It's Wednesday, and as usual I scout around various issues that I have been thinking…
Kicking the can down the road outside the Roach Motel
My friend Marshall Auerback has described the EMU has the Roach Motel – a very North American term but one which resonates everywhere. The full article – is recommended reading. Very amusing and perspicacious. He says – “The Germans might occupy the penthouse suite, but it’s the penthouse suite of a roach motel” which is apposite. The latest decisions of the EU finance ministers after an emergency meeting in Brussels over the weekend will just hold the ultimate crisis at bay for a little while longer. The EMU is currently surviving because the ECB has stepped in as the “missing” fiscal agent and keeping the bond markets at bay. While the ECB is the only entity in the EMU which has currency sovereignty and can “fiscally fund” member state deficits permanently, the underlying logic of the monetary system will continue to ensure these on-going crises will spread across the union. The EU bosses are just buying time and “kicking the can down the road a bit” at the moment. Ultimately, to survive the system has to add a unified fiscal authority and abandon the fiscal (Maastricht) rules (not politically possible) or accept the experiment has failed and dissolve the union. The latter option is clearly preferred and while the can is being kicked down the road apiece the EU leaders should be dismantling the Roach Motel and setting the captives free.
As an aside, I first associated the slang term – Roach Motel – with the way the Java Memory Model orders accesses to synchronised blocks. The US company that developed the cockroach bait used an advertising tag – “Roaches check in, but they don’t check out” – in the JMM memory accesses can be moved into synchronised blocks but you cannot move them out – hence the association.
In the context of the EMU it isn’t clear what the Roach Motel association refers to – a cheap lodging in the seedy part of town – or the asymmetrical access! The inference in Marshall’s New Deal 2.0 article is the latter. It was easy for the politicians to dupe their populations into joining the EMU but it is now a major political problem trying to exit. Recall that the original plan was for a country-by-country ratification process (by referendum) which would have, at least, rendered the decisions to join the union democratically based. But as the early votes demonstrated the people were largely against joining up and so the politicians abandoned that approach and forced through the arrangement via the Lisbon Treaty.
I also borrowed the term – kicking the can down the road – from this Bloomberg article (November 29, 2010) – Ireland Wins $113 Billion Aid; Germany Drops Threat on Bonds – which reported on the agreement worked out at the emergency meeting of European Union (EU) finance ministers in Brussels over the weekend.
The Euro bosses decided to give in to the “bond markets” by giving the Irish government “an 85 billion-euro … aid package” and have diluted the German demands that would have forced “bondholders to cover a share of future bailouts”. The meeting also extended the horizon for Greece to pay back the emergency loans (110 billion euros) which brings both bailouts so far into line – seven-year terms.
Ireland has to impose further anti-growth/anti-people measures on its population courtesy of the IMF to get the cash!
Of-course, Ireland had done everything that was asked of them by the austerity monsters – and as I predicted (here) the situation deteriorated. Now they are having to make further cuts which will further worsen their outcomes. They are racing to a very deep bottom and it is only a matter of time before major civil unrest brings their corrupt and inept government down.
It is clear that the bond markets will pick off EMU countries one by one with Portugal lining up next – then Spain – then Belgium and then …. No EMU member-nation is immune from this crisis as a result of the flawed design of the monetary union.
The Germans demanded that the the EMU extended its austerity rules to allow for orderly defaults that would impose costs on the holders of public debt. I just laughed when I read their policy proposals. What the hell do they think would have happened?
They create a situation where the bond markets rule – totally unnecessarily – then tell the “investors” that if they lend too much they will take losses.
Apparently the “compromise” is that the IMF will determine who takes the losses on a “case-by-case” basis. Handing any discretion to the IMF is a mistake at the best of times. But it will just worsen this crisis and encourage more destructive targetting by the bond traders.
The other point is that the crisis is starting to threaten the penthouse occupants! In this UK Telegraph article (November 26, 2010) – EU rescue costs start to threaten Germany itself – we learn that the “escalating debt crisis on the Eurozone periphery is starting to contaminate the creditworthiness of Germany and the core states of monetary union”, which was always going to happen. All these nations are dependent on the “fiscal capacity” of the European Central Bank as a result of the flawed design of the monetary union.
Apparently, fear is spreading in Germany. The article reports that:
Germany cannot keep paying for bail-outs without going bankrupt itself … This is frightening people. You cannot find a bank safe deposit box in Germany because every single one has already been taken and stuffed with gold and silver. It is like an underground Switzerland within our borders. People have terrible memories of 1948 and 1923 when they lost their savings.
The Germans have been trying to force the pending public debt losses on the bond markets – so-called “creditor haircuts” which has clearly made matters worse. The bond markets have decided (those amorphous decision-makers) that Greece is not the limit of the problem. They soon set out to ruin Ireland and now Portugal and Belgium are being targetted.
The bond markets know that the EMU nations have ceded their currency sovereignty and acted over the last decade in a way that was in denial of that loss of sovereignty. So these governments, which gave up their capacity to “save” or guarantee their own banking systems, then allowed these systems to go berserk and effectively bankrupt their nations. All these governments should resign en masse.
But the point is that the Euro bosses are waging a losing battle – they are just “kicking the can down the road apiece”.
I am not a fan of the “bond markets” and I view public debt as corporate welfare. But I also recognise the logic of their motivation. Given the governments agree to a system where the individual member states are without sovereignty and are thus “financially constrained” they have to rely on the bond markets for funding of their deficits.
To then say to the “investors” that you lose if we overextend is not only a corrupt concept but also foolish. Overextend in this context has to be defined within the ridiculous context of the Maastricht Stability and Growth Pact (SGP) rules which provide no real capacity for any government to adequately address a major demand shock.
In this environment, there is a growing call for Germany to exit the EMU and leave the Euro to the weaker trading nations. For example, in this article – German exit from euro ‘realistic prospect in 2011’ – the author says:
Germany’s presence in the euro is a problem for the PIIGS, since the export powerhouse keeps the value of the single currency high, making it difficult for the likes of Greece and Ireland to escape their crises by increasing their own exports. Without Germany, the euro would fall in value, giving a much-needed boost to the competitiveness of weaker members.
Which as far as so-called informed commentary goes just demonstrates how skewed the debate has become. The fundamental problem facing the EMU is not that the member nations have differential trading capacities.
Certainly, net exports contribute to aggregate demand which drives income and employment growth. So Germany has always relied heavily on its export sector to maintain real output growth, while some of the other EMU nations have not. But it is perfectly reasonable (and desirable) to have strong domestic spending growth brought about by various mixes of consumption, investment and public spending.
The problem for the weaker EMU nations is that the nonsensical rules that have been developed by the monetary union prevent the member governments from using fiscal policy to fill spending gaps that have arisen from a collapse in private domestic spending – net exports status notwithstanding.
It is true, that one of the problems for each EMU nation is the fact they no longer can vary their individual nominal exchange rates and have to try to engineer changes in their real exchange rates via domestic deflation, which savages pay and working conditions for the domestic population. Clearly, a sovereign nation has to not only issue its own currency but also has to float that currency to free up the capacity of domestic policy to pursue public purpose.
But while Germany’s exit from the Eurozone would allow the weaker nations to “devalue” as a block, it still doesn’t restore sovereignty to the individual governments in the “block”. It could work if the remaining members agreed to cede fiscal authority to a unified “fiscal agency” which also was aligned with the currency issuing authority (it could be the same entity).
But without that overall fiscal capacity to meet asymmetric aggregate demand shocks, merely losing the “strongest” nation in the union will not achieve anything constructive for the remaining nations.
Some might say what is the difference between a nominal exchange rate change that generates a real depreciation and the same result achieved by domestic deflation (cuts in nominal wages and inflation). The difference is that workers have nominal contractual commitments which are aligned (more or less) with their nominal pay levels. A depreciation in the nominal exchange rate squeezes these workers somewhat to the extent that they purchase imports or products with significant import components. But they still (within reason) can then prorate the “real income losses” across their overall budget and prioritise their nominal contractual obligations.
But directly cutting nominal pay attacks their capacity to meet their nominal commitments. Yes, the real income losses might be the same but if they do not have enough nominal pay to meet their obligations then default follows.
This is one of the reasons why Keynes and others argued that workers are prepared to take real wage cuts that arise from a rise in the price level but will resist an equivalent real wage cut that might follow a nominal wage cut. The second option exposes the workers to nominal contract default. The argument generalises to why cutting pay is a very poor way to solve unemployment. Please read my blog – What causes mass unemployment? – for more discussion on this point.
Further, Germany’s export strength relies heavily on the import spending of the other EMU nations. This is the myopic aspect of the German position. They want to maintain strong exports but they also want to impose fiscal austerity on the “importing” nations, which will not only significantly reduce public spending but will also reduce private spending (as incomes drop). I am reminded of the Aesops Fable – The Goose with the Golden Eggs:
One day a countryman going to the nest of his Goose found there an egg all yellow and glittering. When he took it up it was as heavy as lead and he was going to throw it away, because he thought a trick had been played upon him. But he took it home on second thoughts, and soon found to his delight that it was an egg of pure gold. Every morning the same thing occurred, and he soon became rich by selling his eggs. As he grew rich he grew greedy; and thinking to get at once all the gold the Goose could give, he killed it and opened it only to find nothing.
Which might be re-written as:
One day Germany realised that the poor saps down south would buy whatever products they offered for sale – in particular, military equipment allegedly to ward of enemy neighbours. Germany couldn’t believe how stupid these southern nations were going into a monetary union with them but realised that they could grow wealthy from exporting to them. As Germany grew rich they also became greedy; they also wanted to take the islands that belonged to the southern nations and so imposed ridiculously harsh austerity programs on those nations to force them to hand over the islands. Soon after, the southern nations went broke and couldn’t buy as much stuff from Germany any more.
Please read my blogs – Export-led growth strategies will fail and Fiscal austerity – the newest fallacy of composition – for more discussion on this point.
There is also some argument about whether the Irish situation is a Euro crisis or a specific country banking crisis. The root cause is definitely the Euro membership and the banking crisis has exposed the lack of fiscal capacity that the EMU member states have as a result of ceding their monetary and fiscal capacity to the ECB.
While the banking crisis is symptomatic and has been instrumental in causing the Irish government’s budget deficit to increase the underlying cause of the problem now is Ireland’s membership of the Eurozone.
It is clear that the pro-free market Irish government lost oversight of its nation and allowed its banking system to run riot as they privatised the profits in the property bubble period. Certainly, the low interest rates coming from the ECB made borrowing cheap and helped fuel the property speculation. The low corporate tax environment also promoted economic allocations that were not in the long-term interests of the Irish population.
All of these developments have clearly combined to make the Irish crisis worse than most and reflect the lack of adequate government oversight.
But even with this appalling record of corrupt and incompetent governance, the Irish government could have reduced the costs of the meltdown had it been sovereign in its own currency and not been held hostage to the SGP fiscal rules.
It is true that the free-market bias of the Irish government which led it into trouble as above has also made it easier for them to impose the harsh fiscal austerity on its people. But that just means the Irish people should ensure they kick the government out of office as soon as possible. But even the most progressive government with all the insights in the world about how to promote domestic employment growth etc will not be able to do anything constructive while they remain in the Eurozone.
An aside also relates to the concept of governance that is lost in the current debate. The private markets are devoid of any “values”. They are amoral in that sense. To think that the decisions that private market participants make will somehow advance public purpose is naive in the extreme.
One of the roles that we seek in government is to mediate the private markets to reflect the “social values” of the nation. The neo-liberal era has successfully eroded the concept of collective will and has actively promoted the idea that nations do not exist beyond being a “collection of self-seeking individuals”. That is the myth that introductory economics textbooks seek to propagate – that optimal outcomes emerge when individuals pursue their self interest.
The current crisis should inform us of the folly of that “religious” belief. And it has also exposed the folly of governments that renege on their responsibilities to adequately regulate the private markets to ensure they work to advance social outcomes and welfare. The Irish government clearly abandoned that responsibility not only in allowing the markets to rip but also in shoe-horning their citizens into the monetary union which was always destined to come unstuck as soon as the first sizeable demand shock emerged.
The following blogs cover my recent commentary on the EMU:
- The sick Celtic Tiger getting sicker
- The Celtic Tiger is not a good example
- Live coverage now on
- World Bank boss has a brain attack
- The Euro bosses ignore all the lessons
- Euro zone’s self-imposed meltdown
- A Greek tragedy …
- España se está muriendo
- Exiting the Euro?
- Doomed from the start
- Europe – bailout or exit?
- Not the EMF … anything but the EMF!
- EMU posturing provides no durable solution
Caption contest
We know that the ECB boss is blinded by neo-liberal ideology and now he seems to be noticing it. I am announcing a new contest which will offer very generous prizes and finish at some unspecified time for the best caption to this photo of Trichet adjusting his glasses while speaking at a press conference after the emergency meeting of European Union finance ministers in Brussels over the weekend just past.
I will announce a winner sometime and no correspondence will be entered into 🙂
When I saw the photo, I started singing – I can see clearly now:
I can see clearly now, the Euro is gone
I couldn’t see all obstacles in my way
Gone are the dark clouds that had me blind
The Euro is dead (dead), gone (gone)
and I am having a very bad day
Clunky, sorry!
Conclusion
Anyway, now the EMU has decided to “kick the can down the road a while” but the monetary system will remain flawed and those flaws will ultimately bring it down unless the ECB keep providing “fiscal support” via their secondary bond market purchases.
The next EU finance ministers’ emergency meeting should have only one agenda item: how the hell can we dissolve the monetary union and restore currency sovereignty to the individual nations and minimise the (huge) adjustment costs that would follow?
While those adjustment costs would be large I guess they would be lower than the accumulating economic and social costs that will accompany their pig-headed attempt to maintain the system.
That is enough for today!
“Zut alors! the situation doesn’t look good in 3D either.”
or
“Sacre bleu, the optician must have been lying when he told me these were progressive lenses”
“Now let’s have look …. What are they saying about me in Wikileaks?”
The banks must be protected at all costs and must never be allowed to fail. It’s only a matter of time……
Dear Bill,
exiting EZ system is quite difficult, as we all know. Could you please explore possibilities of introducing secondary, national “back-up” currency to run along side euro, in other words, running a dual currency system. Would it work? How would it work? Could it provide way to a gradual, smooth transition in to a monetary sovereignty?
Great analogy although I would say the EU is more like the Hotel California — you can check out any time you like but you can never leave!
^^^ I vote for wiki-leaks.
Ironically, Trichet wont the “Vision for Europe” award in 2008, the preceeding winner being Angela Merkel. I expect any moment he will be denouncing revanchists and “splittists” trying to win their independence from the EMU/bank oligopoly.
What I find interesting in this whole discussion is how private sector bank debt is conflated with sovereign debt.
Ireland doesn’t have a terrible sovereign debt burden, but it has an enormous “external debt” burden, meaning that Irish banks have a lot of foreign creditors, primarily British and German man-children.
In a sane political system, these would be the ones to bear the losses as they are the ones who were earning interest. Those who misallocate capital on a massive scale should not be given even more capital to allocate; the bond markets, in order to function, require that these investors become much poorer. If they aren’t made poorer, then there isn’t much reason to have bond markets. In that case, Bill would be right — it is all corporate welfare — and as the outcome of investments is being determined politically, no one should be getting any interest at all.
In this most recent bailout, about 2/3 is going to go to for-profit Irish banks in order to make creditors whole, and this is just the first round of transfers. Irish citizens, who are productive and hard working, and have already been squeezed with declining median wage shares before the crisis began, will now need to go with even more austerity.
“These new glasses are great! I can now see as far as the end of my nose!”
or, as he looks so miserable
“I should have bought the rose tinted variety.”
or
“The smell of decay from these glasses seems to be growing.”
Mr Trichet is reading from the wall:
“A baited banker thus desponds,
From his own hand foresees his fall,
They have his soul, who have his bonds;
‘Tis like the writing on the wall.”
Jonathan Swift’s poem: Run Upon The Bankers
source_http://www.readbookonline.net/readOnLine/38875/
(actually I was looking for the original “MENE, MENE, TEKEL, PARSIN” source_http://www.biblegateway.com/passage/?search=Daniel+5&version=NIV but the poem fits even better).
Triche = Cheats in French.
Meanwhile in Hungary they are grabbing $14 billion in pension savings to fund budget deficit. To boost growth, they are cutting flat rate income and corporate taxes to 16 and 10 percent respectively. ???
On a more positive note, central bank independence is somewhat undermined.
http://www.bloomberg.com/news/2010-11-26/hungary-risks-fund-manager-exit-on-pension-grab-pioneer-says.html
http://www.bloomberg.com/news/2010-11-24/hungarian-government-looks-to-seize-control-of-appointing-policy-makers.html
“With his cunning Clark Kent disguise in place, Trichet escapes unrecognised into the night”.
