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A New Divergence?

A New Divergence?



Do you ever read the last few pages of a fiction book before getting into it?  It seems a bit like watching the economic data now.  We know roughly where it is headed, the unknown is precisely how it gets there.

A common criticism of economists is that they are too late in calling a recession.  One observer suggested that banks don't want their economists forecasting a recession.  That strikes me as little more than an urban myth.   Non-bank economists, central banks, multilateral institutions, like the IMF and World Bank, also often do not see an economic downturn until it is biting them or their neighbors.  At the end of the day, recessions are rare and difficult to forecast.

But this one, which, by some measures, will likely be worse than the Great Depression, has been well anticipated before it began.  The January-March quarter was bad, but the April-June quarter will be horrific.  The precise details are important on the personal level but in terms of the great flows of capital, not so much.  Yet, what may be interesting about next week's US data is it might offer a snapshot of the world's largest economy near the bottom.

The US data will include a glimpse into consumption and output in April, and offer the first indicator for the month of May.  Retail sales are around 40% of consumption and likely fell by approximately 10%.  That follows an 8.4% decline in March.  We already know that auto sales fell sharply in April (the seasonally adjusted annualized rate declined by about 25%). Hence, the new new information is the ex-auto component, which is expected to have slowed by more than 6%.

Industrial output may have contracted by more than 10% last month, on top of the 5.4% decline in March.  The capacity utilization rate may fall below the low of the Great Financial Crisis when it bottomed near 66.7.  One of the consequences of the decline in production could create shortages and force prices higher.  This kind of price increases, from an economic point of view, are not sustainable.  April CPI will be driven down by the drop in energy prices.  It could fall to around 0.5% from 1.5% in March.  The core rate will prove stickier and will only to about 1.7% from 2.1%. 

The pandemic has unleashed powerful deflationary forces. However, the worst is probably in April and early May.   That makes the Empire State manufacturing survey at the end of next week the first test of this hypothesis.  Recall that it averaged 2.3 in the second half of last year and spiked to 12.9 in February.  It fell to -21.5 in March and collapsed to -78.2 in April.  With much of the country still closed in the first half of May, it is too early to look for much more than a scant sign of stabilization.

Europe could be on the cusp of a new crisis.  The German Constitutional Court (GCC)'s ruling attacks at least two fundamental principles at the heart of the eurozone.  First, the GCC challenged the independence of the ECB by encouraging the German government and parliament to press the central bank.  Second, the GCC challenged the notion that the EU law has primacy over national law.  These seemed like settled "doctrines."

It is a bit like the famous case in the US Supreme Court in the early days of the republic, Marbury vs. Maddison.  Marbury was suing Madison, the Treasury Secretary, for not paying him after he was appointed in the waning days of Adams' government before Jefferson took office as the third president.  Jefferson wanted to make his own appointments and refused to authorize Madison to pay Marbury's salary.  The decision by Chief Justice Marshall is considered a foundation of constitutional law.  Although, in the narrow sense it found against Madison, it ruled that the law under which the appointment was made was unconstitutional.  The Supreme Court took upon itself the power to decide the constitutionality of the other branch's actions.  

This is the origin of the principle of judicial review in the US. This power over the legality of EU institutions, which the ECB is among them, is a power granted to the European Court of Justice.  The GCC ruling is nothing short of a putsch against the EU, a nullification of its ruling affirming the legality of the asset purchases.    

The GCC gave the ECB three months to respond, or it prohibited the German central bank from participating in the bond purchases (Public Sector Purchase Program, PSPP), which accounts for around a quarter of the ECB's current bond purchases.  By not responding to the GCC in any formal way in order not to acknowledge that the ECB is subject to its rulings after the European Court of Justice indicated the asset purchases were within its mandate, it shifts the hot potato, as it were, to the Bundesbank.  Bundesbank President Weidmann, who has disagreed with ECB policy, and even testified against it before the ECJ on a different charge, recognizes the importance of the ECB's independence. 

