Writing in Crikey yesterday, Guy Rundle described the Greek imbroglio as the second wave of the Global Financial Crisis:
So let’s try and make it as clear as possible — the second wave of the 2008 GFC has begun, and Greece is where it started from. The first wave was prompted by the collapse of a series of private investment banks, starting with Lehman Brothers. The second is starting with the deep problems occasioned by the indebtedness of sovereign nations using the broad security of the euro, to be entrepreneurial with their budgets. That’s entrepreneurial in a political sense — thus Greece’s centre-right New Democrats left the nation’s finances unreformed as a way of giving the illusion that the wave of post euro-entry prosperity was solidly backed. Instead the country has simply wildly over-borrowed from its future.
That much is Greece’s problem primarily, and Europe’s secondarily. It becomes a global matter when the degree of exposure of the global banking system becomes clear — hot on the heels of the last crunch, and with nothing resembling a real recovery in-between.
Writing in Crikey today, Bernard Keane concluded that things may not be as rosy as we’d thought in Australia:
The euphoria that Australia has avoided a recession is now giving way to the realisation that as the Government’s stimulus withdraws, there are real questions about just how strong the private-sector growth needed to replace it is.
And the threat from overseas, and particularly the impact of sovereign debt and sluggish economic growth on financial and currency markets, has placed a big question mark over external demand.
There’s a close consonance between the shift in political sentiment in Australia and the economy. The assumption that we’re ‘out of the woods’ allows the Opposition to gain traction with its debt message, and that message also builds on the resonances of the false equation between household and state balance sheets. The implication – the point at which it ‘cuts through’ – is that over-geared citizens feel that they’re still very exposed to any further economic turbulence, and the analogy with the government is supposed to be plain.
Keane concludes:
For once, the Government can’t be accused of reacting too late. As a Labor MP told me, there’s a reason why Kevin Rudd endlessly reiterated “we’re not out of the woods yet”. It’s because the Government actually believed it, and conditions are now suggesting it was right to. Like the RBA, the Government has major decisions to make about the level of stimulus it keeps providing. And the data on which it has to make those decisions isn’t at all clear yet.
In his most recent commentary, Immanuel Wallerstein writes of “Chaos As An Everyday Thing”:
As a result, governments are faced with impossible choices, and individuals even more impossible choices. They cannot predict what is likely to happen. They become ever more frantic. They lash out by being protectionist or xenophobic or demagogic. But of course, this solves little.
He concludes:
So, this is what everyday chaos is like – a situation that is not predictable in the short run, even less in the middle run. It is therefore a situation in which the economic, political, and cultural fluctuations are large and rapid. And that is frightening for most people.
Kevin Rudd’s political success last year was built on the dialectic of fear of uncertainty and reassurance. Tony Abbott’s political message this year rests on the same foundations – ‘yes, we’re out of the woods, but if the government goes on spending, things might yet go horribly wrong’. But if external shocks and weak private sector activity are the ingredients of the political economy of an election year, to whom do worried voters turn?
It’s not immediately obvious how either side frames its message in a climate of economic uncertainty and everyday worry. But that’s one of the underlying dynamics of the political contest this year.
Elsewhere: A sociology of global chaos.
I feel a main failing of governments of all colours everywhere was not to let the market feel the full effects of their actions.
If you can take a tablet that makes a really bad case of the flu feel highly tolerable, and if that really bad case of the flu mostly occurs because you go out in the middle of winter wearing a really fashionable t-shirt and jeans (and nothing else), get really drunk and sleep too little, then you will probably continue to behave in that way.
The stimulus prevented many people who were responsible for this world recession from feeling the full effects of the downturn. It also prevented those not responsible from feeling the full effects, and then holding those responsible accountable for their actions, as they were filled with anger and looked for justice.
So I wouldn’t be surprised if we make the same mistakes again, only this time with less ability to spend the money papering over the cracks because countries like the USA owe so much money.
In times of economic uncertainty, voters overwhelmingly turn against the incumbent, but not typically right away. Rudd will win the next election even – perhaps especially – if another crisis hits. But if it turns into a “real” recession in Australia, he will – if history is reliable – be completely destroyed on going for a third term.
