Thursday, July 2, 2009

More on Printing Money in the UK

I'm afraid that I will be remaining on the subject of quantitative easing (QE - printing money). My last post detailed exactly why the only justification for the policy is the funding of UK deficits, and the evidence is mounting that this is the case. Quite simply, the Bank of England's money printing is all that stands between sale of government debt and bankruptcy.

I recently read a report in the Times (following a link in the comments section, thanks), which details the point very clearly. The first point is that overseas holders of gilts (UK government debt) were net sellers:

A record sell-off of UK government debt by overseas investors is fuelling City anxieties over the Treasury’s ability to fund soaring public borrowing that is set to top £150 billion over this year and next.

The surge in foreign selling of gilt-edged bonds and short-term UK Treasury bills is also reinforcing growing fears over the effectiveness of the Bank of England’s controversial quantitative easing (QE) scheme to pump newly created money through the economy.

Bank of England figures released on Monday highlighted record overseas sales of UK government debt during the three months from March to May.

Foreign investors dumped a total of £22 billion in their holdings of UK gilts and Treasury bills, mainly selling these to the Bank itself, through its QE scheme.

To get a sense of the implication of this, below is the distribution of gilt holdings in 2008, sourced from the Bank of England:



The Times article goes on to say the following:
With the Bank expected to wind up its huge purchases of gilts under QE in the next few months, some economists fear that, without this vast £125 billion asset-buying drive, the scale of foreign dumping of government debt signals that the Treasury might struggle to meet its future funding needs through finding enough buyers for fresh gilt issues.
It is a somewhat surprising article, as the implications are very clear. It is only the purchase of gilts by the Bank of England that is supporting the gilts market. As ever, it comes as a surprise that this is not headline news. For those that doubt that the indirect purchase of gilts might be supporting the auction of new gilt issues, this from the Bank of England:
As gilts have made up the bulk of purchases, an important consideration is who typically own gilts and what they are likely to do with the money. Looking at the final seller of the gilts purchased by the Bank could be misleading. For example, some financial institutions may have bought gilts in anticipation of selling them to the Bank.
I have highlighted the important point here. When I first wrote about QE, one of the points I made was that this was one of the ways in which QE would indirectly support the issuance of government debt. I can not help but think that the Bank of England is dropping a huge hint here, in the hope that journalists and analysts will pick up on what is going on. I do suspect that the Bank of England is unhappy with the policy of QE, but that they have been put under pressure to undertake the policy. However, there is no way of finding out if this is the case, and it remains speculation.

It is also very interesting to see the reaction to the news that much of the newly printed money is going to overseas purchasers. This is another article from the Times:

He [Spencer Dale of the Bank of England] addressed concerns that most of the funds spent by the Bank on the asset purchases through which it channels the newly-created cash into the economy had gone on buying government bonds (gilts) rather than or corporate bonds or commercial paper.

Business groups and others have urged the Bank to shift the focus of the scheme and buy more corporate debt in an attempt to stimulate corporate lending markets. Mr Dale said that the Bank was continuing “to review actively the case for extending its operations into other corporate credit markets”.

Confronting criticism that the effectiveness of QE is being undercut as foreign holders of gilts sell these assets to the Bank so that the QE funds then flow abroad, rather than into the UK economy, Mr Dale said that even when this was the case the impact was still beneficial.

“Even if that is the case, it does not mean the asset purchases will not have any economic benefit,” he said. “Rather, more of the effect will come through a lower exchange rate.”

On the one hand we have calls from business to redirect the spending into private assets in the UK, and on the other the Bank of England is claiming to be seeking inflationary pressure through currency devaluation. As a net importer, any devaluation will result in higher prices of goods, and that will be inflationary. Once again, you would expect a policy of active devaluation of the £GB would garner headlines, but still it is tucked away in the financial pages. After all, the devaluation of currency results in relative impoverishment of every holder of the devalued currency.

It is worth taking a moment to understand why net overseas sales of bonds will devalue a currency. As soon as the sale of the gilt to the Bank of England has taken place, the overseas seller is left with a pile of sterling, and needs to do something with it. They have a choice of purchasing another UK asset, or alternatively converting the currency into another currency. Having sold the asset, there is a strong likelihood that they will need to sell the currency, as getting out of the UK bond market is likely to be a signal of moving out of exposure to the UK (the Bank of England also considers this to be the case, though express it less directly). When lots of organisations are selling currency, a flood of currency appears on the market, and outstrips demand for the currency, thereby pushing down the price of the currency.

