Topic: The Global Economy

[Antoine]

The Chinese are willing to sustain them for a long, long time but, eventually, China will demand to be paid and Americans will be very, very unhappy. So unhappy, I fear that some many, including some politicians, may be willing to risk a war that American cannot win.

That is exactly what I say to my surrounding, but no one seems to care. Glad I can read it on a forum.

[Thucydides]

More regulatory failure, note how rating agencies were made into the arm of the State, only now the State turns on them...

http://reason.com/blog/2010/05/10/rater-haters-finally-find-a-re

Rater Haters Finally Find a Reason to Turn On Moody's, and It's a Bad Reason

Tim Cavanaugh | May 10, 2010

That's what a BBB- rating looks like!"You know someone or something is in deep trouble when the search for scapegoats happens in the middle of a crisis rather than after it has ended," Mish Shedlock says in a characteristically no-holds-barred survey of the various targets in the euro-meltdown witch hunt.

The one good thing about witch hunts is that they occasionally catch guilty people. In the trans-Atlantic war on prosperity, governments have finally settled on a common enemy: the investment rating agencies that have been downgrading government debt in Europe and the United States.

Olli Rehn, European Commissioner for Economic and Financial Affairs, says the agencies were "behind the curve and reinforced the curve." That sounds a little like grabbing yourself by the hair and holding yourself at arm's length, and it's typical of the illogical complaints being made by European leaders against Fitch and Standard & Poor's for their rapid downgrading of Greece's sovereign debt.

On this side of the pond, the Securities and Exchange Commission is putting pressure on Moody's, and Sen. Al Franken (D-Minnesota) is introducing regulation of rating agencies into the stalled finance bill.

Note that the rating agencies are not getting dinged in response to their legitimate failures -- the famously too-high ratings awarded to Enron, Lehman Brothers and the universe of junk debt instruments. They're being punished for doing the right thing: sounding the alarm on Europe's manifest sovereign debt crisis and America's looming one. By coincidence, Moody's recently issued a widely publicized warning that the U.S. could be looking at a serious public debt emergency by 2013. No wonder Franken wants to rein in the raters that were considered jim-dandy back when President Obama first introduced his financial regulation bill. The agencies have gotten themselves into trouble by trespassing on government property.

Ironically, the raters have recently been making nice with government by applying a new standard for municipal debt that ups the weighting of historical performance and thus takes some of the heat off over-leveraged local governments. This is the standard Mark Twain applied to Wagner's music: "It's not as bad as it sounds." But what makes the scapegoating of the ratings agencies particularly rich is that their excessive power is itself a creation of government. The London Independent's Nihil Kumar explains:

    The agencies weren't responsible for Lehman's investment decisions, nor did they pile all this debt on Greece's balance sheet. But how is it that despite being criticised in the recent past, a piece of research from one of their ilk triggers such worry in both dealing rooms and the corridors of power? The answer, many argue, is that the agencies are often backed up by the same governments they can unsettle by shuffling their ratings. In the US, New York University professor Lawrence White traces the rise of the agencies from John Moody's ratings of railroad bonds at the turn of the last century. His firm was joined by Poor's publishing company in 1916, and then the Fitch publishing company in 1924, the precursors of today's giants, with the three selling their views in thick ratings manuals.

    The mid-1930s were a key marker. The US Office of the Comptroller of the Currency prohibited banks from putting money in "speculative investment securities" as determined by "recognised ratings manuals". This effectively endowed ratings with the force of law, according to Professor White. Other regulators followed suit and in the 1970s the SEC came up with a new category of nationally recognised statistical rating organisations, or NRSROs. From then on, NRSRO ratings were used to work out the capital requirements of broker-dealers, thereby entrenching the role of the agencies in the financial system.

    These and other moves – in Europe today, for instance, ratings play a role within the Basel II framework of calculating capital requirements for banks – put the agencies on a "pedestal", according to Professor White. The key to curbing their influence is less, not more regulation, he says, arguing for the elimination of regulatory reliance on ratings.

    And that's what a real austerity program looks like! The political imperative seems to be moving in the opposite direction, however. In Europe, the push is towards more rules, as opposed to removing the agencies from the regulatory system. "That is a broader debate, which we should probably have but like a lot of things, is not being pursued at the moment," says Patrick Buckingham, a regulatory partner at the law firm Herbert Smith.

"There are too few agencies in too few hands," says Michel Barnier, European Commissioner for Internal Market and Services. "We'll work with the players of the sector to increase competitiveness." That is simply not true. The plan as of now is not to increase competitiveness but to put the "few hands" under tighter control by the governments they're supposed to be rating.

Of all the reasons to disdain ratings agencies, the Western governments have managed to find the bad one. To blame short sellers or S&P or hedge fund managers or "speculators" is to condemn your only friends, the people telling you to stop gorging, now, and go on a diet. The sovereign deadbeats could have saved themselves all this tsouris by taking the advice of that great economist and monetary policy expert Kate Moss: "Nothing tastes as good as skinny feels."

[E.R. Campbell]

Maybe Al Franken's move is prompted by this report from Forbes, which say that Martin Weiss, who runs his own rating system, is actively advocating stripping the US of its AAA- rating arguing, correctly, in my view, that the USA is not a safe, secure place for individual, American investors.

Weiss says, "Worst of all, by continuing to reaffirm America's triple-A rating, you help create a false sense of security overall--the recipe for a possible meltdown in the market for U.S. sovereign debts."

It's strong medicine, if, Big IF, it ever comes, but it just might instil a wee tiny bit of fiscal realism into Obama, Franken, et al.

[E.R. Campbell]

Here, reproduced under the Fair Dealing provisions (§29) of the Copyright Act from the Globe and Mail, is some excellent advice for the new UK Prime Minister David Cameron which is equally applicable to Barack Obama, Nicholas Sarkozy and most other world leaders:

http://www.theglobeandmail.com/news/opinions/cameron-could-learn-from-the-grand-old-mans-passion-for-economy/article1569535/?cmpid=rss1

Cameron could learn from the Grand Old Man’s passion for economy
Gladstone preferred to let money ‘fructify in the pockets of the people’ rather than waste away in the public purse

Neil Reynolds

Thomas Huxley, the eminent self-taught scientist and one of the great intellects of 19th-century Britain, called William Ewart Gladstone, four times chancellor of the exchequer and four times prime minister, “the greatest intellect of Europe.” And Huxley was a critic. Beyond all argument, this great liberal champion of laissez-faire was a smart man. By the end of his more than 60 years in public service, he had acquired a personal library of 32,000 books; by his own reckoning, and he was precise in his records, he had read 20,000 of them. But he wasn’t merely smart. He was right. Democracy, he said, was a spendthrift affair. He governed accordingly.

More than any other British leader, Gladstone can instruct Prime Minister David Cameron on the way to pay down the national debt – yet win admiration and respect from a dubious electorate that doesn’t quite think he’s up to the job. With a few basic principles as his guide – all of them more practical than theoretical – Gladstone paid down the massive debt incurred in the Napoleonic Wars. With the same principles, Mr. Cameron should be able to take care of a smaller debt with relative ease.

Lord Morley, friend and biographer of Gladstone, wrote of the Grand Old Man’s “passion for economy, his ceaseless war against public profusion, his insistence upon the rigorous keeping of the national accounts.” Gladstone cut taxes repeatedly. He reduced or eliminated scores of miscellaneous taxes. Marginal rate cut by marginal rate cut, he lowered the country’s income tax rate (to 1.25 per cent). Given one more term in office, he probably would have eliminated it. (He was 84 when he delivered his final speech in the Commons.) He rescinded tariffs – often unilaterally. Indeed, by one count he abolished more than 1,000 of them – 95 per cent of Britain’s tariffs. He balanced the budget and, more often than not, produced large surpluses to pay down debt. He preferred, he said, to let money “fructify in the pockets of the people” rather than waste away in the public purse.

It’s no wonder that the British public came to adore “G.O.M.” – or, as his imperialist Tory opponent Benjamin Disraeli jealously pronounced him, “God’s Only Mistake.” Winston Churchill and Margaret Thatcher aside, it’s no wonder that most of his successors in the 20th century looked, in comparison, so very small and so very inadequate. Mrs. Thatcher, for her part, observed that the great Liberal statesman would have “felt right at home” in her Conservative party in the 1980s. Perhaps. By Gladstone’s standards, though, Mrs. Thatcher was spendthrift herself.

With its constant clamour for foreign wars, 19th-century Britain provided Westminster with plenty of plausible excuses for going back into deficits – temporarily, of course. Gladstone, though, permitted no borrowing to fund these episodic misadventures. For a live-or-die war, he would have gone deeply into debt. For optional wars, he made Britain pay as it went. For these wars, indeed, he raised taxes. Of the taxes he raised to finance the Crimean War (1854), Gladstone declared: “The expenses of war are the moral check which it has pleased the Almighty to impose on the ambition and the lust for conquest that are inherent in too many nations.”

In 1815, at the end of the Napoleonic Wars, Britain owed a debt equal to 250 per cent of its GDP, the highest level that the country has ever recorded. Ironically, a century later, post-Gladstone, it had paid down this debt (to a modest 25 per cent of GDP) – just in time to embark on the global wars of the 20th century. By this fiscal discipline alone, Britain survived. Without it, the country would never have made it through the First World War – nor the Second World War, either – without utter economic disintegration.

There are only four ways for countries to get out from under massive debt. They can inflate. They can default. They can pay down the debt over time. Or they can grow their economies at a faster pace – which makes the debt shrink in proportion to a country’s national wealth.

Gladstone’s genius was to repudiate the first two options as immoral and to embrace the latter two as practical. He produced fiscal surpluses and used them to pay down debt. He reduced taxes to promote a higher rate of economic growth. This two-track strategy produced incremental increases in revenue, which he used to finance the next set of tax cuts – which yielded more economic growth: a virtuous spiral that returned ever-larger revenues to the Treasury and which ultimately made Britain the wealthiest country in the world.

