There’s an interesting question about “analysis” which confronts anyone who seriously wants to engage in it: do you organize your focus around what you want to happen (practical policy emphasis) or do you concentrate your efforts in detailing and outlining what you think will happen? Naturally the closer you are to having an ideological discourse the harder this distinction is to either see or maintain. But even for “non ideological” thinking the issue is far from being an easy one. Whether or not there is any such thing as “objectivity” is a complex philosophical question and attempts to achieve it fraught with all manner of difficulty, but surely we at least have to try? Continue reading
Spain’s domestic economy is booming, or so the story goes, and in no small part this boom comes thanks to the arrival of what is being termed the “good kind of deflation”, the sort everyone would like to have, a world where prices fall, real incomes rise, jobs are created, and everyone gets to live happily ever after. Let’s not worry that in the process the boom is steadily transforming an export lead recovery into a domestic consumption – or import driven – one. Continue reading
An interesting twitter debate between Alan Beattie and Frances Coppola, regarding the connection between Greek “structural reforms” and the macro-economy.
Alan argues that shortening business-to-business payment terms and improving contract enforcement should just generally be a good thing and shouldn’t have any macro effects in the short term.
Frances retorts that it’s always cash flow that causes businesses to fail, and anything that tightens cash flow will cause more business failures as the first-round effect.
Alan responds that companies who benefit from going slow on payments are usually just well-connected rent seekers and that they’re exploiting ones that have more potential upside.
I think we can be a bit more precise here. If money gets rid of the need for a double coincidence of wants, finance gets rid of the need for a double coincidence of timing. I don’t necessarily need to wait to sell in order to buy, if I can use trade credit, for example. One of the earliest known financial instruments is just a bill issued by one business that gives the customer 30 or 90 days or whatever to pay, and can be assigned to someone else.
The point here is to increase the value of economic activity that you can carry out before you have to draw on your working capital to pay a bill in cash. The presumption is that businesses are usually constrained by their cash flow, and trade credit is a way of relaxing this constraint and using their holdings of cash more intensively. In that sense, it’s a social mechanism that increases the money supply by increasing the velocity of circulation.
It’s possible to create a huge credit bubble based just on this financial technology – Kindleberger is full of them – even if the cash paid in final settlement is gold or silver or big rocks.
If we now intervene in some way and insist that people settle up their accounts, for cash, faster, what happens? Well, one way of looking at it is that all this informal credit is non-monetary economic activity. Now, it has to become monetised, which means that the demand for money has increased sharply. Another way of looking at it was the one I hinted at earlier. If we count the trade credit as an increase in the supply of money, then either the rest of the money supply must expand to accommodate it, or else the money supply must shrink.
Whether we look at this as an increase in the demand for money, or a reduction of the supply of money, it does mean that the marginal borrower’s interest rate is going up, possibly dramatically, and they also face liquidity risk. Here’s your contraction.
Now of course this can be solved; monetary policy can change.
In practice, the most likely route by which the outstanding bills get monetised is through a bank, because where else do you go to get cash? We can get around this problem if the banking sector’s balance sheet expands enough to take on the outstanding trade credit, or alternatively, if the monetary authority puts more money into circulation. (This is the same thing, in a sense – imagine an economy with one bank.)
The first option means that the banks may need more capital, because they are taking up a bigger share of outstanding risks, the second, that monetary policy must be adjusted. In fact, taking up the first option will probably involve some of the second, as the banks bring more paper into the central bank discount window. But if the banking sector is structurally constrained in some way, and the monetary authority is located in some other country, well, yes, the reform will be contractionary. Better, it will be contractionary, full stop, unless someone does something to counter it.
It’s true, as Alan Beattie says, that slow payment might be one of the ways rent-seekers exploit their suppliers. Anyone who’s ever been involved with a small business will know that there are a lot of unreliable payers out there. However, this is true of the UK and probably of Finland. It’s also idiosyncratically true, not the sort of thing easily accessible by airport-to-hotel reformers. And it’s more true that small businesses will be more likely to run out of cash, if there’s a general drive to collect on bills quicker, than big ones.
The classic mechanism of an economic crisis in an economy that runs on store credit is set out very well in Kindleberger. Chains of bills, representing the outstanding volumes at risk, grow until something happens and causes the marginal creditor to demand cash money. Then a cascade-failure of bankruptcies occurs. It is not obvious, to say the least, that this is desirable.
