Eric Fry here at The Daily Reckoning is “reporting from the Golden State with the tarnished finances”, which was a riddle that I instantly knew was, of course, California. But, for some reason, I never get asked a question when I know the answer. I usually get asked, instead, something like, “For 40% of your final grade, what is the principal export of California and total tonnage exported, expressed in kilograms per fortnight?”
Well, as much as I have enjoyed this jaunt down memory lane, the fact is, as Mr. Fry points out, that California “is facing a budget deficit this year of about $40 billion, which is roughly equivalent to 2% of the state’s $2 trillion economy (GSP). That’s”, he says, “dismal.”
At that display of stoic calmness, I held aloft a shot of tequila and toasted his amazing serenity in labeling California’s $40 billion budget deficit to be merely “dismal”, mostly because there are less than 100 million workers in the entire private sector of the US, and this $40 billion represents $400 for each and every one of us private-sector workers in the Whole Freaking Country (WFC)!
My voice a sudden peal of thunder, I shout, “In the Whole Freaking Country (WFC)!”
Immediately, I thought Mr. Fry’s eyes would glaze over in one of those, “Oh, hell! The Mogambo is yammering about something and he never shuts up!” expressions of disrespect and outright loathing, but instead he decided to just change the subject, and with that, he left this global hemisphere, and went to Greece, completely on the other side of the globe!
As my brain skidded to a shuddering stop at the sudden change of vector, he went on, “But over on the Mediterranean, Greece’s budget deficit is on track to hit $50 billion, which is a very big number for an economy that is one fifth the size of California’s. In fact, that’s a horrific number.”
At this point, I think that vomit, tinged with blood, coming out of my mouth and crapping all over myself in pure terror about such financial calamity speaks more eloquently than mere words allow, and Mr. Fry filled the sudden void with, “What’s more, Greece’s accumulated debt totals $443 billion – a whopping 113% of GDP.” Gaaaahhhh!
So, to distract both you and me from any acts of hysteria caused by such fiscal insanity, I ask you the following question, that will constitute 40% of your final grade: “If you were the prancing, preening, know-nothing, government-leech blowhard who wanted a shot at fame and glory by fixing what cannot be fixed, with lots and lots of other people’s money, while paying yourself and your friends handsomely, what would you do?”
Well, since this constitutes 40% of your final grade, I decided to get a little help to make sure I knew the answer, and I emailed Mr. Fry this very question. Either he did not know, or he just rudely decided not to answer either my original email or the follow-up phone call where his stupid answering machine said that he was “not available” and that I could leave a message “at the beep” and that he would call me back, which I did, and where I said, quite plainly, so there would be no mistake, “Call me back, and if I am not here, keep calling me and leaving messages proving that you called, or I’ll kick your butt, Fry! I’m not kidding!”
Well, whether or not this means anything, he does seemingly answer the question when he writes, “Well, the correct answer is the pricing of credit default swaps (CDS) on 5-year bonds from California and Greece. (Simply stated, a CDS is an insurance policy against default. The higher the CDS price, the higher the cost of the insurance).”
Of course, I understand none of this because I am tragically stupid, pathetically ignorant, am too lazy to do anything about it, and thus totally disinterested in the whole concept, which means that it all sounds like gibberish to me, especially since the bottom line is always the same; losses are on the books, somebody is going to have to take the hit.
Fortunately, mastery of such complexity is unnecessary for me, as I just buy gold, silver and oil, which will benefit mightily as the government and the Fed ruin everything with their deficit-spending of more and more fiat money. Whee! This investing stuff is easy!
Calm in the Face of Fiscal Insanity originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”
The net neutrality debate is festering like a tropical storm still out at sea although no-one seems to define net neutrality with FCC net neutrality legislation. Technological advancements have served to hasten distribution or both physical and intellectual goods which have provided the foundation for humanity to build their economies upon. From ‘roads of rails’ in 1550 to the invention of the pressure cooker in 1679 to the driving of the golden spike at Promontory Summit in 1869 there has been a relentless advance of technology to connect the world and it has shaped it economically, politically and legally.
From contract to tort to property law the railroads left an indelible stamp on American jurisprudence as they advanced and because of the tremendous natural endowment of the land of plenty, America, has presided over the most materially prosperous era of history. And the impact the railroads have had on humanity pale in comparison to the effect of the four decade old Internet. As H.R. 3458 Internet Preservation Act of 2009 and others show, the rules are still being written.
The Internet has already resulted in the most advanced monetary evolution the world has ever seen. From credit cards and cell phones to stock exchanges and ecommerce; from New York to Karachi and Frankfurt to Shanghai everyone has been impacted. And the surface has only been scratched with the most exciting advancements still in the future to be adopted like Apple’s iPad, digital gold currency, and other science fiction dreams of ancient year.
The net neutrality pros and cons which shape the debate are more complex than simple soundbites. In January 2009 I attended a presentation about disambiguating net neutrality. To provide a solid overview for you I invited the presenter, Jeff Turner, to prepare a guest post (Any persuasive views are his own and do not represent RunToGold’s position).
NET NEUTRALITY DEBATE:
PRACTICAL OR POLITICAL?
Over the past several months, I have spent time in Washington D.C. attempting to better understand the participants and issues at the center of the net neutrality debate. As in many Washington debates, while both sides are passionate about their positions, the challenge is to separate rhetoric from core concerns and identify specific areas where common ground exists as the basis to establish a consensus driven solution. Since reasons to be against net neutrality are not limited to within domestic boundaries, solutions designed to address net neutrality should work anywhere in the world.
