Abe

Easily the world's biggest political/economics story of the past few months comes from an East-Asian country, and it's not China nor its buffer state, North Korea. After more than two decades of recession/deflation (see the chart below), which seemed immune to frequent injections of fiscal and monetary stimulus, and a persistently moribund, unloved, under-owned, and cheap, below-book-value stock market, it seems a fire has been lit - in Japan.

Japanese voters brought back Shinzo Abe - a feckless former Prime Minister in 2006-07 - and his Liberal Democratic party last December, in an out-with-the-old, in-with-the-prior, general election. Expectations, within Japan and internationally, weren't high. But Mr. Abe and his cabinet have been anything but listless since then, and as a result, much has changed. As one of his first acts, Mr. Abe appointed Mr. Haruhiko Kuroda as the new central bank governor, providing him with a clear directive to emulate his counterparts in Washington and London by introducing a massive increase in the Bank's program of quantitative easing. And so Mr. Kuroda has, flooding the economy with new money - increasing the monetary base by some 60 trillion yen, five times the rate of increase implemented in 2012. The goal, a far more specific one than markets had predicted, is to achieve - within 2 years - price inflation of 2%, in the process eradicating, once and for all, the persistently deflationary expectations of Japanese citizens over the past decades.

Markets have responded dramatically. To begin, the yen has weakened steadily this year, from some 80 yen to the US dollar, to 101 yen now, a 4-year low. Foreign exchange traders are clearly convinced that Japanese interest rates, at record low levels, will stay that way, reflecting the central bank's backdrop of bond-buying. (The currency depreciation has been so rapid and substantial that some observers - including America's Treasury Secretary Lew - are now alert to the possible emergence of a currency war.)  Because a weaker currency makes a country's imports more expensive, thereby adding to inflation (desirable in Japan), and its exports more internationally competitive, by lowering their price in foreign-currency terms, Japan's stock market has come to life in recent months, with the Nikkei 225 jumping to nearly 15,000 after being stuck in a four-year range of 8,000-10,000; it's been virtually straight up for months, with analysts expecting more of the same. Not surprisingly, the latest reading from Japan's large-firm manufacturing confidence index indicates an improving, though still pessimistic, mood.

This is a start. Mr Abe and his new government have exceeded expectations. But much more needs to happen before the world's third-largest economy can be considered to be on a sustainable growth path. Corporate reluctance to invest, and increase wages paid to their workers, remains; Japanese consumers continue to save; and one of Japan's principal trading partners - China - is slowing. Demographic trends are especially unfavorable in Japan - the workforce is shrinking while the number of elderly are growing. As well, there is a risk that Mr. Abe, a staunch nationalist,​ won't bury such tendencies, essential if Japan's trade with its Asian neighbors is to thrive. But if his Liberal Democratic party members can win a majority in the Upper House of Parliament this July (the LDP looks set for a landslide), he will feel politically secure enough to push ahead with his proposed, long-needed structural reforms to the Japanese economy, thus creating the framework for a long-term national growth strategy. Such an opportunity - and such a marked change it would be from the years of stagnation in Japan. All eyes should be on Shinzo Abe.

Worse Than Thought

"If all we did was collect taxes and pay our debt, we still couldn't pay it off in 20 years. That's the situation we're in now."​

So spoke Bill Nowling, spokesman for Detroit's emergency manager Kevyn Orr. In office for 45 days, Mr. Orr himself previewed, this past weekend, his initial assessment of Detroit's finances, with his full, blunt 41-page report being submitted to Michigan's Treasurer today. If anything, the financial state of the city is more dire than expected - Mr. Orr (a bankruptcy lawyer) avoided using the term "bankruptcy", but said the city is, on a cash flow basis, "insolvent", having "effectively exhausted its ability to borrow" following decades of relying on the issuance of long-term bonds to fund short-term operations. Despite Mayor Bing's expenditure cuts in 2012, the city's deficit for the first nine months of the current fiscal year is $326 million, compared with the previous estimate from the Detroit City Council of $100 million, and is on track to reach at least $456 million in the full fiscal year ending June 30, 2013. That's quite a miss. Total accumulated debt now totals $15.6 billion, about $1.5 billion above an earlier estimate, another big miss.

As serious as this is, there's more.​ The more pertains to Detroit's two city-employee pension funds, particularly, how well-funded, or otherwise, they are. In the somewhat arcane field of pension analysis, mathematical assumptions are typically used by actuaries to assess the value of funds. Detroit officials have been saying for some time that the Detroit General Retirement System, and the Police & Fire Retirement System, have been 83 and 100 per cent funded, respectively. This seemed to be one bright spot in the overall dismal finance picture. But Mr. Orr has had a look at the assumptions, especially the current value of assets. He's found them unrealistic - to such an extent, that he has ordered 56,000 pages of documents from both pension boards to enable his team to produce a truer picture. "Utilizing more current data and/or conservative assumptions could cause a funding deficiency to jump into the billions", Mr. Orr states in his report. And, added to this, there is the hugely unfunded retiree health care benefits system, which unlike the pension funds, is not constitutionally protected, and thus could be impacted (along with many other creditors) by a city bankruptcy.

