A Modern Monetary Theory Approach to Solving Greek Solvency
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Category Archives: Banking
EU stance shifts on Greece default
Mosler bonds issued to both address current funding requirements and buy back discounted Greek govt debt would further enhance the credit worthiness of those bonds by further and substantially reducing Greek govt interest expense.
Interesting how the word now coming out on the French plan, which initially was greeted with a near celebration, is now entirely negative to the point where it’s being dismissed.
And default discussions now moving to the front burner is telling, as just last week that was proclaimed ‘out of the question’
EU stance shifts on Greece default
By Peter Spiegel and Patrick Jenkins
July 10 (FT) — European leaders are for the first time prepared to accept that Athens should default on some of its bonds as part of a new bail-out plan for Greece that would put the country’s overall debt levels on a sustainable footing.
The new strategy, to be discussed at a Brussels meeting of eurozone finance ministers on Monday, could also include new concessions by Greece’s European lenders to reduce Athens’ debt, such as further lowering interest rates on bail-out loans and a broad-based bond buyback programme. It also marks the possible abandonment of a French-backed plan for banks to roll-over their Greek debt.
“The basic goal is to reduce the debt burden of Greece both through actions of the private sector and the public sector,” said one senior European official involved in negotiations.
Officials cautioned the new tack was still in the early stages, and final details were not expected until late summer. But if the strategy were agreed, it would mark a significant shift in the 18-month struggle to contain the eurozone debt crisis.
Until now, European leaders have been reluctant to back any plan categorised as a default for fear it could lead to a flight by investors from all bonds issued by peripheral eurozone countries – including Italy and Spain, the eurozone’s third and fourth largest economies.
Yields on Italian bonds, which move inversely to prices, rose sharply last week due to the Greek uncertainty. Senior European leaders – including Jean-Claude Trichet, European Central Bank chief, and Jean-Claude Junker, head of the euro group – are to meet top European Union officials ahead of Monday’s finance ministers’ gathering amidst growing fears of contagion.
A German-led group of creditor countries has for weeks been attempting to get “voluntary” help from private bondholders to delay repayment of Greek bonds, a move they hoped would lower Greece’s overall debt while avoiding a default.
But in recent days, debt rating agencies warned any attempt to get bondholders to participate would represent a selective default. Rather than abandon bondholder buy-ins, however, several European leaders have decided to return to a German-backed plan to push current Greek debt holders to swap their holdings for new, longer-maturing bonds.
The move essentially scraps a French proposal unveiled last month, which many analysts believed would only add to Greek debt levels by offering expensive incentives for banks that hold Greek debt to roll over their maturing bonds.
Officials said the Institute of International Finance, the group representing large banks holding Greek debt, has gradually moved away from the French plan and begun to embrace elements of the German plan.
“There’s some convergence in the banking community towards a more realistic plan than the French plan, which was out of this world,” said the senior European official. The plan criticised as being self-serving for the banks.
According to executives involved in the IIF talks, banks have pushed for a Greek bond buyback plan in return for agreeing to a restructuring programme, arguing that only if Greece’s overall debt were reduced could a sustainable recovery occur.
European officials said there was support for the proposal in government circles. The plan, originally pushed by German investors, including Deutsche Bank, could see as much as 10 per cent of outstanding Greek debt repurchased on the open market.
Since Greek bonds are currently trading below face value, such purchases would essentially be a voluntary “haircut”, since bondholders would accept payment for far less than the bonds are worth.
It remains unclear how a buyback would be financed, however. The European Commission has long pushed for the eurozone’s €440bn bail-out fund to be used for buybacks, but Berlin blocked the proposal.
Geithner- We’re going to try to get the biggest deal possible
Bill’s blog, below, as always, is well worth a read.
And note today’s news, where, of all things, the Democrats are trying to position themselves as larger deficit cutters than the Republicans:
“We’re going to try to get the biggest deal possible, a deal that’s best for the economy, not just in the short term,” Geithner said on NBC’s “Meet the Press.”
It is a pity that he doesn’t know the answer himself
By Bill Mitchell
We are deep into hard-disk crash trauma at CofFEE today with 2 volumes dying at the same time on Friday and a backup drive going down too. At least it was a sympathetic act on their behalf. Combine that with I lost a HDD on an iMAC after only 2 weeks since it was new a few weeks ago – after finally convincing myself that OS X was the way forward with virtual machines. Further another colleague’s back-up HDD crashed last week. It leaves one wondering what is going on. Backup is now a oft-spoken word around here today. But there is one thing I do know the answer to – Greg Mankiw’s latest Examination Question. It is a pity that he doesn’t know the answer himself. Further, it is a pity that one of the higher profiled “progressives” in the US buys into the same nonsense.
In his latest blog (July 3, 2011) – A Good Exam Question – Mankiw pokes fun at so-called progressive Dean Baker who wrote a column recently in The Republic (July 2, 2011) – Ron Paul’s Surprisingly Lucid Solution to the Debt Ceiling Impasse – where as the title suggests he thinks ultra-conservative US Republican politician Ron Paul is onto something good.
The truth is that none of them – Mankiw, Baker, or Paul – understand how the banking system operates.
First, let’s consider what Baker said in detail.
I think Mankiw’s summary of the Baker proposal is valid:
According to Congressman Paul, to deal with the debt-ceiling impasse, we should tell the Federal Reserve to destroy its vast holding of government bonds. Because the Fed might have planned on selling those bonds in open-market operations to drain the banking system of the currently high level of excess reserves, the Fed should (according to Baker) substantially increase reserve requirements.Mankiw’s reaction is that “(t)his would be a great exam question: What are the effects of this policy? Who wins and who loses if this proposal is adopted?”.