This article seeks to engage commercial interests and public interest groups worldwide in meaningful discussion and work toward achievable consensus on “net neutrality” and “reasonable network management” practices. Achieving consensus definitions to these key terms is the first step in the process of arriving at workable solutions amongst all parties – domestic and international.
DEFINE NET NEUTRALITY
Internet neutrality attracts a wide spectrum of positions, from the more extreme and controversial, to the moderate that advocate reasonable practices through industry self-restraint or group consensus, which could be a starting point for consensus amongst Internet Service Provider (ISP) and public interest participants. Therefore, to define net neutrality or at least that portion being discussed is essential for there to be meaningful dialog in the net neutrality debate.
NET NEUTRALITY REGARDING PHYSICAL DEVICES
To help define net neutrality, the right side of the diagram above, depicts the broad agreement that exists to reaffirm a consumer or business’ right to connect an IP-based (i.e. IP as in Internet TCP/IP protocol) device to a wired or wireless network. In addressing the right to connect an IP device to the network, I take no position on concerns raised regarding any specific relationship and/or offering between a carrier and device manufacturer for example, between AT&T (T) and Apple (AAPL) – and whether such relationship or offering constitutes a violation of device exclusivity net neutrality principles.
This discussion’s focus is solely on IP-based connectivity and does not address ancillary wireless services that involve specific wireless carriers, hardware makers, or other value-added services above that Internet Protocol (IP) layer (this is not to say that wireless IP-based connectivity cannot or should not fall under the model). Communication services that offer IP-based connectivity should clearly allow for any IP-based device to access the Internet via a wired or wireless connection.
Therefore, a sustainable broadband solution need not address value-added relationships (e.g., the iPhone or new iPad) or specific carrier partnerships. Instead, our main focus is on preserving IP connectivity for end-to-end services across the network. When the diagram says any device on the network, we infer that any IP-connected device can access other IP-level services on the other side of the network.
NET NEUTRALITY PRICING
Continuing to define net neutrality, reading to the left, pricing transparency refers to giving consumers greater information and clarity regarding their service beyond providing more definition of “up to” speeds. For example, advertisements promise 10 Megabit per Second (Mbps) broadband services for consumers’ homes or offices. Yet, descriptions of the actual speeds contained in terms of service typically reveal why, in most cases, these connections represent “up to” speeds.
These “up to” speeds result from many homes and businesses that share an upstream connection to the Internet’s backbone networks, while also sharing downstream 10 Mbps connections all through a much smaller link with limited bandwidth. Under these network realities, American households and small businesses cannot possibly receive 10 Mbps everywhere, all the time, irrespective of what “up to” speed the broadband ISP represents in its marketing.
Therefore, the typical consumer or small business rarely receives the “advertised” 10 Mbps connection directly to the Internet, since the connection is shared amongst many in a neighborhood or region. This network configuration is actually similar to the old phone system, where many households and businesses shared common network equipment that supported the basic telephone.
While many consumers typically shared these phone connections, a high degree of reliability existed in getting a dial tone and making a call whenever you picked up the phone. This superior reliability is due in large part to the engineers who designed and operated the network based on the fact that every person would not make calls at the same time. To design the properly sized network, however, they used complex statistical models to predict peak call loads and call duration on how telephony connections were statistically shared.
NET NEUTRALITY LACKS AN ERLANG MODEL
The difference between the phone system and the Internet lies in the fact that an “Erlang model or formula” existed for the phone system. The Internet, however, lacks a similar formula because no stable and reliable statistics exist by which ISPs can easily ascertain how much capacity they must offer in order to guarantee objective measures for service quality and provide a customer experience that meets or exceeds expectations.
In the telephone network, it is commonly known that “Mothers Day” is the typical peak load period for use by residential consumers. During this day, calling volumes above the statistical norm would often result in higher rates of a lack of dial tone or blocked calls. Similarly, broadband networks can also be overwhelmed both on a daily and during certain peak usage hours. Without an Erlang formula for broadband, there is no way to quantitatively measure the broadband consumer’s quality of experience for the variety of applications they consume.
Achieving service transparency in the broadband world will require some form of statistical certainty. Any advertised residential or commercial Internet service offering should have a statistical probability. Formulating greater statistical certainty becomes more challenging as broadband networks become more tiered and manage.
NET NEUTRALITY AND BANDWIDTH HOGS
For example, there are certain applications, such as peer-to-peer (P2P), which may be throttled back during periods of congestion so that other users do not receive a degraded experience. Given these challenges, both consumers and the industry require specific proposals for offering quantifiable metrics for transparency under tiered (or network managed) service offerings.
We should encourage industry and public interest groups to support integrating simple best-effort transparency metrics with a more sophisticated tiered approach. Industry and public interest groups have recently been making good progress in this area and are attempting to reach consensus on how best to inform and represent the broadband consumer data and information on what they are purchasing in terms of performance, reliability, and application compatibility.
FCC NET NEUTRALITY LEGISLATION AND DISCRIMINATION
In addressing these issues, the topic of non-discrimination creates greater challenges– particularly in the context of the FCC net neutrality legislation such as FCC’s NPRM’s paragraph 106. Traditionally, non-discrimination refers to offering a customer the same rate, terms and conditions that was previously offered to a similar (e.g. residential or commercial) customer. During the net neutrality debate, certain proponents advocating FCC net neutrality legislation and regulation appear to conflate non-discrimination with a ban on access tiering.
