Category: Economy

Analysis of the global economy

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Fed NGDP targeting would greatly increase global financial stability | Market Monetarist

Lars Christensen describes how NGDP targeting would help the global economy withstand shocks like another eurozone crisis:

Lets look at two different hypothetical US monetary policy settings. First what we could call an ‘adaptive’ monetary policy rule and second on a strict NGDP targeting rule.

‘Adaptive’ monetary policy – a recipe for disaster

By an adaptive monetary policy I mean a policy where the central bank will allow ‘outside’ factors to determine or at least greatly influence US monetary conditions and hence the Fed would not offset shocks to money velocity…..

In that sense under an ‘adaptive’ monetary policy the Fed is effective[ly] allowing external financial shocks to become a tightening of US monetary conditions. The consequence every time that this is happening is not only a negative shock to US economic activity, but also increased financial distress – as in 2008 and 2011.

NGDP targeting greatly increases global financial stability

If the Fed on the other hand pursues a strict NGDP level targeting regime the story is very different.

Lets again take the case of an European sovereign default. The shock again – initially – makes investors run for safe assets. That is causing the US dollar to strengthen, which is pushing down US money velocity (money demand is increasing relative to the money supply). However, as the Fed is operating a strict NGDP targeting regime it would ‘automatically’ offset the decrease in velocity by increasing the money base (and indirectly the money supply) to keep NGDP expectations ‘on track’. Under a futures based NGDP targeting regime this would be completely automatic and ‘market determined’.

Hence, a financial shock from an euro zone sovereign default would leave no major impact on US NGDP and therefore likely not on US prices and real economic activity…..

Read more at Fed NGDP targeting would greatly increase global financial stability | The Market Monetarist.

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Cyprus: Deposit insurance and moral hazard

The outcry over Cyprus levy on depositors in defaulting banks raises the question: Why were depositors not more wary of where they deposited their funds? Not all banks are created equal. The reason is deposit insurance for deposits under €100,000 implied that the government would stand behind its banks and rescue depositors should the banks ever default. The problem is that no one considered the possibility that all the banks would suffer losses sufficient that the government would be forced to default on both its explicit and implied obligations.

Some time ago I wrote about the moral hazard of deposit insurance:

Deposit Insurance: When too much of a good idea becomes a bad idea

Deposit insurance was introduced in the 1930s and saved the US banking system from extinction. Administered by the FDIC, and funded by a levy on all banking institutions, deposit insurance, however, encourages moral hazard. Depositors need not concern themselves with the solvency of the bank where they deposit their funds so long as deposits are FDIC insured. High-risk institutions are able to compete for deposits on an equal footing with well-run, low-risk competitors. This inevitably leads to higher failure rates, as in the Savings & Loan crisis of the 1980s.

The FDIC does a good job of policing deposit-takers, but no regulator can substitute for market forces. Deposit insurance is critical during times of crisis, but should be scaled back when the crisis has passed. Either limit insured deposits to say $20,000 or only insure deposits to say 90% of value, where the depositor takes the first loss of 10%. That should be sufficient to keep depositors mindful as to where they bank. And restore the competitive advantage to well-run institutions.

Requiring depositors to take the first loss of 10 percent should be standard practice for deposit insurance. The same should hold true for bank creditors. But we need to distinguish between insolvency — where liabilities exceed assets — and a liquidity event where the central bank is only called on to provide temporary respite. If the bank is rescued from insolvency by the regulator, bond holders should be required to take an equivalent haircut — painful yet not life-threatening. No one is entitled to a free ride. And bank shareholders, if a there is a bail-out, should lose everything — similar to the Swedish approach in the 1990s.

