Sunday, 20 March 2016

Interesting fall-out from the dogfight among Britain's Conservatives

The British conservative party is tearing itself apart over the EU referendum in June. The internecine fighting has reached new highs over the recent days and some quite interesting bits of information are contained in the intense exchanges.

Work and Pensions Secretary Iain Duncan Smith resigned last Friday over a particular line item contained in the budget just presented by Chancellor George Osborne, some cuts in spending for handicapped.

Duncan Smith is also known as a passionate proponent of Britain's exit from the EU, the Brexit, and obviously he is free to campaign for his views from outside the cabinet. The British press has over the weekend been full of all kinds of guesswork about his reasons to resign.

The most interesting in this exchange is in fact Duncan Smith's resignation letter, which contained the following statement:

"I am unable to watch passively while certain policies are enacted in order to meet the fiscal self imposed restraints that I believe are more and more perceived as distinctly political rather than in the national economic interest".

Please read this again. One of the uncompromising conservative politicians in the UK states that the economic policies are subject to "fiscal self-imposed restraints".

He is talking about the balance budget target zealously pursued by Osborne in close cooperation with Prime Minister Cameron.

In a few words Duncan Smith revealed what has been clear to economists for a long time: Pursuing a balanced budget at all times is simply a question of ideology rather than the "national economic interest".

In the days after the presentation of the budget, there was a discussion about what would happen if the optimistic growth projections behind the budget did not materialise.

Osbornes view was that it would then be hard to balance the budget, unless further public sector cutbacks were introduced.

So there it is: The British economic policy is driven by the same ideology as the fiscal policy in Germany - and which Germany does everything to stamp upon the rest of the Eurozone.

So at least it has become clear that there are no real economic arguments for the wish to leave the EU.

Former PM Sir John Major is trying to make the opposite point: that there are significant economic reasons for Britain to stay. Britain can not expect that EU should be rushing to give Britain a privileged status, as Britain needs the EU more than the EU needs Britain. Major is afraid the Britain will find herself “sleepwalking into antagonisms it cannot repair”.

I notice use of the word "sleepwalking". Major basically tells his party to wake up and try understand what is at stake.

I am afraid that given the intensity and the personal focus of the exchanges inside the conservative party, his words are likely not to be heard. A good personal jibe is easier to sell to the press than a long historic argument about the role of the EU.

Wednesday, 16 March 2016

Fed: everything normal, so go back to work

Writing about Federal Reserve's monetary policy is rarely exciting, same goes for reading comments about it.

I am sorely tempted to share my opinions about the Republican primaries instead. But since the situation on that front develops every day, I better hold back until things get more stable. There is one connection though.

The Republican party has since Obama's election set new standards in obstruction of the legislative process. It has had some bizarre side effects, such as "Government Shutdown" on a number of occasions.

The legislative gridlock has had one positive effect: any tendency on either side of the political spectrum to introduce "austerity" has been mostly curbed. The effect has been that the US as almost the only country has seen the public sector deficit develop according to the textbooks. As the crisis hit, government finances went deeply into red, providing stimulus to the economy. This stimulus has automatically been reduced as the economy recovered. No German-style destabilising "stability policy" here.

It does not mean that all is good, nor that I find political gridlock as a way to obtain an economic-political target is an idea to imitate.

Together with the timely (albeit rather distasteful) help to the banks, it does mean that the US today is in a better place than most of the other larger economies in the Western world. There has been a long period of economic growth, jobs that disappeared during the crisis are roughly re-created. Growth has been more subdued than seen in the years until 2007, but there has also been a significant improvement of the debt situation of the households, meaning that their savings have increased. That leads to slower growth in the short term.

Of course there are still a multitude of problems stemming from the fact that decisions on the fiscal policy are simply not taken. Still, the US economy is in a better state than the European economies.

Hence it is no surprise that Fed in general are upbeat: the US growth has survived a visible strengthening of the dollar and a slowdown in China. So there is only one way of interpreting Feds inactivity: the Open Market Committee simply finds that they are on the right path and are waiting for inflation to begin crawling up towards the 2 per cent target. And obviously, Fed finds itself on tract for further interest hikes during the year.

Whether it is 2, 3, or 4 hikes is not that important. Important is what Fed's analysis shows about the US economic growth. FOMC was not in doubt. We are on the right track and further rate hikes will follow as prices begin to crawl upwards.