“Bravo, bravo, bravo, Monsieur Triquet!
Your verses are wonderful and very, very nicely sung!”
(From “Eugene Onegin”)
Its a photo of Trichet laughing at a good Irish joke.
Cheers Punchy
The New European Language
The European Commission has just announced an agreement whereby
English will be the official language of the European Union rather than German,
which was the other possibility.
As part of the negotiations, the British Government conceded
that English spelling had some room for improvement and has
accepted a 5-year phase-in plan that would become known
as “Euro-English”.
In the first year, “s” will replace the soft “c”. Sertainly,
this will make the sivil servants jump with joy.
The hard “c” will be dropped in favour of “k”. This should klear
up konfusion, and keyboards kan have one less letter.
There will be growing publik enthusiasm in the sekond year when
the troublesome “ph” will be replaced with “f”. This will make words
like fotograf 20% shorter.
In the 3rd year, publik akseptanse of the new spelling
kan be expekted to reach the stage where more komplikated
changes are possible. Governments will enkourage the removal
of double letters that have always ben a deterent to
akurate speling.
Also, al wil agre that the horibl mes of the silent “e” in the languag
is disgrasful and it should go away.
By the 4th yer peopl wil be reseptiv to steps such as replasing “th” with “z”
and “w” with “v”.
During ze fifz yer, ze unesesary “o” kan be dropd from vords kontaining
“ou” and after ziz fifz yer, ve vil hav a reil sensibl riten styl. Zer
vil be no mor trubl or difikultis and evrivun vil find it ezi tu understand etsh oza.
Ze drem of a united urop vil finali kum tru ..
Und efter ze fifz yer, ve vil al be speking German like zey vunted in
ze forst plas.
“Est-ce possible que j’ai été réellement triché?”
Now, for non-humorous stuff…
“Dear Bill,
exiting EZ system is quite difficult, as we all know. Could you please explore possibilities of introducing secondary, national “back-up” currency to run along side euro, in other words, running a dual currency system. Would it work? How would it work? Could it provide way to a gradual, smooth transition in to a monetary sovereignty?”
Could a dual currency scheme for individual countries be an option to consider to “minimise the (huge) adjustment costs”?
Hm, what is it coming at me? Looks black and heavy. Ouch!… Every man for himself!
Krugman strikes again
In today’s article, Paul Krugman recognizes that EU countries face the possibility of sovereign default. Unfortunately, he completely misunderstands the mechanism by which long term interest rates are increasing in highly-indebted EU countries. Rather than acknowledging that countries with their own currency cannot go broke, which eliminates default risk on their debt instruments and prevents an increase in long-term government debt yields. He attributes the lower public borrowing costs in the United States and United Kingdom to the ability to devalue their currencies. Presumably, he is arguing that if a country can devalue its currency, it can incur current account surpluses, which would allow that country to repay its foreign debt. The only problem with that argument is that the United States will not run current account surpluses at any time in the foreseeable future. So, according to Krugman the interest rate on government debt won’t increase in the United States, because that country can devalue its currency allowing it to run a current account surpluses, so it can repay its foreign debt, and perhaps, have a higher rate of economic growth. I should note that it is difficult to know why Krugman thinks that currency devaluations limit the increase in long-term government debt yields, because he does attribute a causal mechanism to this outcome. But it should be clear that the current account and economic growth channel are not available to the United States, because other countries rely on its current account deficits (to defend their currency pegs) and as such it is difficult to see why its economic growth would increase from a devaluation. It is insane that Krugman has given such a confused explanation, when a straight forward explanation would do. Country’s with their own currency cannot default on public debt denominated in that currency, so interest rates do not increase to compensate for that risk. In Euro-are the opposite is true, country’s can default on their public debt, so interest rates increase to compensate lenders for the risk of default.
http://www.nytimes.com/2010/11/29/opinion/29krugman.html
European, You suggest some Euro countries having a “secondary, back up, national currency” as a transition to full monetary independence. My gut feeling is that that might work. Something of this sort already exists in that some towns in Europe and the U.S. already have their own currencies (e.g. Google “Ithaca hours”).
These mini currencies are a waste of time where full employment can be achieved in the relevant town/country WITHOUT assistance from a mini currency. But given excess unemployment (e.g. because a PIG country cannot devalue), citizens can be encouraged to purchase goods and services with a high local input by distributing mini currency to everyone. Employment is created as a result. This mimicks what happens in the case of devaluation: consumers increase their purchases of “high local input” goods and services because devaluation reduces the cost of these relative to imported stuff.
A mini currency might provide a period of something a bit less brutal than what is being imposed on Ireland. The mini currency would amount to semi succession from the Euro. It would be up to the relevant country to try and get its costs back into line with Germany, or failing that, the mini currency could lead to full monetary independence.
“The EMU is currently surviving because the ECB has stepped in as the “missing” fiscal agent and keeping the bond markets at bay.”
JKH has been critical of this argument and recently over at Mr. Mosler’s website argued that ECB interventions up to this point have not added net financial assets to the European economies. Instead, he argues ECB interventions have not been much different in effect than the Fed’s QE1 operations in the U.S. – i.e. shortening the duration and spreading the credit risk of the collective debt of the Euro Zone. This comment was made in the context of JKH’s criticism of Mr. Mosler’s proposal for the ECB to simply distribute Euro’s on a per-capita basis to the different EMU member nations. I believe RSJ has also recently raised questions about the ability of ECB to act as a fiscal agent that should probably be addressed by those with distribution proposals like Mr. Mosler.
Professor Mitchell, in the sentence “as I predicted here,” the link to “here,” is broken. The sentence comes in the seventh paragraph of this essay.
“Which knob turns up the brightness?”
In memory of Leslie Nielsen who died yesterday, some fitting quotes from ‘Airplane’:
In the UK, the OBR have released their latest (and very detailed and technical) “Economic Fiscal Outlook” document. It mentions such things as NAIRU, ‘Output Gap’ and the way they make their forecasts. I wonder what Bill and others might make of their methodology, and if their growth predictions are plausible.
http://budgetresponsibility.independent.gov.uk/d/econ_fiscal_outlook_291110.pdf
And one last one for good measure:
“The term PIIGS is acceptable, but were not calling France, Austria, and Germany the ….”
Caption entry:
“Resistance is futile.”
“To improve business confidence, Trichet decides to use the telepathic skills he learned from the fairies.”
Caption:
Damn, Mitchell was right after all!
“Sometimes I’ve believed as many as six impossible things before breakfast.”
“Fortunately I’ve the new googles. Wouldn’t want to miss that. Amazing guy this Bob Geldof and his Live Aid 2011 concert. All these impoverished European Third-World countries desperate for debt relief. A shame! And this brilliant new tune from Bono about Irelands plight. Heartbreaking!”
The goat who stared down Europe
Andrew Wilkins: “Sacre bleu, the optician must have been lying when he told me these were progressive lenses”
😉
“Damn! Torpedoes! Hard starboard.”
What you still haven’t explained is
a) Why you don’t think a Bancor-style redistributive scheme could work for the €-zone.
b) Why the ECB can’t simply continue funding member state fiscal policy indefinitely.
c) Why federal industrial policy can’t be used to rebalance the current accounts.
d) Why the problem won’t simply persist after the reintroduction of national currencies, given that there has been virtually no pushback against the thirdworldisation policies imposed by the IMF and ECB as part of the crisis “resolution.”
As a federalist, I would obviously be delighted to see a serious federal fiscal policy. But that proposal is dead on arrival in the current political climate, and will remain so for the foreseeable future. So if this is framed as a choice between giving up the € (something that, however economically sensible it may or may not be, would be a political catastrophe) versus full federal fiscal policy… then you’re arguing for setting back European integration by a generation – something we can ill afford, given the geopolitical realignments that are already happening and will only accelerate over the next quarter century.
Further, the response to a conflict between the core and periphery of a federation cannot be to roll back the federal programme that is the vehicle for expressing that conflict. It must be to resolve the conflict in a mutually acceptable, if not necessarily mutually satisfactory, manner. Otherwise the conflict will persist, and will simply resurface in another institution – and you will end up dismantling the federation one treaty at a time.
I realise that all of my proposed solutions are crude hacks compared to the elegant solution of a unified fiscal policy. And I prefer elegant solutions over crude hacks as much as the next guy. But the European Union is built in large part on crude hacks patching problems introduced by the previous crude hack. And until the present crisis it has served us well enough. In fact, I would argue that even if the present crisis were to become a regular feature, it would still beat the alternative; judging by pre-EU European history we’re just about due for a serious shooting war around now.
– Jake
” Why the ECB can’t simply continue funding member state fiscal policy indefinitely.”
Well, it would first need to start funding member states.
Look, for some reason, people here keep thinking that the ECB is providing support to member states.
It is not.
It is providing, on a limited basis, small amounts of discount window funding to banks for brief periods of times, up until the states agree to a bailout, at which point funding is supplied by the IMF or the by the national governments.
Look at the ECB balance sheet:
//www.ecb.int/press/pr/wfs/2010/html/index.en.html
Nov 2010: 1.8 Trillion
Nov 2009: 1.8 Trillion
Nov 2008: 1.9 Trillion
Nov 2007: 1.3 Trillion
Nov 2007: 1.3 Trillion
Nov 2006: 1.1 Trillion
So when the crisis started, the balance sheet expanded, primarily due to the swap lines with Fed, in order to provide some support to european banks with naked dollar positions. And it also accepted more types of collateral for discount window access for those same banks.
And that’s about it.
No support for sovereign debt. Yields on sovereign debt are high. That’s why you need the IMF and various EU finance ministers agree to supply funds. The ECB can’t do it.
“It is demonstrable that things cannot be otherwise than as they are; for as all things have been created for some end, they must necessarily be created for the best end. Observe, for instance, the nose is formed for spectacles, therefore we wear spectacles.”
Jean Claude “Pangloss” Trichet
“Look, for some reason, people here keep thinking that the ECB is providing support to member states.
It is not.”
While strictly speaking true, that’s only because considerable effort has been made to move those activities off-balance-sheet into the special purpose vehicle known as the European Financial Stability Fund. While that sort of Enron accounting may be politically expedient, it can clearly have no place in any rational analysis of the situation.
– Jake
And in particular, we can look at ECB holdings of “general government debt” denominated in euros:
Nov 2010: 35 B
Nov 2009: 36 B
Nov 2008: 37 B
which doesn’t seem to be a lot of fiscal support.
On the other hand, we can look at ECB support of *banks*, i.e. “Lending to euro area credit institutions related to monetary policy operations denominated in euro”
Nov 2010: 520 B
Nov 2009: 650 B
Nov 2008: 800 B
And finally, we have holdings of non government debt “securities of euro area residents denominated in euro”:
Nov 2010: 450 B
Nov 2009: 330 B
Nov 2008: 120 B
The ECB accepts anything that has a AAA — e..g. MBS
Note that if you add the two, the amounts are stable:
Nov 2010: 940 B
Nov 2009: 980 B
Nov 2008: 920 B
So what the ECB has been doing is providing liquidity to banks, not governments. The governments are the ones that need to supply capital to the ECB, not the other way around.
The ESF itself is an off-balance sheet item of the member states, in the sense that the money is not there until the member states supply it. They have only agreed in principle, to supply the full 750B. So far less has been actually distributed. But whatever has been distributed has been supplied by the member states, not the ECB.
The ESF is not an off-balance sheet liability of ECB, any more than social security is an off-balance sheet liability of the Fed. It is an off-balance sheet liability of treasury. And you can conflate the two all you want for the U.S., but in the Eurozone it makes a real difference.
ESF distributions, as they occur, will be funded by either increased borrowing of the member states or by other budget cuts or increased taxes in the member states. That’s why you see political debates as each nation has to pony up its share of the ESF, including Ireland.
Yes, you can tell he’s blind, all right. He needs to trim his fingernails.
Dear NKlein1553 (at 2010/11/30 at 1:47)
You are so polite! I have fixed the link now. Thanks very much – I appreciate your help.
best wishes
bill
Nklein
I don’t see where Bill’s/Warren’s explanation of what the ECB is doing and JKH’s differ, at least from what you’ve written above, aside from semantically, perhaps. “Fiscal agent,” at least for the Fed, doesn’t mean that it creates NFA–obviously, the Fed doesn’t, yet nevertheless one of it’s official job descriptions is as the US Treasury’s “fiscal agent.” I haven’t kept up with the discussion at Mosler’s, though, so probably missing something.
“And in particular, we can look at ECB holdings of “general government debt” denominated in euros […] which doesn’t seem to be a lot of fiscal support.
On the other hand, we can look at ECB support of *banks*, i.e. “Lending to euro area credit institutions related to monetary policy operations denominated in euro”
[…]
So what the ECB has been doing is providing liquidity to banks, not governments.”
Most of the collateral for that liquidity is €-zone government bonds.
Look, I’ll be in the front row when Trichet is guillotined for his incredible incompetence, and I’d pay money to see Weber and Stark tarred, feathered and sent to Siberia in a leaky cattle truck. But if you put a floor under government bond prices in the secondary market, then you put a floor under them in the primary market as well (give or take a bid-ask spread) – unless you believe that money is suddenly not fungible in the €-zone. And, however incompetently, the ECB has actually been trying to do that in the case of Greece, by making Greek bonds eligible as collateral against the discount window, despite them not being eligible according to their credit rating. (Of course, in any sane universe the central bank would never leave it up to private credit rating agencies to determine what is worthwhile collateral at the discount window… but that is a slightly different point.)
– Jake
JakeS,
The issue is that the ECB has (obviously) not put a floor under government bond prices — look at the yields. Moreover, the balance sheet of the ECB has not grown during either either the first or second round of this sovereign debt crisis, and moreover direct lending to credit institutions has been on an overall decline, so if that lending is largely collateralized by sovereign debt (which is no doubt true), it is still decreasing as this debt crisis unfolds.
At a fundamental level, the ECB’s balance sheet cannot expand because it is also capital constrained. Most of the assets that the ECB holds are risky and the ECB has limited recourse to obtaining more capital. The situation is not analogous to the Fed.
Therefore there is no QE, and no support or “floor” has been put under sovereign debt, nor can such a floor be provided.
If the situation were different, and sovereign debt was not risky, then the ECB could expand its balance sheet as much as it wanted. But the causation goes in the other direction — because the national governments are fiscally constrained, then the ECB is constrained. If the national governments were not fiscally constrained, then neither would the ECB.
It’s not the ECB that funds national governments and could allow them to escape fiscal constraints if only Trichet was a nicer guy. It’s that Trichet has to be an S.O.B. because his balance sheet is ultimately constrained by the member governments’ own limitations.
“It’s not the ECB that funds national governments and could allow them to escape fiscal constraints if only Trichet was a nicer guy. It’s that Trichet has to be an S.O.B. because his balance sheet is ultimately constrained by the member governments’ own limitations.”
In extremis, the ECB can fund itself via seigniorage. It doesn’t say anywhere in the treaties that the ECB has to be solvent to conduct open market operations, and the bulk of its liabilities are not redeemable. So it can’t go broke, though some funny accounting may be needed to placate the politicians. (Funding a collapsing asset side of the balance sheet through seigniorage may not be the optimal way to go about it, but it is clearly possible.) And the moment the ECB decides to put a real floor under member state bonds, the default risk goes away anyway. The ECB may have to launder the bonds through the purifying power of a private bank bid-ask spread first, but that just means that it has to grease some bankster palms, not that it’s impossible for it to set a price floor.
– Jake
@Professor Fullwiler
There has been some back and forth between JKH and Warren over his European per-capita distribution proposal. Maybe the differences are just semantic; some of the debate has been a bit above my level of understanding. One of the specific comments I was thinking of when I wrote my comment at 1:41 is here:
http://moslereconomics.com/2010/11/26/european-debtgdp-ratios-the-core-issue/#comment-34106
I was assuming that the ECB acting as “fiscal agent,” meant it was adding financial assets to the European economies. That may have been a mistake on my part, but still I think Professor Mitchell and Mr. Mosler could be more clear that under current legal and institutional arrangements the ECB is not capable of doing this. I hate to speak for RSJ, who is obviously much more knowledgeable about these matters than I am, but I think some of the objections he has raised here and in other places could be addressed by simply stating the MMT position is that new laws would have to be passed for the ECB to start adding financial assets to the European economies.
“In extremis, the ECB can fund itself via seigniorage. It doesn’t say anywhere in the treaties that the ECB has to be solvent to conduct open market operations, and the bulk of its liabilities are not redeemable. So it can’t go broke, though some funny accounting may be needed to placate the politicians. (Funding a collapsing asset side of the balance sheet through seigniorage may not be the optimal way to go about it, but it is clearly possible.) ”
I’ve discussed this elsewhere. Seignorage income is about .1% of the ECBs balance sheets per year, so no the ECB can’t fund anything substantial with that income.
