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Paul Krugman's response to Arthur Laffer's recent article warning of the dangers of inflation and rising interest rates, as the monetary base is rapidly expanded by the Fed. Krugman points out that there is one thing Laffer omitted to mention. This is the third time in history that a major economy is facing a liquidity trap, where interest rate cuts have reached their limit, and policymakers and the Fed have to use unconventional measures to keep the economy from a steep descent. Krugman says a rising monetary base isn't inflationary when the economy is in a liquidity trap . He cites facts that the monetary base of the USA doubled between 1929 and 1939, but prices fell 19%. Japan's monetary base rose 85% between 1997 and 2003 but deflation continued in Japan. To reverse course now would repeat the mistakes of that period. And he says the US was experiencing growth in 1937 and 1996, when policy makers reversed course pushing the economy back into a descent, whereas today the US is facing negative growth. ...

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The yields on TIPS, Treasury Inflation Protected Securties, suggests the markets expect longterm inflation of about 2.5% ayear up sharply from the 1% in fall 2008. The figures for the CPI are rising a bit, but still down about 0.8% year over year, which suggest deflationary trends. And the markets are expecting the Fed to raise its key target rate from roughly zero to nearly 1.25% by next June. Says Gongloff the market is showing its inflation anxiety about the Fed flooding the market with cash, but the fact remains that the Fed is still making up for the lack of demand in the private sector. He says the fundamentals still suggest deflation is a bigger risk than inflation.

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The 10 year Treasury bond yields went up from 3.0% 3 months ago to 3.78% in April, according to Treasury International Capital data. The Fed is buying Treasurys to keep rates low, but its spending may be creating new worries about inflation. These worries may be pushing rates higher and threaten to choke off a economic recovery.

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A plan being put together in eurozone financial circles is for Spain to request aid and the European Stability Mechanism fund to provide far less than 100 billion euros approved for aid to Spain. With the request Spain would agree to conditions set by the EU, ECB and the IMF for improving competitiveness, reducing rigidity in labor markets, and controlling spending by regions in Spain. This would lead to the ECB taking action to buy Spanish bonds and lower borrowing costs.

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The 129 page internal report on what caused the trading losses of $6 billion at the London based investment unit of JP Morgan Chase bank. The report shows the trading was intended to offset losses of $100 million. Instead the trading assumed large proportions and supervisors ignored the risks, management showed lax oversight. This type of situation occurs in other industries. The costcutting at BP and suppliers resulting in the Gulf Oil Spill and the Toyota costcutting saved small amounts by creating large risks that threatened the companies, with bankruptcy in BP's case and loss of confidence of the customer base in Toyota's case. They also reflected years of costcutting that were showing up in smaller problems that remained unrecognized. BP refinery fires occurred for lack of adequate maintenance. Problems were already developing at JP Morgan Chase with managment changes at the London unit leading to poor oversight and complacency of top management, a culture that took undue risks even as management remained confident in its strategies....

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Heizo Takenaka, head of the supervising agency for banks in Japan under prime minister Koizumi, took strong action to get banks to disclose the full extent of bad loans. This was needed to repair the banking system as piecemeal efforts had failed from 1996 to 2002. Takenaka says he realized that the economy could not recover with stimulus efforts until the banking system was cleared of bad debt and functioned normally to lend to business and consumers. He tells the NYT's Tabuchi that he stood firm and told the banks he was not ready for negotiation even when the banks called him absurd. He describes his experience with the banks, and says he cannot understand why the U.S. is not taking firm action with the banks.

