Thursday's Top 10 with NZ Mint: Slovenia is next on the euro chopping block; Why inflation is dead and that's a bad thing; How suburban sprawl worsens inequality; Dilbert

Here's my Top 10 links from around the Internet at 10 am in association with NZ Mint.

As always, we welcome your additions in the comments below or via email to bernard.hickey@interest.co.nz.

See all previous Top 10s here.

My must read today is #6 from John Hussman on how US corporate profit growth and the stock market valuation that goes with it is ultimately unsustainable. 

1, Nothing to see here. Move along now - Euronews reports that now it's Slovenia that is denying it will need a bailout or will impose haircuts on its bank depositors, despite an OECD warning it faces a banking crisis.

This is of course exactly what Greece, Portugal, Ireland and Cyprus said just before they asked for bailouts.

It brings to mind that saying about football club managers.

The moment you receive the public endorsement of your chairman you know it's just a matter of time...

Before the axe falls.

This is particularly relevant in a world where financial hair triggers are short and people know there is no second prize for exiting second to last in a bank run or crisis.

Here's the chairman's endorsement:

Brussels dismissed the idea that Slovenia was the new Cyprus. European Commission President Jose Manuel Barroso said: “Slovenia is indeed the country – of all the member states of the European Union – where the relative dimension of the financial sector is smaller compared to the overall GDP, so it’s at least abusive to make a comparison on that ground with Cyprus.”

The scale of Slovenia’s problem is much smaller, but it faces a difficult time raising cash to recapitalise the banks. Adding to the pressure Slovenia’s borrowing costs continue to rise with investors reluctant to buy government bonds particularly after the OECD report.

2. The risks with Bitcoin - NewScientist reports things aren't always smooth with Bitcoin.

It is easy to forget that Bitcoin exchanges, where many users store their cash, have a history of being hacked or even folding altogether.

Tracking the fortunes of 40 such exchanges over the past three years, Tyler Moore of Southern Methodist University in Dallas, Texas, and Nicolas Christin of Carnegie Mellon University in Pittsburgh, Pennsylvania, discovered that 18 have closed. Of these, five failed to reimburse their customers, while six claimed they did. The pair were unable to confirm either way for the remaining seven exchanges.

The pair also used mathematical modelling to predict the general behaviour of Bitcoin exchanges, and found that there is a 30 per cent chance of an exchange folding within one year of opening, increasing to nearly 80 per cent after two years.

Unsurprisingly, the larger exchanges such as Mt.Gox are much less likely to implode, but the findings suggest these popular money-swappers are also at greater risk of hack attacks. "The continued operation of an exchange depends on running a high transaction volume, which makes the exchange a more valuable target to thieves," say the pair in a paper presented at the Financial Cryptography conference in Okinawa, Japan, last week.

3. Cypriots now thinking of fleeing the euro - Economist Megan Greene writes at Bloomberg that numbed Cypriots are finally emerging from their shock to think about leaving the euro, which is a sensible idea.

The IMF forecasts that the country’s economy will contract 9 percent this year. The government is now predicting a 13 percent drop in output, but I expect the contraction to be sharper still. In this case, Cyprus will miss its deficit targets and will have to put in place more austerity in an attempt to catch up. The result will be an endless spiral of austerity and recession, ensuring that Cyprus will either need a second bailout or a debt restructuring.

Exiting the euro area is also difficult, but it could be the less painful choice if designed well. Among the greatest costs of any euro-area exit would be bank defaults on their liabilities, capital controls and a sovereign default. Cyprus has already experienced the first two and will most likely see the latter in the next year or two if it stays in the euro area.

So if Cyprus is going to incur some of the worst costs of abandoning the euro anyhow, it might as well print its own currency and benefit from a devaluation and the immediate boost in competitiveness that would follow. The island has three main industries that would do well if they were made much cheaper for foreigners: real estate (12 percent of GDP), tourism (about 7 percent) and business services (as much as 40 percent).

4. 'Only a short term solution' - Martin Wolf writes at FT.com that Japan will need to reform its economy as well as inflate its money supply.

By turning the real interest rate negative and also raising real wealth, the policy might raise investment and lower savings.

Yet, at best, this would only work in the short run. At worst, it could destabilise inflation expectations so dangerously that it pushes Japan from deflation to ultra-high inflation, without stopping for long at any point in between. Thus, the Japanese might decide that the aim of the government is to impoverish them brutally, by reducing the real value of their (admittedly unsustainable) savings. If this frightened them into fleeing the yen, policy makers would be at a loss, since they could not respond by increasing interest rates without devastating the public finances. They might even have to impose exchange controls.

He particularly wants a tax on corporate savings and he makes a great point about China.

