ECB’s Stark: US Has an ‘Enormous’ Debt Problem

So much for Jeurgen’s legacy:

US Has an ‘Enormous’ Debt Problem: ECB Official

September 1 (CNBC) — A debt crisis is still gripping the developed world, European Central Bank policymaker Juergen Stark said, adding there was no alternative but for countries to take painful steps to consolidate their public finances.

“The crisis is not over. Not just in Europe is it not over, it is also not over in other regions of the world,” he said, adding the United States had an “enormous” debt problem and lacked the structures to get the problem under control.

Stark estimated the level of public debt at around 84 percent of gross domestic product for the euro zone and at a little below 100 percent of GDP for the US, according to Dow Jones newswire.

“Just consider what levels of debt we are passing on to future generations,” he said, according to DJ. “This isn’t responsible, politically, morally or ethically.”

Stark, a member of the ECB’s executive board, declined to discuss ECB monetary policy during a panel discussion at the Alpbach Forum economic conference on Thursday.

The Daily Telegraph: Bank borrowing from ECB


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[written on Sunday]

While not a problem in the US for the Fed to do this and more (in fact it should be standard operating procedure), the eurozone has self imposed treaty issues that make it very problematic.

If there are defaults its the national governments that will probably be called on to repay the ECB for any losses, but given the national governments didn’t approve the transactions the result will be chaotic at best.

Without bank defaults it will probably all muddle through indefinitely.

As before, the systemic risk is in the eurozone.

Valve repair tomorrow, going to try to smuggle in a knife under my gown to even the odds…

Bank borrowing from ECB is out of control

by Ambrose Evans-Pritchard

The European Central Bank has issued the clearest warning to date that it cannot serve as a perpetual crutch for lenders caught off-guard by the severity of the credit crunch.

Not Wellink, the Dutch central bank chief and a major figure on the ECB council, said that banks were becoming addicted to the liquidity window in Frankfurt and were putting the authorities in an invidious position.

“There is a limit how long you can do this. There is a point where you take over the market,” he told Het Finacieele Dagblad, the Dutch financial daily.

“If we see banks becoming very dependent on central banks, then we must push them to tap other sources of funding,” he said.

While he did not name the chief culprits, there are growing concerns about the scale of ECB borrowing by small Spanish lenders and ‘cajas’ with heavy exposed to the country’s property crash. Dutch banks have also been hungry clients at the ECB window.

One ECB source told The Daily Telegraph that over-reliance on the ECB funds has become an increasingly bitter issue at the bank because the policy amounts to a covert bail-out of lenders in southern Europe.

“Nobody dares pinpoint the country involved because as soon as we do it will cause a market reaction and lead to a meltdown for the banks,” said the source.

This “soft bail-out” is largely underwritten by German and North European taxpayers, though it is occurring in a surreptitious way. It has become a neuralgic issue for the increasingly tense politics of EMU.

The latest data from the Bank of Spain shows that the country’s banks have increased their ECB borrowing to a record €49.6bn (£39bn). A number have been issuing mortgage securities for the sole purpose of drawing funds from Frankfurt.

These banks are heavily reliant on short-term and medium funding from the capital markets. This spigot of credit is now almost entirely closed, making it very hard to roll over loans as they expire.

The ECB has accepted a very wide range of mortgage collateral from the start of the credit crunch. This is a key reason why the eurozone has so far avoided a major crisis along the lines of Bear Stearns or Northern Rock.

While this policy buys time, it leaves the ECB holding large amounts of questionable debt and may be storing up problems for later.

The practice is also skirts legality and risks setting off a political storm. The Maastricht treaty prohibits long-term taxpayer support of this kind for the EMU banking system.

Few officials thought this problem would arise. It was widely presumed that the capital markets would recover quickly, allowing distressed lenders to return to normal sources of funding. Instead, the credit crunch has worsened in Europe.