But more importantly, you have this backwards. The seignorage income belongs to the capital holders — the member states. Saying that the ECB will fund itself with seignorage income is non-sensical. What you really mean is that the member states will hand over the seignorage income to the ECB. In the current arrangement, the ECB maintains a maximum amount of retained earnings equal to the capital supplied by the member states, and further seignorage income is passed onto them. They are the ones who would be funding the ECB, not the other way around.
That the ECBs liabilities are not redeemable does not make it sovereign in its own currency. What makes you sovereign in your own currency is the ability to have, on the asset side of your balance sheet, the power to tax as well as having irredeemable liabilities.
I think this distinction is lost on people.
Having “taxing power” on the asset side, a floating exchange rate, and irredeemable liabilities means that your balance sheet always balances — you have unlimited capital, and therefore you can supply that capital to anyone else. You need all 3.
But if you only have irredeemable liabilities without unlimited capital, then this isn’t much better than having redeemable liabilities. In many cases, it is worse, because the liabilities cannot be marked down when the assets are marked down.
A regular bank or firm can re-negotiate with its creditors or force losses onto equity holders, but when your liabilities are the unit of account, then you cannot mark them down. This puts the ECB into a difficult position, and is the flip-side of being able to issue irredeemable liabilities.
Advocating accounting fraud doesn’t help this situation. If the ECB “pretends” for, say, 100 years, to be solvent and keeps trying to retain earnings in order to fill a 400 B euro capital loss, then it will need to build up a 200 B capital buffer by raising the capital subscriptions required of the member states. They will need to supply these funds. Then still at some point it will need to come clean, mark down the asset together with the 200B in retained earnings and the 200B in capital subscriptions.
That capital and retained earnings consists of funds supplied by the member states. They could have used those funds for their own budgets and for their own fiscal purpose.
Operationally, this is just a transfer from member states to bondholders, with the ECB acting as broker. The ECB is not the one supplying the funds, it is supplying enough liquidity to allow the member states to supply the funds.
Really? You believe that this is just a liquidity problem?
The core issue here is not that the member states have unmanageable debt burdens — OK that may be a issue with Greece, which has a real (and enormous) problem collecting taxes, but in general the sovereign debt burdens of the PIIGS are neither too high nor unsustainable. Irish sovereign debt to GDP is less than that of the U.S., and also less than German debt to GDP.
The issue is the private debt.
Because all these member states are captives of their respective banking establishments, they have off-balance sheet liabilities that are enormous. 10xGDP for Ireland, for example. And many of those assets are not performing.
The issue is that private banks, not just in the PIIGS, but also in the core, have enormous capital holes that need to be filled, and there is concern that the PIIGS governments cannot fill the capital holes of their own private debtors.
There should be an equal concern that the core nations cannot either, and at some point the debt markets will pick up on those concerns.
This isn’t just a liquidity problem, it’s a solvency problem.
At the core, this is a fight over real resources — whether eurozone citizens will transfer funds to bondholders.
If the citizens cannot be persuaded to do this and will not allow their governments to effect the transfer, then the banks will need to default, and as the EMU governments have effectively guaranteed the financial sector debt, then this corresponds to a sovereign default.
That’s the source of the default risk, not an unmanageable debt to GDP ratio, and not excessively high interest rates.
In all of this, you see the futility of demanding austerity. The more austerity is demanded, the worse the private debt performs, and the capital hole increases.
But at the same time, even if no austerity was demanded, still a default is the only way out. Once a nation’s citizen’s go into debt by say, 3xGDP, then there is no way that the debt will perform. Private debt does not pay the risk free rate, and you do have sustainability issues. It must be defaulted upon, and quickly, as repayment of that debt is an enormous demand drain.
Even should Ireland be currency sovereign, it would need to supply multiples of GDP in NFA to its citizens in order to restore their balance sheets — e.g. Japan — and there would be no benefit to doing this other than permanently shifting the relative wealth of bondholders vis-a-vis everyone else — e.g. also Japan.
Such a transfer would turn Ireland into a feudal society, in terms of wealth inequality. That is why you are seeing street protests at austerity and why the IMF/ECB is demanding austerity. This is a real battle over a wealth transfer from the many to the few. Unless this transfer occurs, then the banks will be closed, and the ECB/IMF represents the interests of the banks, so they are demanding that the wealth transfer occur. The bond markets are skeptical that the transfer will succeed, and so are pricing the debt appropriately. The only power the ECB has here is to try to entice the member governments to guarantee the debt of their banks and then tied them over with liquidity until they beat the real resources out of their domestic populations. In my opinion, the ECB is not going to succeed, nor can it succeed.
The relevant law is Article 123 of the Consolidated Treaties:
So basically, the ECB is prohibited from purchasing government bonds directly, but no law prohibits it from purchasing them in the secondary market from a government-owned bank that bought them on issuance. So if the ECB were to take an accommodationist stance vis-a-vis government deficits, all it would take to get around the rule against buying government bonds would be setting up a government-owned postal bank.
And indeed it must be this way, because otherwise the ECB would lose the power to set interest rates, in which case there really wouldn’t be much point in having a central bank…
– Jake
The ECB does not have the power to set interest rates, neither does the Fed. The ECB (and the Fed) have the power to set interbank rates, and by a process of arbitrage in which private banks purchase longer duration assets with shorter duration funding — i.e. economic rents — then longer term rates can to some degree be bid down as a result of lower short term rates.
But only to some degree, and that degree, even in the best of times, is relatively small.
More importantly, even the banks are constrained because they operate on the basis of leverage. They cannot purchase longer term assets in unlimited amounts, particularly if those longer term assets are volatile in their price or are risky.
So as default risk increases, the ability to force down the yields of longer term debt by means of cheaper finanancial sector short term funding costs decreases. So even the relatively minor downward pressure on long term yields as a result of low short term yields goes away.
No CB has ever succeeded in forcing down long term yields, whether fiat issuing or not. Japan failed to bring down long term yields, just as the Fed failed to bring down mortgage rates. That’s not something that a CB can do.
@RSJ: I think the point you’re missing is that the ECB does not have to be solvent to continue operating. In terms of performing its regulatory and monetary policy functions, the asset side of its balance sheet doesn’t really matter, unless it is insufficient to meet any hard currency obligations the ECB may have.
Now, if the asset side of its balance sheet consists of private debt, overpaying for its assets would be a transfer of real wealth from public to private hands. But as long as the assets it overpays for are public debt, it’s just a transfer from one part of the public sector to another part of the public sector (incidentally, this may include a transfer from the German public sector to the Greek public sector – that’s not a bug, it’s a feature).
If the governments of EU member states swap private debt in insolvent institutions for public bonds, then that constitutes a transfer of real wealth from the public to the creditors of those insolvent institutions. So that’s obviously undesirable. But whether the ECB then takes the resulting government bonds on its balance sheet or not is only a question of whether the transfer is from the victim country to the banksters or from all of the €-zone to the banksters. The transfer happens when the state government decides to make the banksters whole – what happens after that is squabbling over which set of taxpayers get to foot the bill.
– Jake
You’re right, that was poorly phrased. The CB has the power to set a floor under overnight rates. But since only ideological contrivance prevents governments from borrowing at the overnight rate that distinction doesn’t matter too much for the purposes of this discussion.
– Jake
RSJ,
I agree with JakeS.
So what will exactly happen if the market value of ECB (or Fed’s) assets is lower than the value of its liabilities? Obviously they can fiddle with the valuation of the assets and use the nominal value. But let’s assume that they stop fiddling.
Please look at link_http://www.ecb.int/press/pr/wfs/2010/html/fs100511.en.html
What will change if “Capital and reserves” becomes negative? Will there be a bank run on ECB? Yes I know that this will not look good, there will be a political hot potato (or rather a kartoffel) and there might be an exception thrown in the PL/SQL code when the value of the capital becomes negative but I dare to say that noting will change except for the capacity to shrink the balance sheet. Also – the ECB can be easily recapitalised.
The solvency of commercial banks or treasuries in the Euro system is a different issue. There can be a run on a commercial bank which can only be stopped by a bailout or an intervention of ECB. But the balance sheet of a reserve bank is the ultimate graveyard to burry worthless debt assets forever. This is just a database entry. Money is inflationary only when it is spent. So it has already been spent. What can be affected by the asset side of the CB? Only the ability to destroy M1. If we get to that stage it is quite likely that toxic assets may become again worth a bit more…
Ben Bernanke knows that. The Chinese and the Japanese know that as well.
Does Trichet know?
Jake,
“I think the point you’re missing is that the ECB does not have to be solvent to continue operating. In terms of performing its regulatory and monetary policy functions, the asset side of its balance sheet doesn’t really matter, unless it is insufficient to meet any hard currency obligations the ECB may have.”
Jake, I understand that, but my point is that the ECB’s capital is provided by the member states. If, through a series of accounting gimmicks, the ECB continues to operate while having negative capital, then it is still provided by the member states. At some point that capital will be brought to a positive level, and it will be done via transfers from the member states. Having negative capital just means that the ECB is borrowing capital from the member states, it’s still not supplying its own capital. This is not some artificial accounting restriction. The accounting merely measures the underlying reality. Trying to fiddle with the accounting isn’t going to change the underlying reality of who is funding whom.
Therefore it is the member states that are funding the ECB, and not the other way around.
Well, 98.5% of the assets of the ECB are non-government assets, and this has historically been the case. That the ECB contains assets that are loans to banks collateralized (in some part) by the debt of member states doesn’t mean that the ECB is overpaying for government debt. It is overpaying for private debt.
But the larger issue here is not whether it is government debt or not, the larger issue is where capital comes from. When the ECB overpays for an asset, then it loses some capital. Overpaying for an asset is a transfer from the capital providers to the sellers. Now in the case that the asset that is overpaid for is the liability of a capital provider, then yes, that entity would just be transferring money from itself to itself. But the whole problem here is that the EMU nations are not unified and are not willing to effect transfers to each other. If they were, then they would be currency sovereign like the U.S..
You believe, and many people here believe, that because in the U.S. there is a central government that has both Treasury and the CB, whereas the Cb is the one whose liabilities are irredeemable, that the source of fiat powers is actually the bank, and not the Treasury, and that it is the bank that “funds” government. This isn’t the case.
It is treasury that funds the Fed, not the other way around. Treasury bails out the Fed when assets are bad, and because of this, the Fed is allowed to buy assets freely. In turn, the Fed bails out private banks, and because of this, they are allowed to lend freely. Therefore indirectly, the treasury is bailout the banks and providing capital to them in the event of a crisis.
All the central bank does is supply enough liquidity to tied them over until the fiscal transfer is effected.
In the EMU, there is no treasury. Therefore the ECB can try to tied banks over, but this will only be effective if there is a promise of a real fiscal transfer from the member governments to the banks.
If that fiscal transfer is in doubt, then supplying liquidity isn’t going to be effective. Haven’t you noticed that the ECB only provides liquidity once there are assurances of a fiscal transfer? Why is that? Because they are mean people? Or because they know that only the member states can supply capital, whether to the ECB or to the banks, so that there isn’t much point in trying to supply liquidity unless a promise of capital provision from the member states is also forthcoming.
Moreover because the willingness of member states to bail out the ECB is in doubt, the ECB is not able to lend freely in the first place.
So the system is not analogous to the U.S. system.
It’s not a question of a specific technical restriction. The situation would not be materially different even if the ECB was allowed to have negative capital, and it would not be a whole lot different if member states were allowed to run overdrafts (because they would still be under a pegged currency regime, and therefore those overdrafts would need to be funded by the surplus nations).
The core problem here is the unwillingess of the member nations to supply capital to each other and to the ECB on demand. If that willingness were there, then you wouldn’t need to be talking about running over-drafts and accounting fraud. But if that willingness is not there, then overdrafts and fraud aren’t going to help.
@Adam: The problem with what Helicopter Ben has been doing is that he’s giving cash for private trash. He should only be giving cash for public trash. (And the corollary to that is that the other branches of government shouldn’t give cash for private trash either.)
The way to deal with private banks being insolvent is to take them into receivership; wipe out their liabilities – starting with equity and proceeding however far up through the debt you have to in order to restore solvency; and then convert around 20 % of the remaining debt to equity. If your financial regulator has been doing its job, the whole thing takes a weekend for a mid-sized commercial bank.
One problem in the €-zone is, and here I obviously agree with RSJ, that the assorted financial regulators have not been doing their jobs. Instead, they’ve been trying to make bondholders whole. Which obviously can’t be done in real terms, since the debt was used to finance wholly spurious “investments.” And which obviously shouldn’t be done in nominal terms, since making them whole in nominal terms would still have undesirable distributional consequences.
But there are two separate political conflicts in this crisis, which just happen to both involve sovereign debt: On one hand, you have a central bank that refuses to play ball with member states’ fiscal policy stance. On the other hand, you have a massive and unsustainable bailout of bad private debt. Default is the solution for the bailout, but not for removing the fiscal policy constraint. Firing Trichet (and abolishing the German Stupidity Pact) is the solution for the fiscal constraint, but not for the unsustainable bailout.
I’ve mainly been talking about ways to remove the fiscal policy constraint, because that’s what Bill is claiming in the original post cannot be done under the current treaties. That banksters shouldn’t be getting bailouts in any properly managed economy is something I usually take for granted.
– Jake
NKlein
Thanks for the link. I don’t see that JKH is saying anything there that Mosler or MMT’ers in general disagree with. Perhaps JKH is just now understanding the proposal, even though Mosler’s been saying it the same way for months and months, and it’s the exact same thing JKH is saying. JKH wants honest accounting of the transfer as a fiscal act–who ever said MMT’ers didn’t want such a thing? Mosler understands the accounting as well–JKH isn’t saying anything Mosler and I haven’t discussed several times already. It may not be consistent with the ECB legal constraints, but the ECB has already violated those. And, again, one has to understand that Mosler is talking at the operational level–at that more general level, he’s got the correct solution. Getting the specific details at the on the ground level right is obviously necessary, but can’t be done until the operational solution he is offering is understood in the first place.
“What will change if “Capital and reserves” becomes negative? ”
Simple, the ECB will demand an increased capital subscription from the member states. The member states divert some of their spending on their domestic population to fund the ECB, or they borrow more to fund the ECB.
There will be questions asked as to the judgement of the ECB, etc. If the situation persists, the ECB is closed and replaced with a different institution, under different operational constraints.
In order to avoid being closed, the ECB tries to be careful to not upset its capital providers.
The member states — their influence being weighted by the size of their capital contributions — are the ones calling the shots, and they are the ones doing the bailout. They are the ones that must fill the capital hole.
//www.ecb.int/ecb/orga/capital/html/index.en.html
The problem here is not an accounting constraint, but a political constraint.
NKlein,
Allow me to clarify–note that in Warren’s quote on 11/28 at 11:13am that Warren confirms that JKH has understood the proposal and that the two are in agreement about how it works/what it means (at least in Warren’s view–don’t want to speak for JKH, but in my view JKH’s comment just prior was a correct interpretation of what Warren had been saying all along).
Suppose an insolvent private bank pledges a certain species of bond as collateral for a € 100 loan at the discount window (the example assumes that the ECB enforces no haircut on public debt used as collateral at the discount window – a haircut would change the arithmetic but not the substance of the argument). The private bank then goes bankrupt. The ECB, having a secured loan, now takes the bond. How, precisely, does this differ from the ECB obtaining this bond through open market operations? And how, precisely, is putting a floor under secondary market bond prices not a way to fund public debt issuance?
Well, yeah. That’s sort of what I’ve been saying all along. But the current treaties give the ECB very wide latitude to set its own policy. So if the ECB disagrees, it is legally entitled to enforce such transfers over the heads of Mrs. Merkel and Mr. Sarkozy – and it’s their own insistence on their precious principle of central bank independence that makes it so. The treaties can be changed, of course, but reducing central bank independence would be just as much a win for progressive policies as using the central bank to support transfers from core to periphery.
The source of fiat powers is the police, which enforces legal tender laws. Legal tender laws typically have two prongs: Legal tender is (the only) valid asset for extinguishing tax liabilities and every tradesman must quote a price in legal tender, and must transact if a customer is able to provide such legal tender as he demands. So both the treasury and the central bank can exercise fiat power: The treasury can exercise fiat power by boosting demand for the currency in circulation, and the central bank can exercise fiat power by crediting the account of a tradesman with the requisite amount of legal tender, thus obligating him to provide the offered product or service.
Because they labour under the neoliberal delusion that government spending must be “funded.”
Even if you are right about how a fiat currency works, that would still be my answer – because I have seen no evidence that indicates that Trichet, Weber or Stark have the faintest of understandings of how a monetary economy works. They’re all ultra-orthodox neo-classicals – Hell, Weber sounds more like an Austrian at times.
