Income inequality as a sovereign rating input, Italy flouting EU fiscal rules

1 – Moody’s: Widening income inequality will weigh on US credit profile

Rising income and wealth inequality is a key social consideration that will affect the credit profile of the United States (Aaa stable) through multiple rating factors, including economic, institutional and fiscal strength, Moody’s Investors Service says in a new report. While income inequality has generally increased across advanced economies since 2000, it is materially higher and wealth is significantly more concentrated in the US.

Since 1995, the top 10% of US income earners have experienced an overall median net worth increase of close to 200%, while the bottom 40% of income earners have seen a decline. There has been a particularly sharp increase in wealth and income inequality ratios since the global financial crisis.

This is interesting on two levels. First, credit ratings of monetarily sovereign states are largely meaningless. For example, Japan has an A1 rating from Moody’s. But what does that mean in terms of default risk or in terms of interest rate risk? I’m not sure it means a lot, frankly. So I am deeply sceptical of these ratings as anything but political statements, used to cajole governments into fiscal responsibility.

But, having said that, it is interesting that Moody’s is looking at income inequality as one of the political criteria it is using to judge countries by. It says:

For the US’ credit profile, rising inequality will exacerbate pressures on the country’s fiscal strength, its weakest rating factor, since higher government expenditures will likely be needed to support lower-income households, and are unlikely to be offset by revenue raising measures following recent tax cuts.

Is that true? Again, I’m sceptical. I look at rising inequality as introducing political risk i.e. an ‘us vs them’ mentality in the electorate. And this political risk might create governance problems. Equally, to the degree that inequality saps the middle class of income, an economy could have growth problems. But I don’t agree with Moody’s logic here.

2 – Italy Flouts Rules and Sets Itself on EU Collision Course

Background: EU Commissioners Valdis Dombrovskis and Pierre Moscovici have determined there is a “significant deviation” in Italy’s budget targets from the correct fiscal path.

One of the main principles of the European Union’s fiscal rules is that the structural budget deficit may not surpass a medium-term objective of 0.5 percent of GDP if the debt-to-GDP ratio is above 60 percent or 1 percent if that ratio is below 60 percent. Old forecasts had Italy adhering to that commitment by next year, but the new government is openly flouting the rules and setting itself on a collision course with the EU. While Bloomberg Economics believes that a compromise will probably be found, the disagreement marginally increases the probability of the populist government leading the country out of the euro area.

Ten-year yields in Italy are now above the 3.5% mark for the first time since 2014 as Deputy Prime Minister Di Maio shrugged off EU criticism of his government’s plans. Now, remember Germany had been in violation the Maastricht Treaty’s stability and growth pact in 8 of the ten years between 2002 and 2012. Whereas the Italians see themselves as having struggled under the burden of so-called ‘legacy debt’ in a fiscally responsible way. So, it makes sense that the ‘radical’ Italian government would openly flout the rules.

It’s not clear what happens next. Leaving the euro is not even remotely a base case here. Instead watch rising Italian yields as a trigger for an economic crisis in Italy, via Italian banks, which are getting killed due to their holding of government debt. This is where the rubber hits the road because bond market vigilantes will narrow the potential political outcomes for the Italian government. That’s what happens when you borrow in a foreign currency like the Italians do with the euro.

3 – China pumps $109bn into economy as trade war bites on growth

China has slashed the amount of cash some of its banks must hold in reserve as Beijing’s leadership seeks to bolster a flagging economy.

As higher US interest rates and fears of a trade war piles pressure on economies around the world, China’s central bank said on Sunday that it was cutting the reserve requirement ratios (RRRs) by one percentage point from 15 October to lower financing costs and spur growth in the world’s second-biggest economy.

The reserve cut, the fourth by the People’s Bank of China (PBOC) this year, came after Beijing pledged to speed up plans to invest billions of dollars in infrastructure projects as the economy shows signs of cooling further.

Growth is slowing in China. And the question is three-fold: what do they do about it? Can they arrest the slide? And do they cave to US demands on trade? We are now seeing the Chinese pull out all the stops to revive growth. They will continue to do so. But whether this arrests the growth slide is till very much an open question. Nevertheless, I firmly believe that, politically, the Chinese cannot be seen caving to the US, regardless of what happens economically. And that makes the urgency for stimulus that much more apparent.

4 – The risks lurking in a benign global economy

At the IMF annual meetings next week, delegates will survey a now familiar global economic landscape. The US economy is doing fine. For the moment the only question is how quickly, rather than whether, the Federal Reserve will continue to raise interest rates. The other two big central banks, the Bank of Japan and the European Central Bank, are rather slower to travel that particular path. The ECB is en route to withdrawing quantitative easing; the BoJ, for the moment, is keeping its foot pressed to the floor.

Meanwhile, emerging markets are facing a difficult external environment as a stronger dollar and higher US interest rates threaten those economies dependent on foreign financing.

But beneath that largely benign surface risks have been building up, as they did in the years before the global financial crisis in 2008. Whereas recessions used to follow a fairly familiar pattern, coming at the end of a Fed rate-raising cycle, the threat from financial crises is ever present. An episode of turmoil is not necessarily a good guide to the next one.

The last sentence is the key one. No one knows how this cycle will end and whether it will be a garden-variety downturn or a more violent one as it was in the previous downturn. But, ironically, at the point where the economy is doing best we are also in the riskiest phase of this business cycle right now because now is when the policy errors that cause the next downturn occur.