On behalf of the Eurosystem, the Bundesbank buys Bunds under the PSPP.  If German Bunds were not purchased by the BBK, they could be bought by another as the program is still obliged to follow the capital key.   It would leave the GCC challenges unaddressed and would spur others to explore the space that the GCC created for national primacy.  The Bundesbank is not prohibited from participating in the Pandemic Emergency Purchase Program (PEPP), but legal challenges may await.  PEPP is not confined to the capital key, which is the first time the ECB has had so much discretion in its purchases.  At the same time, rather than have the national central banks make the actual transactions for the Eurosystem, the ECB could centralize the market operations under its auspices, which would be more consistent with the practices of other central banks.  

The US monetary and fiscal response has been more aggressive than Europe's. It has little to do with the fact of the dollar's role in the international economy or some exorbitant privilege that is still alleged.  After all, Europe (or at least large parts of it) and Japan can borrow money for less than nothing.  The US cannot do this.  It is a question of institutional capability and desire.  It could, one could that the US has to go bigger because the adverse shock is bigger.  It might turn out to be the case, but look at the recent IMF forecasts.  The US is expected to contact less than Europe this year (-5.9% vs. -7.5%) and match its growth next year (4.7%).  The US is forecast to contract more than Japan this year (-5.9% vs. -5.2%) and rebound stronger next year (4.7% vs. 3.0%).

The return on capital is superior in the US.  Growth likely faster on a two-year view and interest rates are higher, though they cannot be considered high.  The S&P 500 (-9.5%)is also performing better than Europe's Dow Jones Stoxx 600 (-18%) and the Topix (-15%), even though the BOJ buys ETFs linked to this benchmark.  The NASDAQ is positive, albeit slightly, year-to-date.

This could be setting the stage for a new divergence similar to the aftermath of the Great Financial Crisis, where the US outperformance was significant.  The cost will be greater US debt.  The CBO projects a $3.7 trillion deficit this year (~18% of GDP) before this next package (phase 4) that could be more than $1 trillion that has begun being drafted.  Next week, the US Treasury will raise a record $96 bln in coupons at the quarterly refunding.  While the anticipated supply saw the long-end yields rise and the curve steepens, yields by any reckoning are low.

A year ago, the 10-year yield was near 2.4%.  Now it is around 6 8bp.  The market does not appear satiated, and foreign central banks, which were sellers of Treasuries in March (from their custodial account at the Fed) have returned as buyers.  Treasury holdings in the Fed's custody account it maintains for foreign central banks has risen by nearly $34 over the past four weeks.  This replaces a little less than 25% of the amount that was sold the previous six weeks.   

Some market participants are taking more seriously the possibility that the fed funds rate turns negative before the end of the year.  Starting with the March 2021 contract and running through at least January 2022, the implied yields in the futures market are below zero and as much as minus five basis points.   The larger, and arguably more significant market, the Eurodollar futures are not implying a negative rate.  The Eurodollar curve bottoms in Q3 next year around 18 bp.  That said, the US two-year yield fell to a new record low near 10 bp ahead of the weekend before settling around 15 bp.   

Unlike the US, Europe, and Japan, China's economy is expected to expand this year, albeit slowly.  The IMF projects 1.2% growth, while the Bloomberg survey from last month found a median forecast of 1.8%.  Nevertheless, China's ability to take advantage is very constrained.  

First, the trade deal with the US hangs by a thread despite some Panglossian statements by trade negotiators.  The fact of the matter is that through April, US exports to China have fallen by almost 6%  compared to a year ago, and the target lay above the 2017 levels, which was before the tariff escalation began.  

Second, China's prestige has been undermined by how it handled the outbreak of Covid-19.  Many countries have been explicit in their call, and China has pushed back, such as against Australia.  

Third, many countries fearful that Chinese companies, especially state-owned enterprises, will take advantage of beaten-down share prices and swoop in for a wave of acquisition.  Policies regarding direct investment have been tightened.  

Fourth, supply chains were already being reviewed last year in light of US tariffs, and the pandemic appears to be an accelerant.  The US may soon force medical products and medicine to be re-shored, and Europe is thinking along similar lines.  Japan has earmarked funds in this year's budget to help companies who want to move out of China.  India has set aside land for the same purpose. 