FCC NET NEUTRALITY LEGISLATION AND ECONOMICS
How do these two issues with FCC net neutrality legislation overlap in the net neutrality debate when parties presume that the broadband networks and Internet in general will, going forward, remain “flat” under a best-effort service model? If broadband networks remain “flat” and no form of tiered (or network managed) services exist, then some would consider it discrimination if an application service provider (e.g. website operator) were to pay for enhanced or prioritized service to “speed up” one website over another.
Some FCC net neutrality legislation advocates have encapsulated this notion in a sound bite that it would be “unfair for some web sites to receive preferential treatment to reach consumers over others due to special behind-the-scenes business deals struck with their broadband providers.” However, the sound bite is inaccurate because site operators do not typically buy service directly from a broadband ISP.
In fact, they host their content at some data center, which, in turn, purchases bandwidth from another ISP that ultimately reaches the consumer’s broadband network. Only firms with significant IP traffic, like Google (GOOG) or Microsoft (MSFT) have direct service agreements with broadband networks.
On the other hand, small website operators that seek to distribute video from their sites typically buy content delivery network (CDN) services from providers such as Amazon (AMZN), Akamai (AKAM) or Limelight (LLNW). Those CDNs save costs in terms of bandwidth in addition to offering better performance due to the anomaly (or some might say “bug”) in the way the TCP protocol works over shorter latencies on the net today.
The average peer-to-peer downloads, whether the Superbowl, feature-length movies or Linux distribution consumes an enormous amount of bandwidth that can take hours if not days. During that period, a consumer initiating this type of peer-to-peer download would consume the existing limited bandwidth and would interfere with a neighbor’s web surfing experience.
NET NEUTRALITY DEBATE
The core issue is not whether speeding up one website over another is discriminatory, but rather how to offer service levels appropriate for different types of applications.
All consumers are entitled to receive their desired quality of experience for each application they wish to use via broadband. Does it not make sense that consumers may demand differing quality of services depending on the application, like watching the Superbowl live as opposed to reading email?
Neutral third party standards are a mechanism that can be implemented as a foundation to establish “non-discriminatory” tiered, managed networks, with bedrock rational industry practices that advance non-discrimination across all tiers of service. These practices must work hand-in-hand with the pricing and service level policies so that consumers and website owners alike are informed more transparently of their levels of service. By offering hard metrics for each application’s service level, and insuring that those metrics are reported via a neutral third party, the Internet’s current best-effort delivery model can bolster an objective means to prohibit discrimination.
NET NEUTRALITY PROS AND CONS
Many advocates for “keeping the net neutral” argue against byte metering or bandwidth caps. Some contend that if cable or telephone companies, for instance, could set overly low or restrictive limits on the amount of data consumed, then these same companies could directly encourage their subscribers to stick with their ordinary broadcast television service instead of seeking other competitive “over the top” Internet video offerings.
As industry analyst Colin Dixon recently pointed out with regard to Netflix (NFLX), bandwidth caps would “kill the[ir] streaming business overnight.” Caps, particularly small ones, as proposed by Time Warner cable last year, could represent a barrier or delay to pervasive Internet video adoption.
Countries like New Zealand and Australia already charge by the byte when it comes to Internet usage. The Internet consumption patterns in Australia and New Zealand of broadband applications is quite different from the rest of the world. Economics guide behavior and behavior guides culture. Since Internet video streams and files tend to be quite large the users tend not to consume as much.
Arguments against best-effort usage bandwidth caps or charges come fundamentally down to economics. Wired broadband and wireless networks both share the characteristic of having high fixed capital cost outlays with the traffic flowing across those networks having little to no incremental cost of operation.
Therefore, some net neutrality proponents make the case that charging for best-effort bandwidth under ordinary peering and transit agreements and infrastructure simply takes advantage of the consumer. However, charging for premium service (i.e. enhanced or prioritized such as being able to watch the Superbowl live in HD with very low latency) service might make sense since it involves deployment of new infrastructure and higher ongoing operational costs to guarantee those services.
DEFINE NET NEUTRALITY: ACCESS TIERING
Another area where we need to define net neutrality is with access tiering deserves a more detailed description of what it means and an explanation of how it has been conflated with some of the other network neutrality concerns. Some economists, most notably Hal Varian and Jeffrey Mackie-Mason, have done a substantial amount of work on the potential extraction of “monopoly rents” (i.e., higher prices) by carriers providing networks with access to subscribers. Thus the term “access network” describes networks with broadband or “last-mile” connections to consumers. “Tiering” refers to charging for different grades of service in order to reach those subscribers.
Speaking in broad terms, there are three pervasive viewpoints on the issue of access tiering.
- First, some economists argue that access tiering would harm the Internet by encouraging broadband and wireless network providers to promote congested networks in order to extract “monopoly rents.”
- Second, other economists argue that there has been no demonstration of harm to consumers or bandwidth buyers under the Internet’s current peering and transit regime. These arguments and econometric models that have been developed over the years do not reflect industry realities.
- Third, yet more economists, that must breed like rats, regard access tiering as a potentially harmful practice that may require regulation in the future; however, until economic harm has been demonstrated, they believe that proscriptive ex ante regulation via the FCC or congressional action is not warranted.
Access tiering appears to be the core issue of debate amongst the two opposing net neutrality camps. There are those that wish to push for a ban on access tiering prior to demonstration of monopoly rent extraction and those who either do not believe it is an issue or feel it should be dealt with on a jurisdiction by jurisdiction basis.
