VW Scandal and the German Economy

                                                    Comments due by Oct. 2, 2015

The Volkswagen (VOWG_p.DE) emissions scandal has rocked Germany's business and political establishment and analysts warn the crisis at the car maker could develop into the biggest threat to Europe's largest economy.
Volkswagen is the biggest of Germany's car makers and one of the country's largest employers, with more than 270,000 jobs in its home country and even more working for suppliers.
Volkswagen Chief Executive Martin Winterkorn paid the price for the scandal over rigged emissions tests when he resigned on Wednesday and economists are now assessing its impact on a previously healthy economy.
"All of a sudden, Volkswagen has become a bigger downside risk for the German economy than the Greek debt crisis," ING chief economist Carsten Brzeski told Reuters.
"If Volkswagen's sales were to plunge in North America in the coming months, this would not only have an impact on the company, but on the German economy as a whole," he added.
Volkswagen sold nearly 600,000 cars in the United States last year, around 6 percent of its 9.5 million global sales.
The U.S. Environmental Protection Agency said the company could face penalties of up to $18 billion, more than its entire operating profit for last year.
Although such a fine would be more than covered by the 21 billion euros ($24 billion) the company now holds in cash, the scandal has raised fears of major job cuts.
The broader concern for the German government is that other car makers such as Daimler (DAIGn.DE) and BMW (BMWG.DE) could suffer fallout from the Volkswagen disaster. There is no indication of wrongdoing on the part of either company and some analysts said the wider impact would be limited.
The German government said on Wednesday that the auto industry would remain an "important pillar" for the economy despite the deepening crisis surrounding Volkswagen.
"It is a highly innovative and very successful industry for Germany, with lots of jobs," a spokeswoman for the economy ministry said.

But analysts warn that it is exactly this dependency on the automobile sector that could become a threat to an economy forecast to grow at 1.8 percent this year. Germany is already having to face up to the slowdown in the Chinese economy.
"Should automobile sales go down, this could also hit suppliers and with them the whole economy," industry expert Martin Gornig from the Berlin-based DIW think tank told Reuters.
In 2014, roughly 775,000 people worked in the German automobile sector. This is nearly two percent of the whole workforce.
In addition, automobiles and car parts are Germany's most successful export -- the sector sold goods worth more than 200 billion euros ($225 billion) to customers abroad in 2014, accounting for nearly a fifth of total German exports.
"That's why this scandal is not a trifle. The German economy has been hit at its core," said Michael Huether, head of Germany's IW economic institute.


"MADE IN GERMANY"
There are also voices, however, that say the impact on the economy as a whole should not be exaggerated.
"I don't think that the German automobile industry will be lumped altogether," Commerzbank chief economist Joerg Kraemer told Reuters.
"There won't be a recession just because of a single company," Kraemer added.
The German BGA trade association also tried to calm the public by saying there were no signs that customers abroad were starting to doubt quality and reliability of German companies.

"There isn't a general suspicion against goods labeled 'Made in Germany'," BGA managing director Andre Schwarz told Reuters.
But he acknowledges there is a degree of concern among German companies that the scandal over cheating on U.S. diesel emission could have a domino effect on their businesses, eroding the cherished 'Made in Germany' label.
Some observers also see some irony in the scandal.
While the German economy defied the euro zone debt crisis and, so far, the economic slowdown in China, it could now be facing the biggest downside risk in a long while from one of its companies.
"The irony of all of this is that the threat could now come from the inside, rather than from the outside," Brzeski said. (Reuters)

FRAUD, FOOLS & the FINANCIAL MARKETS

                                                     Comments due by Sept 25, 2015

Adam Smith famously wrote of the “invisible hand,” by which individuals’ pursuit of self-interest in free, competitive markets advances the interest of society as a whole. And Smith was right: Free markets have generated unprecedented prosperity for individuals and societies alike. But, because we can be manipulated or deceived or even just passively tempted, free markets also persuade us to buy things that are good neither for us nor for society.

This observation represents an important codicil to Smith’s vision. And it is one that George Akerlof and I explore in our new book, Phishing for Phools: The Economics of Manipulation and Deception.

  

Most of us have suffered “phishing”: unwanted emails and phone calls designed to defraud us. A “phool” is anyone who does not fully comprehend the ubiquity of phishing. A phool sees isolated examples of phishing, but does not appreciate the extent of professionalism devoted to it, nor how deeply this professionalism affects lives. Sadly, a lot of us have been phools – including Akerlof and me, which is why we wrote this book.