What the markets should be spooked about is the capacity limit. Inflationary pressures begin to build as a shortage of certain kinds of labour begins to build. Inflation could also begin to increase if US companies hit their production limits. The fact is that nobody knows where the inflationary limits are. We just know that an awful lot of productive capacity has been dismantled after 8 years of crisis.

So no, further interest rate hikes are not taken off the agenda going forwards.

Friday, 11 March 2016

ECB's Bazooka?

This time ECB delivered what the market expected in terms of easing. By some standards ECB even over-delivered by increasing the monthly bond purchases from 60bn € to 80bn € and by increasing the Targeted Long-Term Refinancing Operations or TLTRO for short. The lead interest rate was lowered to 0.4%

After an initial bout of optimism, the stock markets had second thoughts: By delivering that much, has ECB run out of ammunition for the "bazooka". Stock markets reversed sharply. The Euro also reversed parts of its initial loss.

Reactions from the stock market are largely irrelevant in this context, since they are mostly driven by day to day sentiment anyway. I also have some trouble believing the wisdom of stock market traders when it comes to assessing the effects of monetary policy in the medium and long term. I mean, stock market traders do not usually work on that kind of time horizon, right?

ECB's initative certainly created some angry comments, mainly from Germany, where "flooding" the banks with money is seen as a bad thing. For many German observers, the problem lies mainly in the clash between a macroeconomic reality and the deeply ingrained culture of saving among ordinary Germans. Obviously, negative interest rates removes the most important incentive for saving. And that is considered a very bad thing.

Germany has had a fantastic run of economic success. It has been built on strong exports of high quality industrial products. Germany has through its success in engineering been able to be competitive beyond expectations for decades, and even lived through the 55 years after the end of WWII with a steadily appreciating currency because of strong productivity gains.

Apart from strong productivity, this success was made possible by German savers, who provided the means for the investments necessary. In Germany it is still considered a virtue for households to save.

And of course the anger at ECB is because German newspapers and a great many politicians mistake household economics for macroeconomics. There is even a name for this misunderstanding. It is called the "thrift's paradox". If we all save, we will all get poorer.

Europe does not need any more savings. We need consumption and, in particular, investments to pull us out of the quagmire. The problem is that somehow the glut of savings does not translate into finance for consumption or investment.

The problem is that the intermediary, namely the banks, are badly out of order. Too many banks in Europe are still carrying too many dud loans on the balance sheets. So they remain unwilling or unable to boost their balance sheets with new lending.

And that is the rub. The TLTRO offers cheap liquidity to banks, and is targeting banks which have grown their balance recently. But the previous LTRO programmes have not been strong in inceasing bank lending, So I do not see why it should work this time. It seems that it is not the price of central bank money that stops the banks from lending. Instead it is their bad loans.

Since 2008 I have consistently claimed that in order to get out of the crisis we need to fix the banks and to increase public spending primarily on long-term infrastructure projects.

Markets fear that ECB is running out of ammo. Markets may be right. Markets, however, forget that it is not the responsibility of central banks to push the economy. Politicians must create  fiscal policies that will resolve this crisis. And the Germans have long time ago won a complete victory in pressurising other EU countries to not do what is needed. ECB is put in an uncomfortable position because of a wrong fiscal policy.

When it comes to fixing the banks, this is not the time to be moralists. The Euro-TARP is still needed after 8 years of crisis.

Think about this one: what happens to  banks all over Europe as long as they are afraid of charging clients negative interest rates? Well, they lose money on simple deposits. Certainly, it does not provide an incentive to lend.

Friday, 26 February 2016

Follow-up on Italian banks

In a letter to Financial Times on 23 February, the Director-General of the Italian Treasury provides some info directly related to my previous post.

Vinzenco la Via writes that:

"Between the beginning of 2015 and the beginning of 2016, the Italian government introduced radical changes in the banking sector (...) The new system will exploit economies of scale, allow better use and allocation of skills, and permit better market access, while improving the management of non-performing loans.

Vinzenco, I love what you write.

My only question is: Why did it take you so long??? Where were you between 2008 and 2015?

I know. You were fighting the deeply entrenched interests in the financial sector which had put personal interests ahead of the common good. And various governments had been unwilling or unable to make a serious push to force the banks in this direction.

Has anybody got the guts to make an analysis of the costs to the society of not acting with far more resolve? I'm just asking..

Now I am curious about what happens in the French banking sector. Not to mention in what remains of the partially reformed savings bank sector in Spain.