Fifth, the calendar is not its friend.  After the National People's Congress session later this month, Trump is expected to make a more statement about progress on the trade agreement, and, as now required by Congress, the autonomy of Hong Kong needs to be certified.  These events take place at a point in the US political cycle, the run-up to national elections when the rhetoric and theatrics typically escalate.  


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Why so sad?

Over the past few years, consumer sentiment has increasingly run far below the level predicted by models based on economic data. The Economist illustrates…



Over the past few years, consumer sentiment has increasingly run far below the level predicted by models based on economic data. The Economist illustrates the issue with a graph:

The Economist attributes the gloomy outlook to the lingering effects of Covid.  I suspect the actual explanation is growing political polarization.  Consider the growing partisan gap in how voters evaluate the economy:

Back in the 1990s, there wasn’t much partisan difference in how voters evaluated the condition of the economy.  This was before the public had come to view people with different points of view as the enemy.  I suspect that the responses to polls were more honest back then.  After 9/11, opinion became more polarized.  After Trump was elected, polarization increased even further.  Today, voters in the two major parties live in completely separate worlds, consuming media that is tailored to fit their prejudices.  Thus it’s not surprising that they have radically divergent views of the world.

Voters seem to rate the economy much more highly when their preferred candidate is in power, perhaps partly due to the mistaken assumption that presidents somehow control inflation and the business cycle.  (A myth that is encouraged by our media.)

Until 2021, the biases of the two parties roughly offset, leaving the overall rating roughly equal to the rating one would expect based solely on the economic data.  This changed after Joe Biden became president.  Unlike with President Obama (who inherited a weak economy), Democratic voters are only lukewarm on the current president. 

In contrast, Republican voters have an extremely negative view of President Biden.  With only lukewarm sentiment from Democrats, there is nothing to offset the extremely low economic rating of Republicans.  This leaves the overall rating for the economy far below the level you’d expect with rising real wages, 3.8% unemployment, and 3.7% inflation.  At one point in 2022, consumer sentiment fell below the lowest reading of the early 1980s, when the economy was in far worse shape.

I don’t believe these consumer sentiment figures represent the actual views of the public.  Consumer spending is still very strong, an indication that people feel pretty good about the economy.  Actions speak louder than words.  I suspect the low reported sentiment is mostly a reflection of GOP voters expressing anger at the current political situation.

My own view is that recent economic policy (since 2017) is quite bad, but the negative effects will show up in future years, at a point where we will need to confront the effects of an out of control federal budget.  If people think the current economy is bad, wait until they see what’s coming down the road in a few years!

PS.  Note to commenters:  If you think the economic model is wrong, you need to explain why it fit the data for the 40-year period from 1980 to 2020.


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Menendez indictment looks bad, but there are defenses he can make

The indictment of Sen. Bob Menendez is full of lurid details – hundreds of thousands of dollars in cash stuffed into clothes among them. Will they tank…




Senate Foreign Relations Committee Chairman, Sen. Bob Menendez, D-N.J., right, and his wife Nadine Arslanian. AP Photo/Susan Walsh, File

Reactions came quickly to the federal indictment on Sept. 22, 2023 of New Jersey’s senior U.S. senator, Democrat Bob Menendez. New Jersey Gov. Phil Murphy joined other state Democrats in urging Menendez to resign, saying “The alleged facts are so serious that they compromise the ability of Senator Menendez to effectively represent the people of our state.”

The indictment charged Menendez, “his wife NADINE MENENDEZ, a/k/a ‘Nadine Arslanian,’ and three New Jersey businessmen, WAEL HANA, a/k/a ‘Will Hana,’ JOSE URIBE, and FRED DAIBES, with participating in a years-long bribery scheme…in exchange for MENENDEZ’s agreement to use his official position to protect and enrich them and to benefit the Government of Egypt.” Menendez said he believed the case would be “successfully resolved once all of the facts are presented,” but he stepped down temporarily as the chairman of the Senate’s influential Committee on Foreign Relations.

The Conversation’s senior politics and democracy editor, Naomi Schalit, interviewed longtime Washington, D.C. lawyer and Penn State Dickinson Law professor Stanley M. Brand, who has served as general counsel for the House of Representatives and is a prominent white-collar defense attorney, and asked him to explain the indictment – and the outlook for Menendez both legally and politically.

