OECD revises World Economic Outlook forecast upward

The Organization for Economic Cooperation and Development (OECD) today revised its World Economic Outlook forecast upward for the first time since 2007, indicating that the global economic slide may be approaching a bottom.

The group revised its estimates for 2009 upward, projecting a contraction of 4.1 percent rather than the 4.3 percent it projected before, and also projected slight growth in 2010, whereas before it had projected none.

Here is the text of the OECD report.

The new OECD report coincides with meetings of the U.S. Federal Reserve’s Open Market Committee today in Washington.

A blog entry in the Wall Street Journal says the focus of the Fed’s meetings will be interest rates, how to word its statement on the economy, and the Fed’s asset purchase plan.

Read full story.

U.S. treasury secretary Geithner urges combined U.S.-China efforts to boost global economy

United States Secretary of the Treasury Timothy Geithner

Timothy Geithner, in his first visit to China as U.S. Treasury Secretary, presented a plan for the United States and China to work together to rebuild the global economy and restore growth.

In a speech today at Peking University, Geithner stressed that there is much that both the United States and China need to do to rebalance the world economy. He called for China to make its currency more flexible in exchange for fiscal reforms in the United States. He also said China would need to diversify its economy beyond relying so heavily on exports for growth, and that the United States, in return, would focus on mitigating its ballooning deficit to protect massive Chinese investments in U.S. government debt.

Chinese media focused on Geithner’s implication that China should play a more significant role in global economic policymaking. China Daily says the primary goal of Geithner’s trip, which has included meetings with several leading Chinese economic policymakers, has been to reaffirm China’s faith in U.S. dollar-backed assets and still fears that U.S. budget deficit and loose monetary policy will prompt inflation, undermining Chinese holdings of both the U.S. dollar and U.S. Treasury bonds.

Below is the text of Timothy Geithner’s speech.

***

The United States and China, Cooperating for Recovery and Growth

 Treasury Secretary Timothy F. Geithner

Speech at Peking University – Beijing, China
June 1^st, 2009

 It is a pleasure to be back in China and to join you here today at this great university. 

I first came to China, and to Peking University, in the summer of 1981 as a college student studying Mandarin. I was here with a small group of graduate and undergraduate students from across the United States. I returned the next summer to Beijing Normal University. 

We studied reasonably hard, and had the privilege of working with many talented professors, some of whom are here today. As we explored this city and traveled through Eastern China, we had the chance not just to understand more about your history and your aspirations, but also to begin to see the United States through your eyes. 

Over the decades since, we have seen the beginnings of one of the most extraordinary economic transformations in history. China is thriving.  Economic reform has brought exceptionally rapid and sustained growth in incomes. China’s emergence as a major economic force more fully integrated into the world economy has brought substantial benefits to the United States and to economies around the world.  

In recognition of our mutual interest in a positive, cooperative, and comprehensive relationship, President Hu Jintao and President Obama agreed in April to establish the Strategic and Economic Dialogue. Secretary Clinton and I will host Vice Premier Wang and State Councilor Dai in Washington this summer for our first meeting.  I have the privilege of beginning the economic discussions with a series of meetings in Beijing today and tomorrow. 

These meetings will give us a chance to discuss the risks and challenges on the economic front, to examine some of the longer term challenges we both face in laying the foundation for a more balanced and sustainable recovery, and to explore our common interest in international financial reform.

Current Challenges and Risks

The world economy is going through the most challenging economic and financial stress in generations. 

 The International Monetary Fund predicts that the world economy will shrink this year for the first time in more than six decades. The collapse of world trade is likely to be the worst since the end of World War II. The lost output, compared to the world economy’s potential growth in a normal year, could be between three and four trillion dollars.

In the face of this challenge, China and the United States are working together to help shape a strong global strategy to contain the crisis and to lay the foundation for recovery. And these efforts, the combined effect of forceful policy actions here in China, in the United States, and in other major economies, have helped slow the pace of deterioration in growth, repair the financial system, and improve confidence. 

In fact, what distinguishes the current crisis is not just its global scale and its acute severity, but the size and speed of the global response.

At the G-20 Leaders meeting in London in April, we agreed on an unprecedented program of coordinated policy actions to support growth, to stabilize and repair the financial system, to restore the flow of credit essential for trade and investment, to mobilize financial resources for emerging market economies through the international financial institutions, and to keep markets open for trade and investment. 

That historic accord on a strategy for recovery was made possible in part by the policy actions already begun in China and the United States. 

China moved quickly as the crisis intensified with a very forceful program of investments and financial measures to strengthen domestic demand.

In the United States, in the first weeks of the new Administration, we put in place a comprehensive program of tax incentives and investments ¨C the largest peace time recovery effort since World War II – to help arrest the sharp fall in private demand. Alongside these fiscal measures, we acted to ease the housing crisis. And we have put in place a series of initiatives to bring more capital into the banking system and to restart the credit markets.  

These actions have been reinforced by similar actions in countries around the world. 

In contrast to the global crisis of the 1930s and to the major economic crises of the postwar period, the leaders of the world acted together. They acted quickly. They  took steps to provide assistance to the most vulnerable economies, even as they faced exceptional financial needs at home. They worked to keep their markets open, rather than retreating into self-defeating measures of discrimination and protection. 

And they have committed to make sure this program of initiatives is sustained until the foundation for recovery is firmly established, a commitment the IMF will monitor closely, and that we will be able to evaluate together when the G-20 Leaders meet again in the United States this fall. 

We are starting to see some initial signs of improvement. The global recession seems to be losing force. In the United States, the pace of decline in economic activity has slowed. Households are saving more, but consumer confidence has improved, and spending is starting to recover. House prices are falling at a slower pace and the inventory of unsold homes has come down significantly. Orders for goods and services are somewhat stronger. The pace of deterioration in the labor market has slowed, and new claims for unemployment insurance have started to come down a bit. 

The financial system is starting to heal. The clarity and disclosure provided by our capital assessment of major U.S. banks has helped improve market confidence in them, making it possible for banks that needed capital to raise it from private investors and to borrow without guarantees. The securities markets, including the asset backed securities markets that essentially stopped functioning late last year, have started to come back. The cost of credit has fallen substantially for businesses and for families as spreads and risk premia have narrowed.    

These are important signs of stability, and assurance that we will succeed in averting financial collapse and global deflation, but they represent only the first steps in laying the foundation for recovery. The process of repair and adjustment is going to take time. 

China, despite your own manifest challenges as a developing country, you are in an enviably strong position. But in most economies, the recession is still powerful and dangerous. Business and households in the United States, as in many countries, are still experiencing the most challenging economic and financial pressures in decades. 

The plant closures, and company restructurings that the recession is causing are painful, and this process is not yet over. The fallout from these events has been brutally indiscriminant, affecting those with little or no responsibility for the events that now buffet them, as well as on some who played key roles in bringing about our troubles.

The extent of the damage to financial systems entails significant risk that the supply of credit will be constrained for some time. The constraints on banks in many major economies will make it hard for them to compensate fully for the damage done to the basic machinery of the securitization markets, including the loss of confidence in credit ratings. After a long period where financial institutions took on too much risk, we still face the possibility that  banks and investors may take too little risk, even as the underlying economic conditions start to improve. 

And, after a long period of falling saving and substantial growth in household borrowing relative to GDP, consumer spending in the United States will be restrained for some time relative to what is typically the case in recoveries. 

 These are necessary adjustments. They will entail a longer, slower process of recovery, with a very different pattern of future growth across countries than we have seen in the past several recoveries. 

Laying the Foundation for Future Growth

As we address this immediate financial and economic crisis, it is important that we also lay the foundations for more balanced, sustained growth of the global economy once this recovery is firmly established. 

A successful transition to a more balanced and stable global economy will require very substantial changes to economic policy and financial regulation around the world. But some of the most important of those changes will have to come in the United States and China. How successful we are in Washington and Beijing will be critically important to the economic fortunes of the rest of the world. The effectiveness of U.S. policies will depend in part on China’s, and the effectiveness of yours on ours. 

Although the United States and China start from very different positions, many of our domestic challenges are similar. In the United States, we are working to reform our health care system, to improve the quality of education, to rebuild our infrastructure, and to improve energy efficiency. These reforms are essential to boosting the productive capacity of our economy. These challenges are at the center of your reform priorities, too. 

We are both working to reform our financial systems. In the United States, our challenge is to create a more stable and more resilient financial system, with stronger protections for consumer and investors.  As we work to strengthen and redesign regulation to achieve these objectives, our challenge is to preserve the core strengths of our financial system, which are its exceptional capacity to adapt and innovate and to channel capital for investment in new technologies and innovative companies. You have the benefit of being able to learn from our shortcomings, which have proved so damaging in the present crisis, as well as from our strengths.  

Our common challenge is to recognize that a more balanced and sustainable global recovery will require changes in the composition of growth in our two economies. Because of this, our policies have to be directed at very different outcomes. 

In the United States, saving rates will have to increase, and the purchases of U.S. consumers cannot be as dominant a driver of growth as they have been in the past. 

In China, as your leadership has recognized, growth that is sustainable growth will require a very substantial shift from external to domestic demand, from an investment and export intensive driven growth, to growth led by consumption. Strengthening domestic demand will also strengthen China’s ability to weather fluctuations in global supply and demand.

If we are successful on these respective paths, public and private saving in the United States will increase as recovery strengthens, and as this happens, our current account deficit will come down. And in China, domestic demand will rise at a faster rate than overall GDP, led by a gradual shift to higher rates of consumption.  

Globally, recovery will have come more from a shift by high saving economies to stronger domestic demand and less from the American consumer. 

The policy framework for a successful transition to this outcome is starting to take shape.

In the United States, we are putting in place the foundations for restoring fiscal sustainability. 

The President in his initial budget to Congress made it clear that, as soon as recovery is firmly established, we are going to have to bring our fiscal deficit down to a level that is sustainable over the medium term. This will mean bringing the imbalance between our fiscal resources and expenditures down to the point - roughly three percent of GDP – where the overall level of public debt to GDP is definitively on a downward path.  The temporary investments and tax incentives we put in place in the Recovery Act to strengthen private demand will have to expire, discretionary spending will have to fall back to a more modest level relative to GDP, and we will have to be very disciplined in limiting future commitments through the reintroduction of budget disciplines, such as pay-as-you go rules.

The President also looks forward to working with Congress to further reduce our long-run fiscal deficit.

And, critical to our long-term fiscal health, we have to put in place comprehensive health care reform that will bring down the growth in health care costs, costs that are the principal driver of our long run fiscal deficit. 

The President has also proposed steps to encourage private saving, including through automatic enrollment in retirement savings accounts. 

