Monday, 1 September 2014

Fiscal pessimism


At Pieria, I discuss the inadequacy of monetary policy and the implications of the Fiscal Theory of the Price Level for the conduct of government policy. There needs to be a greater role for fiscal policy, and an end to the fear of debt and inflation that is preventing governments from taking the actions required to restore growth. But this means reversing the prevailing direction of economic thought for the last 30 years:
"In the present situation - what Sims calls “fiscal pessimism” - FTPL predicts disinflation. Fiscal pessimism means that people look with horror at rising government debt burdens and future fiscal commitments such as those arising from an ageing population, and think “how on earth are we going to afford this”? They expect much higher taxes in the future and/or serious cuts to spending programmes. If this is also combined with very low interest rates, so they make little or nothing on their growing holdings of government debt, they feel poorer even though their nominal wealth is actually increasing. They may therefore cut discretionary spending and increase precautionary saving in compensation, causing a disinflationary trend....
"It is all very well observing that hope seems to have departed and people appear to have resigned themselves to a depressing, and depressed, future. But why are people so pessimistic? What – or who - has convinced people that government debt levels are unsustainable and there is significant pain to come? In a word, economists."
Read the whole post here.

This is the second of several posts at Pieria covering topics discussed at the recent Lindau Meeting for Economic Sciences. The first post can be found here


Sunday, 31 August 2014

Fear the fear

"Debt isn't always bad, fearing inflation is stupid and governments should spend far more, suggest top economists", reads a headline in the Guardian. Reporting on proceedings at the Lindau Economics Meeting last week, Philip Inman highlights Christopher Sims's lecture "Inflation, Fear of Inflation and Public Debt", in which Sims argues that fear of both inflation and government debt is driving the developed world into a never-ending slump. As Inman explains, the timing and location of this speech are particularly telling:
Sims was well aware he was speaking in a Germany that fears inflation much as the villagers in the Asterix comic books fear the sky falling on their heads. Without naming Angela Merkel, he said anyone who feels threatened by inflation is stupid.
Ouch.

But actually it is worse than that. Fear of inflation is not just stupid, it is dangerous. And the Germans above all should understand this.

Popular mythology in Germany has it that the Weimar hyperinflation of 1922-23 led directly to the rise of Hitler. This is not true. The Nazi party was formed soon after the end of the First World War, but it struggled to achieve electoral success throughout the 1920s. In the German election of 1928, the Nazi party only managed to win 12 seats in the Reichstag. Four years later, in 1932, it was by far the largest party, winning 230 seats with 37% of the vote. What changed during that time?

Here is an excerpt from a speech given by German Chancellor Heinrich Brüning in 1931, at the height of the Great Depression in Europe (my emphasis):


"I will do my utmost to prevent any inflationary measure of any kind, not only in the spirit of justice, not only to protect the weak, but also because it is my opinion that the honest balance of the German economy has to be recreated, in spite of all bitterness, and that any attempt and any request for inflationary measures only can have the goal in mind to foil this process of establishing a clear balance, to pull another veil over the mistakes over the past. Successes in foreign policy can be achieved all the faster, if we are able to present to the world an honest and clear balance of the German finances and the German economy, for everybody to study.

This is the strongest and most efficient weapon the Reich government had, and to forget this weapon was the task of this administration in its first year. Because of it, public opinion all over the world, without exceptions, now takes a completely different point of view when it comes to the reparations, when compared to years past. Domestically it has to be similarly. Many social and professional tensions would have not become that acute, the political right-wing radicalism would not have gained that much strength, if certain healing processes would have been begun earlier, if the surgeon's knife would have cut earlier and more radically in the private as well as public economy.