– Jake
I think the other point about the Roach Motel is what happens to the occupants. Much like what is happening to the Irish, Greek, Portuguese and Spanish citizenry, and soon to move on to the rest of Europe as the fiscal austerity “medicine” kills the patient it is designed to cure!
Having just arrived in beautiful, sunny Sydney (NOT!), I am looking forward to seeing a number of you (I hope) at the CofFEE conference later this week in Newcastle!
Even with the rain, Australia is still an exceptionally wonderful country!
On the quote front: “il faut reculer pour mieux sauter…Mon Dieu, il n’y a rien là!”
Neither the ECB nor the Fed can put a floor under secondary market prices.
All they can do is buy debt for the above market price.
For example, the CB can offer to lend to any homebuyer at 2%. Or even 1%. Or even 0%. But it can’t force you to lend to a homebuyer at 2%. It cannot force MBS to trade at 2% in the secondary market.
It may need to buy all of the issues, in which case nothing would trade at 2% in the secondary market.
Overpaying for assets is not like humming an infectious tune, so that everyone has to start doing it just because the CB is doing it.
There is money involved here, and don’t mistake front-running for actually valuing the asset at a given price. Front-running buyers can become front running sellers as soon as they believe that the CB will stop buying. That means that the ECB needs to keep buying. That means that it needs to buy all of the debt. And still the debt would not be trading at the price the ECB wants.
This is an important distinction, and it is the same distinction between liquidity and solvency.
For some reason, this liquidity/solvency point is not getting across.
If I would be willing to pay 2%, but perhaps I am worried that the security will go for 3%, or there is a panic, then the CB can step in, and by announcing that it is willing to pay 2%, then I will go ahead and pay 2% as well.
In other words, the CB can help make the security liquid, ease fears, etc. It can help with technical factors that set the price over the short term.
But if I am only willing to pay 3%, then the fact the fact that the CB is willing to pay 2% doesn’t matter. Nothing forces me to pay 2%, and if I already have the security, nothing prevents me from selling all I have to the CB. There is lots of other debt to purchase.
In one case, you are providing liquidity, but in the other case you are making a fiscal transfer.
But when the CB buys $200 Billion, and then the price reverts to $100 Billion after the CB stops buying, then $100 B has been transferred from CB capital suppliers to the bond sellers. That this transfer is not immediately recorded on the ECB balance sheet doesn’t matter. If the ECB were to keep overpaying, at some point it would appear on the balance sheet as a capital hole, regardless of what accounting method is used. Over the long, both cash-basis accounting and accrual accounting converge to the same value.
So the CB capital owners may not be OK with giving their capital to bondholders.
It is not up to the CB to decide whether they are OK with it.
The capital suppliers decide how much capital the CB can blow on trying to prop up the market price.
If the member states want to do this, then fine. If they were willing to have a coordinated fiscal policy, they would be like the U.S., and wouldn’t be having these problems.
But they are not willing to have a coordinated fiscal policy, and so they will not allow the ECB to consistently pay above market prices.
Therefore the CB is not engaging in QE.
But you don’t see a difference between a Zombie CB without a willing capital provider and a real CB that has a willing capital supplier.
You keep wondering to yourself why the ECB is not engaging in the same kind of QE that the Fed and BoJ have done. Why is the ECB balance sheet not growing? From Dec. 2007 until Nov 2010, the Fed increased its balance sheet by 250%. In the same time period, the ECB increased its balance sheet by 20%. And the EMU has worse crises. What is wrong with those people? They must be fascists!
The answer is that a bank is only as powerful as its capital provider, and the member states are not willing to provide the CB with capital to absorb losses and make fiscal transfers.
That’s why they put Trichet in charge and not someone else.
This was seriously funny. Did you make this up yourself Mark?
markg says:
Tuesday, November 30, 2010 at 3:17
“The term PIIGS is acceptable, but were not calling France, Austria, and Germany the ….
Anyway as Billy Connolly says to thoes that get upset at gender jokes. Its just a fuken joke.
Punchy,
The Euro is:
France, United Kingdom, Estonia and Denmark.
This is what Mosler’s proposals address. if I’m not mistaken. With a fiscal creation and distribution mechanism that is both independent of specific national interests (i.e. not run by the Germans) and of national revenues but is also furnished with a malus system as a bound against a race to the bottom, he addresses NFA, independence and moral hazard problems. This could run parallel to the very substantial transfers of national funds that are already in place, I guess.
I’m still uncertain as to whether such an integrated system would manage to contain the glaring discrepancies between the EU nations and eventually put them on a converging path, which must have been the political idea, or whether full monetary sovereignty of each nation would be better at achieving that goal. I know what Bill thinks :-). It seems clear to me that even if the ECB and the national governments recognize the possibilities of the currency system (how likely is that?), they will still have to find a political path to achieve European unity for the whole experiment to be sustainable. That won’t just follow automatically. Until now, each nation has dreamt its own dream under the European umbrella but they are now awakening to a shared nightmare. Do we throw away the umbrella or can we impose matching dreams?
Of course, a better understanding of monetary system would help to clarify matters substantially. So how about MMT as a common language? Punchy? Ve haf vays of making you smeil, Jean-Claude.
Hi RSJ,
Agree with what you have been posting here and have learned alot…Im trying to clarify something (operations) if you will:
When you write: “That means that the ECB needs to keep buying. That means that it needs to buy all of the debt. And still the debt would not be trading at the price the ECB wants.”
Do you envison a trading desk in frankfort that the ecb operates going into the marketplace to buy these securities for the “ECB”, or rather the NCBs themselves have to buy the debt securities and then report the results up to the so-called “ECB”? ie the “ECB” being just an amalgamation of NCB activities? This is something I have been trying to get full clarity on for some time… Resp,
NKlein1553,
Scott Fullwiler has interpreted my comments and their motivation correctly.
The Mosler proposal is something like a “no bonds” conversion at the margin of outstanding EZ debt. It allows conversion of EZ debt to ECB reserves. E.g. this happens if the 1 trillion Euro distribution is used to pay down maturing EZ debt. The distribution becomes new reserves as it is paid to maturing bondholders. This alleviates bond financing stress. Mosler points out that this mechanism per se doesn’t necessarily reflect a change in current EZ deficit levels – that’s a separate issue. Deficits determine NFA, so that is separate as well. That said, to the degree that the mechanism assists with the overall funding of EZ deficits, it is beneficial for feasibility of deficit financing and NFA generation. The proposal is primarily directed at current funding challenges, using the ECB to best advantage in alleviating bond financing pressures, and shifting the funding mix to include reserves.
The accounting resolution can be done in at least two different ways, both of which break the existing rules. The distribution could be recorded in mirror double entry as a set of ECB asset claims on the recipient countries. Or it could be recorded as pro-rata negative capital. Negative capital technically is equivalent to an obligation of EU capital providers to restore the future capital level of the ECB (e.g. through future retained earnings or future capital injections), although in theory there’s no necessary maturity date on such an obligation and therefore no necessary execution of that obligation. It’s a record first. Either way, the accounting record is essentially that of debt owed by the group in question to the ECB – a debt that would otherwise have been funded with bonds, but is that is now effectively funded by an increase in ECB reserve liabilities.
This quote from Mosler captures the spirit, I think:
“I’m saying that right now euro member deficits are high enough to muddle through.
How high the deficits need to be is a political decision.
But that can’t be made in the context of the current solvency issue.
My proposal is for restoring member nation solvency.
Once that’s behind them, they can decide how high they want deficits without the prior solvency issues getting in the way.”
http:
//moslereconomics.com/2010/11/26/european-debtgdp-ratios-the-core-issue/#comment-34106
I’m interpreting “restoring member nation solvency” as the alleviation of bond financing stress via the described distribution/reserve mechanism.
I think I’ve got this right, but Scott can correct any part if warranted.
P.S.
Maybe the increase in ECB reserve liabilities gets eaten up by reducing some ECB credit on the other side of the balance sheet. Haven’t though that through, but its downstream to the main mechanism.
Thank you for the clarifications JKH and Professor Fullwiler. I\’ll probably have to re-read them, the original conversation over at “The Center of the Universe,” and some of the comments by RSJ and JakeS here, a few times to fully digest what is being said.
Right, JKH
The ECB transaction is not an increase in NFA in itself, but additional deficits would obviously be. And the ECB transaction would make it more possible to run larger deficits, but that’s a political issue, in Warren’s words.
As far as ECB balance sheet effects, it’s an asset swap if you exchange for govt bonds, though the balance sheet grows. If you just transfer the balances to govt accounts instead of buying assets, then it’s a reduction in ECB equity, with no growth in ECB balance sheet. Either of these obviously would have political/legal ramifications, but at the operational level that’s how it works.
This is a problem because?
Nothing in the treaties prevents them from doing so.
This is a problem because?
It can also cut the balls off a pump-and-dump scam. It would be very interesting to see how much of the collapse of peripheral economy bonds are due to such operations.
The CB does not have to stop buying.
Look, in any monetary economy with nominal growth (in whatever parameters are behaviourally relevant), the money supply needs to grow in tandem with the nominal growth of the economy, all else being equal. So somebody has to roll over the government’s debt, because government debt can’t go away without crashing the monetary system. The only question here is whether the entity that’s rolling over the debt is the central bank, or we leave the whole process hostage to the hysterical children and economic hit men in the capital markets.
If what you are advocating is a sovereign default before the ECB starts supporting deficit countries’ fiscal policy independence, then you will get no argument from me. But what you seem to be arguing is that the ECB cannot support deficit countries’ fiscal policy independence, and to make that case you’ll have to show where in the treaties it says that the ECB’s ability to do that is limited by its solvency.
That is not my understanding of the relevant EU treaties. The ECB is not restricted in its ability to carry out open market operations by piddling little matters like technical insolvency.
Yes, the current account surplus countries would be outraged, and try to push through changes to the way the ECB operates. That would not cause a constitutional crisis – it would just force the surplus countries to be the ones to bring the constitutional crisis that already exists out in the open, rather than (as it is at present) the onus to do so being on the deficit countries.
The problem here is that there is no will among the polities of Northwestern continental Europe to support economic and industrial development in Southern Europe to the extent required for a sustainable federation. The ECB can not singlehandedly resolve this political crisis, but it can pick which side it wants to be on. At the moment, it is picking the side of the countries who want to eat their cake (support their own industrial development by lending money to their customers in lieu of direct subsidies to their corporations) and have it too (by demanding that their customers repay the industrial subsidies). There is nothing legally, economically or constitutionally superior in this position compared to taking the side of the countries that have been used to launder industrial subsidies – it’s a matter of politics; and I happen to disagree with Messrs. Trichet, Weber and Stark on their choice.
– Jake
RSJ:
“The seignorage income belongs to the capital holders – the member states. “.
Technically, to their NCBs. Now, what is the source of the seigniorage revenue let’s say for France’s NCB ? Is it the private sector debt papers ? It cannot be Agence France Trésor papers by definition, right ?
“you have unlimited capital”
How exactly is “unlimited capital” is possible with the Feds, for example ? Could you give a numeric example ?
JakeS,
Don’t have much time to catch up with comments but I agree with you – the ECB purchasing government debt in secondary markets is NO violation of the Treaty. In fact Article 122 can be used in any which way.
Btw, as far as monetary policy is concerned, purchase of government debt is not needed unlike the case of the US. This is because the institutional setup of most non-Anglo Saxon is different. The central bank does monetary policy operations by lending the banks to satisfy reserve requirements. The MROs are analogous to the Fed’s purchases of government debt (in normal times of course) except that no purchase of government bonds is made – its a repo. ECB repos are different than Fed’s repos. Fine tuning operations are done by movement of government funds in and out of NCBs’ books from/into the credit institutions. They can also be achieved by purchases/sales of FX.
The main problem is that the power is with the ECB and the Euro Zone has no mechanism for fiscal transfers to take care of balance of payments issues. Fiscal transfers happen all the time in sovereign nations without anyone noticing.
RSJ:
“Therefore the CB is not engaging in QE.”
Is there a legal obstacle to ECB’s buying unconventional stuff, with newly issued euros, similar to the Feds not being able to buy commercial bonds ? If yes, where is the limitation spelled out ?
On the face of it, it seems that the ECB has more, not less, freedom to engage in QE by buing private paper, judging by this Trichet’s statement:
“Government securities account for less than half of the nominal value of the securities on the list. The rest are private securities. By contrast with many other central banks, the ECB already accepted private paper before the crisis.
”
So, assuming substantial amount of non-performant paper on the left side of the balance sheet, does the ECB design anticipate formal insolvency and the way to resolve it ? The Feds is now in a somewhat similar position with about $1T of presumably ‘toxic’ MBS it acquired during QE1.
Off-topic: is there a percentage break-down of ‘toxic’ MBS holders before and after QE1 (foreigners, pension funds, banks, etc) ? Somehow, I was unable to locate any information about the pre and post holders.
NKlein1553,
See update at Mosler’s.
Trichet: “No surrender, fight to the end!”
JKH:
That is actually not true and CB can even force secondary market to trade at 1% or 0%. The reason being liquidity requirements which represent cost of business regardless of yield they bring to banks. At any moment of time CBs can define whatever liquidity rules they want and commercial banks have no choice but comply. New Basel III liquidity rules are going to make government bond market pretty much like interbank market: “central bank said it is like this, so we take it as given”
Andrew Wilkins says:
Tuesday, November 30, 2010 at 20:31
Punchy,
The Euro is:
France, United Kingdom, Estonia and Denmark.
So God if he exists is revealed in the Joke of it all. This blog subject is so serious it hurts. Thanks Andrew for the laugh.
I wonder why the rest of you wast your time trying to tell the Euro how to run itself. If there is a less effective way to spend your brain power and time I don’t know what it would be.
Edward de Bono wrote a silly book called Handbook for the Positive Revolution. In it he had one brilliant page with the following.
“If I had to design a system in which it was impossible for intelligent people to be effective, then I would design the following system.
1. People in positions of power would use their intelligence to defend their position and to survive. They would have to look after their own interests on the short-term basis that is necessary for survival. They would need all their intelligence and energy to defend themselves. Initiatives are risky because they only confirm friends and create new enemies. If this sounds a little bit like normal politics that is not coincidence or any fault of the people involved. it is the natural behaviour of the system as it is designed.
2. Intelligent people mainly use their intelligence to attack, criticize and blame others. This is easy to do and is also low risk. This is also the highly esteemed Western tradition of ‘the critical search for the truth’.
The real tragedy is the broken lives via lost jobs in Ireland. I am disappointed Ireland did not default to start again as a Sovereign Nation.
Cheers Punchy
VJK,
“Technically, to their NCBs.”
Yes, but their seignorage income goes to their respective Treasuries.
“Now, what is the source of the seigniorage revenue let’s say for France’s NCB ?”
For marketable debt, it could be anything as long as it is purchased on the secondary market and meets ratings requirements. In the Eurozone, the ECB primarily holds private sector debt as well as direct credit advanced to banks.
“How exactly is “unlimited capital” is possible with the Feds, for example ? Could you give a numeric example ?”
The asset side of Treasury’s balance sheet is the power to tax. Let’s say that Treasury taxes a fixed proportion of national income, so the growth rate of the income stream is the growth rate of NGDP. Now look at the liability side. Long term rates charged on the debt will be the NGDP growth rate. Short term rates will be lower. The maturity of Federal debt will be somewhere in between. That means that the average interest rate on the debt is less than the growth rate of income.
Historically for the post-war U.S., the real rate of interest on federal debt was about 1.7%, and the real growth rate of income was 3%. I once remember looking at this — it was a while ago — but a cross country comparison showed that sovereign nations typically get about 1% discount, in real terms against GDP growth rates, due to the fact that they do not fund themselves with consols but 4-6 year maturities. And this discount is persistent even back to the 19th century, or the 17th century for Holland. What happens during the sovereign debt crises of old was that on some occasions that rate would spike (and on other occasions, government srepudiated debts even when the interest burdens were manageable).
That is how we brought down the Debt/GDP ratio from the WW2 high. It wasn’t because we were running massive surpluses or increasing taxes. We “inflated the debt away”, but with economic growth, not inflation.
You cannot inflate debt away with inflation, because investors will demand an inflation premium as you roll the debt over. Only if they persistently under-estimate inflation will you be able to inflate away debts this way. The ability to print money should therefore be viewed as the ability to never be liquidity constrained, in the sense that investors will only demand an inflation risk premium, and not an inflation premium together with a default risk premium.
Because of that, the Debt/GDP ratio will always stabilize, provided that the long run Deficit/GDP ratio is less than 1. It’s in this net present value sense that Treasury has infinite capital, even though at any given period of time, the ability to tax income is finite.
Again here, the division between central bank and treasury should be viewed as a liquidity/capital distinction. Because the central bank can provide unlimited liquidity to Treasury, Treasury has unlimited capital. Because Treasury has unlimited capital, the CB can provide unlimited liquidity.