Alongside these fiscal actions, we have designed our policies to address the financial crisis to carefully minimize risk to the taxpayer and to allow for an orderly exit or unwinding as soon as conditions permit. Across the various financial facilities put in place by the Treasury, the Federal Reserve, and the FDIC, we have been careful to set the economic terms at a level so that demand for these facilities will fade as conditions normalize and risk premia recede.  Banks have a strong incentive to replace public capital with private capital as soon as conditions permit. 

Let me be clear - the United States is committed to a strong and stable international financial system. The Obama Administration fully recognizes that the United States has a special responsibility to play in this regard, and we fully appreciate that exercising this special responsibility begins at home. As we recover from this unprecedented crisis, we will cut our fiscal deficit, we will eliminate the extraordinary governmental support that we have put in place to overcome the crisis, we will continue to preserve the openness of our economy, and we will resolutely maintain the policy framework necessary for durable and lasting sustained non-inflationary growth.

In China, the challenge is fundamentally different, and at least as complex. 

Critical to the success of your efforts to shift future growth to domestic demand are measures to raise household incomes and to reduce the need that households feel to save large amounts for precautionary reasons or to pay for major expenditures like education.  This involves strengthening the social safety net with health care reform and more complete public retirement systems, enacting financial reforms to help expand access to credit for households, and providing products that allow households to insure against risk.  These efforts can be funded through the increased collection of dividends from state-owned enterprises.

The structure of the Chinese economy will shift as domestic demand grows in importance, with a larger service sector, more emphasis on light industry, and less emphasis on heavy, capital intensive export and import-competing industries.  The resulting growth will generate greater employment, and be less energy-intensive than the current structure of Chinese industry. Allowing the market, interest rates, and other prices to function to encourage the shift in production will be particularly important.

An important part of this strategy is the government’s commitment to continue progress toward a more flexible exchange rate regime.  Greater exchange rate flexibility will help reinforce the shift in the composition of growth, encourage resource shifts to support domestic demand, and provide greater ability for monetary policy to achieve sustained growth with low inflation in the future. 

International Financial Reform

These are some of the most important domestic economic challenge we face, and these issues will be at the core of our agenda for economic cooperation. 

But I think it is important to underscore that we also have a very strong interest in working together to strengthen the framework for international economic and financial cooperation.  

Let me highlight three important areas.

At the G-20 Leaders meeting, we committed to a series of actions to help reform and strengthen the international financial architecture.

As part of this, we agreed to put in place a stronger framework of standards for supervision and regulation of the financial system.  We expanded and strengthened the Financial Stability Forum, now renamed the Financial Stability Board.  China and other major emerging economies are now full participants, alongside the major financial centers, in this critical institution for cooperation.  We will have the chance together to help redesign global standards for capital requirements, stronger oversight of global markets like derivatives, better tools for resolving future financial crises, and measures to reduce the opportunities for regulatory arbitrage. 

We also committed to an ambitious program of reform of the IMF and other international financial institutions.  Our common objective is to reform the governance of these institutions to make them more representative of the shifting balance of economic and financial activity in the world, to strengthen their capacity to prevent future crisis, with stronger surveillance of macroeconomic, exchange rate, and financial policies, and to equip them with a stronger financial capacity to respond to future crises. We also committed to mobilize $500 billion in additional finance through the enlargement and membership expansion of the IMF’s New Arrangements to Borrow in order to provide an insurance policy for the global financial system.

As part of this process of reform, the United States will fully support having China play a role in the principal cooperative arrangements that help shape the international system, a role that is commensurate with China’s importance in the global economy.

I believe that a greater role for China is necessary for China, for the effectiveness of the international financial institutions themselves, and for the world economy. 

China is already too important to the global economy not to have a full seat at the international table, helping to define the policies that are critical to the effective functioning of the international financial system.

Second, we must cooperate to assure that the global trade and investment environment remains open, and that opportunities continue to expand.  As economies have become more open and more closely integrated, global economic growth has been stronger and more broad-based, bringing increasing numbers out of poverty, and turning developing nations into major emerging markets.    The global commitment to trade liberalization and increasingly open investment played a critical role in this process ¨C in the industrialized world, in East Asia, and, since 1978, in China.  As we go through the severe stresses of this crisis, we must not turn our backs on open trade and investment - for ourselves and for those who have yet to experience the fruits of growth and development. The United States, China, and the other members of the G20 have committed to not resort to protectionist measures by raising trade and investment barriers and to work toward a successful conclusion to the Doha Development Round. 

And third, one of the most critical long-term challenges that we both face is climate change.  Individually and collectively, there is an urgent need to ensure that each and every country takes meaningful action to deal with this threat.  Reducing land and forest degradation, conserving energy, and using clean technology are important objectives that complement both our efforts to achieve a new, sustainable pattern of growth and our goal of reducing greenhouse gas emissions. China and the United States already are working closely through the Strategic and Economic Dialogue in areas such as clean transportation, clean and efficient production of electricity, and the reduction of air and water pollution.  We must continue these efforts for the sake of our natio ns and the planet.

Conclusion

In the last few years the frequency, intensity, and importance of U.S.-China economic engagements have multiplied.  The U.S.-China Strategic and Economic Dialogue that President Obama and President Hu initiated in April is the next stage in that process.  I look forward to welcoming Vice Premier Wang, State Councilor Dai and their colleagues to Washington to participate in the first meeting of the U.S.-China Strategic and Economic Dialogue.

 Our engagement should be conducted with mutual respect for the traditions, values, and interests of China and the United States. We will make a joint effort in a concerted way “同心协力“.  We should understand that we each have a very strong stake in the health and the success of each other’s economy. 

China and the United States individually, and together, are so important in the global economy and financial system that what we do has a direct impact on the stability and strength of the international economic system.  Other nations have a legitimate interest in our policies and the ways in which we work together, and we each have an obligation to ensure that our policies and actions promote the health and stability of the global economy and financial system.

We come together because we have shared interests and responsibilities.  We also have our own national interests.   I will be a strong advocate for U.S. interests, just as I expect my counterparts to represent China.  China has benefited hugely from open trade and investment, and the ability to greatly increase its exports to the rest of the world.  In turn, we expect increased opportunities to export to and invest in the Chinese economy.   

We want China to succeed and prosper.  Chinese growth and expanding Chinese demand is a tremendous opportunity for U.S. firms and workers, just as it is in China and the rest of the world. 

Global problems will not be solved without U.S.-China cooperation.  That goes for the entire range of issues that face our world from economic recovery and financial repair to climate change and energy policy.

I look forward to working with you cooperatively, and in a spirit of mutual respect.

Germany’s Recession

The Financial Times reports Germany’s economy shrank at a record pace during the first three months of 2008, shrinking at a faster rate than analysts had predicted and confirming that Germany is among the European countries hardest hit by the crisis.

The New York Times reports the economy of the eurozone as a whole shrank 2.5 percent during the same period. 

Theory of Integrated Macroeconomics

By Professor Solomon Budnik

Former professor of Comparative Law, currently chairman of the Aerospace company UTG-PRI LTD. – Tel Aviv, Israel

Subtitle: Crisis of Unified Economic Systems and Uniform Currency. Macroeconomic Geometry.

ABSTRACT

IN RE: New advances in open economy modeling

With regard to economic modeling, it should be noted that we deal now with the expanding economic universe with ever changing space-time continuum due to ever expanding world population and consumer market. No artificial economic model could adjust to such  circumstances or fit various rigid and incompatible economic systems, particularly not the Nobel Prize in Economics gained behavioral, equilibrium, and game models.

In re:   human behavior and free market  are unpredictable, being unstable, and exercise a cumulative effect upon given economy due to mass public and monetary upheavals. For example, the economy of ill-conceived socio-communist and socialist states was and is based on social rules instead of the rule of capital, and couldn’t therefore be properly planned and predicted, as proven by history.

Astoundingly, the  economic system in USA, etc. is not capitalistic but Capitolistic, judging by politically induced state interference into free market affairs, with catastrophic results remedied by same state with trillions of dollars of misappropriated taxpayers’ money, forcing thereby future generations to slave themselves to repay that national multitrillion dollar debt to totalitarian and human rights violating China and totalitarian, racist and terrorist Arab states controlling the US State Dept. with oil dollars.

The equilibrium model is also wrong, since it contradicts the common sense, physics and geometry, for a physical or economic system doesn’t function or operate in a vacuum of economic space, and  an equilibrium can only be reached  by two corresponding systems positioned in the same economic plane, which is impossible. It means that no monetary system can reach a state of equilibrium in ever changing environment and monetary parameters. In fact, a model or a system in equilibrium is a dead, non-functional body, as is Zimbabwean Central Bank which has abolished its worthless national currency.

The  economic game model is wrong as well, since a game needs at least two players, with the end result of a  winner and a looser, or means a single player that plays with a third-party invented program (Russian and Israeli central banks that used the American FED’s model with devastating results), and usually a game theory is applied post-factum to a past event, as the Israeli economic game theorist applied his game paper to a so-called Oslo Accord and its step-by-step Israeli concessions  never matched by the opposing PA,  the Arab terror outcome of which the Israeli people and economy suffer under since 1993.

In all such circumstances, the society and the free market rebel and correct themselves via revolutions and financial downfalls, with trillions of dollars lost. Accordingly, as the Church had separated itself from the state and became a quasi financial institution above the state, the free market economy should function as a non plus ultra financial institution ruled and protected by integrated macroeconomics with a self-correcting mechanism of a three-tier stock exchange system developed by me.

Accordingly, I suggest that in order to prevent future economic depressions and collapses, the common  macroeconomics should be replaced by integrated macroeconomics (as formulated by me) separated from the monetary and fiscal economics induced and controlled by the state via central bank and the treasury which are self-conflicting bodies without taxpayers’ control.

The reason for such a change is that the capital market should be free from the state control in both

THESIS

Preamble: this paper has been composed due to the fact that all previous economic theories and models have failed in the modern turbulent economic circumstances of the intertwined, dependable and unstable global markets and economic powerhouses, with unpredictable fluctuations of domestic and foreign capital.

In re: let’s reminiscent briefly on the history of the past empires, state unions and confederations that had led to the rise and fall of the British Empire (despite the gold standard of the Pound Sterling which was the primary reserve currency for much of the world in the 18th and 19th centuries, but perpetual account and fiscal deficits, financed by cheap credit and unsustainable monetary and fiscal policies used to finance wars and colonial ambitions eventually led to the pound sinking (read current U.S. economic situation), Spanish and Dutch empires, whose economics were based on colonial assets, and the fall of the Austrian-Hungarian entity. The USA had united independent states which then exist on cash injections of the Treasury and the Federal Reserve via dollar printing and the issue of now unsellable state bonds, e.g., the state of California, which has now a budget deficit of $42B, while the overall national debt per American household is now $35.000, to rise to $75.000 due to President Obama’s financial policy. Economic crisis in America happened a number of times, albeit dollar was the world reserve currency guaranteed by gold.