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Turner Adair, head of Britain's Financial Regulatory Authority thinks that banks have assumed an outsize role in the British and world economy, and are coopting their regulators. He sees the need to check many of the excesses. Why not use profits to build up reserves rather than give out huge bonuses and paychecks, he asks. He sees the need to challenge the accepted thinking on Wall Street and in the City of London, where the ideology of efficient markets became embedded, as it did also in the regulatory community. He came in the week Lehman Brothers collapsed as chairman of the FSA. And he wants to shake up the existing thinking. In March, the Turner Review. a 126 page report was published. A lot of attention was paid to his suggesting atax on financial transactions, called the Tobin tax, but its designed more to get people thinking and questionning the existing way of running banking as Turner said in an interview, "we have begun to accept this idea of liquidity as the new God." Can British or American society and the financial industry in both countries work to the benefit of both? Nobel prize winning economists and other experts have advised ashift to productive investments that grow the economy using technology, science and brainpower and new ideas, as opposed to the investment in mortgages and other speculative investments. As the regulators -including former and current heads of the SEC, and other regulatory bodies in the US, Cox, Schapiro and others- once held on to the same theory of uninhibited operation of free markets as best for generating increased wealth for society as the banking community, they tended to get co-opted in letting bad practices flourish. Went to sleep on the job as it were. See the links in Intelilinks. Adair Turner's admonitions are designed to get people thinking. He says, "banks need to be willing, like the regulator, to recognize that there are some profitable activities so unlikely to have a social benefit, direct or indirect, that they should voluntarily walk away from them." Investments in science, technology and new products, as in the 60's that generated a revolution in living standards, than the mortgages and consumer lending of the last decade, is what he may be saying, as do these Nobel prize winning economists....

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On one hand the issue of the $165 million in bonuses going out to employees in the 370 person Financial Products Group, and oth the other the need to wind up the complex derivative contracts that are causing these huge losses at AIG. But are such huge payouts needed for these employees to do their job? Isn't this aprofessional responsibility of these employees? And AIG's retention-payment program was disclosed a year ago and the amount of the bonuses $400 million, says the Washington Post, had been widely reported. The company is set to pay according to the WPost $600 million in retention awards to about 4700 people throughout the global insurance units. WHat happens to the $600 million, as no opinion has been voiced on these upcoming payments. The whole idea of retention payment raises another question. Will the skills of these employees be needed in a long drawn out economic downturn spread over several years or longer. And will thefailure of such things as derivatives, and the tighter regulation, mean that they will play amuch smaller role in the future. And even in the insurance units will these skills draw a premium in a market where the supply of new talent is larger than the job market ? One expert has sugggested that even if some of them left, there would be younger people to replace them who might bring an even better set of qualifications, with amix of skills, caution and prudence. So is there something self-interested and spurious in the retention argument itself and shouldn't this bluff be called? ...

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Steven Ratner says the Obama administration is not considering bankruptcy for GM and Chrysler, asit does not see bankruptcy as necessarily abetter place for the auto companies, especially because of the consumer-facing nature of these companies. And the government is not considering calling the $17.4 billion loaned to the auto companies. THis takes alot od the pressure off of GM and Chrysler.

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Deocuments from the weekly cabinet meeting show the new budget in France will increase revenues from household income taxes by 23%, and business taxes by 30%. The top marginal income tax rate goes up to 45% from 41%. Limiting a deduction for financial charges for company's taxable income brings in $4 billion in 2013, according to the finance ministry. The goal is to cut the budget deficit to 3% of GDP in 2013 from 4.5% in 2012. The finance ministry has assumed higher borrowing rates for future years- 2.9% on 10 year debt for 2013, up to 3.65% in 2015, and is not relying on the low rate of 2.18% on 10 year government bonds as reported by Trade Web Sept 28, 2012. The overall tax burden will be 46.3% in 2013, and 46.7% in 2015. French debt is at 91% of GDP for the 2nd quarter 2012, expected to be 91.3% in 2013 and falling to 82.9% in 2015. Prime minister Ayrault emphasized- "If we don't put a stop to this, taxpayer money will keep paying for debt reimbursement." Swift anticipatory action and unified government-business-labor posture under a favorable borrowing environment characterizes the approach for Britain and France in 2011-2012, compared to the situation in Spain where government action has been slow, not tough enough in cleaning up the banks, fallen behind in anticipating events and the government-business-labor unified posture has cracked under the strain. As a result under an unfavorable borrowing environment money raised from austerity type tax increases now goes to paying for debt reimbursement in Spain, leading to a situation in which debt and deficit reduction targets just get harder to achieve. A looming drop in credit ratings to junk status for Spain only makes the situation harder to overcome. ...

