Daily Sources 1/23

1. Real Time Economics carried yesterday excerpts from an interview of European Central Bank Executive Board member Lorenzo Bini Smaghi by the Wall Street Journal's Joellen Perry. Some excerpts of the excerpts:

"LBS: ... The transmission mechanism [through which monetary policy feeds through to the real economy] in the US seems to be more impaired. You can see this by comparing the level of the policy rate with the lending rates set by financial institutions. When you compare the euro area and the US, lending interest rates are basically the same, even though in the US policy rates are near zero. This suggests that to achieve the same level [of lending rates], policy rates in the US need to be much lower. Also, cutting interest rates to very low levels is effective in inducing agents to start holding again risky assets if the central bank commits to keeping rates at such low levels for a prolonged period of time. But this strategy is very risky, because it tends to delay the exit strategy. So this strategy should be followed only if you are convinced that there are substantial risks of deflation. And I think that in the euro area right now we do not see this risk of deflation.

WSJ: The risk of deflation is lower in the euro zone than in the US?

LBS: It’s substantially lower. We don’t have evidence, from expectations extracted from financial markets or professional forecasters, that there is going to be deflation. We will see a sharp disinflation in the course of the next few months, due to base effects. But this is not deflation. Deflation is a systematic reduction of prices and wages over several years. In order to avoid deflation, it’s important that inflation expectations remain well anchored at below 2% but close to 2%. If you look at inflation expectations in the US, they seem to be lower, although that doesn’t necessarily mean that deflation is a likely scenario."

...

"WSJ: You suggested recently that governments across the euro-zone should embark on a wholesale program of broad capital injections. Have we seen enough?

LBS: The problem is that the recapitalization programs were voluntary and involved some stigma. So banks have not applied for new capital and remained undercapitalized, at least in the judgment of the markets. We should move from a voluntary scheme to a coordinated scheme and it has to be associated with a clear, aggressive disclosure of losses, which would require a coordination between governments and supervisors in Europe. Which is, of course, not easy. This is why we need a stronger European supervisory structure.

WSJ: Are the market’s concerns that a euro-zone country could default logical?

LBS: No. The fact that we observe spreads [between yields on the bonds of different euro-zone governments] is a confirmation of the credibility of the monetary union institutions: both the independence of the central bank and the no-bailout clause [a provision stipulating that European countries are not liable for one another's debts]. It’s proof that markets believe in it. On the other hand, the size of the spreads is more the reflection of the malfunctioning of the market than a realistic assessment of the default risk."

...

"WSJ: Many things people thought were irrational or highly unlikely have happened. If a euro-zone country were to default, what would the impact be on the rest of the bloc?

LBS: That’s a hypothesis we have not really contemplated. But I also think that those that consider [a country would] exit from the euro area are not understanding the implications. The cost would surely be higher than staying. It would not only be a huge economic cost because, for instance, the [sovereign] debt is in euro, so it would [likely] increase in value. It would also imply exiting from the European Union. So it is also a huge political issue. And in the end no country would be willing to face this."

Well worth reading in full.

2. Edward Hugh at Fistful of Euros reports that early estimates from Germany's Markit purchasing managers' index show it falling to 38.0 from December's 39.5 reading. A reading above 50 means growth; below 50 means contraction.

"A 38 reading on the monthly PMI is probably equivalent to something in the order of a 10% annual rate of GDP contraction (or a 2.5% quarter on quarter drop), which is, well, massive."

...

"The heavy dependence of the German economy on exports means that as demand has fallen back elsewhere so has German economic activity. Exports fell by an unprecedented 10.6% month on month in November and according to an Economy Ministry official on Wednesday they fell by another 10-11% in December."

Worth reading in full.

3. Matthew Saltmarsh at the New York Times reports that the UK officially entered a recession in the fourth quarter, meaning it has met the condition of two consecutive quarters of GDP contraction.

"The country’s gross domestic product fell 1.5% from the third quarter and was down 1.8% from the period a year earlier, the Office for National Statistics said in a preliminary estimate."

4. Daryna Krasnolutska and Kateryna Choursina at Bloomberg report that the Ukrainian President, Viktor Yushchenko, will seek to renegotiate the gas supply contract just agreed upon with Gazprom, characterizing the agreement as "capitulation." Given Ukraine's economic situation, the President is unclear on how the country can afford the cost at this point. And in a very interesting revelation, given all the analysis on this side of the pond about how the dispute was really an dispute between elites on the take about how to distribute earnings from middleman RosUkrEnergo AG, Ukrainian first deputy prime minister Oleksandr Turchynov told reporters that Ukraine has strengthened its position because the company has been removed from the supply chain. RIA Novosti reports that the Federal Statistics Service announced today

"Russia's crude production in 2008 declined 0.7% year-on-year to 488 million metric tons (9.8 mln bbl/d), while natural gas output increased 1.6% to 663 billion cubic meters."

