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MOSLER'S LAW: There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it.

Archive for the 'CBs' Category

Mexico cuts rates

Posted by WARREN MOSLER on 9th June 2014

Little do they know that lowering rates removes interest income from the economy and on the supply side lowers costs and lowers forward prices, thereby reducing inflationary forces…

Mexico central bank unexpectedly cuts rate to spur weak economy

By Michael O’Boyle and Alexandra Alper

June 6 (Reuters) — Mexico’s central bank unexpectedly slashed interest rates to a record low on Friday, saying a sluggish economy gave it room for a one-off cut to spur growth without fanning inflation pressures.

The Banco de Mexico cut its benchmark interest rate by 50 basis points to 3.00 percent, surprising 21 analysts who had unanimously forecast in a Reuters poll that rates would stay on hold.

Latin America’s No. 2 economy barely grew in the first quarter as a harsh winter dragged on growth in the United States, Mexico’s top trading partner, while Mexican tax hikes hit domestic demand.

“Given the greater margin of slack in the economy, the efficient convergence of inflation towards 3 percent is feasible with a lower reference interest rate,” the central bank said in a statement.

Policymakers said they did not expect to further cut rates, suggesting even lower borrowing costs would not be prudent since the United States is expected to begin a tightening cycle and growth in Mexico is forecast to pick up.

The bank’s move stunned markets. Traders reported chaos on trading floors. Mexican bond yields tumbled and the stock market rose to its highest level this year, while the peso currency briefly hit a session low.

Prices for the county’s benchmark 10-year peso bond jumped, pushing down its yield by 33 basis points in the biggest one-day drop since last September. “Banks were really caught off guard,” said one Mexico-based bond broker. The cut was surprising given the bank’s conservative reputation. Analysts speculated the decision was split, reasoning that Gov. Agustin Carstens likely pushed for a bold cut, overriding concerns of other board members about inflation.

In its decision, the central bank said inflation risks have lessened. Annual inflation has been falling since it spiked above the central bank’s 4 percent limit in January, largely due to new taxes on soft drinks and fast food.

But policymakers said there were still risks that economic growth could slow after a weaker-than-expected start to the year. Last month the government cut its estimate for annual growth in 2014 from 3.9 percent to 2.7 percent.

The central bank said despite stronger exports, it was still worried about weakness in domestic spending.

The country’s central bank had not been expected to lower its main rate so far below the current inflation rate, which was 3.44 percent in the 12-month period though mid-May.

In previous years, sharp drops in the peso currency have made Mexican interest rate cuts risky since lower borrowing costs could push yield-hungry investors to dump Mexican fixed income assets and further hurt the currency.

A weak currency can spur inflation through higher import prices. Analysts said the central bank was taking advantage of renewed calm in financial markets and the recent dip in inflation to shore up economic growth.

“They seized the moment,” said Delia Paredes, an economist at Banorte bank in Mexico City. “It was quite a surprise.”

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Professor Andrea Terzi quoted on CNBC

Posted by WARREN MOSLER on 8th May 2014

Well done!!!!

You’d think he’d turn to Brits like Charles Goodhart who wrote volumes on it for the last 50 years!

How QE may be doing more harm than good

By Paul Gambles

May 7 (CNBC) — I’ve spent the last few weeks talking almost entirely about the Bank of England’s (BoE) latest research findings – and that we’re headed toward what could be the most almighty economic and market meltdown ever seen unless we embark on drastic changes in economic policy.

The default reaction to this has tended to be a mixture of incredulity and confusion, with most people wondering “What’s Gambles going on about now?” This piece is an attempt at proclaiming a pivotal moment in economic understanding at a key time for the global economy.

The findings in question are contained in the BoE’s Quarterly Bulletin. The paper’s introduction states that a “common misconception is that the central bank determines the quantity of loans and deposits in the economy by controlling the quantity of central bank money — the so-called ‘money multiplier’ approach.”

This “misconception” is obviously shared by the world’s policymakers, including the U.S. Federal Reserve, the Bank of Japan and the People’s Bank of China, not to mention the Bank of England itself, who have persisted with a policy of quantitative easing (QE).

QE is seen by its adherents, such as former U.S. Federal Reserve Chairman Ben Bernanke, as both the panacea to heal the post-global financial crisis world and also the factor whose absence was the main cause of the Great Depression. This is in line with their view that central banks create currency for commercial banks to then lend on to borrowers and that this stimulates both asset values and also consumption, which then underpin and fuel the various stages of the expected recovery, encouraging banks to create even more money by lending to both businesses and individuals as a virtuous cycle of expansion unfolds.

The theory sounds great.

However it has one tiny flaw. It’s nonsense.

Back in June 2011, when CNBC’s Karen Tso asked me why I was so critical of Ben Bernanke, an acknowledged academic expert on The Great Depression, I explained that I couldn’t justify the leap of blind faith demanded by Bernanke’s neo-classical monetarist theories.

Professor Hyman Minsky was one of the first to recognize the flaw in those theories. He realized that in practise, in a credit-driven economy, the process is the other way round. The credit which underpins economic activity isn’t created by a supply of large deposits which then enables banks to lend; instead it is the demand for credit by borrowers that creates loans from banks which are then paid to recipients who then deposit them into banks. Loans create deposits, not the other way round.

In the BoE’s latest quarterly bulletin, they conceded this point, recognizing that QE is indeed tantamount to pushing on a piece of string. The article tries to salvage some central banker dignity by claiming somewhat hopefully that the artificially lower interest rates caused by QE might have stimulated some loan demand.

However the elasticity or price sensitivity of demand for credit has long been understood to vary at different points in the economic cycle or, as Minsky recognized, people and businesses are not inclined to borrow money during a downturn purely because it is made cheaper to do so. Consumers also need a feeling of job security and confidence in the economy before taking on additional borrowing commitments.

It may even be that QE has actually had a negative effect on employment, recovery and economic activity.

This is because the only notable effect QE is having is to raise asset prices. If the so-called wealth effect — of higher stock indices and property markets combined with lower interest rates — has failed to generate a sustained rebound in demand for private borrowing, then the higher asset values can start to depress economic activity. Just think of a property market where unclear job or income prospects make consumers nervous about borrowing but house prices keep going up. The higher prices may act as either a deterrent or a bar to market entry, such as when first time buyers are unable to afford to step onto the property ladder.

Dr Andrea Terzi, Professor of Economics at Franklin University, also suggests that many in the banking and finance industry, who often have trouble with the way academics teach and discuss monetary policy, will find the new view much closer to their operational experience. “The few economists who have long rejected the ‘state-of-the-art’ in their models, and refused to teach it in their classrooms, will feel vindicated,” he adds.

Foremost among those economists is Prof Steve Keen: a long-time proponent of the alternative view, endogenous money. Having co-presented with Prof. Keen, I’ve been taken with the way that his endogenous money beliefs stand up to ‘the common sense test.’ The proverbial ‘man on the Clapham omnibus’ knows that borrowing your way out of debt while your returns are dwindling makes no sense. Friedman and Bernanke couldn’t see that.

Ben Bernanke positioned himself as a student of history who had learned from the mistakes of the past. Dr. Terzi questions this, “This view that interest rates trigger an effective ‘transmission mechanism’ is one of the Great Faults in monetary management committed during the Great Recession.”

“The reality is that the level of interest rates affects the economy mildly and in an ambiguous way. To state that monetary policy is powerful is an unsubstantiated claim.”

For a central bank to recognize that its economic understanding is flawed is a major admission. However, unless it takes the opportunity to correct its policy in line with this new understanding then it will repeat the same old mistakes.

The world’s central banks are steering a course unwittingly directly towards a repeat of the 1930s but on a far greater scale. It’s not yet clear that there is any commitment to change this course or indeed whether there is still time to do so. Either way, it will be very interesting to see what future economic historians make of Ben Bernanke’s contribution to economic policy.

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Comments on Martin Wolf’s banking article

Posted by WARREN MOSLER on 25th April 2014

Strip private banks of their power to create money

By: Martin Wolf
The giant hole at the heart of our market economies needs to be plugged

Printing counterfeit banknotes is illegal, but creating private money is not. The interdependence between the state and the businesses that can do this is the source of much of the instability of our economies. It could – and should – be terminated.

It is perfectly legal to create private liabilities. He has not yet defined ‘money’ for purposes of this analysis

I explained how this works two weeks ago. Banks create deposits as a byproduct of their lending.

Yes, the loan is the bank’s asset and the deposit the bank’s liability.

In the UK, such deposits make up about 97 per cent of the money supply.

Yes, with ‘money supply’ specifically defined largely as said bank deposits.

Some people object that deposits are not money but only transferable private debts.

Why does it matter how they are labeled? They remain bank deposits in any case.

Yet the public views the banks’ imitation money as electronic cash: a safe source of purchasing power.

OK, so?

Banking is therefore not a normal market activity, because it provides two linked public goods: money and the payments network.

This is highly confused. ‘Public goods’ in any case aren’t ‘normal market activity’. Nor is a ‘payments network’ per se ‘normal market activity’ unless it’s a matter of competing payments networks, etc. And all assets can and do ‘provide’ liabilities.

On one side of banks’ balance sheets lie risky assets; on the other lie liabilities the public thinks safe.

Largely because of federal deposit insurance in the case of the us, for example. Uninsured liabilities of all types carry ‘risk premiums’.

This is why central banks act as lenders of last resort and governments provide deposit insurance and equity injections.

All that matters for public safety of deposits is the deposit insurance. ‘Equity injections’ are for regulatory compliance, and ‘lender of last resort’ is an accounting matter.

It is also why banking is heavily regulated.

With deposit insurance the liability side of banking is not a source of ‘market discipline’ which compels regulation and supervision as a simple point of logic.

Yet credit cycles are still hugely destabilising.

Hugely destabilizing to the real economy only when the govt fails to adjust fiscal policy to sustain aggregate demand.

What is to be done?

How about aggressive fiscal adjustments to sustain aggregate demand as needed?

