By Claus Vistesen, on October 24th, 2011
As I read the latest round-up of comments by Fed officials that they are certainly not ruling out another round of asset purchases I am wondering whether this signals another round of actual quantitative easing by the Fed or whether investors should change their mindset back to before the crisis where it wasn’t the USD that acted as the global carry trade funder but rather the JPY (or maybe the GBP here?).
Quote Bloomberg
Fed Vice Chairman Janet Yellen said yesterday that a third round of large-scale asset purchases “might become appropriate if evolving economic conditions called for significantly greater monetary accommodation.” A day before, Governor Daniel Tarullo said buying mortgage-backed securities “should move back up toward the top of the list of options.”
They join Charles Evans, president of the Chicago Fed, and Boston’s Eric Rosengren in calling for consideration of further stimulus to boost growth and bring down a jobless rate stuck around 9 percent or higher for 30 months. A stock-market rally and gains in manufacturing and retail sales may convince the Federal Open Market Committee, which meets Nov. 1-2, to decide that it’s too soon for a third round of bond purchases.
You see, the recent initiative of the Fed in the form of Operation Twist is not quantitative easing since it does not involve an expansion of the balance sheet. In stead, it is what we refer to as qualitative easing as the bonds the Fed intends to buy on the long end (to move long rates down to help the mortgage market) will be paid for by proceeds of selling bonds on the short end.
The biggest problem for the Fed here is not necessarily that Operation Twist is a bad idea. Indeed, to the extent that it fixes the effort squarely on halting the slide in the housing market and supporting volume and price in the primary and second market for mortgage securities I think it is an excellent idea.
But we are forgetting the auxiliary objective of QE by the Fed; to weaken the USD. Make no mistake that this is an important objective for the Fed even if they have never declared this formally. And herein lies the rub. Quite simply, with the recent announcement by the BOE of another round of QE worth £75 billion, with the ECB now willingly or unwillingly being forced into increased support of peripheral debt markets and with the BOJ also pledging more stimulus, the Fed is starting to look like the conservative central bank in the G4. [1].
In my opinion, this is very significant and also one of the reasons why Fed officials are busy ensuring markets that they have plenty of ammunition left should economic conditions merit it. But investors should not take anything at face value I think. Before the Fed actually starts to buy those MBS and/or moves to lower interest rates on excess reserves there is a real chance that especially the JPY will start to act more like the JPY of old, a.k.a global carry trade anchor of choice. Of course, this requires the BOJ to back up all the pledges with real action. For now though, the only thing we can say is that the Fed looks set to be outgunned by its peers in the G4.
EMU Outflanked
Is Europe now finally getting down to serious business or is it just another round of fudge from the fudge factory that investors have learned to respect for its ability to produce relief rallies out of nothing. Looking at the evidence I thoroughly inclined to go for the latter even if each failed attempt to shore up market confidence brings Europe closer to full fiscal union.
Even if Merkel and Sarkozy, and rightly so, appear most concerned with putting pressure on Italy, the most significant issue remains Greece which is now in default a fact that was un-sanctimoniously confirmed by the leaked bailout document which has the Troika admitting that the medicine they were mandated to administer would only make the patient worse and not better.
Quote FT
Greece’s economy has deteriorated so severely in the last three months that international lenders would have to find €252bn in bail-out loans through the end of the decade unless Greek bondholders are forced to accept severe cuts in their debt repayments.The dire analysis, contained in a “strictly confidential” report by international lenders and obtained by the Financial Times, is more than double the €109bn in European Union and International Monetary Fund aid agreed just three months ago.
The most recent estimate of haircut has now risen to 60% and this, mind you, would only reduce the debt to GDP to 110% and this without any consideration on how Greece is supposed to grow itself out of this level of debt while simultaneously dealing with the default. In addition and only adding to my disdain for the ECB, Reuters reports that the central bank opposed a 60% haircut on account that it the private sector would refuse likely refuse this leading to a “fullscale” Greek default.
I am continuingly amazed by the denial here. Ever since the first Private Sector Proposal (PSI) was put on the table, Greek has been in default and figuring out who would pay for recapitalising banks as a function of how large the final haircut ends up are merely steps in the actual default process.
The second issue on the table is what to do with the increasingly freakishly looking EFSF. There has been no shortage of suggestions on how to increase the scope of the fund using the same guarantee by the same countries for the same amount of money (currently €440 in effective capital). The suggestion that might actually work came from France which has aired the suggestion that the EFSF be turned into a bank which would then allow it to access liquidity from the ECB. Both Germany and the ECB however have vehemently denied this which indicates that there is still notable reluctance to allow the ECB to wield the full arsenal of quantitative easing.
The proposal which currently seems to have most traction is to turn the EFSF into a monoline insurer which would essentially use its capital to insure anything from 10% to 30% on any new issuance of sovereign debt by Italy and Spain. Crucially, the idea is that this “leverage” would bring calm to markets as this insurance could cover as much as 2 trillion worth of debt.