Arguably the second wave seed was sowed when the central banks began the bailouts; circa Sept 2007 in Europe. The EU jitters are a realisation there is a blight in the crop.
Howards position is the right one. Where are the brokers and CEO’s being booted out by shareholders/investors who have seen their wealth destroyed?
Its not happening because governments of all stripes have been conned into the “too big to fail” crapola.
Eg: GE finance in Australia (who fund a huge quantity of car loans) effectively removed themselves from the market because of the crisis in the US. Did anyone stop buying cars on finace??
http://www.themotorreport.com.au/10919/ge-money-and-gmac-pulling-out-of-car-dealer-finance/
No, what has meant is businesses have had to seek out other, usualy smaller comapnies to take their place.
Thats the market working, a company stuffs up on the scale of GE, goes bust, and another more prudent company moves in.
Unless China has a sudden stop to its growth spurt Oz should have strong underlying strength in the economy, if China stalls…..
A figure that causes a bit of doubt about China is its oil imports. Apparently things are great there including their domestic car industry, but then theres this…
“..Yet according to Horseman Capital in London, China’s demand for crude oil actually declined 2.9% over the first six months of the year. Isn’t that statistic surprising?..”
From here: http://rosemanblog.sovereignsociety.com/2009/08/the-chinese-field-of-dreams.html
I cant see Rudd being one term unless China loses its mojo.
With regard to Wallerstein’s, comments:
If markets were predictable, then there would be no market because everyone would either be a buyer or a seller. The market defines the ragged edge of unpredictability.
The novel aspects of the present situation are:
1. the unprecedented levels of liquidity pumped into markets by governments, not in the expectation of making a commercial return but in the hope of preserving the market itself.
2. the magnitude and indeterminate size of impairment of the value of assets on the books of some of the largest and most important financial institutions in the world.
At present factor 1 is masking the effects of factor 2. The crisis arrives when governments lose either the will or the ability to pump in liquidity.
The German government, for example, has lost the will to bail out the Greek government even though Germany has the ability to to that.
Will the US government continue to have the ability to raise loans to fund its deficit? Time will tell.
What happened in China in 2009 was extraordinary, simply extraordinary. If you are in any doubt look at these charts. In the depths of the worst global downturn in 70 years China massively increased its imports of coal, iron ore, and copper. Have no doubt, Chinese stimulus saved Australia from recession.
Now everyone from Glenn Stevens down is forecasting 20 years of blue skies ahead for Australia thanks to the China boom. Long term, they will undoubtedly be correct, but in the short term that huge spike in import volumes has to return to trend. China is already heavily over-invested, and when demand returns from Europe and the US, they’ll have built enough factories, railways and apartments to last a decade.
Karen Maley in today’s Biz Spectator tells the story:
But looking at the ASX today, its “risk on” and lets party!
Elsewhere: A sociology of global chaos.
There’s quite bit of evidence that China is generating substantial internal demand. Don’t have it hand, so you’ll have to rely on hearsay.
There is a risk in terms of countries in trouble, leading to regional then global weakness. The risky proposition in all of this is the US. Have a look at Paul Krugman’s blog, who is scathing at Obama’s stepping away from stimulus. As if the problem is solved – he’s worried, and if he is, so am I.
If the US decides to not use their influence in the international community (and a few others) and looks inwards, the few countries in southern Europe, could become a few more, growing as uncertainty grows.
The problem is that we need credit to keep markets moving. This for basic goods and services. Credit for derivatives and securities is a good way of risk spreading, but it also throws open the doors of the casino. So it’s a good way of risk amplification, too.
We desperately need some global oversight on this issue. Credit is required to a certain point, then less carrot, more stick.
I think part of the problem is still that it’s unclear how problematic bank balance sheets potentially are in the US – and that’s, in turn, partly the fault of the hamfisted and indecisive approach by US authorities to the financial sector post GFC.
That then leads to something else Wallerstein gestures to, but doesn’t make explicit, in his piece. The whole thing is so complex and so interlinked that it’s difficult to get a clear picture of the totality and to foresee:
(a) where the next risk is coming from;
(b) the degree to which apparently sacrosanct things (ie Greece’s sovereign debt) are already interlinked with the bigger picture, but that’s only just become apparent.