A minimum response would leave this industry largely as it is but both tighten regulation and insist that a bigger proportion of the balance sheet be financed with equity or credibly loss-absorbing debt. I discussed this approach last week. Higher capital is the recommendation made by Anat Admati of Stanford and Martin Hellwig of the Max Planck Institute in The Bankers’ New Clothes.

Yes, a 100% capital requirement, for example, would effectively limit lending. But, given the rest of today’s institutional structure, that would also dramatically reduce aggregate demand -spending/sales/output/employment, etc.- which is already far too low to sustain anywhere near full employment levels of output.

A maximum response would be to give the state a monopoly on money creation.

Again, ‘money’ as defined by implication above, I’ll presume. The state is already the single supplier/monopolist of that which it demands for payment of taxes.

One of the most important such proposals was in the Chicago Plan, advanced in the 1930s by, among others, a great economist, Irving Fisher.

Yes, a fixed fx/gold standard proposal.

Its core was the requirement for 100 per cent reserves against deposits.

Reserves back then were ‘real’ gold certificates.

The floating fx equiv would be 100% capital requirement.

Fisher argued that this would greatly reduce business cycles,

And greatly reduce aggregate demand with the idea of driving net exports to increase gold/fx reserves, or, alternatively, run larger fiscal deficit which, on the gold standard, put the nation’s gold supply at risk

end bank runs

Yes, banks would only be lending their equity, so there is nothing to ‘run’

and drastically reduce public debt.

If you wanted a vicious deflationary spiral to lower ‘real wages’ and drive net exports

A 2012 study by International Monetary Fund staff suggests this plan could work well.

No comment…

Similar ideas have come from Laurence Kotlikoff of Boston University in Jimmy Stewart is Dead, and Andrew Jackson and Ben Dyson in Modernising Money.

None of which have any kind of grasp on actual monetary operations.

Here is the outline of the latter system.

First, the state, not banks, would create all transactions money, just as it creates cash today.

Today, state spending is a matter of the CB crediting a member bank reserve account, generally for further credit to the person getting the corresponding bank deposit. The member bank has an asset, the funds credited by the CB in its reserve account, and a liability, the deposit of the person who ultimately got the funds.

If the bank depositor wants cash, his bank gets the cash from the CB, and the CB debits the bank’s reserve account. So the person who got paid holds the cash and his bank has no deposit at the CB and the person has no bank deposit.

So in this case the entire ‘money supply’ would consist of dollars spent by the govt. But not yet taxed. That’s called the deficit/national debt. That is, the govt’s deficit would = the (net) ‘money supply’ of the economy, which is exactly the way it is today.

Customers would own the money in transaction accounts,

They already do

and would pay the banks a fee for managing them.


Second, banks could offer investment accounts, which would provide loans. But they could only loan money actually invested by customers.

So anyone who got paid by govt (directly or indirectly) could invest in an account so those same funds could be lent to someone else. Again, by design, this is to limit lending. And with ‘loanable funds’ limited in this way, the interest rate would reflect supply and demand for borrowing those funds, much like and fixed exchange rate regime.

So imagine a car company with a dip in sales and a bit of extra unsold inventory, that has to borrow to finance that inventory. It has to compete with the rest of the economy to borrow a limited amount of available funds (limited by the ‘national debt’). In a general slowdown it means rates will skyrocket to the point where companies are indifferent between paying the going interest rate and/or immediately liquidating inventory. This is called a fixed fx deflationary collapse.

They would be stopped from creating such accounts out of thin air and so would become the intermediaries that many wrongly believe they now are. Holdings in such accounts could not be reassigned as a means of payment. Holders of investment accounts would be vulnerable to losses. Regulators might impose equity requirements and other prudential rules against such accounts.

As above.

Third, the central bank would create new money as needed to promote non-inflationary growth. Decisions on money creation would, as now, be taken by a committee independent of government.

What does ‘create new money’ mean in this context? If they spend it, that’s fiscal. If they lend it, how would that work? In a deflationary collapse there are no ‘credit worthy borrowers’ as they system is in technical default due to ‘unspent income’ issues. Would they somehow simply lend to support a target rate of interest? Which brings us back to what we have today, apart from deciding who to lend to at that rate, the way today’s banks decide who to lend to? And it becomes a matter of ‘public bank’ vs ‘private bank’, but otherwise the same?

Finally, the new money would be injected into the economy in four possible ways: to finance government spending,

That’s deficit spending, as above, and no distinction regards to current policy

in place of taxes or borrowing;

Same as above. For all practical purposes, all govt spending is via crediting a member bank account.

to make direct payments to citizens;

Same thing- net fiscal expenditure

to redeem outstanding debts, public or private;


or to make new loans through banks or other intermediaries.

As above, that’s just a shift from private banking to public banking, and nothing more.

All such mechanisms could (and should) be made as transparent as one might wish.

The transition to a system in which money creation is separated from financial intermediation would be feasible, albeit complex.

No, it’s quite simple actually, as above.

But it would bring huge advantages. It would be possible to increase the money supply without encouraging people to borrow to the hilt.

Deficit spending does that.

It would end “too big to fail” in banking.

That’s just a matter of shareholders losing when things go bad which is already the case.

It would also transfer seignorage – the benefits from creating money – to the public.

That’s just a bunch of inapplicable empty rhetoric with today’s floating fx regimes.

In 2013, for example, sterling M1 (transactions money) was 80 per cent of gross domestic product. If the central bank decided this could grow at 5 per cent a year, the government could run a fiscal deficit of 4 per cent of GDP without borrowing or taxing.

In any case spending in excess of taxing adds to bank reserve accounts, and if govt doesn’t pay interest on those accounts or offer interest bearing alternatives, generally called securities accounts, the consequence is a 0% rate policy. So seems this is a proposal for a permanent zero rate policy, which I support!!! But that doesn’t require any of the above institutional change, just an announcement by the cb that zero rates are permanent.

The right might decide to cut taxes, the left to raise spending. The choice would be political, as it should be.

And exactly as it is today in any case

Opponents will argue that the economy would die for lack of credit.

Not if the deficit spending is allowed to ‘shift’ from private to public.

I was once sympathetic to that argument. But only about 10 per cent of UK bank lending has financed business investment in sectors other than commercial property. We could find other ways of funding this.

Govt deficit spending or net exports are the only two alternatives.

Our financial system is so unstable because the state first allowed it to create almost all the money in the economy

The process is already strictly limited by regulation and supervision

and was then forced to insure it when performing that function.

The liability side of banking isn’t the place for market discipline, hence deposit insurance.

This is a giant hole at the heart of our market economies. It could be closed by separating the provision of money, rightly a function of the state, from the provision of finance, a function of the private sector.

The funds to pay taxes already come only from the state.

The problem is that leadership doesn’t understand monetary operations.

This will not happen now. But remember the possibility. When the next crisis comes – and it surely will – we need to be ready.


Posted in Banking, CBs, Currencies, Fed | No Comments »

Draghi on the euro

Posted by WARREN MOSLER on 14th April 2014

Draghi says a stronger euro would trigger looser ECB policy (Reuters)

Except by my calculations he has it backwards, as lower rates make a currency like the euro stronger, not weaker, via the interest income channels, etc.

ECB President Mario Draghi said that euro appreciation over the last year was an important factor in bringing euro zone inflation down to its current low levels, accounting for 0.4-0.5 percentage point of decline in the annual rate, which stood at 0.5 percent year-on-year in March. “I have always said that the exchange rate is not a policy target, but it is important for price stability and growth. And now, what has happened over the last few months is that is has become more and more important for price stability,” Draghi said at a news conference. “So the strengthening of the exchange rate would require further monetary policy accommodation.

As above.

If you want policy to remain accommodative as now, a further strengthening of the exchange rate would require further stimulus,” he said.

I agree, except I’d propose leaving rates at 0 fiscal relaxation to the point of domestic full employment, etc.

Furthermore, their policy of depressing domestic demand to drive exports/competitiveness has successfully resulted in growing net exports. However, unless combined with buying fx reserves of the targeted market areas, the euro appreciates until the net exports reverse, regardless of ‘monetary policy.’

Posted in CBs, Currencies, ECB, trade | No Comments »

The BoEs sharp shock to monetary illusions

Posted by WARREN MOSLER on 21st March 2014

The BoEs sharp shock to monetary illusions

Posted in Banking, CBs, Currencies | No Comments »

The Old Lady (of Threadneedle Street) fails to get an A

Posted by WARREN MOSLER on 21st March 2014

The Old Lady (of Threadneedle Street) fails to get an A

Posted in Banking, CBs, Currencies | No Comments »

Comments on Stanlely Fisher’s ‘Lessons from Crises, 1985-2014′

Posted by WARREN MOSLER on 18th March 2014

Lessons from Crises, 1985-2014

Stanley Fischer[1]

It is both an honor and a pleasure to receive this years SIEPR Prize. Let me list the reasons. First, the prize, awarded for lifetime contributions to economic policy, was started by George Shultz. I got my start in serious policy work in 1984-85, as a member of the advisory group on the Israeli economy to George Shultz, then Secretary of State. I learned a great deal from that experience, particularly from Secretary Shultz and from Herb Stein, the senior member of the two-person advisory group (I was the other member). Second, it is an honor to have been selected for this prize by a selection committee consisting of George Shultz, Ken Arrow, Gary Becker, Jim Poterba and John Shoven. Third, it is an honor to receive this prize after the first two prizes, for 2010 and for 2012 respectively, were awarded to Paul Volcker and Marty Feldstein. And fourth, it is a pleasure to receive the award itself.

When John Shoven first spoke to me about the prize, he must have expected that I would speak on the economic issues of the day and I would have been delighted to oblige. However, since then I have been nominated by President Obama but not so far confirmed by the Senate for the position of Vice-Chair of the Federal Reserve Board. Accordingly I shall not speak on current events, but rather on lessons from economic crises I have seen up close during the last three decades and about which I have written in the past starting with the Israeli stabilization of 1985, continuing with the financial crises of the 1990s, during which I was the number two at the IMF, and culminating (I hope) in the Great Recession, which I observed and with which I had to deal as Governor of the Bank of Israel between 2005 and 2013.

