Snub and Switch

The International Monetary Fund (IMF) and The World Bank Group are meeting together this week, as they do formally once a year, this time in Tokyo.  Finance ministers and central bankers, among others, all show up for these gatherings -  except this year, with China (now the second-largest economy in the world) indicating they would not send their two top officials. The snub had nothing to do with the IMF's Annual Meeting, and everything to do with Tokyo. It seems that the current spat between China and Japan over the Diaoyu Islands, or as the Japanese call them, the Senkakus, is escalating.  The simmering began last month, when the Japanese government announced they would buy three of the islands from their private Japanese owner. Chinese protests erupted right away at what was seen as yet another display of Japanese nationalism. Japanese car sales in China dropped so suddenly and precipitously that Toyota and Nissan temporarily shut five of their Chinese plants. Chinese tourists started going anywhere but Japan.

As significant as this growing China/Japan row has become - it is, after all, between the world's second- and third-largest economies - it is almost a side-show to what has just emerged in Tokyo as a remarkable switch in International Monetary Fund policy emphasis. The Fund has been, for decades - as it was mandated - the architect of, frankly, countless bail-out programs for near-bankrupt countries (often Latin American, but even , at times, developed countries like Britain), offering "stand-by" loans while governments implemented austere economic policies to regain solvency and international confidence. With European partners, it is currently doing just that in Greece (Back to Berlin). But here's the switch - earlier this week, Christine Lagarde, the former French Finance Minister who since last July has been the IMF's managing director, publicly highlighted a new IMF study arguing the social impact of austerity measures can be - underestimated. Front-loaded cut-backs may be counter-productive. Further, Ms. Lagarde commented, "we work (in Athens) looking at what can be done, what should be done...over a decent, reasonable period of time". She appealed for "a bit more time", as the coalition Greek government struggles to meet bail-out conditions. Adjustment timescales should vary, she said, according to "factors such as the volume of debt involved, and the degree of market pressure". And this - "adjustment is a marathon, not a sprint".

Ms. Lagarde's emphasis switch is stunning, and realistic. But, German officials aren't having it. They are facing massive electorate fatigue with seemingly endless Greek (and other) bail-outs. Already, in response to the managing director's comments,  the German Finance Minister, Wolfgang Schauble, has been at pains (again, in Tokyo) to point out that, regarding the IMF, "there is no difference, Never. It is impossible. We always agree".​ Protesting quite a bit too much, I think.

Watch for the "troika's" report due early next month regarding Greek finances.​ It will tell whether the Germans or the IMF prevailed.

Back to Berlin

German Chancellor Angela​ Merkel visited Athens yesterday for six hours. It wasn't clear why Mrs. Merkel was going, and, now that she has returned to Berlin, it isn't clear why she went. During the press conference following her talks with Greek Prime Minister Samaras, the Chancellor reiterated Germany's commitment to retaining Greece in the Euro zone, and that the Greek government must continue with its austerity policies. Hardly news.

Her visit, which sparked the usual protests in the streets, replete with a few protestors dressed as Nazis, was a prelude to an expected update in early November from the "troika", officials from the European Central Bank, the IMF and the European Commission, who must decide if Greece is fulfilling (yet) the terms of its bailout loans. An additional payment of $40 billion is at stake. The money is apparently urgently needed - Prime Minister Samaras was quoted as saying that without the payment, Greek finances could hold out "until the end of November, then the till will be empty".

Here's the issue. Greek GDP has been falling for 5 years, and there is no prospect of a resumption of growth anytime soon. The official unemployment rate is 24%, and over 50% for youth. Greek outstanding debt, which was cut significantly in March when private, sovereign bondholders were forced to forgive $126 billion, is nonetheless approaching 170% of GDP, the second highest ratio in the world after Japan's 230%. Devaluing its currency, a typical move by heavily-indebted countries attempting to adjust, is not an option, as Greece exists within the straight-jacket of the euro.  Even with an additional $40 billion loan from the troika, the Greek economy, in its current depressed state, simply cannot sustain such debt levels​. Another semi-default, at least, is inevitable, perhaps as soon as next year. 

Guess Who's Coming to Dinner

Japan's central bank met on Friday and decided to leave its policy stance unchanged. This wasn't  surprising, given that its key policy rate was already set in a range of zero to 0.1 per cent, and has not been higher than 0.5 per cent for over a decade. Also, the Bank did not add to its quantitative easing program beyond the expansion announced just last month (see my posting Asian Dysfunction). But, for the first time in about a decade, a government Minister, in this case, Economics Minister, Seiji Maehara, attended the central bank meeting, apparently to urge even more aggressive monetary stimulus. Japan's "recovery" over the past year, which principally reflects rebuilding from the earthquake and tsunami, is stalling - again. Underlying domestic demand remains dormant. And exports are falling, as growth in China (now Japan's largest trading partner) slows, and debt-ridden Europe slips into recession. A row with China regarding the Senkaku Islands (or, as China calls them, the Diaoyu Islands) could hardly have sparked at a worse time. And, despite all this, the yen remains strong, which makes Japanese exports relatively expensive in world markets. (Here's a quick primer to explain this apparent anomaly - deflation in Japan means that real interest rates, as distinct from near-zero nominal rates, are positive, whereas real rates in, for example, America and Britain, are negative. Thus the relative attraction of the yen.)  Perhaps not surprising, then, that the government, which must call a general election sometime in the next few months, sent along one of its cabinet ministers to the Bank of Japan's monthly meeting.