I also agree that it would be an interesting examination question which I suspect all student who had studied macroeconomics using Mankiw’s own textbook would fail to answer correctly.
I will come back to Mankiw’s own answer directly – which suffers the same misgivings as the suggestion by Baker that we listen to Paul and then Baker’s own addendum to the idea.
Baker referred to Paul’s proposal as:
… a remarkably creative way to deal with the impasse over the debt ceiling: have the Federal Reserve Board destroy the $1.6 trillion in government bonds it now holdsHe acknowledges that “at first blush this idea may seem crazy” but then claims it is “actually a very reasonable way to deal with the crisis. Furthermore, it provides a way to have lasting savings to the budget”.
So we have two ideas here – one to reduce debt as a way of tricking the pesky conservatives who want to close the US government down (or pretend they do for political purposes) by not approving the expansion of the “debt ceiling”. The debt ceiling is this archaic device that conservatives can use to make trouble for an elected government which has not operational validity. After all, doesn’t the US Congress approve the spending and taxation decisions of the US government anyway?
The second idea that Baker leaks into the debate is that by destroying public debt held by the central bank (as a result of their quantitative easing program) it would save them selling it back to the private sector which in turn would save the US government from paying interest on it. And he seems to think that is a good thing. Spare me!
In his own words:
The basic story is that the Fed has bought roughly $1.6 trillion in government bonds through its various quantitative easing programs over the last two and a half years. This money is part of the $14.3 trillion debt that is subject to the debt ceiling. However, the Fed is an agency of the government. Its assets are in fact assets of the government. Each year, the Fed refunds the interest earned on its assets in excess of the money needed to cover its operating expenses. Last year the Fed refunded almost $80 billion to the Treasury. In this sense, the bonds held by the Fed are literally money that the government owes to itself … As it stands now, the Fed plans to sell off its bond holdings over the next few years. This means that the interest paid on these bonds would go to banks, corporations, pension funds, and individual investors who purchase them from the Fed. In this case, the interest payments would be a burden to the Treasury since the Fed would no longer be collecting (and refunding) the interest.First, note the recognition that the central bank and treasury are just components of the consolidated government sector – a basic premise of Modern Monetary Theory (MMT) and should dispel the myth of the central bank being independent.
Mankiw also agreed with that saying “Since the Fed is really part of the government, the bonds it holds are liabilities the government owes to itself”. Which makes you wonder why he doesn’t tell his students that in his textbook. Further, why do those textbooks make out that the central bank is independent when it clearly is part of the monetary operations of the government? The answer is that it suits their ideological claim that monetary policy is superior to fiscal policy.
Please read my blogs – Central bank independence – another faux agenda and The consolidated government – treasury and central bank – for more discussion on this point.
I will come back to that status presently.
Second, the accounting hoopla by which the treasury gets interest income back from the central bank but lets it keep some funds to pay for its staff etc might be interesting to accountants but is largely meaningless from a monetary operations perspective. It is in the realm of the government lending itself money and paying itself back with some territory.
I agree with Mankiw that Paul’s suggestion which Baker endorses “is just an accounting gimmick”. But then the whole edifice surrounding government spending and bond-issuance is also “just an accounting gimmick”. The mainstream make much of what they call the government budget constraint as if it is an a priori financial constraint when in fact it is just an accounting statement of the monetary operations surrounding government spending and taxation and debt-issuance.
There are political gimmicks too that lead to the US government issuing debt to match their net public spending. These just hide the fact that in terms of the intrinsic characteristics of the monetary system the US government is never revenue constrained because it is the monopoly issuer of the currency. Which makes the whole debt ceiling debate a political and accounting gimmick.
Third, note that Baker then falls into the trap that the mainstream are captured by in thinking that in some way the interest payments made by the government to the non-government sector are a “burden”. A burden is something that carries opportunity costs and is unpleasant with connotations of restricted choices.
From a MMT perspective, one of the “costs” of the quantitative easing has been the lost private income that might have been forthcoming had the central bank left the government bonds in the private sector. Given how little else QE has achieved those costs make it a negative policy intervention.
So the so-called “burden” really falls on the private sector in the form of lost income. Once you accept that there are no financial constraints on the US government (which means that the opportunity costs are all real) then the concept of a burden as it is used by Baker is inapplicable.
And then once we recognise that there is a massive pool of underutilised labour and capital equipment in the US at present contributing nothing productive at all then one’s evaluation of those real opportunity costs should be low. That is, at full employment the interest payments made by government to the non-government sector on outstanding public debt have real resource implications that might require some offsetting policies (lower spending/higher taxation) to defray any inflation risks.
With an unemployment rate of nearly 10 per cent and persistently low capacity utilisation rates overall, every dollar the government can put into the US economy will be beneficial from a real perspective.
But it gets worse.
Baker turns his hand to thinking about the monetary operations involved in the central bank destroying the bonds. He might have saved us the pain. He notes that the reason the Federal Reserve “intends to sell off its bonds in future years” is because they want to:
… reduce the reserves of the banking system, thereby limiting lending and preventing inflation. If the Fed doesn’t have the bonds, however, then it can’t sell them off to soak up reserves.
But as it turns out, there are other mechanisms for restricting lending, most obviously raising the reserve requirements for banks. If banks are forced to keep a larger share of their deposits on reserve (rather than lend them out), it has the same effect as reducing the amount of reserves.Baker falls head long into the mainstream myth that banks lend out reserves.
