Financial crisis

On Monday 13th May, I participated in a debate on austerity organised by the New York Review of Books, held in the Sheldonian Theatre, Oxford. The motion was: “Austerity in the Eurozone and the UK: Kill or Cure?”. Those arguing in defence of austerity were Meghnad (Lord) Desai and Sir John Redwood MP. On my side was Lord (Robert) Skidelsky. Here is the speech I presented – a version of which was published in the New York Review of Books, July 11, 2013, Volume 60, Number 12. It can also be found at Read more

A commenter, A.N., objects to my argument that the big reason for the explosion in government bond yields in Spain was not its debt dynamics, which are remarkably like the UK’s, but because it does not have a lender of last resort, as the UK does.

He responds that the debt dynamics of France and Germany were just like Spain’s. But they were not similarly punished. In any case, the facts are clearly otherwise. These are the relevant data for the three mentioned countries. It is quite clear that Spanish debt dynamics are far worse than those of France and Germany. Read more

Roger Altman of Evercore partners is a friend of mine, a distinguished public servant and a respected financial expert. But his column “Blame bond markets, not politicians, for austerity” is, in my view, gravely mistaken. Read more

I recently looked at what happened to private financial balances inside the eurozone. Today’s post looks at what happened to the current account deficits. It fills out the broad story of the eurozone’s across-the-board shift into becoming a very large capital exporter. It is complementary to an excellent post by Gavyn Davies, who addresses the sources of the ongoing adjustment.

As it happens Michael Pettis, professor at Peking University, and author of the excellent book, The Great Rebalancing (Princeton and Oxford: Princeton University Press, 2013) has a complementary post.

In this, he argues that Spain had no choice over what happened to it during the 2000-07 period, given the deliberate policies of Germany, which were aimed at generating a large current account surplus (“improving competitiveness” being the normal way of talking about this form of structural mercantilism). If one’s principal trading partner is seeking to generate a huge current account surplus and so exporting capital, he argues, then a country is effectively forced into running the counterpart deficits, whatever the consequences.

I agree with this analysis of what happened. Indeed, I have argued along these lines for several years, in trying to explain the roots of the eurozone crisis, which is a balance-of-payments cum financial crisis, of which fiscal deficits are a symptom, not, except in the case of Greece, a cause. Read more

“Against the background of renewed market tensions, euro area members of the G20 will take all necessary measures to safeguard the integrity and stability of the area, improve the functioning of financial markets and break the feedback loop between sovereigns and banks. We welcome the significant actions taken since the last summit by the euro area to support growth, ensure financial stability and promote fiscal responsibility as a contribution to the G20 framework for strong, sustainable and balanced growth. In this context, we welcome Spain’s plan to recapitalize its banking system and the eurogroup’s announcement of support for Spain’s financial restructuring authority. The adoption of the fiscal compact and its ongoing implementation, together with growth-enhancing policies and structural reform and financial stability measures, are important steps towards greater fiscal and economic integration that lead to sustainable borrowing costs. The imminent establishment of the European Stability Mechanism is a substantial strengthening of the European firewalls. We fully support the actions of the euro area in moving forward with the completion of the Economic and Monetary Union. Towards that end, we support the intention to consider concrete steps towards a more integrated financial architecture, encompassing banking supervision, resolution and recapitalization, and deposit insurance. Euro area members will foster intra euro area adjustment through structural reforms to strengthen competitiveness in deficit countries and to promote demand and growth in surplus countries. The European Union members of the G20 are determined to move forward expeditiously on measures to support growth including through completing the European Single Market and making better use of European financial means, such as the European Investment Bank, pilot project bonds, and structural and cohesion funds, for more targeted investment, employment, growth and competitiveness, while maintaining the firm commitment to implement fiscal consolidation to be assessed on a structural basis. We look forward to the euro area working in partnership with the next Greek government to ensure they remain on the path to reform and sustainability within the euro area.”


This was the section of this week’s G20 communiqué that dealt with the eurozone.

Let us examine it closely.

“Euro area members of the G20 will take all necessary measures to safeguard the integrity and stability of the area, improve the functioning of financial markets and break the feedback loop between sovereigns and banks.”

The crucial word here is “necessary”. We can safely say that agreement on what this means is altogether lacking. Read more

What do eurozone leaders want most at the meeting of the World Economic Forum? To cease being viewed as the source of global economic threats and return to being a source of economic solutions. It is far more fun – let alone more dignified – to lecture others on their faults than to be lectured on one’s own. It is even more humiliating when those lectures are thoroughly deserved.

