I checked my calendar today thinking I must be a few months out. Upon checking I determined that it wasn’t April 1. So what the hell is going on? I refer to the announcement of a senior appointment at the World Bank. They have just appointed to the role of Vice President and Treasurer the former Lehman Brothers Global Head of Risk Policy who then was Lehman’s Global Head of Market Risk Management as they sailed into bankruptcy. Hilarious. As the Twitter-verse noted – Did they also interview Bernie Madoff? Anyway, I saw this news piece come in as I was studying the 81st Annual Report 2010/11 of the Bank of International Settlements – the central bank of the central banks – which was released yesterday (June 26, 2011). My conclusion: BIS = BS – the I is gone and used to stand for integrity
On the World Bank appointment, the WB President said:
She brings to the Bank an extensive background in the financial industry and a demonstrated record of leadership, innovation, and integrity.
There are many characters who were part of the financial crash (as senior managers etc) who are once again taking senior decision-making positions. Where is the written evidence that this appointee warned of the risk her company was taking and informed the public who were burned by the dishonest and capricious behaviour of the financial sector that they were being dudded?
It seems that this is like all the mainstream economists who have now crawled back out of the woodwork and are now lecturing us again on the virtues of deregulation and fiscal withdrawal after those policies were instrumental in causing the financial crisis in the first place.
BIS Annual Report 2011
Meanwhile the Bank of International Settlements has decided to become political and partisan with the release of their BIS Annual Report 2010/11 – Building a lasting foundation for sustainable growth. There was an accompanying Speech (June 26, 2011) from their General Manager.
To begin I decided to examine the text of the speech using an appropriate parsing tool. Given the topic and the level of the BIS analysis I chose the ABCya Word Clouds for Kids facility, which “was designed specifically for primary grade children”. After deleting the word financial (being the obvious topic), the following graphic was produced.
Just to see whether an “adult” word cloud generator delivered similar outcomes here is the result using Tag Crowd. The message is the same although the colours are more to my liking. The message of the speech stands out – FISCAL, MONETARY, POLICY.
The word clouds leave no doubt which way the BIS is leaning. The BIS speech was introducing the Annual Report and rehearses its main themes.
The General Manager (GM) noted the world economy was improving but that “serious vulnerabilities remain”. His first attack was on monetary policy:
Taking the global economy as a whole, the gap between world demand and productive capacity is closing. And the world economy is growing at a historically respectable rate of around 4 per cent. The recovery, although slow and uneven, has raised output to its pre-crisis levels in some of the countries hardest hit. The resurgence of demand has put concerns about deflation behind us. Accordingly, the need for continued extraordinary monetary accommodation has faded.
I don’t agree with the notion that the low interest rates have been very accommodating – which is a term economists use to denote “expansionary”. I don’t see too many advanced nations growing at anywhere near 4 per cent and credit demand remains low.
I also don’t see a strong resurgence in demand that is pushing towards any inflation barrier.
While I do not think the low interest rates are inflationary – if price pressures in specific asset classes emerge (for example, real estate) then fiscal policy – specifically targetted can deal with that more quickly and more effectively than shunting interest rates up.
The GM then claimed that the financial crisis and the subsequent policy responses:
… continue to cast long shadows. Economies and financial systems are still vulnerable to even modest shocks, and the likelihood of severely adverse developments has not decreased. The global recovery remains uneven, and global headline inflation has risen a full percentage point, to 3.6 per cent, since April of last year.
Economies are becoming more vulnerable because the political responses amidst a wave of irrational conservative emotion are failing to: (a) get the real sectors back onto trend and reducing unemployment; and (b) failing to deal with the initial causes of the crisis. In fact, the conservative influence on the debate is ensuring that the originating factors are being reinstated. A low interest rate regime is not among those factors.
Certainly global headline inflation has risen but this has little to do with the relationship between GDP growth and potential (that is, demand pressures) in nations with low interest rates and elevated fiscal balances. Rather it reflects changing energy demands across the globe as China and India begin to assert their “middle class” development aspirations. Monetary policy is a poor policy tool to deal with this structural change.