This is scheduled to be an after-dinner speech at the end of a fine dinner and after an intensive conference that started at 8 a.m. and ran through 6 p.m. Under the circumstances I shall try to be brief. I shall start with a list of ten lessons from the last twenty years, including the crises of Mexico in 1994-95, Asia in 1997-98, Russia in 1998, Brazil in 1999-2000, Argentina in 2000-2001, and the Great Recession. I will conclude with one or two-sentence pieces of advice I have received over the years from people with whom I had the honor of working on economic policy. The last piece of advice is contained in a story from 1985, from a conversation with George Shultz.

I. Ten lessons from the last two decades.[2]

Lesson 1: Fiscal policy also matters macroeconomically. It has always been accepted that fiscal policy, in the sense of the structure of the tax system and the composition of government spending, matters for the behavior of the economy. At times in the past there has been less agreement about whether the macroeconomic aspects of fiscal policy, frequently summarized by the full employment budget deficit, have a significant impact on the level of GDP. As a result of the experience of the last two decades, it is once again accepted that cutting government spending and raising taxes in a recession to reduce the budget deficit is generally recessionary. This was clear from experience in Asia in the 1990s.[3] The same conclusion has been reached following the Great Recession.

Who would have thought?…

At the same time, it needs to be emphasized that there are circumstances in which a fiscal contraction can be expansionary particularly for a country running an unsustainable budget deficit.

He doesn’t distinguish between floating and fixed fx policy. At best this applies to fixed fx policy, where fx reserves would be exhausted supporting the peg/conversion. And as a point of logic, with floating fx this can only mean an unsustainable inflation, whatever that means.

More important, small budget deficits and smaller rather than larger national debts are preferable in normal times in part to ensure that it will be possible to run an expansionary fiscal policy should that be needed in a recession.

Again, this applies only to fixed fx regimes where a nation might need fx reserves to support conversion at the peg. With floating fx nominal spending is in no case revenue constrained.

Lesson 2: Reaching the zero interest lower bound is not the end of expansionary monetary policy. The macroeconomics I learned a long time ago, and even the macroeconomics taught in the textbooks of the 1980s and early 1990s, proclaimed that more expansionary monetary policy becomes either impossible or ineffective when the central bank interest rate reaches zero, and the economy finds itself in a liquidity trap. In that situation, it was said, fiscal policy is the only available expansionary tool of macroeconomic policy.

Now the textbooks should say that even with a zero central bank interest rate, there are at least two other available monetary policy tools. The first consists of quantitative easing operations up and down the yield curve, in particular central bank market purchases of longer term assets, with the intention of reducing the longer term interest rates that are more relevant than the shortest term interest rate to investment decisions.

Both are about altering the term structure of rates. How about the lesson that the data seems to indicate the interest income channels matter to the point where the effect is the reverse of what the mainstream believes?

That is, with the govt a net payer of interest, lower rates lower the deficit, reducing income and net financial assets credited to the economy. For example, QE resulted in some $90 billion of annual Fed profits returned to the tsy that otherwise would have been credited to the economy. That, with a positive yield curve, QE functions first as a tax.

The second consists of central bank interventions in particular markets whose operation has become significantly impaired by the crisis. Here one thinks for instance of the Feds intervening in the commercial paper market early in the crisis, through its Commercial Paper Funding Facility, to restore the functioning of that market, an important source of finance to the business sector. In these operations, the central bank operates as market maker of last resort when the operation of a particular market is severely impaired.

The most questionable and subsequently overlooked ‘bailout’- the Fed buying, for example, GE commercial paper when it couldn’t fund itself otherwise, with no ‘terms and conditions’ as were applied to select liquidity provisioning to member banks, AIG, etc. And perhaps worse, it was the failure of the Fed to provide liquidity (not equity, which is another story/lesson) to its banking system on a timely basis (it took months to get it right) that was the immediate cause of the related liquidity issues.

However, and perhaps the most bizarre of what’s called unconventional monetary policy, the Fed did provide unlimited $US liquidity to foreign banking systems with its ‘swap lines’ where were, functionally, unsecured loans to foreign central banks for the further purpose of bringing down Libor settings by lowering the marginal cost of funds to foreign banks that otherwise paid higher rates.

Lesson 3: The critical importance of having a strong and robust financial system. This is a lesson that we all thought we understood especially since the financial crises of the 1990s but whose central importance has been driven home, closer to home, by the Great Recession. The Great Recession was far worse in many of the advanced countries than it was in the leading emerging market countries. This was not what happened in the crises of the 1990s, and it was not a situation that I thought would ever happen. Reinhart and Rogoff in their important book, This Time is Different,[4] document the fact that recessions accompanied by a financial crisis tend to be deeper and longer than those in which the financial system remains operative. The reason is simple: the mechanisms that typically end a recession, among them monetary and fiscal policies, are less effective if households and corporations cannot obtain financing on terms appropriate to the state of the economy.

The lesson should have been that the private sector is necessarily pro cyclical, and that a collapse in aggregate demand that reduces the collateral value of bank assets and reduces the income required to support the credit structure triggers a downward spiral that can only be reversed with counter cyclical fiscal policy.

In the last few years, a great deal of work and effort has been devoted to understanding what went wrong and what needs to be done to maintain a strong and robust financial system. Some of the answers are to be found in the recommendations made by the Basel Committee on Bank Supervision and the Financial Stability Board (FSB). In particular, the recommendations relate to tougher and higher capital requirements for banks, a binding liquidity ratio, the use of countercyclical capital buffers, better risk management, more appropriate remuneration schemes, more effective corporate governance, and improved and usable resolution mechanisms of which more shortly. They also include recommendations for dealing with the clearing of derivative transactions, and with the shadow banking system. In the United States, many of these recommendations are included or enabled in the Dodd-Frank Act, and progress has been made on many of them.

Everything except the recognition of the need for immediate and aggressive counter cyclical fiscal policy, assuming you don’t want to wait for the automatic fiscal stabilizers to eventually turn things around.

Instead, what they’ve done with all of the above is mute the credit expansion mechanism, but without muting the ‘demand leakages’/'savings desires’ that cause income to go unspent, and output to go unsold, leaving, for all practical purposes (the export channel isn’t a practical option for the heaving lifting), only increased deficit spending to sustain high levels of output and employment.

Lesson 4: The strategy of going fast on bank restructuring and corporate debt restructuring is much better than regulatory forbearance. Some governments faced with the problem of failed financial institutions in a recession appear to believe that regulatory forbearance giving institutions time to try to restore solvency by rebuilding capital will heal their ills. Because recovery of the economy depends on having a healthy financial system, and recovery of the financial system depends on having a healthy economy, this strategy rarely works.

The ‘problem’ is bank lending to offset the demand leakages when the will to use fiscal policy isn’t there.

And today, it’s hard to make the case that us lending is being constrained by lack of bank capital, with the better case being a lack of credit worthy, qualifying borrowers, and regulatory restrictions- called ‘regulatory overreach’ on some types of lending as well. But again, this largely comes back to the understanding that the private sector is necessarily pro cyclical, with the lesson being an immediate and aggressive tax cut and/or spending increase is the way go.

This lesson was evident during the emerging market crises of the 1990s. The lesson was reinforced during the Great Recession, by the contrast between the response of the U.S. economy and that of the Eurozone economy to the low interest rate policies each implemented. One important reason that the U.S. economy recovered more rapidly than the Eurozone is that the U.S. moved very quickly, using stress tests for diagnosis and the TARP for financing, to restore bank capital levels, whereas banks in the Eurozone are still awaiting the rigorous examination of the value of their assets that needs to be the first step on the road to restoring the health of the banking system.

The lesson remaining unlearned is that with a weaker banking structure the euro zone can implement larger fiscal adjustments- larger tax cuts and/or larger increases in public goods and services.

Lesson 5: It is critical to develop now the tools needed to deal with potential future crises without injecting public funds.

Yes, it seems the value of immediate and aggressive fiscal adjustments remains unlearned.

This problem arose during both the crises of the 1990s and the Great Recession but in different forms. In the international financial crises of the 1990s, as the size of IMF packages grew, the pressure to bail in private sector lenders to countries in trouble mounted both because that would reduce the need for official financing, and because of moral hazard issues. In the 1980s and to a somewhat lesser extent in the 1990s, the bulk of international lending was by the large globally active banks. My successor as First Deputy Managing Director of the IMF, Anne Krueger, who took office in 2001, mounted a major effort to persuade the IMF that is to say, the governments of member countries of the IMF to develop and implement an SDRM (Sovereign Debt Restructuring Mechanism). The SDRM would have set out conditions under which a government could legally restructure its foreign debts, without the restructuring being regarded as a default.

The lesson is that foreign currency debt is to be avoided, and that legal recourse in the case of default should be limited.

Recent efforts to end too big to fail in the aftermath of the Great Recession are driven by similar concerns by the view that we should never again be in a situation in which the public sector has to inject public money into failing financial institutions in order to mitigate a financial crisis. In most cases in which banks have failed, shareholders lost their claims on the banks, but bond holders frequently did not. Based in part on aspects of the Dodd-Frank Act, real progress has been made in putting in place measures to deal with the too big to fail problem. Among them are: the significant increase in capital requirements, especially for SIFIs (Systemically Important Financial Institutions) and the introduction of counter-cyclical capital buffers for banks; the requirement that banks hold a cushion of bail-in-able bonds; and the sophisticated use of stress tests.

The lesson is that the entire capital structure should be explicitly at full risk and priced accordingly.

Just one more observation: whenever the IMF finds something good to say about a countrys economy, it balances the praise with the warning Complacency must be avoided. That is always true about economic policy and about life. In the case of financial sector reforms, there are two main concerns that the statement about significant progress raises: first, in designing a system to deal with crises, one can never know for sure how well the system will work when a crisis situation occurs which means that we will have to keep on subjecting the financial system to tough stress tests and to frequent re-examination of its resiliency; and second, there is the problem of generals who prepare for the last war the financial system and the economy keep evolving, and we need always to be asking ourselves not only about whether we could have done better last time, but whether we will do better next time and one thing is for sure, next time will be different.

And in any case an immediate and aggressive fiscal adjustment can always sustain output and employment. There is no public purpose in letting a financial crisis spill over to the real economy.