I really struggle to find adequate words here. I think this is madness and if any Eurozone politician were afraid that an equivalent of AIG would certainly enter the scene, they now seem content on creating one. The first and most widely flagged issue is this would obviously create a two tier bond market.
Quote Reuters
This would create a division between insured and non-insured debt, that could split a country’s investor base and suck liquidity out of the market unless new bonds were carefully constructed to allow them to trade on a par with existing debt.”The issuer would have to create a new curve of insured debt, limiting the liquidity in both curves with risks that investors would dump the old non-insured bonds,” said Commerzbank rate strategist Christoph Rieger.
Based on a 20 percent insurance model, JPMorgan estimates that insured bonds issued by Italy would trade at a yield around 100 basis points below existing debt with new, insured Spanish debt likely to be priced 80 bps lower than existing bonds.
I think this is significant, but we are missing the main point here. If this is set ut Spain and Italy will likely never be able to issue un-insured debt again and the contingent liability here is not only complex but will lock in future capital commitments to this aim of providing first loss insurance. For me, this is a horrible way to spend already scarce capital.
Another issue is obviously that it assumes that it will make the Spanish and Italian problem go away which it clearly won’t. However, much more fundamentally; while the idea is to ring fence Italy and Spain it almost guarantees painful haircuts in the case of Ireland, Portugal and Greece and once again, who will pay for those I might ask.
The only silver lining I have seen in the latest reports is that it seems to me that while the imminent objective is to fiddle with the EFSF, there has also been serious talk about bringing forward the ESM which would have a much stronger mandate and essentially constitute a first step towards socialising of sovereign risk in the euro zone. Until that happens, the EMU and her politicians will be continuously outflanked by economic realities.
—
[1] – I repeat that with the ECB not formally in ZIRP mode, the Fed still has the yield disadvantage here but do we really expect the ECB not to lower going forward?
By Trace Mayer, on July 14th, 2011
This has to be one of the most ironic and ignorant statement I have heard come out of Washington. The tail risk is with people like Bernanke running the Federal Reserve, Trichet running the ECB, the eurocrats trying to run the rating agencies and politicians trying to design everyone else’s lifestyle.
It appears that despite a fairly short consolidation that the next gold upleg has started. The gold 50dma is $1,522.03 and the 200dma is $1,423.69. The silver 50dma is $36.06 and the 200dma is $32.24.
During this upleg that will likely last until November before a correction or consolidation may see gold run to $1,800 and silver to the $55-60 range. It will be important to see the activity over the next week or so to determine whether the strength will stay. If the monetary metals pull back slightly and continue their usual summer consolidation then it will help the 200dma continue to rise which will lay a stronger base for the autumn and winter rally.
By Claus Vistesen, on December 3rd, 2010
Question: Which picture and caption best describes the outcome of yesterday’s ECB meeting?
“Read my lips, on n’achetera plus de dette”
“Show me to the trough”
Inquiring minds want to know. As far as I can we got the same basic New Speak as we are used to but on the other hand, as FT Alphaville points out the ECB used the occasion of the meeting to pick up a heavy portion of Irish and Portuguese bonds (since essentially, no one else wants to buy at anything near acceptable yields).
Of course, the above picture may be a bit unfair since Trichet did reiterate the “we are here to help” discourse in the sense that existing measures to provide liquidity will be kept in place. However, the expectation was that a heightened risky environment would also call for additional measures. Concretely, investors have been buzzing around the prospects of the ECB moving closer to the outrigt QE position of the BOE and Fed.
On this, Trichet and his colleagues so far stayed their course as the chairman reiterated that purchases on the Securities Market Program would remain to be fully sterilised. So far so good, but as Matteo Regesta from BNP Paribas SA in London points out (via Bloomberg);
“In the scenario where SMP eventually increases to a meaningful size, weekly full sterilization of the stock will become a non- trivial task. The only way to avoid such a jam is to keep the program at a low scale.”
So, there is an inflection point somewhere it seems and we may soon find out where it is.
By Claus Vistesen, on November 2nd, 2010
Well, in case you had not noticed this is a rather big week in the markets so allow me to jump the bandwagon of market participants in dire need of some action after past’s weeks calm before the tempest. I will consequently be featuring Alpha.Sources’ first insta-blogging event which will take place in this post. Of course, I am rather busy this week too so I am not sure how much live blogging I will actually do, but do stay tuned anyway … I might surprise you.
Speaking of surprises, the RBA initiated the central bank action by saying ‘f’ck off, we can take it’ to all actual and soon-to-be QE wielding central banks out there.
(quote Bloomberg)
The Reserve Bank of Australia unexpectedly increased its benchmark interest rate on concern stronger growth will cause inflation to accelerate, driving the nation’s currency toward parity with the U.S. dollar. Governor Glenn Stevens raised the overnight cash rate target a quarter point to 4.75 percent in Sydney, saying the economy has “relatively modest amounts of spare capacity” and citing risk of “inflation rising again over the medium term.” It was the RBA’s first move in six months.
The move signals Stevens wants to avoid a repeat of 2007, when he held off raising rates for months as slowing inflation masked a buildup in price pressures. Growth in Australia, which skirted a recession during the crisis, may strengthen as energy companies such as BG Group Plc add construction jobs.
