Bank of England financial data for Q2 were published this morning. (Available from the Bank's website -- but be warned, the presentation of the tables is baffling). As usual, the initial media coverage has been devoted almost entirely to the mortgage statistics, but the data for corporate loan write-offs are arguably more significant -- and point to a fundamental flaw in government policy.
Let's get the mortgage data out of the way first. The number of mortgage approvals in July rose slightly to just above 49,000, the best figure since May 2010. This is barely more than half the average monthly level seen before the financial crisis. It's striking to note, however, that the aggregate value of mortgages approved has fallen much less steeply than that would suggest, which strongly implies that lenders are concentrating their efforts on higher-value properties, which may be less risky. This is consistent with the emergence of a growing north/south divide -- or more exactly, London/everywhere else divide -- in the housing market. Not a good thing.
Now let's get back to the loan writeoffs. During Q2, banks wrote off £2,935 million in loans to the corporate sector, almost three times as much as in Q1, and significantly above the previous post-crash peak seen in Q4/2009. The Q2 level is close to ten times higher than the average level of writeoffs before the financial crisis hit.
Here's where we get to the contradiction underlying the government's approach to the banking sector. It wants banks to strengthen their balance sheets, but at the same time it wants them to boost business lending -- it has even set specific targets for this, under its so-called Project Merlin agreement. But if you were a banker studying the latest data, you'd surely draw the conclusion that the more business loans you advance right now, the more you stand to lose. And the more you lose, the harder it is to boost your capital.
All bank lenders know that it's easy to shovel money out of the door, but your job isn't done until you get it back. But does Vince Cable know this -- or, like the ostrich in that old rugby song, doesn't he bloody well care?
Tuesday 30 August 2011
Sunday 28 August 2011
Way down in The Hole
For some reason markets managed to half-convince themselves last week that Ben Bernanke was about to pull another quantitative easing rabbit (QE3) out of his hat. This never made any sense: Bernanke was speaking at the Kansas City Fed's annual financial markets conference in Jackson Hole, Wyoming, and it would have been unprecedented for him to unveil a major policy announcement there.
As it turned out, Bernanke went to the opposite extreme. His speech at Jackson Hole was almost unforgivably dull and platitudinous. (You can find it, if you really want to, on the Fed's website). He chided politicians for their recent fiscal brinkmanship, but the only thing to which he committed the Fed was a two-day meeting next month, instead of the usual one-dayer.
Journalists who had made the long schlep out to The Hole got much better value from the new head of the IMF, Christine Lagarde. The Economist provides a good summary of her remarks here. Mme Lagarde's wide-ranging agenda included calls for fiscal rebalancing (to reflect the fact that a revival in growth is essential if deficits are to be reduced), action to reduce the level of foreclosures in the US housing market, and steps to recapitalise Eurozone banks in order to head off a fresh liquidity crisis.
The last of these is clearly the most urgent. There have been sustained declines in European banks' stock prices in recent weeks (triggering a ban on short selling in several countries, led by France) and persistent rumours (and some actual evidence) of a drying-up in inter-bank liquidity, forcing at least a few institutions to rely more heavily on ECB funding.
It's hard to escape the feeling that the situation is only heading for a crisis because markets have decided that it should; in many respects there's a disconnect between how the markets are acting and what's actually going on. While Mme Lagarde's call for banks to be better capitalised is undoubtedly prudent, and while there are signs of stress in the inter-bank markets, a number of large lenders (including ING and Unicredito) have successfully raised long-term capital at attractive rates in the last few weeks, even as equities have been falling. As for the EU fiscal shortcomings that are supposedly at the root of all the problems, it's worth keeping the facts in mind. For example, "beleaguered" Italy has a budget deficit of about 4% of GDP this year, compared to more than 10% in the US -- and, for that matter, in the UK, which Chancellor George Osborne regularly and riskily likes to portray as a safe haven.
What's really striking is how little has changed in the global banking system since the near-death experiences of three years ago. Interconnectedness (no major country except perhaps Japan has a purely national banking industry any more) and reliance on wholesale funding remain cornerstones of the system. The short-term liquidity problems in the Eurozone largely stem from a repatriation of money by US money market funds (the flipside of which is that some US banks are starting to complain of being awash with deposits). Why have the money market funds been doing this? Because they are worried that Eurozone banks have too much exposure to European sovereign debt, even though, as suggested above, the Eurozone is starting to get its fiscal house in order and European banks are bolstering their capital reserves. It should be clear anough by now that wholesale markets will always act like this.
This all seems to bolster the case for separation of retail (or utility) banking from riskier investment activities, and for strictly limiting the extent to which retail banks can rely on the wholesale markets for funding. It's not as if this would be damaging. After all, if we take the UK as an example, the main effect of the rapid rise in wholesale funding on the housing sector was not a surge in new home construction, which would have been entirely welcome, but a completely unproductive inflation in the price of the existing housing stock. Housing markets in countries as diverse as the US, Ireland and Spain were also badly distorted by the flood of wholesale cash.
Mme Lagarde did not call for the break-up of the universal banking model in her speech last week, more's the pity. Then again, she might have been wasting her breath if she had. As The Economist sadly notes at the conclusion of its report, "No other top policymaker has spoken so bluntly about the risks to the world economy or called so bluntly for a co-ordinated plan to address them. Now the question is whether governments will listen to her".
As it turned out, Bernanke went to the opposite extreme. His speech at Jackson Hole was almost unforgivably dull and platitudinous. (You can find it, if you really want to, on the Fed's website). He chided politicians for their recent fiscal brinkmanship, but the only thing to which he committed the Fed was a two-day meeting next month, instead of the usual one-dayer.
Journalists who had made the long schlep out to The Hole got much better value from the new head of the IMF, Christine Lagarde. The Economist provides a good summary of her remarks here. Mme Lagarde's wide-ranging agenda included calls for fiscal rebalancing (to reflect the fact that a revival in growth is essential if deficits are to be reduced), action to reduce the level of foreclosures in the US housing market, and steps to recapitalise Eurozone banks in order to head off a fresh liquidity crisis.
The last of these is clearly the most urgent. There have been sustained declines in European banks' stock prices in recent weeks (triggering a ban on short selling in several countries, led by France) and persistent rumours (and some actual evidence) of a drying-up in inter-bank liquidity, forcing at least a few institutions to rely more heavily on ECB funding.
It's hard to escape the feeling that the situation is only heading for a crisis because markets have decided that it should; in many respects there's a disconnect between how the markets are acting and what's actually going on. While Mme Lagarde's call for banks to be better capitalised is undoubtedly prudent, and while there are signs of stress in the inter-bank markets, a number of large lenders (including ING and Unicredito) have successfully raised long-term capital at attractive rates in the last few weeks, even as equities have been falling. As for the EU fiscal shortcomings that are supposedly at the root of all the problems, it's worth keeping the facts in mind. For example, "beleaguered" Italy has a budget deficit of about 4% of GDP this year, compared to more than 10% in the US -- and, for that matter, in the UK, which Chancellor George Osborne regularly and riskily likes to portray as a safe haven.
What's really striking is how little has changed in the global banking system since the near-death experiences of three years ago. Interconnectedness (no major country except perhaps Japan has a purely national banking industry any more) and reliance on wholesale funding remain cornerstones of the system. The short-term liquidity problems in the Eurozone largely stem from a repatriation of money by US money market funds (the flipside of which is that some US banks are starting to complain of being awash with deposits). Why have the money market funds been doing this? Because they are worried that Eurozone banks have too much exposure to European sovereign debt, even though, as suggested above, the Eurozone is starting to get its fiscal house in order and European banks are bolstering their capital reserves. It should be clear anough by now that wholesale markets will always act like this.
This all seems to bolster the case for separation of retail (or utility) banking from riskier investment activities, and for strictly limiting the extent to which retail banks can rely on the wholesale markets for funding. It's not as if this would be damaging. After all, if we take the UK as an example, the main effect of the rapid rise in wholesale funding on the housing sector was not a surge in new home construction, which would have been entirely welcome, but a completely unproductive inflation in the price of the existing housing stock. Housing markets in countries as diverse as the US, Ireland and Spain were also badly distorted by the flood of wholesale cash.