Unfortunately for the eurozone, there is no chance that its policymakers will escape blame in Davos. They will argue that they are on the way to a resolution. Alas, the more percipient of them, as well as their peers from around the world, know they are not. Their visit to the Swiss mountains will be a discomforting experience.

The eurozone is almost universally regarded as the source of the pre-eminent threat of an economic meltdown. The risk is that both banks and sovereigns could default, probably triggering – or triggered by – a partial or complete break-up of the eurozone. Such a wreck may still be regarded as unlikely, but it is no longer inconceivable.

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Capitalism in crisis

Three years ago, when the worst financial and economic crisis since the 1930s gripped the global economy, the Financial Times published a series on “the future of capitalism”. Now, after a feeble recovery in the high-income countries, it has run a series on “capitalism in crisis”. Things seem to be worse. How is this to be explained?

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What can we see in the world economy in 2012? Risks galore, is the answer.

The debt crisis of the high-income countries is already four and a half years old. Yet it shows no sign of abating, particularly in the eurozone. While emerging and developing countries are in reasonably robust condition, they would be vulnerable to an intensification of the crisis, which could hit them via several channels: trade, finance and remittances. Many countries – both high-income and developing – are in a weaker condition than they were in 2008 and would, accordingly, find it harder to respond effectively.

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AP/Bernd Kammerer

AP/Bernd Kammerer

In the most recent post, I discussed the fullest analysis yet by Hans-Werner Sinn (together with Timo Wollmershäuser), president of the Ifo Institute in Munich, of the role of the European System of Central Banks in funding the balance of payments imbalances inside the eurozone.

While this post elicited many interesting comments, none, I believe, invalidated Professor Sinn’s basic thesis, which is that monetary financing of the balance of payments (ie the current account deficit, plus net private capital flows) is large, growing and decisive in sustaining imbalances inside the eurozone.

Prof Sinn’s work has attracted much controversy. But this is not, in my view, because it is fundamentally wrong (although I think he did initially exaggerate the problems created for managing money and credit in Germany itself), but because it reveals what many policymakers and observers would like to conceal. Read more

I wrote a column on November 24 2011 entitled “Why cutting fiscal deficits is an assault on profits”. My point was summarised as follows: “If the government wishes to cut its deficits, other sectors must save less. The questions are ‘which ones’ and ‘how’. What the government has not admitted is that the only actors able to save less now are corporations. The government’s – not surprisingly, unstated – policy is to demolish corporate profits.”

This column was based on data for the sectoral financial balances in the UK and US. In this comment, I wish to elaborate on this theme, in three ways: first, I would like to show the charts from which my comments were drawn; second, I wish to describe the argument of a note by David Bowers of London’s Absolute Strategy Research (The Fiscal Risks to Corporate Free Cash Flow, November 17 2011), who has elaborated interestingly on this theme; and, finally, I want to consider the broader relevance of this way of thinking about macroeconomic adjustment. Read more

This is Martin Wolf’s response* to Andrew G Haldane’s “Control rights (and wrongs)” Wincott Annual Memorial Lecture, on October 24, 2011

In this lecture, Andy Haldane, executive director for financial stability at the Bank of England, provides a compelling account of the development of western – above all British banking – over the past two centuries. He demonstrates the consequences of a progressive divorce between who controls the banks – shareholders and managers – and who bears most of the risks – society at large and, in particular, taxpayers.

Mr Haldane shows that each step along this road to ruin seemed reasonable, even inescapable. Yet the journey has ended up with over-leveraged behemoths that are too big to fail and, increasingly, too big to save.

Between one and a half and two centuries ago, it was common for equity to account for half of a bank’s funding and liquid securities to account for as much as 30 per cent of its assets. Financial sector assets accounted for less than 50 per cent of UK gross domestic product and the largest banks had assets of less than 5 per cent of GDP. Read more

According to a FT article last week, Lloyds’ bank has a target return on equity of 14.5 per cent. Banks like to argue that this is the level of return on equity they need to earn, in order to gain funding from the markets. Naturally, remuneration is linked to achieving such objectives. The question, however, is whether such objectives make any sense. The brief answer is: no.

Forget banks, for the moment. What would you say if someone offered you an investment with a promised real return of close to 15 per cent? You might say: “How much can I buy?” Alternatively, you might say: “What is the catch?” Sensible people must take the latter view. If you thought that you were being offered a reliable real return at such an exalted level, you would buy as much as you could. This must be particularly true now when real returns on the bonds of relatively safe governments are close to zero.

