Monthly Archives: May 2012

The US treasury department released its semi-annual report on international economic and exchange rate policies last Friday. As usual, the main interest centred on the treasury’s comments about China’s exchange rate policies, which are the subject of contention in the US Presidential race. Mitt Romney says his first act on taking office will be to label China as a “currency manipulator”, which no-one has done since the Clinton years.

While the debate in US politics is far from over, the economic case for labelling China as a currency manipulator has weakened recently. The mix of China’s foreign exchange and domestic economic policies has improved markedly in the past couple of years, a development which will rebound to the benefit not only of China, but the rest of the global economy as well. Read more

Getty Images

Getty Images

Based on the latest opinion polls, the Greek election could result in a highly confused outcome, with the new government being unable or unwilling to meet any budgetary terms acceptable to the Troika, but also unwilling to leave the euro voluntarily. What would happen then?

Economists like Thomas Mayer (Deutsche Bank) and Huw Pill (Goldman Sachs) have recently argued that, in these circumstances, Greece might resort to a “parallel” currency which would be used for some domestic transactions, while keeping the euro in place for existing bank deposits and for foreign transactions. Thomas is favourably disposed to the idea, while Huw foresees many problems with it.

Although I am not at all convinced that this would be a stable solution, since it might just be a prelude to much higher inflation in Greece, it is the kind of fudged development which can appeal to politicians. It could therefore have a part to play in the future of the eurozone. Anyway, it is destined to be widely discussed in coming weeks. Read more

A bank run is now happening within the eurozone. So far it has been relatively slow and prolonged, but it is a run nonetheless. And last week, it showed signs of accelerating sharply, in a way which demands an urgent response from policy-makers.

The fear of bank runs is deeply ingrained in all economists who know anything about the genesis of the Great Depression in the United States in the early 1930s. Then, the failure of the Bank of United States in December 1930 led to multiple bank runs across the country. Bank failures in the following two years wiped out personal savings and greatly exacerbated the collapse of demand in the economy.

The classic account of the crisis, by Milton Friedman and Anna Schwartz, concluded that the collapse was largely the fault of the Federal Reserve, which failed to provide enough liquidity to keep the banks functioning and thus end the panic. After the crash, the establishment of the Federal Deposit Insurance Corporation was intended to ensure that deposit holders never again had to live in fear that their savings would be in jeopardy. What are the lessons for the eurozone? Read more

A few weeks ago, I wrote that the twists and turns in the eurozone crisis had, in the early months of 2012, lost the power to shock global asset prices. The reason given was that the prophylactic provided by the use of the ECB’s balance sheet essentially trumped the deteriorating economic fundamentals in several countries, notably in Spain. This view has since been severely challenged, but it has just about remained intact; after all, American and Asian equities are still 6-7 per cent up so far this year.

However, the crisis which surrounds political events in Greece threatens to change all that. This is the first major revolt by any electorate against the eurozone’s austerity policies, and it is those policies which have underpinned the willingness of the ECB to use its balance sheet to rescue the banking system. Furthermore, Greece is just the tip of the iceberg. The swing against austerity by voters in the eurozone is manifesting itself in many different places. I have been wondering whether this is good or bad news for the resolution of the crisis. Read more

With the Chinese economy seemingly in the midst of a fairly soft landing, global investors have not been paying much attention to China in recent months. However, all that will change as a result of the extremely weak Chinese activity data for April which were published last week. Asian equities and commodity prices have already fallen this quarter, and that will turn into a global problem if the April activity data are a harbinger of things to come.

The April data have not only shaken investors out of their earlier complacency, they have clearly affected policy makers too. The cut of 50 basis points in the banks’ reserve requirement ratio announced on Saturday suggests that the urgent need for a policy injection is at last being recognised. The question now is whether Chinese policy makers, in sharp contrast to their normally sure-footed behaviour,  have left it too late to stem the downward momentum in the economy, and especially in the property sector.  Read more

For the first time in quite a while, the Monetary Policy Committee of the Bank of England has today made a knife-edge decision which genuinely might have gone either way. The outcome, which was to leave the total of quantitative easing unchanged at £325bn, tells us something about the inflation fighting credentials of the MPC, which have been widely questioned in the financial markets. And it also tells us something about the way in which other central banks, including the Fed, might react to similar, if less strained, economic circumstances in coming months. Read more

Central bank balance sheets in the major economies now range from 20 to 30 per cent of GDP, two-thirds of which is due to the emergency measures that have been taken to stimulate economies since the crisis began. As far as I am aware, the global scale of this action is completely unprecedented.

Critics see these bloated central bank balance sheets as the culmination of a decades-long process in which periods of excessively easy monetary policy have caused inflation, asset price bubbles and misallocation of investment flows in the economy. For example, this FT piece by former Republican presidential candidate Ron Paul concludes as follows:

“The world is awash in US dollars, and a currency crisis involving the world’s reserve currency would be an unprecedented catastrophe.”

Such an outcome is perhaps conceivable, but is far from inevitable. Read more

Today’s governing council meeting at the ECB marked a return to “business as usual” after the dramatic injections of liquidity into the banking system in December and February. The ECB understandably wants to return to its regular duties, where it focuses on keeping inflation below its 2 per cent long term target, and is desperate to shift the burden for other aspects of managing the eurozone economy back to member governments.

Mario Draghi’s main message in recent weeks has been that “the ball is in the court of governments” in three different ways: the need for fiscal consolidation, bank recapitalisation and a “growth strategy” involving labour and product market reform. Assuming satisfactory progress on these three objectives, the ECB would retire to the relative obscurity of inflation control, a place where it is always happy to find itself. “Non standard” monetary measures, which involve the use of the ECB balance sheet to finance troubled banks and sovereigns, would no longer be needed.

Unfortunately, it is improbable that the ECB will be granted its wish to remain on the sidelines for very long. The key question is how, when and where it will be called back into action. Read more