Mme Lagarde did not call for the break-up of the universal banking model in her speech last week, more's the pity. Then again, she might have been wasting her breath if she had. As The Economist sadly notes at the conclusion of its report, "No other top policymaker has spoken so bluntly about the risks to the world economy or called so bluntly for a co-ordinated plan to address them. Now the question is whether governments will listen to her".
Friday 26 August 2011
Devalued qualifications
Every year at about this time, when results for the UK's major secondary school exams are announced, there are worries that the tests have been dumbed down. Overall pass rates have been rising inexorably for the past two decades: more than 97% of students taking A-levels (equivalent to US or Canadian Grade 12) achieve a pass, and so many now achieve the top "A" grade that a new "A*" ranking has been introduced to help universities to select the best candidates.
There have been similar trends at the "GCSE" level (roughly Grade 10 equivalent), and this year brought a new and dubious record. A girl named Deborah, from east London, passed GCSE mathematics -- at the age of FIVE! Well done to Deborah -- but just whose idea was it to stage this stunt? Was it a teacher determined to prove that the exams have been devalued? That's unfair and disheartening for the large number of students for whom GCSEs represent an important achievement. After all, it's not the students' fault if the exams are easier than they used to be: the kids can only take the exam that's put in front of them.
Or maybe Deborah was egged on by a pushy parent. In that case, you have to wonder if any thought was given to how the poor child would feel if she failed the exam, as she almost did -- she achieved an "E" grade, the barest possible pass, which means she'll probably have to take the exam again at some point in the future. Getting Deborah to take the exam has done nothing for her, unless of course the whole point was to get her name in the papers, which can't be ruled out as a motivation for almost any kind of behaviour these days.
Meanwhile at the other end of the groves of Academe, we find lovable "Dr Doom" Nouriel Roubini going off on one at the expense of his inferiors. Nouriel, who has parlayed his fifteen minutes into an enviable gig as a media pundit and party animal, has decided that he now knows all the answers, and he's not putting up with anyone who dares disagree. Here's one of a series of amazingly arrogant Tweets from a couple of days ago:
"Keynes was 100% right: 7 of 9 academic/econometric studies of fiscal stimulus prove it worked. Hacks w/o PhD shut up"
There's a lot more like that if you care to check Roubini's Twitter account -- @Nouriel. (Oh and, "7 of 9"?? Wasn't she a rather fetching alien in one of the later Star Trek series? Just who is Nouriel partying with?).
Denigrating the qualifications of anyone without a PhD is certainly a lot more ambitious than devaluing GCSEs, and Roubini can expect no mercy next time he gets something wrong -- Hell hath no fury like a journalist (or, for that matter, a blogger) bitch-slapped. Thing is though, anyone who's worked in finance in recent years will be all too aware that PhDs played a substantial role in generating the financial crisis. The simultaneous arrival in dealing rooms, a couple of decades ago, of legions of PhDs and unlimited cheap computing power gave the world all those CDOs and CDSs that got us into the unholy mess that Roubini now makes good money pontificating about.
Evidently, having a PhD is no guarantee that you'll show sound judgment in the real world, something that Roubini, as a close student of financial markets and an active teacher of postgrad students, ought to know well. He must also know that years from now, some new economist will come along to tear up rewrite many of the things that today's academics believe: who knows, it may even turn out to be young Deborah.
There have been similar trends at the "GCSE" level (roughly Grade 10 equivalent), and this year brought a new and dubious record. A girl named Deborah, from east London, passed GCSE mathematics -- at the age of FIVE! Well done to Deborah -- but just whose idea was it to stage this stunt? Was it a teacher determined to prove that the exams have been devalued? That's unfair and disheartening for the large number of students for whom GCSEs represent an important achievement. After all, it's not the students' fault if the exams are easier than they used to be: the kids can only take the exam that's put in front of them.
Or maybe Deborah was egged on by a pushy parent. In that case, you have to wonder if any thought was given to how the poor child would feel if she failed the exam, as she almost did -- she achieved an "E" grade, the barest possible pass, which means she'll probably have to take the exam again at some point in the future. Getting Deborah to take the exam has done nothing for her, unless of course the whole point was to get her name in the papers, which can't be ruled out as a motivation for almost any kind of behaviour these days.
Meanwhile at the other end of the groves of Academe, we find lovable "Dr Doom" Nouriel Roubini going off on one at the expense of his inferiors. Nouriel, who has parlayed his fifteen minutes into an enviable gig as a media pundit and party animal, has decided that he now knows all the answers, and he's not putting up with anyone who dares disagree. Here's one of a series of amazingly arrogant Tweets from a couple of days ago:
"Keynes was 100% right: 7 of 9 academic/econometric studies of fiscal stimulus prove it worked. Hacks w/o PhD shut up"
There's a lot more like that if you care to check Roubini's Twitter account -- @Nouriel. (Oh and, "7 of 9"?? Wasn't she a rather fetching alien in one of the later Star Trek series? Just who is Nouriel partying with?).
Denigrating the qualifications of anyone without a PhD is certainly a lot more ambitious than devaluing GCSEs, and Roubini can expect no mercy next time he gets something wrong -- Hell hath no fury like a journalist (or, for that matter, a blogger) bitch-slapped. Thing is though, anyone who's worked in finance in recent years will be all too aware that PhDs played a substantial role in generating the financial crisis. The simultaneous arrival in dealing rooms, a couple of decades ago, of legions of PhDs and unlimited cheap computing power gave the world all those CDOs and CDSs that got us into the unholy mess that Roubini now makes good money pontificating about.
Evidently, having a PhD is no guarantee that you'll show sound judgment in the real world, something that Roubini, as a close student of financial markets and an active teacher of postgrad students, ought to know well. He must also know that years from now, some new economist will come along to tear up rewrite many of the things that today's academics believe: who knows, it may even turn out to be young Deborah.
Wednesday 24 August 2011
Don't sweat the big stuff
Late yesterday evening chez nous, a quick skip through the news channels at the end of another eventful day....
BBC News 24 -- Lyse Doucet is in Tripoli, wearing a hard hat, fronting coverage of a group of youths doing donuts in a BMW in the centre of Green Square.
Sky News -- Anna Botting is in Zawiyah, no hard hat but less lip gloss than usual, presenting an interview with a young man who claims to be called Mr al-Windy and is wearing Col Gadhafi's rather baroque military hat, which he has just liberated from the colonel's bedroom.
CNBC -- alternating between Tripoli and the aftermath of the earthquake in Virginia.
Just to round off, let's see how al-Jazeera is covering all this. After all, they did a really good job at the time of the Egyptian uprising. Two minutes to go before they close for the night, so they're bound to finish with their take on the day's top stories. But what's this? "Samir Nasri has today completed his transfer from Arsenal to Manchester City".
Wow! Thanks a lot, Doha boys. If I'd stuck with the UK channels, I might have missed that.
BBC News 24 -- Lyse Doucet is in Tripoli, wearing a hard hat, fronting coverage of a group of youths doing donuts in a BMW in the centre of Green Square.
Sky News -- Anna Botting is in Zawiyah, no hard hat but less lip gloss than usual, presenting an interview with a young man who claims to be called Mr al-Windy and is wearing Col Gadhafi's rather baroque military hat, which he has just liberated from the colonel's bedroom.
CNBC -- alternating between Tripoli and the aftermath of the earthquake in Virginia.
Just to round off, let's see how al-Jazeera is covering all this. After all, they did a really good job at the time of the Egyptian uprising. Two minutes to go before they close for the night, so they're bound to finish with their take on the day's top stories. But what's this? "Samir Nasri has today completed his transfer from Arsenal to Manchester City".
Wow! Thanks a lot, Doha boys. If I'd stuck with the UK channels, I might have missed that.
Sunday 21 August 2011
Bog off, Rogoff!