Please read the following blogs – Building bank reserves will not expand credit and Building bank reserves is not inflationary – for further discussion.
I remind you of this piece of analysis by the Bank of International Settlements in – Unconventional monetary policies: an appraisal – it is a very useful way to understanding the implications of the current build-up in bank reserves.
The BIS says:
… we argue that the typical strong emphasis on the role of the expansion of bank reserves in discussions of unconventional monetary policies is misplaced. In our view, the effectiveness of such policies is not much affected by the extent to which they rely on bank reserves as opposed to alternative close substitutes, such as central bank short-term debt. In particular, changes in reserves associated with unconventional monetary policies do not in and of themselves loosen significantly the constraint on bank lending or act as a catalyst for inflation …
In fact, the level of reserves hardly figures in banks’ lending decisions. The amount of credit outstanding is determined by banks’ willingness to supply loans, based on perceived risk-return trade-offs, and by the demand for those loans. The aggregate availability of bank reserves does not constrain the expansion directly.It is obvious why this is the case. Loans create deposits which can then be drawn upon by the borrower. No reserves are needed at that stage. Then, as the BIS paper says, “in order to avoid extreme volatility in the interest rate, central banks supply reserves as demanded by the system.”
The loan desk of commercial banks have no interaction with the reserve operations of the monetary system as part of their daily tasks. They just take applications from credit worthy customers who seek loans and assess them accordingly and then approve or reject the loans. In approving a loan they instantly create a deposit (a zero net financial asset transaction).
The only thing that constrains the bank loan desks from expanding credit is a lack of credit-worthy applicants, which can originate from the supply side if banks adopt pessimistic assessments or the demand side if credit-worthy customers are loathe to seek loans.
In answering his own “examination question”, Mankiw gets positively angry and says of the plan to raise reserve requirements that it would be:
… a form of financial repression. Assuming the Fed does not pay market interest rates on those newly required reserves, it is like a tax on bank financing. The initial impact is on those small businesses that rely on banks to raise funds for investment. The policy will therefore impede the financial system’s ability to intermediate between savers and investors. As a result, the economy’s capital stock will be allocated less efficiently. In the long run, there will be lower growth in productivity and real wages.First, if the central bank didn’t use the bonds to drain reserves (via open market operations) then it would have to pay market rates of interest to the banks who held reserves with them or lose control of its target policy rate. So unless the central bank is going to keep short-term rates at zero for an indefinite period (which I recommend) then we would be unwise to assume they will not be paying a return on the reserves (as they are doing now).
Consistent with MMT, there are two broad ways the central bank can manage bank reserves to maintain control over its target rate. First, central banks can buy or sell government debt to control the quantity of reserves to bring about the desired short-term interest rate.
MMT posits exactly the same explanation for public debt issuance – it is not to finance net government spending (outlays above tax revenue) given that the national government does not need to raise revenue in order to spend. Debt issuance is, in fact, a monetary operation to deal with the banks reserves that deficits add and allow central banks to maintain a target rate.
Try finding this explanation for public sector debt issuance in Mankiw’s macroeconomics text book.
Second, a central bank might, instead, provide a return on excess reserve holdings at the policy rate which means the financial opportunity cost of holding reserves for banks becomes zero. A central bank can then supply as many reserves as it likes at that support rate and the banks will be happy to hold them and not seek to rid themselves of the excess in the interbank market. The important point is that the interest rate level set by the central bank is then “delinked” from the volume of bank reserves in the banking system and so this becomes equivalent to the first case when the central bank drains reserves by issuing public debt.
So the build-up of bank reserves has no implication for interest rates which are clearly set solely by the central bank. All the mainstream claims that budget deficits will drive interest rates up misunderstand their impact on reserves and the central bank’s capacity to manage these bank reserves in a “decoupled” fashion.
Second, Mankiw falls prey to the same error that Baker makes – that banks lend out reserves. As noted this is a mainstream myth. The banks could still lend out whatever they liked as long as there were credit-worthy customers queuing up for loans. So no small businesses would be affected in the way Mankiw claims.
Anyway, as to what the debt-ceiling means, I was asked by several readers about the status of the US government (by which they meant the Treasury) in relation to the central bank (the Federal Reserve).
The legal code in the US essentially recognises that the central bank and treasury are part of the government sector.
If you consult the United States Code which reflects the legislative decisions made by the US Congress you find, for example, the section – TITLE 31 – MONEY AND FINANCE § 5301 – which deals with the Buying obligations of the United States Government
The US law stipulates the following:
31 USC § 5301. Buying obligations of the United States Government
- (a) The President may direct the Secretary of the Treasury to make an agreement with the Federal reserve banks and the Board of Governors of the Federal Reserve System when the President decides that the foreign commerce of the United States is affected adversely because –
- (1) the value of coins and currency of a foreign country compared to the present standard value of gold is depreciating;
- (2) action is necessary to regulate and maintain the parity of United States coins and currency;
- (3) an economic emergency requires an expansion of credit; or
- (4) an expansion of credit is necessary so that the United States Government and the governments of other countries can stabilize the value of coins and currencies of a country.
- (b) Under an agreement under subsection (a) of this section, the Board shall permit the banks (and the Board is authorized to permit the banks notwithstanding another law) to agree that the banks will-
- (1) conduct through each entire specified period open market operations in obligations of the United States Government or corporations in which the Government is the majority stockholder; and
- (2) buy directly and hold an additional $3,000,000,000 of obligations of the Government for each agreed period, unless the Secretary consents to the sale of the obligations before the end of the period.
