Oil takes a tumble as Fed declines to offer new stimulus

Crude oil declined below $79 a barrel to its lowest levels since September on the New York Mercantile Exchange, extending the drop after the Federal Reserve pledged to keep interest rates at a record low through mid-2013.

U.S. benchmark crude for September delivery, West Texas Intermediate, dropped $2.01 to $79.30 on the New York Mercantile Exchange. That was the commodity's lowest settlement since Sept. 29, 2010. Futures have fallen 17% so far this month and are now down 13% for the year.

European benchmark Brent North Sea oil for September delivery dropped $2.35, or 2.3%, to $101.39 a barrel on the ICE Futures exchange in London. Earlier, it had fallen as much as $5, to $98.74, briefly drifting below $100 for the first time since Feb. 8.

Phil Flynn, an analyst at PFGBest Research, said "the market was hoping it would see some more Fed stimulus."

Flynn added, "The Fed didn't need to tell us they were keeping rates low. We already know that. There is a little bit of disappointment about that. Add to that the numerous reports from sources like the Energy Department on lower oil demand and we have another decline. Oil can be a safe haven, but only if you believe the global economy is going to move up reasonably and steadily."

Retail gasoline prices continued to decline, falling to a national average of $3.652 for a gallon of regular from $3.703 a week ago, according to the AAA Fuel Gauge Report. In California, the average price of a gallon of regular gasoline was $3.783, down from $3.816 a week ago.

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-- Ronald D. White

Chart: The 12-month rolling average for the price of regular unleaded gasoline in California and in the U.S. Credit: AAA Fuel Gauge Report

9,450 restaurants closed in U.S. last year, report says

There are 9,450 fewer restaurants in the U.S. than there were last year, according to a report released Tuesday.

Of those, 8,650 were independent restaurants, which took their steepest dive since market research company The NPD Group began its tally in 2001.

Although chain restaurants stayed relatively stable, companies such as Koo Koo Roo began scaling back their presence in Southern California because of money troubles.

"A volatile economy, more frugal consumers and a lack of financial backing have made it a difficult business environment for independent restaurants," Greg Starzynski, director of product development -– food service for NPD, said in a statement.

The study, conducted from April 1, 2010, through March 31, found that 3,495 quick-service restaurants had closed and 5,965 full-service locations were shuttered.

For more news on Los Angeles restaurant closings, visit the Daily Dish blog.

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Consumer Confidential: Pie chain goes bankrupt, Timberland bought, Arby's sold

Sizzler reorganized with more local ownership

-- Tiffany Hsu

Photo:  Patrons at the bar of Edward's Steakhouse in El Monte, which is closing because of the economy.

Credit: Lawrence K. Ho / Los Angeles Times

Dollar tumbles as Fed sees long stretch for low interest rates

The dollar was the victim Tuesday as the Federal Reserve said it may hold short-term interest rates near zero for another two years.

The prospect of rock-bottom rates continuing through at least mid-2013 drove the dollar down sharply against other major and minor currencies.

The euro surged to $1.437 from $1.418 on Monday. The dollar slumped to 76.96 yen, down from 77.77 on Monday and nearing the recent record low of 76.76 reached on July 29.

The DXY index (charted at left), which measures the dollar’s value against six other major currencies, fell 1.2% to 73.91. It's still above the 2011 low of 72.93 reached on April 29.

The Swiss franc, which has become one of the world’s favorite havens amid the latest market turmoil, was a huge winner as the dollar wilted. The buck’s value fell to a record low 0.721 francs, down 4.5% from 0.755 francs on Monday.

The Australian and Canadian dollars also rose sharply against their U.S. counterpart.

Foreign investors looking for a place to park cash may find the U.S. less appealing if short-term interest rates stay low compared with other countries. That would lead to weaker demand for dollars.

A falling greenback saps Americans’ purchasing power abroad. But it’s a potential boon to U.S. exporters by making their products less expensive for foreign buyers.

-- Tom Petruno

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Dow rockets 429 points after Fed makes new pledge on rates

 

Divided Fed says likely to keep rates low through mid-2013

The Federal Reserve on Tuesday sharply downgraded its outlook for the American economy and took the extraordinary step of signaling that it would hold short-term interest rates at exceptionally low levels "at least through mid-2013."

The move marks the first time that the U.S. central bank has pegged a specific timetable to a pledge on its benchmark interest rate, the federal funds rate, which has been near zero since late-2008.

But the decision came with three dissenting votes from Fed committee members, reflecting concerns about the threat of runaway inflation down the road.

The Fed's statement triggered wild swings on Wall Street. Stocks fell initially, but the market rallied toward the closing bell. The Dow index closed up 430 points, or 4%, to 11,239, after plunging 634 points on Monday amid deepening fears about the economy.

Treasury bond yields dived as some investors rushed to lock in longer-term yields in the wake of the Fed's pledge.

Analysts were surprised by the Fed action as most were expecting Chairman Ben S. Bernanke and his colleagues to offer some reassurance about the economic recovery and to make clear that they had the tools and the will to take action if conditions worsened.