Time was that the IMF was associated with a strictly puritanical view of the world. Whenever countries turned to the Fund for help in dealing with their problems, they were put through the wringer. Mostly the victims were developing countries: Argentina regularly showed up on K Street in Washington, cap in hand, to be force-fed another dose of the Fund's evil-tasting medicine.
Not just developing countries, either. At one point in the 1980s, the Canadian authorities were in such despair at the persistence of inflation that they hired one of the Fund's hard men, John Crow, to run the Bank of Canada. To nobody's surprise, Crow promptly jacked up interest rates to unprecedented levels, squeezing inflation out of the system but tanking the real economy in the process.
It's a surprise, then, to find another Fund alumnus, Kenneth Rogoff, proposing a distinctly un-IMF-like cure for the world's ills. Now on the economics faculty at Harvard, Rogoff was at the Fund as a junior economist in the early 1980s, then again in a much more senior role about a decade ago. Writing in the Financial Times on August 8, Rogoff offered the following:
"If direct approaches to debt reduction are ruled out by political obstacles, there is still the option of trying to achieve some modest deleveraging through moderate inflation of, say, 4 to 6 per cent for several years. Any inflation above 2 per cent may seem anathema to those who still remember the anti-inflation wars of the 1970s and 1980s, but a once-in-75-year crisis calls for outside-the-box measures. Ideally, both the ECB and the Fed would engage in expansionary policy, as otherwise there could be profound exchange rate consequences. Of course, simply trying to stabilise exchange rates without overall monetary expansion – as the G7 seems to have proposed – is far less helpful".
In case Rogoff hasn't noticed, something of what he suggests is already happening, though through inadvertence rather than as a deliberate policy measure. Here in the UK, for example, CPI has already been above the 2% target for more than two years, and the Bank of England expects it to stay there at least through the end of 2012. Indeed, the Bank expects CPI to reach 5%, slap in the middle of Rogoff's zone of comfort, if nobody else's, around the end of this year. (Inflation in the US and Eurozone, though lower than in the UK, is also above the levels that the central banks would usually tolerate).
It would be hard to find anybody in the UK who thinks this is in any way a helpful development. The rise in inflation, and fears or worse to come, is regularly cited as a principal factor holding back consumption, which is, lest we forget, more than 60% of GDP. It's altogether possible that the depressing effect of inflation on growth will more than offset the erosion in the real value of debts that Rogoff is looking for, which would render the whole exercise pointless. Throw in the difficulty of getting inflation back under control once you've lit the fuse, and Rogoff's big idea seems downright dangerous.
Not just developing countries, either. At one point in the 1980s, the Canadian authorities were in such despair at the persistence of inflation that they hired one of the Fund's hard men, John Crow, to run the Bank of Canada. To nobody's surprise, Crow promptly jacked up interest rates to unprecedented levels, squeezing inflation out of the system but tanking the real economy in the process.
It's a surprise, then, to find another Fund alumnus, Kenneth Rogoff, proposing a distinctly un-IMF-like cure for the world's ills. Now on the economics faculty at Harvard, Rogoff was at the Fund as a junior economist in the early 1980s, then again in a much more senior role about a decade ago. Writing in the Financial Times on August 8, Rogoff offered the following:
"If direct approaches to debt reduction are ruled out by political obstacles, there is still the option of trying to achieve some modest deleveraging through moderate inflation of, say, 4 to 6 per cent for several years. Any inflation above 2 per cent may seem anathema to those who still remember the anti-inflation wars of the 1970s and 1980s, but a once-in-75-year crisis calls for outside-the-box measures. Ideally, both the ECB and the Fed would engage in expansionary policy, as otherwise there could be profound exchange rate consequences. Of course, simply trying to stabilise exchange rates without overall monetary expansion – as the G7 seems to have proposed – is far less helpful".
In case Rogoff hasn't noticed, something of what he suggests is already happening, though through inadvertence rather than as a deliberate policy measure. Here in the UK, for example, CPI has already been above the 2% target for more than two years, and the Bank of England expects it to stay there at least through the end of 2012. Indeed, the Bank expects CPI to reach 5%, slap in the middle of Rogoff's zone of comfort, if nobody else's, around the end of this year. (Inflation in the US and Eurozone, though lower than in the UK, is also above the levels that the central banks would usually tolerate).
It would be hard to find anybody in the UK who thinks this is in any way a helpful development. The rise in inflation, and fears or worse to come, is regularly cited as a principal factor holding back consumption, which is, lest we forget, more than 60% of GDP. It's altogether possible that the depressing effect of inflation on growth will more than offset the erosion in the real value of debts that Rogoff is looking for, which would render the whole exercise pointless. Throw in the difficulty of getting inflation back under control once you've lit the fuse, and Rogoff's big idea seems downright dangerous.
Thursday 18 August 2011
Nothin' I do don't seem to work
The risk of a second global recession within three years seems to be increasing by the day, and policymakers appear unable to come up with a coherent response. Now a new element has come into the picture: particularly in the US and EU, voters are impatient with the apparent lack of progress in dealing with the problems and are starting to put increasing pressure on politicians.
This is most obvious in the United States. The recent rancorous debate over the debt ceiling led many non-US observers to view the Tea Party as a lunatic minority -- "a small bunch of right-wing nutters", as Vince Cable so tactfully put it. In truth, the Tea Party speaks for a significant portion of the American public who have no appetite for the Obama government's tax-and-spend approach. (You don't have to be a Tea Partier -- or even a Republican -- to think that the current trajectory of US government spending is unsustainable in the medium term).
For the moment, the fiscal debate has quietened down, and the focus has shifted to US monetary policy. As the race for the Republican presidential nomination heats up, the candidates are taking turns to whack one of the party's favourite pinatas, the Federal Reserve. The most intemperate comments so far have come from Texas Governor Rick Perry, who in effect called for violence to be visited upon poor Ben Bernanke if he ever dares to visit Texas, and said that his advocacy of quantitative easing was "almost treasonous". Given the number of death warrants Gov Perry has signed during his years in office, Bernanke may have reason to worry. The other candidates have been quick to pile on, with both Michelle Bachman and Ron Paul claiming (correctly in Paul's case) to be Fed-bashers from way back.
The issue is no longer whether the Tea Partiers or Governor Perry are right about this. As things stand, the combination of Americans' underlying scepticism about government in general and the failure of the Obama government to solve the problems seems likely to limit severely the options open to the administration if things continue to deteriorate. In the meantime, the role of a previous generation of Republicans in creating the excesses that have led to the current mess stands to be forgotten.
Turning to Europe, this week's meeting between President Sarkozy and Chancellor Merkel seems not to have done much to address the Eurozone's underlying problems. The two leaders have agreed to work toward the establishment of an "economic government" for the Eurozone, but have stopped far short of introducing the Europe-wide fiscal policy, complete with new "Euro bonds", that the markets seem to want. President Sarkozy certainly favours that option -- as more than one commentator has suggested, France is four-square behind any rescue plan it can persuade Germany to pay for.
And that's exactly the problem. Chancellor Merkel is increasingly constrained by a political and public backlash at home against contributing any further towards bailing out their feckless neighbours. As in the US, the question isn't whether these views are right or not. It's plausible to argue that the cost to Germany of further bailouts is likely to be far less than the costs that would have to be borne if the Euro were to collapse. By now, however, Chancellor Merkel is afraid to make that argument, and as a result, the options available for dealing with the underlying problems are shrinking fast.
By comparison, the problems facing the Bank of England seem relatively simple, though that will change fast if the Eurozone crisis goes critical. Minutes of the latest Monetary Policy Committee (MPC) meeting reveal that Governor Mervyn King has seen off the dissenters who had previously called for higher rates. The latest meeting voted unanimously to keep rates at the record low of 0.5%. This time the dissent was in the opposite direction, with one committee member voting for an increase in the bank's asset purchase (quantitative easing) programme.
