, or it may be that low levels of trust inhibit positive social bonds, which could lead to more inequality in society.
The data from the O.E.C.D. correlates with what academics have thought for a long time: Money and trust are integrally bound together. Tom W. Smith, the director of the Center for the Study of Politics and Society at the University of Chicago, who has written about trust and confidence in institutions, teases out some of the connections.
"If you have a higher income and you're substantially above the poverty line, you have more of a margin of generosity. You can be a little more trusting, a little more generous to others. You have this margin where you can be open to others," Smith said. "But if you're at or below the poverty level, there's no margin. You can't be generous towards others because there's nothing you could possible give up."
But many academics who study the relationship between wealth and trust argue that a country's income inequality is far more important than the overall wealth of a country.
"Inequality is much more significant than wealth and the reason is that trust reflects the view that what happens to me happens to you. That we're all in this together. And inequality works exactly to counter that," said Eric M. Uslaner, professor of government and politics at the University of Maryland-College Park, whose research focuses on the reasons people trust each other.
Uslaner also noted that it was important to take the percentages from the O.E.C.D. with a grain of salt. Although the general order of the list did not surprise him -- Nordic countries are always ranked as the most trusting in the world -- the percentages of people expressing a high level of trust in others seemed high to him, across the board.
"I have never seen numbers of generalized trust like that. In virtually any other survey I have ever seen on trust, there are five countries that have trust levels above 50 percent. The Nordic countries always fall into that range. Sometimes Canada, sometimes Australia. So 88 percent is absolutely unheard of," Uslaner said.
According to the, O.E.C.D. 88.8 percent of Denmark's population has a high level of trust. According to figures Uslaner references from the World Values Survey from 1995 (the most trustworthy source in his view), 58 percent of Danes are trusting, while only 36 percent of Americans think other people can be trusted.
Data from the General Social Survey, which conducts annual scientific research on the structure of American society, corresponds closely with the World Values Survey -- the percentage of trusting Americans in the past decade has never risen above 38 percent. Although the GSS does show a decline from 1972, when 47 percent of Americans said that people could be trusted.
The reason for the United States' relatively low trust level given its high GDP is clear, academics say: high income inequality.
"The United States has one of the highest levels of inequality of any industrial countries in the world. It's created a great deal of mistrust in everything," said Brian Vargus, professor of political science at Indiana University-Purdue University Indianapolis who specializes in trust and the government.
The Great Recession has made income inequality in the United States worse, as corporate profits have rebounded while unemployment remains high. On Tuesday, a new study by the nation's largest labor union found that CEOs at 299 U.S. companies earned $3.4 billion combined in executive compensation in 2010. In all, CEO compensation equalled the combined average earnings of more than 100,000 workers in their respective companies.
"People are now talking in the United States about the economy going in two different directions. If you're really rich, it's a great time to be an American; if you're middle class or poor, it's a terrible time," Uslaner said. "It's not surprising that people don't feel this common sense of identity."
Of the 30 countries surveyed by O.E.C.D., most became slightly more trustful over the last decade. The United States was one of six of the 30 countries surveyed that showed a decline in trust. Change in a country's level of trust over time is unusual, academics say, and one of the few things that can alter it is a change in income inequality.
"Trust is extremely sticky -- it doesn't change. And it doesn't change over a course of a person's lifetime that much either. Nor does inequality change that much over time" Uslaner said. "But there is a vicious cycle that many countries get themselves into, with high levels of inequality leading to low levels of trust leading to high levels of corruption which lead to even higher levels of inequality and lower levels of trust. It becomes extraordinarily difficult to break this chain."
Brian Vargus, and others who study the sociology of trust see a strong correlation between high levels of trust -- both between people as well as an individual's trust in institutions -- and a well run government.
"The feeling is, when you look at trust and you see how it moves across government, as people become more mistrustful of government, it's much more difficult to govern," Vargus said. "As trust levels go up, it can help foster better economic relations, but when you've got an economic downturn, high unemployment, the public starts asking, who can I trust?"
Furthermore, Tom Smith notes, mistrust, particularly mistrust based in poverty, has a way of passing down through generations. "If your parents teach you not to trust others, then you grow up with those values and you're likely to pass along those values to your children. so this kind of culture perpetuates itself," Smith said.