The issue, furthermore, has become tightly intertwined with the verbiage surrounding non-discrimination, transparency, network management practices, and tiering. The Internet is vastly different from telephony and today it is lightly regulated under Title I of the Communications Act. Hence, one of the key regulatory challenges is how to modernize the language used to define these concepts and shift focus to the technical realities that exist in today’s Internet using the Commission’s existing regulatory framework. The process to address some of these initial issues has already started within key groups and organizations including the FCC.
DEFINE NET NEUTRALITY: TIERING OR NETWORK MANAGEMENT
When they define net neutrality, some net neutrality advocates seek to ban or disallow tiering or network management. Advocates such as Timothy Wu and Susan Crawford have, in the past, taken a rather hard line.
Their philosophical position is akin to the argument that cities, counties, and states should be required to ever increase the width of their highways so as to ensure that traffic, even during rush hour, can move at some minimum acceptable speed.
Under this philosophy, “diamond lanes”, “truck lanes”, and toll-booths are inherently unfavorable to the common good. The Internet, as a whole, should be a managed public good whereby those traffic engineering standards are in place so that any new application or service can be on a level playing field with all of the others.
The goal in the net neutrality debate then seems to ignore the rather simple fact that the Internet is a network of networks which are all independently operated by cooperating and competing business interests. Thinking of it like a socialized interstate highway system is simply not apropos. In addition, certain applications do place different requirements on the network. Some applications require extremely low latency and packet loss, like gaming, digital gold currency payments or the Superbowl, while others can more robustly accommodate widely varying congestion conditions, such as email or text browsing.
In my opinion, a third party, comprised of various members of the entire Internet ecosystem, is needed to marry the new and proposed rules of the road with the technical realities of the Internet and its surrounding consumer marketplace. By allowing the competing and cooperative business, academic, and governmental interests who all operate their own portions of the Internet to have the freedom to innovate and improve Quality of Service (QoS) standards while experimenting with different business models, the Internet will continue to flourish with a whole new set of opportunities through entrepreneur spawned innovation.
RECONCILING TRANSPARENCY AND NON-DISCRIMINATION
The most controversial issue for both sides of the net neutrality debate is access tiering. This calls for a neutral party to begin the challenging process of creating a governance body that can effectively deal with the remaining issues of application compatibility, pricing, transparency and nondiscrimination.
This body must remain neutral on the policy issues related to the access tiering economic model, no matter which framework or frameworks emerge globally. Today, Inter-Stream has the unique opportunity of establishing a process for self-regulation and the development of a global brand enabling all market participants to support their business interests while also supporting new entrants to innovate in ways yet imagined.
Principal & CTO
DISCLOSURES: Long physical gold, silver, platinum, GOOG, MSFT with no interest in AMZN, AKAM, LLNW, T, AAPL, NFLX, or the problematic SLV, Streettracks Gold ETF Trust Shares or the platinum ETFs.
Savvy telecom startup Wind is hiring Canadian talent while its rivals cower.
Telecom service provider Wind Mobile slipped into Canada’s wireless scene determined to gain every strategic advantage it could over the country’s telecommunications giants.
Last year — mostly through online social networking sites – Wind spread the word that it was hiring. Within a year, the company had targeted and recruited more than 700 employees.
Many larger firms have been lax in retention programs in the past several years, betting that economic conditions would not result in unwanted employee departures. “We have hired some ninja engineers from the competitors … I know for a fact that we have got some very sharp talent from the incumbents,” said Wind Mobile chief executive officer Ken Campbell. Campbell argues that staffing a brand-new company in a field where top techies and first-rate customer service people are in high demand, becomes a much easier task in a down economy.
Wind offers competitive pay, stimulating work and professional development opportunities. Campbell’s firm has a Toronto waterfront headquarters and is the brand name under which Globalive Wireless Management Corp. is now selling its wireless services in Canada.
“The scope and flexibility we give them as a startup is just so much more interesting than what you would get at a larger company. We just have to, because we are small and we have to be agile,” says Campbell.
Many times during economic downturns, employees begin feeling stifled, under-compensated and unchallenged. It is precisely then that they become much more open to other offers — even with a riskier venture.
If large organizations fail to adequately plan for tightening labour markets, they can lose out on employees with the required skills, which dampens their future growth prospects. Those losses are usually a start-ups gain…
Wind human resources vice-president Christina Sanders, who previously worked at Magna International Inc. and Virgin Mobile Canada, said Wind’s employees come from “all sectors and hail from all parts of the world.” What they have in common, she said, is “the right attitude, flexibility, entrepreneurship and passion,” Ms. Sanders said. “For people who are in telecom, this is a very exciting time.”
You may remember last March that we said that successful entrepreneurs know that strong firms retool their businesses during lulls in business cycles and that many well known firms were born during recessionary times. Most serially successful entrepreneurs use these lulls as opportunities to borrow, invest, and grow their business model. They know that when markets return, their businesses will be the ones much better equipped to take advantage of the return to strong demand.
Some say that small businesses are not presently hiring. But Wind Telecom — and many other small start-up firms operating in stealth mode right now — know better.