In post World-War II, the US dollar took over the sterling’s dominant position and became the world’s newest reserve currency. The Bretton Woods Accord, the first major economic transformation toward the end of World War II, established the International Monetary Fund (IMF) and a way to value the various currencies of the world relative to each other. All foreign currencies would trade in relationship to the US Dollar and only the US dollar (as the reserve currency) would be tied to a gold standard (meaning the value of dollars circulating must be backed by gold reserves). The Roosevelt dollar was a schizoid, two-tier dollar, whose purchasing power at home did not match its gold parity abroad. At home, it was a fiat monetary unit, not convertible to gold; abroad, it was convertible to gold at $35 per ounce.

Americans of that era learned rather quickly that the maintenance of wealth in tangible form was preferable to paper wealth, so as bank runs became more pronounced, they rushed into and hoarded gold, since a growing distrust of banks meant an equal distrust of paper money.

Executive Order 6102 of April, 1933 and the United States Gold Reserve Act of January, 1934 changed all that. The 1934 Act raised the official price of gold to 35$ per ounce from the 20.67$ paid to Americans who, under the threat of a 10,000$ fine and/or 10 years imprisonment, had been forced to turn in their gold a few months earlier.

The gold standard caused major problems in the 1960’s when France (under the London Gold Pool) called America’s bluff and demanded gold for payment of debt, rather than US dollars (they understood that USA were printing more money, to finance the Vietnam conflict and fund new social programs, than we had available in gold reserves).

Due to the rapid loss of US gold reserves, President Nixon had no choice but to abolish the Bretton Woods accord in August of 1971 and he took the US dollar off the gold standard (it was $35 per ounce then).

Ruble of the Imperial Russia had also been guaranteed by gold, but that colonial and agrarian country, notwithstanding its industrial output of the 1913, existed due to wars and foreign loans. The crash of that economically poor, on bayonets unified empire was inevitable, as well as the crash of the following Soviet empire due to its domestic and international aggression and annexation, failed Communist ”planed” economy, fifteen fictitious republics on Moscow’s payroll,  one-side introduced fake ruble-dollar parity, purchases of grain abroad for dollars, arms race and non-repaid foreign loans, paid-off by Russia only recently.

And nothing have come up of  the idea of the  Belarus-Russia economic union and  unified currency, and  Belarus now lobbies the EU.

With regard to Euro, it had lost  30% of its value at the issue, and that issue and the annulment of the former European currencies has cost tens billions of dollars. The economy of the leading EU states had thereby been undermined due to the incompatibility of the different economic systems and internal state protectionism of the EU members. The economy of minor states had been damaged due to sharp discrepancies  between the low wages and 2-3 times higher prices due to joining the EU where wages are 10-20 times higher. Example: Bulgaria, Czech Republic, and Baltic States which are virtually bankrupt.

Euro keeps its mark due to free circulation of the paper money in a monetary spread now affecting the UK and Switzerland, but  Euro can fall to a critical point due to reduced  consumption and production,  credit crunch and the strengthening dollar.

EU Central Bank and the Bank of Israel (BOI) had followed suit by emulating FED’s actions applicable in USA only, i.e., by zeroing all interest earning saving deposits and to buying-in own state bonds. In  Israel, the American-led BOI had unreasonably devalued the strong shekel by 30% in favor of  weak dollar and Euro due to threats of total strike and extortion  by the leftist subversive Israeli Labor Union (so-called New Histadrut), albeit the Israeli import is 3-4 times larger then export, and BOI had bought-in the Israeli state bonds, albeit there was no huge foreign debt as in USA, had depleted the Treasury of its large  tax income of 15% on now non-existing shekel saving deposits of the bank customers, had reduced the interest rate to 0.5% thus depriving the bank clients and the banks of their earnings, and made thereby poorer  the consumers. Said erroneous and highly damaging actions had deflated the Israeli economy with no official inflation, caused mass unemployment, closed companies and factories, and caused the 20%-50% rise in travel expenses, food, gas and RE prices due to actual inflation concealed by the BOI, since  its actions are in contradiction to all written and unwritten free market rules, with negative results for Israeli economy, for the reduced money supply wasn’t compensated by a $750B stimulus  package and capital infusion in banks and companies, as in USA.

In Russia, on the contrary, its Central Bank had opted for inflation vs. deflation, and had allowed large interest rates at falling consumer and RE prices, with now value appreciating ruble, thus saving the consumer market, its money circulation and earnings on saving deposits.

Paradox but fact: dollar had appreciated against foreign currencies despite the collapse  of the U.S. economy, since all countries buy up dollars for currency reserves and support of their U.S. market dependent economies.

Hence, it is obvious in my opinion that the U.S. and EU economies and monetary expansions were based quasi on the Einstein’s formula Е = мс2, i.e. energy of the economy is equal to the money mass  multiplied by the speed of its circulation in the quadrature of the given monetary territory. But in case of  the  reduced  circulation of money, as occurs now everywhere, the economy of a state shrinks and is subject to a gravitational collapse due to a  financial black hole.

I would elaborate and picture the economic model in geometric terms of universal macroeconomics, i.e. a circle within a square. Central Bank and the SE of any state are the gravitational monetary bodies in the center of the circle of thereby attracted  economy, and distribute financial energy – the money mass and securitized wealth within the boundaries of given economic universe, whose revolving circle represents the circulation of capital. The ”square” of the GDP, cornering the circle of the economy forms four corners – fields of the given financial space, representing respectively the banks, the RE market, consumption and production.

This represents my Unified Field Theory in Economics, as per Einstein’s theory in Physics, applicable to macroeconomics where accordingly monetary forces between the objects of  economy are not transmitted directly between them, but instead go through intermediary financial fields whose  interactions should be unified  (from strongest to weakest) to prevent the crisis of economy.

To substantiate: when too much monies are pumped into that system as in USA prior to the crisis, the ill fetched economy expands and depresses said fields – cornered banks, RE market, consumers and companies,  constituting the depression with corporate bankruptcies where macroeconomics enter into the conflict with the microeconomics (strongest vs. weakest). To rebound, the economy must contract to relieve the tension from said affected segments of the economy and that had happened recently in USA, proving my assumption.

 Here I also introduce the terms of the “spot” money, “intangible” money with delayed transaction and repayment, and “remote” money, the discrepancies in which had led to enormous consumers’ debt and credit crunch in USA. The matter is that the US economy and financial market were erroneously oriented toward assumed  wealth of the consumers, i.e.,  their unsecured credit cards and loans (intangible money with delayed transaction and repayment), but the actual wealth of the consumer is the real money in his pocket (spot money) and remote money in his bank saving account, so if the US credit report companies and lenders would have had checked and calculated the actual cash status of the consumers/debtors using my money terms above prior to issuing  a mortgage or a loan, the monetary and economic crisis in USA could have been avoided.

It means that apart from the usual state and corporate credit rating, the new gross consumer credit rating (GCCR) should be introduced and used to constitute the essential part of the advanced modern macroeconomics, and that is particularly applicable to REITs, Fannie and Freddie in USA. Here, my term of the General Growth Personal Income (GGPI) should be introduced (as previously applied to RE properties), and calculated by the FED or any Central Bank via IRS and Tax Authorities to keep the economy in check and prevent any crisis.

Nota bene: the problem of common macroeconomics is that it is not based on the Rule of Golden Section and the Fibonacci sequence, albeit all universal systems from the human body, plants and up to the universe are based and develop on this very same principle. To elaborate, I would define the monetary correlation between various states and economic systems in the  following approximate ratio, applying Fibonacci figures: USA to the EU as 1:2, USA - UK as 2:3, to China, Japan, India, Mexico respectively as 3:5, 5:8, 8:13, 13: 21, and so on, showing the dilution of capital, having in mind the relevant buying potential of the consumers  which is low in China and India,  in relation to  the billions of people in said states.

The expanding global economy also reflects the geometry of the Fibonacci spiral that approximates the golden spiral of the universal macroeconomics and globalization based on irrational constant of economic dynamics.

This is all because the GDP based common economy is assumed to be closed, no imports or exports occur.

So my opinion  is that any economy should be based  on  the financial pillars consolidated under one roof, i.e., the real estate market, the stock exchange and the gold trade should constitute a uniform, self-containing system, as the project developed by me, namely the Alternative Int. Stock Exchange, to include the Real Estate SE  and the Gold SE, constituting my Integrated Macroeconomic Theory.

I suggest therefore that apart from the GDP, modern economy should be linked to the Gross Foreign Product  (GFP), as termed by me, including foreign revenues of domestic companies and the offshore assets. This implies the repatriation and reinvestment of the foreign gained income and fled capital as the amortization of the domestic corporate and private assets that constitute thereby  the Cumulative Gain Product (СGP), a term  formulated by me. Said new measure  can mitigate the domestic economic crisis and attract foreign capital due to adjusted financial parameters and upgraded credit rating of the given state.

In re: Concerning the collapse of major U.S. and EU investment banks, with heavy losses at the NYSE,  Russian, EU and Asian stock exchanges and monetary systems and to mitigate the economic and financial situation, I have devised the  project  of the innovative Alternative  Int. Stock Exchange  (AISE), to be established in Jerusalem, to include the Real Estate Stock Exchange and the Gold Exchange to secure investors’ assets and gains. Said project is based on my previous project and bylaws of the Tel Aviv Alternative Stock Exchange solicited by the Israeli Finance Ministry.

Said uniquely integrated three-tier financial system would attract large capital due to innovative self-compensating triple index which is not entirely GDP oriented, as the world economies are based  erroneously upon, leading to collapses, so the Israeli economic and financial system would thereby be based on our introduced GFP as well, thus securing the stability of capital and market and bringing the economy out of recession.

Reprinted with kindly permission of Solomon Budnik. (C) 2009 by Solomon Budnik. All Rights Reserved.

Das Versagen der Eliten

Nicht wer zuerst nach den Waffen greift, verursacht einen Aufruhr, sondern wer die Ursache dafür geschaffen hat. (Niccolò Machiavelli)

Demokratien suchen sich Vorbilder, die immer wieder zu wünschen übrig lassen…

Das Versagen der Eliten wiegt inzwischen vermutlich sehr viel schwerer als die Leistungen, die sie erbringen: man denke nur an das miserable Krisenmanagement bei der Bewältigung der Finanzkrise, die unvermeidbar einen Bürgerkrieg hervorrufen wird. Schlechter Führungsstil gekoppelt mit Arroganz und Ignoranz wird am Ende immer bestraft: alte Lektion des Florentiner Meisters der Politik, Niccolò Machiavelli.