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Cyprus Deposit Levy: No Panic Yet But Scary Long-Term Consequences – Forbes

Karl Whelan, Professor of Economics at University College, Dublin reminds us:

….the fact that we don’t see lines at ATMs in Spain and Italy doesn’t mean there isn’t a bank run going on. The Northern Rock episode was a complete anomaly. Modern bank runs stem from people pushing buttons to execute electronic withdrawals of large amounts of funds. For example, I was living in Ireland in 2010 when non-residents pulled €186 billion out of Irish banks between the end of July and the end of December. This was over 100% of Irish GDP and yet there wasn’t a single sign of panic among retail depositors.

Read more at Cyprus Deposit Levy: No Panic Yet But Scary Long-Term Consequences – Forbes.

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J.P. Morgan, Goldman Get a Dose of Fed's Reserve | WSJ.com

David Reilly reports on the Fed’s latest stress tests:

The passes show how far big U.S. banks have come since the financial crisis. But capital levels seen under the tests, and taking into account the capital-return plans, weren’t especially strong. Tier 1 common ratios for J.P. Morgan and Goldman, for example, were only marginally above the 5% minimum needed.

What’s more, leverage ratios including capital returns are particularly thin: Of the six biggest banks, four had ratios below 5%. While above the test’s 3% minimum, such levels wouldn’t give banks tremendous room to maneuver in a crisis.

The leverage ratios are particularly telling because they don’t allow for risk-weighting of assets. That approach is coming under increased criticism for potentially allowing banks to mask the true level of risk on their books.

Read more at HEARD ON THE STREET: J.P. Morgan, Goldman Get a Dose of Fed's Reserve – WSJ.com.

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ZERVOS: 'This Is A Nuclear War On Savings And Wealth' – Business Insider

Joe Weisenthal reports on Jefferies strategist David Zervos’ latest note:

What happened to Cyprus on Friday evening was one of the most significant developments in the Eurozone since the Greek election last summer. To tax the bank deposits of savers sends an ominous message to the entire global investment community. All of us should really take a moment to consider what the governments of Europe have done. To be clear, they initiated a surprise assault on the precautionary savings of their own people. Such a move should send shock waves across the entire population of the developed world.

Read more at ZERVOS: 'This Is A Nuclear War On Savings And Wealth' – Business Insider.

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NGDP level targeting – the true Free Market alternative (we try again) | The Market Monetarist

Scott Sumner suggests that NGDP targeting is a far more conservative approach than the current inflation targeting practiced by the Fed and many other central banks:

Most of the blogging Market Monetarists have their roots in a strong free market tradition and nearly all of us would probably describe ourselves as libertarians or classical liberal economists who believe that economic allocation is best left to market forces. Therefore most of us would also tend to agree with general free market positions regarding for example trade restrictions or minimum wages and generally consider government intervention in the economy as harmful.

I think that NGDP targeting is totally consistent with these general free market positions – in fact I believe that NGDP targeting is the monetary policy regime which best ensures well-functioning and undistorted free markets.

And here explains why inflation is not a threat under NGDP targeting:

Inflation will be higher under NGDP targeting. This is obviously wrong. Over the long-run the central bank can choose whatever inflation rate it wants. If the central bank wants 2% inflation as long-term target then it will choose an NGDP growth path, which is compatible which this. If the long-term growth rate of real GDP is 2% then the central bank should target 4% NGDP growth path. This will ensure 2% inflation in the long run.

Read more at NGDP level targeting – the true Free Market alternative (we try again) | The Market Monetarist.

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Fed's Fisher: Too-big-to-fail banks are crony capitalists | Reuters

Pedro Nicolaci da Costa reports

The largest U.S. banks are “practitioners of crony capitalism,” need to be broken up to ensure they are no longer considered too big to fail, and continue to threaten financial stability, a top Federal Reserve official said on Saturday……

[Richard Fisher, president of the Dallas Fed] said the existence of banks that are seen as likely to receive government bailouts if they fail gives them an unfair advantage, hurting economic competitiveness.

Read more at Fed's Fisher: Too-big-to-fail banks are crony capitalists | Reuters.

