Who Trusts Governments?

The European Central Bank rode to the rescue today. But there was a limit to how much it could do.

FLOYD NORRIS

Notions on high and low finance.

European stock markets opened lower today at 3 a.m. (all times New York, to avoid confusion) and were down, although not by huge amounts. But within 20 minutes word spread that the central bank was buying Italian and Spanish bonds, as it had said it would do. Within minutes, the stock markets were in positive territory.

Notions on high and low finance.

Futures contracts for the S.&P. 500 rallied more than 30 points within minutes, and it looked like this could be a relatively uneventful day.

Never mind. Markets resumed falling by 4 a.m.

The distinguishing fact about the summer plunge of 2011 is the lack of confidence in governments. It is not that people fear they will do the wrong things. It is fear that governments cannot, or perhaps will not, do much of anything.

On Sunday night the G-7 finance ministers and central bankers, representing the world’s major economies, tried to reassure the world that they would “take all necessary measures to support financial stability and growth in a spirit of close cooperation and confidence.” This morning the G-20, which also includes large emerging markets, chimed in.

If there were any reason to believe there will be “close cooperation” within the American government, this might be a better day. The Sunday talk shows provided an opportunity to send that signal, one that was not taken.

As it is, there is no sign that Republicans are willing to cooperate with Democrats on anything. President Obama’s willingness to give in has made him appear weak and encouraged those who would slash government whatever the economic impact. And it has moved the government in a direction — of cutting the fire hoses while the economy burns — that is risky, to say the least.

Nouriel Roubini, an economist who gained fame for warning of the financial collapse, wrote in The Financial Times today:

So can we avoid another severe recession? It might simply be mission impossible. The best bet is for those countries that have not lost market access – the U.S., U.K., Japan, and Germany – to introduce new short-term fiscal stimulus while committing to medium-term fiscal austerity. The U.S. downgrade will hasten demands for fiscal reduction, but America in particular should commit to look for significant cuts in the medium term, not an immediate fiscal drag that will worsen growth and deficits.

As the American stock market prepares to open, S.&P. futures are down about 30 points, and Dow futures are off about 250 points.

Of course, money must go somewhere. It is going to gold, and it is going to Treasury bonds. Notwithstanding the rating cut, Treasuries are still deemed safe. The yield on 10-year Treasuries is now about 2.46 percent.

Forecasting the E.C.B.

FLOYD NORRIS

Notions on high and low finance.

The European Central Bank is in an unenviable position. It’s only stated mandate is to fight inflation. These days that is not the important issue, to say the least.

Notions on high and low finance.

But it could do a better job of at least seeming to not be one or two steps behind everyone else.

Last Thursday, Jean-Claude Trichet disclosed that the bank was buying European government bonds again. Markets rallied, then fell when it became clear the bank was not buying Spanish or Italian bonds.

Today the bank is buying those bonds.

All this is reminiscent of what happened in the spring of 2010. Then Mr. Trichet seemed stunned at the suggestion, made by a reporter at a news conference, that the bank would buy Greek bonds. One weekend later, guess what happened.

There are times to fight inflation, and times to try to salvage economies. The E.C.B. is being dragged into a recognition this is one of the latter times.

Euroggedon postponed again as ECB gains three weeks

ECB president Jean-Claude Trichet

Euroggedon is postponed again. Jean-Claude Trichet has saved civilization. There will not be a spiralling bond crisis in Italy and Spain in early August after all. An imminent disintegration of Europe’s financial system has been averted.

On balance, this is good, though not optimal. (Lancing the boil immediately by organising an orderly German exit from EMU would be better: it would halt the Fisherite debt-deflation spiral in Club Med and clear the way for recovery.)

Spanish 10-year yields dropped 85 points to 5.2pc, Italian yields fell 76 points to 5.32pc in the first hour or so of trading after last night’s announcement.

Now for the hard part. Unless the ECB is willing to back up its new role as lender-of-last-resort with massive purchases of Italian and Spanish debt, it will inevitably be tested by markets. Weak hands will take advantage of rallies to offload holdings onto the ECB, i.e. onto eurozone taxpayers. Frankfurt will find itself underwater very quickly without a legal mandate or EU treaty authority.

RBS calculates that the ECB will have to buy roughly half the outstanding tradeable debt of the two countries to defend the line. RBS calculates €850bn. I would put it nearer €1 trillion.

This is currently impossible. The ECB is acting as a temporary back-stop until the revamped EFSF bail-out fund is ratified by all parliaments over coming months. The EFSF will then take the baton.

Yet as we all know, the EFSF has no money. The parliaments have not even ratified the earlier boost to €440bn. As of today, the fund has barely €80bn left after all the commitments to Greece, Ireland, and Portugal. It remains a fiction.

As for boosting it further to €2 trillion or more – as suggested by Citigroup, RBS, and the European Parliament – we face a little local difficulty across the Rhine. Bavaria’s Social Christians said they will not back one bent Pfennig for extra bail-outs, and the FDP Free Democrats are almost of the same mood. Angela Merkel’s CDU base is more mutinous by the day. In any case, such an expansion of the EFSF would set off its own chain-reaction as France and then Germany lost their AAAs and slithered into the swamp.