Britain is now on its way toward a national debt of Napoleonic proportions. The Swiss-based Bank for International Settlements, the bank that serves the world’s central bankers, calculates that Britain’s debt will eventually rise to 200 per cent of GDP. Mr. Cameron can handle it – provided he heeds Gladstone’s famous warning words: “Nothing that is morally wrong can be politically right.”

Gladstone was and Reynolds is right: democracy is a spendthrift. A strong, reliable currency is one of the government’s primary obligations to its people: see Thomas Gresham and the ‘restoration’ of a sound currency in Elizabethan England.

The idea of “optional wars” is interesting and one which we all ought to consider.

Finally, Gladstone was right again: inflating (debasing) the currency and defaulting on debts are immoral – but that will not prevent many countries, including some advanced, sophisticated democracies from adopting either or both options, as the USA is doing in 2010; growing the economy and paying down debt are the only proper courses for responsible governments and responsible countries/peoples.
 

[Infanteer]

Shows how far I'm outta the loop - I didn't even know there was an election in the UK....

[E.R. Campbell]

Here, reproduced under the Fair Dealing provisions (§29) of the Copyright Act from the Globe and Mail is more solid analysis and advice:

http://www.theglobeandmail.com/news/opinions/prudent-perhaps-but-the-canadian-model-pays-off/article1585057/

Prudent, perhaps, but the Canadian model pays off
What the rest can learn from what some have called the world’s soundest financial system

Kevin Lynch

From Saturday's Globe and Mail
Published on Friday, May. 28, 2010

While the world economy is now recovering from the first global financial crisis since the 1930s, the global debate on how best to present a reoccurrence is anything but settled. Financial reform proposals in the United States, the European Union, Britain and elsewhere present quite different views on how this core sector should be regulated, with the battle over a proposed bank tax being a prominent example. In all this, as a recent Financial Times article observed, “Canada is a real-world, real-time example of a banking system in a medium-sized, advanced capitalist economy that worked. Understanding why the Canadian system survived could be a key to making the rest of the West equally robust.”

Although Canada was hit by the worldwide recession, the Canadian financial system weathered the global financial crisis comparatively well. Canadian financial institutions were not unscathed by the crisis, but none were excessively affected by toxic assets, no public funds were injected into financial institutions, Canadian banks remained profitable and they continued to lend.

The sharp contrast between the Canadian experience and how negatively the financial crisis affected the United States, and much of Europe, reflects different regulatory regimes, as well as different corporate governance systems, financial institution lending practices and different structures. Interestingly, in the halcyon years before the financial crisis, Canadian practices were often criticized in New York and London as being too conservative, too prudent and too unwelcoming of the new financial innovations that were sweeping global balance sheets.

Canada has integrated regulation of banks, insurance companies and large investment dealers. The head of the Office of the Superintendent of Financial Institutions (OSFI), Canada’s regulator, regularly meets the largest financial institutions, to make sure that they are governed so as to be sound and stable. Canada allows securities firms to be bank-owned, and OSFI regulates the banks on a consolidated basis (retail, commercial, investment and wealth activities) worldwide, in contrast to the regulatory silos in the United States. The Canadian regulatory approach is both prescriptive and principle-based. This combination puts the onus on a financial institution to assure itself that it has met the intent of the legislation, in addition to what is explicitly prescribed.

Canadian financial institutions were less highly leveraged than their international peers in the precrisis period. This reflected the fact that Canada has a regulatory cap on leverage at an asset-to-total-capital ratio of 20 to 1. As a result, major Canadian banks had an average asset-to-capital multiple of 18 in 2008, while the comparable figure for many U.S. banks was more than 25, and numerous European banks were well over 30.

Capital requirements for Canadian financial institutions were above international standards, and Canadian banks typically maintained capital above these minimum requirements. Further, Canadian banks rely more on depository funds than on wholesale funding, compared which banks in many other countries, which provides more stability in times of market volatility.

A key asset class that fuelled the global financial crisis was subprime mortgages. The vast majority of Canadians mortgages are originated by banks to be held, thereby providing a “front-line” incentive not to lend where there is a high risk of default; unlike the U.S., where the majority were originated to be sold. In Canada, this is further buttressed by government regulations that require insurance for high-ratio mortgages and higher credit standards on the eligibility for mortgage insurance.

This financial-sector framework has to be overlaid on a Canadian economy with strong fundamentals: a decade of sustained government surpluses, solid corporate balance sheets, low and stable inflation, low net foreign indebtedness (less than the U.S.), the lowest net government debt as a proportion of GDP among the G7 countries, and an actuarially sound national pension plan. Taken together, this combination of macroeconomic management, regulatory systems, corporate governance structures and banking practices has produced what the World Economic Forum rates as the soundest financial system in the world.

As world leaders contemplate global financial reform, there are lessons to be learned from Canada’s experience and principles for reform to be drawn from the Canadian approach.

First, macroeconomic behaviours and microeconomic systems don’t exist in splendid isolation from each other. Prudent, long-term, fiscal and monetary policies are beneficial for financial sectors; conversely, macroeconomic policies that contribute to imbalances will eventually infect financial markets, no matter how sound the regulatory systems.

Second, globalization, together with the pervasive interconnections among markets it has spawned, has to be better understood. This should inform both the structure and operation of regulatory systems. It requires getting the “perimeters of regulation” right: sufficiently broad to avoid regulatory arbitrage, sufficiently comprehensive to cover all systemically important firms, sufficiently “smart” to allow firms to intermediate efficiently, and sufficiently “simple” to avoid excessive complexity and uncertainty.

Third, prudence may be boring, but it pays off, particularly when viewed over the complete economic cycle. Regulatory systems and business planning should be based on business cycles as the norm; they should not presume benign economic growth. The value and effectiveness of safety-net systems, whether they are financial-system capital requirements or economy-wide programs, have to be evaluated over the complete cycle.

Fourth, regulatory systems can’t be the first line of defence in our complex, decentralized, market-based system, and they can’t be exclusively prescription-based. That first line of defence has to be at the level of the firm, and imbedded in its corporate governance structures, procedures and values. Regulatory systems have to be both principle-based and prescriptive, and put the onus on firms to manage for safety and soundness as a principle, as well as meeting the required rules. This is the regulatory equivalent of general anti-avoidance legislation in the tax system.

Fifth, financial-sector reform needs to increase the quantity and quality of capital that financial institutions are required to hold, but it also needs to address the problem of pro-cyclicality, which is a feature of current regulatory systems. Pro-cyclical regulatory systems effectively require more capital in downturns, when you actually could use the capital buffer, leading to deleveraging and exacerbating the economic cycle. One solution is to take a complete-cycle view of appropriate average levels of regulatory capital, and allow additional capital accumulation during the expansion phase that can be drawn down during the contraction phase.

Sixth, there is much consideration being given to the twin challenges of systemic risk and moral hazard. Some argue that the solution to “too big to fail” is more functional separation of what a financial institution can or cannot do; others make the case that more consolidated risk management and strengthened regulation, including higher capital requirements and greater transparency, are more practical ways to proceed.

In seeking the right balance, policy-makers need to bear in mind that the lack of regulatory oversight on financial activities such as over-the-counter trading, hedge-fund positions and counterparty-risk concentrations played a role in the financial crisis, and that a more comprehensive and consistent regulatory environment should be the end objective.

Seventh, we need to move to a more effective stage of international regulatory co-operation. The financial crisis made self-evident the necessity for reform of national financial systems. But it also underscored the requirement for greater harmonization across national financial systems in a world of pervasive globalization, and the need for more effective international co-operation.

Eighth, on governance, the G20 took the lead in organizing the international response to the global financial crisis. They designated the G20 as the key forum for international economic co-operation, and agreed to a framework for financial-sector reforms. But while this complex international process unfolds over the coming months, the risk is that the urgency and cohesion of 2009 could give way to complacency as the recovery strengthens and to a reassertion of policy differences among countries. Neither development would serve the global economy well. Now more than ever, markets and consumers want signs of concrete progress, and financial institutions need certainty about the reformed system and its rules.

The financial crisis provides the impetus to learn from what went wrong, and to introduce reforms that will make such crises less likely and less traumatic in the future. It will be important to learn these lessons well. Canada, both as chair of the 2010 G8 Summit and co-chair of the G20 Summit, has the opportunity to play a leadership role in an effective reform process. Canada’s unique experience in avoiding the worst of the financial crisis gives it the credibility to lead.

Kevin Lynch is vice-chair of BMO Financial Group and former clerk of the Privy Council and secretary to the cabinet.

There is plenty of credit to go around in Canada: Mulroney, Chrétien, Martin and Harper all get some of it. But so do the apolitical central bankers, like Dodge and Carney and a succession of skilled bureaucrats, not least Lynch himself.

One hopes that our Canadian delegation to the G8 and G20 will heed Lynch’s counsel: we need to part of a global solution but, at the same time, we must not join a global solution that does not adhere to Mr. Lynch’s principles – which none of the EU, UK or US proposals do. None of the EU, UK or US proposals are sensible or acceptable; all must be rejected; let’s hope and pray for some leadership from Canada and some support from China and India.

[Thucydides]

An unstable Euro has all kinds of consequences, most are not good:

http://pajamasmedia.com/blog/what-would-a-euro-collapse-mean-for-the-united-states

What Would a Euro Collapse Mean for the United States?

Posted By Soeren Kern On May 31, 2010 @ 12:00 am In Column 2, Europe, Germany, Greece, Money, Politics, Spain, US News, World News, economy | 11 Comments

Amid growing fears that the Greek debt crisis may engulf Spain, Portugal, Ireland, and even Italy, prominent voices in the European Union and elsewhere are positing an idea that just a few months ago would have seemed inconceivable: the European single currency is in danger of collapsing.