Lesson 6: The need for macroprudential supervision. Supervisors in different countries are well aware of the need for macroprudential supervision, where the term involves two elements: first, that the supervision relates to the financial system as a whole, and not just to the soundness of each individual institution; and second, that it involves systemic interactions. The Lehman failure touched off a massive global financial crisis, a reflection of the interconnectedness of the financial system, and a classic example of systemic interactions. Thus we are talking about regulation at a very broad level, and also the need for cooperation among regulators of different aspects of the financial system.

The lesson are that whoever insures the deposits should do the regulation, and that independent fiscal adjustments can be immediately and aggressively employed to sustain output and employment in any economy.

In practice, macroprudential policy has come to mean the deployment of non-monetary and non-traditional instruments of policy to deal with potential problems in financial institutions or a part of the financial system. For instance, in Israel, as in other countries whose financial system survived the Great Recession without serious damage, the low interest rate environment led to uncomfortably rapid rates of increase of housing prices. Rather than raise the interest rate, which would have affected the broader economy, the Bank of Israel in which bank supervision is located undertook measures whose effect was to make mortgages more expensive. These measures are called macroprudential, although their effect is mainly on the housing sector, and not directly on interactions within the financial system. But they nonetheless deserve being called macroprudential, because the real estate sector is often the source of financial crises, and deploying these measures should reduce the probability of a real estate bubble and its subsequent bursting, which would likely have macroeconomic effects.

And real effects- there would have been more houses built. The political decision is the desire for real housing construction.

The need for surveillance of the financial system as a whole has in some countries led to the establishment of a coordinating committee of regulators. In the United States, that group is the FSOC (Financial Stability Oversight Council), which is chaired by the Secretary of the Treasury. In the United Kingdom, a Financial Policy Committee, charged with the responsibility for oversight of the financial system, has been set up and placed in the Bank of England. It operates under the chairmanship of the Governor of the Bank of England, with a structure similar but not identical to the Bank of Englands Monetary Policy Committee.

Lesson 7: The best time to deal with moral hazard is in designing the system, not in the midst of a crisis.

Moral hazard is about the future course of events.

At the start of the Korean crisis at the end of 1997, critics including friends of mine told the IMF that it would be a mistake to enter a program with Korea, since this would increase moral hazard. I was not convinced by their argument, which at its simplest could be expressed as You should force Korea into a greater economic crisis than is necessary, in order to teach them a lesson. The issue is Who is them? It was probably not the 46 million people living in South Korea at the time. It probably was the policy-makers in Korea, and it certainly was the bankers and others who had invested in South Korea. The calculus of adding to the woes of a country already going through a traumatic experience, in order to teach policymakers, bankers and investors a lesson, did not convince the IMF, rightly so to my mind.

Nor did they need an IMF program!

But the question then arises: Can you ever deal with moral hazard? The answer is yes, by building a system that will as far as possible enable policymakers to deal with crises in a way that does not create moral hazard in future crisis situations. That is the goal of financial sector reforms now underway to create mechanisms and institutions that will put an end to too big to fail.

There was no too big to fail moral hazard issue. The US banks did fail when shareholders lost their capital. Failure means the owners lose and are financially punished, and new owners with new capital have a go at it.

Lesson 8: Dont overestimate the benefits of waiting for the situation to clarify.

Early in my term as Governor of the Bank of Israel, when the interest rate decision was made by the Governor alone, I faced a very difficult decision on the interest rate. I told the advisory group with whom I was sitting that my decision was to keep the interest rate unchanged and wait for the next monthly decision, when the situation would have clarified. The then Deputy Governor, Dr. Meir Sokoler, commented: It is never clear next time; it is just unclear in a different way. I cannot help but think of this as the Tolstoy rule, from the first sentence of Anna Karenina, every unhappy family is unhappy in its own way.

It is not literally true that all interest rate decisions are equally difficult, but it is true that we tend to underestimate the lags in receiving information and the lags with which policy decisions affect the economy. Those lags led me to try to make decisions as early as possible, even if that meant that there was more uncertainty about the correctness of the decision than would have been appropriate had the lags been absent.

The lesson is to be aggressive with fiscal adjustments when unemployment/the output gap starts to rise as the costs of waiting- massive quantities of lost output and negative externalities, particularly with regard to the lives of those punished by the government allowing aggregate demand to decline- are far higher than, worst case, a period of ‘excess demand’ that can also readily be addressed with fiscal policy.

Lesson 9: Never forget the eternal verities lessons from the IMF. A country that manages itself well in normal times is likely to be better equipped to deal with the consequences of a crisis, and likely to emerge from it at lower cost.

Thus, we should continue to believe in the good housekeeping rules that the IMF has tirelessly promoted. In normal times countries should maintain fiscal discipline and monetary and financial stability. At all times they should take into account the need to follow sustainable growth-promoting macro- and structural policies. And they need to have a decent regard for the welfare of all segments of society.

Yes, at all times they should sustain full employment policy as the real losses from anything less far exceed any other possible benefits.

The list is easy to make. It is more difficult to fill in the details, to decide what policies to
follow in practice. And it may be very difficult to implement such measures, particularly when times are good and when populist pressures are likely to be strong. But a country that does not do so is likely to pay a very high price.

Lesson 10.

In a crisis, central bankers will often find themselves deciding to implement policy actions they never thought they would have to undertake and these are frequently policy actions that they would have preferred not to have to undertake. Hence, a few final words of advice to central bankers (and to others):

Lesson for all bankers:
Proposals for the Banking System, Treasury, Fed, and FDIC

Never say never

II. The Wisdom of My Teachers


Feel free to distribute, thanks.

Over the years, I have found myself remembering and repeating words of advice that I first heard from my teachers, both academics and policymakers. Herewith a selection:

1. Paul Samuelson on econometric models: I would rather have Bob Solow than an econometric model, but Id rather have Bob Solow with an econometric model than Bob Solow without one.

2. Herb Stein: (a) After listening to my long description of what was happening in the Israeli economy in 1985: Yes, but what do we want them to do?”

(b) The difference between a growth rate of 2% and a growth rate of 3% is 50%.

(c) If something cannot go on forever, it will stop.
3. Michel Camdessus (former head of the IMF):

(a) At 7 a.m., in his office, on the morning that the U.S. government turned to the IMF to raise $20 billion by 9:30 a.m: Gentlemen, this is a crisis, and in a crisis you do not panic

(b) When the IMF was under attack from politicians or the media, in response to my asking Michel, what should we do?, his inevitable answer was We must do our job.

(c) His response when I told him (his official title was Managing Director of the IMF) that life would be much easier for all of us if he would only get himself a cell phone: Cell phones are for deputy managing directors.

(d) On delegation: In August, when he was in France and I was acting head of the IMF in Washington, and had called him to explain a particularly knotty problem and ask him for a decision, You have more information than me, you decide.

4. George Shultz: This event happened in May 1985, just before Herb Stein and I were due to leave for Israel to negotiate an economic program which the United States would support with a grant of $1.5 billion. I was a professor at MIT, and living in the Boston area. Herb and I spoke on the phone about the fact that we had no authorization to impose any conditions on the receipt of the money. Herb, who lived in Washington, volunteered to talk to the Secretary of State to ask him for authorization to impose conditions. He called me after his meeting and said that the Secretary of State was not willing to impose any conditions on the aid.

We agreed this was a problem and he said to me, Why dont you try. A meeting was hastily arranged and next morning I arrived at the Secretary of States office, all ready to deliver a convincing speech to him about the necessity of conditionality. He didnt give me a chance to say a word. You want me to impose conditions on Israel? I said yes. He said I wont. I asked why not. He said Because the Congress will give them the money even if they dont carry out the program and I do not make threats that I cannot carry out.

This was convincing, and an extraordinarily important lesson. But it left the negotiating team with a problem. So I said, That is very awkward. Were going to say To stabilize the economy you need to do the following list of things. And they will be asking themselves, and if we dont? Is there anything we can say to them?

The Secretary of State thought for a while and said: You can tell them that if they do not carry out the program, I will be very disappointed.

We used that line repeatedly. The program was carried out and the program succeeded.

Thank you all very much.

[1] Council on Foreign Relations. These remarks were prepared for presentation on receipt of the SIEPR (Stanford Institute for Economic Policy Research) Prize at Stanford University on March 14, 2014. The Prize is awarded for lifetime contributions to economic policy. I am grateful to Dinah Walker of the Council on Foreign Relations for her assistance.

[2] I draw here on two papers I wrote based on my experience in the IMF: Ten Tentative Conclusions from the Past Three Years, presented at the annual meeting of the Trilateral Commission in 1999, in Washington, DC; and the Robbins Lectures, The International Financial System: Crises and Reform Several other policy-related papers from that period appear in my book: IMF Essays from a Time of Crisis (MIT Press, Cambridge, MA, 2004). For the period of the Great Recession, I draw on Central bank lessons from the global crisis, which I presented at a conference on Lessons of the Global Crisis at the Bank of Israel in 2011.

[3] This point was made in my 1999 statement Ten Tentative Conclusions referred to above, and has of course received a great deal of focus in analyses of the Great Recession.

[4] Carmen Reinhart and Kenneth Rogoff, This Time is Different, Princeton University Press, Princeton, NJ, 2009.

Posted in Banking, Bonds, CBs, Credit, Currencies, Deficit, ECB, Employment, Government Spending, Housing, Interest Rates | No Comments »

Turkey’s Prime Minister on rates and inflation

Posted by WARREN MOSLER on 30th January 2014

Turkey’s central bank prepared to tighten policy further

“Mr Erdogans own resistance to interest rate rises goes deep: on the flight, the prime minister insisted that, contrary to economic theory, increases in interest rates cause inflation. I believe that inflation and interest rates are not inversely proportional but in direct proportion, he told reporters. In other words, the relationship between inflation and interest is cause and effect: the interest rate is the cause, inflation is the result. If you increase the rate, inflation increases. If you reduce it, both drop together. When you think they are inversely proportional you always get much more negative results.

Posted in CBs, Inflation | No Comments »

Emerging Nations Save $2.9 Trillion Reserves in Rout

Posted by WARREN MOSLER on 4th September 2013

Smart not to intervene and use reserves.