Now, on the basis of the economic dynamics in Australia I can see why this makes sense but in a global economy where the Fed, the Boj and soon, I think, the ECB are in full QE mode it takes a brave soul to go the other way and actually offer yield for all that leveraged carry that is about to flow Stevens’ way.
By Bron Suchecki, on September 7th, 2010
Sales by overseas central banks could see a sharp fall in gold prices, the Financial News reported Wednesday, citing Zou Pingzuo, a central bank researcher.
“Investors should be careful about investing in gold. Gold prices could fall sharply because of intensive gold sales by the U.S. and other overseas central banks,” Zou said.
To me this a sign of desperation by the Chinese. There has been no indication by the US to sell and all recent talk is about central banks buying. They are trying the old scare tactic of central bank selling to try and push the gold price down. They want to buy as much gold as they can but don’t like the current high price. I think they are hoping this “bubble” will deflate and they can continue with their sneaky “get out of dollars and buy gold”. What happens when the Chinese realise the price isn’t going to drop? Will they be forced to go all out and start buying whatever physical they can?
By Claus Vistesen, on August 23rd, 2010
I know this is a cheap shot, but still. Team Macro Man picks up an all time favorite over at MM and asks 20 questions (check this out for other answers) to which I have offered 20 answers.,
- Will the 10yr Treasury yield breach 2% this year?
- When will the Japanese intervene?
- Will the US finally get tough with China in the run up to the mid-terms?
- When will the UK have a 4% CPI print?
- What will US GDP be for 2H 2010?
- Will SNB LLC resume macro punting (aka EURCHF interventions) this year?
- Does the SPX trade 1040 or 1140 first?
- Will Simon Hughes cause the ConDem coalition to collapse?
- Who will win the Labour leadership contest?
- Are we turning Japanese?
- Who will be the first to hike? Fed, BoE or ECB?
- Does Drukenmiller’s departure herald the end of Macro trading?
- When will the divergence between Eurozone and US growth surprises begin to close, and how? Eurozone weakness or US strength?
- Will the Republicans capture the House?
- Will Voldemort ever stop taking the piss?
- Which will be the next Macro fund to call it quits?
- Is the Bank of England losing control of inflation?
- Is there a bond bubble?
- When will the Fed move the Interest On Reserves (IOR) Rate negative?
- What will happen to the GSEs?
And my answers …
1: Yes (Q4)
2: If the USD/JPY hits 80 or if it stays at 85 til Q4
3: No
4: They won’t
5: (qoq) Q3 0.3%, Q4 0.2%
6: No
7: 1040
8: No Idea
9: Ibid
10: Europe is, the US is touch and go; I think they might just make it!
11: Fed in Q4 2011
12: Who?
13: In H02 2010 (Eurozone weakness)
14: Yes
15: No
16: Not yours I hope!
17: No
18: Yes, but it has some time still to run
19: H01 2011
20: Nothing in the next 18 months.
Don’t bet all your portfolio on this though. It is just fun and sports!
By Ajay Shah, on August 17th, 2010
Raghuram Rajan’s book Fault Lines (Princeton University Press for the international edition, and Harper Collins for an Indian
edition with a special chapter on India) is possibly the most thought-provoking contribution in the aftermath of the economic and
financial crisis that has engulfed the West after 2007 with significant global repercussions.
The epilogue of the book summarizes its punch line:
The crisis has resulted from a confusion about the
appropriate roles of the government and the market. We need to find
the right balance again, and I am hopeful we will.
The key idea of Fault Lines is to focus on slow-moving tectonic plates in the global economy: consumption by borrowing in
countries with fiscal deficits, excess savings in exporting countries that are fiscally in surplus, and growing sophistication of the
financial sector. None of these movements might seem dangerous in itself, but when these plates come together and collide, the global economy can get badly shaken. To most players focused narrowly on their own positions, leave alone the movements of the plate they stand on, the earthquake – like this crisis – may seem an unfortunate happenstance. In the analytical framework of Fault Lines, the crisis was not a pure accident and that more severe crises could arise in future unless the root causes are addressed sufficiently soon.
The book presents two important government distortions in the global economy and their underlying causes. These are (i) the push for universal home ownership in the United States, and (ii) export-led growth in countries such as Germany and China. Together,
these policies have led to massive “global imbalances”, with some countries such as the United States, the United Kingdom and
Spain persistently being in deficit, and borrowing from the surplus, exporting nations. While pursuit for home ownership affordability and growth do not necessarily have to be distortionary, the book makes the sharp observation that these have been occurring at the expense of something more important but subtle.
In the United States, there has been growing income inequality, which combined with a relatively feeble safety net for the poor and
unemployed, has created pressure on politicians to find quick ways to bridge the inequality. Instead of improving the long-run
competitiveness of labor force for a global market with a changing mix of industries and required skills, governments have adopted the short-run option “let them eat credit” (the title of Chapter One). The presence of government-sponsored financial firms in
the United States (Fannie Mae and Freddie Mac, in particular) enabled exercising such an option readily through a push for priority
lending to the low-income households (sub-prime mortgages).