Tuesday, 23 February 2016

Euro-Tarp? Maybe... look at Italy

In the dying days of the Bush administration, then Secretary of the Treasury Hank Paulson introduced a US 1tn program called  the Troubled Asset Relief Program, or TARP for short. Translated into plain words, it was an offer to the banks that the Federal Government would buy the worst stinking pieces of bad loans the banks carried on their balances. And it was clear that not too many questions would be asked.

It was a variation of one of the elements in the famous rescue of the Nordic banking sector in the 1990's. At that time, banks signed up to be rescued, the insolvent ones were taken over by the Finance Ministries, who then combed through the bank balances, hunting for the worst stinking pieces of bad loans. The bad loans were then folded into a company which was floated on the market with a time limited loss guarantee from the government.

In the Nordics, shareholders lost their investments and boards and management lost their jobs. In the US the management largely kept their jobs while the shareholders saw their holdings diluted severely.

However, in both cases, the action contributed to "clean out" the bank balances, meaning that the banks relatively quickly could get back to the core business of a bank: to receive deposits and lend money.

Not so in Europe. 8 years after the onset of the crisis, and two "asset quality reviews" later we are stuck in a situation large European banks are sitting with unrealised losses, which - if they were realised - would lead to the demise of the banks in question. I - and several others with me - have a sneaking suspicion that this state of things holds back European bank lending in a significant way.

Last week, the ECB gave a startling confirmation of the gravity of the situation.

Since 2015, the ECB has tried its own version of quantitative easing or QE. This of course refers to the programs whereby central banks in the US, UK, Japan and Canada have purchased enormous amounts of their own government bonds in the market. Some covered bonds, such as mortgage backed bonds have also been purchased. All in the purpose of forcing down interest rates, particularly in the longer maturities.

ECB faces a particular problem in implementing a QE, since its statutes prevents it from financing the individual governments by buying their government bonds. A compromise was found, whereby government bonds were eligible if bought in proportion with the shareholdings in ECB of the individual countries.

It would of course mean that ECB was forced to buy mostly German Bunds - even if it is a relatively small bond market. There are tons of e.g. Italian bonds on the market, but ECB cannot buy that many of those. Then there is some agency debt out there, but having to buy 60bn EUR worth of bonds each month seems to be a problem.

So ECB has had a brainwave: Let us buy some of the worst stinking pieces of bad loans the banks have been carrying on their balances. In casu the Italian banks, who suddenly admit to have a small sum of 225 bn EUR of bad debts they would really, really like somebody else to buy from them.

Which is possible for ECB if the Italian government is guaranteeing the debt. Once that obstacle is cleared away, we can start guessing which other banks are sitting on a mountain of bad debts.

In other words, the ECB QE program is now morphing into a Euro-Tarp. I am sure that the Germans are shaking their heads or even worse. I do not really care. The TARP program gave the US banks a headstart to recover even if bank regulators had to hold their noses while buying the bad debt.

Here in Europe we have had a very peculiar attitude. We want to punish the banks for doing a dirty on us all, so we want them to recover without any help. But we do not want to punish them so badly that the boards and bank managements were actually kicked out. So the "Swedish solution" was also excluded.

The result has been that it has taken waaay too long time for credit growth to return to Europe. It has held back consumption and investment. When we will be writing the story of the financial crisis in Europe, the lack of dealing properly with the banks will stand out as a monumental error.

So monumental that it will almost be on a par with the German insistence on draconian savings programs to curb government debt creation in an environment of weak consumer demands.

Monday, 22 February 2016

Cameron's nightmare - and EU's

So the UK got a watered-down set of modifications to the various EU agreements, delivered with sufficient gravitas that Cameron could declare victory and go home and call the promised referendum to take place on 23 June.

Anybody just vaguely familiar with EU's workings knew already that nothing substantial could be negotiated in a few months. Substantial changes require changes to the treaties, and with 28 member states it will take at least 5 years to change as much as a comma.

But now the referendum has been called - with potential disastrous consequences for EU, Europe and not the least, for the EU.

EU created peace
It is worthwhile to remember the historical roots of the EU. Since Germany created itself as a national state under the stewardship of Bismarck, the country always had the uncomfortable geopolitical situation of having strong and often bellicose neighbours to the east and to the west: Russia and France. Bismarck saw this clearly and built a national strategy on the necessity to be able to fight a two-front war. This national strategy touched upon education, infrastructure, industrial production and defense. The strategy required speed, mobility and technological and tactical advantages. It is probably not wrong to claim that Germany's situation today is a direct consequence of the geopolitical situation and of Bismarck's response.