There's no sign yet of a Rick Perry emerging in the UK to utter threats against Mervyn King, but that could change if the Bank's gamble that inflation will start to fall sharply in 2012 fails to pay off. Retail sales data for July, released earlier today, underline the point that the main factor holding back retail sales is not unemployment or a lack of disposable incomes, but high inflation. In the meantime, government finance data for the fiscal year to date offer depressingly little evidence that the Government's austerity plans are working. It wouldn't take much more bad economic news for UK voters to become as stroppy as their American and German counterparts.
Just why is it that getting the world economy out from under this crisis is proving so diificult? One for the historians, perhaps, but here's a thought: what's being attempted is close to logically impossible. Policymakers are anxious to see the massive overleveraging of the past decade reversed, but they want this to happen without triggering a recession. Quantitative easing is an attempt to get banks to lend again, so it's inherently inconsistent with the long-term need to deleverage; and in any case the banks, scared by what happened a few years ago and of what may happen next, are reluctant to play along. Sad to say, the only element of the banking business that's been stimulated by all of that lovely cheap funding flowing out of the central banks is....investment banking.
The title of this posting is, of course, lifted from "19th nervous breakdown" by the Rolling Stones. You may recall that the next line is "only seems to make matters worse". Avoiding that may be the most we can hope for right now.
This is most obvious in the United States. The recent rancorous debate over the debt ceiling led many non-US observers to view the Tea Party as a lunatic minority -- "a small bunch of right-wing nutters", as Vince Cable so tactfully put it. In truth, the Tea Party speaks for a significant portion of the American public who have no appetite for the Obama government's tax-and-spend approach. (You don't have to be a Tea Partier -- or even a Republican -- to think that the current trajectory of US government spending is unsustainable in the medium term).
For the moment, the fiscal debate has quietened down, and the focus has shifted to US monetary policy. As the race for the Republican presidential nomination heats up, the candidates are taking turns to whack one of the party's favourite pinatas, the Federal Reserve. The most intemperate comments so far have come from Texas Governor Rick Perry, who in effect called for violence to be visited upon poor Ben Bernanke if he ever dares to visit Texas, and said that his advocacy of quantitative easing was "almost treasonous". Given the number of death warrants Gov Perry has signed during his years in office, Bernanke may have reason to worry. The other candidates have been quick to pile on, with both Michelle Bachman and Ron Paul claiming (correctly in Paul's case) to be Fed-bashers from way back.
The issue is no longer whether the Tea Partiers or Governor Perry are right about this. As things stand, the combination of Americans' underlying scepticism about government in general and the failure of the Obama government to solve the problems seems likely to limit severely the options open to the administration if things continue to deteriorate. In the meantime, the role of a previous generation of Republicans in creating the excesses that have led to the current mess stands to be forgotten.
Turning to Europe, this week's meeting between President Sarkozy and Chancellor Merkel seems not to have done much to address the Eurozone's underlying problems. The two leaders have agreed to work toward the establishment of an "economic government" for the Eurozone, but have stopped far short of introducing the Europe-wide fiscal policy, complete with new "Euro bonds", that the markets seem to want. President Sarkozy certainly favours that option -- as more than one commentator has suggested, France is four-square behind any rescue plan it can persuade Germany to pay for.
And that's exactly the problem. Chancellor Merkel is increasingly constrained by a political and public backlash at home against contributing any further towards bailing out their feckless neighbours. As in the US, the question isn't whether these views are right or not. It's plausible to argue that the cost to Germany of further bailouts is likely to be far less than the costs that would have to be borne if the Euro were to collapse. By now, however, Chancellor Merkel is afraid to make that argument, and as a result, the options available for dealing with the underlying problems are shrinking fast.
By comparison, the problems facing the Bank of England seem relatively simple, though that will change fast if the Eurozone crisis goes critical. Minutes of the latest Monetary Policy Committee (MPC) meeting reveal that Governor Mervyn King has seen off the dissenters who had previously called for higher rates. The latest meeting voted unanimously to keep rates at the record low of 0.5%. This time the dissent was in the opposite direction, with one committee member voting for an increase in the bank's asset purchase (quantitative easing) programme.
There's no sign yet of a Rick Perry emerging in the UK to utter threats against Mervyn King, but that could change if the Bank's gamble that inflation will start to fall sharply in 2012 fails to pay off. Retail sales data for July, released earlier today, underline the point that the main factor holding back retail sales is not unemployment or a lack of disposable incomes, but high inflation. In the meantime, government finance data for the fiscal year to date offer depressingly little evidence that the Government's austerity plans are working. It wouldn't take much more bad economic news for UK voters to become as stroppy as their American and German counterparts.
Just why is it that getting the world economy out from under this crisis is proving so diificult? One for the historians, perhaps, but here's a thought: what's being attempted is close to logically impossible. Policymakers are anxious to see the massive overleveraging of the past decade reversed, but they want this to happen without triggering a recession. Quantitative easing is an attempt to get banks to lend again, so it's inherently inconsistent with the long-term need to deleverage; and in any case the banks, scared by what happened a few years ago and of what may happen next, are reluctant to play along. Sad to say, the only element of the banking business that's been stimulated by all of that lovely cheap funding flowing out of the central banks is....investment banking.
The title of this posting is, of course, lifted from "19th nervous breakdown" by the Rolling Stones. You may recall that the next line is "only seems to make matters worse". Avoiding that may be the most we can hope for right now.
Sunday 14 August 2011
Short on logic
I beg the indulgence of regular visitors as I return to a favourite topic: the iniquitous practice of short selling in equity markets, which I last addressed in a posting called "Get Shorty!", as recently as July 24.
The past week's wild gyrations on global stock markets must surely have put paid to any lingering suggestions that modern capital markets are anything more than a casino. The idea that there can be anything rational about the DJIA successively rallying and falling by hundreds of points, day after day, can no longer be sustained. It's hardly surprising that regulators should try whatever measures they can to protect their real economies from the madness. Here in the UK, for example, Lord Myners wants something done about so-called high-frequency trading, which uses computer algorithms to generate prodigious numbers of trades every second. It's estimated that such trading accounts for at least 50% of all activity on the London exchange, and percentages on US exchanges seem to be even higher.
Responding to wild, rumour-driven swings in bank stocks, France and three other European countries have resorted to something more old school: a temporary ban on short selling of financial stocks. As usual, this measure has prompted scornful reactions not only from financial markets themselves, but from a surprisingly wide range of media commentators. (See, for example, the normally sensible Jeremy Warner in the business pages of The Daily Telegraph. You'll find Lord Myners over there as well.)
Let's just go through this again. Investors have a perfect right to fall in and out of love with stocks. If you decide you don't like a particular stock that you own, you can try to sell it to someone else who sees things differently; conflicting opinions of value are the basis of every trade. But short-selling allows you to try to make profits out of something you don't even own, at the expense of legitimate sellers and innocent bystanders. Contrary to the claims of its apologists, there's no way that this activity adds anything to the efficient functioning of markets. When it's combined with rumour-mongering, as seems to have been the case with French bank shares this past week, it crosses the boundaries of the merely under-handed and becomes outright malevolent and immoral.
One of the business news networks concocted a graphic this week that purported to show that short selling bans don't even work. Using data for US stocks when such a ban was imposed at the height of the financial crisis in 2008, it appeared to show that over the following two weeks, the overall market was down 18% (if memory serves), while financials, covered by the short selling ban, fell by 23%.
It is, of course, not possible to test a counterfactual, but recall that at the time of the Lehman Brothers failure, there was a wholesale flight from financial stocks. Nobody attempted to stop those who owned bank shares from selling them, so it's not surprising that they fell more than the broader market. But it's surely reasonable to posit that the ban on short selling prevented gleeful speculators from making the carnage immeasurably worse, which is exactly what it was intended to do.
In the case of the French banks, the shares have actually rallied since the ban on shorting was imposed, which tends to suggest that all of the earlier selling pressure came from short sales rather than from longer-term investors lightening their positions. (There would also have been some short covering, but this would probably not have been enough to push the stocks higher if there were any serious underlying selling pressure).