It might be noted that immediate currency movement are more complex than the picture that I have painted, but that this kind of move in the market sets a baseline on the value of the currency, towards which the currency must eventually move.

What we now have is a situation in which the government is massively expanding borrowing, and overseas creditors are dumping gilts. This means that the UK needs to fund the borrowing of the government from its own resources, and also absorb the sale of previously issued debt. This raises a significant problem. If you think of the chart that is shown earlier, the major holders of government bonds are overseas investors and insurance/pension funds. However, the problem that arises from this is that the amount of money going into investments is unlikely to be expanding fast enough to soak up the new issuance of government debt. Whilst there has been a significant increase in savings, is this enough?

Although incomes fell over the quarter, the survey found that the amount saved as a percentage of income had risen. People saved 6.83pc of their earnings in the spring, up from 6.35pc at the same time last year and from 6.48pc during the winter.

The average amount of money kept in savings rose to £18,443, compared with £17,332 in the previous quarter.
The original data can be found here. The methodology for the calculation is not very clear, and might actually include pay down of debt as 'savings', as the survey of what people are saving for includes 'Pay off mortgage'. One thing that is certain is that the increase in savings is unlikely to be sufficient to allow for the purchase of the massive new issuance of government debt.

Another possible source of internal financing is the pension and life insurance industry. However, in order for these to finance the government borrowing, it must mean a reduction in investment in commercial assets, such as the stock market. As such, if they are purchasing gilts, it is at the cost of investment into the commercial wealth generating sectors. This would defeat one purpose of QE, which is to encourage commercial investment within the UK.

Put in crude terms, if the pension funds and life insurance funds are shifting assets into the expanding gilt market, then the issuance of government debt is crowding out business investment. The same argument applies to the banks.

Whilst the stock markets have seen falls of late, there has been a long period during which government debt was expanding, whilst overseas creditors retreated, and the stock market was rising. As such, the idea that insurance and pension funds are covering the debt issuance over the last six months seems improbable, at least if the upwards move in the stock market is indicative of the balance between government and private investments.

In the case of the banks, there is a further worry. During the economic crisis, the major banks have come under increasing control of the government. That control might come as the cost of pressure to purchase government debt. Furthermore, if the banks that have received bailout money are purchasing gilts, then the situation becomes even more worrying. The government has borrowed money to fund the bailouts, and therefore the banks would be using government borrowed funds to finance government borrowing. This would be akin to a ponzi scheme.

Returning to the Times article, it is difficult to see that the current government borrowing might be financed by anything other than the policy of QE. The policy is soaking up the excess of government debt, and therefore allowing for ongoing success in the issuance of government debt. Whilst the Bank of England might not be purchasing government debt directly, the indirect method of purchase can be the only thing that is currently supporting the gilt market.

It therefore comes as no surprise to see that the Bank of England is putting no end date on the policy of QE or the reversal of the policy:
It is too early for the Bank of England to judge when it will need to start withdrawing the massive stimulus it has delivered to the economy, policymaker Timothy Besley said on Thursday.

In a speech to a financial regulation conference, Besley also said that it was too early to judge whether the Bank's 125 billion pound quantitative easing programme was helping to boost GDP and avoid deflation.

However, once again the Bank of England is dropping massive hints that it is unhappy with its role of printing money to support government expenditure.
There needs to be a clear and open debate on fiscal policy, Bank of England policymaker Timothy Besley said on Thursday.

The government's unprecedently high borrowing levels to fund a bail-out of the banking sector and pull Britain out of recession have led to fears it will be many years before the public finances are returned to a more stable position.

The problem being confronted by the Bank of England is summarised in an article in the Wall Street Journal:

As policy makers discuss how to exit from quantitative easing, investors need to position themselves for the government-bond-market turmoil that is likely to follow.

The markets got a taste of what might be in store this week when the Bank of England decided to stop buying two bonds originally included in its £125 billion ($204.68 billion) quantitative-easing program. The prices of those bonds plummeted, suggesting there is big money to be made for investors who get their trading strategy right.