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Mr Iksil, a trader in Chase's CIO London office made such massive bullish bets on CDX-IG-9 index of 121 companies by selling credit default swaps, to the point where it cost less for protection on the index than for the individual components of the index. This worked in Jan-Feb 2012 with hedge funds on the other side having paper losses. In subsequent months hedge funds realized that Iksil would have to unwind some of these bets to avoid large losses. As a trader at Bank of America put it in a memo, at that point "Fast money smelled blood." The result is that hedge funds accelerated their bets against Mr Iksil's bullish positions, leading to the large $2 billion losses at CIO unit of Chase- losses on depositors money from aggressive bets in a volatile market. Mr Iksil is a French born trader, who has worked for Chase since March 2007. He has earned $100 million each year for Chase. He travels to London from his Paris home each week, and works from home Fridays. Two junior traders work with Iksil, primarily placing bets for complex trades in credit markets....

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President Obama in his speech at Georgetown, April 13, 2009, describes the thinking behind the decisions made in the first 12 weeks of his administration- why the actions are not aggressive and overreaching as some critics say, and why they are not timid as other critics have said. This was not a typical downturn of the business cycle, but a perfect storm arising from irresponsibility and poor decisionmaking in Washington, Wall Street and Main Street- in effect several crises colliding for something like an explosion, if not dealt with at once, and with strong action. He says "the key to dealing with our deficit and debt is to get a handle on out-of-control health care costs, not to stand idly by as the economy goes into free fall." The recognition that the crisis itself brings with it new possibilities, the opportunity for coming to grips with and forging a good solution to health care, energy and education issues that were neglected while Wall Street directed investments to areas other than investment in building for the future. To the critics like Krugman, Rosenfeld and others who say that the takeover of insolvent banks should be done quickly before the situation worsens, he says it is not because of any ideological or political judgement he has made about government involvement in banks, but because it is more likely to undermine than create confidence at this point. He goes on step by step, through the process of decisionmaking, first to step in and boost spending vigorously, second to get lending flowing again to businesses and families, strengthening the non-bank credit market for consumer purchases and loans, the housing plan, the auto plan, and the work at the G-20. Then President Obama goes on to project his vision and the road to getting there. The five pillars he sees for the future are: redirecting Wall Street and banking to constructive investments for the future, investments in education, investments in renewable energy and technology to create new industries and new jobs, investments in health care to cut costs for businesses and families, and new savings in the federal budget to bring down the deficit. Obama says he will look for savings line by line in every corner of the budget, and has already identified two trillion dollars in deficit reductions over the next decade. And the goal is to reduce discretionary spending for domestic programs as share of the economy by more than 10% over the next decade. Procurement reform will greatly reduce no-bid contracts and save $40 billion. Secretary Gates is attacking th problem of hundreds of billions of dollars in waste and cost overruns that have bloated the defense budget, without adding to the nation's safety. And education programs that don't work will be removed, and waste, fraud and abuse in the Medicare program will be controlled. Finally, Mr Obama points to the nation's political system as one more reason we are in this perfect storm- "a fundamental weakness in our political system." He cites the putting off hard decisions for another day, scoring political points instead of rolling up up sleeves to solve real problems, an impatience that is only worsened by the 24 hour news cycle, and a short attention span that focusses on the immediate results and on poll numbers. And there is too much responding to the "tempest of the moment until the furor has died away and the media coverage has moved on, instead of confronting the major challenges that will shape our future in a sustained and focussed way." After these 12 weeks President Obama says, for the first time there are glimmers of hope, and way off in the distance can be seen a vision of America's future that is far different than its troubled past. And citing the parable in the Sermon on the Mount about that "house built on a rock", he sees America's house built on a rock, a house for which we use this moment to lay a new foundation, come together and begin the hard work of rebuilding, persisting and persevering in the face of disappointments and setbacks that surely lie ahead. Then he has no doubt "that this house will stand and the dreams of our founders will live on in our time." Its a remarkable speech in its directness, its simplicity in approaching the subject, and its borrowing from the Bible for that story of that house built on a rock, and its Lincolnesque reference to the house that will stand. And more than a speech, it describes a vision, and the set of actions and steps taken and to be taken to get there. ...