But the Fed statement said economic growth this year has been “considerably slower” than expected, with indicators suggesting “a deterioration in overall labor market conditions.”

Pointedly, the Fed committee said it “now expects a somewhat slower pace of recovery over coming quarters than it did at the time of the previous meeting.” The last meeting was on June 22, when Fed officials said they expected the pace of recovery to pick up over coming quarters.

The weaker economic backdrop, the Fed said Tuesday, was "likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013."

Since 2008, the Fed has kept its key rate near zero and has said repeatedly that it would keep it there for “an extended period” -- which Bernanke has said was meant to indicate a period of a few months.

In signaling that it could maintain that rock-bottom rate for at least another two years, the Fed wants to reduce uncertainty for businesses and investors, hoping to give them more confidence to spend and invest.

But the three dissenters on the Fed board showed the split sentiment about whether the Fed should promise more potential stimulus for the economy. Keeping money excessively loose could eventually fuel a surge in inflation, although many economists believe the recovery is too weak to foster significantly higher inflation for now.

Voting against the change in the statement were Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser,the heads of the Fed's Dallas, Minneapolis and Philadelphia branches, respectively.

They said they "would have preferred to continue to describe economic conditions as likely to warrant exceptionally low levels for the federal funds rate for an extended period," retaining the old language.

Fisher, speaking last month, said he believed that the Fed had "already pressed the limits of monetary policy."

Voting for the change were Bernanke, William C. Dudley, Elizabeth A. Duke, Charles L. Evans, Sarah Bloom Raskin, Daniel K. Tarullo and Janet L. Yellen.

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Bras, batteries and Bachmann: S&P downgrade is ripe for jokes

-- Don Lee and Tom Petruno

Top photo: Fed Chairman Ben S. Bernanke. Credit: Karen Bleier / AFP / Getty Images 

Bottom photo: RIchard Fisher, head of the Fed's Dallas branch. Credit: Bloomberg News

Bras, batteries and Bachmann: S&P downgrade is ripe for jokes

The economy looks headed for the dumps. Unemployment is high. Standard & Poor’s has branded the U.S. with a AA+ credit rating.

Calling all jokesters.

“Congress and obama feverishly searching Wal Marts for AA+ batteries to run the country,” tweeted New York photographer Tom Contrino.

“In bra sizes, going from AAA to AA is a good thing,” Brooklyn resident Jessica Misener tweeted helpfully.

"’AAA to AA’ is a trending topic,” tweeted ArsenalOffside of Greensville, S.C. “Lots of people needing a tow truck to get to their 12-step meeting, apparently...”

Other messages floating around the Twittersphere:  “S&P downgrades Michele Bachmann to Sarah Palin” and “Turns out it was S&P that downgraded Pluto to dwarf planet.”

On "The Daily Show," during a segment titled “Rise of the Planet of the AAs,” host Jon Stewart also took jabs at S&P.

"The ratings agency is Standard & Poor's," he said. "Who's going to listen to a company whose name translates to average and below average? This is a big nothing burger."

“Standard & Poor’s has warned there’s a one-in-three chance we could be downgraded again in the next three years,” said Jay Leno on The Tonight Show. “We could go from AA+ to FU.”

The comedian also took a stab at Treasury Secretary Timothy F. Geithner, joking that he “had suggested he might be leaving and getting a job in the private sector, but thanks to his economic policies there are no jobs in the private sector.”

The economy is so bad, Leno said, that “Angelina Jolie is now adopting kids from America.”

On Tuesday, an airplane flew past the S&P offices in Manhattan trailing a bold banner: “THANKS FOR THE DOWNGRADE. YOU SHOULD ALL BE FIRED.” Apparently, a single mother and investment banker from St. Louis was behind the stunt, according to the New York Observer, which also has photos.

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Market experts lukewarm on Fed statement as Dow fluctuates

-- Tiffany Hsu

Photo: The New York Stock Exchange on Tuesday. Credit: Richard Drew /Associated Press

Herbalife expands distribution facilities

Nutritional-supplement company Herbalife International Inc. expanded its Carson distribution facilities by 82% when it moved to a larger building owned by its longtime landlord, Watson Land Co.

Herbalife has moved from an 82,000-square-foot warehouse it had occupied since 1996 in the Watson Industrial Center into a 148,908-square-foot industrial property at 18431 Wilmington Ave. in Watson Land’s nearby Dominguez Technology Center, the landlord said.

The value of Herbalife’s 10-year lease was not disclosed, but Watson Land asks for rents in the range of 60 cents per square foot per month in Dominguez Technology Center, according to real estate data provider CoStar Group Inc.

The facility is Herbalife’s Los Angeles distribution headquarters. Watson Land has signed 1.1 million square feet of leases in 2011, the company said.

Photo:  Herbalife’s new distribution center.   Credit:  Watson Land Co.

Battered bank stocks rebound

Banks stocks, badly beaten down by fears of a double-dip recession, worries about continued mortgage losses and the debt crises in Europe and the United States, rose sharply higher Tuesday as investors decided a buying opportunity was at hand.