Not to miss out, Nationwide recently announced that it was setting up operations in Ireland, partly in order to be able to take advantage of ECB liquidity if necessary. Any bank can tap ECB funds if they have a registered branch in the eurozone, although collateral must be denominated in euros.

Jean-Pierre Roth, head of the Swiss National Bank, complained this week that lenders were getting into the habit of shopping for funds from those authorities that offer the best terms. The practice is playing havoc monetary policy.

“What we should avoid is some kind of arbitrage by banks, which say they are going to go to central bank X, instead of central bank Y, because conditions are more attractive,” he said.


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THE ECB HAS A SINGLE MANDATE, INFLATION, WITH NO INCENTIVE TO DEVIATE

Not to mention my bent is inflation and growth are, at best, very weak functions of interest rates, and they work mostly through the cost side, but that’s another story – see ‘MANDATORY READINGS‘.

ECB’s Weber Says Interest Rates ‘Accommodative’, Dismisses Cut Bets

by John Fraher and Andreas Scholz

(Bloomberg) European Central Bank council member Axel Weber said interest rates in the euro region are still “accommodative” and investors’ expectations of reductions later this year may be “wishful thinking.”

“We have a positive economic outlook and as long as that doesn’t change I would say that rates are still on the accommodative side and in no way restrictive,” Weber said in an interview with Bloomberg Television in Davos, Switzerland, at the World Economic Forum’s annual meeting.


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ECB on inflation, again

Trichet expresses the mainstream view of monetary policy:

“The financial market correction — it’s a very significant correction with turbulent episodes — that we are observing provides a reminder of how a disturbance in a particular market segment can propagate across many markets and many countries, Trichet said in a debate at the European Parliament economic and monetary affairs committee.

But at times of financial turbulence it is the duty of the ECB and other central banks to anchor inflation expectations, he said.

“In all circumstances, but even more particularly in demanding times of significant market correction and turbulences, it is the
responsibility of the central bank to solidly anchor inflation expectations to avoid additional volatility in already highly volatile markets,” he said.

ECB reiterates rate hike warning

ECB reiterates rate hike warning

FRANKFURT(AFP): The European Central Bank (ECB) reiterated Thursday a strong warning about eurozone inflation, calling for price and wage moderation and suggesting it would raise interest rates if necessary.

A monthly ECB bulletin said it was “absolutely essential” that long-term inflation be avoided, underscoring that the bank “remains prepared to act pre-emptively so that second-round effects” do not materialise. Such effects include further consumer price increases and excessive pay increases. The ECB said inflation pressure “has been fully confirmed” after eurozone consumer prices rose by 3.1 percent in December, the biggest increase in six-and-a-half years.

The report was released a day after Yves Mersch, Luxembourg central bank chief and a member of the ECB board, spoke in an interview of “factors that mitigate inflation risks” and suggested the ECB should “be cautious” amid widespread economic uncertainty. That was taken to mean the bank could lower its main lending rate, currently at 4.0 percent, causing the euro to fall below $1.46 on foreign exchange markets.

Like ECB president Jean-Claude Trichet on Wednesday, the bulletin confirmed the bank’s economic outlook: “That of real GDP (gross domestic product) growth broadly in line with trend potential” of around two percent. But it acknowledged that this projection was subject to high uncertainty owing to the US housing crisis and its unknown final effect on the global economy.

Wording of the bulletin matched that of a press conference by Trichet on January 10, when the bank left its key interest rate unchanged. Among other threats to the economy, the ECB pointed Thursday to persistently high prices for oil and other commodities. While acknowledging growth risks, the bank has stressed concern about rising prices and said that keeping inflation expectations under control was its “highest priority,” suggesting it was more inclined to raise interest rates than to lower them.

Many economists have cast doubt on such a possibility however since the US Federal Reserve and Bank of England have begun a cycle of interest rate cuts.