- (c) With the approval of the Secretary, the Board may require Federal reserve banks to take action the Secretary and Board consider necessary to prevent unreasonable credit expansion.
§ 5301. Buying obligations of the United States Government under Title 31 of the US Code as currently published by the US Government reflects the laws passed by Congress as of February 1, 2010.
So it seems the President can never run out of “money”. Can any constitutional lawyers out there who are expert in the USC please clarify if there are exceptions to this law? The law (including the accompanying notes which I didn’t include here) appears to say that an economic emergency can justify the President commanding the Federal Reserve to hand over credit balances in favour of the US Treasury.
Conclusion
I hope you all answered Mankiw’s examination question correctly.
My attention is now turning to computer hardware!
That is enough for today!ISM/Consumer Credit
Karim writes:
- Similar to Manufacturing ISM, Non-Mfg activity largely stabilized in June.
- Most components also stable
- One notable feature of most PMIs is the collapse of input prices over the last 3mths. Although not a feature of this report, output prices have held largely steady in most surveys-suggesting margins are expanding.
- Interesting mix of data and anecdotals in article below on progress of U.S. household deleveraging.
June May Composite 53.3 54.6 Business activity 53.4 53.6 Prices Paid 60.9 69.6 New Orders 53.6 56.8 Backlog of Orders 48.5 55.0 Supplier Deliveries 52.0 54.0 Inventory Change* 53.5 55.0 Employment 54.1 54.0 Export orders* 57.0 57.0 Imports* 46.5 50.5 *=Non-seasonally adjusted
Best Consumer Credit Since ‘06 Reveals Loan Rebound Across U.S.
June 25 (Bloomberg) — Michael Busick says his credit union “was shocked” to discover his credit score was 812 of a possible 850 when he applied for a $19,500 new-car loan.
The loan officer told Busick he rarely sees scores so close to perfect, said the Charlotte, North Carolina, math teacher, who added that he always pays his bills on time and doesn’t “overextend.” He got the funds in May.
The average U.S. credit score — a predictor of the likelihood lenders will be paid back — rose to 696 in May, the highest in at least four years, according to Equifax Inc., a provider of consumer-credit data. The ratio of consumer-debt payments to incomes is the lowest since 1994, and delinquencies have dropped 30 percent in two years, Federal Reserve data show.
Improving credit quality gives households the ability to lift borrowing as concerns ease about rising gasoline prices, hard-to-find jobs and falling home prices. A reacceleration in spending would belie Morgan Stanley economist Stephen Roach’s assertion that consumers will be “zombies” for years because of too much debt.
“The financial situation of the household sector has improved far faster and far more than everyone thought it would two years ago,” said James Paulsen, chief investment strategist for Wells Capital Management in Minneapolis. “People are still locked into the view that consumers are facing record burdens, and they are not. There has been a change that is sustainable and durable.”
Willing to Lend
Bank senior loan officers reported a pickup in demand for auto loans in the second quarter, following first-quarter growth for all consumer lending — the first increase since 2005, according to a quarterly Fed survey released in May. About 29 percent were more willing to make consumer installment loans, the highest percentage since 1994, the survey found.
“The household deleveraging process is much further along than is appreciated,” said Mark Zandi, chief economist at Moody’s Analytics Inc. in West Chester, Pennsylvania. “This is evident in the rapid improvement in credit quality. ‘Zombie consumers’ is a mischaracterization of the state of the American consumer.”
More borrowing could help spur growth slowed by higher gasoline prices, Paulsen said. That will make stocks more attractive than bonds, pushing the Standard & Poor’s 500 Index up about 8 percent to 1,450 by year end, while raising the yield on 10-year Treasury notes more than half a point to 3.75 percent, he said.
Fewer Defaults
Discover Financial Services’ shares have risen about 43 percent this year to $26.55 on July 1. The Riverwoods, Illinois- based credit-card issuer reported a record second-quarter profit of $600 million on June 23, more than double a year earlier, as consumers spent more and defaulted less.
Fewer losses will benefit stocks of other credit-card and banking companies, said senior analyst Brian Foran of Nomura Securities International Inc. in New York, who has a “buy” rating on Discover, Capital One Financial Corp. and U.S. Bancorp, Minnesota’s biggest lender.
Consumers have reduced debt by more than $1 trillion in the 10 quarters ended in March, according to data from the Federal Reserve Bank of New York, and Roach, nonexecutive chairman of Morgan Stanley Asia, says they will retrench “a minimum of another three to five years.” While household obligations are at a 17-year low because of increased savings and lower interest rates since 2007, debt remains high, he said. He calculates that it amounts to 115 percent of income, compared with a 75 percent average from 1970 to 2000.
‘Overly Indebted’
“What I worry about now is we are creating a whole new generation of zombie consumers in the United States,” Roach said in a Bloomberg Television interview with Carol Massar. “We need to encourage balance-sheet repair and adjustment by overly indebted, savings-short consumers.”
Roach’s view is supported by economists who say the credit that fueled the housing boom from 2002 to 2006 will take years to unwind.
“It’s pernicious, it’s ongoing and it’s holding back the growth because people are going to save more and spend less, and this is a process that will last for several years,” said Kevin Logan, chief U.S. economist at HSBC Securities USA Inc. in New York.
Confidence among U.S. consumers rose to a 10-week high for the period ended June 26 as gasoline prices declined, according to Bloomberg’s Consumer Comfort Index. Expectations had soured in the past few months following a 29 percent surge in regular unleaded prices during the past year, according to AAA, the nation’s largest auto club.