The Eurozone’s current problems are not mainly a result a of prolifigate and reckless spending of government resources in the Eurozone periphery . Even nobel laureate Paul Krugman has begun to forcefully push this argument arguing that the real source of the malaise is the steady build up internal Eurozone imbalances. I only conditionally agree. As I have argued on several occasions, the key to understand the current situation in the Eurozone is to see the connection between the obvious inflection point reached in the context of the public debt/deficit and the need to correct through an internal devaluation (relative price deflation). The main point is then to recognize that the while the former is definitely a prerequisite for the latter, the process itself (deflation) will only serve to intensify the short term and long term pressure on public finances.
Moreover, the recent flurry in the context of interest rate swaps used by the Eurozone (and other) governments to generate current assets for future liabilites in an effort to massage public deficits only serves to add a further layer of confusion and uncertainty to the fiscal aspect of the situation. More generally, and ever since the inception of EMU the growth and stability pact (SGP) has been critisized for being an ineffective tool to police the need for fiscal soundness in the Eurozone member countries. The re-emerging discussion on on the use of interest rates swaps and other financial instruments by Eurozone member countries only further serves to emphasize this critique. Interestingly and despite the rather massive coverage, many financial market pundits have emphasized this as a non-event because the use of such techniques are not new . I respectfully disagree that this is the main point here even if I agree that the there is no reason, in particular, to point the guns at Goldman Sachs  either.
In this way, I think this is in fact quite significant, and I am a bit surprised to see that no-one (bar my regular complice) seems to be getting the main drift here. This is consequently not a question of creative accounting by part of Eurozone debt management offices, but simply a question of drastically poor balance sheet management. Thus, one wonders where we would have been today if these people had actually studied the nature of assets and liabilities of the institutions (i.e. (macro)economies) they were employed to safeguard and how it is affected by things such as a population ageing and the demographic transition rather than studying more or less exotic financial instruments (click on picture for better viewing).
Oh well and before I turn completely Neanderthal on you I am obviously being unfair here. There is nothing wrong with an interest rate swap itself and anyone with even a basic economic intuition can see the clever and sound proposition offered by an interest rate swap in the context of debt issued in foreign currency while your liabilities, obviously, remain in domestic denomination. This would be good balance sheet management then.
What transforms it into poor debt management and essentially poor governance is when those same currency swaps are entered at an exchange rate which is unfavorable to the private market counterparty. The immediate effect is to create a lump sum transfer of funds to the issuer of the underlying debt (e.g. Greece). This is then used to bring down the running deficit or the public debt for the purpose of reducing interest rates. However, it also creates a future liability not recorded in the balance sheet. Felix Salmon provides the best no-nonsense explanation I have seen so far;
How might a deal like this work? Let’s say that Greece issues a bond for $10 billion, which it would then normally swap into euros at the prevailing interest rate, getting $10 billion worth of euros up front. In this case, it seems, the swap was tweaked so that Greece got $11 billion worth of euros up front — and, of course, has to pay just as many euros back when the bond matures. Essentially, it has borrowed $11 billion rather than $10 billion. But for the purposes of Greece’s official debt statistics, it has borrowed only $10 billion: the extra $1 billion is hidden in the swap.
So, why might this be a problem then? Well for a whole host of reasons, but I can think of one in particular.
Essentially, the future liabilities (and assets) of the state finances of Greece, Italy and all other sovereign states ultimately hinges on the demographic transition. At least, this is the case in developed economies where societal structure is largely built upon intergenerational contracts and various forms of pay-go pension and health systems. In this way, trading liabilities into the future for a short term cash flow concretely helps to undermine already eroded public finances. But it gets worse. It creates a mismatch on the balance sheet of the government which is effectively hidden from the market and other stakeholders. More worryingly is then the fact that while these swaps imply long term lump sum liabilities such liabilities can easily be discounted to the present and in the current context with bond vigilanted at large fixing their gaze on the Eurozone sovereigns, long term liabilites may soon turn into current ones if push comes to shove (i.e. this is then what the Titlos affair is all about). This naturally directly undermines whatever credibility the SGP had left, but it also effectively adds uncertainty to a situation which is already beyond difficult for the EU and the Eurozone to handle.
Now, at this point all this is obviously water under the bridge and what is really left now is to slowly but surely try to figure out the extent of the liabilities Eurozone governments have swept under the carpet. As noted, the maturity structure on such instruments mean that while they are not set to payment in the immediate future the implied future liability and its effect on the current stalwart attempts to breathe life back into these economies is likely to make all those neat recovery plans drafted so far worth next to nothing. I would hold this to be particularly true in light of the obvious fact that this is not only something done on the sovereign level, but also on lower levels of governance. It will be interesting indeed to see whether the bond vigilantes will draw the final gasp on this one.
The Right Lesson
At the end of the day the issue of interest rate swaps and other derivatives used by public entities to hide and mask debt is likely going to pass over quickly exactly because it is, as the current choir sings, not news. I understand this dynamic of the market discourse. However, this should not deter a simple macroeconomist from drawing out a longer line of thought.
In this way, I believe that if the Eurozone is going to have a credible future on the back of this mess, it must be equipped with institutions that adamantly establishes a much tighter fiscal coordination mechanism among its member economies. The flurry described above only serves to accentuate this furhter. The SGP should thus be relegated to the eternal dust bin of poor institutional setup where it deserves to be
The idea of a common monetary union was always flawed in a number of ways, but there is also a way forward. Yet, it requires I believe a much more transparent fiscal supranational body to complement the single monetary policy wielded in Frankfurt. Naturally, this will not solve any of the looming problems in the context of how to get and sustain growth faced with a demographic transition locked in towards very rapid ageing. However, it may provide a sound institutional setup on which to start building a future more solid economic edifice.
