Daily Archives: January 10, 2012

The unexpected departure of Bill Daley as Barack Obama’s chief of staff and replacement by Jacob Lew, director of the Office of Management and Budget, is a setback for economic policy going into a critical period. But it also presents the president with an opportunity to improve his case for re-election.

Mr Daley, scion of a famous political family from Chicago, generally got low marks as chief of staff since taking over the position last January. Liberals often complained that the former Commerce Department secretary was too close to the business community and inattentive to the concerns of Democrats in Congress.

Nevertheless, it is not good for any president to have to deal with such an important change going into a tough election year. The White House chief of staff must juggle the president’s political needs on the campaign trail and those of the cabinet as well. He must also keep the ship of state on course while the president’s attention is necessarily heavily focused on campaign strategy. And the chief of staff is often the principal liaison with the Democratic National Committee and other senior political officials.

Moreover, the White House itself is a large organisation that requires a significant amount of nuts-and-bolts managerial attention. (I worked there during the last two years of Ronald Reagan’s presidency.) In short, the chief of staff is sort of an executive director for the entire government. Any change in the position is unsettling.

Mr Lew will have no difficulty filling Mr Daley’s shoes. He has significant government experience both at OMB and the State Department, where he was the number two official from 2009 to 2010. However, his departure leaves the OMB, which has primary responsibility for drafting and implementing the federal budget, without a leader at a time when budget issues are unusually sensitive, both economically and politically.

Democratic partisans will question whether Mr Lew, who is known principally as a technocrat, has the political skills to be chief of staff during a presidential election year. While his managerial skills are unquestioned, Mr Lew has never been known as a “politico”. Mr Obama may need to bring in a seasoned political operator in a senior capacity to fulfil that function.

The president’s annual State of the Union address is scheduled for January 24, followed shortly by submission of his budget and economic report. These documents will lay out the White House’s agenda for the coming year and also be the foundations of Mr Obama’s case for re-election. With the economy being both the most important political and substantive issue he faces, failure to put forward viable economic and budgetary strategy could be highly damaging, politically, and leave policy adrift until after the election.

But while there is obviously danger in being forced to make a major staff change at an inconvenient time, Mr Obama may benefit by having an opportunity to set a new tone and direction for his presidency. In Mr Lew he has someone he can rely upon, who is well versed in the issues upon which his re-election will succeed or fail. It could be a blessing in disguise.

The writer served in the administrations of Ronald Reagan and George H. W. Bush. His latest book, ‘The Benefit and the Burden: Tax Reform – Why We Need It and What It Will Take’, was reviewed in the Financial Times this week

Another day and another previously unthinkable development becomes reality in Europe. Yet what on the surface appears to be good news for Germany – the record low yield at its latest government debt auction – is actually an indication of growing stress elsewhere in the region.

At Monday’s regularly-scheduled auction, the German government sold six-month securities at a negative yield of 0.012 per cent. Investors who bought them made history. Rather than receive interest income for lending money, they were the first to pay the German government for the privilege of converting their cash into securities that, at the margin, are less liquid and subject to mark-to-market volatility.

The outcome should not have come as a great surprise. Negative yields had already occurred in secondary market trading for short-dated German government securities. Moreover, a similar phenomenon had taken place in the US at the height of the global financial crisis.

Some Germans may be tempted to welcome the cheap source of funding. But before celebrating too much, they would be well advised to consider both the causes and the implications.

Investors fleeing dislocated government debt markets elsewhere in Europe are attracted to Germany by its solid balance sheet and its fiscal discipline. Moreover, the fruits of years of structural reforms by Berlin are being harvested in the form of vibrant job creation and solid international competitiveness.

Part of this investor repositioning is funded by the sale of other European government debt. Another is being  channelled through the banking system, with German banks gaining deposits at the expense of most other European banks.

Operational stress in Europe’s financial system is also a factor. Due to technical dislocations similar to what America experienced three years ago, some banks are forced to scramble in order to get their hands on high quality collateral, helping to push German yields to artificially low levels.

The longer these factors persist, the greater the likelihood that other private sector entities will also be pulled in the short-run into buying German securities. Over a longer time horizon, however, negative yields on the bills will reverse course, especially if conditions improve elsewhere in Europe. Yet, even then, there is a risk that a large portion of the new money pouring into German debt could prove more durable given that it is being hardcoded through investor- and depositor-driven changes to investment guidelines and benchmarks.

German rejoicing for borrowing money at negative rates should thus be tempered by the reality of Europe experiencing an accelerating disengagement of the private sector from the region’s economic integration project. This undermines growth and employment, shifts more of the load to taxpayers, and places even greater demands on creditor and debtor countries alike – all serving to aggravate an already-strained process for agreeing on the appropriate policy response and related burden sharing.

At a time of considerable domestic resistance, governments in surplus countries (essentially Germany, but also others such as Finland and the Netherlands), as well as the European Central Bank, will face even greater external pressure to substitute more of their solid balance sheets for the delevering private sector. Meanwhile, debtor countries will be expected to do even more on the austerity front, thereby aggravating internal tensions and sacrificing both actual and potential growth.

Rather than welcome negative yields, Germany should interpret the outcome of Monday’s auction as further indication of the gravity of the situation facing the eurozone as a whole. It is another alarm bell calling for more forceful steps to improve the region’s policy mix, counter banking fragility, and strengthen the institutional underpinning of a “refounded” Europe.

The writer is the chief executive and co-chief investment officer of Pimco

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