Falling Home Values
Unemployment climbed to 9.1 percent in May, the highest this year, figures from the Labor Department showed June 3, while the S&P/Case-Shiller index of property values in 20 cities fell 4 percent from April 2010, the biggest drop since November 2009.
Even so, Dean Maki, chief U.S. economist at Barclays Capital Inc. in New York, says the growth in credit reflects an underlying optimism, part of a virtuous cycle. As a Fed economist in 2000, he published research that concluded “high debt burdens are not a negative force” and the debt-income ratio isn’t reliable in predicting spending.
“Stronger credit growth is associated with stronger consumer spending,” Maki said. “When consumer credit is growing, it is a sign that households have become more confident about income prospects.”
Rising Profits
Craig Kennison, a senior analyst at Robert W. Baird & Co. in Milwaukee, predicts lending profits will rise at CarMax Inc., the largest U.S. seller of used cars, and at Milwaukee-based Harley-Davidson Inc., the largest U.S. motorcycle manufacturer.
Their finance arms “have fully recovered,” said Kennison, who rates both “outperform.” CarMax, based in Richmond, Virginia, “is looking to take a larger share of the loan originations at CarMax dealerships, a sign of confidence,” and “Harley-Davidson is poised to see retail growth for the first time in the U.S. since 2006.”
Households spent just 16.4 percent of their earnings on debt payments in the first quarter, including lease and rental payments, homeowners’ insurance and property taxes. That’s the least since 1994, Fed figures show. Since the 18-month recession began in December 2007, household obligations have dropped by 2.37 percent of incomes.
Even consumers still in trouble are in better shape, said Mark Cole, chief operating officer for Atlanta-based CredAbility, which provides nonprofit credit counseling nationally. Clients have an average of $19,500 in unsecured debt this year, down 30 percent from 2009 and the lowest in at least six years. “We really see people’s credit quality is increasing,” he said.
‘Fine’ Cash Flows
Credit-card charge-offs “are collapsing” as companies have written off debt of people unemployed for 27 weeks or longer, who account for about 45 percent of all the jobless, Foran said. “Consumers spend money based on their cash flows, and their cash flows are fine.”
Discover’s rate of 30-day delinquencies was 2.79 percent in the second quarter, the lowest in its 25-year history, company officials said on a June 23 conference call with investors. The nationwide rate fell in May to 3.09 percent, the lowest since May 2007, according to Bloomberg data.
Jennifer Lahotski, 28, who has a marketing job in Los Angeles, said she’s worked to repair her credit from 2007, when it scored “absolutely below 660,” the minimum considered prime for consumer loans, according to Equifax. The Pennsylvania State University alumnus had been late on some bills and had an old charge of $5 from a gym.
‘Sent Them a Check’
“I went through each expense, each delinquency, and sent them a check,” she said. “I turned myself into a hermit for six months but I did it,” she added, eliminating most restaurant meals and “random Target runs where you come out with $50” of merchandise.
Lahotski, who has a Visa and an American Express card and $15,000 in student loans, said she is saving “a few hundred a month,” with plans to buy a house when she can afford a down payment.
Math teacher Busick, 33, who has a home loan and four credit cards, estimates his near-perfect credit score has risen from the upper 700s in the past few years. While he uses an American Express card to accumulate frequent-flier miles on Delta Air Lines Inc., he pays it off in full most months. Busick says he strives to maintain strong credit.
“I don’t have late payments,” he said. “I pay all my bills on time.”
Busick is eying a Sony television or Dell or Hewlett- Packard computer that could cost $2,000.
“If I want something, I will get it,” he says.Or (and),
With higher gas prices and lower personal income, consumers had to borrow more to buy the same amount. So somewhat lower gas prices might not mean more spending, just less borrowing and some paying down of credit cards
Yes, the federal deficits have largely repaired consumer balance sheets. But a new ‘borrowing to spend’ cycle has not yet emerged, which has been the driver of prior expansions.
The problem is, the prior borrowing to spend cycles were driven by circumstances that no one wants to repeat- the sub prime expansion of a few years ago, the dot com bubble of the late 1990’s, the S and L expansion phase of the 1980’s that drove the Reagan years, the emerging market lending boom of the prior decade, etc. etc. etc.
After Japan’s credit bubble burst in 1991 they’ve been very careful not to repeat that performance, and have stagnated ever since, even with what are considered relatively high levels of govt deficit spending.
My point is, the demand leakages seem to be high enough such that without an extraordinary surge in private sector credit expansion we need a lot higher deficit to close the output gap.
Which to me is a good thing. I’d prefer lower taxes for a given level of public expenditure to another credit bubble. But when govt. doesn’t understand this, and instead looks to reduce the federal deficit, the result is high unemployment and a relatively weak economy, again, much like Japan.
China 2011 new lending seen around 6.7 trln yuan
This kind of direct limiting of lending does slow things down, and can cause a credit implosion induced hard landing. It’s like a cut in govt spending.
It doesn’t have to be a hard landing, but it’s a serious risk, especially going into the second half of the year.
China 2011 new lending seen around 6.7 trln yuan -paper
July 6 (Reuters) — Chinese banks are seen issuing 6.7 trillion yuan ($1.04 trillion) worth of new loans this year, an official paper said on Wednesday, suggesting lending could slow markedly in 2011 as part of Beijing’s drive to tame inflation.
