Part I

I admire Peter Sands, the group chief executive of Standard Chartered. Unlike many of his peers, he does not rely on making arguments behind closed doors. He is prepared to make arguments publicly, instead. He did this in a piece he published in the FT last week (“The dangers of our new regulation”).

The fact that I admire Mr Sands, does not mean I agree with him. On the contrary I found this article valuable, not because I thought it right, but because I found it revealingly wrong.

Mr Sands starts by saying that Standard Chartered (a bank that has, by the way, almost no business in the UK) supports the idea of macro-prudential regulation.

Nevertheless, he argues, the approach taken by the Bank of England’s interim Financial Policy Committee to which responsibility for such regulation will be transferred in forthcoming legislation is “extremely interventionist and extraordinarily blinkered”. Read more

The real interest rate on US and UK government debt is currently near to zero (see chart 1). This is a remarkable fact. True, real interest rates were negative in the 1970s. But it is extremely unlikely that anybody bought bonds expecting this to be the case.

Now, however, the position is quite different. Both of these governments sell index-linked debt that delivers zero real returns. That is a demonstration of the fact that the world has a huge “savings glut”. Indeed, since savings must equal investment at the global level, it is only by its price – the rate of interest – that one can assess whether such a glut exists. Read more

The answer to this question is an unambiguous “yes”. It is not possible, it is true, to have a currency crisis inside a currency union, provided the currency union is credible, though currency risk returns, implicitly, as soon as it is not. But balance-of-payments and currency crises are NOT the same thing. A balance-of-payments crisis can show itself in a currency union in one (or, more likely, both) of two ways: as a credit crisis or as a regional economic slump.

The fundamental point was made by the British economist, Tony Thirlwall, in a column entitled “Emu is no cure for problems with the balance of payments”, in the Financial Times of October 9 1991. In this he was responding to the then widespread argument that “we don’t talk about the balance of payments difficulties of Scotland, Wales and the North of England, or of Sicily and Apulia. But this does not mean that they don’t exist.”

Let us start at the most basic level: that of the individual. Can individuals have a balance of payments crisis? Certainly. 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

Mario Draghi

Mario Draghi, December 8, 2011. Image by Getty.

Will the European Central Bank save the eurozone? This is an extremely controversial question. What is clear, however, is that the central bank is the only entity with the capacity and the calling to do so. Without the euro, the ECB ceases to exist. That is true of no other eurozone institution. It gives it the incentive to act. It is also acting on a large scale.

The resistance to funding governments by purchasing bonds on a large scale, even in secondary markets, remains strong, as Mario Draghi, the new president of the ECB made plain in his interview with the FT on December 18.

Nevertheless, he argued, the ECB took important action the week before:

“We cut the main interest rate by 25 basis points. We announced two long-term refinancing operations, which for the first time will last three years. We halved the minimum reserve ratio from 2 per cent to 1 per cent. We broadened collateral eligibility rules. Finally, the ECB governing council agreed that the ECB would act as an agent for the European Financial Stability Facility (EFSF).”

Thus the ECB is determined to fund banks freely, at low rates of interest, thereby subsidising them directly and the governments they lend to, indirectly. 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

Iceland was the first country devastated by the financial crisis. Lehman Brothers failed on September 15 2008. By October 9, its three big banks – Glitnir, Landesbanki and Kaupthing – had collapsed. The UK government seized Landesbanki UK under anti-terror laws, while Gordon Brown, the prime minister, threatened to seize Icelandic assets in the UK. On October 24, Iceland agreed a deal with the International Monetary Fund.

On October 27 2011, I attended a conference jointly organised by the IMF and the government of Iceland to celebrate Iceland’s graduation from the programme and evaluate the outcome of the rescue. I also moderated the final panel.

The programme remains controversial. Jón Daníelsson of the London School of Economics presented a critique during the conference. Others presented critiques from outside.

What happened to Iceland is clear: its banks ran amuck. 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

Steve Jobs

Image by Getty.

I am a member of a cult. That cult is Apple. Its prophet was Steve Jobs. I am not a shareholder of the company. But I am – and have been for 31 years – a devotee of its products.

This started in 1980, with purchase of the Apple II for a World Bank research project I had promoted. I did not myself use the machine. But I could see the immense advantages of having such a computer for our own use rather than relying on remote access to a mainframe computer under someone else’s control. 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

The Wolf Exchange will now restart. During the year I spent working on the UK government’s Independent Commission on Banking, whose report will appear on Monday 12th September, I could not continue with this venture. I hope to do so now.

My plan is to produce a substantial piece every two weeks, starting now. I hope also to write shorter pieces in between. The topics will be mostly, but not exclusively, about economics. I expect to respond relatively briefly to comments before the next big post. But I will not respond as actively as I did before. That way, I have discovered, madness lies. I will not respond at all to abusive, irrelevant or foolish comments. I will try to respond to comments that are courteous, relevant and thoughtful.

I am writing this in Xi’an, ancient capital of the Chinese empire. This is where the famous terracotta warriors were found, mute witnesses to the scale, resources and organising capacity of the ancient Chinese state. Xi’an is a city of 8m, in the middle of the country Read more

During any period of monetary disorder – the 1970s, for example, or today – a host of people calls for a return to the gold standard. This is not the only free-market response to the current system of fiat (or government-made) money. Other proposals are for privatising the creation of money altogether. (See, on this, Leland Yeager, professor emeritus at the University of Virginia and Auburn University, in the latest issue of the Cato Journal.) But the gold standard is the classic alternative to fiat money. Read more

Should we view the media market as similar to the market for baked beans? Or should we view it, instead, as being unique? If we accept the latter perspective, what implications might this have for ownership of media outlets? These are hugely important questions for the future of democratic societies.  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 posted a section of a speech I delivered in Seoul 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. This week, I am posting the most important section, on reform. This looks at the twin aspects of the global challenge: macroeconomics and so the global imbalances; and microeconomics and so the regulation of finance. Read more