In case of surplus countries, it has been the problem of exporting to grow (the title of Chapter Two). Their single-minded focus on exports has led governments to ignore the domestic sector, preventing sufficient redeployment of surplus for internal development, and somewhat perversely, even boosted domestic savings rates significantly due to lack of adequate safety nets (at
least in case of China, if not in case of Germany). As someone mentioned in a recent dinner conversation: Each child in China is
saving to fund post-retirement expenses not just of two parents but also of four grandparents. These savings have thus had no place to go but outside, giving rise to massive capital inflows that fueled the housing sector expansion in the US, the UK and Spain.
What is fascinating is that Fault Lines explains how these lop-sided government policies of two separate sets of countries have
interacted with each other – and with the financial sector – in fueling the expansion to levels of unsustainable housing bubbles. The
idea here is that the invisible hand operating through the price when the price is distorted can also lead to massive distortions in the
allocation of capital. The financial sector in developed world is so sophisticated and amoral (a great choice of word by the author) that its dispassionate pursuit of profits leads it to direct capital to wherever there is a relative mis-pricing. So if governments are
subsidizing home ownership, efforts will be made to deploy all free capital of the world to the housing sector. If some governments are finding it cheap to borrow because savings are seeking them out, the financial sector will grow at a sufficient rate to absorb and support expansion of housing credit through these capital inflows.
Clearly there have been incentive-based distortions in the financial sector, especially due the short-term nature of accounting-based compensation that ignores true long-term risks. The book explains, however, that the bigger issue was something else: that the imbalance of capital flows and the ease of pushing sub-prime home ownership – both due to government distortions – meant the
financial sector was essentially a conduit to making happen what the rest of the world was seeking to achieve. In the process, banks made a ton of bad loans (but the governments were happy with that till it all really blew up). And some parts of the financial sector pursued this role even more aggressively than one could have imagined due to the steady entrenchment of too-big-to-fail expectations — large banks being repeatedly bailed out through government forbearance and enjoying Central-Bank monetary stimulus each time markets turned south.
Some may question the basis of this argument by saying – why did we see credit expansion across board and not just in low-income
households? Here, Fault Lines focuses on a rather fascinating phenomenon that recoveries from recent recessions, especially in the
United States, have remained “jobless” for extended periods of time. Perhaps as a subconscious response to this (or due to
ideologies in other cases), Central Banks have tended to provide massive monetary stimulus to get the financial sector to push the
household consumption and real sector investment harder and harder through greater lending and intermediation. Such stimulus,
unfortunately, again serves to transfer rents from households to the financial sector (by keeping interest rates low) and produces
mispriced risk. Thus, the economy moved “from bubble to bubble” (the title of Chapter Five), until the most recent bubble could not be mopped up by anyone, not even the most innovative Central Bank of all, despite its own best efforts.
In essence, Fault Lines connects the dots visible to all of us in a rather ingenious manner to provide an explanation of what brought about the perfect storm we have recently weathered.While the book is worth it even just for its explanation of why we had a crisis now rather than at some other points of time, it goes the extra mile and proposes valuable reforms, focusing on all three
issues: building a better safety net in the United States (see in particular, the suggestions to improve education access to all and
extend a greater level of unemployment insurance), reducing the global imbalances, and improving the regulation of the financial sector so that it (and its financiers) pay for mopping up of bubbles it fueled, rather than governments and Central Banks passing on these costs to taxpayers.
The book also helps understand why export-based Chinese and German growth, and their effective vendor financing of consumption in the US and Euro-zone countries, may ultimately face limits as consumption slows. These countries are now being forced to become the stimulators of growth and run the risk of planting seeds of bubbles in their own economies. This is how hidden fractures still threaten the world economy, as the book’s subtitle goes. It also leads one to reconsider that India’s slower growth rate than China, while not entirely faultless, might however be more balanced given its lack of extreme export reliance.
Raghuram Rajan’s writings are always cogent and based in sound set of facts. But this book is special in the sense that here he paints on a much larger canvas, covering bases from distributional issues within income strata of society, to the persistent capital imbalances across large countries of the world, and the ruthless profit-maximizing incentives of modern market-based financial sector.
There is a lot going on in the book. But it is written with great examples and cases – almost lyrical at times (even has a fascinatingpoem recounted in the chapter “The Fable of the Bees Replayed”), and should be accessible to one and all. It willcertainly question some long-held biases about current state ofeconomic conditions in Western countries. But it is hard to not take a deep breath and ponder once you have read it all. In many ways, it shows that when economic conditions so demand or induce, the developed world behaves much the same way as the developing world: they are both after all driven by choices of human beings and the book lays out somecommon patterns of global economic behavior – in households, marketsand governments.