Drawing on its own calculations and without citing sources, the China Securities Journal said the pace of new bank lending could ease considerably from last year’s 7.95 trillion yuan.
The pace of bank lending is a focal point in China’s monetary policy as it is used by Beijing to manage economic growth and inflation. The government tells banks how much they should lend by setting loan quotas.
Although Beijing did not publicly announce a loan quota this year, it is widely believed to have an informal target of 7 trillion-7.5 trillion yuan.
Chinese banks likely lent 4 trillion yuan worth of new loans in the first six months of this year, after lending 3.5 trillion between January and May, the paper said.
Accordingly, total new lending for the year would hit around 6.7 trillion yuan if Chinese banks control their pace of lending according to a formula stipulated by the central bank, the paper said.
It said the formula calls for banks to lend 60 percent of annual loans in the first half of the year, and the remaining 40 percent in the second.
With inflation at 34-month highs and a lending spree by Chinese banks in 2009 feeding worries about a build-up of bad debt, Beijing wants to temper bank lending this year.
Since October, it has increased interest rates four times and raised the reserve requirement ratio for banks six times, effectively ordering banks to lock a record 21.5 percent of deposits with the central bank.China Extends Crackdown on Off-Balance-Sheet Loans
Cutbacks now will further slow things:
China Extends Crackdown on Off-Balance-Sheet Loans
July 4 (Reuters) — China’s bank regulator has cracked down on off-balance-sheet lending by the country’s banks, sources told Reuters on Monday, its latest step to prevent over-zealous and risky lending from hurting its financial system.
China Banking Regulatory Commission (CBRC) has ordered banks to check all their deals in discounted commercial bills after discovering misconduct among some banks, two sources said.
Chinese banks have in the past year taken to off-balance-sheet lending, or keeping loans outside balance sheets after authorities clamped down on bank loans as part of their fight against inflation.
Last week the regulator tightened control on sales of wealth management products to ward off potential risks, and the regulator had earlier told banks to include all their loans extended via trust investment programs into their account books.
Discounted bills, an important source of financing for firms with no access to formal bank loans, accounted for about 2.5 percent of the 49.5 trillion yuan ($7.7 trillion) of total outstanding loans at the end of March, according to data from the Chinese central bank.
The regulator’s latest move comes after discovering that some rural credit cooperatives and banks in the central Henan province were issuing loans through discounted commercial bills and keeping them outside their loan books.
Under China’s banking laws, banks’ deals in discounted commercial bills should be reflected on their balance sheets.
Banks have been asked to investigate all deals linked to discounted commercial bills and submit their findings by Monday, sources said.
Under the review, banks were ordered to verify that bills issued were based on real transactions, and were ordered to track how extended credit was spent, they added.
Banks were also instructed to stop discounting bills that they issued to get funds for property and stock investments.
Analysts welcomed the move towards stringent regulation, which would also boost transparency.
“There is some concern that some borrowers were using these discounted bills as collateral for further borrowing,” said Mike Werner, a China banking analyst with Sanford Bernstein.
“So the idea that the CBRC is going to increase diligence covering this area of the market is not surprising.”
The regulator said bank branches found with serious misconduct would be barred from the discounted commercial bill market entirely, the sources added.
CBRC was not immediately available for comment when contacted by Reuters.
As China tightens policy and rein in lending to tame 34-month high inflation of 5.5 percent, many companies are struggling to get loans.
For these firms, discounted commercial bills are an important source of financing. They let companies bring bills or drafts to banks and request for money to be disbursed before they mature.Greece on the slippery slope
First, I think there isn’t enough political or popular support to leave the euro and go back to the drachma.
As previously discussed, it’s not obvious to the population or the political leadership that there is anything wrong with the euro itself.
Instead, it probably seems obvious the problem is the result of irresponsible leadership, and now they are all paying the price.
So staying with the euro, Greece has two immediate choices:
1. Negotiate the best austerity terms and conditions they can, and continue to muddle through.
2. Don’t accept them and default
Accepting the terms of the austerity package offered means some combination of spending cuts, tax hikes, assets sales, etc. that still leaves a sizable deficit for the next few years, with a glide path to some presumably sustainable level of deficit spending.
Defaulting means no more borrowing at all for most likely a considerable period of time, which means at least for a while they will only be able to spend the actual tax revenue they take in, which means immediately going to a 0 deficit.
What matters to Greece, on a practical level, is how large a deficit they are allowed to run. This makes default a lot more painful than any austerity package that allows for the funding of at least some size deficit.
Therefore it’s makes the most sense for Greece to accept the best package they can negotiate, rather than to refuse and default.
Additionally, the funding Greece will need to keep going is probably funding to pay for goods and services from Germany and some of the other euro member nations.
In other words, if Germany wants to get paid for its stream of exports to Greece it must approve some kind of funding package.
Reminds me of a an old story Woody Allen popularized a while back:
Doctor: So what’s the problem?
Patient: It’s my brother. He thinks he’s a chicken.
Doctor: Have you tried to talk to him about it?
Patient: No
Doctor: Why not?
Patient: Well, we need the eggs
Likewise the euro zone needs the eggs, and so the most likely path continues to be some manner of ECB funding of the banking system and the national govt’s, as needed, last minute, kicking and screaming about how they need an exit strategy, etc. etc. etc. And the unspoken pressure relief valve is inflation, with a falling euro leading the march. It’s unspoken because the ECB has a single mandate of price stability, which is not compatible with a continuously falling euro, and because a strong euro is an important part of the union’s ideology. But a weak euro that adjusts the price level, as a practical matter, is nonetheless the only pressure relief valve they have for their debt issues in general. And, also as previously discussed, it looks like market forces may be conspiring to move it all in that direction.