In the UK this week we've heard a lot of moral outrage about rioters and looters, and a surprising number of commentators have drawn comparisons with the behaviour of expenses-fiddling politicians and amoral investment bankers. A lot of this has been well over the top. All the same, if you were to ask me to make a moral distinction between a rumour-peddling short seller and a youth selling a stolen i-Pad on eBay, I have to admit that I couldn't put a cigarette paper between them.
The past week's wild gyrations on global stock markets must surely have put paid to any lingering suggestions that modern capital markets are anything more than a casino. The idea that there can be anything rational about the DJIA successively rallying and falling by hundreds of points, day after day, can no longer be sustained. It's hardly surprising that regulators should try whatever measures they can to protect their real economies from the madness. Here in the UK, for example, Lord Myners wants something done about so-called high-frequency trading, which uses computer algorithms to generate prodigious numbers of trades every second. It's estimated that such trading accounts for at least 50% of all activity on the London exchange, and percentages on US exchanges seem to be even higher.
Responding to wild, rumour-driven swings in bank stocks, France and three other European countries have resorted to something more old school: a temporary ban on short selling of financial stocks. As usual, this measure has prompted scornful reactions not only from financial markets themselves, but from a surprisingly wide range of media commentators. (See, for example, the normally sensible Jeremy Warner in the business pages of The Daily Telegraph. You'll find Lord Myners over there as well.)
Let's just go through this again. Investors have a perfect right to fall in and out of love with stocks. If you decide you don't like a particular stock that you own, you can try to sell it to someone else who sees things differently; conflicting opinions of value are the basis of every trade. But short-selling allows you to try to make profits out of something you don't even own, at the expense of legitimate sellers and innocent bystanders. Contrary to the claims of its apologists, there's no way that this activity adds anything to the efficient functioning of markets. When it's combined with rumour-mongering, as seems to have been the case with French bank shares this past week, it crosses the boundaries of the merely under-handed and becomes outright malevolent and immoral.
One of the business news networks concocted a graphic this week that purported to show that short selling bans don't even work. Using data for US stocks when such a ban was imposed at the height of the financial crisis in 2008, it appeared to show that over the following two weeks, the overall market was down 18% (if memory serves), while financials, covered by the short selling ban, fell by 23%.
It is, of course, not possible to test a counterfactual, but recall that at the time of the Lehman Brothers failure, there was a wholesale flight from financial stocks. Nobody attempted to stop those who owned bank shares from selling them, so it's not surprising that they fell more than the broader market. But it's surely reasonable to posit that the ban on short selling prevented gleeful speculators from making the carnage immeasurably worse, which is exactly what it was intended to do.
In the case of the French banks, the shares have actually rallied since the ban on shorting was imposed, which tends to suggest that all of the earlier selling pressure came from short sales rather than from longer-term investors lightening their positions. (There would also have been some short covering, but this would probably not have been enough to push the stocks higher if there were any serious underlying selling pressure).
In the UK this week we've heard a lot of moral outrage about rioters and looters, and a surprising number of commentators have drawn comparisons with the behaviour of expenses-fiddling politicians and amoral investment bankers. A lot of this has been well over the top. All the same, if you were to ask me to make a moral distinction between a rumour-peddling short seller and a youth selling a stolen i-Pad on eBay, I have to admit that I couldn't put a cigarette paper between them.
Friday 12 August 2011
The quality of mercy
Late last year there was a series of student protests in the UK, over the issue of higher education fees. One particular demo in London degenerated into running battles with the police, looting of stores and even an attack on a car carrying the Prince of Wales and his missus.
A great many students were arrested and brought before the courts. One such was Charlie Gilmour, stepson of the Pink Floyd guitarist David Gilmour. Among other things, Charlie had scaled the Cenotaph in Whitehall, egged others on to broaden the riots, and thrown a dustbin at HRH's limo. He was sentenced to 18 months in jail, possibly because the judge found his "defence" to be downright insulting. Gilmour, a history student at Cambridge, claimed not to know that the Cenotaph was a memorial to the dead of two world wars, and sought to excuse his behaviour by admitting that he was off his face on booze and illegal drugs at the time!
Then something rather strange happened. A good many media and showbiz types, declaring themselves to be friends of the Gilmours, railed against the sentence as a draconian punishment meted out to a person of previously unblemished character. William Rees Mogg's famous editorial comment when Mick Jagger was jailed for a drug offence back in the 1960s ("Who breaks a butterfly upon a wheel?") was widely cited, even though, if memory serves, Mick's spliff didn't injure any police officers or break any windows.
Now the courts are rushing to deal with the hundreds of people arrested in the wake of the riots earlier this week. Can we expect to hear similar pleas for mercy from the likes of India Knight and Trudie Styler? No sign of it yet. In fact, while there is an entirely understandable demand for justice, it's clear that what a great many people actually want is a spot of vengeance.
On Thursday evening the BBC late night news was running its regular preview of the next morning's papers, and as usual the newsreader was joined by a guest commentator. Usually this is another journalist, but this time it was one Brian Coleman, who was introduced as both the Chairman of the London Fire and Emergency Planning Authority (LFEPA), and a Tory member of the London Assembly.
Unsurprisingly, Coleman's take on the situation was, to say the least, robust. He immediately picked up on a front-page story of a young middle-class woman who had already gone before the courts for looting. She has just completed a degree in social work and is due to start a career in that field in September. "Not much chance of that now", said Coleman with brusque relish.
The young lady in question had indeed boosted a large TV set. However, when she got home with the loot she was overcome with remorse. Next day she returned the goods and went to the police station to turn herself in. There may well be a large number of violent recidivists coming before the courts in the next few days, but she is clearly not one of them, and no doubt there are plenty more with similar stories to hers. She should certainly be punished -- a fact she no doubt accepts -- but it would be a tragic waste if the public demand for revenge derails her incipient career. Her chastening experience may well enhance her ability to help other as a social worker; better that, surely, than that she gets rejected and winds up needing social care herself.
Under immense public pressure to mete out punishment, the magistrates and judges will need to show a lot of good judgement.
A great many students were arrested and brought before the courts. One such was Charlie Gilmour, stepson of the Pink Floyd guitarist David Gilmour. Among other things, Charlie had scaled the Cenotaph in Whitehall, egged others on to broaden the riots, and thrown a dustbin at HRH's limo. He was sentenced to 18 months in jail, possibly because the judge found his "defence" to be downright insulting. Gilmour, a history student at Cambridge, claimed not to know that the Cenotaph was a memorial to the dead of two world wars, and sought to excuse his behaviour by admitting that he was off his face on booze and illegal drugs at the time!
Then something rather strange happened. A good many media and showbiz types, declaring themselves to be friends of the Gilmours, railed against the sentence as a draconian punishment meted out to a person of previously unblemished character. William Rees Mogg's famous editorial comment when Mick Jagger was jailed for a drug offence back in the 1960s ("Who breaks a butterfly upon a wheel?") was widely cited, even though, if memory serves, Mick's spliff didn't injure any police officers or break any windows.
Now the courts are rushing to deal with the hundreds of people arrested in the wake of the riots earlier this week. Can we expect to hear similar pleas for mercy from the likes of India Knight and Trudie Styler? No sign of it yet. In fact, while there is an entirely understandable demand for justice, it's clear that what a great many people actually want is a spot of vengeance.
On Thursday evening the BBC late night news was running its regular preview of the next morning's papers, and as usual the newsreader was joined by a guest commentator. Usually this is another journalist, but this time it was one Brian Coleman, who was introduced as both the Chairman of the London Fire and Emergency Planning Authority (LFEPA), and a Tory member of the London Assembly.
Unsurprisingly, Coleman's take on the situation was, to say the least, robust. He immediately picked up on a front-page story of a young middle-class woman who had already gone before the courts for looting. She has just completed a degree in social work and is due to start a career in that field in September. "Not much chance of that now", said Coleman with brusque relish.
The young lady in question had indeed boosted a large TV set. However, when she got home with the loot she was overcome with remorse. Next day she returned the goods and went to the police station to turn herself in. There may well be a large number of violent recidivists coming before the courts in the next few days, but she is clearly not one of them, and no doubt there are plenty more with similar stories to hers. She should certainly be punished -- a fact she no doubt accepts -- but it would be a tragic waste if the public demand for revenge derails her incipient career. Her chastening experience may well enhance her ability to help other as a social worker; better that, surely, than that she gets rejected and winds up needing social care herself.