Now that his initial assessment is submitted, Mr. Orr is on the offensive in media interviews today, ​stating that "anyone who thinks they can wait this out needs to think again". With Michigan Governor Snyder in full support, Detroit finally has in Mr. Orr an administrator who is set, and empowered. to at least stop the rot. In the remaining 16 months of his term, Mr. Orr will face entrenched interests, especially the public sector unions and bond holders, who can either agree to his view of a new order, or be listed as creditors in a bankruptcy filing.

Unemployment and Profits

It seems that the new Pope Francis fancies himself not only as a spiritual leader, but an economist as well. Yesterday, he wrote on his official Twitter account: "My thoughts turn to all who are unemployed, often as a result of a self-centered mindset bent on profit at any cost".

Pope Francis is quite right to focus on and empathize with the depression-era levels of unemployment - particularly in the peripheral European countries, and particularly among youth everywhere. It is easily the most pressing social issue of our day. To suggest, however, that (corporate) "profit" is a principal culprit, while an oft-heard complaint, is nonsense, and dangerous. One wonders if the Pope has contemplated what unemployment levels would be if the corporate sector did not seek, as its first mandate, to be profitable. He needs only to look at the tragedy of the Soviet Russia/Eastern European 20th-century experience, or the pre-Zhou Enlai era in China, or today's North Korea, or indeed his home country of Argentina ( a severe depression, growing public and external indebtedness, a dearth of corporate profits and investment, and an unprecedented bank run culminated in 2001 in the most serious economic, social, and political crisis in the country's history) to see how economies and indeed societies can virtually collapse when the profit motive is removed. It's this simple - profit allocates always scarce capital, efficiently - nothing else (such as central planning) comes close.

Instead of blaming "profit", Pope Francis might more wisely have called for politicians everywhere to summon political will, and address the many structural impediments to employment in their respective economies. Labor market rigidity, which governments can mitigate, is the core issue. More on this in a subsequent note.  ​

The Improving State of the World

In a blog last week titled Perspective, this writer cited Indur Goklany's book, The Improving State of the World, particularly its focus on the change in life expectancy as a broad indicator of improving human welfare (and its sudden spike beginning in the mid-18th century). We've come a very long way from all those those centuries when humans were lucky to reach age 30; today's babies can expect much more:

The chart below shows another, albeit much narrower, indicator of improvement:  despite a rapid rise in the number of disasters reported, and despite there being many more people in recent decades living in areas where they occur, the number of people killed in such disasters has dropped dramatically over the past century. The explanation seems to be technology, which is clearly better at predicting, and systems (medical and otherwise), which are clearly better at responding:

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Graph

Below 4

Italy's President Napolitano's one condition for accepting a second term, set forth last week, has been met - Italian political leaders agreed over the weekend to a "grand coalition" of technocrats and politicians from the left and right, and formed a new government. A two-month political deadlock following February's indecisive election has thus come to an end. Mr. Napolitano, Italy's ultimate power broker, must be feeling vindicated; "our country and Europe could not wait any longer", he told reporters.

One of the government's first acts today was a bond auction, and given that Italy's public sector debt is the developed world's second largest (accounting for 126% of GDP), market reaction to the auction was critically important. The government easily passed this first market test. Ten-year borrowing costs fell at today's auction, to a few basis points below 4%, compared with 4.66% at last month's auction, and a high at the end of 2011 which exceeded 7%, a rate which forced the resignation of Silvio Berlusconi​'s government and ushered in an emergency technocrat government. Market confidence was also evident in the stock market, with the Italian FTSE MIB stock index closing up over 2% today.

The new Italian Prime Minister is 46-year-old Enrico Letta, the deputy leader of the leftist PD party, and widely regarded as a conciliator. Thus, he has appointed  Angelino Alfano, the 42-year-old politician who runs Silvio Berlusconi's People of Freedom Party, as deputy premier and interior minister.

But it seems that today's market optimism principally reflects the appointment of two technocrats to the cabinet: Bank of Italy's Deputy Chief, Fabrizio Saccomanni, who is close to European Central Bank President Mario Draghi, is the new economy minister, and Enrico Giovannini, the head of statistical agency Istat, will head up the labor ministry. Mr. Saccomanni has already thrown down the gauntlet on austerity, telling the Italian newspaper La Repubblica that in a new "pact" with banks and businesses, he will "restructure the state budget" to support companies and low-earners, while cutting unproductive public spending, thus allowing some tax reductions. He also predicted that Italy's borrowing costs could "plummet".

​Mr. Letta will present the broad vision of his new government ahead of parliament's two confidence votes scheduled for later today in the Chamber and tomorrow in the Senate.  Support for the formation of the new government is widely expected. He then travels to Brussels, to re-iterate his pro-European views, but with a clear message that the unrelenting focus on austerity to rein in European public budget deficits and debt must shift to pro-growth measures. The Germans will be watching and listening.