So, obviously markets will turn very nervous once ECB purchases approach the level that corresponds to the EFSF ceiling. They know that the ECB’s Teutons will die in a ditch rather than cross that line, taking the bond risk directly onto the ECB’s own balance sheet.

That moment could come within three weeks.

Gary Jenkins from Evolution Securities notes that Greek yields fell from 12.43pc to 7.35pc in the week following the ECB’s first bond purchases, only to fly out of control six weeks later.

Good template.

Whether buying time can solve anything depends on whether investors believe that Italy and Spain can grow their way out of debt traps. If we are on the cusp of a new global boom, then Italy and Spain can make it within EMU’s current structure.

If we are going into a global double-dip (defined as global growth below 2.5pc), they have no chance at all unless the ECB throws all caution to the wind, defenestrates the two German members from the 36th floor of the Eurotower, and embraces QE a l’outrance.

Germany might not like that.

I have a nasty feeling that nothing whatsoever has been resolved.

Defining Economic Interest

Nancy Folbre is an economics professor at the University of Massachusetts Amherst.

Republican resistance to raising taxes represents a distinctly minority view. The latest New York Times/CBS poll shows that only 34 percent of adults believe that taxes should not be increased on households earning $250,000 or more to lower the budget deficit. Even this modest percentage surprises me, because only about 2 percent of American households report income above this amount.

Today’s Economist

Perspectives from expert contributors.

Most conservative economists argue that higher tax rates at the top would hurt everyone because they would lower economic growth. I don’t buy this argument for a variety of reasons that I’ve explained elsewhere. However, the argument seems pretty easy to sell.

Perspectives from expert contributors.

People don’t always recognize and effectively act on their economic interests. As one of my favorite behavioral economists, Dan Ariely, put it, we are all more like Homer Simpson than Superman.

I’ve always identified more with Marge Simpson than with Homer, but in any case, if the Simpsons don’t act on what we believe are their economic interests, economists should be able to explain why.

Reaching for a better understanding of the Tea Party seems like a good place to start, since it gets much of the credit or blame for current Republican priorities.

According to last week’s poll, Tea Party members are slightly better educated and more prosperous than the typical American. Still, only 17 percent earned more than $100,000 a year and 2 percent earned more than $250,000. I wish the survey had asked how many were unemployed or working in the public sector.

Some evidence suggests that the Tea Party’s interests are shaped by its racial composition. Surveys show that it includes few African-Americans (3 percent of the total) and has greater membership in the South than in other regions (41 percent of voters compared with 15 percent in the Northeast).

At that time, a majority reported that they believed that “too much has been made of the problems facing black people” (52 percent compared with 28 percent of all Americans).

Asked to volunteer what they don’t like about President Obama, the top answer, offered by 19 percent of Tea Party supporters, was that they just didn’t like him.

The most recent poll confirms this animus: Only 12 percent of Tea Party supporters approve of President Obama’s job performance, compared with 20 percent of Republicans and 48 percent of Americans.

Dislike and disapproval obviously inclined them to support Republicans who gave the president a hard time. But as Kate Zernike pointed out in a recent article in The New York Times, Tea Party members did not line up squarely behind those who wear their mantle in Congress. A CBS News poll taken in mid-July showed that 53 percent of Tea Party members, along with 66 percent of all respondents, favored a combination of tax increases and spending cuts.

One self-identified Tea Party Web site goes so far as to decry wealth inequality and calls for a progressive tax on wealth.

So why did Tea Party Republicans in Congress take such a hard line? Their views — like those of most other elected representatives — are not primarily shaped by the views of their constituents.

While the Tea Party movement got a big initial boost from small donors, its elected representatives quickly began relying on political action committees and major contributions from Wall Street firms. These almost certainly grew after the Supreme Court, in its Citizens United decision in January 2010, loosened campaign finance restrictions.

Many Tea Party members may be unaware of the extent to which wealthy political conservatives like the Koch brothers have bankrolled their efforts and shaped legislative priorities.

Partly because it does enjoy significant grass-roots support, the Tea Party has helped Republicans deflect attention from growing concerns about economic inequality and class conflict.

But these concerns are likely to intensify as unemployment rates remain high and the economy moves back toward official recession.

An ABC News/Washington Post poll conducted last month found that most Americans said the biggest difference between President Obama and Republicans lay in whose economic interests they aimed to serve.

Perceived differences based on household income categories, like the “$250,000” benchmark, seem less salient than those based on big business versus everybody else.

A striking 67 percent of Americans said Republicans were protecting the interests of large business corporations, compared with 24 percent who believe the same of President Obama (see chart below).

Meanwhile, the Tea Party is taking the fall. Its popularity has declined significantly in recent months. The latest New York Times/CBS News poll found the Tea Party was viewed unfavorably by 40 percent of the public, up from 29 percent in April.