Yes, this reform is contractionary, and implementing it requires that the monetary authority pushes against the contraction.
So, if we were to make a little leap of faith, how could SYRIZA and the troika, or eurogroup, or shall we just say the Euros, come to an agreement?
The first issue, I think, is that any agreement needs to pass two tests. It needs to be both acceptable, or it wouldn’t be agreement, and it needs to be effective, or it would be pointless. The red-lines on both sides are pretty clear. SYRIZA went to the polls demanding some measure of debt relief. I take that to mean a reduction in the face value of the outstanding stock of debt to the Eurozone, plus the ECB, plus the IMF. Angela Merkel has stated that no further “haircut” is acceptable. Everyone assumes she is the ultimate veto actor on the Euros’ side.
On the other hand, as everyone seems to think, the debt service, i.e. the interest on the outstanding stock of debt, isn’t a big deal and therefore the stock of debt isn’t either. What matters is the primary surplus, the net transfer from Greece to the Euros, that the current agreement requires every year from here on in. The test of an effective agreement is whether it reduces this enough to restart the Greek economy. The Euros’ target is 4.5% of GDP. Yanis Varoufakis, Greek finance minister and everyone in the blogosphere’s new best mate, wants to cut it to between 1 and 1.5%. Clearly, agreement is possible somewhere between the two values, especially as nobody on the Euros’ side has committed to veto any particular number.
Ironically, the parties can agree on quite a few different options that would work to a greater or lesser extent, but they can’t accept them politically. This is of course better than the other way around. Arguably, the other way around is what we’ve had so far – acceptable, but ineffective.
A lot of people would also agree that the outstanding stock of debts is not really very important. It is, per Krugman, an accounting fiction, per Daniel Davies, the means by which the Euros try to control the Greek government budget, in order to impose something called “structural reform”. Alan Beattie, in a superb blog post, points out that the phrase “structural reform” is nonsensical.
First of all, there is no such thing as “reform” as such. You can’t ring up and order 20 40′ containers full of reform. Reforms are, more than anything else, inherently specific and context-dependent. The enterprise of structural reform is based on the idea that the market knows best, as it embodies the diffuse wisdom of those most concerned. But the reforms are meant to be chosen and delivered by civil servants parachuted (or rather, airlanded) in from some other country, usually isolated from everyone but the airport-to-hotel cab driver. This is at least ironic, and arguably perverse.
Second, reform has goals and in this case the goal is the delivery of the 4.5% annual primary surplus. Looking at this from a sectoral-balance point of view, if the public sector is to net-save 4.5% of GDP, either the private sector must take on a similar amount of net debt, or else the country must run a similar current-account surplus. So far, Greece has tried to reduce its CA deficit by demand destruction, or in other words, cutting down trees around Athens to save on fuel oil. What the structural reformers have in their heads, though, is that Greece increases its exports.
This implies both that somebody else imports them, and also that the Greek private sector increases its capacity. Firms expand by using more capital, one way or another. This seems unlikely in the context of debt-deflation. Reform very often costs money; when Germany carried out what it now thinks of as structural reform in the early 2000s, it blew its budget deficit targets with the Euros quite comprehensively.
Also, the difference between Alan Beattie and Daniel Davies is that Alan accepts that structural reform can be, and often is, stupid. Beattie’s archetypal Christmas-tree program includes a mixture of ideas anyone could agree with, ideas that are impossible to implement, and ideas that in context are insane, but might, tragically, be implemented. Capacity has to go up but demand has to go down. The private sector needs to borrow to invest, but credit has to be tighter. Pensions must be cut to increase the pensioners’ competitiveness in the cut-throat business of retirement. Daniel Davies’ Aunt Agatha doesn’t just want you to do language classes; she also wants you to wear earplugs during them, and also attend the right sort of church like the right sort of people, just to show willing, like.
There is surely a case that the Greeks are the best placed to know what their problems are, and further that SYRIZA is the party that is least complicit in keeping the problems that way. That means, of course, that the reforms must be acceptable to them.
But we already know that the level of the primary surplus is negotiable. We’ve established that. The point is how to deliver something that amounts to debt relief in Greece, but not to a write-off at face value. How can we get to yes?
Here’s an important chart, showing the annual repayments in euros for the various official loans.