Brüning used the memory of the earlier Weimar hyperinflation, together with popular hatred of war reparations, to justify extreme austerity measures. And because the scars left by that hyperinflation are so very painful, he got away with it. When the Reichstag threw out his austerity budget, it was imposed by presidential decree. Among other things, sickness benefits and pensions were cut, unemployment insurance was reduced and workers were required to pay higher contributions. There was also a brutal internal devaluation caused by deliberately tight monetary policy: during the two years of Brüning's chancellorship wages, salaries, rents and prices fell by 20%. The result was similar to the Hoover/Mellon liquidationism in the US: it made what was already a deep recession triggered by a financial crisis far, far worse. By 1932 unemployment was nearly 30%, RGDP was falling by 8% per annum and everyone had had enough. Hitler won the 1932 general election with a landslide. The rest, as they say, is history.

It was fear of inflation, fear of debt and fear of extremism that enabled the Nazi party to come to power.

Related reading:

Germany's hyperinflation-phobia - The Economist

The Greater Depression - Brad Delong (ProSyn)



Wednesday, 27 August 2014

Ultra-liquidity

My first Pieria post about matters discussed at the Lindau Economics Meeting looks at the ever-increasing liquidity of financial assets and the consequences for monetary policy:
Several economists at the Lindau meeting were severely critical of central banks' conduct of monetary policy in the light of continuing depression in the US, Japan and much of Europe, and called for greater use of fiscal policy to bring about recovery. Among the most critical was Christopher Sims, who gave a trenchant presentation on “Inflation, Fear of Inflation and Public Debt”.
He started by announcing the death of the quantity theory of money, MV=PY. Due to interest on reserves and near-zero interest rates, “money” can no longer be clearly distinguished from other financial assets....
Read on here.


Sunday, 24 August 2014

Nobel laureates, halo effects and idiosyncratic markets

Chatting to a young Indonesian economist over breakfast this morning, I discovered that his impression of Nobel laureates had been radically changed by the Lindau meeting.

“I used to think that being a Nobel Laureate meant being a world expert in economics”, he said. “Now I know that's not the case. Nobel Laureates are world experts in their own particular area of research. But they aren't experts in economics as a whole.”

The tendency to regard people who are highly qualified and experienced in one area as therefore competent to pronounce upon everything under the sun is a form of what is known as the “halo effect”. And it can have absurd consequences. In a press briefing that I attended, a journalist from a well-known news publication asked the American economist Peter Diamond to comment on the Eurozone. The journalist in question is an EU citizen resident in Frankfurt who has been reporting on European matters for several years. She has far more practical knowledge and experience of the Eurozone than Diamond. But because of his Nobel laureate status, he was presumed to have opinions on the Eurozone that were of more value than hers.

To his credit, Diamond refused to answer the journalist's question, saying that his area of research was entirely US-focused. But other American Nobel laureates were not so humble.

Edmund Phelps, in a breakfast briefing for young economists, extolled the virtues of American “opportunity” and criticised European “corporatism”. This was in a panel discussion on innovation sponsored by Mars, whose European representative - sitting on the panel next to Phelps – had much to say on innovation within large enterprises. And a young French economist on the same panel talked about entrepreneurialism in European countries. No matter. To Phelps, America was the source of all innovation, and Europe had a “terrible problem”.

But Phelps actually undermined his entire argument by comparing the US with something called “Europe”. Had he compared the US with, say, Germany, it would have been a fair comparison, although I'm not sure his conclusions were justified. But directly comparing a country, even one with a federal model of governance, with a whole continent is absurd. Europe is astonishingly diverse, and although its residents do generally recognise a common identity called “European”, it does not have the strength of the “American” identity. “Europe” is still a work in progress. 

Phelps's views on America and Europe were directly contradicted the very next day by another American Nobel laureate, Joseph Stiglitz. Here is Stiglitz – soundbite king as ever:
The idea that America is a “land of opportunity” is a myth. It's not so much the American dream as the Danish dream, or perhaps the Scandinavian dream.

