Notes From Underground: Reposting the IMF Piece From October 14, 2012

First and foremost, a happy Thanksgiving to all the readers of NOTES FROM UNDERGROUND. The growth in readership and the high level of discourse is something I am very grateful and certainly thankful for in full measure. As much energy as I expend in formulating the blog, it is worth the effort because it helps anchor my thoughts about the impact of the global political economy. It is certainly the definition of a give-get. So again, thanks to all my readers.

I am reissuing a piece from last month as a reminder of the coming role that IMF Director Christine Lagarde is trying to craft for the fund. It certainly seems that the Greek issue will be resolved via some format of the recent idea floated by Germany. The private sector Greek bondholders will take a severe haircut and the public sector–ESM, ECB and EFSF–will do an extend and pretend, with the interest rate being set at a market low rate and probably some sort of moratorium on interest payments as an additional form of restructuring. It appears it will resemble some type of negative amortization. The Greek “resolution” will allow the TROIKA to get on dealing with far greater issues–Spain, et al. The Greek drama is a mere sideshow in which the actor is going to leave the main stage.

Christine Lagarde Is Quietly Raising Her Voice

The IMF took center stage during the last four days as its meeting in Tokyo became the central focus of the global macro world. As usual, the IMF communique promised much via the usual platitudes but as investors and traders we are left in the lurch as much is promised but no real substance is revealed. Probably the most important element in the communique is the line, “WE NEED TO ACT DECISIVELY TO BREAK NEGATIVE FEEDBACK LOOPS AND RESTORE THE GLOBAL ECONOMY TO A PATH OF STRONG,SUSTAINABLE AND BALANCED GROWTH.” Why is this simple statement so critical? In last week’s IMF-produced “World Economic Outlook,” it revealed that the IMF‘s model is probably flawed when measuring the impact of fiscal policy on economic growth.

This quote from the text is extremely important and a giant hat tip to JA for pointing me in the direction. “THE  main finding, based on data for 28 economies, is that multipliers used in generating growth forecasts have been systematically too low since the Great Recession, by 0.4 to 1.2, depending on the forecast source and the specifics of the estimation approach. Informal evidence suggests that the multipliers implicitly used to generate these forecasts are about 0.5. So actual multipliers may be higher, in the range of 0.9 to 1.7.” This is a very critical statement for it is setting the rationale for the TROIKA to be able to suspend the implementation of the austerity budgets that is the basis of ESM “CONDITIONALITY” mandated by the Bundesbank. It also provides the basis for the communique’s reference to breaking negative feedback loops.

The IMF‘s work builds upon the work of the Obama administration’s best economist, Christina Romer, who unfortunately departed Washington for academia (Berkley) and left behind much mediocrity. The IMF research work is reviewed in Saturday’s Financial Times and shows the scatter graph of the 28 economies used in the study. While there is a great deal of discussion about the credibility of the study’s results, I don’t care about the academic arguments at this time. What concerns me as a trader is how the Lagarde-led IMF is going to utilize the results as push back against the German-led argument about fiscal austerity. In an October 11 AFP article, Claire Jones and Peter Spiegel reported Lagarde and Schaueble clashed over plans on European austerity. IMF Director Lagarde was pushing for increased time for Greece and Spain in meeting their promised budget numbers.

Schaeuble was openly opposed to allowing Greece or Spain more time and was not happy that Lagarde was muddying the waters, but if Merkel and Schaueble are going to desire IMF money to aid the European cause then Lagarde is going to demand some input. Ms. Lagarde said world leaders are going to have to end the programs that are “prolonging terrifying and unacceptable” levels of unemployment. Lagarde added “…. governments should no longer pursue specific debt reduction targets but focus on implementing reforms.”

The FT piece on Saturday has a sidebar that attempted to temper the dispute between Lagarde and Schaueble but the final quote can be tossed in the trash bin of European credibility: “When asked whether Greece should be acting on the prescription of the IMF, or Germany, Mr. Schaeuble said: ‘There is no difference, never. It is impossible. We always agree.’” This is more crap strewn about by the Euro politicians and certainly represents the classic rebuttal that oral contracts are not worth the paper they are printed on.

