Monthly Archives: November 2008

I’m afraid this post is going to be rather boring (the comment “What’s new?” is taken as made). I intend to take you on a trip through Barack Obama’s Transition Economic Advisory Board.

AIG, the walking-dead insurance giant, is reported to have gone through $81 bn or so of the $122.5bn worth of financial facilities provided by the Fed since September 2008, first through an expensive (850 basis points over 3-month Libor) 2-year $85 bn facility and soon after through a rather cheaper (as far as I can tell) $37.5 supplementary facility.  Not only is AIG seeking additional Federal assistance.  It is also arguing that the original $85 bn facility is unfairly expensive, compared to the 5 percent plus some warrants charged by the US Treasury for its capital injection into nine large US commercial banks.

AIG is correct in noting and complaining about the inexplicable discrepancy between the cost of official funds charged to the nine banks and that charged to AIG.  The unfairness, indeed the outrage, however, lies in the US Treasury injecting equity into the nine US commercial banks on sweetheart terms, way below what these banks ought to have paid for the money, and way below what it would have cost them to raise the money in the markets, whether from Warren Buffett or from Qatar.

 leaders2.GIF

Thanks to Frank Verrijcken for sending me this photograph and kudos to the photographer (identity unfortunately not known to me) who caught this vignette.

If I got a pound – even the current rather devalued pound – every time an English eurosceptic (it’s almost always an English eurosceptic, hardly ever a Scottish, Welsh or Northern Irish one) utters something utterly insane and hilariously wrong about the EU, the euro area or the euro, I would by now be rich enough to count Peter Mandelson among the regular visitors to my yacht.

Unfortunately, if complete nonsense or an outright falsehood is repeated often enough, it tends to become part of the mental furniture of the public.  This would be unfortunate, because now more than ever, it is essential that the UK give up its opt out from the third stage of Economic and Monetary Union and join the euro area as soon as possible.  I have therefore decided to use this blog to expose and denounce the half-truths, outright lies and nonsense promulgated by the eurosceptic media in the UK.  This is the first of what could become a long series of remedial education classes for eurosceptics.

My target today is Neil Collins’ column in the November 6, 2008 Evening Standard, London’s only remaining evening paper (not counting the two free rags). I will quote him at length so he can do himself an injustice:

“IS BOND MARKET TELLING ITALY ITS NUMBER’S UP?

If you’re thinking of tucking away a few euro notes in case the pound melts down and you can’t afford to cross the Channel, look at the numbers on the notes first. If they start with an X, and the digits of the serial number add up to a number ending in two, hang on to them. These are good, solid German euro notes, worth their face value. If they begin with S, with digits that add up to a number ending in seven, spend these first. They’re Italian euros, and with luck they won’t stand at a discount in Europe’s shops, or at least not yet.

If you think this is fanciful, look at the chart above. It shows the yield on 10-year Italian and Greek debt, less the return on the equivalent German government bond. I wrote last year that the risk of Italy falling out of the euro was underpriced at around 32 basis points (0.32 percent a year) and now the markets are waking up to the danger.”

The chart, not reproduced here, does indeed show the widening spreads of 10-year Italian and Greek government debt over German government debt (Bunds). On Friday, November 7, these spreads were 1.40% for Greece, 0.92% for Italy and 1.04% for Ireland.  As the government securities in question are denominated in the same currency (the euro) and are very similar in all respects except for the identity of the issuer, these spreads reflect differential sovereign default risk and differences in liquidity vis-a-vis Germany.

The Monetary Policy Committee of the Bank of England obviously subscribe to the dictum (often attributed to Keynes) “When the facts change, I change my mind – what do you do, sir?” They cut Bank Rate by 150 basis points to 3 per cent. In contrast, the ECB cut its official policy rate by a mere 50 basis points to 3.25 per cent. For the first time since the euro area was created on January 1, 1999, the official policy rate in the UK is below that in the euro area.

Despite being pleased with this bold move by the MPC, I feel a bit of an idiot. On October 26 I had called for a cut of between 100 and 150 basis points in my Financial Times blog Maverecon. Yesterday, after the horror show of the PMI services survey, I argued for a 150 basis points cut in an interview on the Daily Telegraph’s Telegraph TV. My prediction of what the MPC would do was not the same, however, as my recommendation of what it ought to do. I predicted a 100 basis points cut.

Standard boil-in-the-bag open economy macroeconomics tells us that expansionary fiscal policy, under conditions of perfect international capital mobility and a floating exchange rate is an ‘enrich-thy-neighbour’ policy as regards aggregate demand spillovers.  If the country is a price taker in the international financial markets, and if the fiscal action does not affect the foreign exchange risk premium, the fiscal impulse will be crowded out completely as regards any net impact on domestic aggregate demand, by an appreciation of the nominal and real exchange rates.  The external trade deficit increases by the same amount as the fiscal impulse, so the domestic fiscal expansion ends up spilling over 100% into a boost to aggregate demand in the rest of the world.

In economic policy as in life, the urgent but not necessarily most important invariably takes precedence over the important but not necessarily most urgent.  The current crisis is no exception.  The financial system is falling apart in front of our eyes and nightmare visions of another Great Depression of the 1930s are haunting us not merely in our dreams but even during our waking hours.

What could therefore be more natural than the near-universal tendency to create liquidity in any old way and on any terms, to inject capital into banks and to guarantee some or all of their liabilities without paying any attention to the manner in which this is done, to cut interest rates as far and as fast as technically possible and to roll out the Keynesian deficit-spending blunderbuss?  Natural and understandable, certainly.  But also most unwise and dangerous. This is how we got into this mess in the first place.

Maverecon: Willem Buiter

Willem Buiter's blog ran until December 2009. This blog is no longer active but it remains open as an archive.

Professor of European Political Economy, London School of Economics and Political Science; former chief economist of the EBRD, former external member of the MPC; adviser to international organisations, governments, central banks and private financial institutions.

Willem Buiter's website

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