Meanwhile, Edward Hugh at Fistful of Euros reports that Russian industrial output was down 10.3% in December, following a 8.7% contraction in November, according to an announcement yesterday by the Federal Statistics Service. Here is the graph he helpfully provided, illustrating the current downturn:

"Russia’s international reserves fell $30.3 billion last week, the second-biggest drop on record, as the central bank accelerated the rate of the ruble devaluation and sold increasing quantities of foreign currency in an attempt to manage the pace of the decline. Russia’s reserves have now fallen 34% from the record high of $598.1 billion in August while the ruble has fallen 29% against the dollar over the same period."

And the AFP reports that the Hungarian Prime Minister Ferenc Gyurcsany told reporters today that Europe must, in view of the recent Russo-Ukrainian dispute, seriously pursue the Nabucco pipeline.



Gyurcsany was quoted as saying

"We expect the European Bank for Reconstruction and Development (EBRD) and the European Investment Bank (EIB) to make a clearer commitment to pre-financing the project. This project is not purely about business but also about Europe's energy security. It is therefore vital to make sure we have resources that are backed and guaranteed by the EU."

5. Grant Smith at Bloomberg reports that preliminary estimates from Petrologistics indicate that OPEC will cut supply by a further 5% in January.

"Oil supply from 11 members of the Organization of Petroleum Exporting Countries subject to quotas will average 26.15 mb/d in January, down from 27.65 mb/d, Conrad Gerber, the founder of PetroLogistics, said today by telephone from Geneva. From this month, members have a production quota of 24.845 mb/d. Iraq has no quota.

Saudi Arabia, the group’s largest member, led the cuts, lowering supply to 8.05 mb/d in January from 8.6 mb/d last month, Gerber said. The kingdom’s new total is in line with its Jan. 1 quota."

"Iran reduced supplies to 3.83 mb/d this month from 3.85 mb/d in December. Nigeria cut to 1.76 mb/d from 2.02 mb/d. Venezuela lowered output to 1.97 mb/d from 2.22 mb/d, and Angola trimmed to 1.84 mb/d from 1.88 mb/d, according to PetroLogistics.

Iraq, exempt from the quota system while its oil industry recovers from two wars, increased production to 2.45 mb/d from 2.43 mb/d, the tanker tracker said.

Given that Iran had not made good on 199 kb/d cuts promised in the October 24 meeting, and that the December 17 agreement was for cuts to actual supply--as understood by OPEC--in September, an additional 20 kb/d cut in supply suggests that Tehran is still producing far more than its stated quota. (Whatever their actual quota might be.)

6. Robert F. Worth at the New York Times reports that a former Guantanamo inmate, released to Saudi Arabia in 2007, has reemerged as a leader of al Qaeda in Yemen. This will surely complicate the closing of the extraterritorial prison. Thomas Hegghammer at Jihadica reports that al-Qaeda Yemen is thriving, if a recent flashy 44 page glossy publication is anything to go by, and is explicitly targeting the "far enemy."

7. Jeff Stein at SpyTalk reports that some of President Obama's first public diplomacy initiatives will target South America. Obama is scheduled to attend the April 17 Summit of the Americas in Trinidad and Tobago, "which may turn out to be his international debut as ambassador-in-chief." Obama is also expected to back S 1007, a bill first introduced by Senator Lugar (R-IN) on March 27, 2007 and which passed the Senate Foreign Relations Committee on September 23, 2008. (see Daily Sources 9/30 #12.) The bill is known as the United States-Brazil Energy Cooperation Pact of 2007 and directs the Secretary of State to strengthen energy cooperation between the United States and "willing" nations in the Western Hemisphere. In particular, it directs the Secretaries of State and Energy to establish "a regional-based ministerial forum to be known as the Western Hemisphere Energy Cooperation Forum" which should include "the Governments of Brazil, Canada, Mexico, the United States, and Venezuela."

The bill also seeks to reinforce and extend the biofuels relationship between Brazil and the United States as well as asks the Secretary of Energy to

"work with the Government of Mexico to conduct a technical analysis of the status of Mexican oil and gas production, future technological and investment needs, and recommendations for maintaining and increasing hydrocarbon production consistent with the priorities of the Government of Mexico."

