Top 10 at 10: Brazil-style capital controls?; 'US more duck than phoenix'; Congressional mood turning ugly; Dilbert

Here are my Top 10 links from around the Internet at 10am. I welcome your additions and comments below or please email your suggestions for Monday's Top 10 at 10 to bernard.hickey@interest.co.nz We never mention anyone's ears at interest.co.nz, although we are happy to accept criticism of my hair. 1. Oops - One-time Obama supporter Paul Krugman argues at the New York Times that the appalling bailout of AIG has reduced the chances of a second stimulus package, which Krugman wants to see happen. He now sees a big risk of a Japanese style lost decade because voters won't allow a second stimulus.

Brad DeLong says that the loss of public trust due to the kid-gloves treatment of bankers has raised the probability of another Great Depression, because the public won't support another round of bailouts even if it becomes desperately necessary. I agree "” but I think the bigger cost is that we've greatly increased the chance of a Japanese-style lost decade, with I would now give roughly even odds of happening. Why? Because bank-friendly policies have squandered public trust in all government action: try talking to the general public about stimulus, and it's all confounded in their minds with the deeply unpopular bailouts. By itself, the AIG story would be damaging enough. But it's part of a pattern "” and that pattern has ended up undermining the economy's prospects, big time.

2. More duck than phoenix - Nouriel Roubini writes in the Globe and Mail of a Tale of Two American economies.

There is a smaller one that is slowly recovering and a larger one that is still in a deep and persistent downturn. Consider the following facts. While America's official unemployment rate is already 10.2 per cent, the figure jumps to a whopping 17.5 per cent when discouraged workers and partially employed workers are included. And, while data from firms suggest that job losses in the past three months were about 600,000, household surveys, which include self-employed workers and small entrepreneurs, suggest a number above two million. So, while the United States may technically be close to the end of a severe recession, most of America is facing a near-depression. Little wonder, then, that few Americans believe that what walks like a duck and quacks like a duck is actually the phoenix of recovery.

3. Capital controls? - Arvind Subramanian, a senior fellow at the Peterson Institute for International Economics, writes at The Baseline Scenario about the challenge facing developing economies as low US rates sparks a flood of carry trade capital into economies like Brazil, India and China. He might have also mentioned commodity currencies such as New Zealand and Australia as well. Subramanian suggests coordinated capital controls. Should we throw this into the Pandora's box that Phil Goff has opened by saying New Zealand should abandon its orthodoxy of only using the Official Cash Rate to target inflation alone? My gut feel is no, but it's a new world out there. It is rather frustrating for New Zealand to sit on the sidelines being slowly strangled while America and the rest print money to devalue their economies and fire up their export sectors.

Time and again we have learnt (or rather failed to learn) that large foreign capital flows to emerging markets are not sustainable (Latin America 1982; Asia 1997-98; and Eastern Europe 2008). Think of this: if sophisticated regulatory systems such as those in the US and Europe cannot avoid financial crises, how much more vulnerable are emerging markets? So, how should emerging market countries respond? Is it time for them to impose serious restrictions on capital flows? In answering these questions, two points must be kept in mind: this policy challenge is going to be around for some time, at least as long as the Fed keeps interest rates low; and second, because the cause of the increased flows is common to all countries, namely Fed policy, it will be a policy challenge not just for individual countries but for emerging markets as a group. Chile in the early 1990s and Malaysia in the wake of the Asian financial crisis in the late 1990s are the two poster boys for serious capital account restrictions. The evidence on their effects"”in limiting flows and preventing currency overvaluation"”is contested because restrictions can be circumvented. But Carmen Reinhart and Nicholas Magud suggest that their effects cannot be dismissed. Going forward, there is the technical question of how best to design restrictions on flows: Should they be price-based or quantity-based? What kinds of flows are best addressed, debt or portfolio? When should they be withdrawn? The IMF should deploy its considerable technical expertise to help answer these questions. But there is also the political issue of removing the stigma from countries that want to impose serious capital controls. Brazil recently botched its attempt at such controls because the policy action was half-hearted, anxious about the reaction of markets. One possibility could be coordinated restrictions on capital flows action by a set of emerging markets that could be blessed by the G-20. No doubt this would be risky, perhaps even counter-productive, but in these unusual times no policy option should be off limits, at least for discussion.