You’ll notice that in the short term, the IMF predominates. You’ll also notice that a lot of the repayments are in the really long, we-are-all-dead run, out to the 2040s and 2050s. This is the very definition of a political number. And who owns it? You might be surprised.
Who owns Greek debt – mostly Germany, unsurprisingly. Credit to Open Europe and ABN Amro. From The Times today pic.twitter.com/d0aCYjlOfZ
— Philip Aldrick (@PhilAldrick) January 27, 2015
Everyone always says Germany, but out of the €194bn owing to Eurozone sovereigns, €104bn came from France, Spain, and Italy together. When the history is written, it should take note that Spain in its troubles put its hand in its pocket for serious amounts of money. At the time, there was a lot of talk that the EFSF-and-then-EFSM-and-then-ESM had no credibility because they stood behind it. The record shows they came through. Of course, this makes the idea of a southern front against austerity so much more difficult, as they can afford to lose the money so much less.
This is, I think, where there is a bit of play in the mechanism. The Greeks are floating the idea of linking the debt repayments to growth, like an income-contingent student loan or perhaps more like a debt-for-equity swap. This is, of course, rather like the GDP warrants proposal that was fashionable a couple of years back.
In context, this means that the payoff comes through if the reforms actually work; a discipline never before imposed on such a programme, although of course they always want it for everyone else. This is substantially better than the other option, which is just to extend-and-pretend again.
Although the payoff structure is equity-like, it’s still an obligation of the same face value, so it does not constitute a write-off in the strict sense. As it doesn’t require a cash transfer until some target is reached, though, it is debt relief in a very important sense from a Greek point of view. In an accounting sense, of course, it is – the risk-adjusted net present value would be lower by some percentage depending on your guess about the path of Greek GDP in the fairly distant future.
The further out you go, of course, the easier this is, but then again, the test of effectiveness is what happens to the primary surplus requirement – right? And a swap of bonds for warrants with terms out in the 2040s is a better bet, I think, than hoping for a European fiscal union with actual transfers and without balanced-budget amendments.
As for the IMF, well, will this mean another story about the Europeans hoping the Americans will lend a hand?
The ECB neither provides nor approves emergency liquidity assistance. It is the national central bank, in this case the Central Bank of Cyprus, that provides ELA to an institution that it judges to be solvent at its own risks and under its own terms and conditions. The ECB can object on monetary policy grounds; in order to do so at least two thirds of the Governing Council must see the provision of emergency liquidity as interfering with the tasks and objectives of euro area monetary policy.
Reuters story today based on Bank of Greece source –
Greece’s central bank has moved to protect its banks from any fallout from the coming general election, asking the European Central Bank to approve a stand-by domestic emergency funding line, a Bank of Greece official said on Saturday. The move comes after two major banks applied to be able to tap an emergency liquidity assistance (ELA) window on Friday as Greeks withdraw cash before the snap election on Jan. 25. “We have sent a request to the ECB on ELA approval for all four major banks to have a shield for the banking system,” the official said, declining to be named.
So I spent my Christmas reading the Hypo Alpe-Adria crash investigation, in a follow-up to this post . The point that stands out for me is that I don’t think you can blame this one on incompetence. Too many actors involved got what they wanted for that. Instead, they adopted a form of strategic incompetence that has long historical roots in Austria and its former empire, following the creases left by major historical events.
To kick off, the transition of Carinthia’s state-owned mortgage lender to a universal bank was an event conditioned by several massive historical phenomena. One of these was financial globalisation. Another was the relaunch of European integration. A third was the desire of important politicians in Austria to have alternatives to the postwar long coalition. It’s telling that Hypo Alpe-Adria, hereafter HAA, opened its first international office in 1986, about the time the extreme-right FPO was in government for the first time, in a weird alliance with the Social Democrats. Its new name, with its vaguely imperial claim to the “Alps-Adriatic”, actually appeared before the end of communism, and it began to do business in the former Yugoslavia even before it was former.
So the transformation of HAA gave its shareholders, at the time the state of Carinthia, a Steiermark mutual insurer, and some employees, a number of benefits. One of these was an economic strategy – we’re going to create a financial centre and we’re also going to invest in this new region. Another was something like having your own independent foreign policy – after all, the region was being conceptualised at the same time as the bank was being reorganised. Yet another was a source of budget revenue, from taxes and from the annual premium it paid for its state guarantee. Less legitimately, it was also a slush fund that could be used to look after important political constituencies.