The BKX index of 24 diverse bank stocks was up more than 7%, with some of the largest and most hammered banks significantly higher.

Retail giant Bank of America Corp., which has been hit particularly hard by fears that it can't get a handle on its mortgage troubles, was up $1.09, or 16.7%, at $7.60. The stock had plunged by 20% on Monday in the highly volatile market.

Wells Fargo & Co., also highly exposed to consumer lending, rose $1.85, or 8.1%, to $24.78. Citigroup Inc., which has huge exposure to foreign markets, jumped $3.87 to $31.82, a 13.8% gain, as Chief Executive Vikram Pandit said his bank, extensively restructured after the financial crisis, has "unparalleled resources" to withstand the current storms.

Shares of JPMorgan Chase & Co., regarded as among the strongest banks, rose $2.34, or 6.9%, to $36.40.

The bank stocks jumped early in the day but backed off after Standard & Poors, which helped trigger a market sell-off four days earlier by downgrading the long-term credit rating of U.S. Treasury debt, expressed concerns that bank profits will be depressed by the slow economy, sovereign debt problems and the continuing mortgage and housing fiasco.

The bank shares then resumed their climb after the Federal Reserve, expressing concerns about the weakening economy, said it probably would hold its benchmark interest rate near zero for another two years.

Dow soars 429 points after Fed makes new pledge on rates

The Dow Jones industrial average surged Tuesday, ending a volatile session up nearly 430 points after the Federal Reserve pledged to keep short-term interest rates near zero for at least another two years.

The blue-chip index gyrated throughout the session as investors weighed the implications of the Fed's surprise move. But buyers flooded into battered stocks in the final hour.

The Dow closed up 429.92 points, or 4%, to 11,239.77, its biggest gain of the year.

The central bank's statement after its mid-summer meeting helped energize investors looking for any scrap of good news after a global rout in stocks since Standard & Poor’s downgraded the U.S. credit rating late last week. On Monday, the Dow fell a stunning 635 points, or 5.6%, its worst decline since the financial-system meltdown in 2008.

Many analysts said the market was primed to bounce after deep losses over the last two weeks on fears over the fading economic recovery.

What's more, some noted that the Fed's new pledge on interest rates came as policymakers downgraded their expectations for the economy in the short run. That could cause some investors to reconsider how smart it may be to stay in stocks for the time being.

The Fed said it “now expects a somewhat slower pace of recovery over coming quarters than it did at the time of the previous meeting.”

Also, the Fed's decision on rates drew dissents from three members of the policymaking committee, a sign of fracturing views within the central bank.

Still, the bulls had control late Tuesday. The Standard & Poor’s 500 soared 53.07 points, or 4.8%, to 1,172.53. The tech-heavy Nasdaq composite jumped 124.83 points, or 5.3%, to 2,482.52.

With Tuesday's rebound, the Dow is down 2.9% year to date, the S&P 500 is down 6.8% and Nasdaq is off 6.4%.

Some investors rushed to lock in yields on longer-term Treasury bonds after the Fed statement, with short rates now likely to remain at rock-bottom through "at least through mid-2013," according to the Fed.

The 10-year T-note yield fell to 2.25% from 2.34% on Monday. At one point the yield fell as low as 2.10%. The five-year T-note sank to 0.99% from 1.08%.

 -- Joe Bel Bruno and Tom Petruno

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Photo: Traders in a stock options pit at the Chicago Board of Trade on Tuesday.  Credit: Frank Polich / Reuters

Feds sue Goldman Sachs over credit union losses

Federal regulators have filed the fourth in a series of about 10 planned lawsuits against banks that sold questionable mortgage-related securities to big credit unions that subsequently failed.

The latest target is Goldman Sachs & Co. A $401-million lawsuit, filed Tuesday in U.S. District Court in Los Angeles, accuses the giant Wall Street firm of misrepresenting the soundness of mortgage bonds that were purchased by the now-failed U.S. Central and Western Corporate federal credit unions.

Goldman Sachs spokesman Stephen Cohen declined to comment, saying the firm prefers not to litigate disputes in the media.

Lenexa, Kan.-based U.S. Central and San Dimas-based Western Corporate are so-called wholesale credit unions, which handle transaction processing and investments for the smaller retail credit unions that deal directly with the public.

Shocks from the mortgage meltdown and financial crisis caused five of these wholesale credit unions to fail, and the National Credit Union Administration is now suing to recoup some of the losses on $50 billion worth of bonds that plunged in value.

The other defendants so far are the Royal Bank of Scotland and JPMorgan Chase & Co., with the NCUA seeking a total of about $2 billion in damages.

The lawsuits illustrate how federal authorities, largely stymied in attempts to mount major criminal prosecutions related to the mortgage crisis, are targeting financial firms and their executives in civil lawsuits.

Among the federal agencies pursuing this course is the U.S. attorney's office in Manhattan, which is seeking $1 billion from Deutsche Bank, Germany's largest bank, related to mortgages backed by the Federal Housing Administration.

Another example is the Federal Deposit Insurance Fund, which is demanding that former officers of Washington Mutual, IndyMac and other failed banks cough up hundreds of millions of dollars to cover losses to the nation’s deposit insurance fund.