Routine phishing can affect any market, but our most important observations concern financial markets – timely enough, given the massive boom in the equity and real-estate markets since 2009, and the turmoil in global asset markets since last month.

As too many optimists have learned to their detriment, asset prices are highly volatile, and a whole ocean of phishes is involved. Borrowers are lured into unsuitable mortgages; firms are stripped of their assets; accountants mislead investors; financial advisers spin narratives of riches from nowhere; and the media promote extravagant claims.

But the losers in the downturns are not just those who have been duped. A chain of additional losses occurs when the inflated assets have been purchased with borrowed money. In that case, bankruptcies and fear of bankruptcy spawn an epidemic of further bankruptcies, reinforcing fear. Then credit dries up and the economy collapses. This vicious downward spiral for business confidence typically features phishes – for example, the victims of Bernard Madoff’s Ponzi scheme – discovered only after the period of irrational exuberance has ended.

Epidemics, in economics as much as in medicine, call for an immediate and drastic response. The response by the authorities to the Great Crash of 1929 was small and slow, and the world economy entered a “Dark Age” that lasted through the Great Depression of the 1930s and the Second World War. The 2007-2009 financial crisis portended a similar outcome, but this time the world’s governments and central banks intervened promptly, in a coordinated fashion, and with an appropriately high volume of stimulus. The recovery has been weak; but we are nowhere near a new Dark Age.

For that we should be grateful. Yet some now argue that the fiscal and monetary authorities should not have responded so quickly or strongly when the 2007-2009 crisis erupted. They believe that the primary cause of the crisis was what economists call moral hazard: because risk-takers expected that the authorities would intervene to protect them when their bets went awry, they took even greater risks.

By contrast, our view (supported by plenty of data) is that rapidly rising prices usually reflect irrational exuberance, aided and abetted by phishes. The irrationally exuberant were not thinking of the returns they would garner if the authorities intervened to maintain the economy and the flow of credit (or, in extreme cases, moved to bail out their bank or enterprise). Such possibilities were a marginal consideration in the euphoria preceding the 2007-2009 crisis: those selling at inflated prices were making profits; and buyers “knew” they were doing the right thing – even when they weren’t.

The reluctance to acknowledge the need for immediate intervention in a financial crisis is based on a school of economics that fails to account for the irrational exuberance that I have explored elsewhere, and that ignores the aggressive marketing and other realities of digital-age markets examined in Phishing for Phools. But adhering to an approach that overlooks these factors is akin to doing away with fire departments, on the grounds that without them people would be more careful – and so there would then be no fires.

We found out many years ago, to the world’s great regret, what happens when a financial epidemic is allowed to run its course. Our analysis indicates that not only are there endemic and natural forces that make the financial system highly volatile; but also that swift, effective intervention is needed in the face of financial collapse. We need to give free rein to fiscal and monetary authorities to take aggressive steps when financial turmoil turns into financial crisis. One Dark Age is one too many. (Shiller, Project Syndicate Sept 17, 2015)

Will They or Won't They?

                                                      Comments due by Sept. 18, 2015

This column was published on Sept.11, 2015 one week ahead of the Fed decision on whether to finally start the path of interest rate hikes or not.

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If there was any doubt beforehand, a key economic number Friday finally may have taken September off the table for an interest rate hike.
Consumer sentiment tumbled in September, with a reading of 85.7 in the latest University of Michigan monthly survey.
While that number often garners a fair mount of attention on Wall Street and can move the market, it takes on added importance because of recent comments from New York Federal Reserve President William Dudley.
The influential Federal Open Market Committee member said on Aug. 26 that the confidence survey would play an important role in his thinking when the panel meets next Wednesday and Thursday. That statement came during a press briefing at which he said the case for a September rate hike has become "less compelling" in recent days.
"That loss of confidence feeds back into the real economy through lower spending, and that's what the Fed is very concerned about," said Jeff Rosenberg, chief investment strategist for fixed income at BlackRock, the $4.7 trillion asset manager. "That concern ... that's registered in market expectations that the Fed is unlikely to raise rates. I think the weak data has certainly taken down those probabilities, along with the uptick in financial market uncertainty."

Karen Bleier | AFP | Getty Images

The U.S. Federal Reserve building in Washington.