I wonder which of these august gentlemen is right? I suspect neither. It is too easy to see America as the source of all innovation and Europe as free-riding on America's inventions. But equally, it is unfair to dismiss America, which remains a vibrant individualistic culture. Such competitive comparisons are unhelpful and unnecessary.

This brings me to the subject of American dominance among economics Nobel laureates. In his presentation on the role of the housing market in the Great Recession, Vernon Smith showed a series of extremely interesting slides. Here are a couple of them:



The whole presentation was excellent and his conclusions important. I shall write about this separately. But there is an important omission in the header of each of these slides. And that omission is telling.

Smith was of course talking exclusively about the American housing market. But nowhere on his slides does he show that. The slides are simply about “the housing market”. This was in a presentation to young economists, business and media representatives from 80 countries.

Smith presented to this international audience as if all housing markets everywhere were like the US and therefore he did not need to define the boundaries of his research. But nothing could be further from the truth. Housing markets are astonishingly diverse, no doubt because housing is a basic survival need and in many countries also a primary source of wealth. The US housing market is one of the most idiosyncratic: it has unique features such as 30-year fixed rate mortgages, warehousing and GSEs; it has more extensive government and near-government support than almost anywhere else; and it is as far as I know the only housing market where the majority of mortgages are securitised. Yet Smith did not see fit to tell his international audience that his research ONLY applied to the US and could not be taken as a model for anywhere else. Indeed he possibly didn't even think of that. The parochialism of American economists is at times staggering.

Nor is it just economists who are ignorant of national idiosyncracies in key markets such as housing. I had an interesting discussion with an American freelance economic journalist about the Bank of England's Funding for Lending scheme (FLS). Under the FLS, banks can temporarily swap illiquid prime loans (mostly mortgages) for highly liquid treasury bills, which they can then use as collateral in repo markets, thus enabling them to obtain market funding more cheaply. I explained this to my American friend, and his response was “I don't think people understand securitisation”. Umm. This scheme is not securitisation, and it would not work in a largely securitised marketplace such as that in the US. It only works when banks have large balance sheets made up mostly of illiquid loans.

In most European housing markets, lenders usually carry mortgage loans on their balance sheets rather than securitising and distributing them, which means that as their mortgage lending increases their balance sheets gradually become larger and more illiquid. To an American knowledgeable about economics and familiar with the operation of his own housing market, this is a very strange way of doing things. Yet to a European, it is the American way of doing mortgage lending that is odd. My American friend is indeed correct that people don't understand securitisation. To Europeans, it's a nasty American practice that nearly blew up the world.

This is not unlike the “accent” problem. I have no accent. Of course I don't. Everyone else has an accent, not me. So when I went to the US on a business trip a few years ago, I walked into my company's New York office, said something and was astonished to hear from the other side of the office, “I LOVE that accent!” It took me some time to realise that the person they were speaking about was me. I have an English accent. Of course I do. We do not see our own idiosyncracies.

The economics profession is dominated by Americans, and by research that focuses on American markets and American ways of doing things. Of 17 Nobel laureates presenting at the Lindau Economics Meeting, nearly all were elderly white middle-class male Americans – so hardly representative even of America - and most of them were doing exclusively American research. There is a terrible dearth of research that looks at other markets, particularly emerging ones: and an even greater scarcity of research that compares idiosyncratic markets, not in the Edmund Phelps compare-to-denigrate mode but in the interests of promoting international understanding of different ways of doing things.

All economies have unique features, that grow from deep historical and cultural roots: all have common features too. The problem is disinguishing between those characteristics that are common to all economies, and those that are nationally or regionally idiosyncratic. When one nation is dominant in the field of economics, a research model that narrowly focuses on the economic features of that nation runs the risk of being interpreted as applying to all economies, especially if that model is developed by a Nobel laureate. Halo effects lead to “generalisation from the particular”, and a failure to recognise and promote understanding of economic diversity. There is no one right way of doing things, and the American way – or any other nation's way, for that matter – is neither universally applicable nor even necessarily the best.