4. Tide shifting - The print and borrow policies of America, the UK, Europe and Japan are putting the global trade and monetary systems under real pressure. Investors are borrowing at near zero percent rates in the US and pumping that capital into emerging economies such as Brazil, China and India, as well as developed commodity economies such as Australia, NZ, South Africa and Canada. Those economies with floating exchange rates are effectively been squeezed out by the 'beggar thy neighbour' devaluations of the delinquents. So some are starting to revolt. Brazil's tax on foreign capital flows into its stock and bond markets was the first (flawed) attempt. Last night Brazil shut down a loophole for the tax, sparking fresh debate on a wider move to impose such controls. Indonesia and India are also eyeing controls, the FT reported.

So far most emerging market economies have managed the problem by intervening in currency markets to slow the appreciation of their currencies. However, Brazil and Taiwan have taken more dramatic action, imposing capital controls designed to limit the appreciation of their currencies. Speculation has risen that other countries will follow their lead. "Recent measures from Brazil and Taiwan curbing capital inflows send a clear signal: emerging market policymakers are far away from accepting a sustained reallocation of portfolio capital from the west, and its liquidity and currency implications," said David Bloom at HSBC. Indeed, the Indonesian rupiah dropped sharply after the country's central bank said it was considering steps to limit inflows on Thursday. Darmin Nasution, deputy governor of Bank Indonesia, said the central bank was "seriously" studying the option of limiting inflows into short-term government bonds. Meanwhile, the Indian rupee lost ground on reports that the government was planning set quotas on corporate foreign borrowing in a bid to stem the rupee's advance.

5. 'I'll be back' - Unfortunately for the Governator, California's budget deficit has blown out again despite earlier measures to slash budgets, the LA Times reported. Arnold Schwarzenegger will have to return to Sacramento to find more cuts. This is a key part of Roubini's Tale of Two Economies. Wall St is rolling in record bonuses again as the 'Too big to fail' banks make a killing with their newly minted government guarantees and cheap funding. Meanwhile 'Main St' is groaning under the weight of massive unemployment, tight credit and state/local government cutbacks.

Less than four months after California leaders stitched together a patchwork budget, a projected deficit of nearly $21 billion already looms over Sacramento, according to a report to be released today by the chief budget analyst. The new figure -- the nonpartisan analyst's first projection for the coming budget -- threatens to send Sacramento back into budgetary gridlock and force more across-the-board cuts in state programs. The grim forecast, described by people who were briefed on the report by Legislative Analyst Mac Taylor, comes courtesy of California's recession-wracked economy, unrealistic budgeting assumptions, spending cuts tied up in the courts and disappearing federal stimulus funds. "Economic recovery will not take away the very severe budget problems for this year, next year and the year after," said Steve Levy, director of the Center for Continuing Study of the California Economy.

6. Congressional testes? - The angry, febrile mood on Main St is starting to filter through to leaders in the Congress. Troy Barsten has pointed me to a couple of articles and made this comment.

For some reason Congress decided to grow a pair this week. just before the Thanksgiving break. It looks to me that they want the aura of doing something before they head back to their constituents. Also, the Republicans want a full audit of the financial system including the Fed, and Democrats are calling for blood. I'm not sure if the US public is ready to learn just how precarious their system is and just how much they have been lied too.

Here's the Boston Globe on the new mood on the hill to audit the Fed. A recent official report into the AIG disaster seems to have been the catalyst.

A group of House Democrats are stepping up demands for greater transparency from the Federal Reserve after reports that the Fed mishandled the bailout of insurance giant American International Group Inc. The group, led by US Representative Elijah Cummings of Maryland, wants a congressional review of the Federal Reserve system. They want to allow congressional audits of the Fed as part of financial rules being debated by the House Financial Services and Senate Banking committees, according to a letter yesterday to the committees' chairmen. "Real financial regulatory reform cannot occur without an examination into the structure'' of the Federal Reserve system, the letter says. Details on which banks benefited from AIG's bailout never would have become known without demands from Congress, and a recent report shows flaws in the Fed's structure as a regulator, the lawmakers wrote.