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Royal Bank of Scotland sued by regulators over credit union losses

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Credit unions aren't immune

-- E. Scott Reckard

Photo: Goldman Sachs' New York headquarters. Credit: Mark Lennihan / Associated Press

CalPERS portfolio has lost $18 billion in value since July 1

After posting its best annual performance in 14 years, the California Public Employees' Retirement System is giving back a sizable portion of the 20.7% investment return it reported for the fiscal year that ended June 30.

The value of the country's largest public pension fund was $220 billion at market's close on Monday, down 7.6% or about $18 billion, CalPERS said Tuesday.

"It's bad, but it's not 2008," said Joseph Dear, CalPERS' chief investment officer, in an interview on CNBC. "We have a crisis induced by lack of confidence in the U.S. and European political systems, combined with gloomier and gloomier economic growth forecasts."

Wall Street's massive stock sell-off that began last week "is a tipping point," Dear said, "but it's not a time to panic and run with fear out of the market."

CalPERS was underweight in its stock portfolio at the close of the last fiscal year and now is "considering whether we can go back in" to make long-term investments, Dear said.

Though Dear said he didn't expect the U.S. economy to fall into a double-dip recession, he conceded that the outlook for short-term growth was not rosy.

Those comments contrasted with Dear's enthusiasm for the 20.7% investment return that CalPERS announced on July 18, covering the 2010-11 fiscal year.

"The portfolio is quite healthy with positive benchmark-beating gains for nearly all of our assset classes over the past year," Dear said at the time. "Global equity [public stocks], private equity, fixed income, inflation-linked and cash equivalents all did well, and our real estate portfolio is back in positive territory after reversals during the financial crisis and recession."

CalPERS' portfolio value dropped from a historic high of $260.4 billion in October 2007 to $160 billion in March 2009. It has since risen to a high of $237.5 billion on June 30 before dropping to $220 billion on Monday.

CalPERS' gains during the year ending June 30 were roughly in line with other large institutional investors, according to a report issued Tuesday by the Wilshire Trust Universe Comparison Service, which serves as a performance benchmark for similar investors.

The median return for all large institutional investors was 20.12%, the best showing since 1986, the report said. Public plans such as CalPERS posted a median return of 21.1%, corporate plans 20.4%, nonprofits 20% and labor union plans 19.9%, the report said.

-- Marc Lifsher in Sacramento

 

 

The Fed Splits

FLOYD NORRIS

Notions on high and low finance.

There is more than meets the eye to the split at the Federal Reserve. There must be.

Notions on high and low finance.

The Fed’s statement Tuesday afternoon says that the majority “currently anticipates that economic conditions — including low rates of resource utilization and a subdued outlook for inflation over the medium run — are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.”

Three dissenters said that they “would have preferred to continue to describe economic conditions as likely to warrant exceptionally low levels for the federal funds rate for an extended period.”

Now there’s something to fight over. I say we need low rates “at least through mid-2013.” You say “an extended period.”

All this sounds like much ado about very little, but the Fed majority is all but promising that rates will stay low for nearly two years. We used to think “an extended period” could mean a few months.

In reality, the statement was an implicit invitation to traders to drive rates down further on the two-year Treasury note, and that happened immediately. Before the announcement the two-year rate was around 0.27 percent. Now it is 0.19 percent. That is a record low. Two weeks ago it was over 0.4 percent.

The initial stock market reaction was negative, presumably because there was some hope that the Fed would do more — like start another quantitative easing program, QE3. Instead there is a promise that the Fed “will maintain its existing policy of reinvesting principal payments from its securities holdings. The committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.”

In other words, they might do a QE3. Or they might not.

Perhaps the dissenters really want to essentially say something like “We’ve done all we can, and if the economy is still lousy, that is for someone else to deal with.” And the majority is unwilling to do that.

As it is, the Fed has signed on to the widespread perception that the economy is getting worse. But it is not doing a whole lot.

The fact that the Fed chairman, Ben S. Bernanke, now has three dissenters is a sign that the Fed, like one or two other Washington institutions you might be able to name, is less and less able to speak with one voice.

Spot gold surges to $1,760 after Fed announcement

Spot gold surged to $1,759.90 Tuesday after the Federal Reserve said economic growth is “considerably slower.”

The precious metal has reached several highs in recent days, closing at record levels twice last week and at a new high of $1,710.20 an ounce Monday. Standard & Poor's historic downgrade of the U.S. credit rating Friday only fueled the rush into the safe-haven commodity as fears of a double-dip recession intensified.

Gold has been trending upward for nearly 11 years. A year ago, the metal cost $1,200 an ounce.

Earlier Tuesday, the price soared to $1,779 before slumping to $1,720 in the hours before the Fed announcement.

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-- Tiffany Hsu

Photo: Gold cast bars. Credit: Ron D'Raine/Bloomberg

Fed mixes it up and comes up with the worst of all worlds

Ben Bernanke, chairman of the US Federal Reserve, was able to deliver something to turmoil wracked markets; he promised to keep the fed funds rate close to zero until mid-2013, the first time, as far as I am aware, that the Fed has ever pledged to hold rates for such a long, and specific, length of time.