Monday, 18 August 2014

The Bulgarian Banking Disaster

Another in the Bulgarian banking series at Forbes. Two months on, CorpBank is still closed and there is no end in sight. Depositors are angry, bondholders are nervous after the bank's recent default, and the Bulgarian authorities are making increasingly desperate attempts to find the money to reimburse depositors and - perhaps - recapitalize the bank so it can be reopened. Meanwhile, Tsvetan Vassilev, the bank's majority owner, is in hiding after an international arrest warrant for him was issued on charges of embezzlement. And Delyan Peevski's power base becomes ever larger....

Read the article here.



Depositors protesting about CorpBank's closure. Picture credit: Novinite



Sunday, 17 August 2014

Oil, Angola, and corruption

From Forbes:
The US oil company Cobalt International Energy Inc. has been issued with a Wells Notice by the U.S. Securities and Exchange Commission in relation to its operations in Angola. The Wells Notice formally warns Cobalt that it may face enforcement action for breaches of “certain federal securities laws”:
In connection with such investigation, on the evening of August 4, 2014, the Company received a “Wells Notice” from the Staff of the SEC stating that the Staff has made a preliminary determination to recommend that the SEC institute an enforcement action against the Company, alleging violations of certain federal securities laws. In connection with the contemplated action, the Staff may recommend that the SEC seek remedies that could include an injunction, a cease-and-desist order, disgorgement, pre-judgment interest and civil money penalties. The Wells Notice is neither a formal allegation nor a finding of wrongdoing. It allows the Company the opportunity to provide its reasons of law, policy or fact as to why the proposed enforcement action should not be filed and to address the issues raised by the Staff before any decision is made by the SEC on whether to authorize the commencement of an enforcement proceeding. The Company intends to respond to the Wells Notice in the form of a “Wells Submission” in due course.
It is thought that the laws breached include the Foreign_Corrupt_Practices_Act" (FCPA).....
Bribery and corruption, eh? Well, it is Angola....

Read the whole of this unsavoury tale here.




Thursday, 14 August 2014

The ECB is not doing its job. Again.

At the risk of sounding like a broken record, I'm going to say it again. The ECB is not doing its job. It is sitting on its hands and muttering about inflation while the Eurozone sinks further into depression. Even the mighty Germany's economy is shrinking, France is on the floor, Italy is in a slump and Spain's once-promising recovery looks set to be curtailed as consumer prices slide. What is the ECB doing about it? This:

The targeted longer-term refinancing operations (TLTROs) that are to take place over the coming months will enhance the accommodative monetary policy stance. These operations will provide long-term funding at attractive terms and conditions over a period of up to four years for all banks that meet certain benchmarks applicable to their lending to the real economy. This should help to ease funding conditions further and stimulate credit provision to the real economy.

In other words - nothing. Apart from lending money to banks in the hope they will lend it out, as if this hadn't been tried before and failed dismally. When will monetary authorities learn that throwing money at banks does not make them lend? The much-promised SME ABS programme, which might actually make a difference, is still only being talked about.

The ECB justifies its inaction by arguing that inflation - currently well below target at 0.4% for the Eurozone - is set to rise to near its 2% target over the medium term. It claims that monetary developments in the Euro area support this view. Really? Here's the key table from the June 2014 release of "Monetary Developments in the Eurozone":











There is nothing whatsoever here to indicate that inflation is going to head in any direction other than downwards. The M3 lending figures are still dire. Adjusted June figures are slightly better than those for April and May, but the fact is that lending to the private sector is still falling. The table doesn't show this, but lending to the public sector is also falling as fiscal authorities tighten their budgets. That is concurrent deleveraging by both the public and private sector at the same time, with no monetary easing by the ECB to offset it.

I'm frankly astonished by the ECB's inaction. M3 is not only subdued, but according to the ECB what little growth there is, is driven mainly by investors from outside the Eurozone:

"The increase in the MFI net external asset position, reflecting in part the continued interest of international investors in euro area assets, remained an important factor supporting annual M3 growth."