Aus gegebenem Anlass: Ein musikalisches Pamphlet im Dreierpack (“Entrez, m’sieur dans l’humanité”, “Qui se soucie de nous?”, “Face à la merde”) von Frankreichs Galionsfigur der geschmackvollen Satire, Jacques Dutronc.

G-20-Finance Ministers Meeting

News reports indicate a meeting of finance ministers from the G-20 countries, laying the groundwork for a major April 2nd, 2009 heads-of-state summit addressing the financial crisis, produced agreement in several areas.

Australia’s representative at the meetings said: “Everybody agreed: It’s fiscal stimulus plus. We’ve got to do something about the flow of credit in the financial system; we’ve got to reform our international financial institutions.”

Reportedly the delegates reached general agreement on the need both to boost International Monetary Fund (IMF) resources in the short-term and to reshape the fund in the longer term, including a timetable to increase the voting rights of emerging economies.

Reuters reports the group also agreed to boost funding to the Asian Development Bank (ADB) by $100 billion, bringing the bank’s war chest to $150 billion total.

Security Challenges Arising from the Global Financial Crisis

Statement of Richard Nathan Haass, former Director of Policy Planning in the U.S. State Department, current President of the Council on Foreign Relations, before the Committee on Armed Services of the U.S. House of Representatives

Washington DC, March 11, 2009

Mr. Chairman,

Thank you for this opportunity to testify before the House Committee on Armed Services on security challenges arising from the global financial crisis. Let me first commend you and your colleagues for holding this hearing. Most of the analysis and commentary on the global economic crisis has focused on the economic consequences.

This is understandable, but it is not sufficient. The world does not consist of stovepipes, and what happens in the economic realm affects political and strategic policies and realities alike. It is also important to say at the outset that this crisis, which began in the housing sector in the United States, is now more than a financial crisis. It is a full-fledged economic crisis. It is also more than an American crisis. It is truly global.

I would add, too, that the crisis is unlike any challenge we have seen in the past. It is qualitatively different than the sort of cyclical downturn that capitalism produces periodically. This crisis promises to be one of great depth, duration, and consequence. This crisis was not inevitable. It was the result of flawed policies, poor decisions, and questionable behavior.

It is important that this point be fully understood lest the conclusion be widely drawn that market economies are to be avoided. The problem lies with the practice of capitalism, not the model. Nevertheless, the perception is otherwise, and one consequence of the economic crisis is that market economies have lost much of their luster and the United States has lost much of its credibility in this realm.

It is inconceivable in these circumstances to imagine an American official preaching the virtues of the Washington Consensus. This is unfortunate, as open economies continue to have more to offer the developing world than the alternatives. It also adds to the importance that the U.S. economy get back on track lest a lasting casualty of the crisis be modern capitalism itself.

The impact of the economic crisis will be varied and go far beyond the image of capitalism and the reputation of the United States. Director of National Intelligence Dennis Blair was all too correct when he testified recently that the primary near-term security concern of the United States is the global economic crisis and its geopolitical implications. The crisis will have impact on conditions within states, on the policies of states, on relations between states, and on the thinking of those who run states. I have already alluded to this last consideration.

Here I would only add that initial reactions around the world to the crisis appear to have evolved, from some initial gloating at America’s expense to resentment of the United States for having spawned this crisis to, increasingly, hopes that the American recovery arrives sooner and proves to be more robust than is predicted. This change of heart is not due to any change of thinking about the United States but rather to increased understanding that the recovery of others will to a significant extent depend on recovery in the United States. In a global world, what happens here affects developments elsewhere and vice versa. Decoupling in either direction is rarely a serious possibility. The crisis is clearly affecting the developed world, mostly as a result of the centrality of banking-related problems and the high degree of integration that exists among the economies of the developed world. Iceland’s government has fallen; others may over time. Many governments (including several in Central and Eastern Europe but outside the Eurozone) will require substantial loans.

The economies of Japan, much of Europe, and the United States are all contracting. World economic growth, which averaged 4 to 5 percent over the past decade, will be anemic this year even if it manages to be positive, which is increasingly unlikely. It is worth noting that the most recent World Bank projection predicts negative growth for 2009. Change of this sort will have consequences. There will likely be fewer resources available for defense and foreign assistance. Reduced availability of resources for defense makes it even more critical that U.S. planners determine priorities. Preparing to fight a large-scale conventional war is arguably not the highest priority given the enormous gap between the relevant military capabilities of the United States and others and the greater likelihood that security-related challenges will come from terrorism and asymmetric warfare. State-capacity building, the sort of activity the United States is doing in Iraq, Afghanistan, and Pakistan, will continue to place a heavy burden on U.S. military and civilian assets.

Also remaining highly relevant (and deserving to be a funding priority) will be standoff capabilities designed to destroy targets associated with terrorism and weapons of mass destruction. Developing states may appear to be better off than wealthier countries at first glance. Their growth on average is down by half from previous years, but still positive. Appearances, however, can be deceptive. This growth is measured from a low base in absolute and relative terms. The reduction in growth in some instances has been dramatic. Developing country exports are down as demand is down in the developed world.

Also reduced are aid flows and most importantly investment flows to the developing world. Commodity prices are much lower, a boon to those who rely on imports but a major problem for the many who are dependent on the income from one or two exports. A few countries merit specific mention. One is China. China’s economic success over the past few decades constitutes one of history’s great examples of poverty eradication. This process, one that has involved the migration of millions of people every year from poor rural areas to cities, will slow considerably. The already large number of domestic political protests in China over such issues as land confiscation, corruption, environmental degradation, and public health, is likely to grow. Absent renewed robust economic growth, the chances are high that the government will react by clamping down even more on the population lest economic frustration lead to meaningful political unrest.

Russia is in a different position, one characteristic of countries dependent on raw material exports for much of their wealth. The Russian economy is contracting after a period of boom. As is the case with China, this suggests the likely assertion of greater political control. But Russia is not as fully integrated as China is with the world economy. There is thus a greater (although impossible to quantify) chance that Russia’s leaders will turn to the time-honored resort of manufacturing an overseas crisis to divert attention than will China’s.

The same holds true for Iran and Venezuela, two countries that are heavily reliant on energy exports and whose foreign policies have been counterproductive (to say the least) from the U.S. perspective. But at the same time, it is possible that one or both will pull in their horns. Venezuela is already showing some signs of this, with its more welcoming stance toward international oil companies. This may well be simply a tactical adjustment to immediate needs.

And at least in principle, Iran’s government might find it more difficult to make the case to its own people for its continued pursuit of a nuclear weapons option if the Iranian people understood that it was costing them dearly with respect to their standard of living. Iraq is another oil producing country whose wealth is closely associated with the price of oil. Here the effects are sure to be unwanted. There is the danger that disorder will increase as unemployment rises, prospects for sharing revenue shrink, and the ability of the central government to dispense cash to build broad national support diminishes. In light of the multiple challenges already facing the United States, the last thing the Obama administration needs is the specter of an unravelling Iraq.

Two other countries are worth highlighting. One is Pakistan. Pakistan’s economic performance is down sharply for many reasons, including a decrease in both foreign investment in the country and exports from Pakistan to other countries. Pakistan has little margin for error; the possibility that it could fail is all too real. The worsened economic situation makes governing all that much more difficult. The consequences of a failed Pakistan for the global struggle against terrorism, for attempts to prevent further nuclear proliferation, for the effort to promote stability in Afghanistan, and for India’s future are difficult to exaggerate. North Korea is a second nuclear-armed state whose stability is worsened by the economic crisis.

At issue is the extent to which South Korea (along with China and Japan) can provide resources to the North to help stave off collapse. Another serious consequence of the global economic crisis, one that affects both developed and developing countries, is the reality that protectionism is on the rise. One realm is trade; some seventeen of the twenty governments set to meet in London early next month have increased barriers to trade since they met late last year. Negotiated free trade agreements with Colombia, Panama, and South Korea continue to languish in the U.S. Congress. The president lacks the Trade Promotion Authority essential for the negotiation of complex, multilateral trade accords. Prospects for a Doha round global trade pact appear remote. The volume of world trade is down for the first time in decades. The economic but also strategic costs of this trend are high. Trade is a major source of political as well as economic integration; one reason China acts as responsibly as it does in the political sphere is because of its need to export its products lest potentially destabilizing unemployment jump sharply. Trade has other virtues as well. More than anything else, trade is a principal engine of global economic growth. The completion of the Doha round might be worth as much as $500 billion to the world in expanded economic activity. One-fourth of this expanded output would occur in the United States. This is the purest form of stimulus.

For the United States, exports are a source of millions of relatively high-paying jobs; imports are anti-inflationary and spur innovation. Alas, the economic crisis will make it difficult if not impossible to conclude new trade pacts and to gain the requisite domestic support for them. Economic nationalism is on the rise, and when this happens, the will and the ability of political leaders to support policies that are perceived to hurt large numbers of their citizens (but which in reality help many more) invariably goes down. What is more, the economic crisis may also make it more difficult to reach agreement on a global climate change pact when representatives of most of the world’s countries gather in Copenhagen late this year. Developed and developing countries alike will resist commitments that appear to or in fact do sacrifice near-term economic growth for long-term environmental benefit. What, then, should be done to limit the adverse strategic effects of an economic crisis that is certain to get worse and persist for some time?

The United States – the Obama administration and the Congress – should resist protectionism. “Buy America” provisions in the stimulus legislation will increase costs to American consumers and all but make certain that other countries will follow suit, thereby reducing the prospects for American firms to sell abroad. More American jobs are likely to be sacrificed than preserved. Increased protectionism will also dilute the strategic benefits that stem from trade and its ability to contribute to international stability by giving governments a stake in stability. Similar arguments hold as to why “lend national” provisions are counterproductive. Bringing countries into the world trading system (best done through WTO accession) makes strategic sense, too, as it gives them a stake in maintaining order at the same time it opens government decision-making to greater degrees of transparency. Recession cannot become this country’s energy policy or a reason not to decrease U.S. consumption of oil, imported or otherwise. Lower prices will dilute any economic incentive to consume less oil. Regulatory policy will be the principal means of discouraging demand and encouraging the development of alternative energy sources and technologies. Reduced demand is essential for strategic reasons (so as not to leave the United States highly dependent on imports and so that countries such as Russia, Venezuela, and Iran do not benefit from dollar inflows), for environmental reasons, and for economic reasons, i.e., not to increase the U.S. balance of payments deficit. The goal should be to use this moment of temporarily-reduced prices to decrease the chances we as a country again find ourselves in a world of high energy prices once the recession recedes.