Major Banks Likely to Get Reprieve on New Capital Rules
The real problem is if you understand what a bank is, you wouldn’t be trying to use capital ratios to protect taxpayer money.
First, notice that the many of the same people clamoring for higher capital ratios have also supported ‘nationalization’ of banks, which means there is no private capital. So it should be obvious that something other than private capital is employed to protect taxpayer money.
Taxpayer money is protected on the asset side (loans and other investments held by banks) with lending regulations. That includes what type of investments are legal for banks, what kind of lending is legal, including collateral requirements and income requirements. That means if Congress thought the problem in 2008 was lax and misguided lending, to further protect taxpayer money they need to tighten things up on that side. And that would include tightening up on supervision and enforcement as well.
(Of course, they think the current problem is banks are being too cautious, but Congress talking out of both sides of its mouth has never seemed to get in the way before. Just look at the China policy- they want China to strengthen its currency which means they want the dollar to go down vs the yuan, but at the same time they are careful not to employ policy that might cause China to sell their dollars and drive the dollar down vs the yuan.)
So what is the point of bank capital requirements? It’s the pricing of risk.
With an entirely publicly owned bank, risk is priced by government officials which means it’s politicized, with government officials deciding the interest rates that are charged. With private capital in first loss position, risk is priced by employees who are agents for the shareholders, who want the highest possible risk adjusted returns on their investment. This introduces an entirely different set of incentives vs publicly owned institutions. And the choice between the two, and the two alternative outcomes, is a purely political choice.
With our current arrangement of banking being public/private partnerships, the ratio between the two is called the capital ratio. For example, with a 10% capital ratio banks have 10% private capital, and 90% tax payer money (via FDIC deposit insurance). And what changing the capital ratio does is alter the pricing of risk.
Banks lending profits from the spread between the cost of funds and the rates charged to borrowers. And with any given spread, the return on equity falls as capital ratios rise. And looked at from the other perspective, higher capital ratios mean banks have to charge more for loans to make the same return on equity.
Additionally, investors/market forces decide what risk adjusted return on investment is needed to invest in a bank. Higher capital requirements lower returns on investment, but risk goes down as well. But it’s not a ‘straight line’ relationship. It takes a bit of work to sort out all the variables before an informed decision can be made by policy makers when setting required capital ratios.
So where are we?
We have policy makers and everyone else sounding off on the issue who all grossly misunderstand the actual dynamics trying to use capital requirements to protect taxpayer money.
Good luck to us!
For more on this see Proposals for the Banking System, Treasury, Fed, and FDIC
Major Banks Likely to Get Reprieve on New Capital Rules
By Steve Liesman
June 10 (CNBC) — The world’s major banks may get a break from regulators and be forced to set aside only 2 percent-to-2.5 percent more capital rather than the 3 percent reported earlier, officials familiar with the discussions told CNBC.
News of the potential reprieve—which would affect major global banks such as JPMorgan , Citigroup , Bank of America , Wells Fargo , UBS and HSBC —helped stocks pare losses Friday afternoon.
The new rule, which would force the world’s biggest financial institutions to set aside more capital as a cushion against potential losses, is being imposed after the recent credit crisis nearly caused the collapse of the banking system.
The increased capital buffer would be in addition to a seven percent capital increase for all banks, which was negotiated at last year’s Basel III meeting.
The officials, who asked not to be named, made their comments after global banking regulators met this week in Frankfurt. The US has proposed a tougher three percent charge for big banks, but there has been pushback from some European nations, especially France. Negotiations are continuing.
The news comes after JPMorgan Chief Jamie Dimon rose in an Atlanta meeting this week and directly confronted Fed Chairman Ben Bernanke over the numerous new banking regulations, including a new surcharge for the biggest banks.
Officials say there is a more formal meeting in two weeks of regulators in Basel, Switzerland, where the actual percentage should be formalized as a proposal to global leaders.
Sources caution that the situation is still a moving target, with the U.S. apparently holding out for a higher global surcharge if other countries push lower forms of capital, other than common equity, to be used to meet capital requirements.
Earlier this week, U.S. Treasury Department Secretary Tim Geithner suggested that the higher the quality of capital, the lower the surcharge can be.Bernanke Admits Economy Slowing; No Hint of New Stimulus
In fact, no one on the FOMC has called for QE3, so it’s highly unlikely with anything short of actual negative growth.
So the question is, why the unamimous consensus?
I’d say it varies from member to member, with each concerned for his own reason, for better or for worse.
And I do think the odds of their being an understanding with China are high, particularly with China having let their T bill portfolio run off, while directing additions to reserves to currencies other than the $US, as well as evidence of a multitude of other portfolio managers doing much the same thing. This includes buying gold and other commodities, all in response to (misguided notions of) QE2 and monetary and fiscal policy in general. So the Fed may be hoping to reverse the (mistaken) notion that they are ‘printing money and creating inflation’ by making it clear that there are no plans for further QE.
Hence the ‘new’ strong dollar rhetoric: no more ‘monetary stimulus’ and lots of talk about keeping the dollar strong fundamentally via low inflation and pro growth policy. And the tough talk about the long term deficit plays to this theme as well, even as the Chairman recognizes the downside risks to immediate budget cuts, as he continues to see the risks as asymetric. The Fed believes it can deal with inflation, should that happen, but that it’s come to the end of the tool box, for all practical purposes, in their fight against deflation, even as they fail to meet either of their dual mandates of full employment and price stability to their satisfaction.