The two functions support each other, and require each other. There is no “bootstrap” possible in which you can start with just one and get the other.
The mistake, I believe, that Mosler and others are making is in not recognizing that you need both.
“On the face of it, it seems that the ECB has more, not less, freedom to engage in QE by buing private paper, judging by this Trichet’s statement:”
No, the issue here is that because the ECB can only purchase risky assets, and because it has a thin capital buffer to absorb losses, it wont expand its balance sheet. And because it wont expand its balance sheet, it wont be able to provide enough liquidity support to sovereign debt to ensure that no default premium is charged. And because there will be a default premium, the ECB will be capital constrained.
It’s the same loop, but going in the other direction.
You can’t bootstrap out of the ECB loop into the U.S. loop. To transition from one to the other requires creating a central Euro-wide Treasury that can tax euro assets and provide capital to the Euro ECB. Then the ECB would be a “real” central bank, instead of a large hedge fund holding private paper against immutable currency liabilities, all supported with a minuscule and politicized capital subscription scheme.
JKH:
A quick thanks for the many clearly written and very informative posts. This has been very, very helpful.
“Advocating accounting fraud doesn’t help this situation.”
Beautiful understatement.
Yeah, it’s hard for a layman like me to properly describe how awesome JKH is. It seems every really high quality economics website has one or two exceptional commentators regularly contributing to the comments section. At the Baseline Scenario it’s StatsGuy, at the Economists View it’s paine and Bruce Wilder, and here on the MMT websites JKH is among the very best. RSJ, Professor Fullwiler, and Tom Hickey are right up there too. Probably the really high quality economics websites couldn’t get to be the way they are without the contributions of these commentators. Us laymen and women really owe them a debt of gratitude.
pebird, NKlein1553,
thanks for your kind words
RSJ:
Thanks, all good points.
However:
“It’s in this net present value sense that Treasury has infinite capital, even though at any given period of time, the ability to tax income is finite.
”
I imagine you are assuming infinite time horizon to realize infinite capital since the ability to tax is trivially finite (that’s what has sprung to my mind when I saw the word “unlimited”).
So, assuming hypothetically, that 50% of MBS on the Feds balance sheet becomes worthless (or alternatively all MBS on the Feds balance sheet would lose half of their value during the next year or two), how much time would it take for the Treasury to replenish missing $0.5T (or thereabout) of assets by relying on taxation and economic growth? Would an act of Congress be required for such recapitalization ? Is the Feds closure due to insolvency and a possible Congress refusal to cover losses an option, at least theoretically ?
“Because the central bank can provide unlimited liquidity to Treasury, Treasury has unlimited capital.”
Just to nail it down. My interpretation : (a) “Treasury has unlimited capital” solely due to its ability to tax and the assumed infinite time horizon. (b)therefore, “unlimited liquidity” is a mere accounting technicality. Is that what you mean ?
VJK,
The Treasury may simply hand over Treasury securities to the Fed without having its account credited. That is not breaking any law because its a gift of Treasuries to the Fed not the Fed purchasing to finance the Federal Government.
If that is uncomfortable for you …
section (k) of Title 31 – Money And Finance § 5112 Denominations, specifications, and design of coins of the United States code:
Hence, the Treasury can just gift a coin of denomination $1T to the Fed and the latter is capitalized. Political issues are other things.
The Treasury does not need to tax to “get back the money” in your scenario because tightening fiscal policy will be devastating for the economy.
Btw, one can call tax receivables as the Federal Government’s assets but it is not the best way to do macroeconomics in an accounting consistent way. Better to set it to zero. That way you have a great accounting identity that financial assets sum to zero. That way the Federal Government’s net worth will be negative but that isn’t any problem because its the Government.
Ramanan:
“a gift of Treasuries to the Fed” and “the Treasury can just gift a coin of denomination $1T”
I do not believe any such kind of imaginary Treasury spending is legal without a prior Congress approval — that was my question: “Would an act of Congress be required for such recapitalization ?”
“Government’s net worth will be negative but that isn’t any problem because its the Government.”
”
So far,you seem to have agreed that the Treasury spending balance has to be greater than zero before it can spend. To allow it to be negative would necessitate another legislative event. So, we’ll need at least two changes, apparently, to the existing law to recapitalize the Feds, right ?
“The Treasury does not need to tax to “get back the money” in your scenario because tightening fiscal policy will be devastating for the economy.”
Well, it’s not my scenario but merely my interpretation of RSJ’s scenario, perhaps incorrect. He may clarify.
@JKH
I have not read all the comments in this thread. So I may have missed something. Looks like you are once again arguing that the ECB can go broke. You might want to read the Vox.eu posting: Buiter’s warning: Who is the recapitaliser of last resort for the ECB? And the original Buiter paper linked to in this posting.
___http://www.voxeu.org/index.php?q=node/1148___
So for practical matters that is they way forward for the ECB. Then Germany can decide between cholera and pest. Either they accept higher inflation or they make a fiscal transfer through the backdoor via new capital for the ECB. In regard to EU staff I can only reiterate that we are now ruled by some incompetent idiots who desperately want to drive the EZ against a wall.
Ollie Rhen (EU): “The only way to regain market confidence, is the strict implementation of the savings and reform programs … If these countries can not comply with their savings goals, for example because of reduced growth, then additional savings efforts are inevitably”. I’m not alone with my idiot theory. Barry Eichengreen says (NOT) so because he’s a polite guy:
__http://www.irisheconomy.ie/index.php/2010/12/01/barry-eichengreen-on-the-irish-bailout/#more-8831___
(English translation from the original German version in Handelsblatt)
Ramanan:
“”Government’s net worth will be negative but that isn’t any problem because its the Government.”
”
It is not “will” it’s already “is” about $11T. But, that’s due to borrowing through bond sales, not because “its the Government”.
VJK,
Don’t think that is imaginary – and I have quoted the law for you. However, I do not know what an act of Congress is to talk about it.
The Treasury’s balance at either the Federal Reserve and/or commercial banks is different from its financial net worth.
For example, right now the Treasury has around $100B at the TGA, some $300B at the TSFA and maybe $200B at the commercial banks. (These numbers are just illustrative). The public debt is I don’t know – and depends on how you count – far in excess of this.
As one moves forward in time, the Federal Government’s nominal debt increases forever and the private sector’s wealth – the mirror also increases forever.
This mirror thing has confounded economists no end. Once again, the Federal Government’s balances at banks is not net worth. The first is positive, the second negative.
VJK @7:07,
Thats how it is supposed to be. The zooming of the number to $11T is nothing but a consequence of the deep recession.
Imagine a closed economy. As we move forward in time, the public debt increases forever and the private sector assets increase forever. The public debt/gdp ratio probably converges to some value but in the uncertain world we live in – it keeps fluctuating. In a recession, it increases, in a boom it decreases. Nobody “pays back the public debt.”
Ramanan:
Please ignore this as irrelevant:
“So far,you seem to have agreed that the Treasury spending balance has to be greater than zero before it can spend. To allow it to be negative would necessitate another legislative event. So, we’ll need at least two changes, apparently, to the existing law to recapitalize the Feds, right ?
“
Ramanan:
“Don’t think that is imaginary”
Are you aware of any direct Treasury bonds/notes/bills gifts from the Treasury to the Feds ?
Besides, if the gifted security is to become an asset, it has to be sold to someone from the non-government sector willing to enter into the lender-borrower contract. Without such a contract-asset, the gifted security remains a meaningless piece of paper until it is sold to a non-government party. Therefore, the situation is no different in comparison to the case when the Treasury sold the security at an auction and donated the proceeds to the Feds.
” – and I have quoted the law for you.”
You quoted the law allowing to mint coins. The law does not give the Treasury a blanket permission to gift anything to the Feds.
” However, I do not know what an act of Congress is to talk about it.”
I meant the appropriation bill that spells out specific money spending. So, for the treasury to spend on the Fed, such spending must be included in the bill and approved by the legislature.
You keep falling in the trap of thinking about government bonds as having a market price. This is a completely artificial construct that there is no good reason to adopt. If the central bank says that, say, a Greek bond is worth 2 %, then Greek bonds are worth 2 %. If that means that there is no secondary market in Greek bonds… well, that’s neither a legal nor an economic nor a technical problem. It may be a political problem, but the same politicians who are most likely to be outraged are the ones who believe most fervently in central bank independence. It’s really just a matter of who gets to set the price of government debt, the market or the central bank, and there is no good technical, economic or legal reason to leave that power with a market that has proven itself so manifestly unfit for the purpose of sensible economic planning.
The ECB has infinite liquidity, so it can always roll over government bonds. So there will not be a default on government bonds held by the ECB unless the ECB forces the government’s hand. The fact that if the bonds had been held by a market participant (with limited liquidity) they would have had a default premium is neither here nor there, unless you believe that market prices reflect some sort of “true price” or “fair value” – a belief that actual market behaviour should have disabused you of by now.
Markets – very much including bond markets – are a social convention set up to serve the needs of economic planning. They do not provide any fundamental insight, and they have no magical power to discern information not available to the informed public (nevermind a regulator who is awake and doing his job). If they fail at their task, they should be suspended or dismantled. Crediting markets with the power to find the fair value of government debts denominated in a fiat currency is silly – just as silly as crediting the markets with finding the fair value of a parliamentary seat or the prison term served for a crime.
– Jake
@JakeS
Correct. The ECB has infinite liquidity! Buiter in his latest Bloomberg column ackknowledges this and he is not a MMT proponent.
I have no idea what this the ECB is a normal bank talk here is about? And folks please note Buiters remark: unlimited liquidity
“Looks like you are once again arguing that the ECB can go broke”
not me, not before, not now
RSJ,
“Neither the ECB nor the Fed can put a floor under secondary market prices.
All they can do is buy debt for the above market price.”
Mr Trichet has responded to your concerns. The market prices have already changed.
“The euro has stabilised overnight following comments from ECB President Trichet hinting that the ECB could consider expanding its sovereign debt purchase programme,” said Lee Hardman, analyst at The Bank of Tokyo-Mitsubishi UFJ in London.
link_http://www.telegraph.co.uk/finance/financetopics/financialcrisis/8173394/Trichet-bond-purchase-hint-calms-eurozone-markets.html
There is NO such a thing as an objective and independent market price. The market price is by definition the data which you receive from the exchange for example from link_http://www.euronext.com
We cannot compare a situation when a treasury having limited resources is trying to defend an exchange rate against Mr Soros or other “market forces” (as in UK, Russia or Argentina). In our case the ECB has unlimited resources so the threat is 100% reliable.
The only problem may be the lack of political will, application of an incorrect Monetarist economic theory (Trichet fretting about hyperinflation when he “monetises” the debt) or a phone call from Berlin.
VJK,
“You quoted the law allowing to mint coins. The law does not give the Treasury a blanket permission to gift anything to the Feds.”
Yes absolutely. It will be like TARP where voting is required, twice if necessary 😉
On the other hand,
“Besides, if the gifted security is to become an asset, it has to be sold to someone from the non-government sector willing to enter into the lender-borrower contract. Without such a contract-asset, the gifted security remains a meaningless piece of paper until it is sold to a non-government party. Therefore, the situation is no different in comparison to the case when the Treasury sold the security at an auction and donated the proceeds to the Feds.”
Yes of course, no different from the case. And its not an issue if the proceeds are donated to the Feds.
The platinum coin I keep mentioning is made worthy by law. The Fed can exchange the $1T for 1T $1T coins and each of the coin has to be accepted by law by the citizens if the Fed pays for something such as furniture. I mention it because, because of it the “no-overdraft” rule doesn’t matter.
Combine the Treasury and the central bank balance sheets and you have an entity with a negative net worth. One can keep playing some game where one unit has a positive net worth and the other negative. From the private sector’s perspective, it doesn’t matter.
Sorry should be $1T $1 coins above.
VJK,
For the case of the Fed, it is only allowed to purchase assets guaranteed by the U.S. government in the first place, which is why many of us thought that the MBS program was illegal. This isn’t the case with the ECB, of course.
The Fed is also allowed to make loans, but again, here the FDIC will pick up the losses of any banks that borrow from the Fed and then default. If it gets too big for the FDIC, then congress will set up an RTC, or some other mechanism, but the losses still wont hit the Fed’s books.
Again, in the eurozone, you do not have blanket FDIC insurance. You have a depositor fund that each nation must contribute to, but if the losses exceed that fund, as happened in Iceland, the national government is not obligated to take the losses on its books, as the U.S. did with the RTC.
On the other hand, congress did agree to guarantee the agencies prior to the Fed’s intervention, so to the degree that you believe that this congressional guarantee is sufficient, the Fed is OK. And that means that there won’t be any losses for MBS purchases.
With the Maiden Lane assets, Treasury will pick up the tab and re-imburse the fed for any losses, but those assets are small.
So here you have several examples — RTC, FDIC, Maiden Lane, Congressional guarantees of Agencies — in which losses were prevented from hitting the Fed’s books, rather than an ex-post bailout of the Fed. In none of these cases did we need to wait to recapitalize via interest income. The Federal debt expanded and some of the creditors, of which the Fed will be one — was made whole.
Adam,
You are talking about the euro.
Seriously, there is a huge conflation going on here between forex markets, sovereign debt markets, and private bank debt. And another conflation between an IMF bailout, a “stabilization fund” bailout, and an ECB bailout.
The ECB has not bailed out anyone, or provided fiscal support to anyone, or expanded its balance sheet in a significant way throughout this crisis. Every time the IMF bails someone out, you attribute this to the ECB. Why? Every time the member states bail someone out, you attribute this to the ECB.
And throughout this time, the typical pattern here is that there is a crisis, yields spike, some announcement of support is made, and then yields fall, until people realize that nothing has really improved, and then yields go back up. Then another crisis happens, and more bandaids and scotch tape are applied.
If you look at the long term charts, you can see this pattern quite clearly.
I agree that there is no such thing as an objective market price. The market price, by definition reflects expectations. You can buy A or you can buy B. Which will outperform the other? Should you sell A for B? Should you buy spanish debt, UK debt, Greek Debt, U.S. debt, or corporates? And those expectations are aggregated on an asset-weighted basis. There is no a priori reason to believe that those expectations are correct.
But the “power” of government to control market prices is basically marketing to try to change the expectations. It is short lived, and if the source of the concerns were real, then yields go right back up. The real power is on the fiscal side. To change tax and/or spending policy, together with regulations, in order to improve the underlying economy, rather than trying to change the market perceptions of the economy. Just assume that the perceptions are correct — in this case, they are correct. Yields are not too high, given the likelihood of default.
Would you buy Greek debt? If so, at what price? What do you think is the default risk and estimated recovery rate? You are trying to argue for a schizophrenic view of the world, in which there is no relationship between the chance that you will be repaid and the interest rate charged. Government isn’t going to be able to force such a situation to occur.
JakeS,
“You keep falling in the trap of thinking about government bonds as having a market price. This is a completely artificial construct that there is no good reason to adopt. If the central bank says that, say, a Greek bond is worth 2 %, then Greek bonds are worth 2 %. ”
There is always an opportunity cost to purchasing a Greek bond as opposed to some other asset that is not determined politically, but is determined by the economy.
The real question is whether the “true cost” of buying a Greek bond is reflected in the price of the Greek bond. When those two diverge, then output decreases, as do living standards.
Now when you say that Greek bonds are “worth” 2%, even though no one in the private sector is willing to buy them at 2%, then what you are really saying is that the Greek bonds have no price. All the Greek bonds will be held by the ECB.
OK, fine. That means that the ECB cannot conduct monetary policy.
It cannot sell the Greek bonds into the market in order to drain reserves because no one in the private sector would be willing to buy the Greek bonds, and the ECB would not be willing to sell them at prices lower than 2%.
Therefore the ECB is not buying marketable assets when it buys Greek bonds at all, and it cannot use those assets in the conduct of monetary policy. The ECB becomes a fiscal agent, and there is no monetary agent. This is in line with the MMT belief that money market rates should be zero and reserves should balloon as the central bankers all retire and try to cure cancer. You are pre-supposing this zero rate policy when you say that the ECB can convert it’s liquidity powers into fiscal powers.
Of course the ECB does not operate this way. No central bank operates this way. That’s a type of MMT wet dream, in which you are changing the mandate of the institution as well as the interest rate policy to open up new policy options, and then blaming the ECB for “holding governments hostage” because, in your wet-dream version of reality, the ECB already has these policy options.
But in our reality, the ECB buys the bonds from the secondary market because, in the course of conducting monetary policy, it will need to sell the bonds to the secondary market.
In the course of buying and selling, if it always buys high and sells low, it will get a balance sheet hole. That hole will need to filled with assets supplied by a fiscal agent. But without a fiscal agent, the ECB cannot buy high and sell low. It doesn’t matter whether it buys directly from the member states or on the secondary market. As long as it keeps buying high and selling low, it needs someone else to supply additional capital.