And even the 19% isn’t as much as Japan’s recent approx. 25% drop, so they all remain stronger vs the yen. So the US now loses ‘competitiveness’ vs a whole mob of exporters cutting ‘real’ wages vs US, Canada, UK, and the Eurozone etc. As the ongoing global race to the bottom for real wages continues…

And maybe some day they’ll figure out that cutting rates supports a currency as it cuts interest paid by govt, making the currency ‘harder to get’.

And that exports are real costs and imports real benefits.

And that real standards of living are optimized by sustaining domestic full employment with fiscal adjustments.

Emerging Nations Save $2.9 Trillion Reserves in Rout

By Jeanette Rodrigues, Ye Xie and Robert Brand

September 4 (Bloomberg) — Developing nations from Brazil to India are preserving a record $2.9 trillion of foreign reserves and opting instead to raise interest rates and restrict imports to stem the worst rout in their currencies in five years.

Foreign reserves of the 12 biggest emerging markets, excluding China and countries with pegged currencies, fell 1.6 percent this year compared with an 11 percent slump after the collapse of Lehman Brothers Holdings Inc. in 2008, data compiled by Bloomberg show. The 20 most-traded emerging-market currencies have weakened 8 percent in 2013 as the Federal Reserve’s potential paring of stimulus lures away capital.

After quadrupling reserves over the past decade, developing nations are protecting their stockpiles as trade and budget deficits heighten their vulnerability to credit-rating cuts. Brazil and Indonesia boosted key interest rates last month to buoy the real and rupiah, while India is increasing money-market rates to try to support the rupee as growth slows. Central banks should draw on stockpiles only once currencies have depreciated enough to adjust for the trade and budget gaps, according to Canadian Imperial Bank of Commerce.

“If fundamentals are going against you, it’s not credible to defend a currency level — investors would rush for the exit when they see the reserves depleting,” said Claire Dissaux, managing director of global economics and strategy at Millennium Global Investment in London. “The central banks are taking the right measures, allowing the currencies to adjust.”

‘Fragile Five’
The South African rand, real, rupee, rupiah and lira, dubbed the “fragile five” by Morgan Stanley strategists last month because of their reliance on foreign capital for financing needs, fell the most among peers this year, losing as much as 19 percent.

Foreign reserves in the 12 developing nations including Russia, Taiwan, South Korea, Brazil and India, declined to $2.9 trillion as of Aug. 28, from $2.95 trillion on Dec. 31 and an all-time high of $2.97 trillion in May, data compiled by Bloomberg show. The holdings increased from $722 billion in 2002.

The figures don’t reflect the valuation change of the securities held in the reserves. China, which holds $3.5 trillion as the world’s largest reserve holder, is excluded to limit its outsized impact.

In the three months starting September 2008, reserves dropped 11 percent as Lehman’s collapse sent the real down 29 percent and the rupee 12 percent. India’s stockpile declined 16 percent during the period, while Brazil spent more than $14 billion in reserves in six months starting October, central bank data show.

‘Contagion Potential’
“Often, on the day of the intervention or its announcement, a currency will get a small bounce upward,” Bluford Putnam, chief economist at CME Group Inc., wrote in an Aug. 28 research report. “For the longer-term, however, market participants often return to a focus on the basic issues of rising risks and contagion potential.”

Putnam said “aggressive” short-term interest rate increases that “dramatically” raise the costs of going short a currency can work to stem an exchange-rate slide.

The Turkish and Indian central banks have developed tools to fend off market volatility while keeping their benchmark rates unchanged. Turkey adjusts rates daily and Governor Erdem Basci promised more “surprise” tools to defend the lira while vowing to keep rates unchanged this year. Since July, India has curbed currency-derivatives trading, restricted cash supply, limited outflows from locals and asked foreign investors to prove they aren’t speculating on the rupee.

Records Lows
India’s steps failed to prevent its currency from touching a record low of 68.845 per dollar on Aug. 28. The lira tumbled to an unprecedented 2.0730 the same day.

The rupee plummeted 8.1 percent in August, the biggest loss since 1992 and the steepest among 78 global currencies, according to data compiled by Bloomberg. The lira plunged 5.1 percent, the rand dropped 4.1 percent, the real fell 4.6 percent and the rupiah sank 5.9 percent, the data show.

The Indian currency rose 1.1 percent 67.0025 per dollar as of 1:46 p.m. in Mumbai today, while its Indonesian counterpart gained 0.3 percent to 11,409 versus the greenback. South Africa’s rand appreciated 0.8 percent to 10.2549 per dollar, while the Turkish lira strengthened 0.4 percent to 2.0505.

Interest-rate swaps show investors expect South Africa and India’s benchmark rate will increase by at least 0.25 percentage point, or 25 basis points, by year-end, according to data compiled by HSBC Holdings Plc. In Brazil, policy makers are forecast to raise the key rate by 100 basis points to 10 percent, and Turkey will lift the benchmark one-week repurchase rate by 200 basis points to 6.5 percent, the data show.

Posted in CBs, Currencies, Employment | No Comments »

Turkey’s Babacan Warns Of Financial Turmoil

Posted by WARREN MOSLER on 3rd September 2013

Turkey’s Babacan Warns Of Financial Turmoil

By Yasemin Congar

August 27 (Al Monitor) — Emerging markets will soon find themselves operating in a new world order. Few people are as painfully aware of this as Turkey’s Deputy Premier Ali Babacan.

A soft-spoken politician whose key positions in three successive Justice and Development Party (AKP) governments included a two-year stint as foreign minister, Babacan is currently the highest-ranking cabinet member responsible for the economy.

Needless to say, he was all ears when US Federal Reserve Chairman Ben Bernanke suggested on May 22 before the US Congress that it could begin to downsize its $85 billion-per-month bond-buying program.

Babacan had seen that coming. He warned Turkey repeatedly against overspending in 2012 — even at the risk of displeasing Prime Minister Recep Tayyip Erdogan — because he knew cheap loans would soon grow scarce.

Loans in lira are at whatever the CB wants them to be.

Indeed, the United States is getting ready to curtail the stimulus that has injected cash into emerging markets for the last four years.

QE isn’t about cash going anywhere, including not going to EM.

What they got was portfolio shifting that caused indifference rates to change.

Stocks plummeted at the news and national currencies fell against the dollar, with India, Brazil and Turkey all registering substantial losses.

Again, portfolio shifts reversing causing indifference levels to reverse.

Still, answering questions on live television on May 23, Babacan was as cool-headed as ever. First, he reminded the viewers that the European Central Bank and Bank of Japan would follow suit, thus making the impact of the Fed’s exit even stronger on Turkey. Then he said, “If they carry out these operations in an orderly and coordinated fashion, we will ride it out.”

Hope so. They need to focus on domestic full employment.

As Babacan would surely have known, that is a big if. Despite a recent call for coordination by the International Monetary Fund’s managing director, Christine Lagarde, sell-offs in emerging markets do not seem to be a major concern for the architects of the taper plan.

“We only have a mandate to concern ourselves with the interest of the United States,” Dennis Lockhart, president of the Atlanta Fed, told Bloomberg TV. “Other countries simply have to take that as a reality and adjust to us if that’s something important for their economies.”

In fact, adjustment is not a question of choice here. Emerging economies will have to find a way to continue funding growth and paying off debt without the liquidity infusion. It won’t be easy.

Can’t be easier. Lira liquidity for their banking system is always infinite.

It’s just a matter of the CB pricing it. I’d suggest a Japan like 0% policy and a fiscal deficit large enough to allow for full employment.

The looming exodus of cash and higher borrowing costs have already caused permanent damage in Turkey. The lira weakened dramatically on Aug. 23, with the dollar surpassing two liras for the first time in history.

That was not what caused the decline.

The decline was from portfolio managers changing their indifference levels between the lira and the dollar or euro, for example.

Turkey’s Central Bank dipped into its reserves, but a $350 million sale of foreign exchange reserves failed to calm the market.

A mistake. No reason to buy their own currency with $ reserves, which should only be used for ‘emergency imports’, such as during wartime. All the intervention did was support monied interests shifting portfolios.

Babacan, for his part, has been referring to Bernanke’s May 22 speech as a turning point. The global economic crisis has entered a new phase since that day, he said. “We’ll all see the spillover effects and new faces of the crisis in the coming months.”

What they will mostly see is the effects of their policy responses if they keep doing what they’ve been doing.

He did not stop there. In his signature straight-shooting manner, he also signaled a downward revision. “It should not be surprising for Turkey to revise its growth rate below 4%. … We set our annual exports target at $158 million, but it looks difficult to reach this target as well.”

Which opens the door for a tax cut/spending increase/fiscal adjustment to sustain output and employment.

A politician who seldom walks and talks like a politician, Babacan has been a maverick of sorts in the government. He entered politics in 2001 when he joined Erdogan and others to found the AKP. At the time, he was a 34-year-old with a degree from the Kellogg School of Management and work experience as a financial consultant in Chicago. In 2002, he was appointed the state minister for economy and became the youngest member of the cabinet.

Today, Babacan still has the boyish looks that earned him the nickname “baby face,” and he still exhibits a distaste for populism.

Guess he doesn’t support high levels of employment. In that case they are doing the right thing.

The most significant feature of Turkey’s recent economic success is fiscal discipline, and no one in the government has been a stronger supporter of that than Babacan.

Yikes! Kellogg school turns out flakes… :(

Around this time last year, when a fellow cabinet member, Economy Minister Zafer Caglayan — equally hardworking, yet keener on instant gratification — criticized the Central Bank’s tight monetary policy, Babacan slammed him.

“We do not have the luxury of pressing the brakes,” Caglayan had said. Babacan’s response: “In foggy weather, the driver should not listen to those telling him to press the gas pedal.”

The weather is clear, the driver is blind.

In what came to be known as the “gas-break dispute,” Erdogan threw his weight behind Caglayan and criticized the statutorily independent Central Bank for keeping interest rates too high.


Last week, the Central Bank hiked its overnight lending rate for the second month in a row by 50 basis points to 7.75%. Erdogan and Caglayan watched quietly this time, hoping the raise would help prevent the lira from sliding further. It did not.