One further update - which speaks to the sclerotic nature of Japanese politics. The Liberal Democratic Party (LDP), which ruled for decades but is currently in opposition,  just revealed its choice to lead the Party into the upcoming general election. He is Shinzo Abe, a nationalist former prime minister, who lasted a full 12 months in 2006-07 amid scandal, ineptitude, and personal health issues reportedly induced by stress. Mr. Abe's principal focus as Prime Minister was to openly, and as frequently as possible, deny that women of Asian neighbors were forced to act as sex slaves to the Japanese army during World War II. Does Mr. Abe's revival look just a bit like an act by the LDP of snatching defeat from the jaws of an otherwise likely victory?

Updates

Time for updates, on the US and Japanese economies, and on Europe.​ This posting covers the US; tomorrow's will be about Japan and Europe.

Earlier this morning, the US Department of Labor released the September employment figures - at times​, data that drive the markets - indicating continued, but below-trend, growth in new, non-farm jobs created (mild growth even when upward revisions to earlier months' data are considered). The unemployment rate fell, unexpectedly, to just below 8% for the first time in 4 years, an apparently significant improvement, especially in just one month. Readers are cautioned, however, that a closer look reveals that labor market fundamentals remain weak: the size of the labor force (the denominator of the unemployment rate calculation) is at a 31-year low in the United States, reflecting workers who have simply stopped looking for employment and therefore not counted. The Labor Department's so-called U-6 unemployment rate, which does incorporate these "discouraged" workers and the underemployed, registered 14.7% in September, and has barely moved from about 15% for over a year. September data, therefore, hardly signal the beginning of a strengthening labor market.

A more significant event this week in America was the surprisingly engaging performance of candidate Romney in the first Presidential debate, particularly when set against President Obama's ill-focused aura of issue fatigue. Post-debate political sentiment has shifted noticeably in Romney's favor. In the coming week, watch for the Obama team - intent on momentum recovery - to make much more than warranted from September's drop in the unemployment rate.

Related to employment matters, debate has re-emerged about both the efficacy and potential dangers of the Fed's QE3, its latest round of quantitative easing. (For a description, readers can refer to this writer's posting of ​September 14.) The efficacy argument revolves around whether a further lowering of interest rates (the immediate goal of QE) is akin to "pushing on a string", that is, can it stimulate stubbornly weak aggregate demand in the economy? This concern is valid - given that rates have been very low for sometime while economic recovery has remained tepid. But, given that recession in the US (and the rest of the world) still threatens, and that Washington fiscal gridlock persists, stimulus from monetary policy should be welcomed at this juncture - it's the only available option. Regarding the potential dangers of more quantitative easing, critics worry that, because such unprecedented stimulus will eventually need to be reduced then withdrawn, Fed officials will miss the point at which such an exit strategy should begin. As with so many past inflection points in the economy, the argument runs that inflation will re-ignite then accelerate, prompting a too-little, too-late shift to a contractionary monetary policy. As in past decades, another stop-start pattern would thus emerge. Here's this writer's view about this danger - the Fed under Governor Bernanke (a scholar of the 1930's Depression) is more than competent to at least estimate - if not pinpoint - the timing of an economic turning point. In any case, we aren't close to that yet, so the concern is academic, whereas the threat of another downturn is real.

Japanese and European recessions are real concerns too - more on this tomorrow.​

Infrequent

There are times - when the Fed speaks - ​that its message is extraordinary, pressing, and, today, almost pleading. What Fed Chairman Bernanke said earlier this afternoon to the Economic Club of Indiana, in Indianapolis, is one of those.

As a scholar of the 1930's Depression, Mr. Bernanke was at pains to stress that, while the US economy is not right now in recession, and that a re-emergence of inflation is nowhere on the horizon, his QE3 can't on its own ensure that economic growth strengthens sufficiently to produce a sustainable drop in unemployment. Regular readers of my postings may recognize this theme.    ​

Appointed Fed Chairmen simply don't - usually - comment critically on fiscal policy, which is set by the President and elected representatives of the the Congress. But this afternoon, Mr. Bernanke implored Washington officials to support his monetary policy - in the short-term, to mitigate the upcoming "fiscal cliff" of tax increases and sudden expenditures cuts, ​and, more importantly, to bilaterally adopt a longer-term plan to restore fiscal balance. To this point, here's a part of what he said today:

I certainly don't underestimate the challenges that fiscal policymakers face. They must find ways to put the federal budget on a sustainable path, but not so abruptly as to endanger the economic recovery in the near term. In particular, the Congress and the Administration will soon have to address the so-called fiscal cliff, a combination of sharply higher taxes and reduced spending that is set to happen at the beginning of the year. According to the Congressional Budget Office and virtually all other experts, if that were allowed to occur, it would likely throw the economy back into recession. The Congress and the Administration will also have to raise the debt ceiling to prevent the Treasury from defaulting on its obligations, an outcome that would have extremely negative consequences for the country for years to come. Achieving these fiscal goals would be even more difficult if monetary policy were not helping support the economic recovery.

As a student of economic policy over quite a few years, this writer is astonished that Chairman Bernanke ventured this far with his comments about non-Fed mandates. I'm also encouraged.​