And, from a very high level, it also played an important role in integrating the far right back into Austrian and European politics. The regional concept the bank embodied was one rooted in the empire and revived by the Nazis, and much loved by Austrian and German extremists. While Carinthia was an obscure collection of minor ski resorts crammed up against the iron curtain, its political elite didn’t have much to offer in exchange for rehabilitation, which they needed because their key political party had basically been invented as a lobby for old Nazis’ interests in the late 1940s. (The same thing nearly happened with the German FDP, but its liberal core and the allied oversight won out.) With a key lender in the reunification of Europe under their command, they counted for something. Wir sind wieder wer.
The European project was both a precondition of all this and also a threat to it. Without the facts of reunification and integration, it would never have gone anywhere. Without Austrian membership of the EEA and then the EU, it would never have been practical. But joining the union also made the whole deal problematic. The union didn’t, at least in principle, like state aid or special arrangements. It was especially keen to get rid of the state guarantees for German landesbanken and their equivalents. It was also keen on privatising all the things.
The owners of HAA formed a strategy to let them have it all. They would progressively sell down the shareholding, sticking at a blocking minority. They would put off unwinding the guarantee as long as possible, and load up on as much cheap funding as possible before the evil day. In the end they legislated in such a way as to let them keep guaranteeing HAA as long as it paid a market rate, which they didn’t define. The premiums were nice for the state budget and the cheap funding critical for the growth strategy. Influence would take the place of control.
Of course, people now ask “Why did they sign up to all those guarantees?” The investigation wonders why they kept guaranteeing even after they didn’t have majority control. But this is strategic incompetence for you. First of all, they relied on informal influence and personal networks to steer the bank. Second, the actors who mattered didn’t care about the risks because they well knew they weren’t meaningfully on the hook for them. Similarly, the Bavarian landesbank that bought HAA was convinced that the Austrian federal authorities were in charge, while both they and the Carinthians believed (or faked it) that the Germans were in charge.
The structure permitted all parties to get what they wanted. We don’t usually think of getting exactly what you want as being “incompetent”.
In 2006, when the Carinthians began selling down their shareholding, the accounts used for the due-diligence process dated back to 2002/2003 for the crucial South-Eastern European assets. This seems crazy. But it was just what the people who mattered wanted. There is an Austrian word, Schlamperei, which describes a sort of institutional blundering into the best course for one’s own interests. Then again, when Deutsche Telekom was ordered by its regulator to let other operators unbundle its lines, it regularly just failed to know they existed or where they were.
A poorly controlled SEE-focused landesbank was just what Jörg Haider wanted, and you can read the eventual sale to the Austrian feds as a scheme by the Carinthians and Bavarians, presumably with German federal acquiescence, to burn the other Austrians.
In practice, the strategic incompetence worked like this. In 2004, HAA engaged in a variety of transactions in derivatives that boosted its interest margins while taking risk on the absolute base rate. This worked for a while and then didn’t. They hid the losses, until they got caught. The then CEO, Kulterer, had to quit but couldn’t be questioned by financial regulators because the police wanted to talk to him. Because he wasn’t under a regulatory inquiry, that meant he could become chairman of the supervisory board. (In the changed post-crash climate, he went to jail.)
The plan had been to float HAA, but this was now out of the question. The state of Carinthia had borrowed against the IPO proceeds, which forced someone to do something. Strategic incompetence again. The solution was to do a small rights issue, and get a hedgie called Tilo Berlin to take the other end. The inquiry found that there were no named politicians on his share register but there were some companies whose beneficial owners they couldn’t trace. This was called the Austrian solution, although Berlin’s vehicle was registered as a Luxembourg SARL.
Berlin’s unique selling point was that he was willing to accept a fairness opinion that said HAA was worth what Haider wanted it to be, issued by a local tax adviser in Klagenfurt who got €12m for his trouble, although Haider then demanded half of it back as a “patriotic rebate”. HSBC and Rothschilds were asked, too, but oddly declined to agree with this valuation. HAA’s own auditors thought the due diligence was pathetic, the data room a joke, and the disclosure bordering on the fraudulent, but Berlin and his investors didn’t mind because they almost certainly already knew BayernLB would take it off their hands after a decent interval. After all, they lent them some of the money. Again, everyone with any power got just what they wanted.