So what is the catch? The obvious answer has to be that the real return in question is extremely risky, because it is volatile and offers a significant chance of total wipe-out. Read more

Anniversaries are a time to take stock, to ask where we have been and where we might be going. 2011 offers three remarkable anniversaries: the economic reform of India and the fall of the Soviet Union, both in 1991; and the terrorist attack on the US on 9/11/2001. What should we think about these three events, today? Here are a few tentative answers.

Is it too soon to tell? Yes. It always is. Each generation changes its view of the past in light of the present. That will continue, if not forever, at least indefinitely. We might well disagree about the significance of events that took place centuries ago. It is far too early to tell what these events might mean. Today, for example, 9/11 looks far less significant than it did at the time. One significant act of nuclear terrorism would transform that judgement.

Which of these events might posterity view as the most important? My guess is that it will be the economic reforms in India. The decision of the Indian government, under prime minister P. V. Narasimha Rao and his then finance minister Manmohan Singh (the present prime minister of India) to launch fundamental economic reforms on July 24 1991, in response to a severe balance of payments crisis, was a world-transforming event, in at least five respects. Read more

“You can’t cut debt by borrowing.” How often have you read or heard this comment from “austerians” (a nice variant on “Austrians”), who complain about the huge fiscal deficits that have followed the financial crisis? The obvious response is: so what?  Read more

Last week I went to South Korea, to give the opening keynote speech at a conference organised by the government of the Republic of Korea on “Financial Reform: An Emerging Market Perspective”. This conference was part of the preparation by the South Korean government for the summit of the Group of 20 leading countries, which will take place in Korea in November. An objective of the South Korean government is to focus attention on the perspective of emerging economies on the crisis.  Read more

The future of fiscal policy was intensely debated in the FT last week. In this Exchange, I want to examine what is going on in the US and, in particular, what is going on inside the Republican party. This matters for the US and, because the US remains the world’s most important economy, it also matters greatly for the world.

My reading of contemporary Republican thinking is that there is no chance of any attempt to arrest adverse long-term fiscal trends should they return to power. Moreover, since the Republicans have no interest in doing anything sensible, the Democrats will gain nothing from trying to do much either. That is the lesson Democrats have to draw from the Clinton era’s successful frugality, which merely gave George W. Bush the opportunity to make massive (irresponsible and unsustainable) tax cuts. In practice, then, nothing will be done.

Indeed, nothing may be done even if a genuine fiscal crisis were to emerge. According to my friend, Bruce Bartlett, a highly informed, if jaundiced, observer, some “conservatives” (in truth, extreme radicals) think a federal default would be an effective way to bring public spending they detest under control. It should be noted, in passing, that a federal default would surely create the biggest financial crisis in world economic history.

To understand modern Republican thinking on fiscal policy, we need to go back to perhaps the most politically brilliant (albeit economically unconvincing) idea in the history of fiscal policy: “supply-side economics”. Supply-side economics liberated conservatives from any need to insist on fiscal rectitude and balanced budgets. Supply-side economics said that one could cut taxes and balance budgets, because incentive effects would generate new activity and so higher revenue.

The political genius of this idea is evident. Supply-side economics transformed Republicans from a minority party into a majority party. It allowed them to promise lower taxes, lower deficits and, in effect, unchanged spending. Why should people not like this combination? Who does not like a free lunch? Read more

First comes financial crisis; then comes sovereign debt crisis; then comes financial repression. This is the view of Carmen Reinhart, co-author of This Time is Different, the masterly study of financial crises through the ages. I recently had a fascinating conversation on this topic with her, here in New York, where I have been living since the beginning of April.

So the question for the exchange is: how likely is financial repression? What forms might it take? Might this even be the end of the era of globalised finance? Read more

Update: Read Martin’s final response to readers’ comments.

The question I wish to pose for the next two weeks is whether it is possible for countries to accept large net inflows of capital from abroad, without ending up in crisis. If not, how do we manage a world of capital mobility? Read more

EU flagOne of the most interesting set of questions to arise out of the Greek crisis in the eurozone is whether – and, if so, what – institutional changes are needed to make it easier to manage disarray of this kind.

Some would argue that there is really no problem. When countries within the eurozone get into difficulty, they are supposed to look after themselves. The European Central Bank should continue to look at the performance of the economy as a whole. Meanwhile, given the “no bail-out” provisions of the treaty, each country must be on its own. If a country cannot raise the money it needs to finance its government, it has no choice but to raise taxes, cut spending and, in extremis, restructure its debt. The latter is likely to mean a deep recession, not least because the private sector is likely to be badly affected by a sovereign default. This would be particularly true for the financial sector. Read more