To commit to hold rates at virtually zero for nearly two years is unprecedented, and a mark of just how concerned policymakers have become at the economy’s inability to lift itself out of its funk. It provides markets and business with a degree of certainty on rates that they’ve never had before, and may therefore lift confidence.

But was it enough? The fact that three members of the open markets committee (FOMC) dissented from this promise maintains a strong, hawkish voice on the FOMC that undoubtedly remains fiercely opposed to any further quantitative easing. QE3 was the only thing that would comprehensively have reversed the current market rout, but Mr Bernanke cannot, for the moment at least, deliver it. Undue caution from the Fed combined with continued political paralysis on Capitol Hill does not make for a happy economy.

What committing to two years of zero interest rate policy will certainly do, on the other hand, is further weaken the dollar. Does the Fed know something the rest of us don’t to have taken such an aggressive position on rates. And what does it do if inflation returns? The Chinese, with inflation already at 6.5pc, will be spitting tacks. The Fed has mixed it up and come to a messy compromise which is neither one thing or the other. This was not what we hoped for.

Small-business owners feeling less optimistic in July: report

Main Street is a gloomy place these days, as political bickering and the recent U.S. debt-rating downgrade suck the confidence out of small businesses, according to a new report.

The monthly optimism index from the National Federation of Independent Business fell for the fifth straight month, slipping 0.9 points in July, to 89.9.

"Expectations for growth are low, and uncertainty is great," said Bill Dunkelberg, chief economist for the group. "And considering the confidence-draining performance of policymakers, there is little hope that Washington will stop hemorrhaging money and put spending back on a sustainable course."

Slow growth will continue for the rest of the year, the report suggests, exacerbated by high unemployment and inflation rates. There are more small-business owners say they believe that the economy will deteriorate in six months than those who predict an improvement, the report found.

About a quarter said poor sales were mostly to blame, the report said, but a heavy contingent also pointed to taxes, government regulations and red tape -– even more so than inflation, insurance and competition from larger companies.

In July, 14% of owners cut jobs, compared with the 12% who added positions, the report said. Eleven percent they plan to trim their workforce down the line.

Sales are down for 28% of owners, while profits fell for 38%, the report said.

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Small-business optimism fades as sales stay weak

Must be pretty bad out there for small businesses

-- Tiffany Hsu

Photo: The closed Hott Spot Grill, along with several other businesses that remain on Main Street in downtown Hugo, Colo. Credit: Ed Andrieski / Associated Press

Weak Stocks, Weak Economy?

Amidst the sell-off on Monday and the calmer waters this morning, here’s a thought from Ian Shepherdson, chief United States economist at the High Frequency Economics research firm: a weak stock market is not always a sign of a weak economy.

Remember Black Monday, 1987? By that October day, stocks had fallen 36 percent from their peak in August. Yet in 1988, the economy grew by 4.1 percent, even though the market had recovered only half its losses.

Admittedly, aside from the stock market slide, signs are not exactly great right now for the economy. But Mr. Shepherdson is taking heart from the 4.8 percent increase in chain store sales reported by Redbook Research during the first week of August compared with a year earlier.

Consumer confidence reports have been dismal recently, but Mr. Shepherdson points out that when you ask people “‘how do you feel, they say ‘miserable.’ But that doesn’t necessarily mean you don’t go shopping.”

So maybe that’s something to get a few of those traders to take their heads out of their hands.

Regulators open BMW safety probe

Federal safety regulators have opened an investigation into whether some BMW 7-series sedans are prone to rolling away once parked.

The probe of 120,000 BMWs from model years 2002 to 2008 came after a driver said the car rolled away after the consumer exited the vehicle.

The National Highway Traffic Safety Administration said it is looking at BMW's "Comfort Access" electronic access and ignition system and an electronic transmission shifter with the gear selector mounted on the steering column. The shifter is designed to automatically shift the vehicle to the park position under a variety of conditions, including after the driver has pressed the ignition button to turn the engine off.

Data submitted to the agency by BMW include field reports describing additional roll-away incidents in vehicles equipped with the system. No injuries or crashes have been reported, and the agency said it doesn't know what is causing the roll-aways.

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-- Jerry Hirsch
Twitter.com/LATimesJerry

Photo: BMW logo. Credit: Bloomberg News

Thanks to drift towards fiscal union, Britain is now more creditworthy than Germany

Wow! It now costs more to insure German sovereign debt against default than that of the UK, not withstanding anarchy on London streets. As the graphic below, brought to my attention by Conservative Party researchers via Andrew Lillico, demonstrates, it has become more expensive to buy “credit default swaps” (CDS) for German debt than for British.

Now obviously CDS prices need to be treated with a certain degree of scepticism. The market is thin and not really representative of underlying credit risk. Though the spread has narrowed considerably over the past year, Germany can still raise money more cheaply than the UK.

Never the less, this is a powerfully symbolic moment.

