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.
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