Many will recoil in horror from this blatant political and Eurofederalist argument. Let them recoil I say, but as an economist I see no other alternative. And that, contrary to blaming Goldman Sachs or emphasizing the fact that it is not news, is exactly the right lesson to draw from an obscure tale of obscure interest rate swaps.
 – Someone please look at the future liabilities of Germany!
 – See an original source here, this from FT Alphaville, as well as this which is the original academic piece detailing the issue in an Italian context.
 – Who has been under much scrutiny by part of the Eurozone finance ministers in the context of a particular swap arranged with Greece back in February 2009 under the notional name of Titlos PLC (all this is very wonkish!).
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Two key reports this week continue to indicate that the manufacturing sector continues its strong rebound from a year ago.
On Tuesday, the Empire State general business conditions index jumped nearly 9 points to 24.91 — a reading that indicates substantial month-to-month acceleration in the region’s manufacturing conditions. New orders, at a level of 8.78, and shipments, at 15.14, are both solidly indicating month-to-month expansion. January’s readings were unusually strong relative to December.
Then on Thursday, the Philadelphia Fed’s manufacturing regional index came in at 17.6, indicating month-to-month growth. The level came in above January’s 15.2 level to indicate an accelerating rate of growth — like the Empire Index. Of particular note were new orders which really accelerated this month coming in at 22.7 in February vs. January’s 3.2. Shipments also accelerated to a level 19.7 vs. 11.0 in January.
Both reports point to another month of strength for the ISM’s national manufacturing report to be released on March 1. All three will likely mean accelerated GDP growth in Q1 2010.
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GDP releases are, by nature, lagging indicators and thus do not say a whole lot on the current momentum in the economy. Moreover, the immediate attention span when it comes to the Eurozone remains, and rightly so, focused on the situation in Greece (and Spain) and what plan exactly that is to emerge from the busy meething schedules of Eurozone and EU finance ministers and heads of states. Yet, GDP remain the basic economic output figures we have and with the Q4 2009 GDP print we are able to put an interim conclusion  on an abysmal 2009, but more importantly also on a recovery which just do not seem to be materialising much to the chagrin, I am sure, of Eurozone policy makers (click for better viewing)
Color me smug but I, for one, am not surprised to see that France is all over this reading and basically it is thanks to France that the Eurozone is seeing growth at all. I would venture the claim that this is the beginning of a trend. In terms of the figures, the Eurozone (EU16) grew 0.1% from Q3 when the economy pulled out of recession by growing 0.4% qoq. The figure was primarily held down by continuing contractions in Greece and Spain (-0.8% and -0.1% respectively) as well as of course the stagnation in Germany where the growth rate was flat at 0% qoq after a strong showing in Q3. In Italy, the strong rebound in Q3 GDP at 0.6% qoq was somewhat given back in the form of a -0.2 contraction in Q4.
Year on year, Eurozone output fell by 2.1% with Germany, Greece, France, Spain, and Italy contracting 2.4%, 2.6%, 0.3%, 3.1 and 2.8% respectively.
The biggest losers with respect to national output remain Spain and Greece who, in volume terms over the quarters, have lost 4.8% and 2.4% respectively worth of GDP since the third quarter of 2008. Yet, the rest, save France, do not seem to be able to take up the slack for the these two hitherto sources of demand. The Economist pinpoints the order du jour quite adequately;
The main problem is a familiar one: consumers within the euro zone are not spending enough and the strong currency is making it hard to tap demand in the rest of the world. The best hope for a home-grown stimulus is Germany, where firms and consumers had practised thrift when the rest of the world indulged in a spending boom. Sadly Germany still relies too heavily on exports. Consumer spending and investment both fell in the fourth quarter and were it not for a boost from foreign trade, the German economy would have shrunk. This week Axel Weber, the head of Germany’s central bank, gave warning that cold weather could mean that GDP falls in the current quarter.
Other countries are tapped out. Spain was once a rich source of internal euro-area demand but its consumers are now weighed down by debts accumulated during a long housing boom. The unemployment rate is perilously close to 20% and its rigid jobs markets mean it is unlikely to come down soon. Bond-market pressures mean Spain’s government is having to withdraw some of its support to the economy sooner than it would like. The wonder is that Spain is not in a deeper funk. GDP fell by 3.1% in the year to the fourth quarter, not much worse than in Germany.
Basically, this is like a relay race where the change of baton has gone horribly wrong. Consequently, we were supposed to see a rebalancing of intra-Eurozone growth whereby the consumers of Spain, Greece etc were given a much needed break with those of particularly Germany taking over. This has not materialised and while France is still standing strong it is hardly enough to propel the entire Eurozone economy let alone its export dependent economies growing rapidly in number. I have argued several times that this exactly is now set to be an enduring feature of the Eurozone as an economic entity which of course makes it even harder for those intra-Eurozone imbalances to be resolved in an orderly manner.
Additionally, Eurozone growth or the lack of an even more catastrophic contraction in some member countries is still driven by large fiscal deficits. In this way, it does not take much economic intuition to see that if 2010 is set to be the year of the big fiscal scare (in a global context) the natural and inevitable retrenchment of fiscal deficit spending is going to reveal, in all certainty, just what the underlying growth momentum is. Personally, this is where I think the biggest negative surprise will come in terms of overall activity measured by national output.