Both those factors feed further uncertainty, which contributes to the vicious cycle Wallerstein identifies.
So, in part, a continued lack of transparency compounds the problem. And Roger @6, I strongly suspect that’s as much in play with China as anywhere else.
Consumption in China is growing in absolute terms, but consumption as a share of GDP has been falling for decades, from 50% in 1990 to 35% today. By contrast, 70% of US GDP is consumption.
I’m not suggesting that the Chinese should become rabid debt-fueled consumers like Americans (and er, Australians) but don’t count on the Chinese consumer leading the world out of recession any time soon.
I suggest you read The difficult arithmetic of Chinese consumption by Michael Pettis (professor at Peking University’s Guanghua School of Management)
Where is Mr Wallerstein proposing to walk to once his predictions fail?
If that happens of course.
Indeed, though it’s important to note – contra the Barnabys of the world – that if it can’t continue to see enough Treasury paper to fund all of its deficit (which is a different thing from raising loans, btw) then all is not lost:
Not that that would be without its implications.
Depends on what you mean by “all”.
It is true that “quantitative easing” has been employed to add liquidity to the US financial system. This process does not entail raising loans. But this process is not connected with the problem of funding the US budgetary deficit. The monies thereby raised (or created) are not available to the US government for expenditures on any programs that the executive may feel fit. Rather it is liquidity which is made available to financial institutions affiliated with the Federal Reserve.
So long as institutions holding $US denominated assets believe that QE will not contribute to inflation and thereby undermine the value of their assets as denominated by other means (eg., gold or Euros or Swiss francs, etc.) then QE will have limited adverse effects.
However, if it is perceived or feared that QE may stimulate a significant fall in the value of the $US against other stores of value, then the effects of QE may be serious and rapid, most notably in a sudden flight from $US denominated assets.
It is a mystery to me why the USD has maintained its health for even this long.
Everybody knows that there are far too many USD – but still they queue up to buy them.
Time to start reading about the Iranian oil bourse again!
“It is true that “quantitative easing” has been employed to add liquidity to the US financial system. This process does not entail raising loans. But this process is not connected with the problem of funding the US budgetary deficit. The monies thereby raised (or created) are not available to the US government for expenditures on any programs that the executive may feel fit. Rather it is liquidity which is made available to financial institutions affiliated with the Federal Reserve.”
Katz, I think you have the Fed’s policy a little confused. From the Fed’s website:
“Broadly speaking, the Federal Reserve’s response to the crisis and the recession can be divided into two parts. First, our financial system during the past 2-1/2 years has experienced periods of intense panic and dysfunction, during which private short-term funding became difficult or impossible to obtain for many borrowers. The pulling back of private liquidity at times threatened the stability of major financial institutions and markets and severely disrupted normal channels of credit. In its role as liquidity provider of last resort, the Federal Reserve developed a number of programs to provide well-secured, mostly short-term credit to the financial system. These programs, which imposed no cost on the taxpayer, were a critical part of the government’s efforts to stabilize the financial system and restart the flow of credit.1 As financial conditions have improved, the Federal Reserve has substantially phased out these lending programs.
Second, after reducing short-term interest rates nearly to zero, the Federal Open Market Committee (FOMC) provided additional monetary policy stimulus through large-scale purchases of Treasury and agency securities. These asset purchases, which had the additional effect of substantially increasing the reserves that depository institutions hold with the Federal Reserve Banks, have helped lower interest rates and spreads in the mortgage market and other key credit markets, thereby promoting economic growth. Although at present the U.S. economy continues to require the support of highly accommodative monetary policies, at some point the Federal Reserve will need to tighten financial conditions by raising short-term interest rates and reducing the quantity of bank reserves outstanding. We have spent considerable effort in developing the tools we will need to remove policy accommodation, and we are fully confident that at the appropriate time we will be able to do so effectively.”
The liquidity support measures are distinct from the quantitative easing measures. The latter are a monetary policy instrument put in place once the zero lower bound in short term rates was reached. As a tool of monetary policy, the second category of measures is aimed at supporting economic activity more broadly (by pushing down the long-end of the yield curve for example) and also helping to prevent low underlying inflation becoming deflation.