I am keeping an open mind about the resiliency of the financial system. But, my general bias is towards believing the system will prove inadequate.

5 – Twilight of the Terminal: The Disruption of Bloomberg L.P.

The Bloomberg Terminal’s success in the 1980s birthed an empire. Today, that empire is under siege from competitors, government regulations, and the changing nature of finance itself.

More than 320,000 people around the world — mainly traders, analysts, and brokers — pay about $24,000 a year each to use the Bloomberg Terminal to access real-time market data, communicate with other users, get the latest news, pull company data, and more…

The revenue Bloomberg drives from these other lines of business, however, is negligible when compared to the terminal. Reporting on the news, doing research, and other unprofitable lines of business are tolerable for Bloomberg if they can deliver value to terminal users.

I look at this as a media story. Bloomberg News is now charging for access to its articles. Right now, you pay $39 a month to get access to more than 10 articles a month. The paywall is leaky though, because it’s based on browser cookies. My guess is that the paywall will harden over time, as it has done at the FT and the Wall Street Journal.

Slowly but surely, the ‘free’ Internet is diminishing because advertising is not a sustainable business model on the Internet. But unlike with the newspaper, you can’t just buy one copy, you have to get a subscription. What that means is that people of lesser means will opt out of the ‘paid Internet’, leaving them vulnerable to the less scrupulous, rumour-filled and misleading click-bait journalism that will fill the void left by ‘real journalism’. This is the world I foresee. And, as with many things happening now, it will drive partisanship and division. See here, for example. Axios does a good overview of the trends here.

6 – Among the Thousands of FBI Tips, a Statement From an Aggrieved Truck Owner

One document likely in the stack would be a notarized statement submitted to the FBI Tuesday by a truck owner, who allegedly confronted an inebriated college student who was “smashing the black cargo box” in the bed of his parked Ford Courier on a New Haven, Conn., street in the fall of 1986.

“I yelled again at the person, and realized it was Brett Kavanaugh,” reads the statement, which goes on to allege that the future Supreme Court nominee, “uncontrollably, incoherently drunk,” later refused to pay for the damage when confronted over the incident at meeting of Truth and Courage, the secret society both Yale undergraduates belonged to. Judge Kavanaugh, through his attorney, denies the incident took place.

The former truck owner, whose redacted statement was reviewed by The Wall Street Journal, says that Truth and Courage members met twice weekly through senior year to hang out and drink. When “heavily drunk,” Mr. Kavanaugh, could turn “belligerent, offensive and even possibly criminal,” the statement says. The judge has denied such allegations about his alcohol habits in testimony before the Senate.

Arge O’Neal, then a Yale freshman, said he was friends with the truck owner through the swim team and heard him complain that Mr. Kavanaugh had “broken into” his vehicle.

This one is about partisanship too!

In case you think I was making it up about Kavanaugh lying about nearly everything, here is something unearthed in the FBI background check that went unexplored. It confirms what everyone not close to Kavanaugh said about him: he was often a belligerent drunk when in school. Of course, Kavanaugh lied and said it wasn’t true.

The point: partisans don’t care. They fall back on the argument that Kavanaugh’s excessive drinking as a youth is not relevant even though it’s the lying today, not the drinking 30 years ago, that matter. That’s how confirmation bias works.

7 – Great Leaps in American Collapse

How did America get here?…

The first of these giant leaps — or the first one that I want to discuss, at any rate — is what happened in the aftermath of 9/11. The Department of Homeland Security was created — a new institution…

What would have happened at precisely that point if America had built a National Healthcare System instead of a DHS? Let’s actually think about it. Europeans live about five years longer. Given America’s population, if an American NHS system raised life expectancy by five years, that would be the equivalent of 20 million lives saved…

The second great leap in America collapse was the financial crisis of 2008…What did the government — this time Obama, not Bush — do? It bailed out the banks — but didn’t reform them in any way whatsoever. It gave the financial sector infinite (literally) free money — but not the struggling, fracturing middle class, and the desperate poor…

That brings me to the third giant leap in American collapse — the election of Trump. But I don’t just mean the literal election — I mean the atmosphere of denial, complicity, obliviousness, and foolishness by elites which surrounded it. Throughout that year — do you remember? — elites declared it flatly impossible that America would elect such an obviously unfit leader. Meanwhile, they pilloried Hillary at every opportunity — since they were sure she would win. They hadn’t understood any of the above yet — that from within, America was something like a volcano, ready to explode.

Umair often makes emphatic statements whose tone you might consider excessive. But, his logic is good. I suggest you read this piece. His tale: an insecure American populace was ready for Trumpism because its insecurity made it desperate.

8 – Finance, the media and a catastrophic breakdown in trust

In 1990, when I started at the FT, trust in financiers and the media who covered them was, if anything, excessive.

Very much in line with the last post, but told from a British perspective. For me, the key point is that this ‘breakdown in trust’ of institutions has happened across a broad swathe of western countries. If you’re looking at your own country and thinking its pathologies are unique, you need to read this article.

My view: Economic and cultural security in the western middle classes has eroded tremendously over the past generation. I see globalization as the likely dominant contributing factor. How do we reverse this? I don’t know. There is no consensus on which tweaks to make to globalization, if any. This is why I fear that only war, depression or revolution will way to placate western middle classes. Your comments are appreciated