More generally something, naturally, has to give here and according to the FT’s Martin Wolf, Germany needs to return the favor as he puts it, or more specifically; the Eurozone needs German consumers.
(…) Germany was able to offset extreme domestic demand weakness with robust external demand, from both inside and outside the eurozone. Indeed, as much as 70 per cent of the increase in Germany’s GDP between 1999 and 2007 was accounted for by the increase in its net exports.
Germany needs to return the favour. More precisely, the only way for eurozone countries to slash huge fiscal deficits, without their economies collapsing, is to engineer another private-sector credit bubble or a huge expansion in net exports. The former is undesirable. The latter requires improved competitiveness and buoyant external demand. At present, none of this is available. It is difficult to regain competitiveness when the euro is strong, partly because Germany is so competitive, and eurozone inflation also so low.
This argument is similar to one Mr. Wolf made recently on Japan and in the context of which he and I had a tête-à-tête on just what the possibilities are for Japan’s economy and its consumers to stage a recovery driven by domestic demand. My argument and beef with Mr Wolf is the same here. Thus, it is not because I think that Wolf is wrong and certainly not because I cannot see the fundamental need for Germany to attempt a rebalancing of its economy. However, the key question here is not what Germany needs to do, but whether it is feasible to expect Germany to pull forward the Eurozone through growth in domestic demand? I think it is not and I think you need to take a long hard look at the increasingly ageing German population and how this feeds into the ability of the economy to generate growth based on domestic demand.
Yet, as Martin Wolf adequately pointed out to me during our bataille on Japan that argument hardly brings anything to the table in terms of solution. I concur that it does not in the state that I present here. Yet, the consequence of the argument (and thus in some sense the solution) is very clear I think. If the Eurozone before the financial crisis had economies that were able, or who were allowed/pushed onto an unsustainable growth path where domestic demand/credit flourished it does not have these economies anymore (save perhaps France). It follows logically from this that while Germany (and Italy) was the main export dependent economy in the Eurozone before the financial crisis, the whole Eurozone is now effectively dependent on exports to grow. Notwithstanding the Economist’s point that this means the recent weakening of the Euro is actually a blessing, it also provides a very important perspective to the discourse on the global imbalances and how to unwind them.
It is all about the Eurozone at the moment of course and not so much about the Q4 reading but more fundamentally about the Eurozone/EU itself in the wake of the growing economic crisis in Spain and most notably Greece. My good friend Edward Hugh is pretty much pushing forward the discourse at the moment (on Spain and in general) with his recent piece in La Vanguardia (in Spanish!, see also this) as well as his amusing yet important post on Chart Wars featuring as prominent a cast as the recent economics nobel laureate Paul Krugman and the Kingdom of Spain itself. Meanwhile, in a different media another good acquaintance of mine, Jonathan Tepper from Variant Perception, has an interview on the economic situation in Spain which is also much worth a look. Finally, I had a piece this week on the Guardian’s Comment is Free edifice which got a host of interesting comments.
So, enjoy reading!
 – We don’t have a detailed break-up yet on country and Eurozone wide level.
Earlier this day, I came across Moody’s Misery Index (link) which estimated the size of macroeconomic difficulties in European countries. In particular, European countries within and outside the Eurozone are likely to face stagnant GDP growth rates, high unemployment rates, deflationary pressures and a depressing fiscal outlook.
Moody’s Sovereign Misery Index
Source: FT Alphaville (link)
The most problematic European countries seem to be the peripheral edge of the Europen Union – Greece, Spain, Portugal, Slovenia and Italy. Greece, Portugal and Slovenia are small economies without very much effect on the European GDP dynamics. However, the size of Spain’s and Italy’s economy is large enough to be able to exacerbate significant effect on GDP dynamics within the European Union and the Eurozone.
Debt-to-GDP ratio in selected countries
Source: Market Oracle (link)
Spain topped the Moody’s Misery Index due to the highest estimated unemployment rate for 2010 and a whopping fiscal deficit. Where’s the trouble? As I wrote earlier (link), prior to the outbreak of financial crisis, Spain had a favorable fiscal outlook in 2006 and 2007 and an unfavorable current account balance . In 2007, Spain experienced a 10 percent of the GDP current account deficit largely due to net capital inflows from surplus countries such as Germany and Netherands. These net capital inflows further inflated asset prices, causing an outburst of asset bubble. In the mean time, asset price inflation escalated and real estate price index soared. Government’s remaining choice was to push for a fiscal surplus to avoid the inflationary shocks. When the bubble turned into burst, the shortage of external demand (in spite of favorable domestic consumption rate) caused the economy’s overcapacity and a deeply negative output gap. In 2008, Spain’s economy overheated and the output gap increased to historic highs (3.06 percent of potential GDP). In 2010, the estimated output gap is -2.12 percent of potential GDP. Due to weak aggregate demand – especially weak investment and external demand – asset and consumer prices are decreasing. As firms are reluctant to hire new labor, the result is high rate of unemployment, deflationary pressure and non-existent GDP growth. The macroeconomic situation in Spain pretty much reflects the general macro outlook for the entire Eurozone.
If the ECB decided to raise interest rates significantly, it would further depress an already weak investment activity. If ECB’s interest rates decreased further, there would be a serious danger of deflationary trap which dragged the Japanese economy into a decade long period of deflation rates, zero-bound interest rates and stagnant economic recovery. As European population is aging rapidly (as in Japan and other industrialized nations), the outlook for the European economic recovery is rather timid.