The United States should work with other developed and reserve-rich countries to increase the capacity of the IMF to assist governments in need of temporary loans. Current capacity falls short of what is and will be needed. It would be helpful if aid budgets were not victims of the economic crisis. Aid is needed on a large scale not just for humanitarian reasons (to fight disease, etc.) but also to build the human capital that is the foundation of economic development. Aid will also be a necessary substitute in the short and medium run for investment. Absent such flows we are likely to see greater misery and an increased number of failing or failed states. The upcoming G-20 summit in London provides an opportunity to adopt or encourage some useful measures in many of these realms. It is essential that others, including Europe and Japan, take steps to stimulate their economies. It is equally important, though, that guidelines be promulgated so that stimulus programs do not become a convenient mechanism for unwarranted subsidies and “buy national” provisions that are simply protectionist measures by another name.

The London meeting is also an opportunity to increase IMF capacity, to generate commitments to provide aid to developing countries, and to agree on at least some regulatory principles for national banking and financial systems. There is not time, however, to try to rebuild the architecture of the international economic system, solve the problems caused by countries that run chronic surpluses, or revamp the system of exchange rates. Let me close with two final thoughts. Much of this hearing and statement is focused on the question of the consequences of the economic crisis for global security. But it is important to keep in mind that the relationship is not only one way. Developments in the political world can and will have an effect on the global economy.

Imagine for a second the economic consequences of, say, a Taiwan crisis or fighting between India and Pakistan or an armed confrontation with Iran over its nuclear ambitions. This last possibility is the most worrying in the near term and underscores the importance of trying to negotiate limits on Iran’s enrichment program lest the United States be confronted with the unsavory option of either living with an Iranian near or actual nuclear weapons capability or mounting a preventive military strike that, whatever it accomplished, would be sure to trigger a wider crisis that could well lead to energy prices several times their current level.

Finally, getting through this economic crisis should not be confused with restoring prolonged calm in the markets or sustainable growth. Enormous stimulus measures here at home coupled with equally unprecedented increases in the current account deficit and national debt make it all but certain that down the road the United States will confront not just renewed inflation but quite possibly a dollar crisis as well. At some point central banks and other holders of dollars will have secnd thoughts about continuing to add to their dollar holdings, currently larger than ever given the desire for a safe harbor. Ongoing U.S. requirements for debt financing, however, will likely mean that interest rates would need to be raised, something that could choke off a recovery. This underscores the importance of limiting stimulus packages to what is truly essential to reviving economic activity and to taking other measures (such as entitlement reform and the already discussed steps to reduce oil use) lest the current crisis give way to another one.

Zimbabwe’s Currency

Zimbabwe’s government for the first time acknowledged the severe problems faced by the country’s local currency.

Harare’s finance minister released the country’s new budget proposal denominated in U.S. dollars in a move SW Radio Africa says will officially pave the way for the disappearance of the Zimbabwean dollar, which has suffered from severe hyperinflation.

Meanwhile, the BBC reports South African officials have said Zimbabwe’s opposition party will agree to endorse a deal for a power-sharing government. Officially, the party has yet to endorse the deal.

Financial Crisis: Those who forget the past are destined to repeat it…

I have sworn upon the altar of God eternal hostility against every form of tyranny over the mind of man. (Thomas Jefferson)

Thomas Jefferson, the principal author of the U.S. Declaration of Independence (1776), wrote to James Monroe, the fifth President of the United States of America, on January 1, 1815:

“If the American People ever allow the banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children wake up homeless on the continent their fathers occupied. The issuing power of money should be taken from the bankers and restored to Congress and the people to whom it belongs. I sincerely believe the banking institutions having the issuing power of money are more dangerous to liberty than standing armies.

We are completely saddled and bridled, and the bank is so firmly mounted on us that we must go where they ill guide.

The dominion which the banking institutions have obtained over the minds of our citizens…must be broken, or it will break us.”

***

Congressman Charles A. Lindbergh, Sr. revealed the Bankers Manifesto of 1892 to the U.S. Congress somewhere between 1907 and 1917.

Bankers Manifesto of 1892

“We (the bankers) must proceed with caution and guard every move made, for the lower order of people are already showing signs of restless commotion. Prudence will therefore show a policy of apparently yielding to the popular will until our plans are so far consummated that we can declare our designs without fear of any organized resistance.

Organizations in the United States should be carefully watched by our trusted men, and we must take immediate steps to control these organizations in our interest or disrupt them.

At the coming Omaha convention to be held July 4, 1892, our men must attend and direct its movement or else there will be set on foot such antagonism to our designs as may require force to overcome.

This at the present time would be premature. We are not yet ready for such a crisis. Capital must protect itself in every possible manner through combination (conspiracy) and legislation.

The courts must be called to our aid, debts must be collected, bonds and mortgages foreclosed as rapidly as possible.

When, through the process of law, the common people have lost their homes, they will be more tractable and easily governed through the influence of the strong arm of the government applied to a central power of imperial wealth under the control of the leading financiers.

People without homes will not quarrel with their leaders. History repeats itself in regular cycles. This truth is well known among our principal men who are engaged in forming an imperialism of the world. While they are doing this, the people must be kept in a state of political antagonism.

The question of tariff reform must be urged through the organization known as the Democratic Party, and the question of protection with the reciprocity must be forced to view through the Republican Party.

By thus dividing voters, we can get them to expend their energies in fighting over questions of no importance to us, except as teachers to the common herd. Thus, by discrete actions, we can secure all that has been so generously planned and successfully accomplished.”

Iceland’s Financial Collapse

Iceland raised its benchmark interest rate from 12 percent to 18 percent as the country sought to stave off financial collapse.

The prime minister said another $4 billion in loans would be necessary to stabilize Iceland’s banks. The IMF has already granted Iceland a $2 billion loan, and several of the country’s banks have received money from Russia. The Financial Times reports IMF funding could soon run short, given the needs of many different nations.

Bloody Party on financial markets has just begun

The Central Banks have lost control, market panic spreads and several exchanges suspend trading.

Yesterday’s rapid sell-off on Wall Street, which dragged the Dow Jones Industrial Average down more than 7 percent in late trading, kicked off a wave of global selling today that some analysts termed a panic selling.

Japan’s Nikkei index plunged nearly 10 percent, as did London’s FTSE index at market open, before making a slight recovery to losses of around 8 percent. In Asia, markets in Hong Kong, South Korea, India Thailand, Indonesia, Australia were among those that suffered major losses.

Shares also fell sharply across Europe, with Germany and France each showing early losses over 7 percent. Russia, Indonesia, Iceland, Austria, and Thailand all halted trading after steep losses.

The New York Times reports the United States and UK appear to be converging on coordinating global action to end the decline. The article says the idea that governments should inject money into banks in return for partial ownership and guarantees of loan repayment will be closely examined when IMF finance ministers meet tomorrow.

The Wall Street Journal reports the U.S. Treasury has begun a process of interviewing financial executives to gauge interest in new programs aimed at injecting capital into banks.

European economy goes into recession

European and Asian markets stabilized today, showing sober gains following unprecedented coordinated interest rate cuts by many of the world’s major central banks. Russian stock markets, which had suffered worse losses than any major market, gained 17 percent.

Meanwhile, the International Monetary Fund (IMF) said it projects Europe is headed toward a recession and that the continent’s banking system is currently under “extraordinary financial stress”.

Read full story.

Globalised Economy

In the International Herald Tribune, Paul Kennedy, director of International Security Studies at Yale University, and author of the bestseller The Rise and Fall of the Great Powers: Economic Change and Military Conflict from 1500 to 2000, comments on how the consequences of the financial crisis are affecting all parts of an increasingly globalised economy.

“Even the rising Chinese superpower is being blasted by these distant capitalistic convulsions. How could its Finance Ministry, seduced by the advice of Wall Street bankers and consultants to place billions of dollars into American so-called ’safe havens,’ not be badly shaken by the financial tumults of the past few weeks?

Should China trust the Yankee capitalist system? What will happen to its vital exports to that enormous, volatile consumer market? Already The People’s Daily in Beijing has published a noteworthy piece by the economist Shi Jianxun calling upon the world to create ‘a diversified currency and financial system and (a) fair and just financial order that is not dependent on the United States.’ Where goes the dollar then, and its reputation as a safe haven?”

Read full story.

Russia Call to Action On Financial Crisis

President Medvedev records his video at the Kremlin. Photo: © ITAR TASS

While the severe global crisis of confidence in financial markets continues to grow, and with a succession of EU countries announcing individual rescue plans, the Wall Street Journal reports on greater call for a coordinated response to the crisis threatening the bloc’s financial system.

Iceland, one of the countries hardest hit due to its highly developed banking sector, says it has arranged for a 4 billion euro bailout package from Russia, though the Financial Times reports Russia thus far has denied reports of the loan.

Russian President Dmitri Medvedev issued a call for coordinated global action to confront credit problems and said he would present a plan for how to tackle the crisis in meetings later this week in France.

Read full story.

America’s Economy Will Recover Faster Than Britain

In The Times of London, Lawrence B. Lindsey says the economic crisis will not result in Depression-era hardship.

“Even the smartest people make mistakes. Sir Isaac Newton lost money in the South Sea Bubble. He not only figured out gravity, but was Master of the Mint, as close to being a central-bank governor as one could be back then. Recognising the developing bubble, he sold his position. Then, when prices continued to rise, he felt that he might have been mistaken and bought back in just before the top, losing a small fortune.

With roughly three and a half centuries of experience with financial bubbles that burst, we can make some reasonable judgments on how this one will end and what the world will look like afterwards.”

Read full story.

Central Banks respond to worst financial crisis since 1929

Several of the world’s most influential central banks unveiled a coordinated response to this week’s market turmoil and broader concerns about financial markets.

The U.S. Federal Reserve announced it would make an additional $180 billion available to foreign banks for overnight and longer-term money markets.

The European Central Bank, Bank of Japan, Bank of England, Bank of Canada, and Swiss National Bank made a joint statement that they would work with the U.S. Fed to help make short-term loans available to financial institutions in their countries.

Separately, the Financial Times reports Russia will inject over $19 billion to support its sputtering financial markets, following a dramatic stock slide.

A backgrounder from the Wall Street Journal says the credit crisis, spawned from bad U.S. mortgage-backed debt, has spread into the worst financial crisis since the 1930s, and that there is no clear end in sight.

Read full story.

