Thursday, February 2, 2012

Still more improvement in the Eurozone

I've been highlighting the importance of swap spreads as good leading indicators for over three years, and three weeks ago I noted how euro basis swap spreads (a measure of the difficulty that Eurozone banks are having in obtaining dollar liquidity) were pointing towards improvement in swap spreads. Well, things are really picking up. Eurozone 2-yr swap spreads haven't been this low since last October, and U.S. 2-yr swap spreads are back to August levels.

It really does look like the world may be exiting the Eurozone sovereign debt crisis, thanks mainly to the improvement in liquidity conditions in the Eurozone financial system. I caution that the fundamental problem in the Eurozone—bloated government spending—remains unsolved, but at least the world can deal with the problem if financial markets are able to function with some semblance of normality. That's the key. In a worst-case scenario, PIIGS defaults might erase some $2 trillion in capital, but that's a only a drop in the $100 trillion global capital market bucket. If financial markets can spread the risk around, we can deal with a loss that size. But if financial markets are frozen, it's like what happens when someone yells "fire" in a theater and the exits are blocked: panic.


McKibbinUSA said...

Hi Scott, I agree that wiping out $2 trillion in sovereign debts is a only a "roadbump" for the global economy -- which begs the question of why so much effort has been invested in avoiding a default -- the reason is that hundreds of millions of people in Portugal, Italy, Ireland, Greece, and Spain would be instantly disenfranchised from the global economy, which quite possibly could result in a rise of Fascism and/or Communism in these regions -- should the entire southern flank of Europe become Fascist and/or Communist, the costs could change from a couple of trillion dollars, into a hundred trillion dollars plus millions of lives lost -- the economics of a default are easy to deal with -- but, you cannot use polemics to "wish away" political instability -- herein is the great challenge for economists today -- to be able to concede that the economic uncertainties take no account of the concomittant political uncertainies that often follow economic collapse. Thanks for the opportunity to comment...

Benjamin Cole said...

Here is some commentary from right-wing economist Scott Sumner, a Cato contributor. Low interest rates may be the new normal, he says.

"This is the first recession in my entire life where nominal interest rates fell to near zero. And yet I wouldn’t be at all surprised if this occurred in every single future recession during my lifetime. In my view, Japan is the future of the global economy. Not the deflation (I think the Fed will be able to keep inflation close to 2%) but the low real interest rates. In retrospect the 2001 recession (when rates fell to 1%) was the canary in the coal mine. Nominal rates will probably be unusually low from this point forward. Global saving will increase dramatically as Asian countries get richer (remember that most people are Asians) and slowing population growth outside of Africa will dramatically reduce the demand for investment funds."

I perhaps disagree with Sumner; right now the Fed is failing to keep inflation at 2 percent (we are at zero now) and is doing nothing about it. We have hit deflation already.

What is sad is that most "right-wing" economists, who have been mostly correct in previous decades, are encrusted into their habits and shibboleths, and are now mostly wrong.

Low interest rates do not mean the Fed is being "easy," and QE will have to become regarded as "conventional;" not unconventional. Even monetizing debt will have to become a tool. (BTW, monetizing debt just means putting currency into the hands of people who own US bonds. It is not theft. They can choose to spend it, or invest in equities, real estate or directly into businesses--how terrible!)

Think about it: Milton Friedman, Allan Meltzer, John Taylor and Ben Bernanke all called for QE in Japan, and Taylor gushed about the positive results of a QE program in Japan in 2006.

But now, primarily from encrusted habit and perhaps a super-rigid even hysterical political agenda on the right, these GOP solons cannot call for QE in the USA (Bernanke has, but the others no).

Scott Sumner and the Market Monetarists are showing the way forward to real security and prosperity for the USA. I hope the left and the right can abandon their pet theories and safe refuges, and embrace this necessary and bold approach.

McKibbinUSA said...

PS: Unemployment in Spain is now 22.8% aas of January 2012 -- witness the emerging conditions for Fascisim and/or Communism...

Javier Viana said...

Dear Dr. William,
I am spanish and I live in Spain and I see no fascism or comunism in this country. I will even tell you more, we have had 40 years dictatorship and you problably don't know what it is to live in it, so please do not play the game to try outguess what other countries are least you could come and visit this beautiful tourist based country and leave some dollars...and in the meanwhile you will note that there is no fascism nor comunism.
Do not take this critic the bad way, I like to read you.