[and]

The snag is that some government-bond markets are so potentially distorted by central-bank programs that it is hard to feel confident of where prices should be. Consider the two bonds the BOE will no longer purchase: 5% gilts due 2014 and 8% gilts due 2021. The BOE already owns more than half of both issues. In fact, combined with holdings by the U.K. Debt Management Office, at least two-thirds of both are in public hands, according to Barclays Capital.

The dilemma faced by the Bank of England is that, if it stops the purchases, the gilt market will likely collapse. If it continues, then government profligacy will continue. It is becoming increasingly clear that the Bank of England is running out of patience with the government, and that they are increasingly unhappy with what they are undertaking.

However it is spun, it is apparent that government borrowing is being funded through the printing of money, the weasel worded 'quantitative easing'. However it is spun, it is fundamentally no different from Zimbabwe, Argentina or the Weimar Republic. Resorting to the printing press is the action of a bankrupt government.

The UK government is bankrupt.

Note 1:

I am still plugging away at the fixed fiat currency question, but am not sure that I have covered all the angles yet. It will come soon. I am also hoping to do something on commodities soon, as I have several reports on the sector that have proved to be interesting.

Note 2:

I note that white supremacists are posting in the comments section again. I do not censor comments, as a follower of Mill's argument in 'On Liberty'. It is nice to see the responses of other commentators, as they demonstrate that Mill was correct. If an argument comes out into the open, then it can be addressed. Thanks, Tiberius.

Note 3:

Lord Keynes (a commentator) is producing some very interesting material. In particular he has linked to a comparison of now and the Depression, which I first picked up on Reddit, where it was very popular.

He also offered an interesting comparison of QE in 1930s Japan, in which hyper-inflation did not follow. As he recognises, the policy was undertaken in a situation where it was possible to reverse the policy:
Of course, the Japanese economy had a productive manufacturing sector.and no large private debt bubble to liquidate in 1931, unlike the US and the UK today.
I have not studied this case, and suspect that the answer here is in the ability to rapidly reverse the policy. As I have outlined, there is no such potential in the UK without prompting a collapse in the bond market, as the growing fiscal deficits stretch out over a very long time.

In a later debate with Acca, the subject of devaluation came up. I think that it is worth reiterating that devaluation is a form of impoverishment. As Acca rightly points out, there is a price....devaluation of the currency means that the value of labour in a country falls in relation to the value of labour in other countries. That equals relative impoverishment. I think Lemming has grasped this point:
I'm still having trouble understanding the role of separate currencies in economics.

Talking to someone about how some Asian workers slave for £7 a day he replied "Ah yes, but what can £7 buy you in Asia?" and surely he does have a point.

Lord Keynes, you explain how devaluation helped Japan to boost exports. Wouldn't just cutting prices have achieved the same effect? (Or is the aim to get the country's general population to subsidise an effective price cut whether they want to or not?)

How can a currency be over- or under-valued? Isn't this just another variable which obscures economic fundamentals and prevents the capitalist system, such as it is, from working properly?
Note 4:

Jonny asks whether the Japanese carry trade would see a jump in Japanese GDP. A subtle and interesting question, which I will try to ponder for a while. I am afraid that I do not have a simple answer. Thoughts on this one welcomed.

As a background, the following is my take on the relationship between the carry trade and QE, and why Japan did not suffer from inflation:
The answer is rather odd. As fast as the Japanese central bank pumped out newly printed money, Japanese banks also pumped money out of Japan into Western banks. Having reduced inflation to virtually zero, any holdings of the currency were moved into countries with higher interest rates in what was known as 'the carry trade'. In other words, the lack of the ability to earn interest in Japan drove Japan into diverting lending outside of Japan.

In this trade, what was happening was that you could borrow at no cost in Japan, drop the money into a Western economy, and be paid interest on money that you borrowed for nothing. In doing so, even though the money was being devalued by the government printing more money, you could offset the devaluation by the interest you gained through investing it in Western countries. The following is a (grossly) simplified explanation:

If you are printing money such that the base money supply increases by 5% per year, and interest rates are zero, you can borrow that money, invest in a country offering 7% interest, and actually make a currency whose value should be falling, increase in value. In investing the money overseas, you are actually creating an improvement to your current account that offsets the impact of the increase in units of your currency. You are creating greater foreign reserves as a result of the return on that overseas lending, such that you are accumulating ever more foreign reserves, thereby strengthening your currency. If you look at a chart for the value of the JPY against the $US, you will see that the rate fluctuated but has only recently fallen significantly.