 

Indeed, while surveys of experts including economists and strategists indicate a belief the Fed will hike rates next week for the first time in more than nine years, futures trading shows just the opposite. 
The CME's FedWatch gauge now assigns just a 21 percent probability for a September move, down 24 percent from the day before and 45 percent a month ago. Traders believe December is the most likely date, assigning a 58 percent chance.
After a relatively placid seven months, markets turned violent in August as investors fretted that a slowdown in China would reverberate globally, and as anticipation built over the Fed's first rate hike since June 2006. Fed officials at one point had been teeing up March 2014 as a likely hike date, but that got pushed back repeatedly as economic data have been uneven and volatility has built up in financial markets.
Most Fed watchers believe an October hike is unlikely in part simply because there is no post-meeting news conference scheduled with Chair Janet Yellen. However, Yellen indicated back at the March meeting that a conference was not a prerequisite for a hike; one could be scheduled impromptu so she has the opportunity to explain the rationale behind the move.
Deutsche Bank is now among the few Wall Street firms to change its forecast from a September hike, and stands nearly alone in now predicting an October move.
Read More September shaping up as Fed's worst nightmare
"We expect an October rate hike to be followed by two more 25 basis-point increases at next year's March 15-16 and June 14-15 FOMC meetings," Deutsche Bank's chief economist Joe LaVorgna and others said in a note to clients Thursday. "Then, the Fed could pause in order to assess the lagged impact of modestly tighter monetary policy on economic activity."
LaVorgna believes seven conditions would have to be met for an October hike: Market stability, a halt in U.S. dollar appreciation, steady economic growth, improvement in the inflation picture, a statement from Yellen next week that October is a "live" possibility, a Yellen press conference and, "most importantly, the financial markets have to be discounting a reasonably high probability of an interest rate hike."


Elsewhere on Wall Street, Goldman Sachs believes a December hike is more likely, and Credit Suisse said Friday that September is now unlikely but October is a possibility.
"We are forecasting a December liftoff, although if markets stabilize in short order and the data continue to cooperate, the October meeting may prove to be a more compelling entry point," Credit Suisse Chief Economist James Sweeney and others said in a note.

Past, Present and Future of Economics.

                         Comments due by Sep. 11, 2015

Olivier Blanchard began his tenure as the International Monetary Fund’s chief economist at the start of the 2008 global economic crisis and is leaving his post amidworld-wide market turmoil.

But one would be hard-pressed to say that it’s not a changed world.

In the latest issue of the IMF’s research magazine, Mr. Blanchard gives a high-altitude survey of the recent past, present and future of the global economy and the science of economics (or alchemy, depending on your view).

Here are a few highlights:

The recent past:

“The financial crisis raises a potentially existential crisis for macroeconomics. Practical macro is based on the assumption that there are fairly stable aggregate relations, so we do not need to keep track of each individual, firm, or financial institution–that we do not need to understand the details of the micro plumbing. We have learned that the plumbing, especially the financial plumbing, matters: the same aggregates can hide serious macro problems. How do we do macro then?”

“In the context of the Greek program discussions, it made good sense to argue for debt relief first in private. We did. And when we thought our argument was not getting through, it made good sense to then go public. It would have been wrong to go public from the start, or to never go public.”

“The issue I have been struck by is how to indicate a change of views without triggering headlines of ‘mistakes,’ ‘fund incompetence,’ and so on. Here, I am thinking of fiscal multipliers. The underestimation of the drag on output from fiscal consolidation was not a ‘mistake’ in the way people think of mistakes, e.g., mixing up two cells in an Excel sheet. It was based on a substantial amount of prior evidence, but evidence which turned out to be misleading in an environment where interest rates are close to zero and monetary policy cannot offset the negative effects of budget cuts. We got a lot of flak for admitting the underestimation, and I suspect we shall continue to get more flak in the future. But, at the same time, I believe that we, the fund, substantially increased our credibility, and used better assumptions later on. It was painful, but it was useful.”

The present:

“There is a good chance that we have entered a period of low productivity growth. There is a chance that we have entered a period of structurally weak demand, which will require very low interest rates. And low growth combined with increasing inequality is not only unacceptable morally, but extremely dangerous politically.”

“There is a clear swing [in economic policy making trends] of the pendulum away from markets towards government intervention, be it macro prudential tools, capital controls, etc. Most macroeconomists are now solidly in a second-best world. But this shift is happening with a twist—that is, with much skepticism about the efficiency of government intervention.”

“Some propositions that would have been considered anathema in the past are being proposed by ‘serious’ economists: For example, monetary financing of the fiscal deficit.”

The future:

One of the key ways the IMF’s role will evolve is through “liquidity provision. Again, the gross asset and liability positions create the risk of very large sudden stops, and the need for international liquidity provision on a very large scale.  The current haphazard combination of central bank swap lines and fund liquidity programs is a strange contraption. It should be improved, if only to eliminate the role of political factors in who gets what. The two should be better integrated, and integrated with regional agreements.” (WSJ)