Fed’s Follies

In an op-ed in the Wall Street Journal, Benn Steil argues that the U.S. Federal Reserve has damaged the credibility of inflation targeting by pursuing other objectives inconsistent with price stability.

“In the dozen or so years until 2007, it had become as close to a global orthodoxy in economic policy making as we ever see: Central banks should target a low and stable rate of inflation.

This replaced earlier orthodoxies – such as that central banks should maintain a fixed exchange rate with an ounce of gold, which was abandoned in 1971. Though inflation targeting left far more latitude for government officials to expand the money supply, it too ultimately proved too great a shackle on the exercise of central bank wisdom.

The U.S. Federal Reserve, the European Central Bank, the Bank of England and other rich-country central banks have generally made 2% inflation, give or take a smidge, the touchstone of good performance. Fed officials have for 20 years paid public obeisance to their statutory ‘dual mandate,’ to maximize employment as well as stabilize prices. But in practice, until recently, they treated it much like a mildly embarrassing biblical injunction that could be safely ignored, if not repudiated.”

Read full story.

U.S. Banking Collapse

Harvard University Professor Kenneth Rogoff, former chief economist of the International Monetary Fund (IMF), said the worst of the global financial crisis is yet to come and “a large U.S. bank will fail in the next few months.”

His comments at a Singapore conference came as shares in Fannie Mae and Freddie Mac sank on a report that the home lenders would, in effect, be nationalized.

Read full story.

Inflation in Latin America

The Christian Science Monitor reports bubbling inflation in several Latin American countries has emerged as a top political concern. Venezuela’s 25 percent inflation is second only to Zimbabwe’s globally.

Read full story.

Iran “central banker of terrorism”

At a hearing of the United States Senate’s Finance Committee, a senior official in the US Treasury Department has called Iran “the central banker of terrorism”.

Outlining some of what Iran is known to be doing to support anti-American and anti-Israeli fighters, the under-secretary for Terrorism and Financial Intelligence, Stuart Levey, said Iran “uses its global financial ties and its state-owned banks to pursue its nuclear and ballistic missile programs, and to fund terrorism.”

He also told lawmakers that Iran used front companies and “cut-outs” to “engage in ostensibly innocent transactions that are actually related to its nuclear missile programs.”

“We have seen Iran’s banks request other financial institutions take their names off of transactions when processing them in the international financial system. This practice, which is even used by the central bank of Iran, is intended to evade the controls put in place by responsible financial institutions and has the effect of threatening to involve those financial institutions in transactions that they would never engage in if they knew who or what was really involved,” Levey said.

Levey heads the Office of Foreign Assets Control (OFAC), which is responsible for tracking money being filtered into terrorist groups. In all, since June 2005, the OFAC has identified 51 entities and 12 individuals as proliferators of weapons of mass destruction, of whom 36 entities and 11 individuals were tied to Iran, nine entities and one individual were tied to North Korea and three entities were tied to Syria. Levey told senators that efforts to cut off money to Al Qaeda had shown success – especially in the last 18 months. He cited senior al-Qaeda leaders’ complaints that they had suicide bombers ready to go but no money to finance operations.

Click here to read the full statement.

The U.S. Federal Reserve New Alphabet Soup

by Vincent R. Reinhart, former director of the Federal Reserve Board’s Division of Monetary Affairs (2001-2007)

Over the past few weeks, the Federal Reserve added to its alphabet soup of new facilities to deal with ongoing strains in financial markets. Taken together, these programs represent a clever gamble to provide large institutions some time to get their financial houses in order. Fed officials have effectively rewritten the rules on the role of a central bank in a market economy.

First, the mnemonics. On March 14, 2008, the Federal Reserve extended access to its discount window to a non-depository, Bear Stearns, for the first time since the 1930s. (The discount window is the Fed’s lending facility, where loans are made at a rate above the federal funds rates and can be secured with a wide variety of collateral.) According to the Federal Reserve Act, lending to such an individual, partnership, or corporation (an IPC) requires the affirmative vote of five of the governors of the Federal Reserve Board.

Moreover, the Federal Reserve must attest that there are “unusual and exigent” circumstances and that failure to lend would impair the economy. On March 16, 2008, the Federal Reserve granted other investment banks access to its lending facility.

On the prior Tuesday, the Fed had introduced a new program called the Term Securities Lending Facility (TSLF), under which it will loan some of the Treasury securities currently on its balance sheet to key financial market participants in return for other securities as collateral. The term of these transactions is 28 days, and the fee paid for the loan of Treasury securities will be set in an auction.

For the past few months, the Fed has been holding regular auctions for depositories of its discount window credit, also for a term of 28 days. This is referred to as the Term Auction Facility (TAF), in which depositories bid for credit. Earlier this month, these auctions were bumped up to total $100 billion per month. To put that sum in perspective, the amount of discount window loans outstanding this month will likely be nine times the previous monthly record from 1919 to the inception of the TAF (see the nearby chart). And if the TAF continues at its recent pace through June of this year, the Federal Reserve will have extended a greater volume of loans over the first eight months of the program than it had cumulatively lent over the prior 90 years.

Last but not least, the Fed also announced that it will loan another $100 billion in the form of 28-day term repurchase (RP) agreements. RPs are the bread-and-butter of a central bank’s open market operations. In the typical RP, the Fed lends money to its dealer counterparties for a fixed term, taking collateral in the form of Treasury securities or the debt and mortgage-backed securities of the government-sponsored lenders, Freddie Mac and Fannie Mae.

If we tally up all these new programs, the Federal Reserve appears willing to commit almost one-half of its balance sheet, around $400 billion, to promote the renewed health of financial markets.. Given its open-ended invitation for investment banks to follow the Bear Stearns route and tap the Fed’s discount window, it may wind up committing even more.

Why do Fed officials think these programs will work? To households, mortgages are the obligations that make home purchases possible. But to financiers, mortgages are collateral. Those loans are pooled together so that their combined payments provide a steady stream of income in a variety of mortgage-related securities. The problem is that mortgage defaults of the magnitude we are now experiencing even dry up payments to “safe” securities. Some of those securities are quite complex and difficult to price. Even worse, they are held in part on balance sheets of financial institutions that are opaque and difficult to understand.

Investors have withdrawn from the entities they fear are tainted by these losses. But because they cannot pin down precisely who bears the brunt of the losses, the retreat from risk taking has been spread across a broad front. As a result, there is no effective market price for some of these securities-because the market has disappeared.

Losses across large financial firms could mount considerably beyond what has already been announced. If so, those firms will have to retrench to conserve their capital. Credit will be more expensive and harder to get.

Ultimately, the industry needs more capital. That infusion may come from elsewhere in the private sector: possibly from hedge funds and long-term investors, or from official sources abroad. (Here another mnemonic comes to mind-SWF, or sovereign wealth funds.) But if it does not come from those sources, it will likely require government intervention, which is the way banking crises around the world are often resolved.

The Federal Reserve is using its balance sheet as a safe harbor for the financial industry until that capital arrives. It is doing so by transforming mortgage – related securities – for which there is currently no effective market-into something useful. Financial institutions can now pledge them with the Federal Reserve in open market operations (via RPs) or at the discount window (via the TAF and IPC lending). Or, they can swap those securities for Treasury securities via the TSLF. For 28 days, those firms get better assets on their balance sheets, which allow them to postpone the unloading of their mortgage-related holdings.

Let’s be clear: the Federal Reserve is accepting an unprecedented degree of credit risk.

If one of its counterparties fails in the 28-day window of an outstanding transaction, the Fed will potentially be left holding illiquid mortgage paper. Such unusual policies cannot be extended indefinitely. Financial institutions have to come to grips with their losses, and their management has to swallow hard and find more capital, which is likely to be very costly. They should not use the Fed’s largesse as an excuse to delay.

Reprinted with kindly permission of The American Enterprise Institute.

U.S. Federal Reserve takes radical action

The U.S. Federal Reserve took action to boost liquidity and stave off market meltdown. The Fed said it would offer the bond market $200 billion in Treasury bonds for a month at a time, accepting ordinary triple-A rated mortgage-backed debt as collateral.

Several major global central banks followed suit with similar moves.

The Wall Street Journal calls the move a “surgical strike” in response to a growing wave of investors selling out of mortgage-backed securities. Global markets made heady gains on the news, and U.S. stocks posted their largest single day of gains in over five years.

Despite the move and the market gains, experts remained skeptical about the prospects for quick economic recovery. The economist Nouriel Roubini writes on his blog that many of the world’s most prominent economists are now subscribing to his estimates – formerly considered extreme – that U.S. financial losses could top $1 trillion.

Eastern Caribbean Currency Union (ECCU)

A new report from the International Monetary Fund (IMF) examines efforts by eastern Caribbean states to establish a currency union.

Read full story.

Israels Währung gewinnt internationale Anerkennung

Der Shekel wird bald auf dem globalen Währungsmarkt präsent sein. In drei Monaten soll die israelische Währung auf den internationalen Finanzmärkten voll konvertierbar sein und damit in den Kreis der bislang 15 führenden Währungen aufgenommen werden.

Praktisch bedeutet dies, dass der Shekel zukünftig international im Austausch für eine der 15 Spitzenwährungen gekauft und verkauft werden kann und in allen größeren Banken der 80 entwickelten Länder der Erde erhältlich sein wird.

Insgesamt wird Israels Status bei öffentlichen und privaten Investoren und – was nicht weniger wichtig ist – den internationalen Krediteinstufungs-Agenturen Moody’s, Standard and Poor’s und Fitch aufwerten. Die FTSE-Gruppe, ein bedeutender Sicherheitsindex-Anbieter, hat das technologieschwere Israel bereits im vergangenen September hoch gestuft.

Neben dem israelischen Shekel soll auch der mexikanische Peso in die Liste der dann insgesamt 17 großen Weltwährungen aufgenommen werden.

© Haaretz, 14.02.2008

Bearing Down – The coming recession

Desmond Lachman doubts that monetary policy can stem the looming recession.

by Desmond Lachman

Wall Street estimates that bank losses stemming from bad lending behavior will range anywhere from $500 billion to $1 trillion. These numbers dwarf the losses from the savings-and-loan crisis of the 1980s.

Until very recently, most Wall Street analysts were in denial about the prospect of even a mild economic recession, let alone a serious and prolonged one. Ever optimistic, they turned a blind eye to the onset of the worst U.S. housing bust since World War II. They also minimized the gravity of the subprime mortgage crackup, the subsequent credit crunch (which has been plaguing the U.S. banking system since mid-2007), and the approximate doubling of global oil prices to around $90 a barrel.

Now that practically every economic indicator is signaling recession-from rapidly falling home prices to abysmal Christmas spending figures to declining employment growth to tightening bank lending standards-Wall Street analysts are conceding, reluctantly, that America might experience a recession in the first half of 2008.