Rapidly rising fiscal deficit (link) and public debt is a permanent threat to the stability of the Euro. Of course, the best possible cure to decrease the debt-to-GDP ratio is higher economic growth and also higher rate of inflation which decreases the stock of public debt through higher price level. Europe’s real macroeconomic disease is not just low productivity growth and high tax burden but also very asymmetric economic policies. While the ECB sets interest rates for the entire Eurozone, Euroarea countries set independent fiscal policies. In addition, the appreciation of the euro hinders currency swaps into high-yield currencies. That could enable covered interest parity and the reinvestment of foreign currency back into Euro when its appreciation trend would reverse.
Asymmetric fiscal policies are likely to cause significant public debt concern if fiscal policies are discretionary. Prior to the emergence of economic crisis, half of the European countries ran discretionary deficit-financed fiscal policies. If European countries ran prudent fiscal policy based on low government spending and balanced budget, the asymmetric fiscal shocks weren’t a major problem at all. However, strong public sector, high government spending and the lack of rule-based fiscal policies pose a significant concern for the stability of the Euro.
What I propose, is not the harmonization of fiscal policy but a strong committment of European countries to limit the scope of discretion in fiscal policy. Each country should forge a prudent fiscal policy without high fiscal deficit. In addition, countries should set a medium-term perspective of public debt reduction. That would ease the problem of asymmetric shocks during economic downturns and enhance the prospects of European single currency. In addition, European countries should rigorously liberalize labor markets. The liberalization of the labor market would remove the unneccesary wage adjustment rigidities. When wages are rigid downward – especially during the recession – higher wages exacerbate a significant pressure on unemployment. And when unemployment rate is high, the demand for discretionary fiscal policy and deficit spending is very high as well.
Without the necessary liberalization of labor market and the pursuit of prudent fiscal policies, the future of Euro and the prospects of the Eurozone are not bright at all.
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Many of you have emailed us with the Organizing for America’s chart on job savings and creation since the stimulus bill was passed last year.
I’ve recreated their chart here:
We all know there is a long way to go and many Americans are still struggling to find jobs, but there is certainly cause for optimism depicted in this chart.
No doubt many of you were reminded of the chart we’ve been tracking with linear fit trending since October. Perhaps the Obama administration took note of how we presented these same facts in our earlier post!?
Thanks to all for the emails. Keep them coming.
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Paul Krugman has blogged an interesting analysis of the anatomy of the recent economic crisis in Europe (link).
Europe’s difficult macroeconomic situation in the aftermath of the financial and economic crisis has exacerbated rising fiscal deficits and public debt alongside strong deflationary pressures. These pressures were triggered by the highly negative output gap – the difference between the economy’s potential output and the real output. In fact, a brief observation of the output gap estimates (link) shows that the sick men of Europe (Portugal, Greece, Spain, Italy, Slovenia) are likely to face negative output gaps. In 2010, Spain is likely to reach -2.12 percent output gap. Slovenia, Italy and Greece will also face a negative output gap. The negative output gap triggered strong deflationary pressures since the nominal aggregate demand is insufficient, causing a decreasing price level.
Before the financial and economic crisis of 2008/2009 evolved, Europe’s peripheral economies faced strong asset price bubble. As real estate prices were soaring, these economies attracted significant capital inflows which lead to inflationary pressures. Before the crisis, the inflationary dynamics in the peripheral countries of the Eurozone were strong. In Greece, Spain and Slovenia, consumer prices increased by more than 3 percent on the annual basis. The asset bubble was further spread by low interest rates. The asset price inflation in these countries was very high. In Slovenia, five-year asset prices increased by 500 percent (see: IMF, International Financial Statistics). As the increase in asset prices widened, Europe’s sick men were faced with rising current account deficit.
In 2007, Spain’s current account deficit amounted to more than 10 percent of the GDP. In such circumstances, a clever monetary policymaker would push up interest rates. As interest rates were at historic lows during the pre-crisis period, the real cure was on behalf of the fiscal policy. Before the crisis, Spain’s fiscal picture was very well indeed. From 2004 to 2007, Spain was running a fiscal surplus which reached the level of 2 percent of the GDP in 2006 and 2007. However, massive capital inflows were not sterilized by raising interest rates which further inflated the real estate bubble and overheating of Spain’s economy.
Independent fiscal policies and a common monetary policy – which is an economic model of the EMU – cause asymmetric shocks. During the years of high growth, these shocks are mostly neglected. However, during the crisis these shocks might cause a serious trouble in the macroeconomic adjustment. Greece, which recently declared a worrisome possibility of debt default, is a typical case of what happens when asymmetric shocks persist.
As Greece, Spain, Italy, Portugal and Slovenia now face high fiscal deficits and poor economic growth, these countries will likely face years of deflationary pressures and high unemployment. The fiscal policymakers already exhausted the ability of governments to boost spending. Further growth of government spending is impossible unless European countries want the Greek debt episode to evolve in a domino effect throughout the Eurozone. The ECB will sooner or later this year raise the baseline interest rates to avoid the inflationary swings in Germany, Austria, Netherlands and other countries with current account surplus.
The macroeconomic outlook for the Eurozone is backlashed by the debt crisis in Mediterranean countries. An economic recovery may include indepedent monetary policies to adjust interest rates and prevent another asset bubble episode as well as to target current account balance. However, European countries will have to rethink the role of indepedent and discretionary fiscal policies pursued by the sick men of the Eurozone.
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