Meanwhile, Haider and his circle ran the bank like they wanted. It lent enormously in the Balkans and looked after his people. When an ill-thought out airline venture was close to failure, Haider himself as chairman ordered that it get a €3m equity contribution, plus a €2.5m line of credit that was drawn down and lost within two days. The loan agreement was recorded as a “note on the file”. An Austrian senator with €9.23m in debts as a sole trader got a 50% writeoff, with more of the debt converted to an equity-kicker, permitting him to save the inheritance. Strangely, HAA never tried to collect on the land he put up as security.
Although it couldn’t be said for the man himself, Haider’s machine in Carinthia got out in time. None of the regional shareholders bothered to contribute a cent to the first bailout in 2008. With the crisis, HAA met another group of powerful people who wanted to have it all – the European Commission, which wanted stability as long as it didn’t cost anything. In order to comply with the state aid restrictions, it was necessary for the Austrian central bank, OeNB, to decide whether HAA was “distressed” or “not distressed”, and also whether it was “sound” or “not sound”. The OeNB held that it was “not distressed”, but stated that this did not mean it was “sound”. Helpful!
But then again, everyone who mattered got what they wanted. The state of being not distressed helped on interest rates, while the state of not being sound helped with regulatory clearance. If the situation was absurd, well, that was precisely what strategic incompetence was meant for, and anyway, shouldn’t the people who made the rules take some responsibility?
Then, as J.K. Galbraith said, things became more serious. As 2009 went on, a classic “slow” or “invisible” run on the bank developed, led by big-ticket depositors, often wholesale. Ironically, one of the biggest single names to move out was the state of Carinthia’s treasury.
This is where I disagree with the crash report. Concretely, BayernLB forced their hand by pulling HAA’s lines of credit with the parent company and invoking a mandatory set-off clause that effectively froze much of its cash. The inquiry argues that the Austrian government could have put HAA into insolvency and challenged this in the bankruptcy court, had they only taken more legal advice. Instead, BLB offered to maintain some of HAA’s liquidity and write off €500m of debts if the Austrian feds would buy the bank.
Interestingly, BayernLB had actually done something similar in the past, when they owned a Croatian bank. On that occasion, there was a run on the bank and BayernLB insisted on selling it back to the Croatian fisc. The circumstances of this were such that in 2007, the Croatian central bank tried to block the sale of HAA unless BLB cooperated with their inquiry, dramatically restricted its loan growth, increased its regulatory capital, and made a public apology. However, “high political pressure” was brought to bear – I think this means either the European institutions or Germany or both – and the central bank reversed itself. They didn’t even get the apology.
But I find the criticism wise after the event. It’s true that both the Bavarians (and the German feds) and the Carinthian pols got away with it at the expense of the Austrian federal budget. But nobody knew what would happen if a federal state became insolvent, or what would happen to BayernLB, or to the South-Eastern European banking system, still less what would happen if all of them happened at once. The prospect of perhaps recovering more money in insolvency in the distant future must have seemed a little remote and vague. HAA might not have been systemically important in 2008, but one of the major lessons of the great financial crisis was that it is fear that makes systemic importance.
Similarly, the inquiry rather oddly complains that the feds spent too much time and money combing the crash site for clues. The main evidence of this is that the HAA management complains a lot about how many employees are seconded to help with the special audit. But, as the late Mandy Rice-Davies would say, he would say that, wouldn’t he?
There is a good point here, though. HAA was probably the most directly and egregiously crooked of the bank failures of 2008-2009. But the problem wasn’t that Herr Marolt got let off half his debts, and treating it as if a really big forensic audit would fix it was a mistake. Although the post-crash investigation was meticulous, and quite a few HAA execs went to jail, the Austrian taxpayer is no less on the hook for the money than she was at the beginning of the process, and HAA is still stinking up the shed. It’s even paying premiums to Carinthia.
The problem, really, is that HAA’s rise and fall followed all sorts of deep features of the EMU and enlargement projects. It was bigger and more interesting than just a fraud. At every turn, you find arrangements that let various privileged groups get what they wanted, usually allowing them to have several contradictory advantages at once by dumping risks on someone else. Even the European Commission was at it – although it repeatedly badgered the Austrians to create a state-owned bad bank, it also pushed the “six pack” balanced budget amendment and insisted that the rest of the budget suffer for it. Similarly, it somehow determined that the €30-odd billion in total that BayernLB got from the Bavarian and German governments wasn’t state aid although the Austrian bailout of its subsidiary HAA kind of was.