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House Ways and Means Committee chairman Dave Camp says the implicit subsidy on "too big to fail" financial firms needs to be addressed. His proposal is for a quarterly tax of 0.035% on assets over $500 billion. The tax would raise tax revenues of $86.4 billion over 10 years. The tax does not go into some bailout fund, which is one reason it does not address the problem adequately, says the WSJ.

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Two realities are affecting exchanges. One is that trading commodities and derivatives is a $600 trillion business worldwide and is more profitable than trading in corporate shares. This shows in the value of ICE and NYSE in the stock market. In April 2011 ICE was valued at $1.5 billion less than NYSE, in Dec 2012 ICE was valued at $4 billion more that NYSE as it makes its bid to merge with NYSE. The other is that the Dodd-Frank financial system overhaul in the U.S. after the 2008 financial crisis has created a new model for derivatives trading providing advantages to regulated electronic exchanges and clearinghouses that handle derivatives trades with transparency. Jeffrey Sprecher, CEO of ICE, the IntercontinentalExchange, which handles derivatives trading through its clearinghouse operations, says: "For the past decade, our solutions made our markets increasingly electronic and increasingly clear. Today, financial reform is imposing that vision on many markets through a rule-making process." Bart Chilton, a member of the CFTC which regulates derivatives trading says Dodd-Frank legislation supports the business model of derivatives exchanges. This is especially true for Mr Sprecher and ICE. Sprecher has a good relationship with regulators with whom he talks directly, and is supportive of CFTC efforts to close loopholes as he is confident he can make money as long as the rules are clear. His confidence stems from his model which is technology based from day one, with its own clearinghouse and technology based transparency of the ICE data vault, information it shares with regulators. Sprecher stumbled upon this opportunity. He is an executive in the power industry. Working on developing power plants Sprecher found it was difficult for power firms to hedge investments in energy with financial contracts because there was no well organized, clear and transparent market for such contracts. This he set out to do by buying a little know exchange in Atlanta for buying and selling electricity, later getting the the backing of BP, and investment banks such as Goldman Sachs and Morgan Stanley, to form ICE in 2000. Banks liked the idea of a having an organized clear place to buy and sell derivatives in oil and other commodities, and having an alternative to the Chicago Mercantile Exchange in futures trading. Swaps trading under Dodd Frank supervision is converting to old style futures contracts where there is less competition for ICE's futures trading creating new opportunity. ICE setup its own clearinghouse, and acquired the Clearing Corporation, which was the base for a derivative called credit-default swap. To make derivatives trading transparent and reduce systemic risk Dodd-Frank legislation required exchanges to provide information to data warehouses which would then share the information with regulators. ICE setup its own data warehouse to do this called ICE Trade Vault. Dood-Frank rules envisioned the formation of clearinghouses and exchange such a ICE to provide a clear process, transparency and reduce systemic risk in derivatives trading. ICE under Sprecher by making this vision its own and using technology has created new opportunity. ...

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The Bernanke Fed's low interest rates are hurting seniors and savers who are earning very little on their savings. This is taking money away from millions of savers and reducing consumption spending by seniors and savers. According to the Labor Department average annual investment income for 24.6 million American households headed by seniors over the age of 65 was $2,564 in 2009. This is down significantly from prior years. A survey by the Employee Benefit Research Institute shows that one in three retirees have had to dig deeper into their savings to cover basic necessities in 2010. With inflation at an annualized rate of 5.6% in the first quarter 2011, interest rates of 0.24% on savings accounts do little to cover inflation. There is a sense that this is hurting retirees who have lived prudently and worked hard and on savers of different ages. This actually discourages healthy savings that would protect Americans from job losses and build a safer future. American contributions to bank and 401 (k) accounts is only 4% of disposable income in 2010, according to the Fed. Another danger is that the smaller 401 (k) accounts of the average American family after losses in earlier stock market declines, will again be exposed to the fluctuations and risk in the stock market. This could happen as money is shifted to the stock market in the hope of earning better returns. Seniors are an active voting group, and voting patterns show a shift to Congressional candidates who question Fed policy....