What did you think when you first read this indictment?

As an old seafaring pal once told me, “even a thin pancake has two sides.”

Reading the criminal indictment in a case for the first time often produces a startled reaction to the government’s case. But as my over 40 years of experience defending public corruption cases and teaching criminal law has taught me, there are usually issues presented by an indictment that can be challenged by the defense.

In addition, as judges routinely instruct juries in these cases, the indictment is not evidence and the jury may not rely on it to draw any conclusions.

A man in a suit pointing at a poster board with various photos on it.
Damian Williams, U.S. Attorney for the Southern District of New York, speaks during a press conference on Sept. 22, 2023 after announcing the Menendez indictment. Alexi J. Rosenfeld/Getty Images

The average reader will look at the indictment and say “These guys are toast.” But are there ways Menendez can defend himself?

There are a number of complex issues presented by these charges that could be argued by the defense in court.

First, while the indictment charges a conspiracy to commit bribery, it does not charge the substantive crime of bribery itself. This may suggest that the government lacks what it believes is direct evidence of a quid pro quo – “this for that” – between Menendez and the alleged bribers.

There is evidence of conversations and texts that coyly and perhaps purposely avoid explicit acknowledgment of a corrupt agreement, for instance, “On or about January 24, 2022, DAIBES’s Driver exchanged two brief calls with NADINE MENENDEZ. NADINE MENENDEZ then texted DAIBES, writing, ‘Thank you. Christmas in January.’”

The government will argue that this reflects acknowledgment of a connection between official action and delivery of cash to Sen. Menendez, even though it is a less than express statement of the connection.

Speaking in this kind of code may not fully absolve the defendants, but the government must prove the defendants’ intent to carry out a corrupt agreement beyond a reasonable doubt – and juries sometimes want to see more than innuendo before convicting.

The government has also charged a crime calledhonest services fraud” – essentially, a crime involving a public official putting their own financial interest above the public interest in their otherwise honest and faithful performance of their duties.

The alleged failure of Sen. Menendez to list the gifts, as required, on his Senate financial disclosure forms will be cited by prosecutors as evidence of “consciousness of guilt” – an attempt to conceal the transactions.

However, under a recent Supreme Court case involving former Gov. Bob McDonnell of Virginia for similar crimes, the definition of “official acts” under the bribery statute has been narrowly defined to mean only formal decisions or proceedings. That definition does not include less-formal actions like those performed by Sen. Menendez, such as meetings with Egyptian military officials.

The Supreme Court rejected an interpretation of official acts that included arranging meetings with state officials and hosting events at the Governor’s mansion or promoting a private businessman’s products at such events.

When it comes time for the judge to instruct the jury at the end of the trial, Sen. Menendez may well be able to argue that much of what he did not constitute “official acts” and therefore are not illegal under the bribery statute.

This case involves alleged favors done for a foreign country in exchange for money. Does that change this case from simple bribery to something more serious?

The issue of foreign military sales to Egypt may also present a constitutional obstacle to the government.

The indictment specifically cites Sen. Menendez’s role as chairman of the Senate Foreign Relations Committee and actions he took in that role in releasing holds on certain military sales to Egypt and letters to his colleagues on that issue. The Constitution’s Speech or Debate Clause protects members from liability or questioning when undertaking actions within the “legitimate legislative sphere” – which undoubtedly includes these functions.

While this will not likely be a defense to all the allegations, it could require paring the allegations related to this conduct. That would whittle away at a pillar of the government’s attempt to show Sen. Mendendez had committed abuse of office.

In fact, when the government has charged members of Congress with various forms of corruption, courts have rejected any reference to their membership on congressional committees as evidence against them.

Three men in suits, standing in front of a fire engine.
NJ Gov. Phil Murphy, left, seen here in 2018 with fellow Democrats Sens. Robert Menendez and Cory Booker, has called on Menendez to resign. AP Photo/Wayne Parry

How likely is Sen. Mendendez’ ouster from the Senate?

Generally, neither the House nor Senate will move to expel an indicted member before conviction.