After Germany had tried to "solve" the geopolitical dilemma twice, each time ending in defeat, the US influence over Europe led to a major geopolitical change. By putting Germany under the US nuclear umbrella and by uniting Germany and her erstwhile enemy France in a close political and economic cooperation, Germany could finally forget the need to fight two enemies at once. The existence of the EU changed important geopolitical parameters.

EU is in other words the political and economic "leg" of the post-WWII re-organisation of the European map. Together with NATO, EU has been spectacularly effective. So much so that people today forget how efficient the combo has been in preventing war in Europe. The 70 years of peace in Europe since 1945 has been one of the longest and most prosperous periods in the continent's war-torn history.

The Britons have always had an ambivalent relationship to EU: why participate in the club of losers (of WWII) when we were one of the victors? For centuries Britain managed to survive nicely by playing the other European nations against each other and profiting from her naval superiority.

And now?
Fast forward to today. Many brits appear to have forgotten entirely that they do not any longer dominate the seas. They do not any longer have colonies. And more seriously: The Americans do not any longer consider the "Special Relationship" between USA and Great Britain as particularly special. President Obama even told the Brits directly that Great Britain would be more useful to the USA inside the EU than out.

Europe has also lost in importance on a global scale. The larger powers do not any longer focus on the Europe. Instead it is China's growth, Russia's possible reemergence as a major player and the continued global dogfight over access to oil and minerals that dominate. Britain may have been good at manipulating the other European nations into wars for 400 years. That ability is just much less marketable today.

Zbigniew Brzezinsky, a former national security adviser to US president Carter put it brutally: Great Britain is not a geostrategic player… Its ambivalence regarding European unification and its waning special relationship with America have made Great Britain increasingly irrelevant (The Grand Chessboard: American Primacy and Its Geostrategic Imperatives (1998)).

A tactical error
In 2013 Prime minister Cameron feared a major incursion on traditional Tory ground by the UK Independence Party. In order to placate the notoriously loud Euro-sceptical wing of his party and in order to convince euro-sceptical voters of his own credentials in this department, he promised a referendum on "in or out", in case he was re-elected as PM.

At that time, not much looked as if it would ever happen. The Tories were lagging Labour in the opinion polls, UKIP seemed to be a threat, and the Lib Dems still had some credibility and were not at all foreign to threaten Cameron to switch sides if needed.

And then things began to pear-shaped. First there was the 2014 Scottish referendum on independence. Scotland was deeper divided than expected and the outcome too close for comfort (55% voted to stay in the UK, 45% against). The next act was the 2015 general elections. The Conservatives had nearly no representation north of the border. So Scottish voters who wanted to vent their frustration hit Labour hard. The party was viped out in Scotland and that alone was enough that an expected national majority evaporated. UKIP did worse than expected because of a very weak party organisation, and the Lib Dems were hit badly by the law saying that the junior partner in a coalition partner most often suffer badly at the next elections (ask FDP in Germany).

Suddenly Cameron had a majority in Parliament - and had given a promise to the right wing of his party to make a decisive referendum after a round of negotiations with the EU. He had solidly painted himself into a corner with no way out. Except of course by resigning, which is not on the cards for now.

The European refugee crisis has changed the dynamics in Europe as well as in the UK. By many voters not steeped in history, "migrants" of any colour and shape are seen as the result of Europe's open borders and flagrant disrespect for national values. Europe has certainly not handled the refugee crisis in a reassuring way, and it has given wind in the sails to illiberal nationalist parties across the continent.

Also in the UK, this particular political mood has gained strongly despite the weakness of UKIP. It is visible in the fact that Cameron's negotiation strategy has been to gain concessions on "migrants" even if the people in question are far from being refugees. Most often they are quite skilled labourers who quickly find jobs, particularly in the UK construction sector.

So the refugee crisis has in Cameron's strategy morphed into a general "bash the migrants" policy - which obviously annoys the eastern European EU members.

How bad could it end?
We may be heading towards one of those rare moments in history where one man's actions actually matter.  Cameron's wrong reading of the situation inside his own party in 2013 could now lead to the following scenario:

Were UK to leave the EU, Cameron will be toast having campaigned for UK to remain in the EU and will have to resign. His own party, the Conservatives, will suffer a deep division that will take decades to heal.