Of course not. It makes it weaker via the govt spewing out more in lira interest payments to the economy.

As Babacan’s proverbial fog is slowly lifting to reveal a slippery slope, I can’t help but wonder if he feels vindicated by the turn of events. Probably not, since the risk that awaits Turkey now is worse than a taper tantrum, and Babacan must know just how bad it can get.

The Fed’s decision exposed Turkey’s vulnerability.

Yes, ignorance.

Described by economist Erinc Yeldan as “a gradually deflating balloon, subject to erratic and irregular whims of the markets,” Turkey’s speculative growth over the last four years has been financed by running a large current account deficit, which in turn was funded with hot money that is no longer readily available.

Nonsensical doubletalk.

As Standard Bank analyst Timothy Ash pointed out last week, “It is a bit hard to recommend [buying the lira or entering] bond positions while inflation remains elevated, and the current account is still supersized at $55-60 billion, with that huge external financing requirement.”

Or, it’s hard selling the dollar or euro with their intense deflationary/contractionary policies…

Estimated at $205 billion, or a quarter of Turkey’s gross domestic product (GDP), the external financing requirement is huge, indeed.

There is no such thing.

“A more extreme measure of vulnerability would add the $140 billion of foreign-held bonds and shares,” Hugo Dixon wrote in his Reuters blog. “If this tries to flee, the lira could plunge.”


Babacan admits that “Turkey might feel the negative effects of the Fed’s policy shift a bit higher than others … due to our already higher current account deficit.”

Turkey’s reliance on hot money to turn over its short-term external debt, which has been increasing more rapidly than the national income, is only the tip of the iceberg. What makes Turkey’s robust growth rates of 9% in 2010 and 8.5% in 2011 unrepeatable might be the disappearance of cheap loans. However, the real reason behind the unsustainability of such growth is structural.

Growth can be readily sustained with lira budget deficits and a 0 rate policy would help with price stability as well.

From insufficient capital accumulation and a low savings ratio to poor labor efficiency, the Turkish economy suffers chronic ills that can only be cured through radical reforms, including a major overhaul of the education system.

Education is good, but unemployment is the evidence the deficit is too small.

Again, Babacan knows it. Earlier this year, he commented on the government’s plan to increase the GDP per capita to $25,000 in 2023 by pointing out an anomaly:

“No other country in the world with an average education of only 6.5 years has a per capita income of $10,500. And no country with such an education level ever had an average income of $25,000. Without solving our education problem, our 2023 targets will remain a dream.”

Some say ignorance is bliss. Listening to Babacan makes me think they may be right. After 11 years, being part of a government that failed to do what you know should have been done cannot be much fun.

Posted in CBs, Currencies, Employment, MMT | No Comments »

brazil hikes rates to fight inflation

Posted by WARREN MOSLER on 30th August 2013

Fundamentally this increases govt deficit spending/interest income for the private sector, a negative for the currency and inflation, especially as it adds to costs.

However it also adds to spending/output/employment which causes policy makers to think they got it right by hiking as the stronger economy ‘needs’ the higher rates, etc.

Brazil in fourth consecutive rate rise

(FT) Brazil’s central bank has moved to restore investors’ confidence in Latin America’s biggest economy by resorting to its fourth consecutive interest rate increase to tame stubbornly high inflation. The central bank’s monetary policy committee, Copom, raised Brazil’s benchmark Selic rate by 50 basis points to 9 per cent late on Wednesday, the latest increase in a 175 basis point tightening cycle since April. “The committee evaluates that this decision will contribute to set inflation into decline and ensure that this trend persists in the upcoming year,” it said, repeating the brief statement issued at its last meeting in July. On Thursday last week Alexandre Tombini, Brazil’s central bank president, launched an unprecedented $60bn intervention programme to halt the plunge of the real.

Posted in CBs, Interest Rates | No Comments »

China to keep credit growth steady: Central bank

Posted by WARREN MOSLER on 15th July 2013

This is ridiculous, of course:

China to keep credit growth steady: Central bank

July 14 (Reuters) — China’s central bank pledged on Sunday to use a mix of policy tools to adjust banking liquidity to ensure steady credit growth, in an apparent bid to soothe market concerns about tighter monetary conditions.

The central bank will “use a mix of price and quantitative policy tools to adjust liquidity in the banking system and guide steady and appropriate growth in money, credit and social financing”, it said in a statement on its website.

The central bank allowed short-term inter-bank borrowing costs to spike to close to 30 percent on June 20, a blunt warning to overstretched lenders that they must bring risky lending under control.

Posted in CBs, China | No Comments »

Chinese liquidity drill

Posted by WARREN MOSLER on 26th June 2013

With floating fx, it’s necessarily about price (interest rate) and not quantity.

That includes China’s ‘dirty float’, a currency not convertible on demand at the CB, but with periodic CB market intervention.

Loans necessarily create deposits at lending institutions, and they also create any required reserves as a reserve requirement is functionally, in the first instance, an overdraft at the CB, which *is* a loan from the CB.

So from inception the assets and liabilities are necessarily ‘there’ for the CB to price.

Liquidity is needed to shift liabilities from one agent to another.

For example, if a depositor wants to shift his funds to another bank, the first bank must somehow ‘replace’ that liability by borrowing from some other agent, even as total liabilities in the system remain unchanged.

That ‘shifting around’ of liabilities is called ‘liquidity’

But in any case at any point in time assets and liabilities are ‘in balance.’

It’s when an agent can’t honor the demand of a liability holder to shift his liability to another agent that liquidity matters.

And if a bank fails to honor a depositor’s request to shift his deposit to another institution, the deposit remains where it is. Yes, the bank may be in violation of its agreements, but it is ‘fully funded.’

The problem is that to honor its agreements to allow depositors to shift their deposits to other banks, the bank will attempt to replace the liability by borrowing elsewhere, which may entail driving up rates.

Likewise, banks will attempt to borrow elsewhere, which can drive up rates, to avoid overdrafts at the CB when the CB makes it clear they don’t want the banks to sustain overdrafts.

The problem is that only the CB can alter the total reserve balances in the banking system, as those are merely balances on the CB’s own spread sheet. Banks can shift balances from one to another, but not change the total.

So when the total quantity of reserve balances on a CB’s spreadsheet increases via overdraft, that overdraft can only shift from bank to bank, unless the CB acts to add the ‘needed’ reserves.

Or when one bank has excess reserves which forces another into overdraft, and the surplus bank won’t lend to the deficit bank.

This is all routinely addressed by the CB purchasing securities either outright or via repurchase agreements. It’s called ‘offsetting operating factors’, which also include other ‘adds and leakages’ including changes in tsy balances at the fed, float, cash demands, etc.

And when the CB does this they also, directly or indirectly, set the interest rate as they do, directly or indirectly, what I call ‘pricing the overdraft.’

So to restate, one way or another the CB sets the interest rate, while quantity remains as it is.

And those spikes you are seeing in China are from the CB setting rates indirectly.

The evidence from China is telling me that the western educated new kids on the block flat out don’t get it, probably because they were never told the fixed fx ‘monetarism’ they learned in school isn’t applicable to non convertible currency???

In any case the CB is the monopoly supplier of net reserves to its banking system and therefore ‘price setter’ and not ‘price taker’, and surely they learned about monopoly in school, but apparently/unfortunately have yet to recognize their currency itself is a simple public monopoly?

Thinking back, this is exactly the blunder of tall Paul back some 33 years ago. He made the same rookie mistake, for which he got credit for saving the US, and the world, from the great inflation of his day.

However, the fact that he made it worse, vs curing anything is of no consequence.

What matters is how the western elite institutions of higher learning spin it all…


Posted in CBs, China, Currencies | No Comments »

Bill Gross – Fed tapering plan may be hasty:

Posted by WARREN MOSLER on 26th June 2013

I agree with a lot of this

‘Mortgage originations have plummeted by 39% since early May.’

The Fed’s financial obligations ratios have turned up as well.

But it’s not about QE in any case

It takes private credit expansion or net exports to overcome fiscal drag.

Bill Gross: Fed tapering plan may be hasty

By William H. Gross

June 25 (Bloomberg) — “June Gloom,” as the fog and clouds that often linger over the Southern California coast this time of year are known, appears to have spread to the Federal Reserve. At his press conference last week, Fed Chairman Ben Bernanke said the central bank may begin to let up on the gas pedal of monetary stimulus by tapering its asset purchases later this year and ending them in 2014.

We agree that QE must end. It has distorted incentives and inflated asset prices to artificial levels. But we think the Fed’s plan may be too hasty.

Fog may be obscuring the Fed’s view of the economy—in particular, the structural impediments that will inhibit its ability to achieve higher growth and inflation. Bernanke said the Fed expects the unemployment rate to fall to about 7% by the middle of next year. However, we think this is a long shot.

Bernanke’s remarks indicated that the Fed is taking a cyclical view of the economy. He blamed lower growth on fiscal austerity, for example, suggesting that should it be removed from the equation the economy would suddenly be growing at 3%. He similarly attributed rising housing prices to homeowners who simply like or anticipate higher home prices, as opposed to emphasizing the mortgage rate, which is really what provided the lift in the first place.

Our view of the economy places greater emphasis on structural factors. Wages continue to be dampened by globalization. Demographic trends, notably the aging of our society and the retirement of the Baby Boomers, will lead to a lower level of consumer demand. And then there’s the race against the machine; technology continues to eliminate jobs as opposed to provide them.

Bernanke made no mention of these factors, which we think are significant forces that will prevent unemployment from reaching the 7% threshold during the next year. Falling below “NAIRU” (the non-accelerating inflation rate of unemployment—usually estimated between 5% and 6%) is an even more distant goal.

Indeed, the Fed’s views on inflation may be the foggiest of all. Bernanke said the Fed sees inflation progressing toward its 2% objective “over time.” At the moment, we’re nowhere near that.