There have been rare exceptions, such as when Sen. Harrison “Pete” Williams was indicted in the FBI ABSCAM sting operation from the late 1970s and early 1980s against members of Congress. He resigned in 1982 shortly before an expulsion vote. With current Democratic control of the Senate by a margin of just one seat, Sen. Menendez’ ouster seems unlikely even though the Democratic governor of New Jersey would assuredly appoint a Democrat to fill the vacancy.

“In the history of the United States Congress, it is doubtful there has ever been a corruption allegation of this depth and seriousness,” former New Jersey Sen. Robert Torricelli said. True?

That seems hyperbolic. The Menendez case is just the latest in a long line of corruption cases involving members of Congress.

In the ABSCAM case, seven members of the House and one Senator were all convicted in a bribery scheme. That scheme involved undercover FBI agents dressed up as wealthy Arabs, offering cash to Congressmembers in return for a variety of political favors.

In the Korean Influence Investigation in 1978 – when I served as House Counsel – the House and Department of Justice conducted an extensive investigation of influence peddling by Tongsun Park, a Korean national in which questionnaires were sent to every member of the House relating to acceptance of gifts from Park.

Going all the way back to 1872, there was the Credit Mobilier scandal that involved prominent members of the House and Vice President Schuyler Colfax in a scheme to reward these government officials with shares in the transcontinental railroad company in exchange for their support of funding for the project.

Stanley M. Brand does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.

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Von Der Leyen Speech Suggests Russia Dropped Nuke On Hiroshima 

Von Der Leyen Speech Suggests Russia Dropped Nuke On Hiroshima 

Von der Leyen just said what?…

This past Wednesday, President of the European…



Von Der Leyen Speech Suggests Russia Dropped Nuke On Hiroshima 

Von der Leyen just said what?...

This past Wednesday, President of the European Commission Ursula von der Leyen delivered a speech before the 2023 Atlantic Council Awards in New York, where she sounded the alarm over the specter of nuclear war centered on the Russia-Ukraine conflict. But while invoking remembrance of the some 78,000 civilians killed instantly by the atomic bomb dropped on Hiroshima at the end of WWII, she said her warning comes "especially at a time when Russia threatens to use nuclear weapons once again". She  actually framed the atomic atrocity in a way that made it sound like the Russians did it. Watch:

There was not one single acknowledgement in Von der Leyen's speech that it was in fact the United States which incinerated and maimed hundreds of thousands when it dropped no less that two atomic bombs on Japanese cities.

Here were her precise words, according to an Atlantic Council transcript...

You, dear Prime Minister, showed me the meaning of this proverb during the G7 summit in Japan last year. You brought us to your hometown of Hiroshima, the place where you have your roots and which has deeply shaped your life and leadership. Many of your relatives lost their life when the atomic bomb razed Hiroshima to the ground. You have grown up with the stories of the survivors. And you wanted us to listen to the same stories, to face the past, and learn something about the future.

It was a sobering start to the G7, and one that I will not forget, especially at a time when Russia threatens to use nuclear weapons once again. It is heinous. It is dangerous. And in the shadow of Hiroshima, it is unforgivable

The above video of that segment of the speech gives a better idea of the subtle way she closely associated in her rhetoric the words "once again" with the phrase "shadow of Hiroshima" while focusing on what Russia is doing, to make it sound like it was Moscow behind the past atrocities.

Via dpa

Russian media not only picked up on the woefully misleading comments, but the Kremlin issued a formal rebuke of Von der Leyen's speech as well:

In response to von der Leynen's remarks, Russian Foreign Ministry spokeswoman Maria Zakharova accused the European Commission president of making "no mention whatsoever of the US and its executioners who dropped the bombs on populated Japanese cities."

Zakharova responded on social media, arguing that von der Leyen's assertions on Moscow's supposed intentions to employ nuclear weapons "is despicable and dangerous" and "lies."

Some Russian embassies in various parts of the globe also highlighted the speech on social media, denouncing the "empire of lies" and those Western leaders issuing 'shameful' propaganda and historical revisionism.

Tyler Durden Sun, 09/24/2023 - 13:15

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