The minority view has always been skeptical about the wisdom of merging the economies and currencies of 16 European countries that have different languages, cultures, economic stages of development, and social practices. Up until just recently, however, the EU’s politically correct thought police had effectively silenced public debate about the “European project” by branding critics as anti-European traitors [1].

But European officialdom is now reeling from an outbreak of apostasy within its own ranks. The chief heretic is German Chancellor Angela Merkel, who in recent weeks has said publicly what many have been speculating about privately: “The euro is in danger. … If we don’t deal with this danger, then the consequences for us in Europe are incalculable,” Merkel recently told [2] Germany’s Süddeutsche Zeitung. She repeated the warning in a speech to the German Bundestag [3]: “The current crisis facing the euro is the biggest test Europe has faced in decades. It is an existential test and it must be overcome … if the euro fails, then Europe fails,” she said

Merkel’s fears have been echoed by European Central Bank President Jean-Claude Trichet [4], who told the German newsmagazine Der Spiegel that these are “dramatic times” for the euro and “the most difficult situation since the Second World War, perhaps even since the First World War.”

Italian Prime Minister Silvio Berlusconi [5] told fellow European leaders in Brussels that the euro is in a “state of emergency.” (Berlusconi once said that the euro “screwed everybody [6].”)

Meanwhile, French President Nicolas Sarkozy [7] is said to have threatened to pull out of the euro altogether unless Merkel agreed to back the EU’s giant €750 billion bailout. The threat was reported by Spain’s El País newspaper, which attributed the information to Spanish Prime Minister José Luis Rodríguez Zapatero. El País reported that Sarkozy “banged his fist on the table and threatened to leave the euro, which obliged Angela Merkel to bend and reach an agreement.”

By publicly second-guessing the euro in such existential terms, European leaders have inadvertently drawn attention to many of the design flaws built into the single currency. This, in turn, has accelerated the euro’s depreciation in recent weeks and called into question its reliability as a reserve currency. The speed of the euro’s reversal of fortune is startling, especially considering that just a few years ago economists were predicting [8] that the euro would challenge the U.S. dollar’s status as the world’s dominant international currency.

As the debate over the future of the euro gains momentum, the question arises: How would the collapse of Europe’s single currency affect the United States? The demise of the euro (which may or may not be imminent) would have both negative and positive consequences for America in two broad spheres, namely in economics and geopolitics.

Economic & Financial Consequences:

In assessing the effects of a potential collapse of the euro, timing is everything. A sudden disintegration of the euro due to financial panic on international markets would almost certainly increase the risk of financial contagion spreading to the United States, especially in light of America’s $12 trillion debt load. In the ensuing turmoil, American banks could stand to face billions or possibly trillions of dollars in losses on their credit exposure to Europe, and thus call into question the solvency of the entire American financial system. At a very minimum, economic and financial chaos in Europe would severely disrupt American exports to Europe, and thus slow the economic recovery in the United States.

On the other hand, in a controlled break-up of the euro (a scenario whereby Germany tires of its role as EU paymaster and makes a policy decision to exit the single currency and reinstate the Deutsche Mark in an orderly, phased-in fashion), the United States could stand to benefit handsomely. Any unraveling of the euro would end that currency’s function as a reserve currency and boost the demand for safe-haven assets in the United States. As a result, a stream of money from Asia and elsewhere would flow into United States Treasury bonds, and thus provide financing for U.S. deficits. Although a stronger dollar would hurt American companies trying to sell abroad, a stronger greenback would also bring benefits to American consumers, in the form of lower oil and commodity prices and lower inflation.

Geopolitical Consequences:

A collapse of the euro would almost certainly spell the end of the EU as we know it. This, in turn, would have broadly positive implications for the United States. The architects of European integration have always dreamed of building a United States of Europe that could act as a counter-balance to America on the global stage. In recent years, European zeal to achieve superpower status has caused endless transatlantic friction on questions ranging from Airbus aircraft to Chiquita bananas to the war in Iraq.

But the euro crisis has already underscored the fundamental weakness of the EU by calling into question the financial viability of its social welfare model [9], which has long been promoted as a primary element of the EU’s soft power alternative to American hard power.

Unfortunately for Europe, the entire European project is hanging by the thread of a highly symbolic but woefully fragile euro. If the euro comes undone, it would rob the EU of its main source of international influence. A post-euro EU would probably devolve from the economic and political union that it is today to a simple free trade zone. In the process, it would deprive Europe of any hope of becoming a viable pole in a future multipolar world. It would also eliminate a would-be geopolitical rival to the United States.

With so much at stake, Europeans are unlikely to abandon the euro without a fight. Nor will Eurocrats, who understand that having a single currency is their best hope of holding and accumulating more power, allow the current crisis to go to waste. Thus it comes as no big surprise that rather than addressing the fundamental root cause of the EU’s current problems, namely profligate spending, Europe’s elite class is now advocating the transfer of yet more political power to an unelected bureaucracy in Brussels.

European leaders are saying that in order for the euro to survive, Europe urgently needs an “economic government [10],” one that would transfer all remaining responsibility for economic decision-making from individual EU nation states to Brussels. Under the scheme, EU countries would forfeit complete sovereignty over national tax and spending policies, all in the interests of “improved coordination.”

Romano Prodi, the former president of the European Commission, once told CNN [11] that the euro was “not economic at all; it is a completely political step. The historical significance of the euro is to construct a bipolar economy in the world. The two poles are the dollar and the euro. This is the political meaning of the single European currency. It is a step beyond which there will be others. The euro is just an antipasto.”

It remains to be seen whether the euro will stand or fall. But either way, Europe seems set to lose.
--------------------------------------------------------------------------------

Article printed from Pajamas Media: http://pajamasmedia.com

URL to article: http://pajamasmedia.com/blog/what-would-a-euro-collapse-mean-for-the-united-states/

URLs in this post:

[1] branding critics as anti-European traitors: http://www.stedwardspress.co.uk/Brussels_laid_bare.html

[2] Merkel recently told: http://www.bundeskanzlerin.de/nn_683580/Content/DE/Artikel/2010/05/2010-bkin-sz.html

[3] German Bundestag: http://www.bundeskanzlerin.de/nn_683580/Content/DE/Artikel/2010/05/2010-05-19-regierungserkl_C3_A4rung-stabilisierung-euro.html

[4] Jean-Claude Trichet: http://www.spiegel.de/international/europe/0,1518,694960,00.html

[5] Silvio Berlusconi: http://www.eubusiness.com/news-eu/greece-finance.4j7

[6] screwed everybody: http://www.independent.co.uk/news/business/news/berlusconi-euro-screwed-everyone-500629.html

[7] Nicolas Sarkozy: http://www.elpais.com/articulo/espana/Zapatero/Sarkozy/amenazo/salirse/euro/elpepiesp/20100514elpepinac_2/Tes

[8] economists were predicting: http://www.imf.org/external/pubs/ft/wp/2006/wp06153.pdf

[9] financial viability of its social welfare model: http://pajamasmedia.com../../../../../blog/european-social-welfare-state-model-running-out-of-time-and-money/

[10] economic government: http://www.eubusiness.com/news-eu/finance-economy.3xx

[11] once told CNN: http://books.google.ca/books?id=hl-LBuoF5RcC&pg=PA439&lpg=PA439&dq=prodi+euro+antipasto&source=bl&ots=88ttQXG202&sig=1E0Ut3HpSmRDla9jTVH1icUZLAY&hl=en&ei=s9z9S5-CBZPINeHFjcgN&sa=X&oi=book_result&ct=result&resnum=4&ved=0CB0Q6AEwAw#v=onepage&q=prodi%20euro%2

[E.R. Campbell]

Here, reproduced under the Fair Dealing provisions (§29) of the Copyright Act from the Globe and Mail, is a thoughtful piece by Nouriel Roubini, the fellow who, in 2005, predicted the housing bubble and the chaos that followed:

http://www.theglobeandmail.com/report-on-business/economy/solutions-for-a-crisis-in-its-sovereign-stage/article1588038/

Solutions for a crisis in its sovereign stage
Nouriel Roubini and Arnab Das say the euro zone offers a lesson in how not to respond to a systemic crisis

Nouriel Roubini and Arnab Das

FT.com
Published on Tuesday, Jun. 01, 2010

The largest financial crisis  in history is spreading from private to sovereign entities. At best, Europe’s recovery will suffer and the collapsing euro will subtract from growth in its key trading partners. At worst, a disintegration of the single currency or a wave of disorderly defaults could unhinge the financial system and precipitate a double-dip recession.

How did it come to this? Starting in the 1970s, financial liberalisation and innovation eased credit constraints on the public and private sectors. Households in advanced economies – where real income growth was anaemic – could use debt to spend beyond their means. The process was fed by ever laxer regulation, increasingly frequent and expensive government and International Monetary Fund  bail-outs in response to increasingly frequent and expensive crises, and easy monetary policy from the 1990s. Political support for this democratization of credit and home-ownership compounded the trend after 2000.

The result was a consumption binge in deficit countries and an export surge in surplus countries, with vendor financing courtesy of the latter. Global output and growth, corporate profits, household income and wealth, and public revenue and spending temporarily shot well above equilibrium. Wishful thinking allowed asset prices to reach absurd heights and pushed risk premiums to incredible lows. When the asset and credit bubbles burst, it became clear that the world faced a lower speed limit on growth than we had banked on.

Now, governments everywhere are releveraging to socialize private losses and jump-start private demand. But public debt is ultimately a private burden: governments subsist by taxing private income and wealth, or through the ultimate capital levy of inflation or outright default. Eventually governments must deleverage too, or else public debt will explode, precipitating further, deeper public and private-sector crises.

