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CDS Deja Vu: Speculation, stabilizing or destabilizing?

The following is a cross-post from Perry Mehrling’s new blog The Money View. Mehrling is a Columbia University economist and his blog is part of a broader effort to re-think macroeconomics and finance sponsored by the Institute for New Economic Thinking.

CDS Deja Vu: Speculation, stabilizing or destabilizing?

Today’s Financial Times articles: US muni smackdown (Feb 2, 2011), Wall St looks to boost market in US muni CDS (Feb 6, 2011)

“Muni veterans are from Mars, Meredith Whitney is from Venus,” so says Lex, commenting on the wide divergence in current views about the future of the US municipal bond market. Whitney sees a coming wave of defaults; veterans see municipal debt/income ratios far below those that sovereign states routinely bear.

Lex frames the divergence as a matter of political judgment. Municipalities have made promises to bond investors, but they have also made promises to public sector unions in the form of wage and pension contracts. When the numbers do not add up, which promises will wind up being honored and which breached?

From a money view perspective, an alternative frame presents itself, namely the possibility of refinance. Quite apart from the possibility of public refinance, already we hear isolated stories of private refinance, which involve purchase of distressed municipal debt as a way of gaining control over the underlying assets, perhaps a hotel, or a stadium, or an airport.

Read the full piece at The Money View.

Post-Crisis Rationalizations: The three-lane highway to recovery?

C.P. Chandrasekhar

In the effort to restore economic optimism and talk up global growth, the favourite phrase doing the rounds today is “multispeed recovery”. Unevenness in growth, which was earlier seen as a sign of global imbalance, is now being celebrated as cause for optimism.

World Bank President Robert Zoellick speaking on global economic prospects, and business leaders and experts debating in Davos, have recently argued that all segments of the global economy are on a highway to recovery, even if on lanes that permit different speeds. There are at least three speeds at which the recovery is expected to proceed during 2011: 6 per cent in the emerging economies led by China and India, 3 per cent in the US and less than 2 per cent in the euro area. Put together, these are presented as a significantly positive rate for the global economy as a whole. While the working people in a host of countries, developed and developing, may be short of jobs and incomes, a truly global perspective seems to provide cause for optimism.

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The Financial Crisis Inquiry Commission Report: Downplaying derivatives

Matías Vernengo

The Financial Crisis Inquiry Commission (FCIC) released its report last week, and concluded that the crisis was foreseeable and avoidable. The FCIC argues that authorities were permissive and that: “the prime example [of permissiveness] is the Federal Reserve’s pivotal failure to stem the flow of toxic mortgages, which it could have done by setting prudent mortgage-lending standards.” The report is right to emphasize that failures of regulation and supervision were crucial to the eventual collapse, which by the way is a fitting indictment of Geithner, Bernanke and several other policy-makers still in key positions.

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Economists Issue Statement on Capital Controls and Trade Treaties

Since the onset of the global financial crisis, Triple Crisis bloggers have been commenting on the need for policy space for capital controls in developing countries and the need to reform US trade agreements, which generally prohibit their use. To further that end, Triple Crisis co-chair Kevin Gallagher and Sarah Anderson of the Washington-based Institute for Policy Studies initiated an economist sign-on letter, which has more than 250 signatures including many Triple Crisis bloggers. It was released today and presented to Congress and the Obama Administration. The press release, with links to the letter and further information, follows.

More than 250 Economists Call for Trade Reforms to Allow Capital Controls

In a letter delivered January 31, more than 250 economists urged the Obama administration to reform U.S. trade rules that restrict the use of capital controls.

The statement reflects growing consensus among economists that capital controls, while no panacea, are legitimate policy tools for preventing and mitigating financial crises.

Signatories include several economists who have been generally supportive of free trade but are critical of the capital control restrictions (e.g., Arvind Subramanian, Senior Fellow of the Peterson Institute for International Economics and Nancy Birdsall, President of the Center for Global Development), as well as former IMF officials (e.g., Olivier Jeanne of Johns Hopkins University) and a Nobel laureate (Joseph Stiglitz).