By Claus Vistesen, on June 2nd, 2010
Turning back the Clock on Global Monetary Policy
Sovereign risk and debt continues to mark the fault lines in the global macro landscape and thus the main discourse. In this context and although the technical recovery is still a reality the discourse has started to move into a decidedly bearish mood. I find this interesting since while financial markets, in traditional fashion, have reacted strongly and early on the sovereign debt crisis in Europe it is only now that we are about to close the book on H01-2010 that we are seeing significant and lingering worries from all sides that the we are headed straight into a double-dip recession.
To put it differently. My call, a week ago, concerning short term belief in a technical recovery may now return to haunt me. Of course, in that specific note I did talk about divergence and I think this is really important to factor in when talking about the global economy. Consequently, and even in the context of developed economies alone there will sharp divergence between economies that will return to some form of growth and others who will linger in depression. Conversely, in relation to the emerging economy edifice I am largely constructive and indeed, the problem here is how to deal with the volume and volatility of yield chasing inflows as a result of super abundant liquidity provided by the G3 central banks. As I keep on emphasizing the idea of a global monetary transmission mechanism (and subsequent carry trades) and how they interact with domestic monetary policy decisions and objectives is very important to factor in to your analysis.
In that respect, Morgan Stanley’s Manoj Pradhan had a very good birds eye view of global monetary policy last week and specifically, the following point is a good way to conceptualize some of the costs and challenges associated with being the first to raise interest rates while G3 liquidity is provided in ample quantities.
Thanks to the Great Recession and the synchronised policy response to it, central banks find themselves riding in a monetary peloton. Central banks like the Bank of Israel, the Norges Bank and the RBA that started hiking rates early (the front-riders) faced dual headwinds. First, the widening interest rate differential and abundant liquidity drove their currencies’ values higher. Second, higher policy rates failed to translate into tighter financial conditions due to low bond yields and buoyant equity markets in the major economies to which most financial markets around the world remain linked.
This is very close to my own viewing of the current setup in the global economy and also a setup which links in with the discourse on global imbalances. Concretely, you only need to add Pradhan’s first and second point above to see how it may effectively make higher interest rates counter productive relative to the aim of cooling domestic overheating and bubbles in the making. In fact, by raising interest rates while the G3 are in QE may lead to an exacerbation of the very boom in domestic inflation/assets that the tightening bias was meant to secure against in the first place.
Apart from chapter 4 of the recently published Global Financial Stability Report by the IMF (which is really a must read), a new paper from the Asian Development Bank also discusses this issue with specific focus on Asia and the distinction between floaters and non-floaters relative to the USD.
Turning to the immediate economic cycle Pradhan notes the fact that hitherto hawkish central banks (e.g. Israel, Norway, and Korea) have recently backtracked on their interest rate increasing credentials.
Just a few months ago, most central banks were likely deciding how soon they would have to begin their hiking process. It was too early then for most G10 central banks to start raising rates (with the notable exceptions of Norges Bank and the RBA) but markets mostly saw risks that would tempt monetary policymakers to hike sooner rather than later. That was then. Now, the risk of a spillover of euro area problems into global growth and commodity prices and a subsequent dampening of inflation expectations have shifted risks the other way. Our US and euro area teams have pushed back the first rate hikes from the Fed and the ECB to 1Q11 and 3Q11, respectively. In addition, the ECB’s asset purchase programme (and, to a much lesser extent, the reinitiating of FX swap lines between the Fed and major central banks) has been a step in a direction directly opposite to an exit from QE. In other G10 economies too, central bank statements show increasing concerns about global growth and funding market stress.
In its recent monetary policy report, Norway’s central bank played down the expected increase in interest rates (although I expect them to resume hiking in due course), the central bank of Korea also opted to leave interest rates on hold and so did the Bank of Israel. More importantly and contrary to earlier expectations the first half of 2010 has not seen the reduction of QE wielding central banks, but actually added one to the fold in the form of the ECB biting the bullet and engaging in outright purchases of Eurozone government paper. And thus as Mr. Pradhan points out, the day when excess liquidity is going to be mopped up has been postponed yet again. If, as I expect, the Reserve Bank of Australia also opts to shelve an otherwise planned (or earlier expected) interest rate hike this Tuesday, a clear picture of monetary backpedaling is emerging.
Bugs in the System …
To be perfectly honest, Martin Wolf does not really put anything new to the table in his latest column which paints the global economic system as one being populated by grasshoppers (the importers/deficit nations) and ants (the exporters/surplus nations). Still, his allegory is interesting and useful in terms of pinpointing the current setup of the global economy characterised, as it were, by macroeconomic imbalances and no real way to resolve them since there are simply too many would-be ants and not enough grasshoppers. But wait a minute, this my spin on the story not quite, I think, how Mr. Wolf sees it;
Today, the ants are Germans, Chinese and Japanese, while the grasshoppers are American, British, Greek, Irish and Spanish. Ants produce enticing goods grasshoppers want to buy. The latter ask whether the former want something in return. “No,” reply the ants. “You do not have anything we want, except, maybe, a spot by the sea. We will lend you the money. That way, you enjoy our goods and we accumulate stores.”
(…)
What is the moral of this fable? If you want to accumulate enduring wealth, do not lend to grasshoppers.