This is already happening in the front-line of the crisis, eurozone sovereign debt. Greece is first over the edge; Ireland, Portugal and Spain trail close behind. Italy, while not yet illiquid, faces solvency risks. Even France and Germany have rising deficits. UK budget cuts are starting. Eventually Japan and the US will have to cut too.

In the early part of the crisis, governments acted in unison to restore confidence and economic activity. The Group of 20 coalesced after the crash of 2008-09; we all were in the same boat together, sinking fast.

But in 2010, national imperatives reasserted themselves. Co-ordination is now lacking: Germany is banning naked short selling unilaterally and the U.S. is pursuing its own financial sector reform. Surplus countries are unwilling to stimulate consumption, while deficit countries are building unsustainable public debt.

The euro zone offers an object lesson in how not to respond to a systemic crisis. Member states started going it alone when they carved up pan-European banks along national lines in 2008. After much dithering and denial over Greece, leaders orchestrated an overwhelming show of force; a €750-billion bail-out bolstered confidence for one day. But the rules went out of the window. Sovereign rescues are legitimized by an escape clause from the “no bail-out” rule intended for acts of God, not man-made debt. The European Central Bank began buying government bonds days after insisting it would not. Tensions in the Franco-German axis are palpable.

Instead of Balkanized local responses, we need a comprehensive solution to this global problem.

First, the euro zone must get its act together. It must deregulate, liberalize, reform the south and stoke demand in the north to restore dynamism and growth; ease monetary policy to prevent deflation and boost competitiveness; implement sovereign debt restructuring mechanisms to limit moral hazard from bail-outs; and put expansion of the euro zone on ice.

Second, creditors need to take a hit, and debtors adjust. This is a solvency problem, demanding a grand work-out. Greece is the tip of the iceberg; banks in Spain and elsewhere in Europe stand knee-deep in bad debt, while problems persist in US residential and global commercial property.

Third, fiscal sustainability must be restored, with a focus on timetables and scenarios for revenues and spending, ageing-related costs and contingencies for future shocks, rather than on fiscal rules.

Fourth, it is time for radical reform of finance. The majority of proposals on the table are inadequate or irrelevant. Large financial institutions must be unbundled; they are too big, interconnected and complex to manage. Investors and customers can find all the traditional banking, investment banking, hedge fund, mutual fund and insurance services they need in specialised firms. We need to go back to Glass-Steagal on steroids.

Last, the global economy must be rebalanced. Deficit countries need to boost savings and investment; surplus countries to stimulate consumption. The quid pro quo for fiscal and financial reform in deficit countries must be deregulation of product, service and labour markets to boost incomes in surplus countries.

Nouriel Roubini is founder and chairman of Roubini Global Economics. Arnab Das is RGE’s managing director for market research and strategy

The Glass-Steagal Act, referenced in the penultimate paragraph, established the Federal Deposit Insurance Corporation (FDIC) in the United States and introduced banking reforms, some of which were designed to control speculation. Glass-Steagal was repealed in 1999.

I’m not sure that the creditors, especially China, are willing to “take a hit” in order to help restore global solvency but I agree with Roubini that it is their best, long term interests to do so.

[Thucydides]

Taking a hit will happen, the only real question is will it be a controlled process or will it happen due to some sort of cascade failure (take your pick, the Euro and EU unravelling; unfunded public service pensions pushing municipalities and State governments in the US into bankruptcy, a prolonged capital strike due to massive State intervention in the US economy, personal debt defaults turning into a tidal wave in Canada, Chinese real estate bubbles popping....)

As military people we have certain habits and skills which support levels of self sufficiency. This means that with proper preparation and maybe with a little coordination we can survive and even prosper in the turmoil to come, so long as we have a stockpile of tools, a "victory garden", a posse of friends, co workers or fellow travelers to pool skills and resources with and (worst case scenario) the means to defend what is ours from the looters.

For me the worst part of this is I grew up in a time of incredible optimism. Man landed on the Moon, Canada celebrated the Centennial and all kinds of things seemed to be possible just over the horizon (remember flying cars and missions to Mars?). Throughout my adult life, things seem to have "shrunken", and what sort of world will be left for my children?

[Thucydides]

Proof that the solution does not lie in impoverishing ourselves and our children:

http://freedomnation.blogspot.com/2010/05/cut-spending-without-delay.html

Cut spending without delay

I have heard several politicians and members of the chattering class claim that cutting spending immediately would be disastrous to the economy. This was a constant refrain of Gordon brown during the recent UK elections. Mr. Brown constantly claimed that it would be ‘taking money out of the economy.’ The Cato Institute takes on this assumption by using a historical example:

...the “Depression of 1946″ may be one of the most widely predicted events that never happened in American history. As the war was winding down, leading Keynesian economists of the day argued, as Alvin Hansen did, that “the government cannot just disband the Army, close down munitions factories, stop building ships, and remove all economic controls.” After all, the belief was that the only thing that finally ended the Great Depression of the 1930s was the dramatic increase in government involvement in the economy. In fact, Hansen’s advice went unheeded. Government cancelled war contracts, and its spending fell from $84 billion in 1945 to under $30 billion in 1946. By 1947, the government was paying back its massive wartime debts by running a budget surplus of close to 6 percent of GDP. The military released around 10 million Americans back into civilian life. Most economic controls were lifted, and all were gone less than a year after V-J Day. In short, the economy underwent what the historian Jack Stokes Ballard refers to as the “shock of peace.” From the economy’s perspective, it was the “shock of de-stimulus.”

At present the greatest threats to the economy in every western country are the deficit and the debt. The sooner that these issues are dealt with the better it will be for the long term strength of economic development. There is no convincing argument to delay the cuts that are needed.

Posted by Hugh MacIntyre at 3:15 PM
Labels: Economics, smaller government
1 comments:

Anonymous said...

    look at our GDP that came out today, 6.1% in the last quarter.

    does any sane individual believe that this number is the result of REAL economic growth? it is american stimulus leaching into our country through auto sales and other raw materials, thats all. give it one year and we will be once again screamin the blues, only there will be no escaping the next depression. the american (and european for that matter) cupboard is bare.
    economic collapse is imminent. just remember angela merkels words regarding the greece bailout " we bought ourselves two years." NOT " the problem is fixed now, smoooth sailing ahead" like many keynesians hoped.
    buy gold and a bunker, shes going to get nasty.

    brad maynard
    May 31, 2010 11:59 PM

[E.R. Campbell]

Here, reproduced under the Fair Dealing provisions (§29) of the Copyright Act from the Globe and Mail, is a good explanation of what’s wrong with the Euro-American “bank tax,” Obama's latest brain fart:

http://www.theglobeandmail.com/news/world/g8-g20/economy/why-harper-is-taking-his-bank-tax-fight-to-europes-doorstep/article1590224/

Why Harper is taking his bank-tax fight to Europe's doorstep
With the G20 approaching, time is running out for the Prime Minister to sell his maverick opposition to the world

Grant Robertson
Banking Reporter

From Thursday's Globe and Mail, updated on Thursday, Jun. 03, 2010

When Prime Minister Stephen Harper meets in London today with newly minted British Prime Minister David Cameron, there will be sparse time for pleasantries. Mr. Harper has a pressing item to deal with, one that has come to suddenly dominate his government’s foreign-policy agenda of late: stopping the push for a global tax on banks.

With little more than three weeks to go until the G20 summit in Toronto, where a bank tax will be on the agenda, the Harper government knows time is short to marshal opposition to what it believes is a dangerous plan.

The bank tax, an idea first raised last year in response to the debate over how to pay for bailouts of financial institutions that collapse during economic crises, is an idea that has seen Canada break from the pack of G20 nations. Though the idea has significant support in the European Union, Ottawa is trying to convince those in the G20 that a bank tax could do more damage than intended. Members of Mr. Harper’s cabinet have fanned out across the globe to argue that such a tax could lead to bigger problems.

If there is ground to be made for Canada, Mr. Harper will find out this week. Following his meeting with the British PM, he will deliver a similar message to French President Nicolas Sarkozy. Jim Flaherty will meet with G20 finance ministers in South Korea on weekend, where similar conversations will take place.

From those talks, a new vernacular has been created. In short, the bank-tax debate turns on three key issues that could dominate the agenda in Toronto.

1. Orderly failure

When the concept of a bank tax was first raised in G20 circles, the world was reeling from a financial crisis that saw billions of taxpayer dollars poured into propping up financial institutions, most notably in the United States, to keep the contagion from spreading.

Amid pressure from EU countries in the G20, the International Monetary Fund was instructed last year to come up with a suggested plan for a bank tax. Its report described a scenario where financial institutions are taxed to cover the cost of the recent bailouts, and to create a contingency fund against future economic disasters.

That contingency fund would provide for what the European Commission calls “orderly failure.” Rather than a hard crash, banks would have money on hand for a soft landing. But in this case, the banks themselves pick up the tab through the tax on their operations.

But the details are a problem: What exactly would be taxed? Proposals have suggested everything from taxing bank profits to executive compensation and individual transactions, and there is no clear consensus. Canada is concerned that the cost of any sort of tax would flow to the consumer.

Of greater concern, though, is who would administer these funds. Would there be a global organization to handle and disperse the emergency dollars when needed – a sort of financial United Nations? Or do countries preside over their own tax funds?

Already there is a divide over that issue: some governments want bank tax money to go into general revenues, not to be held in a contingency account. “France and the U.K. think this tax should go into the budget, not into a fund,” French Finance Minister Christine Lagarde told reporters in Paris. If this sounds like a sticky issue, it is. Keeping track of where the money goes could be a problem. Should a tax be adopted by the G20, the debate over who holds the keys to the vault is only just beginning.