RSJ,
The impact on bond prices is described in the article which I linked. I just pasted the headline. If you want more information, it is here:
link_http://www.irishtimes.com/newspaper/finance/2010/1202/1224284573209.html
Here are the actual charts:
link_http://www.bloomberg.com/apps/quote?ticker=GIGB10YR:IND
link_http://www.bloomberg.com/apps/quote?ticker=GSPT10YR:IND
The market price of long-term bonds is determined by the demand and supply. It may reflect expectations about inflation and in some cases include a default risk premium but if the reserve bank steps in then the price may be strongly affected by that action because supply is elastic and the sellers cannot wrestle the price away from the level supported by the central bank.
An example of direct intervention of the Bank of Japan on bond markets was QE.
The impact can be seen on Figure 1 link_http://www.imes.boj.or.jp/english/publication/mes/2001/me19-1-4.pdf
It is obvious that such an action will also affect expectations of the traders.
I am not convinced whether my view is schizophrenic I simply don’t believe in the story about the objective power of the markets stronger than any government and central bank. The currently existing bond markets are a social convention. We can imagine different arrangements. For example during WWII bonds used in the US as saving vehicles were sold at a fixed discount.
link_http://en.wikipedia.org/wiki/Series_E_bond
The question whether the Greek or Irish debt is going to be repaid in Euro or not is mainly a political one.
RSJ ,
If the ECB wants to drain the reserves and only sells Greek bonds then if the default risk premium is eliminated (it can be eliminated by the ECB), the markets will have to accept Greek bonds because it is better to hold them at 2% then cash at 0%. Obviously if ECB wants to sell German and Greek bonds at the same price, the markets will prefer German bonds because of the residual risk associated with the Greek bonds.
Again this is all a matter of making certain arbitrary decisions.
RSJ,
“For the case of the Fed, it is only allowed to purchase assets guaranteed by the U.S. government in the first place”
Ive read this a while back though, from the Fed’s Purposes and Functions Manual (Pg 36):
“Open Market Operations
In theory, the Federal Reserve could conduct open market operations by purchasing or selling any type of asset. In practice, however, most assets cannot be traded readily enough to accommodate open market operations. For open market operations to work effectively, the Federal Reserve must be able to buy and sell quickly, at its own convenience, in whatever volume may be needed to keep the federal funds rate at the target level. These conditions require that the instrument it buys or sells be traded in a broad, highly active market that can accommodate the transactions without distortions or disruptions to the market itself.
The market for U.S. Treasury securities satisfies these conditions.”
So to me, the near-exclusive use of Treasury securities in omo sounds like another self-imposed (not a ‘legal” per se)constraint. This reads like they could buy used cars if they wanted to, adding/subtracting reserves thru the bank accounts of the used car dealers. Resp,
Matt,
From the Federal Reserve Act, section 14, Open Market Operations, the Fed is allowed to:
1. Buy and sell short term bills (in maturities not exceeding 6 months) that are obligations of counties, governments, and foreign governments.
2. Buy and sell gold
3. To purchase from member banks bills of exchange, and to sell bills of exchange ( to anyone).
4. “To buy and sell in the open market, under the direction and regulations of the Federal Open Market Committee, any obligation which is a direct obligation of, or fully guaranteed as to principal and interest by, any agency of the United States.”
//www.federalreserve.gov/aboutthefed/section14.htm
Ramanan,
“Combine the Treasury and the central bank balance sheets and you have an entity with a negative net worth. ”
No, because on the asset side of Treasury is the power to tax. That, as a balance sheet item, is what ensures that the Treasury’s balance sheet pretty much always balances.
By your logic, every non-financial business has negative net worth, as it’s assets are primarily real assets as well as things like “market power”. Really the assets are earnings power, and these are held against financial liabilities.
RSJ,
Yes you may want to add tax receivables in the assets. However, its simple if not added. That way financial assets sum to zero and it incredibly simplifies things!
If you add tax receivables in the Federal Government’s assets, you have to include tax liabilities of the future in households and corporations’ balance sheets.
Neither Z.1 nor Blue Book (UK) add the item in assets.
Adam,
“If the ECB wants to drain the reserves and only sells Greek bonds then if the default risk premium is eliminated (it can be eliminated by the ECB)”
This is where you assume your conclusion. Yes, if default risk could be eliminated, then the CB could buy the bonds in unlimited amounts. But how would the risk be eliminated? Only by buying the bonds in unlimited amounts. So you are not proving anything, you are assuming the conclusion.
The whole point is that you have two modes in which the CB + fiscal arm can operate. In one state, the fiscal arm has taxing power and guarantees capital for the CB, while the CB guarantees liquidity to the fiscal arm. This allows the CB to expand its balance sheet however it wants, and it allows the fiscal arm to enjoy risk-free rates.
In the other mode of operation, the fiscal arm does not guarantee capital for the CB, and therefore the CB cannot guarantee liquidity to the fiscal arm. In that mode of operation, the fiscal arm does not enjoy risk-free rates, and the CB cannot expand its balance sheet however much it wants.
The U.S. operates in the first mode, whereas the E.U. operates in the second.
RSJ:
“FDIC insurance.”
is irrelevant because it is funded by the member banks.
“On the other hand, congress did agree to guarantee the agencies prior to the Fed’s intervention, so to the degree that you believe that this congressional guarantee is sufficient, the Fed is OK”
“Guarantee” is a very vague word. Specific amounts should be allocated through a appropriation bill.
“And that means that there won’t be any losses for MBS purchases. ”
Do you mean to say that the losses will be absorbed by taxpayers or by additional debt issuance, or you have some other mechanism in mind ?
“Congressional guarantees of Agencies ”
Again, congressional guarantees is a promise. Were/wiil specific amounts of money be allocated to absorb losses, and where will the amounts come from ?
Let’s say for the argument sake that the toxic asset losses on the Fed balance sheet are $500B. Who will pay ? The treasury ?
Understanding the Fed recapitalization mechanism may also shed some light, hopefully, on the Eurozone situation.
Ramanan,
No, you would need to do more than add tax-receivables, you would need to add all future tax receivables. So no one bothers to add these in. In other words, it’s not really the case that the balance sheet of the government is allowed to “not balance”. It just means that the taxation powers of government are sufficiently powerful that we allow negative financial net worth, because the government has large non-financial assets (e.g. the ability to tax, and to increase taxes, etc.)
And you can view a sovereign debt crisis — for example, in a pegged regime — as one in which the market begins to doubt the strength of the taxing power as being sufficient to cover the negative financial net worth.
So in all cases, the balance sheet balances. Both for firms or for governments. When the assets are too small, the liabilities must also shrink — e.g. default of some kind. Government balance sheets must balance as with everyone else.
But this highlights the fundamentally subjective nature of calculating balance sheets. In order to calculate balance sheets, you need some asset valuation method, and there is objective or expectations-free algorithm. There are only series of commonly accepted customs to try to enforce consistency.
“But without a fiscal agent, the ECB cannot buy high and sell low. It doesn’t matter whether it buys directly from the member states or on the secondary market. As long as it keeps buying high and selling low, it needs someone else to supply additional capital.”
Are you sure about that. The bonds are priced in Euros and the ECB creates those. Only regulation stops a bank creating an infinite amount of money.
So surely the ECB can just create the money like any other bank does. The ‘hole’ in the balance sheet is then just ‘Euros outstanding’.
“Only regulation stops a bank creating an infinite amount of money.”
No, the capital providers stop the bank from creating an infinite amount of money, because the hole comes out their capital. That is why you have Bill Black arguing “the best way to rob a bank is to own one”.
For the ECB, the ones that constrain activity are the ones that supply the capital subscriptions. They are Germany, France, etc. Should the ECB buy Greek debt high in the primary market and sell low in the secondary market, then money is being transferred from Germany to Greece, and Germany will veto that operation. Germany will be the one that needs to supply more capital to the ECB to make its balance sheet balance in the event that the ECB incurs losses. And therefore Germany will constrain the ECB to operate in such a way as to minimize losses. It doesn’t matter whether the debt is denominated in euros. What matters is who pays the debt.
And the capital providers — the member states — will be the ones that constrain what the ECB does and how much its balance sheet expands. If their balance sheets were unified, so that there was no German debt or Greek debt, but only “EU” government debt, it would be one branch of government lending to another, with no noticeable effect on the consolidated balance sheet of the unified government entity.
Then you would be in the better mode of operation in which ECB capital was unlimited and EU debt was riskless. But as long as the governments are pitted against each other, with a separate group supplying ECB capital and a different group wanting to borrow from the ECB, then the group wanting to borrow from the ECB will not find a sympathetic ear, and they will be told to make a separate arrangement with the group supplying the capital. The ECB cant do anything for them.
RSJ:
Somehow my message did not make through, so I’ll make a short one 😉
For the argument sake, let’s assume that the Fed incurred $500B asset loss on its balance sheet. Who specifically will remit money to cover the loss regardless of specific operational arrangements (RTC, Maiden Lane, whatever) ?
Is it the Treasury ?
If it is the Treasury, under the current operational and *legal* arrangements, the money can come either from taxes or debt issuance, correct ?
I think it’s a fairly straightforward question the answer to which that may help shed light on the Eurozone situation.
VJK,
Yes, the treasury will most likely issue more debt to cover the losses. And you are right, this sheds light on the EU constraints.
RSJ @ 1:01 agreed.
Btw, there is a chapter in Complexity, Endogenous Money And Macroeconomic Theory: Essays In Honour Of Basil J. Moore which seems to worry about the ECB’s capital. Its written by a person called Otto Steiger.
Ramanan,
How do you find all these references? I’m amazed. You should post a bibliography one day.
But I’m not going to pay $180 for that book 🙂
RSJ,
I do a massive massive research without being an economist. I buy those books!
You can preview most of that chapter on Google Books btw.
I recently managed to get Moore’s book Horizontalists and Verticalists after a mega search online. Ended up buying a used copy from a seller at Amazon France. It was not straightforward, the seller was not Amazon itself and would deliver only in selected countries. So I had to ship it to a friend in the US to get it via him. Plus I had to dodge some French at the Amazon France website! Google Chrome’s auto-translate was handy. (Anyway you can preview many pages of the book at Amazon)
RSJ,
Try the following links:
The Endogeneity of Money and the Eurosystem
Which Lender of Last Resort for the Eurosystem?
The European Central Bank and the Eurosystem: An Analysis of the Missing Central Monetary Institution in European Monetary Union
For the case of Ireland, it was the Irish Central Bank that was the lender of last resort. Its balance sheet grew to a tenth of the ECBs.
“For the ECB, the ones that constrain activity are the ones that supply the capital subscriptions”
More ‘pay off the overdraft’. ECB could still do it on a cashflow basis because it creates the Euros. It’s not restricted because of capital. It’s restricted because of politics – the Germans won’t sanction the transfer payments nor a ‘negative equity’ central bank.
Food for Thought.
It is not enough to have your sovereign currency with flexible exchange rates and an integrated Treasury with the monetary authority but also must have policy rules that take advantage of these powers and not restrained by ideology. For exmple you might have Trichet as Governor of the joint authority! Policy makers matter………
Neil,
Euros are a liability of the ECB.
Not an asset.
The ECB cannot create net financial assets for itself.
Write the ECB balance sheet as A = assets. E = euro liabilities. C = capital.
So we have A = E + C.
And C = A-E
Now suppose that the ECB creates more euros, dE, and buys assets with them, dA. Then we have
A + dA = E + dE + C
C_new = A-E + (dA – dE) = C_old + (dA-dE)
Now suppose the ECB overpays, or that some assets do not perform (remember, most of the assets that the ECB holds are private sector debt). Say dE = 2dA.
Therefore C_new = C_old – dA
So the capital providers take a hit of dA = the amount by which the ECB overpaid.
Given this hit, it doesn’t matter if the ECB recovers the loss by keeping interest income (that would have gone to Germany), or by asking Germany for dA more capital.
In either case, it is Germany and not the ECB, that is overpaying for the asset.
The ECB is just the conduit for the subsidy, but the source of the subsidy is the capital provider.
Therefore you can understand why the capital providers may want to constrain the ECB, to prevent it from engaging in fiscal policy. If they wanted to subsidize Greece, then they would have done so — and they are doing so via the ESF.
On the other hand, suppose that we have a unified EU, and that the ECB only buys government debt.
Now, on the one hand, the government loses dA of capital. But on the other hand, the ECB shuttles dA of funds to the government.
In the unified scenario, the unified government does not incur a loss (or gain) when the ECB overpays for a government asset.
Therefore in the unified scenario, attempts to boost asset prices are politically palatable, since no one suffers (in the government). Non-asset holders in the private sector may suffer (and asset holders in the private sector may benefit), but the government does not suffer or benefit.
This is why unified central banks can expand their balance sheets and attempt to boost asset prices whereas the ECB cannot. This is why Germany and the other core nations impose constraints on the ECB. Those constraints would go away in a unified government scenario.
Neil, RSJ
It is the NCBs that create the Euros not the ECB. I just searched for Otto Steigers paper that Ramanan quoted to RSJ above. The European Central Bank and the Eurosystem: An Analysis of the issing Central Monetary Institution in European Monetary Union
LINK_http://econstor.eu/bitstream/10419/39508/1/37077356X.pdf
The ECB has very little power, it only gives the outward appearance of independence when in fact the power resides with the Council of Governors of the Eurosystem who meet once a month and determine the interest rate and then instruct the ECB who are just the newsreaders for the media. It doesn\’t even have a lender of last resort facility, everything is still decentralised to the NCBs.
BFG,
Then it may not be technically 100% accurate to say “the ECB buys X”, etc. (could be splitting hairs but its best to know the details first) I guess on a macro level the “ECB” does these kinds of things. But to me it’s like Trichet in reality just acts as an “honest broker” (I know loose language!) sort of between the NCBs.
I often wonder in these sort of convoluted arrangements if there is something that operationally prevents for instance the Irish NCB from buying Ireland Govt debt at much lower rates for the citizens of Ireland… like due to the external deficit the system in Ireland ends up actually short of balances that prevents this operationally, and they have to go ‘hat in hand’ to the surplus countries via Trichet … anyway good point.
Resp,
BFG,
Yes of course the NCBs do “the work” but the ECB is the ultimate authority. For example, if some government bonds have to be purchased, its the ECB giving the orders. My understanding is based on the following rules:
From GUIDELINE OF THE EUROPEAN CENTRAL BANK of 26 April 2001 on a Trans-European Automated Real-time Gross Settlement Express Transfer system (Target)
Article 4 Interlinking Provisions (b) 1 says:
2 says:
The ECB Annual Report says:
So … just like banks hold settlement balances at the central bank, the NCBs hold balances at the ECB.
On the other hand, banks will clear the overdrafts by borrowing from other banks but the NCBs do not do that. This is because NCBs are passive. If a nations banks are short of reserves, its NCB’s indebtedness to the ECB also would have increased. However when the banks borrow funds from foreign banks/cross border, the NCB’s indebtedness decreases. There is no inter-NCB market.
Have to read the paper you quoted in detail. My understanding is that the authors think that since the ECB’s balance sheet is “small”, its small. The way the article has been written makes it difficult to debate the other way :). Have to come up with something. For example they seem to argue that the ECB argues less currency and hence has less power. But the real reason is banks ask NCBs for currency notes not the ECB!
I found a nice thing BFG btw in that article – “mousetrap currency” – something I have been looking for though didn’t know the jargon – thanks.
On a different note, you must have read Wynne Godley Maastricht And All That rt ?
Matt,
In the ECB’s legal framework I have found some articles where the ECB has instructed NCBs to stay away from government debt by moral suasion. That was before the crisis. Will search it out.
That is not a problem.
Of course it can. You do not need open market operations to conduct interest rate policy.
Set reserve requirements high enough to ensure that there are negative excess reserves in the system (yes, that can be higher than 100 % – that’s not a problem), and conduct monetary policy at the discount window instead of the secondary bond market.
Nothing in the treaties requires the ECB to conduct monetary policy through open market operations rather than the discount window, and nothing in the treaties prevents it from using open market operations to support the prices of government bonds in the secondary markets. So it is, in fact, correct to chastise the ECB for not using the powers it already has to reduce the disruption to orderly economic planning that these interest rate spikes represent.
You have yet to show me where in the treaties it says that the capital subscribers can do any such thing. The ECB has ridiculously great independence, precisely because the crazy German inflation hawks wanted it to be immune from democratic accountability. Such immunity cuts both ways. Of course if they make sure that only ultra-orthodox neoliberals like Trichet, Stark and Weber are appointed, then they can be sure that they will use their lack of democratic accountability in their favour. But that is a policy decision, and as such open to political criticism.