Unfortunately, this is not a function of the UK becoming more creditworthy. It is because as the eurozone moves towards a eurobond and shared responsibility for sovereign debt, Germany is becoming less so. According to calculations circulating in the German press, an interest rate 1 percentage point higher than otherwise would cost the German taxpayer around £20bn annually, or approximately equivalent to the fiscal transfer that still takes place between West and East Germany. Do the Germans want to subsidise the rest of Europe to that degree. I don’t think so.

See this brilliant Otmar Issing commentary for the most powerful articulation I’ve yet seen of what may loosely be described as the German view. European Central Bank intervention may temporarily have succeeded in depressing Italian and Spanish bond yields, but the political debate on Europe’s now unmistakable drift to fiscal union has yet to be had. How long can even the mighty Germany maintain its triple A rating once it assumes responsibility for Italy’s debts? This is a crisis which is going to run and run.

Stock markets bounce ahead of Fed meeting

Stock markets broke their long downward slide as investors look forward to any relief that might come out of Tuesday's Federal Reserve meeting.

Coming off the heels of the worst day of trading since 2008, the Dow Jones industrial average climbed over 120 points in early trading.

The Dow was recently trading up 127.98, or 1.2%, to 10,937.83. The broader Standard & Poor's 500 index was up even more sharply. 

Markets in England and France are up modestly, while Asian indexes recovered some of their losses after opening down Monday night.

After Monday's rout, which was sparked by Standard & Poor's Friday evening announcement that it was downgrading the credit rating of the United States, a number of market analysts concluded that the markets had been driven lower than the economic data warranted.

One economic indicator suggests that executives are viewing stock in their own company as cheap and are buying up shares.

Investors are also eagerly awaiting a statement from the Federal Reserve at 2:15 p.m. Tuesday, which could lay out measures the central bank is taking to support the economy.

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-- Nathaniel Popper

Photo: Television crews broadcast from Wall Street. Credit: Mark Lennihan / Associated Press.

Wall Street Roundup: Break in the clouds. The big short.

Gold: Trading now at $1,751 per ounce, up 2.2% from Monday. Dow Jones industrial average: Trading now at 10,937.83 , up 1.2% from Monday.

Break in the clouds. The long downward slide of stocks appears to have at least temporarily reversed itself as investors look forward to the Federal Reserve meeting today and whatever promises of stimulus it might bring.

Blame game. People from all sides of the political spectrum are claiming credit for having called the recent market rout, and are spreading the blame for having caused it. Meantime, many insiders are seeing a chance to buy stocks on the cheap.

The big short. Someone reportedly bet nearly $1 billion that the U.S. credit rating would be downgraded, and may have made close to $10 billion because it happened -- but who was it?

Secret committee. A look at the guarded committee of thinkers at Standard & Poor's who made the decision to downgrade the United States' credit rating last Friday.

Falling faces. One blog records for posterity all those crestfallen traders with their hands on their faces as stock markets fall. 

-- Nathaniel Popper in New York

Credit: Stan Honda / Getty Images

 

The Fed to the rescue, again?

The Federal Reserve may not launch a new stimulus plan for the economy when policymakers meet Tuesday, but the central bank almost certainly will try to assure investors that it has a plan, if needed.

The Fed holds its normal mid-summer meeting at a time when stock markets worldwide have been in a free fall, as investors fear that the economic recovery is in serious jeopardy.

The Dow Jones industrial average plunged 5.6% on Monday, to 10,809, after tumbling 5.8% last week. Some broader U.S. market indexes now are in bear market territory, meaning they’ve fallen more than 20% from this year’s highs.

Many analysts believe the Fed will try to boost confidence in its post-meeting statement Tuesday by suggesting that the U.S. economy is better than it looks. The Fed has noted repeatedly that some of the headwinds the economy faced in the first half have faded.

Case in point: Oil prices have reversed. On Monday, U.S. crude oil futures sank $5.57 to $81.31 a barrel, the lowest since November. The price has tumbled 28% from its spring high. That will put at least some money back into consumers’ pockets.

But even if the U.S. isn’t facing a new economic crisis, it is surely facing a new crisis of confidence, egged on by Standard & Poor’s downgrade of the government’s credit rating after the bitter partisan battle in Congress over the federal debt ceiling.

The Fed can’t afford for business and consumer confidence to fall into a black hole. That would make another recession self-fulfilling.

So the post-meeting statement is “likely to talk in detail about possible options” if the economy needs more help, said Anshul Pradhan, fixed-income strategist at Barclays Capital in New York.

Bernanke and other Fed officials have previously spelled out other steps they could take to try to bolster the economy. One would be to pledge to hold short-term interest rates near zero for a specific period -- say, two years -- rather than for an “extended period,” the wording the Fed has been using.

In theory, that could give businesses and investors more incentive to do something potentially more productive with their money than keep it in bank accounts earning nothing.

The Fed also could try to pull long-term interest rates (including mortage rates) down further by reinvesting the proceeds from its $2.65-trillion Treasury- and mortgage-bond portfolio only in long-term Treasuries, such as 10-year and 30-year bonds.