Now, let me reciprocate Martin Wolf in his analysis by also bringing nothing new to the table in my continuing emphasis on demographics and specifically how demographics ultimately determine whether you turn up being an ant or a grasshopper or perhaps even how and why you merge from the latter into the former. My small niggle with Mr. Wolf’s argument is thus the implicit assumption, as I see it, that you can actually choose to be either an ant or a grasshopper. Naturally, to some extent you can, but I would qualify the argument in a very important way. In this way, demographics and specifically an economy’s median age is a good yardstick through which to determine whether it will act more as an ant or a grasshopper. In a nutshell, as the median age increase you become more and more like an ant with the subsequent desire and need to accumulate liabilities on others in order to achieve economic growth and preserve wealth. And this brings us to Wolf’s final point and the alleged moral which I believe is false, indeed almost non sequitur. In this way, we need the grasshoppers just as well as we need the ants and specifically if ageing (which is a convergent global phenomenon), as I argue, leads to an increasing prevalence of ant like behavior the scare resource becomes the grasshopper who are willing and able to borrow.
Small business, big effect
One of the great unsung stories of this “crisis” (at least seen from my perch) has been conditions for small business and especially credit and lending conditions. This is odd since in terms of the real economy these companies are far more important than their bigger listed brethrens; or at least as important. Consequently and while the post March-09 rally has seen many a big listed company head back to the trough in the form of issuing stock or debt (as well as the odd IPO and M&A) the conditions for small business has in many respects remained lackluster. Or have then? Well, I have not done the analysis myself and any analysis on this subject is bound to be very sensitive not only to the country in question, but indeed also the region/state and industry.
This makes it inherently difficult to generalize but I still found this report by the Atlanta Fed about the credit conditions for small businesses in Alabama, Florida, Georgia, Louisiana, Mississippi and Tennessee (using a survey sample of 311 companies) an interesting read. What I especially like was really the introduction in which Paula Tkac (assistant vice president and senior economist at the Atlanta Fed) touches on the very important issue of disentangling supply and demand drivers in the context of assessing the impact of “tighter” credit conditions. In this sense, deleveraging which has now become one of the main underlying structural forces that drive real economic activity essentially may be propelled by both demand and supply factors.
On the demand side, simple changes in preference may lead to a lower demand for debt or more precisely, the correct discounting, by the individual or the company, of her economic situation may lead to less demand for debt. In addition (and very relevant for the analysis by the Atlanta Fed) demand may go down because some would-be borrowers are “discouraged” from applying for credit as they anticipate a negative outcome of their application. On the supply side and beyond the obvious effect of raising price/the interest rate (in a wide discretionary move) credit may simply not be available in the same quantities or some economic agents may be precluded entirely from having access to credit.
As Paula Tkac notes, it is difficult to say when one ends and the other begins and ultimately, supply and demand effects will be interrelated. The concrete results from the Atlanta Fed survey, while note general, suggest that the traditional discourse of blaming conservative or frightened banks (or perhaps even capital requirements and thus regulation) is essentially a pot shot;
Indeed, the results of our April 2010 survey suggest that demand-side factors may be the driving force behind lower levels of small business credit. To be sure, when asked about the recent obstacles to accessing credit, some firms (34 firms, or 11 percent of our sample) cited banks’ unwillingness to lend, but many more firms cited factors that may reflect low credit quality on the part of prospective borrowers. For example, 32 percent of firms cited a decline in sales over the past two years as an obstacle, 19 percent cited a high level of outstanding business or personal debt, 10 percent cited a less than stellar credit score, and 112 firms (32 percent) report no recent obstacles to credit. Perhaps not surprisingly, outside of the troubled construction and real estate industries, close to half the firms polled (46 percent) do not believe there are any obstacles while only 9 percent report unwillingness on the part of banks.
In many ways, the idea that demand side factors are just as prevalent in the process of deleveraging as are supply side conditions is an important entry point to understand the real economic dynamics from the crisis on, in this case, the US economy. In this sense and if you will allow me to briefly expand the perspective it means that there is no switch that can be turned on which will bring us back to normal once funding conditions in the bank sector returns to normal. Indeed, during the initial phases of the crisis in which the seizure of the wholesale money market was the talk of the town a widespread assumption emerged, almost by definition, that once central banks had restored confidence the supply of credit/funding could return to normal and we could be back on our merry way. We know now of course that this was not the case and while the huge back draft of turd assets and the concrete need to rebuild balance sheets still acts as an important supply side constraint I take the Atlanta Fed’s analysis as a small and local evidence for the notion that a more profound structural change has taken place.
Well, I may be taken it too far of course and I certainly would not want to make the Altig et al. at the Atlanta Fed straw men for my musings, but I still hold this to be significant. The report by Paula Tkac is worth reading in its entirety as it also goes into the obvious point that the impact on small business credit conditions from the crisis is strongly industry biased (basically, construction and real estate companies face much tougher credit conditions).