However, they are all too quick to reassure us that this recession will be short and shallow, with a slowdown in the first half of the year to be followed by an early and vigorous rebound in the second half of the year. In making that forecast, they are pinning much hope on two things: the Federal Reserve’s recent decision to slash interest rates aggressively and the $168 billion fiscal stimulus package announced last week on Capitol Hill.

It would be wonderful if the Wall Streeters were right this time in their sanguine prognostication. The sad truth, however, is that all the important clues are pointing in the opposite direction. The main forces driving us toward a recession-high oil prices, a serious credit crunch, and the bursting of a major asset price bubble-are operating in combination with each other. At the outset of America’s three previous recessions-in 1981, 1990, and 2001-these forces were operating separately. Therefore, it seems reasonable to expect that a recession today will be longer-and more painful-than the postwar average (around nine months).

Steven Roach of Morgan Stanley argues, correctly, that the present housing market bust is affecting a very much wider swath of the U.S. economy than did the dot-com bust (which led to the 2001 recession). After all, the combined output of the housing sector and housing-related industries accounts for roughly 10 percent of the total U.S. economy-a considerably larger share than technology investment. And there is every reason to believe that national home prices will fall by at least another 10 percent in 2008, under the weight of record inventories of unsold homes, the scheduled resetting of adjustable rate mortgages, and a severe tightening of mortgage lending standards. These facts alone suggest that a 2008 recession will be more serious than the one in 2001.

In a similar vein, the present credit crunch is far more debilitating than was the savings-and-loan crisis of the mid-1980s. For while the credit woes of the 1980s were largely confined to the savings-and-loan sector, today’s credit problems seem to be much more pervasive, going well beyond subprime mortgage lending. Indeed, Wall Street estimates that bank losses stemming from bad lending behavior will range anywhere from $500 billion to $1 trillion. These numbers dwarf the losses from the earlier savings-and-loan crisis.

The optimists are hoping that the 2.5 percentage point cut in interest rates over the last few months, coupled with the recently announced fiscal stimulus package, will soon turn the economy around. But they choose to forget that interest rates had to be cut by 5.5 percentage points (to as low as 1 percent) following the dot-com crash before the economy began to recover. They also choose to overlook the troubled state of today’s banking system, which may reduce the efficacy of interest rate cuts this time around.

The good news is that both the Bush administration and the Federal Reserve have finally (if belatedly) grasped the urgency of the present situation. This indicates that they will do whatever it takes to prevent the U.S. economy from succumbing to the sort of vicious cycle that crippled the Japanese economy after the bursting of its asset price bubble in 1990. Yet monetary and fiscal policies often take a long time to have their full effect on economic activity. Indeed, at this late stage, it’s doubtful that either the administration or the Fed can prevent a nasty recession.

About the author: Desmond Lachman joined The American Enterprise Institute after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the IMF’s Policy and Review Department and was active in staff formulation of IMF policies toward emerging markets. Lachman has written on topics such as economic policy, fund arrangements, monetary reform, import restrictions, and exchange rates.

Reprinted with kindly permission of The American Enterprise Institute.

Prospects for the U.S. Economy in 2008

In remarks last Thursday, Dr. Janet L. Yellen, the president and CEO of the Federal Reserve Bank of San Francisco, outlined the major risks she sees threatening U.S. growth over the coming year. Yellen said further housing market declines, a weakening job market, and lingering troubles in the financial sector continue to pose big problems.

Speech to the Chartered Financial Analysts of Hawaii

by Dr. Janet L. Yellen, February 7, 2008

Good evening, and thanks for inviting me to be part of CFA Hawaii’s Annual Economic Forecast Dinner tonight. As President of the Federal Reserve Bank of San Francisco, it’s my responsibility to be in touch with what’s happening to the economy throughout our District, which includes Hawaii and eight other Western states. I do this both by monitoring developments and by visiting in person. I must say that this responsibility gives me particular delight when it comes to this beautiful and diverse state. For many years, my family and I have come to these islands for the perfect getaway, and, though I’m not able to stay for much R&R this time, simply being here in Hawaii adds a special kind of pleasure to this business visit.

Tonight I am giving my first speech of the year. And though the year is only seven weeks old, a great deal has already happened in the realm of monetary policy. On January 22, the Federal Open Market Committee cut its main policy rate-the federal funds rate-by three quarters of a percentage point. Then, on January 30, at the scheduled meeting, the Committee voted to cut the policy rate again, this time by half a percentage point to 3 percent. Taking these actions together with those that began last September, the Committee has cut that rate by a total of 2¼ percentage points.

The purpose of these actions is to stimulate demand in the face of the combined impact of the severe contraction in housing and the related financial market disruptions. While housing construction has been weak for more than two years, its effects did not spill over to most other sectors until fairly recently. That’s why we used to talk about a “dual economy,” with housing notably weak, but other sectors doing well. However, financial markets became disrupted in the middle of last year, which has not only intensified the housing slump, but also has tightened credit conditions for some households and businesses. The combined impact has led to slowing more broadly through the economy. It is this broader slowdown that has elicited Federal Reserve actions in recent months.

In my remarks today, I plan to discuss my views on policy and on the prospects for the nation’s economy this year and beyond.

Financial markets

I’d like to begin with a discussion of the disruptions in U.S. and global financial markets, because they influence not only the economy’s most likely course but also the risks that could alter that course. In my view, these disruptions are likely to continue for some time. In other words, I think they have laid bare some fundamental issues with the structure of the financial system that will require significant adjustments.

The financial disruptions are centered in the markets for asset-backed securities. The aim of such instruments is to diversify and spread risk, potentially enhancing economic welfare by broadening access to credit and lowering its cost. These instruments have been around a long time. For example, for many years, when a bank originated a mortgage, instead of holding it on its books, it may have sold the mortgage to one of the government-sponsored agencies, Fannie Mae or Freddie Mac. The agencies, in turn, would then bundle that mortgage with other similar mortgages into a security. The virtue of this mortgage-backed security is its liquidity-that is, it can be traded in financial markets. Since around 2003, private investment banks and commercial banks have increasingly been involved in securitizing mortgages and other assets as well. This business has grown dramatically, securitizing many types of underlying loans and, importantly, about 75 percent of all subprime mortgages in 2006.

Advances in financial engineering have led to new and complex forms of asset-backed securities. For example, CDOs, or collateralized debt obligations, package multiple mortgage-backed securities-essentially securitizing several already securitized bundles of long-term debt instruments. Typically, they include tranches-literally, “slices”-of mortgage-backed securities with different exposures to risk based on a prioritization of the payments from the underlying mortgage securities, and are a type of “structured credit.” There are even instruments, known as CDO2, that consist of tranches based on holdings of other CDOs, rather than “simple” mortgage-backed securities, and CDO3 that, as you might now guess, consist of tranches based on holdings of CDO2.

To deal with the complexity of these instruments, many market participants, including financial institutions and other sophisticated investors, relied to a great extent on credit rating agencies for assessments of the risk. However, last summer, to the surprise of many, the rating agencies announced a set of substantial downgradings of highly rated tranches of a number of subprime mortgage-backed securities in light of rapidly rising delinquencies in some types of those mortgages. These downgrades raised concerns not only about mortgage-backed securities themselves, but also about the quality of rating agencies’ evaluations of risk in other structured credits. As a result, investors grew wary, as they had trouble knowing what risks were embedded in these instruments, how to price the risks, and who would ultimately bear the risks. The consequence is that the markets for many such assets are now highly illiquid and all but closed for new business.

With the benefit of hindsight, it is now apparent that underwriting standards slipped substantially in the United States as house prices soared. For example, permissible combined loan-to-value ratios edged up during 2005 and 2006. And no- or low-documentation loans-so-called “stated income” loans-became more prevalent. Such loans might have performed reasonably well if house prices had continued to rise, but once house prices leveled off and then began to decline, the stage was set for trouble.

The financial turmoil has spread beyond the mortgage market in part because structured credits have been based on a wide variety of underlying loans, such as business loans, including the loans used to finance the recent wave of leveraged buyouts, or LBOs, commercial real estate, student loans, credit card loans, and subprime mortgages, to name a few.

The bottom line is that, in recent years, the financial system has gone through a significant restructuring that made evaluating and pricing risk difficult. The reverberations of the resulting financial disruption are still with us. I’d like to describe some of them now.

As investors have sought to shun risk, there has been a worldwide “flight to safety,” leading to a strong demand to hold U.S. Treasury securities-the safest and most liquid instruments in the world. This demand has contributed to a sharp decline in interest rates on Treasuries. Of course, these rates also have declined because of the Committee’s moves to ease policy.

However, the potential stimulatory effects of this drop in risk-free Treasury rates have been offset in many cases by another key feature of the financial turmoil, namely, a sharp rise in interest rate risk spreads, as riskier borrowers have had to pay higher premiums to compensate lenders for a perceived increase in the probability of default or losses in that event. On the corporate side, prime borrowers have actually experienced some net decline in interest rates since the shock first hit-that is, even though risk spreads are higher, they have been more than offset by lower Treasury rates. However, issuers of low-grade corporate bonds with greater credit risk, in contrast, face notably higher interest rates.

The mortgage market has been the epicenter of the shock, and, not surprisingly, greater aversion to risk has been particularly apparent there, with spreads above Treasuries increasing for mortgages of all types. Although borrowing rates for low-risk conforming mortgages are now lower than they were before the financial shock hit, fixed rates on jumbo mortgages are higher on net. Subprime mortgages remain difficult to get at any rate. Moreover, many markets for securitized assets, especially non-agency mortgage-backed securities, continue to experience severe illiquidity; in other words, the markets are not functioning efficiently, or may not be functioning much at all.

The turmoil is reverberating in depository institutions as well.1 One problem is an unanticipated buildup of mortgages as well as LBO-related loans on their balance sheets. These loans were in the pipeline for securitization but could not be sold. This problem has hit banks in part because they themselves were involved in creating structured credits that held mortgages and the leveraged loans that they had originated. In addition, they face problems with some structured investment vehicles, or SIVs, that they had sponsored and backstopped to hold and fund portfolios of securitized assets through the issuance of asset-backed commercial paper. When the SIVs were in danger of failing, the banks were concerned about reputational effects and decided to rescue them by taking the underlying assets back onto their own balance sheets. Furthermore, as investors have pulled back from the markets for asset-backed securities, the value of these securities and CDOs has fallen dramatically, so banks and other financial institutions have had to write down their values, which has shrunk their capital and driven their stock prices down.