Instead, governments will have to invest more in alternative energy research and improved mass (public) transport systems in recognition that their lower income groups will not be able to enjoy cheap energy for very much longer. Please read my blog – Be careful what we wish for … – for more discussion on this point.
Then the BIS GM gets onto debt. First, “(t)he repair of private balance sheets still has some way to go”. Yes, and given that the heightened risk that led to the crisis came from the excess private borrowing and given that private spending has to be part of a solid and sustainable recovery, the policy environment has to be focused on supporting this process of private deleveraging.
Second, the GM said:
And the threats posed by public sector debt have materialised, reaching a crisis point in some countries. There are still substantial risks of contagion between sovereign and financial sector fragilities.
So once again the explicit idea that the private debt crisis has now become a sovereign debt crisis. The public sector debt situation has only reached a crisis where the same conditions existed which made the private debt vulnerable – where there is credit risk.
This vulnerability is built into the design of the Eurozone monetary system – as an explicit conservative tool to limit the capacity of national governments to effectively manage their own economies. At the time the EMU was established there was an explicit decision to reduce the fiscal capacity across the zone. This was a reflection of the blind faith the neo-liberals placed in monetary policy as an effective counter-stabilising policy tool (that is, interest rate adjustment) and the ideological dislike for government spending and taxation.
The problem is that this ideology does not match with the way the economy works and all the EMU bosses did was to install a system that was incapable of responding in any effective way to a major asymmetric aggregate demand shock that arose out of the private spending collapse in the US as the sub-prime fiasco unfolded.
They could have easily overcome this vulnerability by centralising the fiscal capacity at the EMU-level (democracy considerations aside) and aligned it with the central monetary policy capacity. The reliance on a single monetary policy target across a very disparate regional space and the lack of any fiscal capacity is the reason there is a public sector debt crisis in Greece, Ireland, Portugal, Spain and more to come yet.
There is no public debt crisis in the sovereign nations – that is, the nations that have full currency-issuing capacities and float those currencies on international markets.
Further, as I have noted before – and most recently in last Friday’s blog – Ignorance undermining prosperity – there are systemic constraints on both the public and private domestic sectors simultaneously reducing their debt levels that have to be taken into account.
For a start, for any nation that is running an external deficit (current account deficit) such an aim is impossible. We then have to consider what the responsible policy position should be when there is still massive idle capacity in many nations and the private sector is demonstrating that it wants to increase its saving ratio out of disposable income and is reluctant to demand credit to fuel a renewed consumption and investment binge.
In answering that question – what should the responsible policy position be – we need to reflect on what the purpose of macroeconomic policy is in the first place.
From the perspective of Modern Monetary Theory (MMT) policy is only justified if it advances public purpose – or social welfare – which has to include maintaining high levels of employment – eliminating labour underutilisation which saps human potential – and making sure there is sufficient equity in the distribution of income and wealth such that people can enjoy access to enough real production to maintain a reasonable material standard of living.
With that purpose in mind, it is clear that macroeconomic policy should be supportive not combative. What that means is that MMT emphasises the capacity of fiscal policy to “finance” the private sector saving efforts. The inverted commas are denoting that this role is indirect and works through the impact fiscal policy can have on aggregate demand and hence income growth.
Aggregate saving is a function of national income and it, in turn, responds to aggregate demand (spending). Spending creates income. Spending also brings forth its own saving. The government has to ensure that once all the other spending decisions are taken (by the private sector) that there is sufficient aggregate demand to allow national income to reach its potential (which is limited by the real capacity of the economy to produce goods and services at any point in time).
In that way, the government can support the deleveraging efforts of the private sector and ensure that over time the risks embodied in bloated private balance sheets are reduced and finally rendered benign.
It is clear that if the non-government sector in pursuing surpluses then the government has to support that aspiration by providing deficits. There is no way around that National Accounting reality. If the government resists that need, then national income falls and under most circumstances the reaction of the private sector (lower employment, lower incomes etc) will push the government balance into increased deficit anyway (via the lost tax revenue as a result of the lower level of economic activity).