The issue is not whether the purchasing of treasuries will lead to inflation – it is aimed at supporting at low levels – it is whether the Fed’s exit strategy is credible such that it can do so without inflation reaching level high enough to threaten price stability and cause holders of US dollar denominated assets to sell them.
At the moment there is little sign that the bond market is unduly concerned about high inflation in the US in the future.
LO, you appear to have misread my comment.
I never said, nor implied, that they weren’t.
True, so what? Though they are distinct, they are related. QE recommended itself when the traditional (i.e., non-novel) methods proved to be insufficient.
Agreed. And?
Here, you appear to be confused. The “purchasing of treasuries” you refer to, I presume, is the sale of treasuries by the Fed on behalf of the US Government (and not the opposite transaction). You are correct about the stated and probably actual aims of the Fed in this regard. However, an aim is quite different from a result.
As I said in the comment in question, time will tell whether the Fed can manage the clawback of QE and thus avoid the threat to stability that you mention. I think you will concede that this program is quite unprecedented in US financial history, at least since the fiasco of the Continentals during the War of Independence and Confederate paper currency during the American Civil War.
Little, but some. Alan Kohler had a graphic the other night that demonstrated that US Treasury instruments are no longer regarded by the market as risk-free. It now costs money to purchase a CDS on US Treasury instruments.
Bottom line: the sky isn’t falling but it does appear to be subject to the force of gravity.
Labor Outsider @ 15, I can’t see how the “liquidity support measures are distinct from the quantitative easing meassures”. I tend to agree with Katz, in that, at a minimum, they are related, but would argue that they are indeed one and the same.
Whether it be by ‘ordinary’ use of monetary policy, or by the purchase of banks’ holdings of “troubled assets”, or through the purchase (by a central bank) of other government or commercial paper through QE, all have the effect in one way or another of supporting liquidity.
I think this notion that budget deficits can be funded through constant quantitative easing is taking simplicity to the extreme. (Maybe Barnaby has a point! He just needs to work on his articulation skills.)
Yes, it is technically possible; but as alluded to already on here, the ramifications of this are immense.
The Katz – Labor Outsider debate had the potential to muddy the waters between financing a budget deficit and quantitative easing.
Quantitative easing (QE), as Katz quite rightly states, is a mechanism to support the liquidity of an affiliate (or primary dealer) of a central bank. Not everyone can just trade directly with a central bank and enjoy the fruits of QE. Primary dealers, flush with funds from the central bank, acquire government and other commercial debt, thereby increasing the issuer’s liquidity.
Katz you have said “the monies thereby raised (or created) are not available to the US government for expenditures on any programs that the executive may feel fit”. In the case of governments, these funds do count as borrowings in a fiscal budget. But the real aim of any QE program is to stimulate activity in the private sector – the commercial debt issuance; not to self-fulfil the borrowing requirements of the State. But this is conceivably the path we are headed down.
Yes, a government can seemingly “borrow from itself” infinitely, but we all know this is fraught with outcomes no one has yet contemplated – mainly because it would probably blow policy-makers’ minds. This is why the sovereign risk is such a compelling issue at the moment: Because it is ultimately the private sector that has to fund any fiscal budget going forward. Much of the financial crises turmoil has been transferred: from private to public. But it is the private sector that needs get back on track and continuing State intervention, in any way, shape or form, is unlikely to ever address the core issues.
Incidentally, I read an article in The Age last weekend, penned by a guest-contributor (who had a background in Stockbroking, I think), who simply argued that soverign risk was a risk becuase people “thought it was a risk”. He drew an analogy with a mortgagor, whose outstanding debt was say $130k, and annual income of $80k. By his reckoning, the mortgagor was in debt to the tune of 163% of their “GDP”. Therefore, Greece et al had it ‘made in the shade’; their debt levels are in the region of 80-110%, so what was all the fuss about?
Now that’s what I call oversimplification.
This is quite true Rob.
There are two elements of interest here.
1. The value of the assets exchanged for this liquidity.
2. The fact that QE was ostensibly intended to encourage banks to recommence private lending. In fact, much of this money was recycled into buying US government instruments. And as Rob implies, this recycling does enable the US government to ramp up its indebtedness, at least in the short term.