Faced with such scepticism, Trichet raised his tone last week, saying the bank would not tolerate an upward spiral in consumer prices and wages, a message in part to trade unions gearing up for pay talks.

Faced with drops in purchasing power, labour representatives have become particularly militant in Germany, the biggest eurozone economy. The ECB has raised its rates eight times since an increase cycle began in December 2005, with the benchmark lending rate rising from two to four percent.

An additional hike was expected in September but rates remained on hold owing to the US subprime mortgage market crisis.


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Re: banking system proposal

Dear Philip,

Yes, as in my previous posts, bank stability is all about credible deposit insurance.

I would go further, and have all regulated, member banks, be able to fund via an open line to the BOE at the BOE target rate.

That would eliminate the interbank market entirely, and let all those smart people doing those jobs go out and do something useful, maybe cure cancer, for example!

This would not change the quantity of retail bank deposits, only the rate paid on those deposits, which would be something less than the BOE target rate. Loans create deposits so they are all still there, but with this proposal all the banks would necessarily bid a tad less than the BOE target rate for deposits. And note this pretty much the case anyway.

With insured deposits market discipline comes from via capital requirements, and regulators also tend to further protect their
insured deposits by creating a list of ‘legal assets’ for banks, as well as various other risk parameters. The trick is to make sure the shareholders take the risk and not the govt.

This would change nothing of macro consequence but it would enhance the efficiency and stability of the banking sector, presumably for further public purpose.

Note to that the eurozone has the same issue, only perhaps more so, as the ECB is prohibited by treaty from ‘bailing out’ failed banks. Hopefully this gets addressed before it is tested!

All the best,

Warren

On Jan 5, 2008 7:46 PM, <noreply@sundayherald.com> wrote:
>
>
> Hi Warren Moslder,
>
> Philip Arestis stopped by Sunday Herald
> website and suggested that you visit the following URL:
>
> http://www.sundayherald.com/business/businessnews/display.var.1945229.0.outbreak_of_common_sense_could_save_british_banking.php
>
> Here is their message …
>
> Dear Warren,
>
>
>
> Interesting developments over here. Would it make much difference I wonder.
>
>
>
> Best wishes, Philip
>
>


♥

A Rescue Plan for the Dollar

A Rescue Plan for the Dollar

By Ronald McKinnon and Steve H. Hanke
The Wall Street Journal, December 27, 2007

Central banks ended the year with a spectacular injection of liquidity to lubricate the economy. On Dec. 18, the European Central Bank alone pumped $502 billion — 130% of Switzerland’s annual GDP — into the credit markets.

Misleading. It’s about price, not quantity. For all practical purposes, no net euros are involved.

I have yet to read anything by anyone in the financial press that shows a working knowledge of monetary operations and reserve accounting.

The central bankers also signaled that they will continue pumping “as long as necessary.” This delivered plenty of seasonal cheer to bankers who will be able to sweep dud loans and related impaired assets under the rug — temporarily.

Nor does this sweep anything under any rug. Banks continue to own the same assets and have the same risks of default on their loans. And, as always, the central bank, as monopoly supplier of net reserves, sets the cost of funds for the banking system.

The causation is ‘loans create deposits’, and lending is not reserve constrained. The CB sets the interest rate – the price of funding – but quantity of loans advanced grows endogenously as a function of demand at the given interest rate by credit worthy borrowers.

But the injection of all this liquidity coincided with a spat of troubling inflation news.

At least he didn’t say ’caused’.

On a year-over-year basis, the consumer-price and producer-price indexes for November jumped to 4.3% and 7.2%, respectively. Even the Federal Reserve’s favorite backward-looking inflation gauge — the so-called core price index for personal consumption expenditures — has increased by 2.2% over the year, piercing the Fed’s 2% inflation ceiling.

Yes!

Contrary to what the inflation doves have been telling us, inflation and inflation expectations are not well contained. The dollar’s sinking exchange value signaled long ago that monetary policy was too loose, and that inflation would eventually rear its ugly head.

The fed either does not agree or does not care. Hard to say which.

This, of course, hasn’t bothered the mercantilists in Washington, who have rejoiced as the dollar has shed almost 30% of its value against the euro over the past five years. For them, a maxi-revaluation of the Chinese renminbi against the dollar, and an unpegging of other currencies linked to the dollar, would be the ultimate prize.

Mercantilism is a fixed fx policy/notion, designed to build fx reserves. Under the gold standard it was a policy designed to accumulate gold, for example. With the current floating fx policy, it is inapplicable.

As the mercantilists see it, a decimated dollar would work wonders for the U.S. trade deficit. This is bad economics and even worse politics. In open economies, ongoing trade imbalances are all about net saving propensities,

Yes!!!

not changes in exchange rates. Large trade deficits have been around since the 1980s without being discernibly affected by fluctuations in the dollar’s exchange rate.

So what should be done? It’s time for the Bush administration to put some teeth in its “strong” dollar rhetoric by encouraging a coordinated, joint intervention by leading central banks to strengthen and put a floor under the U.S. dollar — as they have in the past during occasional bouts of undue dollar weakness. A stronger, more stable dollar will ensure that it retains its pre-eminent position as the world’s reserve, intervention and invoicing currency.

Why do we care about that?

It will also provide an anchor for inflation expectations, something the Fed is anxiously searching for.

Ah yes, the all important inflation expectations.

Mainstream models are relative value stories. The ‘price’ is only a numeraire; so, there is nothing to explain why any one particular ‘price level’ comes from or goes to, apart from expectations theory.

They don’t recognize the currency itself is a public monopoly and that ultimately the price level is a function of prices paid by the government when it spends. (See ‘Soft Currency Economics‘)

The current weakness in the dollar is cyclical. The housing downturn prompted the Fed to cut interest rates on dollar assets by a full percentage point since August — perhaps too much. Normally, the dollar would recover when growth picks up again and monetary policy tightens. But foreign-exchange markets — like those for common stocks and house prices — can suffer from irrational exuberance and bandwagon effects that lead to overshooting. This is precisely why the dollar has been under siege.

Seems to me it is portfolio shifts away from the $US. While these are limited, today’s portfolios are larger than ever and can take quite a while to run their course.

If the U.S. government truly believes that a strong stable dollar is sustainable in the long run, it should intervene in the near term to strengthen the dollar.

Borrow euros and spend them on $US??? Not my first choice!

But there’s a catch. Under the normal operation of the world dollar standard which has prevailed since 1945, the U.S. government maintains open capital markets and generally remains passive in foreign-exchange markets, while other governments intervene more or less often to influence their exchange rates.

True, though I would not call that a ‘catch’.

Today, outside of a few countries in Eastern Europe linked to the euro, countries in Asia, Latin America, and much of Africa and the Middle East use the dollar as their common intervention or “key” currency. Thus they avoid targeting their exchange rates at cross purposes and minimize political acrimony. For example, if the Korean central bank dampened its currency’s appreciation by buying yen and selling won, the higher yen would greatly upset the Japanese who are already on the cusp of deflation — and they would be even more upset if China also intervened in yen.

True.

Instead, the dollar should be kept as the common intervention currency by other countries, and it would be unwise and perhaps futile for the U.S. to intervene unilaterally against one or more foreign currencies to support the dollar. This would run counter to the accepted modus operandi of the post-World War II dollar standard, a standard that has been a great boon to the U.S. and world economies.

‘Should’??? I like my reason better – borrow fx to sell more often than not sets you up for a serious blow up down the road.

The timing for joint intervention couldn’t be better. America’s most important trading partners have expressed angst over the dollar’s decline. The president of the European Central Bank (ECB), Jean Claude Trichet, has expressed concern about the “brutal” movements in the dollar-euro exchange rate.

Yes, but the ECB is categorically against buying $US, as building $US reserves would be taken as the $US ‘backing’ the euro. This is ideologically unacceptable. The euro is conceived to be a ‘stand alone’ currency to ultimately serve as the world’s currency, not the other way around.

Japan’s new Prime Minister, Yasuo Fukuda, has worried in public about the rising yen pushing Japan back into deflation.

Yes, but it is still relatively weak and in the middle of its multi-year range verses the $US.

The surge in the Canadian “petro dollar” is upsetting manufacturers in Ontario and Quebec. OPEC is studying the possibility of invoicing oil in something other than the dollar.

In a market economy, the currency you ‘invoice’ in is of no consequence. What counts are portfolio choices.

And China’s premier, Wen Jiabao, recently complained that the falling dollar was inflicting big losses on the massive credits China has extended to the U.S.

Propaganda. Its inflation that evidences real losses.

If the ECB, the Bank of Japan, the Bank of Canada, the Bank of England and so on, were to take the initiative, the U.S. would be wise to cooperate. Joint intervention on this scale would avoid intervening at cross-purposes. Also, official interventions are much more effective when all the relevant central banks are involved because markets receive a much stronger signal that national governments have made a credible commitment.

And this all assumes the fed cares about inflation. It might not. It might be a ‘beggar thy neighbor’ policy where the fed is trying to steal aggregate demand from abroad and help the financial sector inflate its way out of debt.

That is what the markets are assuming when they price in another 75 in Fed Funds cuts over the next few quarters. The January fed meeting will be telling.

While they probably do ultimately care about inflation, they have yet to take any action to show it. And markets will not believe talk, just action.

This brings us to China, and all the misplaced concern over its exchange rate. Given the need to make a strong-dollar policy credible, it is perverse to bash the one country that has done the most to prevent a dollar free fall. China’s massive interventions to buy dollars have curbed a sharp dollar depreciation against the renminbi;

Yes, as part of their plan to be the world’s slaves – they work and produce, and we consume.

they have also filled America’s savings deficiency and financed its trade deficit.

That statement has the causation backwards.

It is US domestic credit expansion that funds China’s desires to accumulate $US financial assets and thereby support their exporters.

As the renminbi’s exchange rate is the linchpin for a raft of other Asian currencies, a sharp appreciation of the renminbi would put tremendous upward pressure on all the others — including Korea, Japan, Thailand and even India. Forcing China into a major renminbi appreciation would usher in another bout of dollar weakness and further unhinge inflation expectations in the U.S. It would also send a deflationary impulse abroad and destabilize the international financial system.

Yes, that’s a possibility.

Most of the world’s government reaction functions are everything but sustaining domestic demand.

China, with its huge foreign-exchange reserves (over $1.4 trillion), has another important role to play. Once the major industrial countries with convertible currencies — led by the ECB — agree to put a floor under the dollar, emerging markets with the largest dollar holdings — China and Saudi Arabia — must agree not to “diversify” into other convertible currencies such as the euro. Absent this agreement, the required interventions by, say, the ECB would be massive, throwing the strategy into question.

Politically, this is a non starter. The ECB has ideological issues, and the largest oil producers are ideologically at war with the US.

Cooperation is a win-win situation: The gross overvaluations of European currencies would be mitigated, large holders of dollar assets would be spared capital losses, and the U.S. would escape an inflationary conflagration associated with general dollar devaluation.

Not if the Saudis/Russians continue to hike prices, with biofuels causing food to follow as well. Inflation will continue to climb until crude prices subside for a considerable period of time.

For China to agree to all of this, however, the U.S. (and EU) must support a true strong-dollar policy — by ending counterproductive China bashing.

Mr. McKinnon is professor emeritus of economics at Stanford University and a senior fellow at the Stanford Institute for Economic Policy Research. Mr. Hanke is a professor of applied economics at Johns Hopkins University and a senior fellow at the Cato Institute.