2. Moral hazard

The global bank tax is often considered an insurance policy against bank bailouts, since banks’ mismanagement of risky investments – particularly those tied to U.S. housing and mortgages – is what sparked the crisis of 2008.

But Canada worries a bank tax will have a reverse effect – making the global financial system weaker by encouraging the banks to take more risks than before. Under the so-called moral-hazard argument, the banks would inherently know there is a pool of money to tap if their investments go awry.

“It penalizes strong performers, it increases moral hazard in the system, and it focuses on remediation of future banking failures rather than the regulatory prevention of future financial problems,” said Kevin Lynch, vice-chair of BMO Financial Group and a former clerk of the Privy Council.

Mexican president Felipe Calderon lent his support to Canada’s argument last week in Toronto putting it another way: “If the global economy builds a fund in order to bail out banks – you can be sure that there will be bailouts in the future,” he said.

3. Embedded contingent capital

Knowing he needs a counter proposal, Mr. Harper is taking a complex idea with him to London and Paris: embedded contingent capital.

It’s not the most eye-catching terminology (“bank tax” made for better headlines in the British election). But this is the Canadian solution. Under the plan, banks would sell debt that could be quickly converted to shares in the event of a crisis, giving the banks emergency capital to bail themselves out. The move would cost the banks, since it would dramatically dilute their share pool, hurting shareholders. But if done right, it could prevent messy insolvencies. This notion has gained traction inside Ottawa, since it puts the cost of a bailout at the feet of the financial institutions without explicitly taxing them.

But here, too, the details are yet to be worked out.

“The embedded capital idea, it’s really at an infant stage in its development,” said Steve Foerster, professor of finance at the Richard Ivey School of Business at the University of Western Ontario. “It’s the notion of issuing debt which – in a time of crisis somehow to be determined by a regulator – would then morph into equity. Which would somehow provide a cushion for a bank that was in trouble.”

There are several reports in the media indicating that Brazil, China and India are “on side,” with Canada, on this issue and one hopes that will be enough to put paid to this Euro-American populist rubbish.

[Thucydides]

A further look ahead:

http://american.com/archive/2010/june-2010/athens-on-the-potomac

Athens on the Potomac

By Veronique de Rugy Friday, June 4, 2010

Filed under: Economic Policy, Boardroom, Government & Politics, Numbers, Public Square
Paul Krugman is right: America isn’t Greece. That doesn’t mean we aren’t in worrisome shape. And by one measure, we are in worse shape than Greece.

In a recent New York Times editorial, Paul Krugman wrote, “Everywhere you look there are editorials and commentaries, some posing as objective reporting, asserting that Greece today will be America tomorrow unless we abandon all that nonsense about taking care of those in need. The truth, however, is that America isn’t Greece.”

Krugman’s argument is that while both countries face serious and roughly equal deficits as a percentage of GDP, the United States is not at the same risk of defaulting on its debt as Greece is. First, he writes, markets treat both countries differently, as evidenced by the difference in interest rates on Greek government and U.S. government bonds. That’s because Greece is seen as a much riskier investment than the United States.

It is also true that there is no firm rule on when deficits or public debts are too high relative to an economy’s size. Prior to the crisis, the general consensus was that rich countries could safely have public debts worth 60 percent of GDP. And although Japan’s debt has exceeded 100 percent of GDP for many years, the government has yet to suffer a financing crisis.

However, it doesn’t mean that things won’t change. Investors judge default risks on a curve. They will assess one government against others (for instance, the United States vs. France, Germany, China, and Norway). When the markets do lose confidence in a government’s fiscal rectitude relative to others, a crisis can arise quite quickly, forcing countries into painful political decisions. And this could very well happen to the United States.

A recent International Monetary Fund study’s main finding is that the United States might not look better than most other governments forever, and that the hill the United States has to climb to fiscal stability is much steeper than most other countries.

First, under the Obama administration’s current fiscal plans, the gross national debt in the United States will climb above 100 percent of GDP by 2015.

What’s more, the chart above shows that when taking into account entitlement and all other obligations, America’s structural deficit as a percentage of our GDP is far bigger than almost any other country’s (more on this here); it is, in fact, worse than Greece’s.

And don’t forget, the United States has a far shorter maturity of government debt than most other countries, meaning that even if it weren’t borrowing extra cash it would have to issue a large chunk of new stuff over very short periods of time. In other words, the United States is like an addict always looking for his next fix.

This large financial need means that our country is spectacularly vulnerable—probably more than others—if the market suddenly decides it doesn’t want U.S. debt. When that happens, we might be no better situated than Greece.

Veronique de Rugy is a senior research fellow at The Mercatus Center at George Mason University.
FURTHER READING: De Rugy has uncovered many alarming trends in federal debt over past months, including “In-the-Red State,” “America’s Precarious Net Position,” “Mediscare: Our Government-Administered Insurance Looks into the Abyss,” and “What Unsustainable Looks Like.” AEI’s Newt Gingrich discusses a “Mandate for a Balanced Budget,” Desmond Lachman explores “The Greek Economic Crisis and the U.S. Economy,” and Kevin Hassett says “Greece’s Bailout Heroes Arrive in Leaking Boats.”

Image by Rob Green/Bergman Group.

[E.R. Campbell]

It appears, according to this report, reproduced under the Fair Dealing provisions (§29) of the Copyright Act from the Globe and Mail, that the “rest” of the G20 (including Australia, Brazil, China and so on) have sided with Canada and have put paid to that bit of American and European populist political rubbish, the bank tax:

http://www.theglobeandmail.com/news/world/g8-g20/economy/canada-wins-key-fight-against-bank-tax/article1593382/

Canada wins key fight against bank tax
G20 finance ministers approve a plan that allows countries to manage the issue as they see fit.
 
Bill Curry

Busan, South Korea — Globe and Mail Update

Published on Saturday, Jun. 05, 2010

Canada has won a key fight in its high-profile international campaign against a global bank tax as G20 finance ministers Saturday approved a plan that allows countries to manage the issue as they see fit.

Proponents of such a tax _ including the United States and Europe _ are free to go it alone, but the new plan allows the rest of the G20 to avoid the controversial idea and find other ways to reduce banking risks.

“The majority of the countries in the G20 do not support an ex ante bank tax, that is clear,” Canadian Finance Minister Jim Flaherty said at a news conference following a two-day meeting of G20 finance ministers and central bankers.

“At the end of the day, different countries will chose different ways of reaching the goal [that banks should pay for government interventions] but there is no agreement to proceed with an ex ante bank tax,” he said.

In their final communiqué, G20 finance ministers and central bankers said the financial sector must make a “fair and substantial” contribution to paying for any of the burdens associated with government intervention.

However, the statement then goes on to include wording that will allow most G20 members to avoid a bank tax, should they choose. For instance, the requirement for banks to pay back government aid is limited to those countries that actually bailed out their banks. There is also wording allowing countries to choose from a “range” of policy options in this area that take into account their own individual circumstances.

Europe and the United States are the main proponents of a bank tax _ partly to recoup taxpayers’ money used to bail out banks during the recession. But the European Union and the United States have also argued that it is in the interests of all G20 countries to create a fund via a global bank tax so that governments aren’t on the hook again to cover the huge costs of protecting vulnerable banks in a downturn.

Japan’s Deputy Finance Minister Naoki Minezaki and Australian Finance Minister Wayne Swann also spoke out publicly against the tax here this weekend. The G20 leaders will receive a second International Monetary Fund report on the proposal when they meet in Toronto, but it is clear there will be no broad agreement for joint action on a bank levy.

The decision to make the bank tax voluntary for G20 members is essentially what Canada, through Mr. Flaherty and Prime Minister Stephen Harper, have argued in recent weeks as the two men blitzed key the world for face-to-face meetings with key G20 members including the E.U., China and India.

On the complex issue of banking reforms _ including a common definition for high-quality capital and the percentage of capital banks should have on hand _ the G20 has agreed that a plan will be announced in November when leaders meet in Seoul.

Banks generally resist higher capital requirements because it cuts into profits. But many G20 leaders say sorting out this issue is the most important way governments can prevent the kind of risky practices that were at the root of the financial meltdown.

Agreement is proving a challenge however because the United States, Europe and Asia currently have dramatically different rules on what qualifies as Tier 1 capital and how banks can leverage money.

U.S. Treasury Secretary Timothy Geithner said the G20 is focused on a finding agreement in time for the November meeting of G20 leaders in Seoul in November.

“The United States is moving aggressively to fix the things we got wrong and to strengthen our economic fundamentals and we will give our full support to the G20 agenda of growth and reform. ”— U.S. Treasury Secretary Timothy Geithner

Mr. Geithner also warned that the G20 should not count on American consumers to fuel an economic recovery.

“Within the G20, we discussed how the ongoing shift toward higher savings in the United States needs to be complimented by stronger domestic demand growth in Japan, in the European surplus countries and by sustained growth in private demand, together with a more flexible exchange rate policy in China,” he said.

The G20 includes the G7 countries of Canada, France, Germany, Italy, Japan, the United Kingdom and the United States as well as Argentina, Australia, Brazil, China, India, Indonesia, South Korea, Mexico, Russia, Saudi Arabia, South Africa, Turkey and the European Union.

Of course the Americans and Europeans can still punish the survivors of the financial crisis and, thereby, appease the economically illiterate majorities in their populations. Bank taxes are popular and stupid; people want them so the American and European governments will give in. Obama may actually believe in what he’s doing.

[Brad Sallows]

I can only hope the "bank tax" is dead.  It is an insurance scheme which just happens to propose payments based on some formula tied to revenue rather than an actuarial calculation.  I am not impressed by an invitation to share the costs of insurance we do not need, from those  those who would draw on the insurance pool.