In the end, everyone who mattered got exactly what they wanted.
Frances Coppola blogs on the Austrian government’s crash investigation into the failure of Hypo Alpe-Adria (latest detail – the biggest participant in the run on the bank was its garantor), also known as Haiderbank, and on the related topic of the Juncker Commission’s “investment plan”. The link is that the investment plan relies on a succession of heroic accounting assumptions to bulk up the final number without putting in any, you know, actual munn, and the Austrians’ response to the Haiderbank’s failure was based on a lot of funny figures. Frances so:
But what struck me from this report was the sheer naivety of the government officials involved. They were like children playing with fireworks. The instruments they were handling blew up in their faces and they were badly burned. And Juncker wants government officials to do MORE of this sort of thing?
There is a worrying tendency at the moment for public officials worried about deficits and debt/gdp ratios to hide public liabilities off the balance sheet. But the HGAA saga should sound an alarm about this practice. The Carinthian guarantees were all off-balance sheet – but collectively, they were enough to bankrupt Carinthia, which as a sub-sovereign must balance its books. In fact they were sufficient to place the finances of Austria itself under considerable strain, as well as setting up a nasty spat between Austria and Germany with EU-wide implications. And it is painfully evident that government officials lack the expertise to understand the legal and financial implications of the complex financial instruments involved. The ease with which BayernLB’s experts could deceive Austrian government officials is frightening.
I disagree. I would be very surprised if Austrian finance ministry officials were at all naive about the possibilities of structured finance at the edge of the zone of acceptability. Why? Well, way back in the day when Hypo Alpe-Adria was doing its thing funding Jörg Haider’s career and I lived in Vienna, I remember that time Karl-Heinz Grasser, then finance minister before being disgraced in a corruption scandal, got the federal government to sell the lakes of Carinthia to the federal forestry service, for which the government extended its foresters €215m in credit until they could sell other property to meet the bill.
Somehow, because the deal was “Maastrichtkonform” in the jargon of the day, this meant that Grasser could book the money as in-year revenue but not any additional government debt in the EUROSTAT definition (because while the foresters had acquired a liability of €215m, the fisc had a matching receivable of €215m), and as a result, that he (and Haider as junior coalition partner, and prime minister Wolfgang Schlüssel) were lionised for achieving, you guessed it, a “schwarze Null”, although that wasn’t the expression they used.
I’ve no idea how the accounting treatment could possibly work, but of course that wasn’t the point. By the time the matter had gone up to where-ever it needed to go in Brussels, the relevant deadline would have passed, and if the European Commission complained, well, there would be a fine opportunity to indulge in nationalist whining. Hauptsache, the budget was balanced, for an instant, under their preferred definition, on the relevant day. As it turned out, the assets were worth about a quarter of that.
Wonderfully, since then, some of the same property has become the object of another financial scandal.
The point of this bit of dated little-country political gossip is that funny figures aren’t an exception in the eurozone. They’re constitutive of it. The original Stability Pact launched a culture of creative accounting that is still well with us. France got in because France Telecom “voluntarily” loaded up its balance sheet with debt to finance a “voluntary contribution” to the government that just so happened to be enough. The phone company could do this because the government still owned it and guaranteed its debts.
I’m sure every other country in the eurozone has at least one similar story – it was the first great era of financialisation and privatisation, creating all sorts of interesting opportunities just at the same time as there was a huge incentive to cook the books.
That said, you’ll get no disagreement from me about this:
This is no way to do public investment. We should be keeping public investment ON the balance sheet, where the risks can be seen and properly managed, not sweeping it under the carpet and pretending it doesn’t exist. Juncker’s call for EU member states to make greater use of “innovative financial instruments” is madness
If at first you don’t succeed, try, try again…… aka third time unlucky.