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Dousing the flames with gasoline

We are in the fifth year of recovery from the worst collapse of global financial markets in more than 50 years fueled by massive debt expansion, with non-financial debt rising as a percentage of GDP from 50% in the 1980s to almost 100% in 2008.

Household Credit Market Debt as % of GDP

Household debt subsequently fell to 80% of GDP during the GFC as households diverted income away from consumption to reduce debt. But now we are starting to see worrying signs: consumer debt is again rising as a percentage of disposable income.

Consumer Debt % of Disposable Income

Corporate bond yields have fallen to lows last seen in the 1960s.

Yields on Baa Corporate Bonds

Interest margins for large banks are falling

Large Bank Interest Margins


Yahoo: Steve Keen Interview
(Click on the image to open the Yahoo: Steve Keen interview in

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The Keen Model [technical]

I know Steve Keen has taken criticism for his projection that the Australian property market would collapse in 2008 but his reconciliation of MMT, where the sum of all sectoral balances must equal zero, with his Monetary Circuit Theory, where Effective Demand = GDP + change in Debt, is brilliant.

For those who struggle with the terminology:
Ex ante = before the event
Post ante = after the event
Endogenous money simply means banks expand and contract the money supply as customers borrow and repay loans. See Wikipedia for a more detailed explanation.

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Australia: RBA should emulate the Swiss

Australia is suffering a similar fate to Switzerland, where the Swiss Franc soared against the Euro during the Eurozone sovereign debt crisis. Flight to safety caused the Franc to rocket, threatening local manufacturing industry. Exporters were priced out of international markets while imports were undercutting local suppliers. The Swiss National Bank (SNB) did not sit on its hands but pledged to maintain an effective currency peg against the Euro. Catherine Bosley at Bloomberg writes:

The Swiss central bank pledged to keep up its defense of the franc cap after almost doubling its currency holdings to shield the country from the fallout caused by the euro zone’s crisis.

The Swiss National Bank cut its forecasts for inflation and said it will take all necessary measures to keep the “high” franc within the limit of 1.20 per euro……

The SNB, led by President Thomas Jordan, put the ceiling in place in September 2011 after investors pushed the franc close to parity with the euro and threatened to choke off growth. The central bank’s campaign to defend the cap has led to foreign currency holdings ballooning to more than 400 billion francs, almost three quarters of annual output. It spent 188 billion francs on interventions last year, 10 times the 2011 amount.

Australia’s position is in some ways even worse than Switzerland. Not only do international investors increasingly view the Australian Dollar as a safe haven, with higher bond yields and a stable economy, but booming mining exports have caused a bad case of Dutch Disease — rising exports killing local manufacturing and service industries such as tourism and education.

Bulk Commodity Exports

While not suggesting that the RBA accumulate huge holdings of greenbacks and euros — these are depreciating currencies, with central banks engaged in widespread QE — but the idea of a sovereign wealth fund is appealing. Investing in international equities is a risky business that would cause most central bankers to tremble, but sovereign wealth funds have been successfully run by Norway, China, Abu Dhabi, Saudi Arabia, Singapore and others. Far safer than international equities would be to buy Australian international debt, targeting the roughly $400 billion owed to foreign investors by major Australian banks.

Net Foreign Liabilities

The appeal would be two-fold: eliminate currency risk while generating a stable return on investment.

Printing more dollars, whether you spend them locally or offshore, will normally increase inflation risk. But with high local savings rates and slowing rates of debt growth, deflationary pressures are rising. The only real inflationary pressure is from higher oil prices. So the RBA has room to maneuver.

A weaker Australian dollar would make exporters more competitive and rescue local manufacturers from international competition. Tourism and education, formerly major export earners, would hopefully recover from the belting they have taken in recent years. Miners would also not complain as a weaker dollar would boost profit margins.
Read more at SNB Keeps Up Franc Defense as Euro Crisis Risks Persist – Bloomberg.

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