More QE, More Bank Bailouts....

I have several unfinished posts sitting awaiting attention. If I am completely honest, I am now overwhelmed with the number of subjects that I would dearly like to discuss, and am therefore procrastinating. China, the EU, the US, the UK, the banking industry and so forth; all facing, or potentially facing, crises. The magic wands of policy makers are now firmly bouncing off reality. Also, I have had an ongoing niggle, which is that it appears that the Economist magazine may have plagiarised the thesis that I have developed as an explanation for the world economic crisis. I will start with this subject, then give some comments on the current state of play in some stories of interest.


Has the Economist Magazine Plagiarised Cynicus Economicus?

According to Dictionary.com, plagiarism is:

the unauthorized use or close imitation of the language and thoughts of another author and the representation of them as one's own original work, as by not crediting the author: It is said that he plagiarized Thoreau's plagiarism of a line written by Montaigne. Synonyms: appropriation, infringement, piracy, counterfeiting; theft, borrowing, cribbing, passing off.

The key part in the definition is that of imitation of thoughts without crediting the original author. As a longstanding reader of the Economist, I was interested to see that they recently had a special report on the world economy (link here to the introduction of the 18 page special report). On reading the report, I started out thinking things like 'good, they have finally understood this', but as I continued reading, it seemed that the structure of the report was based around my thesis for why we are in an economic crisis.There are several potential sources of the explanation for the economic crisis which may have been plagiarised, and I have listed them below:

Copy One on Huliq is a piece titled 'Underlying Economic Crisis Caused Financial Crisis', and appears to now be unavailable. This is perhaps the most comprehensive of the discussions, but is no longer available. Another version can be found in TFR magazine here, another version on the blog here, and another version again on the blog here. In addition, there are references and discussions of the thesis throughout the blog, and it informs much of what I write throughout the blog. The TFR version is a short introduction, but you will also find references to the ideas as far back as 2008, and see the development of the ideas behind the thesis from the early days of the blog. In addition to having very similar views to the above articles, the report is littered with other ideas that just happen to be exactly the views/theories/perspectives expressed in this blog.

The Economist special report has several elements which, up until now, I have never seen discussed elsewhere, and it seems unlikely that, by coincidence, they would all appear in the same place at the same time. I have listed just a few of the commonalities:

• The financial crisis was caused by an underlying economic crisis - the savings of the East pouring into the Western banking system, rather than the financial crisis causing the economic crisis.
• The massive input of labour into the world economy, alongside bottlenecks in the supply of commodities.
• The massive demand for commodities (in relation to the above), as the emerging economies develop infrastructure.

There are many other similarities. Of course, the devil is in the detail. The Economist report is 18 pages in the hard copy version, so there is considerable detail in the special report which is different from the blog. There are some areas where the ideas of this blog and the Economist article diverge. For example, they do not follow my thesis about the world economy to the logical conclusion of the  hyper-competition and zero sum game. This would not fit with the editorial policy of the Economist, and I would be interested to see how the special issue was edited. However, even these ideas are partially visible in the special report.

Whilst it is flattering to see your own ideas reproduced, it is also beholden on those using the ideas to give credit for them to the appropriate source. The Economist typically gives credit to academic authors that they use in their articles, but perhaps the ideas of a 'mere blogger' are not considered as a source that might be given credit. Of course, it is always possible that, by coincidence, the Economist authors have simply seen the logic of the arguments of this blog for themselves. It is also possible that I am overstating the similarities, but I do not think so. Reading the special report, I was very clear in my mind that there was an uncanny similarity with many of the ideas of this blog. I would be interested to hear the views of the longstanding readers of this blog; do you think that they have plagiarised, or do you think that I am over-stating the similarities?

On a more positive note, at least the ideas are getting 'out there' into the mainstream.....

The Bank of England Printing Money Again.......