The bill would also create an energy industry group and oil and gas group to try and increase private sector energy engagement in the Western Hemisphere.

Senator Lugar is an éminence grise in foreign affairs circles and, though the bill does speak to his own constituency of Indiana in terms of biofuels production, it is also clearly aimed at countering Chavez's oil diplomacy in the region and it is fairly sure that Obama is picking up on that vein of the legislation, at least in part. But the other, and rather important issue that Lugar foresaw coming in early 2007, was the decline in Mexican production, which fell by a full 9% in 2008 from 2007--which was reported on the day of Obama's inauguration no less. (see Daily Sources 1/20 #13.) The full text of the bill can be found here.


8. Robert Zoellick, president of the World Bank, has an op ed in the New York Times today which argues that President Obama, in the April meeting of the G-20 in London, should send an "audacious symbol of hope" by calling on each country to devote 0.7% of their stimulus packages to a fund for assisting developing nations weather the current crisis.

"The United States could begin by pledging some $6 billion of its own $825 billion stimulus package—-just 4% of what was provided to American International Group. With this modest step, the United States would speed up global recovery, help the world’s poor and bolster its foreign policy influence."

Zoellick concludes that with less than 1% of our stimulus package, President Obama can show global leadership and "reintroduce America to the world." Worth reading in full.

9. Jeffrey Gettleman at the New York Times reports that Gen. Laurent Nkunda, the Rwandan rebel leader in eastern Congo was arrested Thursday night by a joint Congolese-Rwandan military offensive. He is being taken to Kigali, the Rwandan capital. Apparently the Rwandan and Congolese governments have struck a deal whereby Rwanda helped to put an end to the Nkundan rebellion after Congo had allowed Rwandan troops to enter Congo so as to crush Hutu militants operating there.

10. In an particularly interesting story, Blaine Harden at the Washington Post reports that Japan--bedeviled by an aging and shrinking demographic--is now seeking to get immigrant workers to stay in the country even as it faces job losses.

"[The] extreme exposure of immigrant families to job loss and their sudden abandonment of Japan--has alarmed the government in Tokyo and pushed it to create programs that would make it easier for jobless immigrants to remain here in a country that has traditionally been wary of foreigners, especially those without work.

'Our goal is to get them to stay,' said Masahiko Ozeki, who is in charge of an interdepartmental office that was established this month in the cabinet of Prime Minister Taro Aso. 'As a government, we have not done anything like this before.'"

"No country has ever had fewer children or more elderly as a percentage of its total population. The number of children has fallen for 27 consecutive years. A record 22 percent of the population is older than 65, compared with about 12 percent in the United States. If those trends continue, in 50 years, the population of 127 million will have shrunk by a third; in a century, by two-thirds. "

Here is a projected population pyramid for Japan for 2010, courtesy of NationMaster.



A must read.

11. In something I missed, but that I noticed at Clarisse's Les Carnets Des Clarisse, the Vatican decided effective January 1 that it would no longer automatically adopt the laws of Italy, per David Willey at BBC. The Vatican had, per the Lateran Accords signed in 1929, agreed to immediately adopt any law made in Rome.

"A senior Vatican Canon lawyer, Monsignor Jose Maria Serrano Ruiz, has gone on record as saying that Italian laws are too many, too unstable and too often conflict with the moral teachings of the Catholic Church."

And, perhaps more significantly,

"The Vatican has also decided to scrutinise international treaties before deciding whether or not to adhere to them."

It may seem like a historical curiosity, but the Church has a place of preeminence in Western Law, having founded the first Law University in Bologna in around 1088 AD, just 11 years prior to the first Bull of Crusade. (Of course, at that time, and well into the 18th century, all universities in the West were church institutions, at first all Catholic of course, later Protestant schools were founded, like the majority of universities found in the United States.)

Notions of jurisprudence and evidence that we take for granted today as part of the inheritance of the Enlightenment were, in fact, formed in the crucible of competing jurisdictions of the Church (or Canon) Courts, the courts of the Kings, the courts of the Lords, and custom. Indeed, the Inquisition, often considered one of the most damning moments of the Catholic Church, was primarily a court, which had different rules of evidence, because the traditional canon rules made it too difficult to ever convict anyone of heresy, though it was quite clear to Rome that heresy was taking place. Indeed, the traditional rules of evidence in canon courts are rather strict--meaning it is difficult to prove something under them--even more so, in some instances, than US Federal Courts.