But some analysts say a continuing stock market meltdown could force the Fed to launch yet another massive "quantitative easing" program to buy Treasury debt across the board, in concert with similar bond-buying campaigns by the European Central Bank, the Bank of Japan and perhaps others.

The idea: Keep printing money and injecting it into the financial system, hoping it will kickstart economic growth.

George Goncalves, interest-rate analyst at Nomura Securities in New York said the Fed, the ECB and the Bank of Japan might have to commit to injecting $3 trillion to $5 trillion into the global financial system to have the necessary effect, given that their previous cash injections were insufficient.

"I think you need shock and awe," he said.

That would undoubtedly unleash a new round of inflation at some point. But if Bernanke has to choose between inflation and depression, it should be an easy decision.

"They will not sit by and watch this thing cascade," Goncalves said.

-- Tom Petruno

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Photo: Fed Chairman Ben S. Bernanke. Credit: Mandel Ngan / AFP / Getty Images

 

Morning Optimism

The great sell-off may be taking pause.

About two hours before the New York opening, Dow futures are up about 150 points and S.&P. futures show similar gains.

In Asia today, afternoon trading raised prices and China’s market even ended up for the day. Japan, off 4.7 percent at its lunch break, ended the day having recovered two-thirds of the fall.

European indexes are lower for the day, but turned up around 4:30 a.m. New York time. The FTSE 100 in London fell below 4,800 points before it began to recover, but is now over 5,000.

What remains to be seen is whether there will actually be buyers for shares when trading opens in New York. Phil Roth, a longtime market watcher with Miller Tabak, says there is little evidence that either individual investors or traditional money managers are putting in money, so buying by hedge funds may be needed.

Political union can save the euro – but only the right sort

Jeremy Warner correctly points to Otmar Issing’s devastating piece in today’s FT, which slams the form of fiscal union towards which the Eurozone is drifting, predicting that it would be likely to lead to the collapse of the EU. Issing says that, although he was an outspoken advocate of the idea that political union should accompany monetary union, it is a mistake to believe that the current crisis can, by forcing a debt union, be a device for political union, bypassing a democratic mandate. He notes the extreme moral hazard created by current arrangements, whereby fiscal incontinence is rewarded and fiscal prudence is punished.

What is intolerable (rightly intolerable) to Germans is the notion that they should fund the spending and borrowing decisions of fiscally irresponsible governments elsewhere in the Eurozone. That cannot stand. No political union built on that premise could be sustained.  As some of us have urged from the start, the real risk of collapse for the euro was never that Greece, Portugal, etc. weren’t bailed out – it was always that they were, and to such an extent that Germany lost faith in the project and withdrew.

No arrangement whereby hard-working Germans, for decades, send their money to be spent by the Berlusconis and Papandreous can work. And the euro cannot survive without transfers over decades. But it does not follow that the euro therefore must collapse. The Germans won’t accept Berlusconis and Papandreous spending their money, but that doesn’t mean they won’t accept anyone doing so. The only body that would be trusted by the Germans to spend money in Italy, and by the Italians to spend money in Italy, is the European Union’s central authorities.

Not only can that work, but it seems to me to be part of what is envisaged (albeit with insufficient detail) by the July 21 agreement. The  agreement empowers the EFSF to spend money directly in member states (bailing out their banks), without going via their governments. It envisages an extension of EU structural funds (monies that are allocated centrally), to address longer-term competitiveness issues within the Eurozone. It envisages much stricter central oversight of member mtate national budgets. In his end-of-summit statement, Sarkozy said that he and Merkel will bring forward proposals for new “economic governance” arrangements for the Eurozone later this year.

A transfer union of debt pooling cannot work. The Germans will not accept it – Issing’s position reflects a wider German sentiment but also a fundamentally correct and inescapable analysis. It does not follow that the euro must therefore fail.  The alternative is a Eurozone confederacy, in which transfers are spent from the centre.

An Experiment in Austerity

Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul.

Today’s Economist

Perspectives from expert contributors.

One reason that economics is not a true science is that economists can’t really perform experiments in which certain details are altered to see if they change the results and in what way. Of course, small experiments can be done using student volunteers playing economic games, but we can’t rerun the 1980s without the Reagan tax cut, which was signed into law 30 years ago this Saturday, and see if we would have gotten slower growth. Economists do their best to simulate alternative scenarios, but it’s not the same thing as rerunning the same history under different sets of policies.

Perspectives from expert contributors.

But once in a while economists get to observe a natural experiment where policy is changed in a way that allows a theory to be tested by real-world results. We are about to run just such an experiment by tightening fiscal policy and cutting spending significantly below baseline projections at a time when the economy is weak. As I pointed out in a July 12 post, we performed this experiment once before, in 1937. The budget deficit was sharply reduced and a recession immediately followed.

Since the beginning of our recent economic woes, there has been a theoretical debate among economists about the proper governmental response. I think it is reasonable to say that most supported the idea of fiscal stimulus in principle, although there certainly were different opinions about the size and structure of the February 2009 Recovery Act. But there were also conservative economists arguing that the stimulus was a bad idea for the same reasons they urged Franklin D. Roosevelt to balance the budget in 1937. Funds that the government borrows would be better invested by the private sector, they said.