– Jake
RSJ, Ramanan, Matt
RSJ, you could of wrote the following paper: Which Lender of Last Resort for the Eurosystem? LINK_http://www.zei.de/download/zei_wp/B04-23.pdf
Ramanan, if you get the time read the above paper, the writers imply that it is the Governing Council which is the main decision-making body of the ECB. It consists of
■the six members of the Executive Board, plus
■the governors of the national central banks of the 16 euro area countries.
The ECB cannot make independent decisions without the say-so of the Governing Council.
There is some reflection of the alarming lack of power of the ECB which the Maastricht Treaty reveals in its Article 73f -unchanged as Article 59 in the Amsterdam Treaty. This Article states that in the case of a currency crisis the Council of the European Community (ECOFIN, i.e. the ministers of finance of the fifteen member states of the EU) can suspend capital flight out of the euro, a decision concerning which the ECB is only consulted.
Ramanan, RSJ and others book readers
I suggest to buy books not on Amazon but here_http://www.bookdepository.co.uk
This shop has free global shipping and prices are typically 20-30% lower than on Amazon. For instance, that book that costs $180 on amazon, costs $150 from this shop. I’ve been using them for quite a while (already bought 10+ books) and never had any problem.
This is not advertising and I make nothing from it 🙂 Just wanted to share but if Bill says no, then no.
RSJ,
I think you’ve got stuck in a rut.
There is nothing stopping the notional capital of the ECB being negative – that’s just equity plus the profit&loss account. Since it creates Euros (via the NCBs if that’s the sleight of hand) it can still settle its debts or provide loans in the currency of issue – because that’s its job. Nobody is going to put the ECB into administration or bounce its cheques.
It is entirely possible for the ECB to run negative equity for as long as it wants operationally although it is likely that bond sales losses would be offset by increase reserve repayments from Germany’s NCB since the Euros have to end up somewhere within the currency area. It could sit with that on its balance sheet until the arguments over who ‘funds’ the difference are settled.
After all they’ve run the whole of Europe with dodgy accounts for decades.
1. For those confused, the ECB has no credit risk if it acts as a “buyer of last resort” in secondary public bond markets (assuring investors to purchase new public issues of Eurozone countries without risk of default) and does not sterilize the liquidity reserves from its purchases (QE) and its euro reserves are not a “liability” as it is fiat and not convertible.
For those who want to compare CB responses including the ECB see, http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1253.pdf
Sergei,
Thanks. Will try Book Depository next time.
RSJ,
Okay here is what you are trying to say (my interpretation). You may actually empathize with Steiger’s points.
The central bank is finally backed by the Federal Government. The Federal Government’s liabilities are backed by its power to tax. In the Euro Zone, there is no single entity and its a confused set of several governments. The acceptance of the central bank money is on the faith that it will keep its capital positive. Else people may refuse to accept the central bank money. (And there have been cases in the past such as 17/18th century where – when banks were issuing notes – people refused to accept bank notes.
For the case of the US, even if the Fed lands up with zero capital – maybe due to rise in long term interest rates, its functioning is backed by the US Federal Government. In the case of the Euro Zone, there is no such authority and there is no lender of the last resort for the Eurosystem (the ECB/NCBs). Etc.
In most €-zone countries, it is not legal for a tradesman to refuse to accept legal tender. You are sometimes (though far from always) allowed to quote a price in both legal tender and foreign currency – at whatever exchange rate you want – but you have to quote a price in legal tender if you wish to legally transact with the general public.
So printing money in the €-zone can, at worst, lead to inflation. But since inflation is not a realistic risk at the moment, that is not a problem.
– Jake
JakeS,
Thanks for the info.
However going by your comments, I am a bit surprised by your usage of “printing money” and that leading to inflation. Nothing wrong with the usage of “printing money” but the phrase is used as if issuing currency notes is a supply-led process. Also, it doesn’t cause any inflation. That is because money is printed on demand, not supply. If households (who mostly need them) need more currency notes, they ask their banks and the bank reduces the household’s deposit and hands over the notes. The banking system may then demand more notes from the central bank either by selling government bonds to the central bank or increasing its indebtedness through a repurchase agreement (the MROs).
The household has just exchanged deposits for currency notes and currency notes by themselves cannot cause inflation.
@Ramanan
I know that “printing money” is a somewhat sloppy vernacular, and I don’t believe that accommodating government fiscal policy causes inflation either (although the fiscal policy thus accommodated can obviously cause inflation, which would have been prevented by holding fiscal policy hostage to an inflation target – but that’s a somewhat different issue).
But the question was what would happen if people didn’t want to accept ECB money in an economy where the legal tender laws force them to do so at some price. The natural response to such laws, if I were a tradesman who found the € disagreeable, would be to quote a price in dollar and another price in €, at some ridiculous exchange rate that would ensure that people would prefer to pay in dollars. So in principle, enforcing such a law could result in inflation, if people lose faith in the € as a store of value. I just don’t believe that’s a realistic risk at the moment; hence the “at worst” 😉
But more to the point, I just don’t believe that the solvency of the central bank is important to the question of whether its currency is a viable store of value, when the currency is not redeemable. Obviously, the solvency of the central bank in hard currency terms is important, but I don’t see any mechanism for how soft currency insolvency can transmit itself out of the central bank.
– Jake
JakeS,
No disagreement. I haven’t made up my mind one way or the other about the ECB’s capital.
So you are saying that as long at inflation is low and people don’t care about ECB’s capital, what’s the worry. Sellers don’t even know what such things mean, they are interested in obtaining products and selling it for a bit higher and making a profit.
Its true that the ECB is liable to pay in its own liabilities and cannot go bankrupt in that sense. What Steiger (whose articles are discussed above) are saying is that its true but it comes with the assumption that this trick is acceptable by citizens.
Also at present, in my opinion is that the only way out is to keep rescuing governments and resorting to direct monetization if needed and Article 122 of the Lisbon Treaty allows that. But while this keeps happening, convergence to some kind of solution is required and its via the creation of a supranational fiscal authority and a blueprint for nations to exit the Euro Zone when they wish, without causing any damage to anyone. At present nobody dares doing that.
And while I’d be absolutely delighted to see a unified fiscal and industrial policy, I fail to see how that’s going to happen in the current political climate. So that’s why I persist in pushing the idea of a less than fully federal mechanism that will still balance out the internal current accounts. That could be a higher inflation target, based on each member’s need to either increase or decrease their real terms of trade; it could be a direct transfer equal to the output gap or the CA imbalance; or it could be something as simple as forcing the ECB to grant the member states unlimited overdrafts on terms no worse than the Frankfurt overnight rate, and then let the ECB issue €-bonds.
The point is that I don’t want to lock us into a double-or-nothing mentality where we either go full-on federation or break up the union. Because then it’ll be breakup, given current political sentiments on the subcontinent.
But all money comes with that assumption. In fact, all institutions come with that assumption. And with the possible exception of the crazy professors, I don’t think anybody is going to even notice that the ECB’s notional capital goes negative.
I can think of a lot of things that would make people lose faith in the €. The sign of the ECB’s equity is not one of them.
– Jake
JakeS,
Good points and I think I fully agree with you. JMK said
Maybe barter never existed but Keynes was right about problems arising out of international trade.
The balance of payments problems is the root of the crisis in the Euro Zone. However I think there is no way to solve this without resorting to explicit ban on imports within the Euro Zone. At least for some time. The external debt of Spain is around 90% and there is no mechanism from stopping this process from continuing forever. I also think that it won’t lead to inflation because the Euro Zone is a developed world and such things are more likely to happen in the less developed nations where there is less competition and local producers may hike prices in response to the featherbedding the get. Some amount of inflation is good for the government anyway.
At any rate, I agree with you and am completely anti-empathetic to any plan such as breaking up. That will throw zillions of people homeless and individual nations’ fiscal policy will become a slave to the currency markets.
Hi Ramanan,
Related to the Euro, Prof. Wray made a point wrt the Euro back in April at a conference that as long as taxes were implemented and payable in Euros (and enforced) that the Euro would always have significant value…
Also, I’d like to get your opinion as to whether you agree with the idea that the problems in the Eurozone are not with the Soveriegn Credits (For instance Greece and Ireland (so far)) but rather with their domestic financial institutions ? (I believe BFG & RSJ made this point and I agree with this).
When the juggernaut of the negative media focus seemingly in succession on these periphery countries total debt (first Greece, now Ireland, next ?), how the markets are trashing the govt credits seems like ‘guilt by association” to me.
Resp,
PS wrt the external balance: Our 50B/mo external deficit here in the US is what is really killing us currently imo…
For any concerned noneconomists, let me assure them that the ECB faces no”capital risk”; see my comment December 3, 22:24. Private investors will buy “roll over”issues of Eurozone public debt as long as they know that the ECB stands ready to off load this debt from their balance sheets and not sterilize the extra reserves generated. Furthermore, let me assure them that the euro is legal tender in the Eurozone and that all taxes levied by Eurozone states are payed in euros.
Matt,
Re your PS, yes, for a given fiscal stance, imports are not benefits. So questions on whether its a benefit is for different scenario. In the real world, governments tighten fiscal policy if external trade is not doing well and imports are far from beneficial. The US government cannot relax fiscal policy sufficiently to bring unemployment back to lower levels without both the public debt and the external debt hurtling toward unchartered territory.
The “twin deficits” hypothesis first advocated by IMF’s Jacques J Polak says that any fiscal expansion with lead to a leakage to the external sector, mainly due to the identity relation net private saving, budget deficit and current account balance. (Though not sure he knew the identity) In the simplest form the hypothesis is incorrect because it seems to give a behavioral hypothesis to the accounting identity. The relation of the various flows of the identity is through output both domestically and in the rest of the world. So there is a leakage due to fiscal expansion.
So lack of political will on one hand means that fiscal policy alone cannot do the trick. However, even looking at the matter from a non-political perspective, there is a genuine constraint – if the external debt is restricted to 100%, a differential between a growth rate and interest paid to foreigners of 2% restricts trade balance to not go beyond 2%. Of course there is no sharp cut-off as the US does not have to settle international debt in Gold, but the limit is decided by foreigners – and can change from time to time. One way or the other fiscal policy is dependent on the exchange rate.
The balance of payments problems are severe in the case of the Euro Zone. Also since governments do not have their own central bank, the lenders can ruin them anytime. This is because as the governments spend, income and wealth increases but there is a leakage too. Hence the domestic private sector is unable to satisfy the supply of government bonds in the market. Due to substitutability effects, other Euro Zone investors won’t continue financing the government deficits and this leads to pressure in auction of government securities.
Before the crisis, investors will indifferent to the government securities and one saw all governments bond yields are nearly the same levels.
The problem with the Euro zone is with everyone. For the United States, the US Treasury has the power to finance its deficit even if overdraft and direct monetization are not allowed – via changing the law through voting and the power to create its own coins. Plus foreigners have higher preference for US Treasuries and the leakage due to imports causes no issue in financing the deficit. Thats the story now – automatic stabilizers do not work in the case of an open economy. The story is different if the public debt keeps increasing – foreigners liking the story is an implausibility.
If the Euro Zone nations somehow manage to keep trade balances and indebtedness to each other at ultra low levels, the Euro Zone can continue indefinitely. (Of course some amount of guarantee needs to be given so that governments don’t default).
However imagine if a supranational fiscal authority is made. Now whatever mainstream economists say and however capitalist any nation is – there is a big institution which behaves in a socialist way – the government. Its the reality as opposed to alternative. Even in the present scenario, the institution is already in place in the Euro Zone – the confused group of leaders is a mini supranational fiscal authority. The job of this institution is to help “weak” regions. I use weak in quotes because Germany is stronger than Greece due to historic and sociological reasons. So this authority has to make substantial equalization payments. It cannot provide stimulus by performance because that will make the weak nations even weaker.
So in some sense it is like one government. However the alternative is dreadful. There is no way single nations can go back.
I would say “problems” are due to governments. They cannot help but be indebted to their citizens simply due to the sectoral balance identity. However, the blueprint of the monetary union doesn’t help them behave that way without troubles.
@Matt: There really aren’t any €-zone countries with a sovereign debt problem. If what we are seeing right now were sovereign debt problems, then France and Belgium would also be under attack (since they have larger debts and deficits than Portugal, which is the current target).
In the case of Greece, what you are seeing is a balance of trade problem (and a corruption problem, and a military pork barrel problem). In the case of Ireland, what you’re seeing is a case of economic suicide by the ruling party, who are willing to scuttle the Irish economy to protect their bankster friends. In Portugal and Spain, you’re looking at a balance of trade problem (and a structural import dependency on petroleum). Italy is, well, Italy.
Bottom line: Greece is not Ireland, Ireland is not Iberia and Iberia is not Italy. The symptoms are the same, but that’s only because the way the €-zone works ensures that a bond run is one of only a few possible expressions of underlying policy conflicts.
– Jake
Barry Eichengreen, Ireland’s rescue package: Disaster for Ireland, bad omen for the Eurozone
Ramanan,
“for a given fiscal stance, imports are not benefits.” This is perhaps a good way to put it…ie: ‘for a given fiscal stance’. Here in the US we are spending ‘political capital’ at the rate of 110B/mo (current deficit), but its like our people (and mostly at the top end) are only reaping 60B/mo of it due to the 50B/mo CAD. Without a federally implemented JG or other strict full employment policy, I dont see how our people get out of this gracefully.
PS I noticed that Iceland has swung around to a CA surplus in the last reported qtr., does this follow your script? This from the Iceland central bank website:
Jake,
I dont have access to professional data, but are not the 10-yr govt bonds of Greece and Ireland at about a 10% yield?
Based on the last three comments from Ramanan, Panayotis, & yourself, it looks like the Greece and Ireland Govt Bonds may be a “buy of a lifetime”… especially for someone in the Euro area.
Resp,
JakeS,
Net external debt is a good proxy.
Portugal 88.6%, Ireland 75.1%, Greece 82.5%, Spain 80.6%, Italy 37.3%. These are end of 2009 IIP figures.
Germany on the other hand is minus 21.7%
Will find Q3 2010 figures.
Matt @ 5:47
Yes and no. Depends on how the politicians and the ECB do and whether they allow a default.
Here is some stat at the end of Q2 2010. Data from central banks and statistical institutes.
International Investment Position at the end of Q2 2010: Spain €916b, Ireland €189b, Greece €218b, Portugal €180b, Italy €260b
(4 times Q2 2010 GDP) : Spain €1,086b, Ireland €156b, Greece €235b, Portugal €171b, Italy €1,514b
Hence (-IIP/GDP) ratio is Spain 84%, Ireland 120%, Greece 93%, Portugal 105%, Italy 17%
As JakeS explains, government debt is not the problem. Its the indebtedness to the rest of the world due to trade imbalance which is the problem.
You won’t get out gracefully, if your political class is any indication. You’ll keep offshoring your industry to China until you run out of civilian industry to offshore. At which point China will revalue the Yuan on their time table, and start dealing bilaterally with your (then former) colonies (the genius of the post-Bretton Woods American empire has been to saddle your colonies with unpayable dollar debts rather than garrison them to the extent of the old-fashioned empires… but in a dollar collapse, that cuts both ways).
Then the US will have to start living within its means, in terms of foreign trade. That will be painful.
I don’t think there’s a “script” for countries as seriously FUBAR as Iceland. But it’s not excessively surprising. Their currency collapsed pretty hard when the banksters fled with their loot. That destroys their ability to import luxury goods, while their exports remain priced in hard currency. So a medium-term improvement in the foreign trade is not surprising. Sort of a painful way to go about it, though.
Ireland is going to default. It is mathematically impossible for them to adhere to the conditions imposed on them as part of the bondholder bailout, and they have a foreign trade surplus, so there is no real downside to defaulting. For Greece, I don’t know. It depends on whether the cost of having to rebalance their foreign trade overnight is worth the gain from defaulting, and on when the federal EU institutions come to their senses. I’d give it about 50/50 that you’re never going to see those € again if you buy a Greek bond right now.
Yep, but external debt != sovereign debt.
Besides, if you have a large foreign trade surplus (like Ireland but unlike Club Med), you can always tell your foreign creditors to go away and perform reproductive acts with farm animals. Because that means that the rest of the world thinks it needs you more than you think you need ROW.
– Jake
Here is the opening of a paper A simple model of three economies with two currencies: the eurozone and the USA by Wynne Godley and Marc Lavoie, 2006
Of course doesn’t take into consideration the possibility of breaking up – which is difficult to model – but insightful.
JakeS,
This is amusing. Ireland has a trade surplus. Seems to have lost heavily in other items on BOP/IIP.
It’s not (just) losses in other parts of the current accounts. Ireland had lots and lots of foreign direct investment in the last few decades. That will make your balance sheet look like that. I’d expect the Chinese data to look much the same. With the obvious difference that those companies that off-shored to China will probably not be allowed to off-shore to Viet Nam when China decides to revalue their currency. Whereas Ireland has no effective tools to prevent their transnats from offshoring to Slovenia or the Czech Republic, since they’re all in the EU.