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Curbing Hot Capital Flows to Protect the Real Economy

Triple Crisis bloggers Stephany Griffith-Jones and Kevin P. Gallagher published the following proposal to stem the excessive flows of speculative capital into developing countries in Economic and Political Weekly. In their approach, the United States and developing countries each regulate the outflow and inflow of hot money and redirect investment toward the real economy.

Curbing Hot Capital Flows to Protect the Real Economy

Developing countries are once again the destination for speculative capital flows with in inlows reaching pre-crisis levels, leading to currency appreciation and asset bubbles. Many of these nations are deploying prudential capital regulations to stem these flows. However, this may only be a partial remedy to the problem – such measures should be coupled with action by the developed countries in order to fully steer capital to productive use and to avoid future crises.

Download the full article at Economic and Political Weekly.

Food Price Volatility: Market fundamentals and commodity speculation

Timothy A. Wise

As Jayati Ghosh explained in her recent post on the “Frenzy in Food Markets,” high food prices are back and market fundamentals do not adequately explain the price rise. Still, a wide range of analysts and commentators, from Paul Krugman to the International Food Policy Research Institute, dismiss the argument that a significant part of the 2006-8 food price surge was due to speculation. They are more dismissive now, two years further removed from the bursting bubbles of the housing and financial crises.

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State of the Union: The war on demand and the Sputnik moment

Matías Vernengo

President Barack Obama’s call for a five-year freeze in non-security, discretionary spending during his State of the Union address is exactly what should not be done, for the economy and for the future of his presidency. The President’s call for a government that lives within its means shows that, at least in terms of ideas, he has caved to what Krugman has suitably termed the “war on demand.” The great Polish economist Michael Kalecki long ago explained the reasons for the dislike of demand policies in his classic on “The Political Aspects of Full Employment,” in which he argues that it is the elites’ abhorrence of empowering the lower classes that is behind the doctrine of “sound finance” (i.e. balanced budgets).

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Nothing Lasts Forever: The Future of the Dollar in the International Monetary System

David Nelson Black, re-posted from the World Policy Institute’s World Policy Blog, a Triple Crisis partner. We periodically cross-post items of interest.

For the foreseeable future, the US government’s inability — or refusal — to embrace fiscal responsibility will likely remain one of the global economy’s most pressing issues and one of its most reliable constants. Barring any radical and unforeseen change of course, this means that the US dollar is likely to continue to decline in importance. Private investors, along with foreign governments and their central banks, will gradually lose confidence in the notion that the US possesses the political will or ability to preserve the underpinnings of a healthy monetary system. Gone will be the latitude afforded by being the world’s financial capital and holder of its reserve currency — what Charles DeGaulle and his finance minister 50 years ago labeled the United States’ “exorbitant privilege.”

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Should Economists Declare Conflicts of Interest?

Gerald Epstein

Triple Crisis blogger Gerald Epstein was recently interviewed by the Real News Network on his and Jessica Carrick-Hagenbarth’s study on the failure of economists to disclose conflicts of interest when providing financial analysis in the media. They spearheaded an effort to get the American Economic Association to adopt an ethics code for economists with a sign-on letter that garnered the support of close to 300 economists. In this video, Epstein discusses the letter’s impact at this month’s AEA annual meeting, which resulted in the creation of a committee to research and consider new ethics standards for economists.

Read more of Epstein’s commentary on economists’ conflicts of interest in two recent blog posts (here and here).

The Case for Controlling Capital Outflows

Stephany Griffith-Jones

Emerging countries, and even some low-income ones, are being flooded by short-term capital flows which they do not need; much of this money originates via the carry trade from the second wave of US quantitative easing (QE2). The intent of the US Federal Reserve is to expand the supply of credit in the US, so as to support the recovery and to lower long-term interest rates in the US.

So the impact of the carry trade is negative both for the US (as it undermines the aims of QE2) and for developing countries, which see their exchange rates become overvalued and their asset prices increase excessively.

The response of developing countries has been varied, but increasingly many of them are beginning to impose capital controls, both of the traditional kind, but also more innovative ones, that is those which deal with the new ways in which capital enters developing countries, in particular via derivatives. Indeed, many of these derivatives were initially invented to avoid precisely regulations on capital inflows or other types of financial activity.

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