To me, the interesting question is whether the Obama administration really expected the QE funds to do what they said they expected them to do, or conversely to help to fund the burgeoning US deficit.
Katz @ 20:
Exactly … that liquidity needed a home. Let’s not forget, throughout the crisis, the imperative of the private sector was to deleverage; indeed private debt capital markets were effectively closed until the early part of 2009.
I think the US and European financial sector is still extremely tentative, and will remain so for a long while. Yes, institutions commenced recapitalisation in 2009, and many successfully so. But much of that was underpinned by State guarantees, State-mandated sell-offs, and punitive covenants – not to mention the favourable equity market conditions.
Katz you’re right: sovereign risk is more and more looking like an unintended consequence of liquidity support. We’re kind of expecting this support to galvanise the financial sector into a sprint; problem is, this sector needs a pair of legs first.
In the meantime, governments are wearing the cost, and the public are doing the maths.
The problem with China is that it is still thinking like a small business. A small business is too small to have much effect on the financial health of its customers so it sells what it can.
However, the Chinese economy is large enough to have a very significant effect on the financial health of its customers. In particular, its very success in creating a large trade surplus against America is undermining US capacity to continue buying from China. For this reason the Chinese model is unsustainable. Either China will rethink its position and move to balance its trade or the US will start doing something to wind back imports and rebuild its manufacturing industry. The reality is that while China needs the US the US would be better off if the Chinese economy collapsed.
We are at serious risk until China recognizes that it is no longer a small business and starts to become seriously concerned re the financial health of its customers.
Nice.
“Whether it be by ‘ordinary’ use of monetary policy, or by the purchase of banks’ holdings of “troubled assets”, or through the purchase (by a central bank) of other government or commercial paper through QE, all have the effect in one way or another of supporting liquidity.”
I think both you and Katz need to bone up on what economists mean by the term liquidity. Ordinary use of monetary policy is not a liquidity support measure. Jump on the ECB’s website for example and read their statements set out clearly how their liquidity support measures are distinct from their monetary policy stance.
And I am not confused. The Fed was not selling Treasuries on behalf of the government, they were actively purchasing them. That is what quantitative easing is. The purchase of government paper using “new” money to expand the money supply.
The issue I had with your original statement was that you seemed to be implying that if QE was successful it would provide liquidity to financial institutions without altering inflation expecations. I think that is wrong because the one of the primary aims of QE is to raise inflation expecations (or maintain them) when there is a risk of deflation or undue disinflation.
If I misinterpreted you, then I apologise.
“Because it is ultimately the private sector that has to fund any fiscal budget going forward. Much of the financial crises turmoil has been transferred: from private to public. But it is the private sector that needs get back on track and continuing State intervention, in any way, shape or form, is unlikely to ever address the core issues.”
This is simplistic. The financial crisis was both a liquidity and solvency crisis that had a large real impact on the economy. Households and firms in part responded to the crisis and their perceived decline in wealth by raising their saving rates and deleveraging. If the public sector had not reduced its own saving rate to offset the increased private sector saving rate the economic consequences would have been horrendous. At the same time, central banks have provided a combination of liquidity support, banking guarantees/troubled asset programs and monetary policy support measures to help ease private sector credit constraints. Through these policies they are accommodating the budget deficit. In the short-run that is the right thing to do. Bond markets will only become concerned if they think that the short-term accomodation of the deficit will continue into the medium term and undermine the real value of their bond holdings.
The important issue now is the appropriate timing and scale of exit strategies. The concern about the US deficit should not be the magnitude of the current deficit per se, but whether the government/congress has a credible plan for restoring fiscal sustainability. Current long-term bond yields suggest that the bond market is not unduly concerned about future inflation or solvency. That could change of course, but it is hardly the most likely scenario.
“In the meantime, governments are wearing the cost, and the public are doing the maths.”
I just don’t know what you mean by this. Only a small number of countries have seen their long-term borrowing rates increase noticeable in recent months. Most governments are funding their borrowing at much cheaper rates than before the crisis began. The currrent 10 T-bill yield in the US is 3.8%! While that is up from its trough at the end of 2008, it is way below its 10 year average. Moreover, the yield is excactly the as it was 8 months ago. So, what cost are governments wearing and what math is the public doing? THe US is not Greece or Portugal.