It becomes more obvious when a nation is running an external deficit which drains spending (demand) from the local economy. Then the public deficits have to not only fill the gap left by the external drain but also has to provide the demand support to allow national income growth to be consistent with the private saving decisions.
Otherwise, recession occurs and the losses are huge.
The BIS GM clearly didn’t want to acknowledge any of that. His blueprint for a “lasting foundation for robust, stable and sustainable growth” is exactly what will undermine that goal and re-establish the conditions which drove the world economies into crisis in 2007.
He claims the challenges that must be addressed to provide for this “lasting foundation” are:
1. Fiscal reckoning – he claims there is now a “significant hole left by the collapse in tax revenues” (prior to the crisis) that ensure the “aftermath is a sovereign debt crisis”.
He claims that the crisis has “simply brought forward an approaching problem” which is that the demographic changes mean that “the fiscal trajectories of some of the world’s largest advanced economies are unsustainable”.
While I agree with his statement that “(t)his is not news” it is also not correct. Rising “dependency ratios” just mean that there are less people producing real goods and services than who are drawing on them. It is a problem if productivity growth does not continue and demand aspirations do not maintain some boundaries. But there will never be the problem that the US or UK or Japanese governments cannot buy whatever real goods and services are available for sale in their respective currencies.
It is simply a lie to assert otherwise. The political machinations might deem spending on health care to be a luxury that a nation no longer desires and less spending will be devoted to that accordingly which might impinge on the health care standards of that nation. But that has nothing to do with the financial capacity of the government to render the health care to proper standards.
It might be that there are not enough real goods and services to go around such that everyone has adequate health care (for example). Then tough political choices have to be made about the way in which the finite available health care is rationed. But that has nothing to do with the financial capacity of the government to render the health care to proper standards.
Shame on the BIS General Manager for contributing to and reinforcing the erroneous nature of this debate with lies.
While public deficits in many nations did rise before the crisis (as tax cuts were provided etc), I didn’t observe an outbreak of full employment and inflation. That tells me that the budget deficits that were seen in various nations were not excessive and were in the most part probably deficient. How do I know that?
The fact is that the neo-liberal growth strategy relied on the financial sector pushing increasing amounts of debt onto the private sector to fund spending while at the same time undermining the capacity of workers to enjoy real wages growth in line with productivity growth. If the private credit binge had have been tempered and within the boundaries of reasonable risk, then growth would have been slower unless net public spending was stronger.
The BIS GM also rehearses the standard line that:
Financial market participants can ignore such looming problems for a long time until, suddenly, they enforce changes that are swift and painful.
Not unless the governments allow them to do that. A sovereign government is always in charge and can control relevant interest rates and spend at appropriate levels irrespective of what the private bond markets are doing.
Please read my blog – Who is in charge? – for more discussion on this point.
The BIS GM then concludes from these spurious assumptions/statements that:
… the need for fiscal consolidation is even more urgent than when I spoke a year ago. According to the OECD, the average OECD country must improve its primary balance by nearly 7 per cent of GDP just to stabilise its debt-to-GDP ratio by 2026.
We will not have lasting macroeconomic and financial stability until we have taken decisive measures to put public finances on a sound and credible path. The creditworthiness of the sovereign is a prerequisite for a well-functioning economy. The default of the sovereign breaks the social contract and undermines the trust that is essential to the smooth running of both the state and the economy. No economy – no matter how large, rich and powerful – is immune to the risks posed by fiscal incoherence.
All sovereign nations have no credit risk. So statements like the “creditworthiness of the sovereign is a prerequisite for a well-functioning economy” are redundant and designed to deceive.
Further, as noted above, we “will not have lasting macroeconomic and financial stability until we have taken decisive measures” until we have restored private balance sheets, curtailed the out-of-control financial sector including the banks, and restored income growth via job creation.
Persistent fiscal deficits (some larger than others) will be required for years to come. Fiscal austerity, which the BIS GM wants, will undermine that agenda.