[E.R. Campbell]

According to this report, reproduced under the Fair Dealing provisions (§29) of the Copyright Act from the Globe and Mail, American legislators remain laughably hypocritical:

http://www.theglobeandmail.com/report-on-business/economy/chinese-trade-numbers-fuel-angry-us-response/article1599957/

Chinese trade numbers fuel angry U.S. response
Lawmakers demand to know what Obama administration will do to address widening imbalance

Brian Milner

Globe and Mail Update
Published on Friday, Jun. 11, 2010

China’s powerful export machine is back in overdrive, adding fuel to one of the world’s great trade battles as pressure mounts on Beijing to raise the value of its currency.

The latest trade numbers from China , much stronger than analysts had anticipated, are turning up heat on the Obama administration to curb what has been widely viewed as an unfair Chinese trade advantage stemming from its deliberately undervalued yuan and hefty subsidies to the export sector.

Even before the latest data, U.S. lawmakers had joined in rare bipartisan agreement to press for a tougher stance on China, as Beijing continued to rebuff international calls  for a currency revaluation. Thursday, exasperated senators, facing growing anger from constituents over high unemployment and a sluggish recovery, demanded to know what the administration is going to do to address the widening imbalance.
China reported that exports soared 48.5 per cent in May from a year earlier. Not even a surge in imports could keep the country’s trade surplus from ballooning to $19.5-billion (U.S.) from $1.7-billion in April and a deficit in March. The surplus on trade with the U.S. widened in April to $19.3-billion from $16.9-billion, and the shortfall is expected to grow in the months ahead, as a slowly reviving U.S. economy sucks in more imports.

“The distortions caused by China’s exchange rate spread far beyond China’s borders and are an impediment to the global rebalancing we need,” U.S. Treasury Secretary Timothy Geithner told the Senate finance committee Thursday. A “more flexible” currency “will allow market forces to play a more active role over time in facilitating strong, balanced and sustainable growth globally,” he said.

The fresh reading brought renewed calls in the United States to force Beijing’s hand.

“I'm not sure what this administration’s policy is,” fumed Montana Democrat Max Baucus, head of the finance committee and a long-time protectionist.

Another trade hawk, New York Democrat Charles Schumer, told Mr. Geithner that lawmakers will push ahead with legislation to impose countervailing duties and other penalties on the goods of any trading partner whose currency is found to be “fundamentally misaligned” with the U.S. dollar.

“There’s no doubt that there’s a lot of pent-up frustration with China in the United States,” said Marc Busch, a professor of trade policy and law at Georgetown University in Washington. “The politics are largely outstripping any economic reality in this discussion.”

The Chinese allowed the yuan to appreciate by 22.5 per cent against the dollar between 2006 and mid-2008, but then froze it at a level slightly above 6.8 yuan to the greenback in response to the global crisis. It has stayed there ever since, while its implicit value has climbed steadily, thanks to economic gains.

“The trade deficit with China is reducing U.S. GDP by more than $400-billion or nearly 3 per cent,” said Peter Morici, a business professor at the University of Maryland and former chief economist with the U.S. International Trade Commission. “Unemployment would be falling rapidly and the U.S. economy recovering more rapidly but for the trade deficit with China and Beijing’s currency policies.”

China has argued repeatedly that revaluing the currency would not affect the trade imbalance with the United States, and said changes to policy will be made at its own pace, not that of other countries. And it is by no means clear that a revalued yuan would dampen imports from China or even cause prices to rise.

“How much of the Chinese value chain is priced in Chinese currency?” Prof. Busch asked. “Much of it is denominated in U.S. dollars, so would a revaluation accomplish anything?”

Numbers being bandied about in Washington and other finance circles indicate that an appreciation of 5 to 8 per cent might be enough to mollify China’s Western trading partners. But that would likely have no impact, he said. “What revaluation are we waiting for that’s going to undo the trade imbalance?”

In any case, the anti-Chinese lobby is ignoring a crucial piece of information, namely that Chinese imports are also surging, some China trade watchers say.

“The big news on the trade front for China is the soaring import numbers,” said Ken Courtis, founding partner of Themes Investment Management in Hong Kong.

Japan, South Korea, Taiwan, Australia and several other Asian countries are running hefty surpluses with China. Germany is headed for a positive trade balance by the end of the year, and China has emerged as the fastest-growing market for U.S. exports.

First: China should float its currency, despite the near term, but temporary, economic hardship that will create for its own people. My guess is that internal social harmony is much, much more important to the Chinese leadership than is all the huffing and puffing the USA can manage.

Second: the US is debasing its own currency in a conscious effort to emulate the Chinese by artificially lowering the price of their exports and, concurrently, making imports more expensive. That’s why people like Baucus, Geithner and Schumer are hypocrites. Oh, and intentionally debasing one’s own currency is economic stupidity – congratulations, Mr. President, on shooting yourself (and your country) in the foot.

[Kirkhill]

Max Baucus is an annoying, arrogant, pig-headed b*st*rd.  He is the face of Softwood Lumber and Montana.

He is also a great Senator that constantly gets re-elected because he does what he is paid to do: protect the interests of those that elected him. He fights bare-knuckled in a bare-knuckled world and really doesn't care if that makes him appear hypocritical to the rest of the world - including his own party.  Check that comment about "his" administration. 

“I'm not sure what this administration’s policy is,”

.  In that he is not alone.....

I detest hypocrisy as much, or more, than the next man.  It makes it harder to plan.  But personal morality doesn't translate well into the corporate sphere and sure doesn't have much of a following in those corporations we know as the nation-state.

Besides, one man's hypocrisy is another's following the democratically expressed desire for a different policy.

I'd sooner Max Baucus as President than the pusillanimous, vacuous non-entity that is currently in office.  I may not like the policies that proceed from his values but he has  values and I can understand them and thus make useful predictions about what he will do.

Surprise is only useful militarily.  In virtually all other fields I value predictability.

[E.R. Campbell]

Following from an item posted just a few days ago: here, reproduced under the Fair Dealing provisions (§29) of the Copyright Act from the Globe And Mail, is a report on China’s reaction to Timothy Geithner’s recent hectoring re: echange rates:

http://www.theglobeandmail.com/report-on-business/china-hits-back-at-us-over-yuan/article1603071/

China hits back at U.S. over yuan
Foreign ministry says Washington ‘politicizing’ the exchange issue as an excuse to engage in trade protectionism

Beijing — Reuters
Published on Monday, Jun. 14, 2010

China’s Foreign Ministry on Monday hit back at fresh calls by the United States for Beijing to let the yuan currency rise in value, saying the exchange rate was not to blame for the U.S. trade deficit with China .
Foreign Ministry spokesman Qin Gang was responding to a question about recent comments by U.S. Treasury Secretary Timothy Geithner as well as calls from U.S. lawmakers to pass a bill threatening to press China over its yuan exchange rate  controls.

“A huge amount of facts has demonstrated the renminbi exchange rate is not the main cause of the imbalance in Sino-U.S. trade,” Mr. Qin said in a statement on the Ministry’s website.

“Do not politicize the renminbi exchange rate issue,” he said. The renminbi is another name for the yuan currency.

Mr. Qin said the Chinese government would keep the yuan exchange rate stable at a “reasonable and balanced” level and proceed with reform in a “gradual and controllable” way, in a tone that largely reiterated Beijing’s long-standing official line.

He added that Beijing would take both international and domestic economic conditions into consideration when it came to deciding when and how to reform the way it set exchange rates.

China has repeatedly insisted that it will not respond to foreign criticism and will itself decide currency issues.

Beijing is facing international calls to let the yuan return to the path of appreciation after effectively repegging the currency at about 6.83 to the dollar to help its exporters ride out the global credit crunch.

Complaints eased over the last two months as the euro zone debt crisis took centre stage. But U.S. Treasury Secretary Timothy Geithner said last week that the yuan was an impediment to global rebalancing, suggesting that U.S. patience with China’s currency policy was wearing thin.

U.S. Senator Charles Schumer said last week that he and other colleagues would push for a vote within two weeks on legislation to allow the U.S. Commerce Department to use anti-dumping and countervailing duty laws against China or any other country with a fundamentally misaligned exchange rate.

Qin Gang said that imbalances in Sino-U.S. trade had mainly been caused by globalization and the international division of labour, citing that a 21 per cent appreciation of the yuan against the dollar since 2005 had not helped to reduce the U.S. deficit.

He said U.S. exports to China has risen about 50 per cent in the first quarter, but Washington’s restrictions on high-tech exports were holding back trade.

He urged U.S. politicians to stop pointing figures at other countries and instead rethink their own structural economic faults.

“It is completely unreasonable to politicize the renminbi exchange issue and use the exchange rate issue to engage in trade protectionism against China. The only outcome will be hurting oneself as well as others.”

I especially liked this bit: ” U.S. Treasury Secretary Timothy Geithner said last week that the yuan was an impediment to global rebalancing, suggesting that U.S. patience with China’s currency policy was wearing thin.”



Who on earth, at least in the ‘middle kingdom,’ cares what the US thinks about China’s economy?

This is a fairly sharp, public rebuke, suggesting that Beijing’s patience with Washington’s hectoring has worn away.

[Baden Guy]

I have been waiting for an update on Paul Krugman's thinking on the international economy and here it is  from the New York Times:
LINK

June 17, 2010
That ’30s Feeling
By PAUL KRUGMAN
BERLIN

Suddenly, creating jobs is out, inflicting pain is in. Condemning deficits and refusing to help a still-struggling economy has become the new fashion everywhere, including the United States, where 52 senators voted against extending aid to the unemployed despite the highest rate of long-term joblessness since the 1930s.

Many economists, myself included, regard this turn to austerity as a huge mistake. It raises memories of 1937, when F.D.R.’s premature attempt to balance the budget helped plunge a recovering economy back into severe recession. And here in Germany, a few scholars see parallels to the policies of Heinrich Brüning, the chancellor from 1930 to 1932, whose devotion to financial orthodoxy ended up sealing the doom of the Weimar Republic.