They also see downside risk to US GDP from China, Japan, and Europe for all the well publicized reasons.
And, with regard to statements warning against immediate budget cuts, I have some reason to believe at least one Fed official has read my book and is aware of MMT in general.
Bernanke Admits Economy Slowing; No Hint of New Stimulus
June 7 (Reuters) — Federal Reserve Chairman Ben Bernanke Tuesday acknowledged a slowdown in the U.S. economy but offered no suggestion the central bank is considering any further monetary stimulus to support growth.
He also issued a stern warning to lawmakers in Washington who are considering aggressive budget cuts, saying they have the potential to derail the economic recovery if cuts in government spending take hold too soon.
A recent spate of weak economic data, capped by a report Friday showing U.S. employers expanded payrolls by a meager 54,000 workers last month, has renewed investor speculation the economy could need more help from the Fed.
“U.S. economic growth so far this year looks to have been somewhat slower than expected,” Bernanke told a banking conference. “A number of indicators also suggest some loss in momentum in labor markets in recent weeks.”
He said the recovery was still weak enough to warrant keeping in place the Fed’s strong monetary support, saying the economy was still growing well below its full potential.
At the same time, Bernanke argued that the latest bout of weakness would likely not last very long, and should give way to stronger growth in the second half of the year. He said a recent spike in U.S. inflation, while worrisome, should be similarly transitory. Weak growth in wages and stable inflation expectations suggest few lasting inflation pressures, Bernanke said.
On the budget, Bernanke repeated his call for a long-term plan for a sustainable fiscal path, but warned politicians against massive short-term reductions in spending.
“A sharp fiscal consolidation focused on the very near term could be self-defeating if it were to undercut the still-fragile recovery,” Bernanke said.
“By taking decisions today that lead to fiscal consolidation over a longer horizon, policymakers can avoid a sudden fiscal contraction that could put the recovery at risk,” he said.
All Tapped Out?
The central bank has already slashed overnight interest rates to zero and purchased more than $2 trillion in government bonds in an effort to pull the economy from a deep recession and spur a stronger recovery.
With the central bank’s balance sheet already bloated, officials have made clear the bar is high for any further easing of monetary policy. The Fed’s current $600 billion round of government bond buying, known as QE2, runs its course later this month.
Sharp criticism in the wake of QE2 is one factor likely to make policymakers reluctant to push the limits of unconventional policy. They also may have concerns that more stimulus would face diminishing economic returns, while potentially complicating their effort to return policy to a more normal footing.
But a further worsening of economic conditions, particularly one that is accompanied by a reversal of recent upward pressure on inflation, could change that outlook.
The government’s jobs report Friday was almost uniformly bleak. The pace of hiring was just over a third of what economists had expected and the unemployment rate rose to 9.1 percent, defying predictions for a slight drop.
In a Reuters poll of U.S. primary dealer banks conducted after the employment data, analysts saw only a 10 percent chance for another round of government bond purchases by the central bank over the next two years. Dealers also pushed back the timing of an eventual rate hike further into 2012.
The weakening in the U.S. recovery comes against a backdrop of uncertainty over the course of fiscal policy and bickering over the U.S. debt limit in Congress, with Republicans pushing hard for deep budget cuts.
Fragility is Global
Hurdles to better economic health have emerged from overseas as well. Europe is struggling with a debt crisis, while Japan is still reeling from the effects of a traumatic earthquake and tsunami.
In emerging markets, China is trying to rein in its red-hot growth to prevent inflation.
Fed policymakers have admitted to being surprised by how weak the economy appears, but none have yet called for more stimulus.
In an interview with the Wall Street Journal, Chicago Federal Reserve Bank President Charles Evans, a noted policy dove, said he was not yet ready to support a third round of so-called quantitative easing. His counterpart in Atlanta, Dennis Lockhart, also said the economy was not weak enough to warrant further support.
While Boston Fed President Eric Rosengren told CNBC Monday the economy’s weakness might delay the timing of an eventual monetary tightening, the head of the Dallas Federal Reserve Bank, Richard Fisher, said the Fed may have already done too much.
Evans and Fisher have a policy vote on the Fed this year while Rosengren and Lockhart do not.the euro zone in transition
As previously discussed since inception, operationally the euro zone, much like every other nation with its own currency, will, one way or another, wind up with the ECB, the issuer of the currency,
‘funding’ fiscal deficits sufficient to meet any net savings desires in that currency, as well as funding the banking system’s liabilities.The open question has always been is how it gets from here to there, and the answer to that has never been clear.
So far it’s doing it with great reluctance, with the ECB funding the banking system and select national govts only as a last resort, and not yet in the normal course of business.
A weakening global economy now seems to be forcing the next move towards the ultimate expected outcome.
We may have reached that point where their austerity measures, rather than bringing national govt deficits down, will instead make those deficit go up, as they induce macro economic weakness which ‘automatically’ increases transfer payments and decreases tax revenues.
This is a highly unstable equilibrium condition that can accelerate into a variety of forms of oblivion, which ultimately reaches the core as default risk premiums move down the line, much like a multi car pile up as one car after another crashes into the lead pack of wrecked cars.
And as the core is threatened, holders of euro financial assets, including foreign govts that hold various forms of euro financial assets as foreign currency reserves, feel the walls closing in, as one credit after another falls by the wayside.
Only a sudden increase in world aggregate demand, or a sudden change of policy that includes pro active ECB funding, is likely to be able to reverse what’s been happening