By Ajay Shah, on February 26th, 2010
Financial stability, regulatory coordination, financial reforms
So far, in India, regulatory coordination was based on the HLCC. This has not been a particularly good experience. The HLCC was not statutory and there was no defined mechanism through which decisions would be obtained. Many inter-regulatory difficulties simply languished. One peculiar aspect of the HLCC was that it was chaired by the RBI governor, while RBI was at the centre of many inter-regulatory disputes. It was awkward, having one of the competing views on a question being the chair.
On these questions, the Raghuram Rajan report had said:
A Financial Sector Oversight Agency (FSOA) should be set up by statute. The FSOA’s focus will be both macro-prudential as well as supervisory; the FSOA will develop periodic assessments of macroeconomic risks, risk concentrations, as well as risk exposures in the economy; it will monitor the functioning of large, systemically important, financial conglomerates; anticipating potential risks, it will initiate balanced supervisory action by the concerned regulators to address those risks; it will address and defuse inter-regulatory conflicts, and look out for the build-up of systemic risks.
The FSOA should be comprised of chiefs of the regulatory bodies (with a chair, typically the senior-most regulator, appointed from amongst them by the government), and should also include the Finance Secretary as a permanent invitee. The FSOA should have a permanent secretariat comprised of staff including those on deputation from the various regulators. There should be a prescribed minimum frequency of meetings of the FSOA. All issues of regulatory co-ordination, and supervision of systemically important financial conglomerates and financial institutions will be taken up by the FSOA.
The discussions of the FSOA with the management of systemically important institutions will be principles-based, and ts will initiatete the process of gradually implementing more principles-based regulation throughout the system. It will be important that the FSOA add value by substituting for some existing processes instead of adding another layer, while bringing collective regulatory views to bear. It is not our intent that the FSOA be a super-regulator displacing existing regulators. Instead it provides needed coordination and fills gaps that current structures have proved inadequate for.
In addition, there is merit in setting up a Working Group on Financial Sector Reforms with the Finance Minister as the Chairman. The main focus of this working group would be to monitor progress on financial sector reforms (such as the proposals of the Patil, Parekh, Mistry, and this committee), and to initiate needed action. The working group’s membership would include the regulators, as well as ministries on as-needed basis. The working group would be supported by a secretariat inside the Finance Ministry.
There was a contrasting view. After the global financial crisis, we got a strong campaign by RBI, based on the proposition of financial stability. It was claimed that now that financial stability is important, the original role and structure of RBI (as envisaged in the 1934 legislation) is the right one, so all reform proposals should now be shelved. Suggestions were made that the financial stability function should be handed over to RBI, which could ultimately lead to RBI becoming the super-regulator of finance, with the power to give instructions to other regulators such as SEBI based on financial stability considerations. Every bureaucracy likes to stave off change, and to grow its turf, so the arguments put forward by RBI were less than persuasive given its self-interest.
I have been skeptical about the idea of placing financial stability functions at RBI, for a few reasons:
- Crisis management involves utilisation of taxpayer resources, which can only be authorised by the treasury. Indeed, if a banking regulator is given a stability function, he will be inclined to cover up for the failures of banking supervision by utilisation of taxpayer money.
There is a similar problem when a banking regulator who is also a central bank is inclined to cover up for the failures of banking supervision by giving `short-term liquidity support’. This problem is already with us in India. We should not make matters worse.
- The essence of financial stability thinking is to break out of India’s silo system, and look at the overall financial system. The inhabitants of any one silo in India are likely to be ill equipped to think about the overall financial system.
- Financial stability thinking repeatedly involves asking any one regulatory agency to question its existing way of thinking. If an existing agency doing a lot of financial regulation is asked to do financial stability, this will not come about. Worse, there is the danger of `regulatory capture’ where every regulatory agency tends to adopt the world view and maximisation of its firms. If RBI is asked to do financial stability work, we run the risk that these new levers of power will be used to favour banks at the expense of other kinds of financial firms.
- It is hard to obtain sensible notions of transparency and accountability in the nascent field of financial stability. There is much merit in a principal-agent problem approach in designing the block diagrams of government. When a clear document can be written down specifying a job that has to be done, then it is better for government to contract that out to an external agency, since the clarity of mandate makes possible accountability. But for the things where a clear contract cannot be written down, contracting-out to an external agency is hard, and it is better to in-source these functions.
- New work that we initiate in India should not interfere with our long term goals of establishing a proper central bank.
I am quite comfortable with the two interesting models out there. In the US, there are many financial regulators, and stability functions are being placed in a council of regulators. That makes sense. And in the UK, the Bank of England does no financial regulation, and it has been asked to do stability work. That also makes sense since the BoE takes an outsiders view of the work of the FSA. The staff quality of the Bank of England also encourages confidence that this will be in a technically sound way, without being imbued with an ideology of hostility to finance. In an Indian setting, both approaches make sense. Either all financial regulation is removed from RBI, a high quality central bank is created with staff quality matching that of the BoE, and this is tasked with the financial stability function. Or, we go for a council of regulators.