But despite these warnings, the deficit hawks are prevailing in most places — and nowhere more than here, where the government has pledged 80 billion euros, almost $100 billion, in tax increases and spending cuts even though the economy continues to operate far below capacity.

What’s the economic logic behind the government’s moves? The answer, as far as I can tell, is that there isn’t any. Press German officials to explain why they need to impose austerity on a depressed economy, and you get rationales that don’t add up. Point this out, and they come up with different rationales, which also don’t add up. Arguing with German deficit hawks feels more than a bit like arguing with U.S. Iraq hawks back in 2002: They know what they want to do, and every time you refute one argument, they just come up with another.

Here’s roughly how the typical conversation goes (this is based both on my own experience and that of other American economists):

German hawk: “We must cut deficits immediately, because we have to deal with the fiscal burden of an aging population.”

Ugly American: “But that doesn’t make sense. Even if you manage to save 80 billion euros — which you won’t, because the budget cuts will hurt your economy and reduce revenues — the interest payments on that much debt would be less than a tenth of a percent of your G.D.P. So the austerity you’re pursuing will threaten economic recovery while doing next to nothing to improve your long-run budget position.”

German hawk: “I won’t try to argue the arithmetic. You have to take into account the market reaction.”

Ugly American: “But how do you know how the market will react? And anyway, why should the market be moved by policies that have almost no impact on the long-run fiscal position?”

German hawk: “You just don’t understand our situation.”

The key point is that while the advocates of austerity pose as hardheaded realists, doing what has to be done, they can’t and won’t justify their stance with actual numbers — because the numbers do not, in fact, support their position. Nor can they claim that markets are demanding austerity. On the contrary, the German government remains able to borrow at rock-bottom interest rates.

So the real motivations for their obsession with austerity lie somewhere else.

In America, many self-described deficit hawks are hypocrites, pure and simple: They’re eager to slash benefits for those in need, but their concerns about red ink vanish when it comes to tax breaks for the wealthy. Thus, Senator Ben Nelson, who sanctimoniously declared that we can’t afford $77 billion in aid to the unemployed, was instrumental in passing the first Bush tax cut, which cost a cool $1.3 trillion.

German deficit hawkery seems more sincere. But it still has nothing to do with fiscal realism. Instead, it’s about moralizing and posturing. Germans tend to think of running deficits as being morally wrong, while balancing budgets is considered virtuous, never mind the circumstances or economic logic. “The last few hours were a singular show of strength,” declared Angela Merkel, the German chancellor, after a special cabinet meeting agreed on the austerity plan. And showing strength — or what is perceived as strength — is what it’s all about.

There will, of course, be a price for this posturing. Only part of that price will fall on Germany: German austerity will worsen the crisis in the euro area, making it that much harder for Spain and other troubled economies to recover. Europe’s troubles are also leading to a weak euro, which perversely helps German manufacturing, but also exports the consequences of German austerity to the rest of the world, including the United States.

But German politicians seem determined to prove their strength by imposing suffering — and politicians around the world are following their lead.

How bad will it be? Will it really be 1937 all over again? I don’t know. What I do know is that economic policy around the world has taken a major wrong turn, and that the odds of a prolonged slump are rising by the day.

[Thucydides]

What Paul Krugman refuses to see is there is no easy out now. Either deficits and debts are dealt with in a controlled fashion, or the market will rebalance itself in a drastic and probably unexpected way.

The Great Depression was a reaction to the huge inflation central governments allowed and encouraged in order to prosecute the "Great War" of 1914-1918. All the fiddling of the British Empire trying to maintain the Sterling and the US Federal Reserve playing with interest rates in the 1920's may have been the actual trigger, but the huge bubbles were deflated away, one way or another. The huge bubbles of credit and debt that central banks have encouraged (and reckless spending by Federal State and municipal governments) will be deflated.

The Credit Strike of 1937 was more of a reaction by business to the chaos caused by the New Dealer's micromanagement of the economy (and the crossed signals caused by such micromanagement; see the local knowledge problem), Krugman's efforts to prod government into greater economic control will simply lead to the same end state or worse; Soviet style controlled economies have horrible records, and the DPRK is probably the only example of the ultimate end state of this line of thought we will see in our lifetimes.

[Baden Guy]

More Paul Krugman with a fuller explanation of why we should "Spend now, while the economy remains depressed; save later, once it has recovered."

The New York Times

June 20, 2010
Now and Later
By PAUL KRUGMAN
Spend now, while the economy remains depressed; save later, once it has recovered. How hard is that to understand?

Very hard, if the current state of political debate is any indication. All around the world, politicians seem determined to do the reverse. They’re eager to shortchange the economy when it needs help, even as they balk at dealing with long-run budget problems.

But maybe a clear explanation of the issues can change some minds. So let’s talk about the long and the short of budget deficits. I’ll focus on the U.S. position, but a similar story can be told for other nations.

At the moment, as you may have noticed, the U.S. government is running a large budget deficit. Much of this deficit, however, is the result of the ongoing economic crisis, which has depressed revenues and required extraordinary expenditures to rescue the financial system. As the crisis abates, things will improve. The Congressional Budget Office, in its analysis of President Obama’s budget proposals, predicts that economic recovery will reduce the annual budget deficit from about 10 percent of G.D.P. this year to about 4 percent of G.D.P. in 2014.

Unfortunately, that’s not enough. Even if the government’s annual borrowing were to stabilize at 4 percent of G.D.P., its total debt would continue to grow faster than its revenues. Furthermore, the budget office predicts that after bottoming out in 2014, the deficit will start rising again, largely because of rising health care costs.

So America has a long-run budget problem. Dealing with this problem will require, first and foremost, a real effort to bring health costs under control — without that, nothing will work. It will also require finding additional revenues and/or spending cuts. As an economic matter, this shouldn’t be hard — in particular, a modest value-added tax, say at a 5 percent rate, would go a long way toward closing the gap, while leaving overall U.S. taxes among the lowest in the advanced world.

But if we need to raise taxes and cut spending eventually, shouldn’t we start now? No, we shouldn’t.

Right now, we have a severely depressed economy — and that depressed economy is inflicting long-run damage. Every year that goes by with extremely high unemployment increases the chance that many of the long-term unemployed will never come back to the work force, and become a permanent underclass. Every year that there are five times as many people seeking work as there are job openings means that hundreds of thousands of Americans graduating from school are denied the chance to get started on their working lives. And with each passing month we drift closer to a Japanese-style deflationary trap.

Penny-pinching at a time like this isn’t just cruel; it endangers the nation’s future. And it doesn’t even do much to reduce our future debt burden, because stinting on spending now threatens the economic recovery, and with it the hope for rising revenues.

So now is not the time for fiscal austerity. How will we know when that time has come? The answer is that the budget deficit should become a priority when, and only when, the Federal Reserve has regained some traction over the economy, so that it can offset the negative effects of tax increases and spending cuts by reducing interest rates.

Currently, the Fed can’t do that, because the interest rates it can control are near zero, and can’t go any lower. Eventually, however, as unemployment falls — probably when it goes below 7 percent or less — the Fed will want to raise rates to head off possible inflation. At that point we can make a deal: the government starts cutting back, and the Fed holds off on rate hikes so that these cutbacks don’t tip the economy back into a slump.

But the time for such a deal is a long way off — probably two years or more. The responsible thing, then, is to spend now, while planning to save later.

As I said, many politicians seem determined to do the reverse. Many members of Congress, in particular, oppose aid to the long-term unemployed, let alone to hard-pressed state and local governments, on the grounds that we can’t afford it. In so doing, they are undermining spending at a time when we really need it, and endangering the recovery. Yet efforts to control health costs were met with cries of “death panels.”

And some of the most vocal deficit scolds in Congress are working hard to reduce taxes for the handful of lucky Americans who are heirs to multimillion-dollar estates. This would do nothing for the economy now, but it would reduce revenues by billions of dollars a year, permanently.

But some politicians must be sincere about being fiscally responsible. And to them I say, please get your timing right. Yes, we need to fix our long-run budget problems — but not by refusing to help our economy in its hour of need.


http://www.nytimes.com/2010/06/21/opinion/21krugman.html?hp=&pagewanted=print

[Brad Sallows]

When Krugman writes of depressed revenues, I wonder what he regards as the normal level?

I speculate that the revenues enjoyed by governments at all levels prior to the recession represent levels well above normal, sustainable levels (a bubble economy).  Governments must now adjust not only to a fall back to the "normal" level, but to a level further below.  The reason is simple: government revenues depend, mostly, on the net volume of economic transactions. Fewer transactions means fewer sales taxes and less gross income to be taxed (corporately or privately).  The past period of prosperity was debt-fueled.  Governments with the authority to increase their own money supply can do that indefinitely; a corporation or private person can not.

Krugman's point is simple enough: fill in the revenue hole in front of us until we reach the other side, by clawing in from a pile on the other side (future revenues).  What if the hole is too large (ie. the period of depressed revenues endures for too long)?  What if the pile on the other side (the ability of lenders to finance so much debt, or future revenues) is too small?  Then we will have to cut spending anyways, and have a much larger net debt - and cost of debt servicing - to boot.

I maintain my position from the fall of 2008: cut spending now, at all levels of government, to match current revenues.  As revenues recover, retire debt and reduce the cost of supporting debt.  Each time we push off the reckoning, we find it is harder to face when it comes due.  It is not going to go away.

A policy of spending tomorrow's money today assumes that tomorrow will be prosperous enough to cover its own requirements as well as today's burden.  The assumption is not reasonable, and on the evidence is invalid.