Fiscal austerity when there is slow private spending growth and massive pools of idle productive resources is the exemplar of “fiscal incoherence”.
The BIS GM claims that:
Nowhere is the link between fiscal sustainability and financial health more apparent than in parts of Europe today.
That is the only place where there is a link. The problem has nothing to do with fiscal policy as a counter-stabilisation tool. The problem is a flawed broken monetary system that the neo-liberals contrived as noted above.
He then went on to the inflation fear mongering:
The welcome recovery and absorption of spare resources have brought with them the less welcome spectre of inflation.
There is very little pressure on price levels coming from the slightly increased levels of capacity utilisation in the advanced nations. The price pressures are in part related to the way the financial markets have been speculating in energy and food (bio-fuels) and partly, as noted above, the result of major structural changes in energy demand.
And like any good neo-liberal (monetarist) he linked inflation fears to monetary policy.
The longer that interest rates are low, the more severe these side-effects and the greater the risk of a disruption when yields inevitably rise. There is a need to normalise monetary policy. The prevailing, extraordinarily accommodative policy rates will not deliver lasting monetary and financial stability. Real short-term interest rates have actually fallen in the past year, from minus 0.6 per cent to minus 1.3 per cent globally.
Real interest rates have fallen as the world economy has slowed again.
Japan has had low interest rates for years with no inflation threat and at times during this period relatively strong real GDP growth. A government facing a generalised inflation threat can more easily deal with it via fiscal policy. As I have noted in the past, monetary policy is not a tool that can target price pressures very effectively without bluntly damaging growth. A central bank cannot reduce the price of oil.
He thinks that rising interest rates are the best way to deal with “current account imbalances” via an appreciating currency (as capital flows in attracted by the relative interest rate advantages).
While the concept of a “current account imbalance” is loaded and wrongly assumes that exports are a benefit while imports are a cost, MMT focuses on movements in floating exchange rates to alter terms of trade and hence trade volumes. The domestic economy should not be pilloried because there are current account deficits.
From there the speech goes further downhill and I have run out of time to analyse it in detail.
The point is that the BIS should refrain from introducing erroneous analysis into an already ridiculously distorted political debate about fiscal policy.
IMF fingers the financial sector
Meanwhile, you might get some perspective on this by reading this – Who’s Behind the Financial Meltdown? – is also drawn upon and is worth reading.
The IMF study is based on a “new data set of U.S. financial companies’ politically targeted activities during 1999-2006”.
The key points:
1. “there was a clear association between the money affected financial firms spent on lobbying and the way legislators voted on the key bills considered before the crisis. The more intense the lobbying, the more likely legislators were to vote for deregulation. Moreover, lobbying was more likely to garner votes for deregulation from conservative legislators”.
2. “If a lobbyist had worked for a legislator in the past, the legislator was very likely to vote in favor of lax regulation”.
The implications drawn from the study are that “financial reform proposals should not be considered apart from these political factors”. They claim, however, that it is difficult to separate lobby as “rent seeking” and lobbying as “a desire to garner information”. They think that in the second case “lobbying would be considered a socially beneficial way to help lawmakers make knowledgeable decisions”.
I think I can solve that impasse for them based on the impacts of the lobbying on policy design, the behaviour of the private financial markets after legislation (in their favour) was or was not passed, and the results of the behaviour which can be summarised as the global financial crisis.
In that case, we should assume that rent-seeking behaviour dominates and agree with the authors’ conclusion that “it would be justifiable to curtail lobbying for its socially undesirable outcome”.
If the legislators desire further information on a pending piece of legislation then they might seek advice. But
The key to preventing another crisis is to ensure workers can maintain a satisfactory material standard of living from their wages and do not rely on credit to fund consumption growth. Growth will instead come from productivity gains feeding into real wages.
Further, ban all lobbying in the case of financial market legislation.
Also, please read the following blogs – Operational design arising from modern monetary theory and Asset bubbles and the conduct of banks for further discussion.
That is enough for today!