If international investors pull their money - which if the Eurozone goes deeper into depression, or geopolitical risks centred on Ukraine worsen, they may well do - the whole thing could collapse. It seems the ECB prefers to rely on external investors to do its monetary easing for it, despite the fragility that such cross-border dependence creates for the financial system. I thought the ECB had a responsibility to ensure financial stability?

The ECB's forecast of rising inflation over the medium-term seems critically to depend on banks. The thinking seems to be that the reason why lending figures are so awful is that banks are in a mess, so once banks have cleaned themselves up in order to pass the forthcoming stress tests they will start lending again, growth will return and inflation will start to rise. I fear this is magical thinking. The sort of lending that banks would need to do to restore growth across the whole Eurozone would soon put their balance sheets back in unacceptably risky territory. Are regulators really going to allow them to do this? Indeed, do we really want them to?

The damage that is being done to the supply-side in many Eurozone countries in the name of "reform" raises credit risk and discourages lending. Repairing banks is not going to offset this. The fact is that companies in depressed countries are more likely to go bankrupt than companies in countries experiencing vibrant growth. Even a cleaned-up bank is not going to expand SME lending in a seemingly endless recession. They will lend in other countries that are doing better.

And nor will reducing fiscal deficits and implementing "structural reforms" make banks any more willing to lend to risky enterprises in depressed economies. But nonetheless the ECB breathes fire at fiscal authorities:
As regards fiscal policies, comprehensive fiscal consolidation in recent years has contributed to reducing budgetary imbalances. Important structural reforms have increased competitiveness and the adjustment capacity of countries’ labour and product markets. These efforts now need to gain momentum to enhance the euro area’s growth potential. Structural reforms should focus on fostering private investment and job creation. To restore sound public finances, euro area countries should proceed in line with the Stability and Growth Pact and should not unravel the progress made with fiscal consolidation. Fiscal consolidation should be designed in a growth-friendly way. A full and consistent implementation of the euro area’s existing fiscal and macroeconomic surveillance framework is key to bringing down high public debt ratios, to raising potential growth and to increasing the euro area’s resilience to shocks.
Let's spell this out. Fiscal authorities are NOT RESPONSIBLE for the depression in the Eurozone. This is what is really going on:























See the fall in the solid black line from mid-2012 onwards? That's monetary tightening. There has been a whopping monetary contraction in the Eurozone for the last two years. No wonder it is not recovering. In fact, no wonder the depression is now widening out to engulf the core as well as the periphery. Far from offsetting the effect of painful fiscal consolidations imposed on Eurozone countries, the ECB's excessively tight monetary policy has made their suffering worse and delayed or prevented their return to growth.

As market monetarists know, I am not a wholehearted believer in monetary offset, because I think monetary and fiscal policies have different distributional effects. In my view the Eurozone would still be suffering even if the ECB were doing monetary easing as other central banks have done. But making no attempt whatsoever to offset fiscal consolidation with monetary easing is simply disastrous. Hard-money ideology is driving the Eurozone into what Ambrose describes as "the most serious depression in Europe for 170 years" - far worse than the European Great Depression that led to the rise of Hitler. The only astonishing thing is that so far there has been so little public unrest. How on earth have the people of Europe become so docile?

The ECB is not even achieving its mandate of price stability. It is a disaster.

Broken record:

 So what exactly can the ECB do, anyway?
Why negative rates won't work in the Eurozone - Forbes
Spain, the ECB and the power of talk - Forbes
Why the ECB won't do QE
The Eurozone credit crunch
Deflation and the ECB
The ECB is irrelevant and the Euro is a failure - Pieria
It's the Euro, stupid - Forbes
About that ECB interest rate cut
A central bank crisis
Draghi's debt trap
It's the currency, stupid