Under immense public pressure to mete out punishment, the magistrates and judges will need to show a lot of good judgement.
Wednesday 10 August 2011
Portrait of the underclass?
The rioting and looting in London and elsewhere have unleashed a tidal wave of opinions in the media. Just about everyone is blaming "social problems", but of course what that term means depends where you are on the political spectrum. Over on the loony right, Melanie Philips thinks that the problem is absentee fathers. Prime Minister David Cameron says the problem is a "complete lack of responsibility. People allowed to feel that the world owes them something, that their rights outweigh their responsibilities, and their actions do not have consequences".
Then there's the admirable Camila Batmanghelidjh, who trended on Twitter throughout Tuesday thanks to a thoughtful article in The Independent. Ms. B (I'm not going to spell that out again!) runs a remarkable drop-in and help centre for kids in Peckham, one of the areas hit by looting on Monday evening. Her view is that society has neglected its poorer young people, leaving them resentful and anomic, so that they see rioting as an opportunity for revenge.
Well, maybe. The first riot-related cases have started to appear in court. Here's an extract from a piece in Wednesday's Telegraph:
"Alexis Bailey, 31, from Battersea, south London, who was arrested in Richer Sounds in Southend Road, Croydon, pleaded guilty to burglary with intent to steal.
The 31-year-old, who, the court heard, works full-time in a primary school in Stockwell and lives with his parents, was given bail but must adhere to a curfew.
.....Student David Attoh, 18, from Retreat Place, Hackney, was caught on August 8 in Hackney, with two Burberry t-shirts.
Attoh, who the court heard has completed an ICT B-Tech at Hackney Community College and was due to have an interview for an apprenticeship on Tuesday, admitted theft by finding.
The student, who was fined £150, had been receiving Education Maintenance Allowance (EMA) while completing his B-Tech, but over the summer was supported by his mother, the court heard.
.....One man who denied his charge was 19-year-old Adam Ozdas, from Hindrey Road, Hackney, who is accused of receiving stolen goods.
He was stopped by police in Clarence Road, Hackney, and found to be in possession of a large bottle of Southern Comfort, a large number of National Lottery scratchcards, tobacco, £90 in cash, and confectionery, the court heard.
Ozdas, who, the court heard, is due to start a college course in September, pleaded not guilty and was granted conditional bail to appear again next month".
A teaching assistant; a student/would-be apprentice; a student about to start college. These may not be typical examples -- they are taken from the Torygraph, after all -- but they certainly don't, on the face of it, support Ms. B's thesis.
A good number of (mostly male) writers have offered an alternative explanation that may well be closer to the truth than anything based on sociology: rioting is fun, if you think you can get away with it. The best piece on these lines is by Kevin Sampson in Wednesday's Guardian. If this argument is right, the trouble will be ended by arresting a lot of people (thus changing the odds of getting away with it) and by sheer boredom. A good downpour or two would probably help, too.
Then there's the admirable Camila Batmanghelidjh, who trended on Twitter throughout Tuesday thanks to a thoughtful article in The Independent. Ms. B (I'm not going to spell that out again!) runs a remarkable drop-in and help centre for kids in Peckham, one of the areas hit by looting on Monday evening. Her view is that society has neglected its poorer young people, leaving them resentful and anomic, so that they see rioting as an opportunity for revenge.
Well, maybe. The first riot-related cases have started to appear in court. Here's an extract from a piece in Wednesday's Telegraph:
"Alexis Bailey, 31, from Battersea, south London, who was arrested in Richer Sounds in Southend Road, Croydon, pleaded guilty to burglary with intent to steal.
The 31-year-old, who, the court heard, works full-time in a primary school in Stockwell and lives with his parents, was given bail but must adhere to a curfew.
.....Student David Attoh, 18, from Retreat Place, Hackney, was caught on August 8 in Hackney, with two Burberry t-shirts.
Attoh, who the court heard has completed an ICT B-Tech at Hackney Community College and was due to have an interview for an apprenticeship on Tuesday, admitted theft by finding.
The student, who was fined £150, had been receiving Education Maintenance Allowance (EMA) while completing his B-Tech, but over the summer was supported by his mother, the court heard.
.....One man who denied his charge was 19-year-old Adam Ozdas, from Hindrey Road, Hackney, who is accused of receiving stolen goods.
He was stopped by police in Clarence Road, Hackney, and found to be in possession of a large bottle of Southern Comfort, a large number of National Lottery scratchcards, tobacco, £90 in cash, and confectionery, the court heard.
Ozdas, who, the court heard, is due to start a college course in September, pleaded not guilty and was granted conditional bail to appear again next month".
A teaching assistant; a student/would-be apprentice; a student about to start college. These may not be typical examples -- they are taken from the Torygraph, after all -- but they certainly don't, on the face of it, support Ms. B's thesis.
A good number of (mostly male) writers have offered an alternative explanation that may well be closer to the truth than anything based on sociology: rioting is fun, if you think you can get away with it. The best piece on these lines is by Kevin Sampson in Wednesday's Guardian. If this argument is right, the trouble will be ended by arresting a lot of people (thus changing the odds of getting away with it) and by sheer boredom. A good downpour or two would probably help, too.
Monday 8 August 2011
Go away and leave us alone
Ex-Maestro Alan Greenspan has offered up a remarkable stream of platitudes in the wake of the S&P ratings downgrade. Here are some extracts from an article on the Business Week website:
Former Federal Reserve Chairman Alan Greenspan said he expects stocks to continue their decline after Standard & Poor’s downgraded the nation’s credit rating, even as an S&P official predicted little market impact.
“Considering the momentum in which the market went down over the last week, it is very unlikely, if history is any guide, that this isn’t going to take a while to bottom out,” Greenspan said on NBC’s “Meet the Press” program. “So the initial reaction in my judgment is going to be negative.”
.....Greenspan said U.S. government bonds are safe investments. “Very much so,” he said. At the same time the S&P downgrade, which stemmed from the political clash over the debt limit, “hit a nerve that there’s something basically bad going on,” Greenspan said.
Don't you just love that Dylanesque last phrase? You know there's something happening, but you don't know what it is, do you, Mr Jones?
And if Al isn't quite sure what's happening, it probably means he doesn't have any idea who's to blame, either. Well, Al, if you're reading this, here are a few hints:
Who was the Fed chairman who repeatedly cut interest rates in response to every setback in equity markets (creating the infamous "Greenspan put") and kept them far too low throughout the economic expansion of the mid-noughties?
Who enthusiastically endorsed the Bush tax cuts and spending initiatives that are the true cause of the US's current fiscal woes; this after he had ferociously castigated the Clinton administration for even thinking about fiscal stimulus?
Who pushed for ever-greater deregulation of the financial sector, effectively dismantling the Glass-Steagall rules that had helped keep the US financial system relatively stable for half a century?
It's quite a charge sheet, though the man himself has never given the slightest hint of having second thoughts, let alone feeling any remorse. The big surprise is that Business Week and Meet the Press still solicit his opinions. Then again, maybe there's money to be made here. As Daniel Gross (@grossdm) of Yahoo tweeted when he saw the Business Week piece, "Breaking! Reliable buy signal! Greenspan says stocks will decline further".
Former Federal Reserve Chairman Alan Greenspan said he expects stocks to continue their decline after Standard & Poor’s downgraded the nation’s credit rating, even as an S&P official predicted little market impact.
“Considering the momentum in which the market went down over the last week, it is very unlikely, if history is any guide, that this isn’t going to take a while to bottom out,” Greenspan said on NBC’s “Meet the Press” program. “So the initial reaction in my judgment is going to be negative.”
.....Greenspan said U.S. government bonds are safe investments. “Very much so,” he said. At the same time the S&P downgrade, which stemmed from the political clash over the debt limit, “hit a nerve that there’s something basically bad going on,” Greenspan said.