Conservatives lost the first round, but have launched a counterattack. Their primary argument is that Congress enacted a $787 billion stimulus package and two and a half years later the economy is still in neutral. Stimulus supporters, like this paper’s columnist Paul Krugman, have long argued that the stimulus was too small to do more than moderate the downturn and wasn’t large enough to offset the negative economic momentum that the Obama administration inherited.

To average people, however, $787 billion sounds like a lot of money; more than enough to do the job if the theory on which it was based was sound in the first place. Consequently, many people have concluded that the stimulus experiment has failed and are receptive to the conservative theory that fiscal contraction may do a better job of jump-starting growth.

A June NBC News/Wall Street Journal poll asked if a cut in government spending would help or hurt the economic recovery; 37 percent said it would help, 31 percent thought it would hurt and 23 percent said would have no effect. A July Washington Post/ABC News poll asked people if they thought large cuts in federal spending would do more to create jobs or cut jobs; 47 percent said it would create jobs, with 44 percent saying it would cut jobs.

Space prohibits a full discussion of the theory and data underlying the debate among economists on what the economic effects of fiscal consolidation will be. Prominent economists at respected institutions have been discussing the effects for some time with complicated results.

The European Central Bank has published a number of papers over the last several years strongly endorsing the idea that fiscal contractions can be expansionary. Its latest study was published on July 12 and finds that the economy’s reaction to higher spending depends critically on expectations. If it is expected to be reversed in the future it is expansionary, but if it is expected to continue indefinitely then it is contractionary. If the results are symmetrical, then cuts in spending viewed as temporary may be contractionary while those viewed as permanent may be expansionary.

The International Monetary Fund has also published a considerable amount of research on this topic. Its latest study was published on July 6 and found that analyses which show fiscal contraction to be expansionary have misspecified the relevant changes in the fiscal balance. They lumped deficit reductions resulting from nonpolicy-driven factors, like stock market booms that raised government revenues, together with those explicitly engineered by policy makers. The I.M.F. study concluded that when the analysis was limited to policy-driven fiscal contractions, they were all economically contractionary. It found that a 1 percent of gross domestic product fiscal consolidation reduces real private consumption by 0.75 percent and real G.D.P. by 0.62 percent over the next two years.

A June 16 paper for the Bank for International Settlements found that the principal stimulus from fiscal consolidation came from lower interest rates and exchange rate depreciation, which boosted exports. Therefore, if interest rates are already quite low and depreciation is not possible, then there may not be any mechanism whereby fiscal consolidation can be expansionary.

The Congressional Research Service explained in a June 6 report that the economic effects of fiscal consolidation depend a great deal on the point in the business cycle in which it is carried out. Those occurring when the economy is operating close to its potential were successful by freeing public resources for private use, exactly as conservatives say, but those that took place when there was a large amount of unused capacity were not. The study concluded, “Fiscal adjustments beginning in a slack economy (like the current situation in the United States) appear to have a low probability of success.”

My point is not to exhaust the issues involved in calculating the economic effects of fiscal contraction; only to show that it is complicated. Readers should be skeptical of simplistic studies that cherry pick their examples, fail to control for variables other than the deficit as a share of G.D.P. and don’t make any effort to explain examples that don’t prove their point. A good place to start any analysis is a recently compiled data set of fiscal consolidation episodes by the I.M.F.

Asian markets recover after early losses

Asian stocks rebounded after a volatile day of trading Tuesday that sent markets nosediving in the morning before clawing back to more stable territory.

Japan's Nikkei 225 stock average closed down 1.7% to 8,944.48 after losing more then 4% earlier in the day and briefly reaching its lowest level since March 15, the aftermath of the nation's devastating earthquake and tsunami.

Mitsubishi UFJ Financial Group fell 3.2% and Canon, the world's largest camera maker, slid 1.9%. Inpex Corp., Japan's biggest oil exploration company lost 5.5% in response to falling oil prices, which dropped to $78 a barrel amid a dumping of commodities.

Trading swung even more wildly on Australia's S&P/ASX200 which hit a two-year low in the morning before turning around at noon to end the day at a gain of 1.2% to 4,034.80.

Analysts told the Australian Associated Press that investors returned to buying after China's consumer price index data showed non-food inflation declining, delaying the prospects of another interest rate hike in Beijing. Australia is a major supplier of commodities to China.

South Korea's Kospi fell by as much as 10% only to recover for a loss of 3.6% to 1,801.35 at its closing. The index, which was battered by fleeing foreign investors, was being bolstered later in the day by public institutions and pension funds, the Wall Street Journal reported.

Hong Kong's Hang Seng was trading down 1.9% by late afternoon, a significant improvement from the morning when investors were spooked by China's inflation report showing year-on-year consumer price growth at a 37-month high.

--David Pierson

RELATED:

Dow tumbles 634 points on recession fears

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Oil reaches a 2011 low; gasoline prices should fall

Photo: A woman is reflected on an electronic stock indicator in Tokyo. Credit: Shizuo Kambayashi / Associated Press.