The story is not as simple as I paint it here, as Japan also has a large trade surplus and considerable savings, other countries were inflating their money supply and so forth.... The reason for pointing this out is that we have in principle is a system in which it is possible for a central bank to print money, flood that currency into another market, and still retain the relative value of the currency. It is quite an extraordinary notion and I therefore find it hard to believe myself and, as such, comments on this are welcome.
So did the carry trade raise GDP? My thoughts are that it would do so through increased aggregate wealth, but I need to think on this more for the full picture. As I said, comments welcomed.

Note 5:

There have been many other interesting coments, and my apologies for not responding to them all.

20 comments:

  1. Thanks four your research CE!

    Over at Sweden the deposit rate has apparently been cut to a NEGATIVE 0.25%
    http://globaleconomicanalysis.blogspot.com/2009/07/sweden-cuts-deposit-rate-to-negative-25.html

    WTF is this?

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  2. I am testing a new comments system, which I hope will start from the next post. It offers several improvements over the standard system that comes with Blogger.

    As such, I am hoping there will be no glitches on the comments for the next post, and that I can provide an improved system. I will keep an eye on feedback once it is up and running.

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  3. Thanks for this post. I definitely get the sense of the economy being on borrowed time. I just wonder when and how it will all come crashing down.

    What worries me more, as always, is that everybody else is talking about "stabilisation" and "the recession being nearly over."

    This silly argument in national politics about "cuts versus investment" is madness.

    There will be no choice but cuts, and big ones - pretty much everywhere.

    I can't help think that a cross-party group could come up with a fair balance of where they could start which would be least-damaging to the vulnerable.

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  4. The recession hasn't even started yet. Great blogging here as ever.

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  5. On the one hand we have calls from business to redirect the spending into private assets in the UK, and on the other the Bank of England is claiming to be seeking inflationary pressure through currency devaluation. As a net importer, any devaluation will result in higher prices of goods, and that will be inflationary. Once again, you would expect a policy of active devaluation of the £GB would garner headlines, but still it is tucked away in the financial pages. After all, the devaluation of currency results in relative impoverishment of every holder of the devalued currency.
    In ordinary circumstances, a currency devaluation would make British exports more competitive on the world market, and actually improve the UK trade deficit, by leading to a surge in exports. The surge in the prices of imported goods (domestic inflation) would decrease consumption of imports and lead to current account balance, and more investment in production at home.
    But since we are in the early stages of a worldwide economic slump resembling the Great Depression, demand for goods and international trade has collapsed, so this is clearly not a good solution now.
    But the simple belief that a large government debt to GDP ratio is inevitably disastrous is also false.
    The US emerged from WWII with a government debt at 120% of GDP (see http://zfacts.com/p/318.html). By Cynicus’ measure, the US government was totally broke in 19445. And yet the Bretton Woods era (1945-1971) that followed was the most prosperous in US history, with the highest growth rates the US has ever had, and largest rises in the US standard of living ever.
    The major factor is whether the government can engineer a successful recovery and the re-establishment of productive investment in the economy. For that, we will need to return to the mixed economies of the Bretton Woods era.
    Correcting the system will mean full nationalization of the banks, and careful auditing of them, orderly liquidation of debts (instead of a return to asset price bubbles), proper financial and banking regulation, and a return to a government role for allocating investment in the economy to rebuild manufacturing.

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  6. We Need to Return to Effective Financial and Banking Regulation


    In the Bretton Woods era of sound financial regulation (1945-1971), there was only 1 major banking crisis in the Western world. There have been 26 major banking crises from the 1970s to the 1990s after financial deregulation, and now one world-wide financial collapse on the scale of the Great Depression.
    Think about it: 1 crisis under regulation, and 26 plus a global financial collapse under deregulation.

    See Phillip Anthony O’Hara, Growth and Development in the Global Political Economy: Social Structures of Accumulation and Modes of Regulation, Routledge, London and New York, 2006. p. 54.

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  7. The UK can in fact Reverse its QE


    [sc. the success of Japan's QE was] in the ability to rapidly reverse the policy. As I have outlined, there is no such potential in the UK without prompting a collapse in the bond market, as the growing fiscal deficits stretch out over a very long time.