The Fed’s plan strikes us as a bit ironic, in fact, because Bernanke has long-standing and deep concerns about deflation. We’ve witnessed this in speeches going back five or 10 years—the “helicopter speech,” the references not only to the Depression but to the lost decades in Japan. He badly wants to avoid the mistake of premature tightening, as occurred disastrously in the 1930s. Indeed, on several occasions during his press conference, Bernanke conditioned his expectations of tapering on inflation moving back toward the Fed’s 2% objective.

The chairman, of course, may be equally concerned about the market effects of tapering and determined to signal its moves early. However, as the spike in interest rates shows, this path is fraught with danger, too.

We’re in a highly levered economy where households can’t afford to pay much more in interest expense. Monthly payments for a 30-year mortgage have jumped 20% to 25% since January. Mortgage originations have plummeted by 39% since early May.

High levels of leverage, both here and abroad, have made the global economy far more sensitive to interest rates. Whereas a decade or two ago the Fed could raise the fed funds rate by 500 basis points and expect the economy to slow, today if the Fed were to hike rates or taper suddenly, the economy couldn’t handle it.

All this suggests that investors who are selling Treasurys in anticipation that the Fed will ease out of the market might be disappointed. If inflation meanders back and forth around the 1% level, Bernanke may guide the Committee towards achieving not only an unemployment rate but also a higher inflation target.

It’s reasonable, of course, for Bernanke to try to prepare markets for the inevitable and necessary wind down of QE. But if he has to wave a white flag three months from now and say, “Sorry, we miscalculated,” the trust of markets and dampened volatility that has driven markets over the past two or three years could probably never be fully regained. It would take even longer for the fog over the economy to lift.

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last update from Rome, home tomorrow

Posted by WARREN MOSLER on 24th June 2013

Markets remain in ‘QE off’ mode, with stocks down and longer term rates up.

‘QE on’ was a misguided speculative bubble in any case, as QE is, at best, a placebo, and in fact somewhat of a tax as it removes a bit of interest income.

But obviously global markets view it as a massive stimulus, as per the various market responses.

The real economy, however, continues to suffocate from a too small US federal budget made even smaller by the proactive tax hikes and spending cuts.

Yes, there is some private sector credit expansion trying to fill the ‘spending gap’ caused by the fiscal tightening, but all that and more is needed to keep it all growing in the face of the ongoing automatic fiscal stabilizers that make it an ‘uphill’ battle for the forces of non govt credit expansion.

So seems to me this all leads to lower equity prices as prospects for earnings and growth fade, and, at some point, lower bond yields as expectations for Fed rate hikes are pushed further into the future by the economic reality.

I also look for confidence readings, one of the few ‘bright spots’, to fade with the equity sell off as well.

And, at some point, ‘QE on’ ceases to matter, under the ‘fool me once…’ theory???

And should that happen, and the Fed be exposed as ‘the kid in the car seat with the toy steering wheel who everyone thinks is driving’, no telling what happens…

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Friday update- deficits matter, a lot!

Posted by WARREN MOSLER on 21st June 2013

So back to basics

For 16t in output to get sold there must have been 16t in spending, which also translates into 16t in some agent’s income.

And (apart from unsold inventory growth), for all practical purposes nominal GDP growth is another way to say sales growth.

To state the obvious, sales = spending, income = expense, etc. Working against growth is ‘unspent income’, also called ‘demand leakages’. Those include pension contributions, insurance reserves, retained earnings, foreign CB fx purchases, cash hoards, etc. etc. etc. And for every agent that spent less than his income, some other agent spent more than his income, to the tune of the 16t GDP.

And GDP growth is a function of that much more of same.

Well, the 2% or so growth we’ve been getting once included the govt spending maybe 10% more than its income to keep sales growing more than the demand leakages were working against sales growth. And with growth, the so called automatic fiscal STABILIZERS work to temper that growth, as growth causes govt revenues to increase and govt transfer payments to decline.

You can think of this as institutional structure that causes the economy to have to go uphill to grow. That’s because as the economy grows, the growth of govt net spending is ‘automatically’ reduced.

So after a couple of years growth the govt went from spending maybe 10% more than its income to something under 6% of its income, which translated into about 2% real growth, and about 3.5% nominal growth.

Well, to keep this going in the face of the demand leakages, some other agents were picking up the slack.

Looking at the charts it seems to me it was the home buyers and car buyers who were consistently spending more than their incomes, driving the nominal GDP growth.

But then on Jan 1 fica taxes went up as did some income tax rates, by about 3.5 billion/week, removing that much income from potential spenders. And a few months later the sequesters hit, both reducing GDP by the amount of those spending cuts and reducing income by about another 1.5 billion per week.

In other words, the govt suddenly reduced the amount it was spending beyond its income by about 1.5% of GDP, which had been working along with the domestic credit expansion to outpace the demand leakages.

So how has domestic credit managed to expand to fill that spending gap caused by the already retreating govt deficit spending proactively dropping another 1.5%?

With great difficulty!

Since January, after climbing steadily, car sales look to have gone sideways. And looks to me like the rate of domestic deficit spending on housing has declined as well. In any case there hasn’t been an the increase these ‘credit expansion engines’ needed to fill the spending gap from the proactive drop in govt deficit spending. And add to that decelerating person income stats (and remember, the pay for additional jobs comes from someone else’s income, and hopefully income spent on output).

And in any case to keep growing at about 2% credit expansion has to overcome the demand leakages and climb the hill of the automatic fiscal stabilizers as with the current institutional structure nominal growth automatically reduces the contribution of govt deficit spending, which is now maybe down to 4% of GDP. Note that with forecasts of 2% growth the forecast for the govt deficit spending falls to only 2% of GDP, implying far more rapid increases of ‘borrowing to spend’ in the domestic sector. And if that net new borrowing doesn’t materialize, the sales don’t either.

Is it possible for housing related credit expansion to suddenly accelerate? Sure, but is it likely, especially in the face of the drag the govt layoffs and tax increases that made the hill the domestic credit expansion needs to climb that much steeper? And sure, the foreign sector could suddenly spend that much more of its income in the US, but is a US export boom likely in the current anemic global economy? I wouldn’t bet on it.

Now add this to the taper nonsense.

As previously discussed, QE is at best a placebo, and more likely a negative as it removes interest income from the economy.

But with none of the name institutions of higher learning teaching this, today’s portfolio managers think it’s somehow a ‘stimulus’ and act accordingly, driving up stock prices globally, supporting global ‘confidence’, even as growth and earnings show signs of fading. And then when the Fed even discusses the possibility of reducing the volume of QE, they all stampede the other way, with bonds reacting to the same misguided QE logic as well. But in any case, these are misguided, one time portfolio shifts, that tend to reverse with time as the reality of the underlying economy/earnings eventuates, refudiating the presumed effects of QE… :)

To conclude, I just don’t see the source of the credit expansion needed for anything more than modest nominal growth, which has now continued to decelerate to maybe 3% of GDP, and a real risk that the domestic credit expansion can’t even keep up with the demand leakages, and real GDP goes negative, along with top line growth and earnings growth.

In fact, with annual population growth running at about 1.25%, per capita GDP is already only about equal to productivity growth, as the labor force participation rate hovers at multi decade lows.

Have a nice weekend!


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Posted by WARREN MOSLER on 22nd May 2013

Karim writes:

Question: On timing of tapering
If the labor market continues to improve at the current pace, could taper in the next few meetings.
Asked if he expected this to occur before Labor Day; depends on the data.
Did not answer question about how much warning he would give the market before tapering.

Question: Exit principles
First have to wind down purchases. He emphasized that the outlook for the labor market is the key driver (not inflation) for whether to taper. And he emphasized that buying at a lesser pace is still easing.
Says no need to sell securities at this point. Makes case for letting securities roll-off in terms of market impact and remittances to Treasury. And he also expresses a desire to return to a Treasury only balance sheet at some point, though also says MBS likely to just roll off the balance sheet.

Text Excerpts Below

  • A key adjective between some and improvement in the labor market is still missing!
  • Removing policy accommodation and policy tightening not appropriate at this juncture (no guidance).
  • Also notes that buying assets at a lower pace (tapering) is still providing accommodation.
  • Many focusing on removing policy accommodation phrase thus has nothing to with tapering (that it is referring to ending QE altogether).
  • Rest of text is largely a rehash of defense of cost/benefit analysis of low rates, headwinds from fiscal policy, and scarring effects of long-term unemployment.

Good report, thanks!

Some interesting language here:

Conditions in the job market have shown some improvement recently. The unemployment rate, at 7.5 percent in April, has declined more than 1/2 percentage point since last summer. Moreover, gains in total nonfarm payroll employment have averaged more than 200,000 jobs per month over the past six months, compared with average monthly gains of less than 140,000 during the prior six months. In all, payroll employment has now expanded by about 6 million jobs since its low point, and the unemployment rate has fallen 2-1/2 percentage points since its peak.

Despite this improvement, the job market remains weak overall: The unemployment rate is still well above its longer-run normal level, rates of long-term unemployment are historically high, and the labor force participation rate has continued to move down.

Over the nearly four years since the recovery began, the economy has been held back by a number of headwinds. Some of these headwinds have begun to dissipate recently, in part because of the Federal Reserve’s highly accommodative monetary policy. Notably, the housing market has strengthened over the past year, supported by low mortgage rates and improved sentiment on the part of potential buyers. Increased housing activity is fostering job creation in construction and related industries, such as real estate brokerage and home furnishings, while higher home prices are bolstering household finances, which helps support the growth of private consumption.

Recognizing the drawbacks of persistently low rates, the FOMC actively seeks economic conditions consistent with sustainably higher interest rates. Unfortunately, withdrawing policy accommodation at this juncture would be highly unlikely to produce such conditions. A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further.

The Chairman has previously indicated that inflation risks are asymmetrical, as they feel reasonably secure about being able to deal with higher inflation via rate hikes, vs feeling reasonably insecure about addressing deflationary forces given the 0% lower bound on rates.

Such outcomes tend to be associated with extended periods of lower, not higher, interest rates, as well as poor returns on other assets.

Japan, for example

Moreover, renewed economic weakness would pose its own risks to financial stability.

Euro zone?