[Kirkhill]

Merkel Tells Obama Spending Cuts to Boost Economy, Not Put Brake on Growth

  Link

Soros tells Germany to step up to its responsibilities, or leave EMU
Legendary investor George Soros has called on Germany to leave the euro unless it willing to embrace a growth strategy, describing Berlin’s austerity doctrine as a threat to democracy and political stability in Europe.

  Link

If he's against it, it must be ther right thing to do.  I'm for it.

[Thucydides]

So the G-20 plans to reduce deficit spending by 1/2 by 2013? A bit like trying to bail out the Atlantic with a tea cup.

The problem of deficits and massive overhanging debts (and unfunded liabilities like government pensions) must be addressed or the current structure of the global economy will be destabilized and swept away in a series of chain reaction failures. The PIIGS will probably crack the Eurozone and end the Euro as a currency (if not the EU in its current form), and there are enough apocalyptic predictions about the US economy that I need not go on here.

And yet...

The biggest economic non event ever was the "Great Depression of 1946". Don't remember that one? Keynesian economists widely predicted economic disaster as the US ended wartime contracts and wound down military spending (and demobilized millions of servicemen). The economy rapidly adjusted and the economy prospered (largely due to the "Do Nothing" congress, which refused to impliment President Truman's plans for a highly controlled and regulated economy). Note the economy didn't really take off until President Kennedy implimented a series of deep tax cuts early in his administration, ushering the "go-go 60's".

I have calculated that if Canada were to eliminate Crown Corporations, transfers to other levels of government and economic subsidies (while not touching transfers to individuals; although wrong, they would be political suicide for whoever tried to eliminate them), we would eliminate the National Debt in a bit over six years. (savings such as elimination of government departments would fule small tax cuts during that period). Once the payoff period passed, deep tax cuts would be possible to drive the economy and cover the unfunded liabilities like Government pensions and CPP.

So if bold action were to be taken, we could eliminate the structural causes of the current economic crisis, and position ourselves for a stable economy into the forseeable future.

[Baden Guy]

One more try from Paul Krugman NEW YORK TIMES

 --------------------------------------------------------------------------------

June 27, 2010
The Third Depression
By PAUL KRUGMAN
Recessions are common; depressions are rare. As far as I can tell, there were only two eras in economic history that were widely described as “depressions” at the time: the years of deflation and instability that followed the Panic of 1873 and the years of mass unemployment that followed the financial crisis of 1929-31.

Neither the Long Depression of the 19th century nor the Great Depression of the 20th was an era of nonstop decline — on the contrary, both included periods when the economy grew. But these episodes of improvement were never enough to undo the damage from the initial slump, and were followed by relapses.

We are now, I fear, in the early stages of a third depression. It will probably look more like the Long Depression than the much more severe Great Depression. But the cost — to the world economy and, above all, to the millions of lives blighted by the absence of jobs — will nonetheless be immense.

And this third depression will be primarily a failure of policy. Around the world — most recently at last weekend’s deeply discouraging G-20 meeting — governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending.

In 2008 and 2009, it seemed as if we might have learned from history. Unlike their predecessors, who raised interest rates in the face of financial crisis, the current leaders of the Federal Reserve and the European Central Bank slashed rates and moved to support credit markets. Unlike governments of the past, which tried to balance budgets in the face of a plunging economy, today’s governments allowed deficits to rise. And better policies helped the world avoid complete collapse: the recession brought on by the financial crisis arguably ended last summer.

But future historians will tell us that this wasn’t the end of the third depression, just as the business upturn that began in 1933 wasn’t the end of the Great Depression. After all, unemployment — especially long-term unemployment — remains at levels that would have been considered catastrophic not long ago, and shows no sign of coming down rapidly. And both the United States and Europe are well on their way toward Japan-style deflationary traps.

In the face of this grim picture, you might have expected policy makers to realize that they haven’t yet done enough to promote recovery. But no: over the last few months there has been a stunning resurgence of hard-money and balanced-budget orthodoxy.

As far as rhetoric is concerned, the revival of the old-time religion is most evident in Europe, where officials seem to be getting their talking points from the collected speeches of Herbert Hoover, up to and including the claim that raising taxes and cutting spending will actually expand the economy, by improving business confidence. As a practical matter, however, America isn’t doing much better. The Fed seems aware of the deflationary risks — but what it proposes to do about these risks is, well, nothing. The Obama administration understands the dangers of premature fiscal austerity — but because Republicans and conservative Democrats in Congress won’t authorize additional aid to state governments, that austerity is coming anyway, in the form of budget cuts at the state and local levels.

Why the wrong turn in policy? The hard-liners often invoke the troubles facing Greece and other nations around the edges of Europe to justify their actions. And it’s true that bond investors have turned on governments with intractable deficits. But there is no evidence that short-run fiscal austerity in the face of a depressed economy reassures investors. On the contrary: Greece has agreed to harsh austerity, only to find its risk spreads growing ever wider; Ireland has imposed savage cuts in public spending, only to be treated by the markets as a worse risk than Spain, which has been far more reluctant to take the hard-liners’ medicine.

It’s almost as if the financial markets understand what policy makers seemingly don’t: that while long-term fiscal responsibility is important, slashing spending in the midst of a depression, which deepens that depression and paves the way for deflation, is actually self-defeating.

So I don’t think this is really about Greece, or indeed about any realistic appreciation of the tradeoffs between deficits and jobs. It is, instead, the victory of an orthodoxy that has little to do with rational analysis, whose main tenet is that imposing suffering on other people is how you show leadership in tough times.

And who will pay the price for this triumph of orthodoxy? The answer is, tens of millions of unemployed workers, many of whom will go jobless for years, and some of whom will never work again.

More on the same theme at:

http://www.theglobeandmail.com/news/world/g8-g20/economy/g20s-plan-for-deficit-cutting-draws-fire-from-paul-krugman/article1622050/



   

[GAP]

We can complain all we want, but the south is.....er.......going south......

Imagine the ramifications if public sector workers, etc. went from an average of 65,000 a year to 15,000......

Calif. state workers brace for minimum wage
By JUDY LIN Associated Press Writer Jul 3, 8:12 AM EDT
Article Link

  SACRAMENTO, Calif. (AP) -- Some California state workers are preparing to tap into their savings while others already are cutting expenses as Gov. Arnold Schwarzenegger's minimum wage order moved one step closer to reality.

On Friday, the Schwarzenegger administration won an appellate court ruling saying it has the authority to impose the federal minimum wage of $7.25 an hour on more than 200,000 state workers as California wrestles with its latest budget crisis. It was not immediately clear if the state controller, who cuts state paychecks on a decades-old payroll system, will comply. The office says its computers are unable to make the change until an upgrade is completed in two years.

The effect, however, was chilling for state government workers, many of whom say they have to prepare as if the pay cut will happen.

"I feel like we have a target on our backs," said Robert Blanche, a 20-year state worker in the disability division of the Employment Development Department. "My wife stays at home with the kids. This is our sole source of income. And people are going to lose their homes, lose their cars."

The loss of wages - even temporarily - for such a large work force would deal an especially harsh blow to the capital region, where one out of 10 workers is a state government employee. According to the state Employment Development Department, there were 84,600 state workers out of 819,100 people employed in the Sacramento region in May. The number is higher when counting colleges and universities.

A cut to a minimum wage would mean state workers would make the equivalent of $15,000 a year. The average state worker makes $65,000 annually, according to the state Department of Personnel Administration.

"We all understand the immense budget pressure facing governments right now," Sacramento Mayor Kevin Johnson said in a statement. "However, paying state workers minimum wage will have a devastating effect on Sacramento's economy and on thousands of families."

Jeff Michael, director of the Business Forecasting Center at the University of the Pacific in Stockton, said it's hard to judge how workers and their families will react to this latest possible financial hardship. He said some may pull back spending while others may charge bills to their credit cards and "hope the money will come back before the bill is due."

State workers already have endured 46 days of furloughs that cut their pay by 14 percent. The furloughs ended in June, with Schwarzenegger trying to persuade unions to take a 5 percent pay cut through contract negotiations.

Sacramento-based Golden 1 Credit Union, which serves more than 56,000 state workers, has announced it will provide a loan to members who receive minimum wage or do not get paid as a result of the budget impasse. State doctors and workers will not get paid until a budget is signed because by law they cannot be paid minimum wage.

Some of the loans will be interest-free.

In what has become an annual spectacle, California began its new fiscal year Thursday without a balanced budget. The budget gridlock usually affects only a few thousand workers, many whom work for lawmakers, while companies that contract with the state have to plan for payment delays.

This year, after several previous rounds of budget cuts, Schwarzenegger and Democratic state lawmakers remain far apart on ways to close the state's $19 billion deficit. Several workers taking their lunch breaks near the Capitol on Friday indicated they already have begun cutting back because Schwarzenegger has been threatening the minimum-wage move for months.

Niki Ortiz Levy, 33, an office technician at the transportation department, said she is hoping Schwarzenegger and lawmakers can reach a compromise on the budget before paychecks are cut at the end of the month. She makes $29,000 a year.

"We're not going to spend any money on anything we don't need," said the mother of a 3-year-old. "We're not eating out, we're going to cancel our DirecTV. We can't not plan for it." Ortiz Levy said she and her husband, who works for Hewlett-Packard Co., expect to tap into savings to pay for day care and other expenses if the minimum wage goes into effect.

Michelle Carlson, a 42-year-old married mother of two, said her family can weather the minimum wage for a short time.

"We can absorb it for a few months, but I've heard a lot of people say they cannot," said Carlson, a recycling specialist at the Department of Resources, Recycling and Recovery. "For some people, it could be pretty tough."

Schwarzenegger's minimum wage order will not affect all of California's government employees. The 37,000 state workers represented by unions that recently negotiated new contracts with the administration will continue to receive their full pay because they agreed to pay cuts and pension reforms.

Salaried managers who are not paid on an hourly basis would see their pay cut to $455 a week.
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