    But then you assume there will be no further government control over the banks. If the government effectively nationialized the banks and exerted direct control over their management, you could reduce the money supply by stopping them from using the money they have been given through QE and by restricting their loans, as well as traditional means like higher discount rates and higher reserve requirements.

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  8. Reply on Japan’s Monetization of Government Deficit


    I think that it is worth reiterating that devaluation is a form of impoverishment

    As I already said, the yen had been significantly overvalued in the 1920s (Teranishi 2005: 130-133), and this had seriously harmed Japanese exports and caused trade deficits in the 1920s. Since Japan’s exports were badly hurt by the overvalued yen, the yen depreciation in 1932 stimulated demand for Japanese exports overseas, especially for Japanese textiles in Asia. Thus the yen devaluation allowed a surge in Japanese exports, and this actually improved Japan’s current account. Japan actually had a trade surplus in 1935.
    The yen devaluation discouraged consumption of more expensive foreign imports, and also stimulated consumption of domestic goods. In a developing economy, if you shift your consumption from more expensive imports to relatively cheaper domestic goods, then you are not impoverishing yourself, but stimulating demand at home, and actually creating the incentive for more domestic investment and more jobs. In the short term, this form of import substitution industrialization might result in higher average prices due to inflation of raw materials costs and energy inputs from overseas, but in the long term, as domestic manufacturing and production develops and trade surpluses develop, it pays for itself, as per capita GDP rises.

    The claim that devaluation is a form of impoverishment is false in the long term.

    For instance, Japan still had an undervalued yen in the 1960s and 1970s, which allowed its exports to be more competitive internationally. But can anyone really believe that Japan is now an impoverished nation because of this policy? Japan is the 4th largest economy on the world!

    BIBLIOGRAPHY
    Teranishi, J., 2005, Evolution of the Economic System in Japan, Edward Elgar Pub., Cheltenham, UK and Northhampton, MA.

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  9. Lord Keynes:

    I will not answer all your specific points, as there are simply too many of them. However, I will address the fundamental problem in your approach. You frequently cite history in support of your arguments. For example, you cite that the relative lack of bank crises during 1945-71.

    The essential problem here is that you are not taking into account the specific circumstances of each time. In this case, there was a lack of stress on the system. Was there any equivalent of?

    1. Globalisation running at an astounding rate, with the entry into the world economy of the labour of India and China?

    2. Was there any equivalent of the Carry trade in which Japan poured their monetary inflation into the US economy?

    3. Was there the flood of capital into the US from countries like China?

    4. Was there a massive surge in global competition?

    5. Was there competition for resource such as oil, such that there was a zero sum game?

    6. Was there a comparable size of emerging economies, combined with technology, market access and the availability of capital?

    I could go on with many key points of difference.

    Comment continues....

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  10. Comment continued....

    The point is that you make comparisons without explaining why the previous circumstance might be comparable. In other words, you can not take one set of circumstances, and use them to explain or compare with current circumstances. History may help us to understand now, but it offers no explanation of the actual circumstances now.

    Each economic situation is entirely unique. We might carry forward some ideas from one situation, but we need to accept that they might not translate.

    A good example of this from your arguments is that of banking regulation. You suggest that the lack of regulation in comparison to the past is the source of many problems, citing the lack of bank failures in the past (I dispute any idea that there has been significant deregulation of the financial system, but I will put that to one side for now).

    There is a key difference for the financial system between recent times and the past.

    In the past, there was no flood of easy money from the East. However, can you imagine that in your perfectly regulated banking world of the past that the bankers would have said 'no' we do not want your money?

    It is highly improbable.

    As such, there would still have been the same flood of credit, and therefore some kind of bubble would have emerged. The only thing that might have been different would have been where the bubble emerged. If given money, bankers will utilise that money, and if the money supply exceeds the potential for good investment, it can only end in a bubble.

    I see nothing in the regulation of the past that might have prevented a bubble economy, excepting the tie of currencies to gold (albeit a weak tie). If there had been a gold standard, then the flood of gold out of the economy to pay for consumption might have prevented the **scale** of the bubble.