“The reality is that while China needs the US the US would be better off if the Chinese economy collapsed.”
That is one of the silliest things I’ve read in years. Financial risk aversion would go through the roof if the Chinese economy collapsed, not to mention the impact it would have on global demand. How on earth would the US be immune from that process?
Katz:
“Here, you appear to be confused. The “purchasing of treasuries” you refer to, I presume, is the sale of treasuries by the Fed on behalf of the US Government (and not the opposite transaction).”
The Fed:
“As a third set of instruments, the Federal Reserve has expanded its traditional tool of open market operations to support the functioning of credit markets through the purchase of longer-term securities for the Federal Reserve’s portfolio. For example, in November 2008, the Federal Reserve announced plans to purchase up to $100 billion in government-sponsored enterprise (GSE) debt and up to $500 billion in mortgage-backed securities. In March 2009, the Federal Reserve announced plans to purchase up to $300 billion of longer-term Treasury securities in addition to increasing its total purchases of GSE debt and mortgage-backed securities to up to $200 billion and $1.25 trillion, respectively.”
LO , maybe a year ago I was wondering about the genius of the Wall Street workers- how they managed to create a situation where they could sell long term debt at such low rates. The US T-bill 30 year bond was paying under 2%.
Even more outstanding is that they have shovelled private debt onto the various governments and they in turn are transferring this to the taxpayer.
Time for big bonuses all round!
Murph, I certainly won’t disagree with you that the incentives built into the financial system are perverse. The adage “heads we win, tails you lose” has more than a ring of truth to it unfortunately. That said, it seems to me that when the crisis hit, Bernanke and co had little choice but to act as they did. The disappointment is that subsequant financial reform has been so lacklustre.
Labor Outsider, your lengthy response has a sense of bigotry about it: it’s as if you have to be right.
This whole crisis was extremely complex. There are many ways of looking at it; people will come to it with different perspectives. It cannot be explained-away in a couple of paragraphs. Though perhaps you think it can.
Allow me to “dissect” a couple of your comments:
The Fed (or the central bank itself) does not purchase a debt security. It provides the ability for its primary dealers to do so by introducing new funds. The private sector needs to be involved in some way, otherwise how does the augmented money supply support liquidity in the commericial banking sector? Where it’s most needed.
I don’t understand what this means at all. So are you saying that the central bank is pushing for higher inflation? This seems counter-productive.
You have said that my broad statement:
was simplistic. Well, shit, it wasn’t meant to inspire much awe! And it was a simple summary, really. But if that was simple, your counterpoints would have to complex, right?
Now THAT’S simple!
So is that.
That’s bleedin’ obvious.
I said:
You said you didn’t understand! What is this whole topic about Labor Outsider? It’s about sovereign risk: governments with significant borrowings. Surely we agree there is a cost associated with that. The public “doing the maths” is a throw-away line which you clearly have over-analysed. It means the public is now interested in the question of how we are to work through this, as a society? Shit, the whole point you and I and others are on here?
You said:
So low borrowing rates now means everything is OK? The crux, which you also admit, is about the ramifications of repaying the principal!
More complex stuff from you:
I gathered that, not least because the former is to the west of the Atlantic, and the latter two are to the east.
I’ll end where I started: It’s a complex issue, not easily explained. But you need to forget about dissecting everyone’s individual sentences with a view to asserting your high-ground, and approach the subject holistically. This would enable you to be able to add some insight to the discussion.
PS Quantitative Easing is exactly the same as a central bank’s Open Market Operation activities: the latter ceases to be effective because the equilibrium price of money is nigh on Zero.
If you agree that QE supports cash liquidity and results in an augmented money supply, then you also have to accept that when an overnight Cash rate moves the money supply has also changed and it has an effect on liquidity aswell!
Forget the mechanics of QE. I think we can all agree that it’s designed to stabilise and stimulate.
Though after all that bollocks, what is your view on European Sovereign Risk Labor Outsider? You’ve used the US as a case in point and seem to conclude everything there is quite rosy.
Is the current vicious cycle sustainable?
“I don’t understand what this means at all. So are you saying that the central bank is pushing for higher inflation? This seems counter-productive.”