If the Lagarde position gains ascendancy over the Germans, especially as the IMF paper provides the needed cover, the Draghi policy will become much more powerful. In the near term the Outright Monetary Transaction will have a much greater impact on the near-term money and the 2-YEAR NOTES of the EU sovereigns are the key to what is to take place in determining the outcome for the debt stressed. Ten-year notes will be a trading issue but the short-term notes will be the best barometer.

***In a post-IMF conference statement, Chinese and Japanese officials say they will support the ESM. Tachiko Nakao, Japan’s Vice Finance Minister, said Japan will “positively consider” buying bonds issued  by the ESM. The Chinese PBOC Deputy Governor Yi Gang also stated that China will ‘cooperate’ with the ESM. Longtime readers of NOTES know that in December 2009, it was the Chinese reneging on a promise to buy Greek 10-year notes that set into motion the drastic rise in the debt of Greece and the other Peripherals (PIIGS). China has made other promises to the Europeans about purchasing the debt of Portugal and Spain and failed to deliver.

I find the Japanese statement to be of greater interest as I wonder if the Japanese receive the support of the IMF and Europeans to weaken the YEN a quid pro quo. It was reported in a Bloomberg article on October 11 that Prime Minister Noda said in an interview that the “… Yen is a ‘serious problem’ out of step with Japan’s economic performance and ‘when necessary, we will take decisive action.’” Japanese purchases of ESM bonds and support for increased IMF funding for Europe=SERIOUS YEN INTERVENTION? Something about which to be alert so the YEN 200-day moving average and all of the YEN crosses will need to be closely watched.

***In a further comment on the IMF‘s recent World Economic Outlook, Paul Krugman added a little bit of Schadenfreude by calling the research report “… An extensive document in hand wringing.” In a Reuters article by Antoni Slodkowski and Julien Toyer, Krugman added, “kudos to the Fund for having the courage to say this, which means bucking some powerful players as well as admitting that its own analysis was flawed.” Now I await the economic voice of record to challenge the predictive models of the FED. The importance of Krugman raising his voice in support of the IMF actions is to give Lagarde further cover for action in her coming battles with the Germans and of course Jens Weidmann.

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6 Responses to “Notes From Underground: Reposting the IMF Piece From October 14, 2012”

  1. Richard H Papp Says:

    I bring to your attention John Plender’s 21 Nov 12 FT article “UK
    Economic Growth Hobbled by Overambitious Banks”. You can change the country to any of the majors and the issue is the same.

  2. Nico Says:

    I read each piece and will continue to do so this blog exist.
    The sharp insight into the markets today are very rare.
    So thank you, Regards Nico

  3. Mark T Says:

    While I agree as a trader, you have to deal with the world as you find it, the stimulus case is driven by deliberate short term focus and long term blindness. Even if the multiplier is 1.7, that is not a permanent jump in output, just a temporary one. Eventhe Romers of the world acknowledge it peters out within 2 years and then what do you have? You have the debt you incurred to stimulate, the cost of servicing it, and an economy that has fallen back to pre-stimulus levels but still has to service that debt. Robust analysis would factor in the drag that creates as to future income and the implications of decreased solvency or of monetizing that debt to avoid default. But the party in power and its allies in academia and the NGO world never face up to that for political reasons.

  4. Mark T Says:

    Just further to my comment above, with Eurozone taxes equal to about 40% of GDP, you need a multiplier north of 2.5 to have net stimulus AND retire the debt that funded it. In the US, because the tax take is lower, you need a higher multiplier still.

  5. yra Says:

    Mark T–good points and it refers back to “dynamic inefficency” and its impact on demand going forward.As the banks keep bringing demand forward and loading up on debt to do so–well do the math.As the brightest person in global macro I know–Bernard Connolly,he notes on those who want to follow what you say go reread Rogoff’s book on International Economics and the role that “dynamic inefficency”

  6. yra Says:

    Mark–the IMF work on the multiplier was to show the opposite side of the Romer work in that austerity has a greater drag then previously supposed ,which of course got Krugman to crow at teh door of the henhouse

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