So it is in that light that one could see this as an especially interesting turn of historical events. The notion that the Church might decide to retire from certain international treaties that it was, de jure, a signatory to under the Lateran Accords also might prove interesting, given that the Church still wields considerable influence--or in the modern argot "soft power"--internationally. It is something to keep an eye on.

12. George Soros has an opinion piece in the Financial Times in which he argues that a "bad bank" is the wrong way for the US to proceed.

"Although the details have not yet been decided, this approach harks back to the approach originally taken – but eventually abandoned – by Hank Paulson, the former US Treasury secretary. The proposal suffers from the same shortcomings: the toxic securities are, by definition, hard to value. The introduction of a significant buyer will result, not in price discovery, but in price distortion.

Moreover, the securities are not homogeneous, which means that even an auction process would leave the aggregator bank with inferior assets through adverse selection. Even with artificially inflated prices, most banks could not afford to mark their remaining portfolios to market so they would have to be given some additional relief. The most likely solution is to 'ring-fence' their portfolios, with the Federal Reserve absorbing losses that extend beyond certain limits.

These measures–-if enacted-–would provide artificial life support for the banks at considerable expense to the taxpayer, but would not put the banks in a position to resume lending at competitive rates. The banks would need fat margins and steep yield curves for a long time to rebuild their equity."

...

"The hard choice facing the Obama administration is between partially nationalizing the banks, or leaving them in private hands but nationalizing their toxic assets. Choosing the first course would inflict great pain on a broad segment of the population – not only on bank shareholders but also on the beneficiaries of pension funds. However, it would clear the air and restart the economy."

Soros concludes with:

"President Barack Obama can fulfil his promise of a bold new approach only by establishing a discontinuity with the previous team. Congress and the public are right in feeling that too much has been done for the banks and not enough for beleaguered householders. The government ought to take the GSEs out of limbo and use them more actively to stabilise the housing market. Having done so, it could go back to Congress for authorisation to recapitalise the banking system the right way."

Well worth reading in full.

13. Ryan J. Donmoyer at Bloomberg reports that the Senate Finance Committee’s $455 billion stimulus plan announced today would provide $30 billion in tax incentives to producers of renewable energy.

14. Keith Johnson at Environmental Capital has a post regarding the US Armed Forces efforts to secure reliable alternative-fuel possibilities. Clearly, this is an important strategic issue, as the fact that the US is a net importer of oil means that in order to secure our logistical supply line the Armed Forces are (potentially) required to project force overseas. (This requirement in and of itself makes otherwise imperialistic policies rather more palatable to the public, and thus creates another set of political problems.) The US Navy, which is substantially powered by nuclear already, on the other hand, is already ahead of the curve. But overall the Pentagon is the largest consumer of petroleum in the country--which itself is the largest consumer of petroleum in the world. However, Johnston reports that Jane's Information Group's Industry Quarterly showed that:

"The bottom line is that for all the economic and operational advantages a shift to alternative fuels could bring—from a smaller logistics burden to greater energy security—those are still outweighed at present by the military establishment’s worries about the maturity and reliability of new technology—no small concerns in combat situations."

The complications posed by batteries are preventing the implementation of alternative fuels for Army uses. But change might come in the Air Force, which apparently uses more oil than the country of Denmark. Evidently it is looking both at biofuels--and it is possible to create bio-jet fuel nearly indistinguishable from the petroleum-based kind (see Daily Sources 10/3 #10)--and coal to liquid, the solution used by the Germans in WWII, a resource of which we have the largest reserves in the world, and very, very, dirty. Biofuel, on the other hand, requires lots of arable land or cooking oil waste in order to be logistically feasible for an enterprise the size of the US Air Force, not to mention the US Armed Forces as a whole. Worth a look.

15. The Federal Highway Administration yesterday released data showing that in November, Americans drove 12.9 billion vehicle miles traveled (VMT) less in November than were driven in November 2007, a 5.3% decline.

"The consecutive 13-month trend of declining driving--between November 2007 and November 2008--now tops 112 billion VMT, compared to the same 13-month period a year earlier. It dwarfs the 49.9 billion VMT decline of the 1970s, a decade characterized by high gas prices, fuel shortages and a recession."

The data show that the South Atlantic region and the West experienced the largest declines. The South Atlantic region may in part be explained by the gasoline shortages the region saw in October. (see Daily Sources 10/2 #8.) At least, that might explain why VMT fell there more than in the Northeast, where gasoline prices are typically much higher (than the South Atlantic region.) The West tends to have the highest prices in the nation.