That is of course what I am saying. From a central bank’s perspective the optimal inflation rate is positive. Why do you think Japan was employing QE for all those years? They were trying to exit from deflation. Although the Fed is not an inflation targeter it implicitly has an inflation target close to 2%. If it think that macrofactors are likely to push inflation below that target they will take policy measures that to ensure the target is reached at some desired horizon.
“The private sector needs to be involved in some way, otherwise how does the augmented money supply support liquidity in the commericial banking sector?”
I never said the private sector wasn’t involved. QE involves purchasing treasuries from financial institutions with newly created money and then holding those treasuries on the Fed balance sheet. I was making the point that it was wrong to say that Fed was selling treasuries when in fact it was purchasing them.
Look, I’m a macroeconomist by training and profession. I found some statments misleading. I tried to qualify them. If you thought I was being unfair. I apologise.
Of course there is a cost to borrowing. But like anything that has a cost the question is whether the borrowing was worthwhile and whether it is sustainable. For example, should we be worried that the US net public debt path is explosive? My view would be that the US deficit has to come down considerably but there is good reason to believe it will. I am confident that the US will neither default on its debt or pursue policies that push inflation to high levels to reduce the real value of that debt.
Bond markets are less confident that some euro area countries will do the same. Greece, Portugal, Spain and Italy all have long term competitiveness problems but lack the policy will to do what is necessary within a currency zone to raise competiveness. Their fiscal problems are quite acute. Without the implicit backing of other euro area countries yields on Greek bonds would be even higher. That said, the most likely scenario is that Greece receives support from other European countries, with stiff conditions attached. Those actions will ease the concerns of the bond markets and current concerns about sovereign risk will abate.
So, when you talk about a vicious cycle and whether it is sustainable, I’d say no – governments continuing to borrow at current rates is not sustainable. But no government has the intention of borrowing at current rates with most if not all intending to raise their own saving as private sector confidence returns and private demand becomes more self-sustaining. In the meantime, for governments wanting to avoid the judgement of the market and face much higher borrowing costs it is incumbent upon them to provide clear, credible plans for fiscal consolidation as economies recover.
There is a middle ground between saying everything is rosy and saying that sovereign defaults are likely.
Btw – the opposite of simplistic is not complex. Simplistic refers to statements that are not just simple, but misleading. They don’t need to be countered with statements that are complex, just accurate.
Look, I probably should have been less grumpy and high minded before. It is just that what often passes for economic commentary on this blog is pretty bad. But you (and Katz) clearly have a good insight into economic matters and so I shouldn’t have been dismissive of your views.
Interesting discussion, thanks LO, Rob and Katz.
Question on discussion above re China-US economic dynamic, how would the large US debt to China come into play, should the China economy go sour?
http://news.bbc.co.uk/2/hi/business/8518438.stm
Record monthly drop in foreigners buying US debt. It is only a single figure however.Japan now holds greater amount than China.
IIRC US households still hold US treasury bonds to an amount equal or greater than foreigners .
Interestingly, and quite unexpectedly, the Fed has raised the discount rate, citing inflation concerns.
And inflation is occurring in a financial environment where bank loans to private investors has continued to plummet. Indeed the Telegraph reports that bank lending in the US has plummeted more rapidly in 2010 than at any other time in history, a history that includes the great credit contraction of the Great Depression.
These two facts would suggest that whatever the Federal Government and whatever the Federal Reserve Bank were trying to achieve with low interest rates and with quantitative easing isn’t working.
And now, perhaps, the Federal Reserve Bank has lost its nerve, seeking monetary stability over economic stimulus when those two objectives are, at last, perceived to be contradictory aims.
The above is not unconnected with this:
Arguably, the Federal Reserve knows that interest rates must rise to restore Chinese appetite for US government paper.
But, of course, rising interest rates only serve to depress further the historically unprecedented fall in appetite for commercial loans from US banks. This state of affairs is disastrous for recovery of the jobs market in the medium term.
Jobs, especially jobs traditionally done by the white middle class, are unlikely to reappear for quite some time.
Is it true that the Obama administration and the Federal Reserve Bank have broken ranks and are now pursuing contradictory approaches to achieving recovery?