It comes as no surprise to that the Bank of England (BoE) is again embarking on money printing, otherwise know as quantitative easing. The CPI is at 4.5% and the RPI is at 5.2%, so inflation is marching upwards. This is what the BoE Monetary Policy Committee report has to say on inflation in their minutes for the September meeting:

The Committee’s view remained that the most likely near-term path for inflation was for a temporary rise to a peak of over 5% before the year end, in part reflecting announced utility price changes. Inflation was then expected to fall back sharply in the first part of 2012, with the impact of the change in VAT dropping out of the twelve-month comparison contributing around 1 percentage point to the fall.

It is really quite extraordinary. We have now heard about forthcoming falls in inflation for so long now that the BoE has no credibility on this issue whatsoever. Even more amusing is the letter to the Chancellor, which the BoE must write (yet again) for exceeding their 2% inflation target:

At its meeting today [the MPC] judged that, in order to keep inflation on track to meet the 2% target over the medium term, its programme of asset purchases should be increased to a total of 275 billion [...].

Yes, that's right; yet again, inflationary policy will be put in place even while inflation is rising, and whilst inflation is again missing the inflation target by a large margin, and yet again the medium term will sort it out. As I pointed out in a recent post, even the BoE has acknowledged the inflationary impact of QE. There are also some disingenuous moments in the letter, such as the discussion of 'domestic' measures of inflation indicating that inflation will 'contained'. However, the letter says nothing about international inflationary pressures; it's as if the economy of the UK is like the geography of the country, a financial island with no influence from the rest of the world economy.

Returning to the MPC minutes, they acknowledge that the fall in the value of sterling was responsible for the inflation (which has been the argument of this blog for a long while, but which the BoE did not factor into past calculations),and it also appears that there are varying views on more money printing. The one certainty I have about the nature of the debates in the MPC (not those that are published) is that the real reason for money printing is nothing to do with inflation. There are several possible reasons for the policy (1) They really believe that the economy needs to be 'stimulated' (2) They want to hold down the value of sterling, or see even greater falls (3) They want to pre-empt risks of the current positive sentiment in bond markets to the UK turning negative - a sort of insurance policy to ensure that gilt auctions have a buyer. As I discussed in my last post, the current state of policy chaos around the world, with potential for full blown currency war, seems to provide a rationale for the policy, but I would dearly love to hear how this is discussed behind closed doors.

Unsurprisingly, the Conservative party is now behind the measure as the general malaise in the UK economy deepens. Perhaps the most interesting aspect of George Osborne's endorsement of the policy is his repeated emphasis on the independence of the decision of the BoE. This brings to mind that he protests too much....

Coverage of the policy has been mixed. Alen Mattich at the Wall Street Journal argues that the BoE is engaged in ongoing policy mistakes, with this as just a further error in a catalogue of errors.  He worries, quite rightly, that the BoE is highlighting the risks of deflation, ignoring the risks of inflation, and is over-confident in the ability to tame inflation if it takes off. David Blanchflower, a former insider, says the following:

Concerns such as those expressed by Ros Altman – that QE2 is "another throw of the policy dice which could damage pensions, impoverish pensioners and increase risk in all financial markets" – have been raised. Mervyn King has responded to these criticisms and I agree with him: not doing QE would push us back into recession at a time when output is slowing and fiscal policy is tightening. Rising unemployment, falling incomes and slowing output would just be worse. So QE2 is not perfect but doing nothing is worse.

On the other hand, we have a commentary from a Conservative MEP in the Telegraph suggesting that:

According to the BBC, the Bank of England has decided to 'inject a further £75 billion into the economy'. Who knew it was that easy? I mean, why not inject £500 billion? Or a trillion? By the BBC's logic, it would surely make us the wealthiest nation on Earth.

I can't believe I'm having to write this, but nothing new will be manufactured, invented or developed  as the result of this monetary splurge, no services offered, no businesses founded. Rather, the money already in circulation – the money in your bank account, in your purse, under your mattress – will be worth less. The government, in other words, is helping itself to your savings – and, in doing so, is damaging productivity, disincentivising work and weakening the competitiveness of the British economy.