As the economy nosedives, Tea Party populists are likely to become even less popular. And perhaps Tea Party members will change their perception of where their own economic interests lie.

Asian stocks plunge on first day of trading after U.S. downgrade

Asian shares plummeted Monday on the first day of trading after an unprecedented downgrading of U.S. government credit last week, raising fears the global economy was heading for deeper trouble.

In what could be a preview of U.S. markets, Hong Kong's Hang Seng fell 2.3% to 20,464.03, Japan's Nikkei 225 stock average dropped 2.2% to 9,097.56 and the Shanghai Composite Index lost 3.8% to end at 2526.82.

  “From how fast the market is falling I can see people are really scared,” said Chen Wenzhao, an analyst for China Merchant Securities in Shanghai. “In the short term, it may be really hard for people to overcome their worries.”

The steep losses came even after global policy makers said efforts would be made to restore confidence in financial markets.

Trading on South Korea’s Kospi was briefly halted after it nosedived by as much as 7.4% in the afternoon. The index ended the day down 3.8% to 1,869.45.

“We’re seeing real panic selling now,” said Im Jeong Jae, a Seoul-based fund manager at Shinhan BNP Paribas Asset Management Co., which oversees about $29 billion, told Bloomberg. “Concerns about global economic conditions are affecting Asian markets overall. Korea, which has relatively more liquidity, is feeling a harder pinch.”

Indonesian President Susilo Bambang Yudhoyono said he would hold an emergency meeting with his cabinet after stocks in his country fell about 5%, Reuters reported.

In other Asian markets, Taiwan’s Taiex slumped 3.8% to 7,552.80, Australia's S&P/ASX 200 index dropped 2.9% to 3,986.10 and Singapore's Straits Times Index fell 2.9% by later afternoon.

--David Pierson

RELATED:

S&P downgrades U.S. credit rating

Policymakers try to calm markets' fears

What the U.S. downgrade may mean for markets

Memories of the stock market crash leave investors on edge

Photo: An investor in front of a stock price board at a brokerage in Shanghai earlier this year. Credit: Eugene Hoshiko / Associated Press

No rush from U.S. Treasuries, as yields fall while Asian stocks slump

U.S. Treasury bonds' status as a haven seemed intact in Asia on Monday, as yields fell despite Standard & Poor's downgrading of Uncle Sam's credit rating on Friday.

It may have helped Treasuries that Asian stocks were broadly lower, as some investors bailed out ahead of European and U.S. equity trading.

The 10-year Treasury note yield slid to 2.50% in late Asian trading, down from 2.56% on Friday.

Shorter-term yields also fell. The two-year T-note dropped to a record low 0.26% from 0.29%.

Over the weekend, analysts had been uncertain as to how global investors would react to S&P’s move late Friday to lower the U.S. government’s credit rating to AA+ from AAA -- the first time in history that America has lost its top-rung rating.

S&P cited concerns about the nation’s growing debt load and uncertainty about Washington’s willingness to rein-in borrowing.

Many on Wall Street argued that investors were unlikely to flee Treasuries, because even with the one-notch downgrade there still is no significant risk that the U.S. would be unable to pay its bills.

What’s more, with the global economic recovery fading and stock markets stumbling, many investors seemed likely to continue to turn to Treasuries as a place to hide.

In Asian trading, Treasury yields fell as stock markets’ losses worsened Monday. Japan’s Nikkei-225 index was down 2.1% late in the day’s session after tumbling 5.4% last week.

Australian’s main market index was off 2.5% after slumping 7.2% last week.

In China, the Shanghai composite index was down 3.7%. Taiwan’s main index, which plummeted 9.2% last week, was off 3.6%.

For updated Asian market indexes, go here.

-- Tom Petruno

RELATED:

S&P downgrades U.S. credit rating

What the U.S. downgrade may mean for markets

Memories of the stock market crash leave investors on edge

Geithner says he will stay on as Treasury Secretary into 2012

Photo: A trader walks by the stock price board at the Malaysian stock exchange in Kuala Lumpur. Credit: Mohd Rasfan / AFP / Getty Images

How U.S. market circuit breakers would work in a major sell-off

How bad would a U.S. stock market plunge have to get before trading would be halted?

Seriously bad, based on the current parameters of the New York Stock Exchange’s circuit breakers.

The Dow Jones industrial average would have to fall 1,200 points, or about 10.5% based on Friday’s closing level of 11,444, to trigger a one-hour trading halt across the markets.

That’s assuming the decline comes before 2 p.m. EDT. If the Dow were to fall by that amount between 2 p.m. and 2:30 p.m. EDT, it would trigger a trading halt of 30 minutes.

After 2:30 p.m., no trading halt could be triggered unless the Dow were to fall 2,400 points, or about 21% from Friday's level.

U.S. markets also now have circuit breakers in place for individual stocks. Go here for the details.

-- Tom Petruno

Here's an NYSE graphic explaining the circuit breakers for the market as a whole: