The past 24 hours have seena lot of comment on the notion that China (holder of $3.2 trillion of foreign exchange reserves) may intervene to buy Italian government bonds, providing vital support to the market.
I’m not holding my breath, mainly because this all seems very familiar:
October 2010 – China pledges to buy Greek bonds
December 2010 – Portugal asks China to buy its bonds
January 2011 – China backs Irish bailout
January 2011 – China promises to buy Spanish bonds
For the last two years the Euro-Crisis has worked to a familiar script, roughly put is goes something like this:
Government denies it is in trouble, government passes austerity package, growth slows, deficit either widens or refuses to come down, bond yields increase, government denies a bailout is coming, bond yields rise, EU authorities deny a bailout is coming, more austerity, deficit still high, bond yields hit 6%, talk of Chinese (other Asian) support, EU ‘rescue’ agreed at last moment – in reality just kicks the can down the road, more austerity, deficit rises.
It looked a few weeks ago like the ECB might have broken the circle by heavy intervention in the Spanish and Italian debt markets. I speculated a month ago that this wasn’t panning out to plan.
Post the resignation of Stark, and the rise of Italian yields to back about 5.7% it looks like we are back on script.
The problem is that Eurozone leaders are running out of road to kick the can down.
The UK economy is beset by a multitude of problems – falling real wages, a consumer recession on the high street, contracting manufacturing, weak business investment, high inflation and worrying signs of trouble in the labour market. In internationally the Eurozone is in crisis, the US economy is slowing and unable to generate jobs and the ‘currency wars’ look to be flaring up once again.
The fact that I greatly respect many of the signatories makes this even more depressing.
Treasury analysis shows that Labour’s decision to raise the rate to 50p for those earning £150,000 a year or more has generated up to £2.4 billion a year.
The central argument of the 20 objectors is that Britain is now:
one of the highest personal tax regimes in the industrialised world, making it less competitive internationally, and making us less attractive as a destination for both foreign investment and talented workers
I also notice that the economists make no effort to put a figure on what the contribution to growth of cutting the 50p rate would be.
We’ll get a Treasury analysis of the effects of the 50p rate in the next few months – not that this will settle the argument, the crucial assumptions on how the rate has affected behavior will no doubt be subject to argument, one year after the bankers’ bonus pay roll levy there is still a fight about how much it raised. This letter seems an attempt to soften the ground for cutting the rate.
In this situation a powerful alliance is likely to be formed between big business and rentier interests, and they would probably find more than one economist to declare that the situation was manifestly unsound.
Remember the currency wars?
After a relatively peaceful 2011 – some yen intervention and by now traditional Chinese moaning aside – they seem to be flaring up again.
As the Macro Man blog notes in perhaps the best bit of analysis so far:
SNB just announced that they are the World’s issuer of currency and liquidity provider of last resort.
This is the boldest response we have seen from anyone during this crisis. They must have been watching Crocodile Dundee ..”That’s not an intervention…. THIS is an intervention”
SNB have handed monetary control of Switzerland to ECB
SNB have lost control of their balance sheet.
SNB may also lose control of their mandated responsibility towards price stability
Is pegging yourself to a currency that may split in two the wisest thing to do?
Is the act of pegging to euro to be read as a huge vote of confidence in it?
Swiss rates “should” converge with Europe if currencies are pegged.
BUT If you have the choice of buying CHF or EUR assuming that they are pegged, then on a “will it be there tomorrow” front you always buy CHF
So that means that interest rates CAN be different and will solely reflect Euro blow up risk plus SNB failure risk.
A rebirth of the currency wars matters for Britain.
The current consensus of independent economists (tables 1 & 4) is that net trade will contribute 100% of 2011 growth and 30% of 2012 growth. Anything which makes exporting more difficult will have a serious impact without a change of policy.
As I’ve noted myself, perhaps the best contributionBritain could make to resolve these fraught international issues is to establish a State Investment Bank.
The Swiss have shocked the markets with this unilateral move and there are questions as to if it will work – if the Eurocrisis worsens and risk aversions rises again then the SNB is going to have to intervene very heavily to prevent appreciation.
But what if it does work? Could this possibly, 30 years after the end of Bretton Woods, be seen as the start of a new system of fixed exchange rates? Mervyn King has audibly pined for something similar in the past – it can’t be ruled out. This might not be the start of a new round of ‘currency war’ but the birth of a new international monetary system.
Today’s Service Sector PMI showed the biggest month on month slowdown in the crucial sector in a decade. Taken together with the weak manufacturing and construction PMIs from last week there is now a fair chance that the UK economy is actually contracting once again.
Whilst it would be wrong to lay all of the blame for this at the feet of the Chancellor – he can hardly be held responsible for the US and European economies – it is fair to ask if now is the time to think again on the pace of his cuts programme.
It is now well established that ‘expansionary fiscal contraction’ is a myth. Cutting government spending slows growth rather than adding to it. Whilst the deficit has to be brought down in the medium term, a programme of tough austerity at a time of falling demand is a recipe for disaster. The Chancellor himself believes that the economy is currently too weak to reform the banks, so why is it strong enough to cope with the austerity agenda?
Banking reform and the timetable for implanting whatever the Vickers’ Independent Commission on Banking recommends are once again making the headlines.
The Government, according to the FT, are looking at delaying implantation until 2015.
Whilst most blog posts start from a strongly held view and marshal arguments to support that view, this one will be a little different. Because I am genuinely torn on this question and still making up my mind.
Whilst I have argued for a long-time that banks need serious reform, and whilst I thought the interim ICB report was, if anything, a bit weak I can also see the point that proponents of delay are making.
Andy Haldane is surely right to argue that financial stability policy needs to get ‘macro-prudential’ and ‘lean against the wind’. In boom times regulators should be acting as a brake on banking sector exuberance but in times such as these they should be encouraging more lending – something than is, in many ways at odds with calls for firewalls, separately capitalised institutions and higher capital ratios.
On the other hand – a banking crisis seems to be brewing in the Eurozone one which will no doubt impact UK banks.
In many ways my preferred answer is, the rather useless, ‘I wouldn’t start from here’.
I think the mandate of the ICB was seriously limited as it didn’t really deal with the crucial question of ensuring the banking sector was ‘fit for purpose’ in terms of providing credit to the real economy.
The government tried to handle this separately through the very weak Merlin deal.
My ideal banking reforms – a state investment bank, more regional banks, more business-focussed patient investors and lenders, more mutuals – where never really on the table given the narrow mandate that Vickers had to work with.
But I am certain of one thing – the government’s current line makes little economic sense.
A case can be made, on macro-prudential grounds, for delaying banking reform as the economy is currently to weak with deal it. But to make that case whilst simultaneously pressing ahead with a severe fiscal tightening is completely muddle headed.
If the economy is too weak to deal with modest banking reform how can it possibly be strong enough to cope with the scale of the cuts?
In today’s FT we learn:
- The IMF thinks that Eurozone banks may have far more severe losses on sovereign debt than they have reported.
- Eurozone unemployment is rising but inflation is stable.
- Portugal is passing even tougher austerity measures and the economy is expected to contract next year. Debt to GDP will rise to 106%.
- In Italy the government is rapidly losing credibility and the economy is becoming even more unstuck.
- Greece’s fourth largest bank has sought emergency liquidity support.
All of which begs the question – what on earth was the ECB doing raising interest rates this year???
(Having trouble with links – will add later)
As regular readers will be aware I am quite a fan of the monthly round up of independent economic forecasts published by the Treasury.
The August edition was published two weeks ago and contained the tri-annual additional set of ‘medium term forecasts’ out to 2015. These make for depressing reading.
The table below shows the average growth forecast for each year out to 2015 both as they currently stand and how they were just six months ago in February.
Not only has 2011 been downgraded (in a very substantial manner) but so has growth in each of the subsequent years.
To make these numbers more ‘real’ I’ve also included the medium term forecasts for claimant count unemployment in each year, as they are today and how they were six months ago. The orange bar is the difference between the forecasts.
The effect of the downward revisions to 2011, 2012, 2013, 2014 and 2015 is to move the peak of unemployment back a year from 2012 to 2013.
Unemployment in 2013 is now expected to be 770,000 higher than it was just six months ago.
I’m rather surprised this hasn’t generated more headlines.
UPDATE: 5th September – It seems that since I wrote this post the Treasury have re-issued their August forecast document.
It looks like their summary data included an error (including an ILO rather than claimant count figure) and rather then unemployment being 770,000 higher in 2013 it will be a ‘mere’ 130,000 higher.
At the start of this month I took part in a (highly enjoyable!) LSE/Radio 4 debate on Keynes versus Hayek (45 minute radio edit available here and ‘un-cut’ 90 minute video version available here) with Lord Skidelsky and myself representing Keynes opposed by George Selgin and Jamie Whyte..
The structure of the debate limited our opening contributions to around 4 minutes each and the format meant (rightly) that what was emphasised was the differences and disagreements. Which was entirely correct for a public debate/radio programme but the advantage of writing a blog is that allows me to be more nuanced.
I actually have a lot of time for some Hayek’s work – I usually disagree with the policy recommendations which (especially amongst Hayek’s modern day adherents) seem to be driven as much by political ideology as by economic analysis but there is something in Hayek’s analysis of the causes of financial crashes that the left cannot ignore.
So whilst I disagree with most modern day Hayekians on the supposed virtues of cutting public spending during a ‘balance sheet recession’ (Richard Koo’s term, recently used (perhaps unwittingly) by the Chancellor) I can see their point that, given how the modern financial system currently operates, a long period of low interest rates can lead to severe mal-investment and unsustainable bubbles.
The crucial word there being ‘currently’. I can also envisage circumstances in which low interest rates allow a heavily reformed financial system (more banks, more industry focussed banking, regional banks, less speculation) to actually support the productive economy.
But the question that really interests me at the moment, and what inspired this blog post, is the issue of how to deal with the failure of large banks. An issue that I hope doesn’t arise in the near future but which may well do rather quickly if the worst case scenarios come to pass).
At the debate Whyte and Selgin were keen to brand the policies pursued in 2008 (broadly put – huge central bank liquidity support coupled with direct government recapitalisation and varying degrees of nationalisation) as ‘Keynesian’. I’m not at all sure that is fair, I think Kaynes would been far more inventive – perhaps using QE to capitalise a National Investment Corporation. But, that aside, it certainly wasn’t Hayekian.
Their argument (again broadly put) was that bad banks should have been allowed to fail and that by propping them up the government is stopping money going to well functioning banks and holding bank the recovery. The ‘liquidation’ of bad assets has to be allowed to happen in order for a sustainable recovery to begin.
Back in 2008, I supported the actions taken by Western Governments, I thought large scale bank failures would have turned the recession into an actual depression as savers took large loses, payments systems broke down and cash machines actually ceased to operate. That would have been a disaster.
But bank failure in 2011 or 2012 or 2020 could be different. Back in 2008 the crisis surprised policy makers and the response was haphazard and driven by fear and confusion.
If an institution is not viable, it will fail eventually whatever steps are taken to prop it up. The problem is that when it does fail, it brings a lot of others down with it. The larger and more interconnected the failing institutions, the greater the risk they pose to the world economy - and the louder the cries of people who depend on those institutions that governments should act to prevent their failure.
If the international financial system is so fragile that it can only survive with constant infusion of mammoth amounts of public money, then IT IS ALREADY IN A STATE OF COLLAPSE. And as any mining engineer knows, propping it up is not only expensive, it is dangerous.
I would like to suggest that the international financial system should be ALLOWED to collapse. That doesn’t mean that governments should abandon their responsibility to protect the people affected and as far as possible prevent long-term damage to the economy. On the contrary, governments should be actively involved in managing the collapse of the current unsustainable system and the building of a new system that meets our needs better.
This point, which could be dubbed ‘Interventionist Hayekian’, seems right to me.
I also think it is possible to get to the same conclusion in a fundamentally Marxist way. Basic Marxist Crisis Theory says, amongst other things, that as booms expand the amount of capital employed increases, eventually the rate of profit begins to fall leading to a recession in which much of the capital stock is destroyed – allowing higher profits on the remaing capital stock and hence a resumption of expansion.
If we then add on some of the work of modern Marxist economists on how capital has been ‘financialised’ then we get to an interesting conclusion. Foster and Magdoff have written (in a book that I’d highly recommend despite it being somewhat to the left of my usual reading habits):
For the owners of capital the dilemma is what to do with the immense surpluses at their disposal in the face of a dearth of investment opportunities. Their main solution from the 1970s on was to expand their demand for financial products as a means of maintaining and expanding their money capital. On the supply side of this process, financial institutions stepped forward with a vast array of new financial instruments; futures, options, derivatives, hedge funds, etc. The result was skyrocketing financial speculation that has persisted now for decades.
One could then argue that if financial capital has replaced physical capital and the state is preventing financial assets from being destroyed there is no way, according to standard Marxist theory, for the ‘crisis’ to end. Which leads one into calling for revolution and the overthrow of capitalism or acknowledging that simply nationalising failed banks is unlikely to ever end the crisis.
We are in an odd place indeed when Marx and Hayek are pointing in the same direction.
Which take us to Minsky, who although he called himself a Keynesian was a far more interesting and nuanced thinker who paid as much attention to Fisher on debt –deflation as he did to Keynes (and his Keynes was far more about the Treatise and the Tract than the General Theory).
As the standard interpretation of Keynes was assimilated to traditional economics, the emphasis upon finance and debt structures that was evident in the 1920s and the early 1930s was lost. In today’s standard economic theory, an abstract nonfinancial economy is analysed. Theorems about this abstract economy are assumed to be valid for economies with complex financial and monetary institutions and usages. As pointed out earlier, this logical jump is an act of faith, and policy advice based upon the neoclassical synthesis rests upon this act of faith. Modern orthodox macroeconomics is not and cannot be a basis for a serious approach to economic policy.
And this is what we need – a modern way of thinking about the macroeconomy which takes asset bubbles seriously, we looks at over-speculation and which understands how banks operate rather than assuming them out of existence.
The odd thing is that it will probably draw as much from Hayek as from Keynes.
I’m now away for few days on the world’s most beautiful tax haven.
Blogging will resume next week.
In the mean time you should all read the excellent IPPR paper, ‘Surviving the Asian Century’, from Adam Lent & David Nash and the ‘must read’ note from UBS’s George Magnus on the political economy of the current crisis.
See you all next week,
It firmly roots the agenda of Rick Perry and Ron Paul in the tradition of Jefferson and Jackson and I’d highly recommend a read of it.
However (and to be fair they do acknowledge this in the post) I think there is a very important difference between the latest bout of GOP Fed-bashing and the long history of anti-bank politics in the US: the radicals are attacking the Fed not sticking to ‘hard money’ policy of high rates but for being too lax.
And this is, for me at least, a bit of a conundrum. There is now a (sizeable?) constituency in US politics arguing for not only fiscal tightening but monetary tightening as well (in the UK Fraser Nelson too seems to be in this camp).
The whole argument of the ‘Expansionary Fiscal Contraction’ camp is that government spending cuts allow the central bank to keep interest rates low and this supports the recovery. Whilst I may disagree with that argument I can at least understand it.
What I can’t understand is policy makers arguing for tight monetary policy coupled with tight fiscal policy at a time of faltering global demand. That’s a recipe for depression and the fact that major political figures are now advocating it is a worry to be very concerned.