    However, I suspect that you would not accept the idea of a gold standard, as this would prevent central bank manipulation. In particular, under a genuine gold standard, the money supply would have contracted as gold flooded out of the US in the consumption binge. This would have halted the bubble before it got out of hand (as a note, I do not advocate a gold standard, but it is at least better than the current fiat system).

    In the case that I am giving here it is the manipulation of the money supply and interest rates (Japan) and currency manipulation (China) that led to the flood of money. In other words, government interventions of the kind that you defend at great length.

    The fact that these eventually lead to severe problems for the world as a whole seems to be missed in your analysis.

    Like yourself, I look to history for precedent and analogy. The difference between us is that I recognise the circumstance of today. The circumstances are unique, and therefore history can only be informative in a limited way. I would never suggest disregarding history, but some discretion in application of lessons needs to be applied.

    If A resulted in B under circumstance C, it does not mean that the same will occur under circumstance D. Economics is fluid system, in which the infinite number of variables combine in unique ways.

    All we can do is analyse the here and now, in light of our best understanding of the circumstance of today. We might use history to help us, but should not think it offers the answers.

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  11. Willem Buiter:
    Quantitative easing, credit easing and enhanced credit support aren’t working; here’s why.

    Quantitative easing - expanding base money in circulation (mainly bank reserves with the central bank by purchasing government securities) - isn’t working in the US, the UK or Japan...These policies are not improving the ability and willingness of banks to lend to the non-financial sectors. They have had little positive impact on the corporate bond market. It is not surprising why this should be so, once we reflect on the actions and the conditions under which they are taking place.

    In a nutshell: quantitative easing (QE), credit easing (CE), and enhanced credit support (ECS) are useful when the problem facing the economy is funding illiquidity or market illiquidity. It is useless when the binding constraint is the threat of insolvency. Today, liquidity is ample, even excessive. Capital is scarce. Capital is scarce first and foremost in the banking sector.

    Quantitative easing
    The central bank buying longer maturity government securities will help when the underlying problem is too high a value of risk-free long-term interest rates. That, however, is not the problem. If anything, long-term risk-free rates continue to be surprisingly and damagingly low. So outright purchases of government securities by the central bank do nothing to alleviate liquidity pressures on banks, let alone the banks’ capital shortage. They are no more than a sop to the ministry of finance and its deficit financing preoccupations. At best, such monetisation of the public debt will, if it not expected to be reversed, have a ‘fiscal’ effect - helicopter money. But if households are saving their windfalls, even this will fail to boost the economy.


    http://blogs.ft.com/maverecon/2009/07/quantitative-easing-credit-easing-and-enhanced-credit-support-arent-working-heres-why/

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  12. Response on Financial Regulation 1


    In the past, there was no flood of easy money from the East. However, can you imagine that in your perfectly regulated banking world of the past that the bankers would have said 'no' we do not want your money? It is highly improbable … As such, there would still have been the same flood of credit, and therefore some kind of bubble would have emerged.
    The “easy money” from the East would be accepted in a regulated banking world, but prevented from causing destructive asset bubbles. Proper regulation is precisely the thing needed to stop asset bubbles.
    There are plenty of uses to which inflowing money can be put, apart from stock market and real estate bubbles and exotic unregulated financial instruments.
    For instance:
    (1) Larger state funded R&D programs to advance science and technology
    (2) Application of advances in technology to industry and business to increase productivity
    (3) Investments in infrastructure, like public works or hospitals
    (4) Investment in domestic industry
    With sound financial regulation and a partial role for government in allocating investment money, this would have stopped the financial crises resulting from speculation and asset bubbles.
    If given money, bankers will utilise that money, and if the money supply exceeds the potential for good investment, it can only end in a bubble.
    But in actual fact, regulation should impose a limit to how much investment flows into a country anyway, just as in the Bretton Woods era. In the case of large trade surplus countries like China, a carefully regulated financial system in the West would have stopped the Chinese from sterilizing a large part of their current account surpluses that prevented increases in domestic Chinese demand. If the money from Chinese trade surpluses had entered the domestic economy, then this would surely have spilled over into Chinese purchases of US and European imports, helping Western economies and correcting trade imbalances.
    Furthermore, preventing the destructive effects of short term speculative capital or “hot money” was a major achievement of Bretton Woods era financial regulation, and should be restored today.
    Short term speculative capital flows are often unproductive and de-stabilizing, and their regulation would have prevented many of the currency crises in Third World countries since the 1970s.