This debate had simmered for some time. In the budget speech today, the Finance Minister announced the decision taken by government on how this should be handled:
37. The financial crisis of 2008-09 has fundamentally changed the structure of banking and financial markets the world over. With a view to strengthen and institutionalise the mechanism for maintaining financial stability, Government has decided to setup an apex-level Financial Stability and Development Council. Without prejudice to the autonomy of regulators, this Council would monitor macro prudential supervision of the economy, including the functioning of large financial conglomerates, and address inter-regulatory coordination issues. It will also focus on financial literacy and financial inclusion.
This seems to be some kind of fusion between the Raghuram Rajan proposals of the FSOA and the Working Group on Financial Sector Reforms. More details are awaited from DEA on how they want to play this.
Financial Sector Legislative Reforms Commission
The four major committee reports on Indian finance — Patil, Mistry, Rajan and Aziz — have all emphasised a comprehensive overhaul of outdated laws. The laws of 1934, 1952, 1956, etc. are quite out of touch with the India of today. And this job is complicated by the fact that one amendment to the laws at a time does not cut it. You might like to see my article in Pragati magazine in August 2009, where I argue that changing the laws is the essence of financial reform in India today.
In today’s budget speech, the FM said:
101. Most of our legislations governing the financial sector are very old. Large number of amendments to these Acts made at different points of time has also increased ambiguity and complexity. The Government proposes to set up a Financial Sector Legislative Reforms Commission to rewrite and clean up the financial sector laws to bring them in line with the requirements of the sector.
Large complex IT-intensive projects
Stepping away from new laws, economic reform in India is critically about big and complex IT systems. These present unique challenges of public administration, when compared with the traditional ways of working of government in India. A new process manual is required through which these big complex IT-intensive projects can be rolled out and run.
In today’s budget speech, the FM said:
104. An effective tax administration and financial governance system calls for creation of IT projects which are reliable, secure and efficient. IT projects like Tax Information Network, New Pension Scheme, National Treasury Management Agency, Expenditure Information Network, Goods and Service Tax, are in different stages of roll out. To look into various technological and systemic issues, I propose to set up a Technology Advisory Group for Unique Projects under the Chairmanship of Shri Nandan Nilekani.
Co-contribution for unorganised sector in NPS
There is an increasing sense that a government should help grow the participation of the informal sector in a defined-contribution individual account pension system by having co-contribution. In today’s budget speech, the FM said:
90. To encourage the people from the unorganised sector to voluntarily save for their retirement and to lower the cost of operations of the New Pension Scheme (NPS) for such subscribers, Government will contribute Rs.1,000 per year to each NPS account opened in the year 2010-11. This initiative, “Swavalamban” will be available for persons who join NPS, with a minimum contribution of Rs.1,000 and a maximum contribution of Rs.12,000 per annum during the financial year 2010-11. The scheme will be available for another three years. Accordingly, I am making an allocation of Rs.100 crore for the year 2010-11. It will benefit about 10 lakh NPS subscribers of the unorganised sector. The scheme will be managed by the interim Pension Fund Regulatory and Development Authority.
91. I also appeal to the State Governments to contribute a similar amount to the scheme and participate in providing social security to the vulnerable sections of the society.
A coherent vision for pension reforms is not yet in place: right alongside this, the government talks about a National Social Security Fund for unorganised sector workers with Rs.1000 crore.
Entry barriers in banking
One of the key mistakes in Indian banking has been the entry barriers: until recently, the rules inhibited placement of ATMs, placement of branches, new private banks, branches by foreign banks, money market mutual funds. There has been some progress on placement of ATMs and branches in recent months. A next step was announced in the budget speech:
38. The Indian banking system has emerged unscathed from the crisis. We need to ensure that the banking system grows in size and sophistication to meet the needs of a modern economy. Besides, there is a need to extend the geographic coverage of banks and improve access to banking services. In this context, I am happy to inform the Honourable Members that the RBI is considering giving some additional banking licenses to private sector players. Non Banking Financial Companies could also be considered, if they meet the RBI’s eligibility criteria.
A coherent vision for banking policy is not yet in place: right alongside this, the government promises to put Rs.16,500 crore or roughly 0.3% of GDP to increase the equity capital of PSU banks.
By Bron Suchecki, on January 11th, 2010
Two interesting quotes caught my eye in a recent Andy Smith note:
“We cannot stop terrorism or defeat the ideologies of violent extremism when hundreds of millions of young people see a future with no jobs, no hope, and no way ever to catch up to the developed world” Hillary Clinton, Remarks to the Center for Global Development at the Peterson Institute for International Economics
For a moment there I thought she was talking about the US – “when millions of young Americans see a future with no jobs, no hope, and no way ever to catch up to the Baby Boomers”. Generational class warfare anyone?
“could seriously disrupt bond markets if it triggered concerns about creditworthiness or inflation because of concerns with government incentives to inflate debt away” Bank for International Settlements in invitation to top central bankers and financiers for a meeting in Basel
This doesn’t need any further comment for readers of this blog, suffice to say I find it interesting that the BIS acknowledges that inflating debt away is an option.
PS – unfortunately Andy Smith’s stuff is not publically released, because I rank him as the top precious metals analyst.
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