Another problem for bank balance sheets is that credit losses have been edging up.
The latest reverberation involves monoline financial guarantors. These companies guarantee the timely payment of principal and interest due on various types of securities, including structured credits. The guarantees can increase the credit rating of the covered securities and thus increase the value of those securities on banks’ balance sheets. The problem today is that the guarantors are reporting sizable losses because of the increased riskiness of the securities they are covering. Those losses can affect the guarantors’ capital positions and even their own credit ratings. A rating downgrade of a guarantor reduces the value of its credit enhancements and lowers the price of the covered securities. Holders of those securities such as banks then have to take write-downs to reflect the lower value of the securities.

Fortunately, the banking system entered this difficult period in a strong position. Most institutions were extremely well capitalized. However, the combination of unanticipated growth in assets and in write-downs has put increased pressure on banks’ capital positions. Given their concerns about capital adequacy and their increased caution in managing liquidity, it is not surprising that they are tightening credit terms and restricting availability. At first, the focus was mostly on mortgages, but now it has spread to other kinds of loans, including home equity lines of credit, credit cards, and other consumer credit, as well as business loans. The tightening of credit is also a response to a now noticeable deterioration in credit quality, particularly for subprime mortgages; the losses in other parts of the consumer loan portfolio remain at relatively low levels from an historical perspective, but they, too, have edged up.

Finally, equity markets have hardly been immune to recent financial turbulence. Broad U.S. equity indices have been very volatile, and, on the whole, have declined since August, representing a restraint on spending. More recently, some of these declines have occurred as profits have come in below market expectations for some financial firms due to write-downs of the value of mortgage-backed securities.

My overall assessment is that the turbulence in financial markets is due to some fundamental problems that are not likely to be resolved quickly. The effects of these problems have now made credit conditions tighter throughout most of the economy’s private sector, and this will restrain spending going forward. The impact hit economic activity mainly in the fourth quarter, and so far, it has been starkly negative. After robust performance in the second and third quarters of last year, growth slowed significantly in the fourth quarter-to a pace of only ½ percent. This brings me to the outlook for the economy.

Economic outlook

Current indicators point to continued anemic growth for at least the first half of this year as well as significant downside risks even to those weak expectations. As I mentioned at the outset, though the prolonged slump in housing construction did not spill over significantly to the rest of the economy during 2006 and much of 2007, when combined with the recent financial market turmoil, it has been central to the emergence of today’s slow-growth environment. And the course of its resolution will be a key factor in the economic outlook.

Forward-looking indicators of housing activity strongly suggest that the downward cycle may be with us a while longer. Housing permits and sales are dropping, and inventories of unsold homes are at very high levels. Those inventories could rise even higher as foreclosures continue to mount. I’m not referring only to foreclosures on subprime adjustable-rate mortgages, which, as we all know, have increased sharply over the past couple of years. More recently, we’ve begun to see increases in foreclosures on subprime fixed-rate mortgages and even on prime adjustable-rate mortgages.

Within this Federal Reserve District, housing has been harder hit in some areas than in others. For example, builders and homeowners in parts of Arizona, Nevada, and the inland regions of California have seen some of the worst of the downturn, watching prices fall and equity evaporate as homes sit unsold for extended periods.

Hawaii has been near the opposite end of the spectrum. Indeed, the sales pace for existing homes actually increased during the first nine months of the year compared with the same period in 2006, reflecting healthy economic conditions in the state, and a lower exposure to the subprime mortgage market. Subprime lending accounted for only about a fifth of mortgage originations in Hawaii in 2006, compared to about one-third in parts of Arizona, California, and Nevada. Nevertheless, the foreclosure rate has risen sharply here, although it remains well below rates in the harder-hit states. Following several years of double-digit appreciation rates, prices on existing homes in Hawaii largely flattened out by the end of 2007, but have not shown the declines that are evident in some other parts of the District.

On the national level, housing construction probably will continue to contract through the end of this year. It is true that the residential construction sector is a fairly small piece of the overall economy and is unlikely to cause significant overall weakness in and of itself. But the fallout from the housing cycle has many dimensions, and in the fourth quarter there were signs of spillovers to other sectors of the economy, most worrisomely, to consumer spending. This sector is a huge part of the economy-about 70 percent-and its growth slowed to a rate that is somewhat below its long-run trend in the face of spillovers from the housing market and rising energy and food prices.

Looking ahead, developments related to housing are likely to continue to put a strain on consumers. For example, house prices have fallen noticeably and the declines have intensified. Moreover, futures markets for house prices indicate further-and even larger-declines in a number of metropolitan areas this year.

With house prices falling, homeowners’ total wealth is declining, and that could lead to a pullback in spending. At the same time, the fall in house prices may constrain consumer spending by lowering the value of mortgage equity; less equity reduces the quantity of funds available for credit-constrained consumers to borrow through home equity loans or to withdraw through refinancing.

Indeed, it would not be surprising to see even more moderation over the next year or so, as consumers face additional constraints due to the declines in the stock market, the tightening of lending terms at depository institutions, and the lagged effects of previous increases in energy prices. National surveys show that consumer confidence has plummeted. And I have been hearing comments and stories from my business contacts in the retail industry that are also downbeat. The rise in delinquency rates across the spectrum of consumer loans is strongly indicative of the growing strains on households.

Finally, another negative factor for consumption is that labor markets have softened. In recent months, growth in employment from a survey of business establishments slowed sharply, actually falling in January, and many other indicators point in the same direction. Slower job growth will have a negative impact on the disposable income available to households and therefore will provide an additional restraint on consumer spending.

Slower growth in consumer spending has already started to affect the Hawaiian economy. Up to last year, Hawaii enjoyed an extended run of robust growth in the tourism industry, spurred primarily by visitors from the U.S. mainland. This helped Hawaii achieve the lowest unemployment rate in the nation during 2004 through 2006. Last year, tourist visits actually dropped a bit, largely because fewer mainlanders came over. Employment growth in the state has slowed accordingly, and the unemployment rate is up by more than a percentage point from its remarkable low of 2 percent at the end of 2006. Nevertheless, economic conditions remain sound by historical standards, and the state appears well-positioned to weather any further spending reductions by U.S. consumers.

With the domestic consumer likely to be pretty hobbled, it is tempting to look at consumers beyond our own borders to be a source of strength for economic activity. Foreign real GDP has advanced robustly over the past three years. With the dollar falling well below its level of a year ago, U.S. exports have done very well; partly for this reason, U.S. net exports-exports minus imports-which consistently held growth down from 2000 to 2005, actually gave it a lift over the past couple of years. I expect net exports to remain a source of strength. But some countries-especially in Europe-are experiencing direct negative impacts from the ongoing turmoil in financial markets. Others are likely to suffer indirect impacts from any slowdown in the U.S. A slowdown here could well produce ripple effects lowering growth there through trade linkages, and recently this factor has been reinforced by a worldwide drop in stock prices.

Economic policies are another important factor in gauging the economic outlook. As I have noted, the FOMC has eased the stance of monetary policy substantially in the past five months. Moreover, there is considerable talk in Congress about passing a fiscal stimulus package to help the economy. If such a bill is passed soon, it could provide notable stimulus in the latter half of this year.

Even with such policy stimulus, the overall economy is still likely to turn in a very sluggish performance this year, expanding by a rate well below potential and creating more slack in labor markets. At 4.9 percent, the unemployment rate is already slightly above my estimate of its sustainable level. Slow growth this year would most likely push unemployment even higher.

To sum it up, for the next few quarters, I see economic activity as weighed down by the housing slump and the negative factors now impacting consumer spending. It remains particularly vulnerable to the continuing turmoil in financial markets. My comments haven’t even touched on possible slowdowns in business investment in equipment and software and buildings. I see the growth risks as skewed to the downside for the near term. In circumstances like these, we can’t rule out the possibility of getting into an adverse feedback loop-that is, the slowing economy weakens financial markets, which induces greater caution by lenders, households, and firms, and which feeds back to even more weakness in economic activity and more caution. Indeed, an important objective of Fed policy is to mitigate the possibility that such a negative feedback loop could develop and take hold.

Now let me turn to inflation. The recent news has been disappointing. Over the past three months, the personal consumption expenditures price index excluding food and energy, or the core PCE price index-one of the key measures included in the FOMC’s quarterly forecasts-has increased by 2.7 percent, bringing the increase over the past 12 months to 2.2 percent. This rate is somewhat above what I consider to be price stability.

I expect core inflation to moderate over the next few years, edging down to around 1¾ percent under appropriate monetary policy. Such an outcome is broadly consistent with my interpretation of the Fed’s price stability mandate. Moreover, I believe the risks on the upside and downside are roughly balanced. First, it appears that core inflation has been pushed up somewhat by the pass-through of higher energy and food prices and by the drop in the dollar. However, recently, energy prices have turned down in response to concerns that a slowdown in the U.S. will weaken economic growth around the world, and thereby lower the demand for energy.

Another factor that could restrain inflationary pressures is the slowdown in the U.S. economy. This can be expected to create more slack in labor and goods markets, a development that typically has been associated with reduced inflation in the past.
A key factor for inflation going forward is inflation expectations. These appear to have become well-anchored over the past decade or so as the Fed’s inflation resolve has gained credibility. Very recently, far-dated inflation compensation-a measure derived from various Treasury yields-has risen, but it’s not clear whether this rise is due to higher inflation expectations or to changes in the liquidity of those Treasury instruments or inflation risk. Going forward, we will need to monitor inflation expectations carefully to ensure that they do indeed remain well anchored.

Monetary policy

Now let me turn to monetary policy. The federal funds rate has been cut by 2¼ percentage points since September and now stands at 3 percent. With near-term expected inflation of just above 2 percent, the real-inflation adjusted-funds rate is around 1 percent or slightly lower, which represents an accommodative posture.

I believe that accommodation is appropriate because the financial shock and the housing cycle have significantly restrained economic growth. While growth seems likely to be sluggish this year, the Fed’s policy actions should help to promote a pickup in growth over time. I consider it most probable that the U.S. economy will experience slow growth, and not outright recession, in coming quarters. At the same time, core consumer inflation seems likely to decline gradually to somewhat below 2 percent over the next couple of years, a level that is consistent with price stability.

However, economic prospects are unusually uncertain. And downside risks to economic growth remain. This implies that, going forward, the Committee must carefully monitor and assess the effects of ongoing financial and economic developments on the outlook and be prepared to act in a timely manner to address developments that alter the forecast or the risks to it.

Can accounting standards be blamed for the financial collapse?

An article by French financial expert Nicolas Veron, originally published in French but translated on the website of Veron’s Belgium-based think-tank, questions whether European accounting standards might be to blame for some of the continent’s financial turmoil.

Read full story.