Sunday, December 14, 2008

News In Brief

-The Fed is expected to drop the Fed funds target to 0.5%. Yet with the effective funds rate already at 0.14%, the so-called target rate has lost all meaning. And if they're going to accept an effective rate of 0.14%, why not drop the formal target to 0.15% or at least to 0.25%?

-Meanwhile, I don't have any number for effective rate for Switzerland, but they have already lowered their target rate to 0.5%, and now there is talk of zero interest rate policy for Switzerland, and of quantitative easing once zero is reached. Switzerland is clearly abandoning their old status as a hard money bastion, which is why people should stop consider the Swiss franc as a safe haven (I did that before too, but this change in policy clearly changes things.)

-Somewhat unexpectedly, the U.S. trade deficit rose in October, as an increase in the non-oil deficit and higher oil import volumes overwhelmed the decline in the price of oil. As the increase in oil imports is not sustainable given the decline in demand and as the price was much lower in November than October, the oil deficit should decline dramatically in November, likely leading to an overall decrease despite an increase in the non-oil deficit.

For the quarter as a whole, the deficit will therefore be lower than in the third quarter, though not dramatically so. However, since the entire decrease and more is because of the collapse in the oil price, net exports will subtract substantially from the standard volume GDP. With the volume measure of the trade deficit running at a level $6 billion per month higher than in the third quarter, it could subtract as much as 2 to 2.5 percentage points from growth, which given dramatic declines in consumer spending and investment could mean an overall volume decline of 6 to 7% at an annual rate. Properly measured the decline will be less dramatic, but even in terms of trade adjusted terms, the decline will be relatively dramatic, 3 to 4%.

-The inventory to sales ratio in U.S. businesses reached new multi-year highs in October, something which will likely mean that businesses will have to reduce production more.

-Meanwhile the federal budget deficit rose to $402 billion in the first two months of fiscal 2009, up from $155 billion in the first two months of fiscal 2008. Much of that reflects the TARP, but even excluding that the deficit is soaring. This enormous deficit of course implies that the supply of Treasury securities is soaring too, something which you would normally expect to lower their prices. But in fact, prices have soared, which is reflected in the dramatic decline in yields. This suggests that demand is increasing even faster than supply, something which in turn reflects excess liquidity.

-California's state deficit and debt is also increasing at an ever faster rate, yet because California does not have its own central bank, it can't be as reckless as the federal government. So there is broad agreement that some forms of fiscal tightening measures are needed. Governor Schwarzenegger proposes a combination of tax increases (thus terminating his previous commitment not to raise taxes) and spending cuts, yet because Republicans in the state legislature refuse to agree to tax increases and because the Democrats refuse to agree to spending cuts and because both sides can apparently block a new budget, a stalemate has become reality, increasing the risk that California might default on its debt.

-Money manager Bernard Madoff appears to have run a giant Ponzi-scheme that swindled investors of as much as $50 billion, which is said to be the biggest such swindle ever. Unless you count the Fed-induced housing bubble, of course.

-As the pound reach new record lows against the euro, the U.K. government is planning a bailout of its car industry similar to the ones planned by Sweden and perhaps also the U.S.. Meanwhile, there is an increasing fear that London's leading position in the crisis hit financial sector could be threatened.


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