7. Sack em - Even Obama's most liberal supporters are getting grumpy about the way the Federal Reserve and Treasury appear to have favoured Wall St over Main St, according to The Hill blog. They're even talking about dumping Treasury Secretary Tim Geithner and Obama's Chief Economic Adviser Larry Summers. Hallezlujah.

A Congressional Progressive Caucus (CPC) member said there's "growing consensus" among liberals that Treasury Secretary Timothy Geithner should step down. Rep. Peter DeFazio (D-Ore.) said Wednesday that he and other liberal House members are becoming increasingly tired of Obama administration economic policies that they say are too focused on maintaining the stability of Wall Street firms and largely ignore "Main Street." "A growing consensus in the caucus [believe that Geithner should be removed]," DeFazio said on MSNBC this evening, adding that some lawmakers are "considering questions regarding him and other economic advisers."

8. Not so easy money - Moody's is about to downgrade the ratings of A$24 billion worth of hybrid securities issued by the big four Australian banks, the Sydney Morning Herald's Eric Johnston reported. That may make it harder for these Australian banks to raise money cheaply and will eventually trickle down to us in the form of higher interest rates.

The Moody's ratings agency is reviewing the way it assesses hybrid shares following actions by governments aimed at stabilising the global banking system. It believes hybrids are now more vulnerable to being hit by defaults, and has warned it could be forced to cut the ratings of securities issued by some of the nation's biggest banks to just a notch above junk. Any ratings downgrade could trigger a sell-off by some institutional investors, while banks may be more cautious about future issues of hybrid shares. Of most concern to Moody's is the prospect that regulators such as the Australian Prudential Regulation Authority could order banks to halt interest payments on hybrid securities to ensure the capital base of banks is protected in the face of rising lending losses.

9. Will we listen? - The IMF and the OECD have come out with reports reflecting what we already know: New Zealand needs structural reform to rebalance away from housing and towards export production or it risks a loss of foreign investor confidence that could make life very difficult for us and our banks in the long run. Will we listen though when someone in 'authority' outside New Zealand says what our own authorities have been saying all year? Here's the OECD's conclusion:

New Zealand is finally emerging from its five-quarter long recession, the beneficiary of strong domestic and global policy stimulus. But the recovery could be hampered by the overhang of high private sector indebtedness, ongoing credit contraction, the currency's recent strength and rising unemployment. Given weak and fragile private demand, it is appropriate that monetary and fiscal policies remain expansionary for the time being. However, if the recovery takes hold as projected, stimulus should start to be withdrawn by mid-2010 in order to reinforce balance-sheet restructuring and, in conjunction with structural reforms, to steer activity toward tradeables production rather than housing investment as the main generator of income and wealth.

Here's the IMF's conclusion:

The global financial crisis is creating stress on banking systems across the world through funding and asset quality shocks. This paper combines different stress scenarios, as well as cross-country analysis, to assess New Zealand bank vulnerabilities to the global crisis and the domestic recession. It finds that a sharp worsening of asset quality would be required to reduce bank capital below the regulatory minimum. On the funding side, a disruption to banks' offshore funding may put pressure on the exchange rate, but would not trigger a systemic liquidity problem.

10. Useful factoid - DairyDairyNZ Tight Management campaign leader Rob Brazendale has disclosed that on average dairy farmers will spend around quarter of their payout this year servicing debt. Brazendale suggests farmers use the higher payout this year to reduce debt... That isn't what farmers have done in the past, but let's see what they do now the banks have stopped shovelling easy new money down their throats (although banks are still growing lending to pay for ongoing cash deficits rather than new farm purchases).

"The average level of indebtedness of New Zealand dairy farmers is approximately $20/kgMS. This means on average around a quarter of this year's milk payout will be used to service debt through interest payments. However, reducing principle will decrease interest expenditure in future years."

Utterly irrelevant video on Barack Obama's home teleprompter failing Obama's Home Teleprompter Malfunctions During Family Dinner