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  13. Response on Financial Regulation 2


    I see nothing in the regulation of the past that might have prevented a bubble economy, excepting the tie of currencies to gold (albeit a weak tie). If there had been a gold standard, then the flood of gold out of the economy to pay for consumption might have prevented the **scale** of the bubble.


    The Gold Standard did not prevent the rise and fall of asset bubbles. Asset bubbles occurred regularly during the 17th, 18th, and 19th centuries, under the gold or bimetallic commodity standards.
    And you only have to think of the railroad bubbles of 19th century America. In Australia in 1880s, there was a massive real estate bubble, despite the fact that Australia was under the gold standard and had no central bank.
    The post-Keynesian economist Hyman Minsky has plausibly shown that asset bubbles are an inherent feature of capitalism. See http://en.wikipedia.org/wiki/Hyman_Minsky.


    Joseph E. Stiglitz has shown how the asset bubbles of the past 20 years could have been prevented:


    To deal with the high-tech bubble [of the late 1990s], [Greenspan] could have increased margin requirements (the amount of cash people need to put down to buy stock). To deflate the housing bubble, he could have curbed predatory lending to low-income households and prohibited other insidious practices (the no-documentation - or "liar" - loans, the interest-only loans, and so on). This would have gone a long way toward protecting us. If he didn't have the tools, he could have gone to Congress and asked for them

    Joseph E. Stiglitz, “Capitalist Fools” Vanity Fair, January 2009
    http://www.vanityfair.com/magazine/2009/01/stiglitz200901

    Under the Bretton Woods system, these could have been easily implemented.

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  14. On Financial Regulation 3


    A good example of this from your arguments is that of banking regulation. You suggest that the lack of regulation in comparison to the past is the source of many problems, citing the lack of bank failures in the past (I dispute any idea that there has been significant deregulation of the financial system, but I will put that to one side for now).


    Here is a simple proposition:
    Financial regulation from the 1980 to today is comparatively less extensive and restrictive than it was from 1945-1973.

    From the 1945 to the early 1980s, most countries had vigorous financial regulation that included many of the following:

    1. Interest rate ceilings
    2. Liquidity ratio requirements
    3. Higher bank reserve requirements
    4. Capital Controls
    5. Restrictions on market entry into the financial sector
    6. Credit ceilings or restrictions on the directions of credit allocation
    7. Separation of commercial from investment (“speculative”) banks
    8. Government ownership or domination of the banks

    Ito, H. 2009. “Financial Repression,” in K. A. Reinert, R. S. Rajan et al. (eds), Princeton Encyclopedia of the World Economy, Princeton University Press, Oxford and Princeton, N.J. pp. 431–433.

    Many of these have been abolished and in particular capital controls.

    Capital controls were a major and restrictive aspect of Bretton Woods regulation.
    Their abolition has led to an explosion is speculative capital movements, particularly short term capital.
    Can anyone seriously deny that our system of capital liberalisation is not comparatively less regulated than the Bretton Woods era?

    In the US, two acts of deregulation are particularly important:

    (1) the Financial Services Modernization Act of 1999 (also called the Gramm-Leach-Bliley Act of 1999)
    (2) the Commodity Futures Modernization Act of 2000

    Financial deregulation has led to the emergence of the shadow banking system, an almost completely unregulated financial sector that has played a major role in the meltdown of 2007-2008.

    http://en.wikipedia.org/wiki/Shadow_banking_system

    ReplyDelete
  15. Lord Keynes:

    So you want to go back to capital controls? You want the government telling you what you can and can not do with your own money? This is the only point in regulation that might have prevented the recent credit bubble.

    You say:

    "The “easy money” from the East would be accepted in a regulated banking world, but prevented from causing destructive asset bubbles. Proper regulation is precisely the thing needed to stop asset bubbles."

    But the current regulators did not even manage to see the bubble in front of their faces, even at the point where the monstrous bloatedness was about to explode. Why should the next lot be any wiser? You are thinking that the regulators can see risk that others can not - this is a fantasy...