Perhaps the most interesting aspect of the commentary is that the MEP goes on to discuss QE in terms that would be used by Austrian Economists, such as counterfeiting. I say this is interesting, as it seems that Austrian economics appears to be reaching into the thinking of UK politicians, and this is the first time I have seen thinking so explicitly rooted in Austrian economic thought.

My own view is that I am against printing money in principle but, as I discussed recently, with increasingly extreme policy around the world, it may be necessary to react to the policy of others with extreme policy. This is why I would like to hear what is going on behind closed doors. If the policy makers are working against the extreme policy of other states, then perhaps, just perhaps, there might be some justification for this very high risk policy. However, I have never seen a justification for money printing that might overall justify the risks and damage that money printing might do. On the other hand, in the current climate of chaos in the world economy (of which the BoE QE policy is just another contributory element), it becomes ever more impossible to see how policies might impact....in this state of chaos, it seems that there are no clear answers.

The European Crisis

As the readers of this blog are mostly very well read individuals, I am sure that you will have heard about the latest ratings agency downgrades. This from the Wall Street Journal:

A pair of ratings downgrades sent the euro tumbling by more than a cent within an hour on Friday, bringing a jolting end to what had would have been the third-straight daily gain for the European currency versus the dollar.

When Fitch Ratings announced around midday in New York that it had cut its ratings on both Italy and Spain, it put a spotlight on the risks swirling around the third- and fourth-largest economies in the 17-member euro zone. If the downgrades further complicate those countries' capacity to borrow, it will likely raise fears that they will be unable to withstand a bout of "contagion" in their debt markets if, as many expect, Greece defaults on its debt in the weeks ahead.
The Italy downgrade wasn't a major surprise, as both Standard & Poor's and Moody's Investors Service had recently cut Italy's sovereign ratings. But Fitch's action on Spain came out of the blue. It hadn't put either country's rating under review.
The response from investors was swift. Having bid the euro higher through much of the day, when it was propelled by healthy U.S. jobs data and indications that European officials are becoming more willing to take aggressive crisis-fighting action, they rushed to buy dollars. Having been above $1.35 before noon, the euro was trading at $1.3390 at 1pm EDT, where it more or less spent the rest of the day.

The complexity of the mess of the Euro area almost defies explanation as it encompasses the European banking system, the US banking system, the politics of individual countries, and the economics of a failed monetary union, past and present regulation, and the ratings agencies. Add in a dollop of media madness, and you have a situation of almost unbelievable complexity.

Starting with the politics...we have a situation in which electorates threaten punishment of politicians for their actions. In the case of the potential rescuers, such as Germany, there is the unwillingness of the electorate to bail out the 'profligate' nations. In the case of those in need of rescue, there is the unwillingness of the electorate to be 'dictated' to by the rescuers. Then there are the politicians who are determined to rescue the grand European project in the face of the electorate, and the others who fear the consequences of a banking meltdown in the face of sovereign default (or who are basing their own positions in both perspectives).

The essential problem is that there is such heavy exposure in the European banking system to defaults on sovereign debt in the at risk states. This exposure can be laid firmly at the door of the Basel Banking Accords (see here for an extended discussion from 2008, but still applicable as an explanation), which set up a system in which European sovereign debt was considered to be 'safe', and where European banks were themselves considered to be 'safe'. In consideration of bank capital adequacy ratios, this encouraged the holding of this 'safe' debt. In Basel II, the ratings agencies were also placed firmly into the mix, with their central role in determining capital adequacy ratios based upon their ratings systems for assets, where their ratings determined what assets the banks should hold. Movements in the ratings then determines the solvency of the banks. The problems is that the ratings agencies might be described as useless in that they are reactive, rather than predictive. By the time that they react, the assets are already held by the bank as 'safe' and then become unsafe. With that 'unsafe' designation, the banks must then shore up their balance sheets....