Both the EU and the UK ends up weaker and destabilised.

Egged on by national conservative movements, more countries will ask for substantial opt-outs, in particular in the fields of EU law and integration. Scotland will request independence from the UK as the Scots are firmly in favour of a continued EU membership.

The EU may end up being split and the UK may be torn apart. That could be the parting shot for independence movements elsewhere, in Catalonia, in Belgium and who knows, in Wales?

Cameron may still go down in history as the man who made the worst tactical gamble possible and refused to see the implications of it until it was too late.

And over in Moscow, Putin and his inner circle will be all smiles.

Friday, 19 February 2016

Same old, same old

Famously, the rapper Eminem declared "I'm back" on one of his albums and reviewers noted with some surprise: Has he been gone at all?

I have not been away, I have been working my blog under the name "Connecting the dots" and it is likely to reappear soon under that name soon. But until that is in place, I will publish my opinions here.

When I review what I wrote in 2012, it is surprising to see how little has changed:

QE is still in place, except that ECB has now replaced FED as the driver. Economic growth is still way weaker than politicians hope, and the reasons are the same: consumers are still saving too much and the European banks still carry too many bad loans on the balance in order for them to lend freely.

Japan remains an unmitigated disaster. Seen from the helicopter it is incredible that anybody is still surprised to see that a country with a rapidly shrinking population is experiencing negative growth.

The German establishment is still fighting against a reasonable European monetary policy, based on a mixture of angst and a rigid belief that rest of Europe must become like Germany in order for healthy economic growth to return to the continent.

Egged on by the Tea Party, US Republicans have taken further steps away from economic sanity - one would have sworn that it was impossible. The only good thing is that the political paralysis has created a situation where the economy has been able to recover healthily, undisturbed by ideological incursions.

A couple of things are new, though. Some countries have negative interest rates, Denmark, Sweden, Germany, Switzerland. Oil has fallen to comfortable levels. Russia is trying to reestablish Soviet era glory on the backdrop of an impending economic disaster.

And then over to a subject as relevant today as in 2012: The European monetary policy and in particularly the impact of the debt crisis on certain South European countries. Italy is of course the 800 pound gorilla in the room with a government debt in excess of 130 per cent of GDP and more than 2,000 bn EUR.

Add that Italian banks still drag a ton of bad debts along. 8 years after the onset of the financial crisis, many banks in Europe's south (broadly defined) have still not managed to write off the bad loans and move on.

Italy, German wise men and haircuts

I found this article and it is interesting reading. Apparently the German Council of Economic Advisors now recommend that before the institutions of the Eurozone will help a country with a bail-out, the holders of the country's debt will have to take a "haircut", i.e. a programmed loss of a certain percentage of the bonds. Rumours are that Finance Minister Schäuble is backing the proposal.

This breaks with a tradition that has survived even the Greek debt crisis: Eurozone countries holding debt of another Eurozone country will not suffer losses on that debt. Private debt holders, however, can lose money, as they did in the case of Greece.

By now gingerly suggesting that other countries must suffer a loss before help can be granted to a country in need, Germany will make sure that they will not be the only ones to insist on budget discipline. They simply obtain that everybody else will also stand to lose money. The effect is of course to avoid that Germany is the only villain to insist on budgetary discipline.

If the proposal is accepted by the other Eurozone countries, Germany will not be alone in resisting "frivolous" proposals from left-wing or populistic new governments in e.g. Portugal, Spain or, oh horror, Italy.

The Germans are understandably tired of being portrayed as latter day nazis imposing iron discipline on freedom-loving countries with young and dynamic governments, as it happened in Greece. The German proposal would remove the focus from Germany as the sole source of budgetary rectitude. Everybody else would have an incentive to put pressure on countries who habour pipe dreams of breaking with austerity demanded by the Eurozone.

It is intelligent, at least seen from a German point of view. To me it again looks as if Germany in its rigid adherence to the belief that every Eurozone country should become a mini-Germany continues to impose rules that simply imposes more instability in the name of stability.

The proposal will give other governments an incentive to put pressure on "irresponsible" governments. It will also give all investors a motive to sell government debt in the affected countries as soon as the word "bail-out" is mentioned.

Ideology continues to stand in the way of ending the economic crisis. Ideology prevents an economic policy that will support economic growth in Europe. Wonder if anybody has calculated the price Europe has paid as a result of a sluggish recovery over the past years.