The Euro crisis has all the signs of being back amongst us, and this time it may be here to stay. After two earlier false alerts – one in July around the collapse of the Portuguese Banco Espirito Santo, and another in October over the state of the Greek bailout negotiations – the announcement this week that the Greek presidential decision was being brought forward to December has sent the markets reeling off into a complete tizzy. Continue reading
The Berkeley Economic History Lab is blogging a lot of its recent working papers, and they’re a goldmine of great stuff. Here’s Richard Sutch writing in October this year, whose The Liquidity Trap, the Great Depression, and Unconventional Policy: Reading Keynes at the Zero Lower Bound basically recovers an important idea from the General Theory and Keynes’ practice during the Depression.
Sutch’s gloss of Keynes is that an important way in which the zero lower bound constraint bites is that there is always a term-structure of interest rates, rather than anything like a single economywide rate of interest. As a result, even if short rates hit the ZLB or even go negative, a large segment of the yield spectrum will still be significantly positive. This of course has some consequences for the debate about when Keynes broke with the Wicksellian idea of a single market interest rate that might deviate from a full-employment natural rate.
He argues that Keynes micro-founded this on differences between the risk profiles of borrowers and lenders. Borrowers and lenders both face the risk that whatever enterprise is being financed will fail and the loan won’t be paid off. Borrowers stand to lose whatever security is put down for the loan, while lenders stand to lose the difference between the security and the principal (i.e. their risk is fundamentally about estimating how much security is enough). In theory, arbitrage should transmit lower rates at the short end along the whole curve, because if you can borrow for a year and roll it over cheaper than you can borrow for 5 years, you will.
But here’s the problem; lenders bring their own idiosyncratic risk to the table. Each event of refinancing brings with it the risk that potential lenders have become illiquid, a so-called sudden stop. This always exists unless the life of the loan matches the life of the asset exactly, and it is an attribute of lenders, not borrowers. Therefore, long-term credit comes at a premium, and in a sense what is “long” is defined in relation to the typical life of capital investments.
Therefore, it’s quite possible for the policy rate to hit zero or even theoretically drive through the ZLB, while a large proportion of the universe of credit still has significantly positive real interest rates. This implies that unconventional policy of some sort – perhaps a combination of QE and an “Operation Twist”-like effort to target long rates, or direct fiscal reflation – would be needed and that’s what the man concluded.
An example of the sudden stop would be another of their papers, Olivier Accominotti and Barry Eichengreen’s The Mother of All Sudden Stops: Capital Flows and Reversals in Europe, 1919-1932. In this one, Accominotti and Eichengreen have literally discovered a trove of historical documents in an archive. It’s a catalogue of major capital-raising exercises in Europe in the 1920s and 1930s, covering the major financial centres and most of the second tier as well. The conclusion is that the rolling financial crisis starting with Creditanstalt in 1931, defined as a sudden stop of international lending followed by capital flight, was driven by volatility in the stock market – it was, in fact, the Great Crash and its lesser crashes that did it. The correlation with volatility in world equities was much higher than with any economic variable in the countries affected.
An example of policy would be Eric Monnet’s Financing a Planned Economy: Institutions and Credit Allocation in the French Golden Age of Growth (1954-1974). This one comes from Paris School of Economics – surely the fac Piketty these days – and you can tell because it’s crunchy with empiricism. Monnet has constructed a database of lending registered with the Banque de France that provides series into very detailed industrial sectors, and another one of firms’ operating results based on tax returns, going through what sounds like epic pain to match the excisemen’s classification up with the central bankers’ and further with the national statistics. The key result is that the change in the state-directed, or as he would put it, state-influenced lending was very strongly correlated with internal rates of return, implying that the system worked well as an allocator of capital.
He’s also done a lot of qualitative work to understand how the French financial sector worked at the time. It was a lot more complicated and subtle than the caricature of being directed by the government, and it evolved over time. To begin with, a lot of lending really was directed by government and issued by the finance ministry, mostly to large capital projects in infrastructure and heavy industry. With time, the heavy lifting moved to a new layer of specialist lenders who faced projects in manufacturing, housing, and tourism. Influence rather than control was very much the point. The key financial product was long-term lending of 5 years plus.
There’s much more stuff in there – the fall of the USSR in a trade perspective, equities and anti-Semitism, Ottoman and Austrian administration and their long-term effects on growth.
The recent move by the Bank of Japan to take further measures to accelerate the rate at which it ramps up its balance sheet took almost everyone – market watchers included – completely by surprise. The consequence was reasonably predictable – the yen has once more fallen strongly against almost all major currencies – and most notably against the USD – and Japan’s main stock indexes are sharply up. Continue reading