What we now have is a situation in which banks are now sitting on a pile of 'safe' assets that are now 'unsafe'. It is all down to the idiocy of regulations from a bunch of supposedly smart people who actually thought that they could determine future risk. They didn't get the idea that, just by creating a system in which assets were deemed as 'safe', they would become 'unsafe'. As soon as an asset is declared as safe, thought and calculation, and the regulatory system itself creates an incentive to the over-issuance of the assets in question. It also relies upon organisations and individuals who are able to see into the future, analyse the complexity of macro and micro economics and so forth.

Throw a dysfunctional economic union into this mix, and it is no real surprise that there is now a massive crisis brewing. The problem is this. If the at risk states default on their debt, much of the European banking system will go down in a thunderous crash. With that crash, the very electorates that are determined not to support the bailouts of the at risk states will find that, with the collapse of the European financial system, their savings and pensions will be decimated. The alternative is that they pay for the bailouts, one way or another, through the tax system. In the case of countries like France, just to add to the toxic mix, there is the possibility of over-extending their own credit, and thereby risking their own sovereign debt position. The countries doing the bailouts risk creating contagion through the bailout process itself.

So where does the US banking system slot into this system, and why the pressure on the EU to sort out a massive bailout? This from Robert Reich:

That’s where Wall Street comes in. Big Wall Street banks have lent German and French banks a bundle.
The Street’s total exposure to the euro zone totals about $2.7 trillion. Its exposure to to France and Germany accounts for nearly half the total.
And it’s not just Wall Street’s loans to German and French banks that are worrisome. Wall Street has also insured or bet on all sorts of derivatives emanating from Europe – on energy, currency, interest rates, and foreign exchange swaps. If a German or French bank goes down, the ripple effects are incalculable.
Get it? Follow the money: If Greece goes down, investors start fleeing Ireland, Spain, Italy, and Portugal as well. All of this sends big French and German banks reeling. If one of these banks collapses, or show signs of major strain, Wall Street is in big trouble. Possibly even bigger trouble than it was in after Lehman Brothers went down.

Again, look to the regulatory framework that saw, for example, a German bank as 'safe' and EU sovereign debt as being 'safe'. Indeed, OECD banks in general were 'safe'. And so banks could leverage up without negatively impacting their capital adequacy ratios....leaving themselves ever more exposed to the point in time when 'safe' became 'unsafe'. Thus we have the multitudes of cross exposure of banks to banks, with derivatives exposures as a further ratchet.

The end result of this is a problem so profound that there really is no resolution. The scale of the problem means that it is impossible to do anything but delay the inevitable disaster. The politicians cannot undo the structure that they played a part in creating. It is simply too late. The only point I think I have not covered is the media madness. For this, exhibit A is Ambrose Evans Pritchard*, who has issued ever more hysterical commentaries, which are screaming that 'SOMETHING MUST BE DONE'. He is not alone, but is an exemplar. He offers the correct diagnosis (in some respects, but not with regards to underlying causation) that there is a horrendous crisis, but fails to see that there is nothing to be done other than delay the crisis. This is from a fairly recent sub-head from his column:

Europe, the G20, and the global authorities have one last chance to contain the EMU debt crisis with a nuclear solution or abdicate responsibility and watch as the world slides into depression, endangering the benign but fragile order that has taken shape over the last three decades.

Perhaps there is some undiscovered genius who can put Humpty Dumpty back together again, but at the moment, all the kings' horses and all the kings' men cannot put.....and that is the problem.

* I actually really like to read his columns, as he is a fantastic source of information (and I use this often), but most of his analysis is (to say the least) problematic.

Note: I was going to throw the new Basel framework into the mix, but this is already an over-long post....Apologies for the lack of posting but I have been horrendously busy.....