In the current economic environment, monetary policy is providing significant benefits. Low real interest rates have helped support spending on durable goods, such as automobiles, and also contributed significantly to the recovery in housing sales, construction, and prices. Higher prices of houses and other assets, in turn, have increased household wealth and consumer confidence, spurring consumer spending and contributing to gains in production and employment. Importantly, accommodative monetary policy has also helped to offset incipient deflationary pressures and kept inflation from falling even further below the Committee’s 2 percent longer-run objective.

Again, deflation concerns

That said, the Committee is aware that a long period of low interest rates has costs and risks. For example, even as low interest rates have helped create jobs and supported the prices of homes and other assets, savers who rely on interest income from savings accounts or government bonds are receiving very low returns. Another cost, one that we take very seriously, is the possibility that very low interest rates, if maintained too long, could undermine financial stability. For example, investors or portfolio managers dissatisfied with low returns may “reach for yield” by taking on more credit risk, duration risk, or leverage. The Federal Reserve is working to address financial stability concerns through increased monitoring, a more systemic approach to supervising financial firms, and the ongoing implementation of reforms to make the financial system more resilient.

Posted in CBs, Employment, Fed, Inflation | No Comments »

Thinking Caps On – Grab a Coffee – Sales/Trading Commentary

Posted by WARREN MOSLER on 20th May 2013

At: May 14 2013 07:41:14

Consider the following thought experiment. These are the scenarios:
A. The Treasury decides that it will fund itself 30% more in Overnight Bills and reduce issuance across the curve.
B. The Fed announces it will increase QE by 30% (it will remit the net income of this activity back to the Treasury like taxes)
C. Congress announces a new tax on all passive income from USTs, to holders both at home and abroad (ie Central Banks), for all new-issue USTs
D. Lew pre-announces that we will ‘selectively default’ and apply a haircut of on all future Treasury coupon payments of new issues.

Here’s what’s funny. Most intelligent market participants will say things like:
A. Stocks down a few percent on fear of downgrade. Economy slightly weaker or unchanged.
B. Stocks up 5-10% and economy grows another 1% for 1-2yrs; monetary stimulus.
C. Stocks down 5-10% on tax hike (like last year) that maybe corrects. Economy slows 1-2% for a year or so because it’s a tax hike (ie fiscal consolidation).
D. Stocks down 80% and we go into a great depression on steroids. All investment dollars flee the US. I can’t tell you what happens next because my Bloomberg account gets shut down. They might even declare an Internet Holiday.

Here’s what’s craziest: THESE ARE ALL THE SAME THING. The name and the process is different, the OPTICS is different, but the net is the same. There’s the government and there’s everyone else. The government either pays more out – in interest payments or transfer payments or vendor payments, or it takes back more in taxes or default or interest ‘savings.’ Everything the government net gets in ‘revenue’ the rest of the world loses in income. Everything the government dissaves (deficits) the rest of the world saves. Equal and opposite.

[You need to further get around the idea that reserves are overnight bills and there's no such thing as 'monetary base' - just interest rates; that lower discount rates are lower no matter how you get there; that rate cuts are taxes are austerity, even considering the benefit to risk assets from 'lower riskfree discount rates'... it's all basically true if you think abt it long and hard].

Here we are, almost 550 rate cuts into this thing, and inflation everywhere with QE is basically falling (see chart), and incomes are falling everywhere but in the top brackets (see page 9 here for a TRULY SOBERING CHART)… let us never forget that the goal is TO IMPROVE PEOPLE’S QUALITY OF LIFE NOT TO JUICE GDP . Thus economics as a whole also has some major shortcomings. Exporting your way to prosperity is the same as turning your entire population into servants to foreign masters. Disinflation due to lower input costs or better goods or technological gains are good things. HOWEVER if suddenly 20-somethings find social currency in free online friend status rather than cars and houses and weddings – if it makes them happy that’s great but it is also a downward shift in the demand curve that if isn’t replaced leads to someone somewhere being unemployed. These are different issues that shouldn’t all be swept under the ‘disinflation’ rug.

But I digress. Where am I going with all this?
Let’s pretend risk is now in the last 6m-18m phase where everything rallies, everyone in the pool, everyone chases any risk premium to sell, and the underlying income trends are irrelevant. Since I also will posit the Fed isn’t hiking in the next 18 months, I now believe the Fed will entirely miss this risk cycle. Which means they are on hold beyond any trading horizon. So what triggers the end of the cycle? Most would argue – the fear that they ‘tighten’ or ‘hike’ or ‘aren’t on hold anymore.’
To that I disagree…the income and earnings just isn’t there and QE is hurting…in fact the reason the consumer is now tracking +3-4% has been due to a decline in the savings rate (1-handle in q1 as tax hikes hit) that is prone to reverse…it’s MUCH more likely is what triggers the end is that the world starts to understand that QE is a lot like a tax (+ some ‘Richfare’) rather than a stimulus…and that lower rates do raise asset prices for the asset rich but lower incomes and the net to the median person is not what it appears…I see progress on this day every front…TBAC is starting to get it…the inflation markets are starting to get it… we’ll get there … low rates forever…buy blues..

Posted in CBs, Equities, Fed, TREASURY | No Comments »


Posted by WARREN MOSLER on 2nd May 2013

If anyone can get a message to him, please tell him that, functionally, negative rates are just a tax on deposits that ultimately reduces spending/output/employment, much like the PSI did in Greece and whatever you want to call the ‘deposit confiscation tax’ in Cypress.

>   (email exchange)
>   This is a bit unexpected



“on the deposit facility rate… we are technically ready. There are several unintended consequences that may stem from this measure. we will address and cope with these consequences if we decided to act. We will look at this with an open mind and stand ready to act if needed”

Posted in CBs, ECB, EU | No Comments »

Overall view of the economy

Posted by WARREN MOSLER on 29th April 2013

This is my overall view of the economy.

The US was on the move by Q4 last year. A housing and cars (and student loans) driven expansion was happening, with slowing transfer payments and rising tax revenues bringing the deficit down as the automatic stabilizers were doing their countercyclical thing that would eventually reverse the growth. But that could take years. Look at it this way. Someone making 50,000 per year borrowed 150,000 to buy a house. The loan created the deposit that paid for the house. The seller of the house got that much new income, with a bit going to pay taxes and the rest there to be spent. Maybe a bit of furniture etc. was bought on credit as well, again adding income and (gross) financial assets to the recipients of the borrowers spending. And increasing sales added employment as well as output, albeit not enough to keep up with population growth etc.

I was very hopeful. Back in November, after the ‘Obama is a socialist’ sell off, I wrote that it was time to buy stocks and go play golf for three years, as, left alone, the credit accelerator in progress could go on for a long time.

But it wasn’t left along. Only a few weeks later the cliff drama began to intensify, with lots of fear of going over the ‘full cliff’. While that didn’t happen, we did go over about 1/3 cliff when both sides let the FICA reduction expire, thus removing some $170 billion from 2013, along with strong prospects of an $85 billion (annualized) sequester at quarter end. This moved me ‘to the sidelines’. Seemed to me taking that many dollars out of the economy was a serious enough negative for me to get out of the way.

But the Jan and then Feb numbers showed I was wrong, and that the consumer had continued to grow his spending as before via housing and cars, etc. Even the cliff constrained -.1 GDP of Q4 was soon revised up to .4. Stocks kept moving up and bonds moved higher in yield, even as the sequester kicked in, with the market view being the FICA hike fears were bogus and same for the sequester fears. Balancing the budget and getting the govt out of the way does indeed work to support the private sector. The UK, Eurozone, and Japan were exceptions. Austerity inherently does work. And markets were discounting all that, as it’s what market participants believed and the data supported.

Then, it all changed. April releases of March numbers showed not only suddenly weak March numbers, but Jan and Feb numbers revised lower as well. The slope of things post FICA hike went from positive to negative all at once. The FICA hike did seem to have an effect after all. And with the sequesters kicking in April 1, the prospects for Q2 were/are looking worse by the day.

My fear is that the FICA hikes and sequesters didn’t just take 1.5% of GDP ‘off the top’ as forecasters suggest, leaving future gains from the domestic credit expansion there to add to GDP as they had been. That is, the mainstream forecasts are saying when someone’s paycheck goes down by $100 per month from the FICA hike, or loses his job from the sequester, he slows his spending, but he still borrows to buy a car and/or a house as if nothing bad had happened, and so GDP is reduced by approximately the amount of the tax hikes and spending cuts, with a bit of adjustment for the ‘savings multipliers’. I say he may not borrow to buy the house or the car. Which both removes general spending and also slows the credit accelerator, shifting the always pro cyclical private sector from forward to reverse. And the ‘new’ negative data slopes have me concerned it’s already happening. Before the sequesters kicked in.

Looking at Japan, theory and evidence tells me the lesson is that lower interest rates require higher govt deficits for the same level of output and employment. More specifically, it looks to me like 0 rates may require 7-8% or even higher deficits for desired levels of output and employment vs maybe 3-4% deficits when the central bank sets rates at maybe 5% or so, etc. And US history could now be telling much the same.

And another lesson from Japan we should have learned long ago is that QE is a tax that does nothing good for output or employment and is, if anything, ‘deflationary’ via the same interest income channels we have here. Note that the $90 billion of profits the Fed turned over to the tsy would have been earned in the economy if the Fed hadn’t purchased any securities. So, as always in the past, watch for Japan’s QE to again ‘fail’ to add to output, employment, or inflation. However, their increased deficit spending, if and when it materialize, will support output, employment, and prices as it’s done in the past.

Oil and gasoline prices are down some, which is dollar friendly and consumer friendly, but only back to sort of ‘neutral’ levels from elevated ‘problematic’ levels And there is risk that the Saudis decide to cut price for long enough to put the kibosh on the likes of North Dakota’s and other higher priced crude, wiping out the value of that investment and ending the output and employment and currency support from those sources. No way to tell what they may be up to.

So my overall view is negative, with serious deflationary risks looming.

And the solution is still fiscal- a tax cut and/or spending increase.
However, that seems further away then ever, as the President is now moving towards an additional 1.8 trillion of deficit reduction.


Posted in CBs, Comodities, Credit, Employment, Fed, GDP, Government Spending, Japan, Political | No Comments »