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The FDIC acknowledges that it has not been able to get banks interested in a pilot program called the Legacy Loans Program. That program was designed to give the banks an opportunity to sell off $1 billion of troubled mortgages. Since November with the efforts of the Troubled Asset Program under Secretary Paulson to have the banks sell off these assets in an auction or some other way, the whole issue of getting the toxic or troubled assets off the books of the banks has been effectively shelved. The Obama administration's version of this was the Geithner Public Private Partnership program, but this like Paulson's TARP never really got off the ground. Instead several things have happened that have enabled banks to show higher profits and improve stock prices. The period from March 2009 to June 2009, a period of several months has seen bank stock prices recover and banks are now able to raise capital on their own from investors. The government's "stress tests" gave the banks credibility with investors and they were designed not to be so stringent as to affect confidence. The mark to market rule has also been relaxed so that banks are no longer required to show these toxic assets at prices that reflect large losses. Bank executives also are wary of the new executive compensation rules of the government. All of these things have combined to create asituation where some confidence has been restored, but at the same time experts are pointing out that the underlying problems of an estimated $1 trillion in troubled assets remains. Banks are even less likely to want to part with these assets at lower prices now that some semblence of confidence is returning, as they would then have to show large losses. What this implies is that if the economy suffered a setback, these problems would return and be just as intractable as ever....

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Michael Porter who is an authority on competitiveness and national strategy, is a Professor at Harvard University. He last servedin a national economic strategy advisor capacity in 1983, as a member of the President's Commission on Industrial Competitiveness. His view is that the USA badly needs an economic strategy. And the political system of the USA discourages developing such a strategy. The political dialogue also discourages the discussion from focussing on the key aspects of a strategy and because of the ideological slant the discussion between Republicans and Democrats tends to cancel each other out leaving the important work undone. What is an economic strategy? Its thinking clearly what are the advantages or strengths America as a nation has and how best to preserve these advantages in the future? And its thinking clearly about the weaknesses, and how to address the weaknesses, and where money and other resources should be allocated and what actions need to be takento get results. As strategy is a long term thing, it requires patient and perseverent effort and allocation of resources. The strengths he goes on to list are, an unparalleled environment for starting new companies and the science and technology, and the regional universities and clusters of high tech workers and resources in different regions of the country,the educational institutions for higher education, and the committment to competition and free markets, efficient and deep capital markets, and the acceptance of the uncertainty and cost in the huge job churn (restructuring of industry that destroys millions of jobs per year with net positive job creation). The problems that have arisen with these advantages have compromised some of them. Free markets are not really free as anti-trust enforcement has been lax resulting in mergers dominating markets and weakening compeititon. Many times the "free market' talk has become rhetoric and distorted for individual purposes. And regulatory oversight has been weakened in the name of "free markets", as if the market system could be run with no government regulation at all. The weaknesses are: remaining an energy inefficient nation even as countries like Japan have become increasingly and way more energy efficient, and doing nothing about it, not having any policies to fix this and assign a big priority to it. In the area of access to education, which is critically important to national competitiveness, the US ranks poorly in the number of college graduates and in the opportunties for access to college across the middle and working classes. Says Porter, the US ranks 12th in the college or higher educational attainment for 25-34 year olds. And the US he says has made no progress in this area for 30 years. This is a disturbing trend in a economy that must have the education and skills to justify its high wages, and how will Americans compete for jobs that can be moved elsewhere in these circumstances he asks. Strategy requires honesty with ourselves in identifying and addressing the strengths to be preserved and the weaknesses to be fixed. Solutions have to go to the heart of the problem, with the patient effort needed for longer term solutions, when problems have become embedded in the system, and in the habits, culture, and way of doing things, that will produce disaster down the road. Wen it comes to spending on priority investments, Porter prefers to tax rebates the spending that goes into educational assistance and into logistical infrastructure. ...

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Greenberg of AIG asks why Goldman got paid in full while AIG suffered and languished? Questions he raises about the way Goldman Sachs acted during and before the crisis, with its actions helping precipitate the crisis, and the need for investigative reporting to uncover the facts. Serious questions raised by Greenberg.