– Jake
Jake,
“There really aren’t any €-zone countries with a sovereign debt problem.” vs “Ireland is going to default.”
Jake these two dont seem congruent. I’m sure I’m missing something. Resp,
The Irish debt problem isn’t the government’s. The Irish debt problem is that their banks gambled with other people’s money and lost. And then they had their friends in Fianna Fail bail them out. A default would simply be a way to not socialise private losses.
The Greek debt problem isn’t the government‘s debt, it’s the country’s foreign debt. The fact that it is held by the government is neither here nor there (there are reasons for that, of course, but they’re not pertinent to the present discussion).
In both cases, describing it as a government debt crisis – that is, a crisis resulting from past fiscal policy – implies a wrong cause-and-effect story. And it’s the cause-and-effect story that’s interesting if you want to treat the problem rather than the symptoms. After all, the symptoms are easy to treat – just default on the damn bonds, already. In Ireland’s case, that would also treat the problem – which was a socialisation of private losses – but in Greece it would not, because it would not address the underlying trade imbalance.
– Jake
Jake,
I agree with what you are writing in general, even if Ireland perhaps would repudiate this “screw deal” (US term) that their govt has foisted upon them, why would they default on their general obligation govt bonds that perhaps many of their own citizens own? Resp,
They don’t have to default on all their bonds. Governments can make strategic defaults, such as defaulting on all bonds held by foreigners, or all bonds issued before or after a certain date (such as the date they overthrew the previous government, or the date they started socialising private bank losses).
But in Ireland’s case well over three quarters of the government debt is, in fact, odious socialisation of private losses. The number of widows and orphans who’ll get shafted by a full default is not very large, and they can be made whole through other means. So it’s not a distinction that I usually bother to make in Ireland’s case.
– Jake
Ramanan @ 7:28,
No, I’m not arguing about people refusing to accept euros. Actually, the whole argument that fiat money has value because of taxes is a bit weak. Money is accepted because others accept it, and taxes is one way (and not the only way) to kickstart this process.
My argument is that all banks are capital constrained. What makes the central bank special, in a unified government scenario, is that the capital provider and the liquidity provider can support each other in a mutually beneficial way. When the central bank is always ready to buy the debt of the capital provider, the capital provider enjoys risk-free rates, and therefore has unlimited capital to supply to the central bank. The central bank therefore has unlimited liquidity. A allows B, given that B occurs. B allows A, given that A occurs. It’s a symbiotic relationship.
In the EU, the central bank remains capital constrained. At the end of the day, the capital providers are on the hook for any CB losses. Sure, a CB can go through a period of having negative capital if the capital suppliers allow it. Negative capital is effectively a loan from the capital suppliers, as well as suspension of seignorage payments to these suppliers. Should a CB “earn back” capital by accumulating seignorage income, then this is no different than just receiving a capital injection up front, as the seignorage income should have gone to the capital provider. You are just converting the asset gift into a series of small gifts spread over a large period of time. Nevertheless the capital providers are the ones paying the for the capital loss, regardless of the nature of the loss recognition process.
If, for some reason, the capital provider is not willing to supply the CB with unlimited capital to absorb losses on Greek debt, then the CB wont buy Greek debt in unlimited amounts. As a result, Greek debt will be risky. It’s simple.
So what’s really going on here is that there are multiple government entities that supply the ECB with capital, and the ones supplying the bulk of the capital are not the ones needing the bulk of the funding.
Therefore political constraints enter the picture in a way that doesn’t happen in a unified government framework. Those political constraints are realized as operational and economic constraints, and translate into more conservative CB behavior and a refusal to engage in large-scale asset purchases of the peripheral debt. Instead of criticizing the CB for this conservatism, or even worse, pretending that the ECB is supporting peripheral debt, understand that the ECB is constrained in a way that the U.S. Fed is not, just as the Euro governments are constrained in a way that the U.S. is not.
Who is going to take the ECB through bankruptcy if its notional capital becomes negative?
Given that our Dear Leaders are barely willing to take commercial banks into receivership when they become insolvent, for fear of triggering another round of panics, I really don’t see that happening (and I don’t believe anybody has the formal authority to do it anyway).
For that matter, given that a run on the ECB is impossible, who decides what totally illiquid assets are worth? Further along the same line of reasoning, who decides what any of the ECB’s assets are worth? The fact that “the market” says they’re worth N doesn’t mean that particular value has anything to do with any applicable economic fundamentals, so “market prices” clearly cannot be used to value the ECB’s balance sheet.
I understand perfectly well that buying Greek sovereign bonds would be a fiscal transfer from Germany to Greece. I also understand perfectly well that nobody in Germany believes that the ECB should be allowed to do that. What you have failed to persuade me is that it’s any of Germany’s business, according to the current treaties. The fact that it’s Germany’s money is neither here nor there – if they don’t have a legal way to prevent the ECB from doing it over their heads, then it’s the ECB’s decision whether to do it or not.
– Jake
JakeS,
If you truly want to know the mechanisms, then the NCB of Germany can refuse to supply capital to the ECB. And the ECB does not have a provision that allows it to operate with negative capital. If you combine these two constraints, then you get a constraint on ECB behavior.
But this is really missing the point. You are not going to get all of these realities just by looking at treaty obligations.
This reminds me of the discussion in which (IIRC) Ramanan pointed out that the U.S. Treasury could issue a trillion dollar platinum “coin”, and so retire the federal debt with a few of these coins.
But it’s not really the case that the Treasury has this latitude. In the same way, you might be able to find some rationale by which the ECB could go on a Greek debt buying orgy or follow Mosler’s “Plan” to provide fiscal support.
The reality is that the ECB does not have this power, just as the Treasury does not have the power to issue a Trillion dollar coin. It doesn’t matter that the current law doesn’t specifically prohibit it. If the law doesn’t explicitly prohibit it, then this tells you more about what the author’s concerns were than it does about what Treasury’s power is.
When you walk into a store and see a sign that says “no dogs allowed”, it tells you the store had a problem with dogs. The store doesn’t have a sign that says “do not vomit on attendant”, or “do not bring alligators”, because its understood that you wont. But there is doubt that you may bring a dog. Treaties are meant to clear up these doubts, and provide sufficient operational guidance in order to agree on how things will be done. But which things will be done will be constrained by many factors not specified in treaties.
Poring through legal documents in order to find loopholes isn’t a good way of determining the real constraints on behavior. It may be fun to discover that Treasury “could” issue a trillion dollar coin, but you have to keep in mind that Treasury doesn’t have this power.
Should the ECB attempt to deviate from its expected behavior, then the ECB will be forced to change its behavior, rather than forcing Germany to subsidize Greece. That’s what it means to lack a unified fiscal government — nothing can force Germany to subsidize Greece. Until that changes, Greek debt will remain risky.
By who?
Germany can’t force the ECB to not operate with negative capital unless it is willing to either a) withdraw from the € system – at enormous cost to Germany, b) forcibly expel Greece from the €-system – something for which there is neither mechanism nor precedent or c) revise the treaties – fat chance of Greece going along with that. Herr Weber cannot put on his Deutche Bundesbank hat and go to the ECB and say “I want my money back” – because the ECB’s liabilities are not redeemable and there is no established institutional mechanism for putting the ECB through bankruptcy.
Except the fact that in the face of a determined ECB stance in favour of the deficit countries rather than the surplus countries, not subsidizing Greece would be more expensive in real terms than continuing the subsidies. It’s a game of chicken race to the cliff, and the ECB decides whose car starts closer to the cliff. Right now it is siding with the surplus countries, but there is no legal, institutional or economic reason for this to be its default behaviour. That is a purely political decision on part of Messrs Weber, Trichet and Stark. It may be the predictable decision, given their history and training, but that does not make it any less a political decision for which they should be held politically accountable.
– Jake
RSJ,
Not that I advocate this. Its just a way of saying that the US Treasury has supreme powers. Also when I talk of setting the yield curve, I do not mean that I think governments should be doing that. When I give such examples, I just mean to talk of the power to do so.
So back to coins, the US government earns revenue because of coins it issues as opposed to its usual spending – minor compared to other items but its there nonetheless. Its demand-led and endogenous however and the US Treasury doesn’t decide to exogenously do that.
RSJ,
section (k) of Title 31 – Money And Finance § 5112 Denominations, specifications, and design of coins of the United States code:
I am sure the US Treasury secretary has the power to just write xyz on a piece of paper and declare it as money.
“I am sure the US Treasury secretary has the power to just write xyz on a piece of paper and declare it as money.”
The second that Treasury decides to mint a trillion dollar coin is the second that that the law is changed and this loophole is closed.
So Treasury does not have this power.
And that’s the point.
RSJ,
Back to your general points – the fact that the ECB creates money out of thin air gives it a supreme power compared to other institutions. Even banks do that but its a promise to convert the liabilities into central bank liabilities on demand or the promise to transfer it to another bank and also the power to use it to purchase foreign stuff if the relationship is such (such as usage of debit cards to purchase something in foreign currency).
The ECB liabilities are promise to pay in its own liabilities unlike a bank. You quoted the ECB’s balance sheet and I do not think it is so straightforward to figure out how much government bond it holds – simply because of the language it uses in putting the balance sheet on the website.
Now the only question then is whether there is any limit on doing so etc. It can be that the ECB capital goes negative due to some reason. Is that the end ? Not really. If the citizens accept that the negative capital is fine. the game goes on. If a financial institution’s capital goes negative, other financial institutions stop lending it and it has to be closed by a complicated process. The ECB on the other hand doesn’t need the support of others as far as Euros are concerned – because its a central bank.
The ECB can continue to operate with a negative capital. There is no rule which says that people will stop accepting this game at point X. The man on the street doesn’t know these things and will pay and demand Euros. The man on the street can refuse it even if the capital is positive.
Why am I saying this ? For the moment, there are powers within the system which allow prevention of defaults. Greek government may default by its volition or it may default because the ECB didn’t bail it out. There is no rule which says that the ECB can’t bail it out. The ECB can directly monetize the Greek government’s debt by appealing to Article 122. Any crib will simply be a moral attack.
This Euro zone game is longer than previously thought
“The ECB can continue to operate with a negative capital.”
No, it can’t.
It must pass losses onto the NCBs, who must pass losses onto the member governments. And the member governments are not required to accept losses or to fund them. They can say “no”.
Therefore the member governments prevent the ECB from taking risks in the first place, provided that they are not willing to cover losses.
Therefore the ECB is constrained by the member governments.
This explanation of constraints is consistent with reality — with actual ECB behavior during this crisis.
Aren’t you more interested in understanding actual behavior?
The ability to create money isn’t a big deal. That an institution can create more liabilities for itself doesn’t make it powerful at all.
Many institutions can create liabilities in large amounts.
What makes an institution powerful is the ability to net financial assets, not liabilities.
The supreme power is the ability to supply capital to whoever needs it. That’s power.
RSJ, you keep simply assuming that funding comes with total discretionary power to withdraw said funding. That is not necessarily true, which is why I keep pushing for you to outline a concrete mechanism for how to prevent the ECB from continuing operation with negative capital.
Germany is also a major source of funding for the European Court of Human Rights. That does not mean that Germany can simply close down the court should it find its rulings objectionable. Institutional relationships don’t work that way. So unless a specific mechanism already exists ahead of time for how to shut down an ECB governor who goes off the reservation, a conflict between a member state and an ECB governor will be a constitutional crisis, not a simple matter of pulling the plug on an unruly civil servant. My suspicion is that such a mechanism does not, in fact, exist, since the explicit desire when the treaties were framed was to make a central bank that was wholly insulated from democratic accountability.
Now, if the ECB were all alone in that crisis, then it wouldn’t have much of a chance. They’d just change the treaties and be done with it. But the countries who stand to benefit from an accommodationist central bank have veto powers over any treaty change. And even if that were not the case Ireland would still be constitutionally obligated to hold a referendum, and there’s not a snowball’s chance in a blast furnace that a treaty that is widely believed to serve narrow German national interests is going to pass an Irish referendum for the next decade or two.
Germany can always simply pick up their marbles and leave the €-zone, of course, so in that sense the ECB cannot force Germany to bail out anybody. But the ECB can make sure that Germany’s choice is between bailing out PIGS and leaving the €-zone, just as it can make sure that Greece’s choice is between Austerity(TM) and leaving the €-zone.
– Jake
JakeS,
I would look at things differently. That the peripheral nations need to approve the treaties means that the real constraints placed on the ECB will not be accurately represented in the treaties. Because the core nations do not want to supply the ECB with unlimited capital, the ECB will be more averse to expanding its balance sheet and will refuse to provide fiscal support in the first place.
The ECB will continue to represent the interests of the core nations until there is a constitutional crisis. That’s how the institutions work. The ECB does not have wide latitude to go against the interest of its main capital suppliers, which is why it hasn’t been supplying fiscal support.
So what is your mechanism for the ECB to go off the reservation? Why would they? Why is Ireland agreeing to IMF covenants instead of rolling over ECB funding? Why was Trichet appointed?
In other words, you can take the point of view that Treasury can mint the trillion dollar coin, and for some unknown reason it hasn’t elected to do so, or you can argue that Treasury cannot mint the trillion dollar coin, regardless of what the law says, and that only a crisis would allow Treasury to mint the coin.
I’m arguing that only after a real confrontation between the periphery and the core — possibly a constitutional crisis — will the ECB change its behavior. That would require Ireland standing up to its banking sector, for example, and credibly threatening to leave the euro. Then there would be a fight involving the banks, Germany and Ireland and the result of that fight will either be a unified EU in which the ECB has real power, or it will be a dissolved EU, in which the ECB disappears.
But the actual latitude is not there yet, and wont be there if all the deficit nations keep rolling over and agreeing to the austerity demands coming from the core.
The political constraints, you mean.
Which I understand. I just happen to be of the opinion that political decisions should be subject to political criticism, not walled off as some sort of mechanical inevitability.
Open market operations.
To preserve the smooth functioning of the European financial system. That’s their day job when they’re not moonlighting as amateur macroeconomists.
Because Fianna Fail is a gang of corrupt criminals who like handing taxpayer money over to their cronies.
He was promoted to his level of incompetence, because nobody who matters in Europe understands elementary macroeconomics.
That paints the ECB as a mostly passive entity here. I’m not buying that. To take one example, the ECB was even more insane in the Greek negotiations than the IMF. Taking a more extreme stance than the US State Department’s tribute collection agency is not consistent with the theory that the ECB is passively following the path of least resistance. It’s really only consistent with their negotiators being hard-core neoliberal ideologues.
Which is their right, of course. I just happen to think that it should disqualify them from any position of responsibility more important than municipal dog catcher.
– Jake
JakeS,
@9:58
Okay FDIs it is.
The numbers are amazing. The annual GDP is around €156b. The balance sheet size of the Central Bank of Ireland is €186b. External assets is €4.41 trillion and liabilities to foreigners is €4.60 trillion. Mind blowing.
JakeS,
The only constraints are political constraints and real resource constraints. We have an endowment of real resources and politics determines what we do with that endowment.
That’s it.
There are no operational constraints, ever.
If you believe that you’ve obtained some insight as a result of studying operational constraints, then you may be right.
People can obtain insight from many sources.
But don’t confuse the source of your insight as being a constraint on outcomes.
There are no operational constraints. As soon as Nixon didn’t want us to be on the gold standard, we left the standard. We were not constrained by the gold standard. Same for FDR.
The only benefit from studying operations is that if you are misled as to the real constraints — e.g. the political and resource constraints — then studying the operations can be a source of theory-free feedback that can clear up your political and real resource misconceptions. But there are never any operational constraints.
RSJ, not all political constraints are created equal. Operational constraints do in fact become political constraints when your organisation has been operating in the same way long enough, and tightening or expanding the operational constraints against a strong precedent requires more political capital than simply changing your policy stance within those operational constraints.
But more to the point, there is a difference between saying “the ECB has no discretionary power to side with the deficit countries in this crisis,” saying “the ECB has some discretionary power, which it does not exercise because it does not believe that the deficit countries will win, and it wants to remain on the winning team” and saying “the ECB has some discretionary power, but does not exercise it because it is staffed by neoliberal quacks who do not believe in exercising discretionary power.”
The first statement is quite clearly untrue. The ECB does have considerable discretionary power to pick sides in this crisis. The difference between the second and third statements is whether Trichet et al are cowards or traitors. For myself, I believe that they are ideologically neoliberal, making them traitors more than cowards, but now we’re in the realm of guessing about motivations. Either way, they need to go away and be replaced with people who have both a modicum of courage, a basic understanding of elementary macroeconomics and enough common honesty to serve the people rather than the banks.
– Jake