The policy options include: a huge reduction in depreciation allowances; a punitive tax on retained earnings, possibly combined with incentives for higher investment; and reform of corporate governance, to give more power to shareholders. The aims would be to deprive companies of the cash flow cushion that has featherbedded inefficiency. The worst possible tax rise is the one on consumption now planned, since Japan consumes too little. Tax corporate savings, instead.

Such reforms really would be radical. Is there the smallest chance that Mr Abe might move in this direction? No. But without this sort of reform, the BoJ’s new policy will prove, at best, a short-term palliative and at worst an inflationary disaster. Meanwhile, China needs to note that this is the end result of an economy built by favouring investment and suppressing consumption. That is a great strategy for catching up with the rich world, but it leaves huge headaches when fast growth is over.

5. America's great export is cash in the form of US$100 bills - Bruce Bartlett writes at The New York Times that exports of US$100 are rising as the black economy globally gets bigger and America's great monetary expansion leaks out the sides.

This is one of the disconnects made by those who apologise for massive money printing on the grounds its a legitimate domestic response to deflation that won't cause inflation. It's true it won't cause inflation at home, but it will sure cause asset price inflation abroad.

According to a Federal Reserve study, the vast bulk of United States currency held abroad is $100 bills. Indeed, 65 percent of all $100 bills in existence circulate outside the United States. One consequence of the rising share of United States currency held abroad is that it may distort analyses of the relationship between the money supply and economic activity.

Many economists believe that inflation results largely, if not exclusively, from an increase in the money supply, much of which consists of currency, the rest being bank deposits, travelers checks and other forms of money. But if much of the money supply circulates abroad, then any analysis correlating the money supply to domestic economic activity may be distorted and provide false conclusions.

6. Eventually the excess corporate profits will end - John Hussman argues in this piece that the rise in US corporate profits is unsustainable because it comes at the expense of government deficits and household savings slumps.

He thinks that will ultimately reverse and wipe out the recent gains in stock markets....

The exeception is if there has been a permanent lift in the corporate profit share... There has been 20 year trend of rising corporate profit share...

Here's his thinking thought that says it will revert. 

Elevated profit margins are also strongly mean-reverting over the economic cycle. In general, elevated profit margins are associated with weak profit growth over the following 4-year period. The historical norm for corporate profits is about 6% of GDP. The present level is about 70% above that, and can be expected to be followed by a contraction in corporate profits over the coming 4-year period, at a roughly 12% annual rate. This will be a surprise. It should not be a surprise.

7. Suburbs worsen inequality - Here's an interesting debate that ties into the current brouhaha in Auckland over how to develop the city. Should it only sprawl on the fringes in a new rash of suburbs? Or should we build higher density houses closer to the centre of town with all the redevelopment and blocked views that entails?

Here's Becky Nicolaides and Andrew Wiese at The New York Times:

Today’s suburbs provide a map not just to the different worlds of the rich and the poor, which have always been with us, but to the increase in inequality between economic and social classes.

From the historian’s perspective, these patterns also reveal another truth about suburban places: their tendency to sustain and reinforce inequality.

Some of this is obvious. High property values support high-achieving schools, which in turn increase property values and personal wealth. Racial redlining holds property values down, limiting investment in schools and preventing families from building equity, disadvantages that pass to the next generation like a negative inheritance. The point is not simply that rich and poor people live in different places through a kind of class sorting in the marketplace. The places themselves help to create wealth and poverty. Because of this power of places to fix inequity over time, current patterns are likely to outlive their residents.

8. Inflation is not a problem - So says the IMF in this report. David linked to it yesterday in his 90 at 9, but I think it's worth a look. Again, the powers-that-be are apparently unworried about asset price inflation and leverage. It's the same old one-track mind of consumer price inflation. Globalisation of labour markets and technological unemployment have changed the connections between economic growth, wages and prices. yet the economists don't see it. Yet.

I agree with the IMF that consumer price inflation is no longer a problem. Real wage deflation for the middle to lower income groups in the developed world, is a big problem, as are the resulting financial imbalances.

Here's the IMF.

In contrast to previous recessions, inflation has not fallen sharply during the Great Recession, and it is unlikely to spike as the recovery strengthens, according to a new study by the International Monetary Fund (IMF). There is little risk of monetary policy repeating the mistakes of the 1970s and igniting stagflation.

The stability of inflation in recent years reflects two key factors, concludes the research published in the IMF’s most recent World Economic Outlook report. The chapter uses econometric analysis and case studies to examine the drivers of price behavior.

First, inflation expectations have become more strongly anchored, or resistant to change, reflecting people’s confidence that inflation will remain close to the targets set by national central banks (see chart). Second, the response of inflation to changes in cyclical unemployment has become more muted.

9. Here's a fun interactive graphic that allows you to model how Auckland should meet its housing shortage. It's real easy online...

10. Totally Jon Stewart talking to David Stockman about the US economy.  Stockman is no fan of money printing and Too Big To Fail banks.