Don't you just love that Dylanesque last phrase? You know there's something happening, but you don't know what it is, do you, Mr Jones?
And if Al isn't quite sure what's happening, it probably means he doesn't have any idea who's to blame, either. Well, Al, if you're reading this, here are a few hints:
Who was the Fed chairman who repeatedly cut interest rates in response to every setback in equity markets (creating the infamous "Greenspan put") and kept them far too low throughout the economic expansion of the mid-noughties?
Who enthusiastically endorsed the Bush tax cuts and spending initiatives that are the true cause of the US's current fiscal woes; this after he had ferociously castigated the Clinton administration for even thinking about fiscal stimulus?
Who pushed for ever-greater deregulation of the financial sector, effectively dismantling the Glass-Steagall rules that had helped keep the US financial system relatively stable for half a century?
It's quite a charge sheet, though the man himself has never given the slightest hint of having second thoughts, let alone feeling any remorse. The big surprise is that Business Week and Meet the Press still solicit his opinions. Then again, maybe there's money to be made here. As Daniel Gross (@grossdm) of Yahoo tweeted when he saw the Business Week piece, "Breaking! Reliable buy signal! Greenspan says stocks will decline further".
Friday 5 August 2011
Bond math
Here's an extract from an article in today's Guardian:
The European Commission president, Jose Manuel Barroso, also expressed "deep concern" at the rise in Italian and Spanish borrowing costs, with investors continuing to demand interest rates of more than 6 per cent to lend money to either country. Although off earlier highs, at 6.1 per cent for Italy and 6.27 per cent for Spain, the rates remain within striking distance of the 7 per cent level seen as unsustainable by investors.
And here's something from Ian King, business editor of The Times:
The yields on Italian and Spanish bonds are now well above 6 per cent, edging ever closer to 7 per cent, the danger level at which the debt burden of a country starts to become unmanageable.
And now a question for you: based on these statements, do you think that Italy and Spain are now having to pay out almost 7% in interest on their entire outstanding stock of debt? Because they're not.
A talking head on CNBC this lunchtime, US fund manager Jim McCaughan, was closer to the truth when he said that neither Italy nor Spain could afford to refinance their debts at current interest rates. Maybe that's true, although it's not that long ago that yields of 6-7% for long-term (say, 10-year) debt were nothing unusual for most countries. But here's the really important point: neither Italy nor Spain actually has to refinance their debt at today's rates. They only have to refinance it when it becomes due. Until that happens, they only have to pay the rates that applied when the bonds were originally sold.
As far as I can tell -- most of the media reports are vague on this, probably because the authors don't really understand what they are talking about -- the 6-7% figure is supposed to represent the current yield to maturity on Italy or Spain's outstanding 10 year bonds. It's true that any new 10-year issuance would probably require these countries to cough up something like that yield in order to get a deal away, but that's a whole lot different from arguing that the burden of the existing debt is becoming unaffordable.
Let's look at something that actually happened in the market this week. Spain issued a new tranche of bonds at a yield of....4.84%. Now, it has to be borne in mind that these are 3-year bonds (2014 maturity), and that the yield was 50 bp higher than the last time Spain made a comparable offering, just a month ago. Still, that's a portion of Spain's debt now locked in for 3 years at a cost far below the supposedly fatal 7%.
There's another interesting feature of the latest Spanish bond issue too, if you can bear a bit more bondspeak. The bid-to-cover at the bond auction was 2.4, which means that for every 1000 euros of bonds offered, there were bids to buy 2400 euros. That doesn't seem like evidence of investor panic. The hedgies and other short sellers may be getting all the headlines, but it looks as if for now, there are plenty of other investors looking to take on Spanish risk at current levels.
These facts suggest that the ECB doesn't need to panic in response to the current market turmoil. Rather, it needs to work closely with Italy and Spain to assess their need for new funding over the near term, and if necessary work with creditor countries (Germany,for the most part) to see if a "backstop bid" can be put in place when those countries next come to the bond market.
In that context, some of the ECB's actions over the past day have been perplexing. It has reportedly been buying up Portuguese and Irish bonds in the secondary market, in order to support prices. A City of London type on the news last evening described this as "a misguided missile", which seems a fair description. Both Portugal and Ireland are fully funded for the next year and more: they won't have to come to public markets any time soon. If private investors want to take lumps out of each other by shorting Irish and Portuguese bonds right now, that's of very little consequence for the countries themselves, and would not seem to warrant ECB involvement when there are more pressing issues to be addressed.
Note however that the shorting is of "very little" rather than "no" consequence. If the bonds are held by banks, short selling in combination with mark-to-market accounting means that bank balance sheets may be impaired, which creates a whole new set of issues. Those issues become much more serious when we are talking of Italian or Spanish bonds being shorted, rather than Irish or Portuguese. This explains why European bank shares fell sharply in response to the latest bond market declines. A second round of taxpayer-led bank recapitalisations is not a realistic option, so the ECB's primary goal should be to ensure that Italy and Spain's borrowing and refinancing needs can be met until such time as markets calm down. Both countries have robust budget-balancing plans already in place; there is no reason to allow the short sellers to have their way at the taxpayer's expense yet again.
The European Commission president, Jose Manuel Barroso, also expressed "deep concern" at the rise in Italian and Spanish borrowing costs, with investors continuing to demand interest rates of more than 6 per cent to lend money to either country. Although off earlier highs, at 6.1 per cent for Italy and 6.27 per cent for Spain, the rates remain within striking distance of the 7 per cent level seen as unsustainable by investors.
And here's something from Ian King, business editor of The Times:
The yields on Italian and Spanish bonds are now well above 6 per cent, edging ever closer to 7 per cent, the danger level at which the debt burden of a country starts to become unmanageable.
And now a question for you: based on these statements, do you think that Italy and Spain are now having to pay out almost 7% in interest on their entire outstanding stock of debt? Because they're not.
A talking head on CNBC this lunchtime, US fund manager Jim McCaughan, was closer to the truth when he said that neither Italy nor Spain could afford to refinance their debts at current interest rates. Maybe that's true, although it's not that long ago that yields of 6-7% for long-term (say, 10-year) debt were nothing unusual for most countries. But here's the really important point: neither Italy nor Spain actually has to refinance their debt at today's rates. They only have to refinance it when it becomes due. Until that happens, they only have to pay the rates that applied when the bonds were originally sold.
As far as I can tell -- most of the media reports are vague on this, probably because the authors don't really understand what they are talking about -- the 6-7% figure is supposed to represent the current yield to maturity on Italy or Spain's outstanding 10 year bonds. It's true that any new 10-year issuance would probably require these countries to cough up something like that yield in order to get a deal away, but that's a whole lot different from arguing that the burden of the existing debt is becoming unaffordable.
Let's look at something that actually happened in the market this week. Spain issued a new tranche of bonds at a yield of....4.84%. Now, it has to be borne in mind that these are 3-year bonds (2014 maturity), and that the yield was 50 bp higher than the last time Spain made a comparable offering, just a month ago. Still, that's a portion of Spain's debt now locked in for 3 years at a cost far below the supposedly fatal 7%.
There's another interesting feature of the latest Spanish bond issue too, if you can bear a bit more bondspeak. The bid-to-cover at the bond auction was 2.4, which means that for every 1000 euros of bonds offered, there were bids to buy 2400 euros. That doesn't seem like evidence of investor panic. The hedgies and other short sellers may be getting all the headlines, but it looks as if for now, there are plenty of other investors looking to take on Spanish risk at current levels.
These facts suggest that the ECB doesn't need to panic in response to the current market turmoil. Rather, it needs to work closely with Italy and Spain to assess their need for new funding over the near term, and if necessary work with creditor countries (Germany,for the most part) to see if a "backstop bid" can be put in place when those countries next come to the bond market.