    You say:

    "But in actual fact, regulation should impose a limit to how much investment flows into a country anyway, just as in the Bretton Woods era. In the case of large trade surplus countries like China, a carefully regulated financial system in the West would have stopped the Chinese from sterilizing a large part of their current account surpluses that prevented increases in domestic Chinese demand. If the money from Chinese trade surpluses had entered the domestic economy, then this would surely have spilled over into Chinese purchases of US and European imports, helping Western economies and correcting trade imbalances.

    Furthermore, preventing the destructive effects of short term speculative capital or “hot money” was a major achievement of Bretton Woods era financial regulation, and should be restored today.
    Short term speculative capital flows are often unproductive and de-stabilizing, and their regulation would have prevented many of the currency crises in Third World countries since the 1970s."

    How?

    I think the only way that the Western credit bubble could be stopped was to say that China could not invest in the US and that the government could not borrow money from China. I would like to know *exactly* what mechanism might work in this way? Your comments offer no explanation of how government deficits, for example, might have been restricted. How would you judge 'hot money'? How would you allow investments into China, without a quid pro quo?

    If you are arguing against globalisation, then make that argument.

    In other words, what economic world do you want? Do you want a world in which narrow trading groups hide behind walls of capital controls, tariffs and other forms of protectionism? Do you want the US and Western world to move into their bunkers?

    If we are to be allowed to move our money into other economies, then they must be allowed to do the same. Do you believe in free and fair trade? (note: I believe that you have made arguments in favour of tariffs and protectionism in previous comments).

    I am not sure, in the current circumstances that all of this is even possible without falling into poverty (but that is another argument).

    Other than capital controls, you have done nothing to explain why the mass movement of money from the East into the West as credit might not have created a bubble under your tighter regulatory regime.

    Continued....

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  16. continued....

    On a personal basis, I do not think I have the right, or anyone else, to restrict where people move their money. It is, after all, their own money. How they utilise it, short of crime, is their own business. As an example, you could suggest that all of the people who have moved their retirement from the UK to Spain might in future have their move declared as being a crime.....

    On another personal note, I saw the effect of globalisation first hand. I watched as more and more people in China were lifted out of poverty. I would not like to see the potential for this to be removed. Globalisation, from my perspective, is a good thing. It is freeing huge numbers of people from poverty.

    The problem is that governments and central banks in the West pretended it was not taking place, and allowed China to grow without insisting on fair trade (these are the same groups who you would have setting regulation)........even now they are sticking their fingers in their ears and singing 'lah, lah, lah!'. If you have faith in these people, then I am genuinely puzzled.

    P.S. If you read my post, I relate the current bubble and the gold standard to the influx of money from the East, not a claim that a gold standard prevents all bubbles.


    I will leave it there for now.

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  17. Lord Keynes:

    Sorry, a last point. You may wish to read this. This is why the past circumstance no longer apply.

    http://www.bloomberg.com/apps/news?pid=20601087&sid=aqO3hUtyjtuw

    The world is a very different place indeed, and it is not even finished in the great shift. It will be bumpy, but nothing will stop it.

    If you think that we can hide behind walls and still achieve prosperity, I believe that you are mistaken.

    It is too late. The world has moved past the point where such action might have worked.

    ReplyDelete
  18. What puzzles me is that while CE pointed out,in many of his posts, the root cause of the current crisis, we still keep addressing symptons of the crisis/banking,financial regulations, currrency, gold standars,QE, reserve currency etc./
    By discussing solutions to these symptons we managed to sidetrack our attention from the real problem, which is increasing surplus of labour and decreasing amount of commodities,the two fundamental factors that set the stage for the crisis the world is in. Now how a global reserve currency or strict financial regulations are going to solve the problem of rising populations and commodities constraints, I wonder.
    We keep fighting the shadows instead of admitting that we do not have,just like our leaders, a solution.

    ReplyDelete
  19. Interesting take from Charles Hugh Smith: China - Neoliberal Capitalism's Last Fix

    http://www.oftwominds.com/blogjune09/globalization06-09.html

    On an offbeat note: China to buy old rock stars: http://www.thecrunchtimes.co.uk/html/090630chineserocks.html

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  20. Hi Cynicus,

    long time reader here. If you've still got questions about QE then Charlie Bean will be happy to answer them. See http://www.bankofengland.co.uk/monetarypolicy/qe/ask.htm
    It would be great to see a discussion between you two.

    Fiat Pete

    ReplyDelete

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