In that context, some of the ECB's actions over the past day have been perplexing. It has reportedly been buying up Portuguese and Irish bonds in the secondary market, in order to support prices. A City of London type on the news last evening described this as "a misguided missile", which seems a fair description. Both Portugal and Ireland are fully funded for the next year and more: they won't have to come to public markets any time soon. If private investors want to take lumps out of each other by shorting Irish and Portuguese bonds right now, that's of very little consequence for the countries themselves, and would not seem to warrant ECB involvement when there are more pressing issues to be addressed.
Note however that the shorting is of "very little" rather than "no" consequence. If the bonds are held by banks, short selling in combination with mark-to-market accounting means that bank balance sheets may be impaired, which creates a whole new set of issues. Those issues become much more serious when we are talking of Italian or Spanish bonds being shorted, rather than Irish or Portuguese. This explains why European bank shares fell sharply in response to the latest bond market declines. A second round of taxpayer-led bank recapitalisations is not a realistic option, so the ECB's primary goal should be to ensure that Italy and Spain's borrowing and refinancing needs can be met until such time as markets calm down. Both countries have robust budget-balancing plans already in place; there is no reason to allow the short sellers to have their way at the taxpayer's expense yet again.
Wednesday 3 August 2011
Cuts? What cuts? (US edition)
Reactions to the US debt deal range from the exaggerated to the downright hysterical. Republicans are bragging about putting an end to Washington's culture of spending, even though the agreed spending cuts are back-end loaded to such an extent that they will almost certainly never happen. Media pundits are overstating the likely macroeconomic impact, as per this headline from Bloomberg: "Debt Agreement Puts U.S. on Path to End Stimulus Just as Economy Falters". In a similar vein, one Wall Street investment house has warned that the US is switching "from massive stimulus to massive restraint".
Over on the left there's anguish. Democrats lined up on the floor of the House and the Senate to stress how much they hated what they were about to vote into law. Pundits are even more distressed: David Weigel on Slate calls the deal a "generational defeat" for the Democrats, while on his blog, Paul Krugman sounds totally disillusioned: "It’s much, much too late for Obama and co. to say 'Trust us, we know what we’re doing.' My reservoir of trust is now completely drained. And I know I’m not alone".
This deal only ever got done because absolutely none of these things is true.
It's important to realise that there are, in the aggregate, no actual spending cuts here. Sure, some programmes may get axed down the road -- and remarkably, given the final package was supposedly dictated by the Republicans, big ticket defence projects seem to be squarely in the firing line. Overall, however, all that has been agreed after all of the rhetoric and wrangling is a path to slow the growth in US Federal spending over a ten-year horizon. The US Government will still be spending more with each passing year -- just "less more" than was previously projected. As Bill Gross at Pimco points out, on reasonable GDP growth assumptions the US will still be running deficits of 7-8% of GDP by 2018 -- ten years after the onset of the financial crisis.
The fact that virtually none of the spending "cuts" will take effect before the November 2012 Presidential election ensures two things. First, the growth impact of the spending cuts in the near term will be nugatory. The US economy may well head back into recession in the coming quarters -- that seems to be what stock markets think, anyway -- but it won't be because of anything decided in Washington this past weekend. Secondly, almost none of the envisaged cuts will actually happen. As Larry Summers and others have pointed out, this Congress and President can't control the actions of their successors. Experience in the US and elsewhere shows all too clearly that long-term spending reduction plans never pan out.
Amazingly, then, I find myself with two altogether unaccustomed bedfellows here: Michelle Bachmann, who has said ad nauseam, but undoubtedly correctly, that the deal just "kicks the can further down the road"; and (gulp) Anatole Kaletsky, who writes in The Times today (paywall protected) that contrary to the consensus, President Obama came out on top in the negotiations. I hope Paul Krugman has a Times subscription.
Over on the left there's anguish. Democrats lined up on the floor of the House and the Senate to stress how much they hated what they were about to vote into law. Pundits are even more distressed: David Weigel on Slate calls the deal a "generational defeat" for the Democrats, while on his blog, Paul Krugman sounds totally disillusioned: "It’s much, much too late for Obama and co. to say 'Trust us, we know what we’re doing.' My reservoir of trust is now completely drained. And I know I’m not alone".
This deal only ever got done because absolutely none of these things is true.
It's important to realise that there are, in the aggregate, no actual spending cuts here. Sure, some programmes may get axed down the road -- and remarkably, given the final package was supposedly dictated by the Republicans, big ticket defence projects seem to be squarely in the firing line. Overall, however, all that has been agreed after all of the rhetoric and wrangling is a path to slow the growth in US Federal spending over a ten-year horizon. The US Government will still be spending more with each passing year -- just "less more" than was previously projected. As Bill Gross at Pimco points out, on reasonable GDP growth assumptions the US will still be running deficits of 7-8% of GDP by 2018 -- ten years after the onset of the financial crisis.
The fact that virtually none of the spending "cuts" will take effect before the November 2012 Presidential election ensures two things. First, the growth impact of the spending cuts in the near term will be nugatory. The US economy may well head back into recession in the coming quarters -- that seems to be what stock markets think, anyway -- but it won't be because of anything decided in Washington this past weekend. Secondly, almost none of the envisaged cuts will actually happen. As Larry Summers and others have pointed out, this Congress and President can't control the actions of their successors. Experience in the US and elsewhere shows all too clearly that long-term spending reduction plans never pan out.
Amazingly, then, I find myself with two altogether unaccustomed bedfellows here: Michelle Bachmann, who has said ad nauseam, but undoubtedly correctly, that the deal just "kicks the can further down the road"; and (gulp) Anatole Kaletsky, who writes in The Times today (paywall protected) that contrary to the consensus, President Obama came out on top in the negotiations. I hope Paul Krugman has a Times subscription.
Monday 1 August 2011
Chrome and optimism
The big event of this past weekend around our way was the annual display of classic American cars at Knebworth House. Seeing the arrayed lines of heavy metal was a reminder of better times. Inefficient, oversized and unreliable they may have been, but the American cars of the fast-retreating past were symbols of America's optimism and can-do attitude. (Yes, even the '58 Edsel in the picture!)
It's all quite a contrast with the dispiriting spectacle of the past few weeks, with the President and the main parties in Congress at each other's throats in a debate that was only superficially about the conceptually ludicrous debt limit. In reality, it was about different visions of how to prepare America for a world in which it will no longer be the leading economy, a world in which dealing with a mountain of debt is made ever more difficult by intractably slow growth in domestic output.
This was all forcefully brought home by a discussion on CNBC's "Squawk Box" today. Despite relief over the apparent debt deal, the resident panellists and their guests were competing with each other to see who could be the gloomiest about America's future. The main guest was Pimco's Mohamed el-Erian, who pointed out that his company had described the factors that would lead to a decade or more of slow growth as long ago as 2009. Boiled down to its most basic, the need to unwind a decade of progressive over-leveraging would outweigh any attempts at stimulus. The "noughties" in effect used debt to borrow growth from the future. In the payback decade ahead, Pimco believes that the trend rate of growth for the US economy will be no more than 2% a year.
The conundrum this sort of outlook creates is that it becomes extremely difficult to achieve any real headway against deficit and debts when the underlying economy is growing so sluggishly -- a lesson which the UK economy is, unfortunately, relearning right now.
We can loop back to where we started -- the US car industry -- to see just what this means. The "big three" have rallied remarkably well in the past couple of years, thanks to a variety of factors -- good management (Ford), public money (GM) and, of all things, Fiat (Chrysler). However, their recovery has now stalled in the face of rising unemployment and falling confidence. This Bloomberg story suggests that projected sales for the 2012 model year may have to be scaled back by as many as 1.5 million units, or more than 10%. That may well be just the start of another dark time for the industry.
One of the striking things about any US vintage car show is the number of vehicle marques that vanished long ago: Hupmobile in the distant past, the likes of Desoto, Studebaker and AMC rather more recently. Today's big three have drastically pruned their brand offerings to meet the demands of more straitened times, with marques like Pontiac and Mercury falling by the wayside in the last year or two. Even if the companies themselves survive, however, it seems unlikely that when today's vehicles are put on display at the Knebworth show in 2061, they will engender the same warm feeling of nostalgia as their predecessors did.
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