YES WE CAN!! have a global depression if we really continue to work at it…

I used to be optimistic about the capacity of our political leaders and central bankers to avoid the policy mistakes that could turn the current global recession into a deep and lasting global depression.  Now I’m not so sure.

I used to believe that the unavoidable protectionist and mercantilist rhetoric would not be matched by protectionist and mercantilist deeds.  Protectionism was one of the factors that turned a US financial crisis into a global depression in the 1930s.  Protectionism imposes large-scale structural sectoral dislocation, as exporters are ejected from their foreign markets and domestic producers that depend on cheap imported imports suddenly find themselves to no longer be competitive, on top of the global effective demand failure we are already suffering from.

I used to believe that our central bankers would overcome their natural conservatism, caution and timidity to do what it takes to bring to bear the full measure of what the central bank can deliver on a disfunctional financial sector and on a depressed economy, at risk of deflation.  Now I’m not so sure.  While the Fed is turning on most of the taps (albeit in a unnecessary moral hazard-maximising way), the Bank of England and the ECB are falling further and further behind the curve.  What the Bank of Japan does, no-one fully understands, and I will observe a mystified, if not respectful silence.

I used to believe that our fiscal policy makers would, when faced with a combination of national and global disaster, manage to come up with a set of national fiscal packages that would be modulated according to national fiscal spare capacity and that would be designed not only to boost domestic and global demand but also to eliminate or at any rate reduce the underlying global imbalances that are an important part of the story of this global crisis.  Instead we find the US engaged in fiscal policies that will aggravate the underlying global imbalances.


The odious US House of Representatives has tagged a Buy American clause onto the Obama administration’s $819 bn (or more) fiscal stimulus bill.  If this were to become law, US federal spending would, wherever possible, be restricted to goods and services produced by US companies.  The main promotor of this act of global economic vandalism was the US steel industry, but other import-competing industries have lobbied also.  It is quite likely that the Buy American net will be cast even more widely when the Senate gets its turn at the fiscal stimulus act.

There is little doubt that if the Buy American provisions of the Economic Stimulus Package were to become law, this would amount to an economic declaration of war on the rest of the world.  The response of the assembled non-US finance ministers in Davos made this clear.  Retaliation from the EU countries and the rest of the world would follow swiftly.  Because this disastrous US Congressional actions follows so closely on Treasury Secretary Geithner’s declaration that China is manipulating its currency, it is essential that the Obama administration draw a clear line in the sand.  If anything like the Buy American clause inserted by the House survives in the bill president Obama gets on his desk, he must veto it.  The questionable value of the fiscal stimulus is overwhelmed by the unquestionable domestic and global harm caused by the Buy American clause.  If president Obama fails to veto a protectionism-laced bill, it will be clear that we have a wuss in the White House.  If such is the case, God help us all.

The US is not alone in moving down the protectionist track.  Since the last G20 meeting (with its unanimously endorsed call to avoid protectionism), virtually all the emerging market member nations of the G20 have introduced or announced  protectionist measures.

In the UK, prime minister Gordon Brown is reaping the protectionist storm he sowed with his infamous protectionist and xenophobic call for “British jobs for British workers”.  What was he thinking?  Follow the logic: ‘British jobs for British workers’,'Scottish jobs for Scottish workers’ (along with ‘It’s Scotland’s oil’), ‘Welsh jobs for Welsh workers’ and ‘English jobs for English workers’.  Why not London jobs for London Workers, or London jobs for native-born London workers, or even London jobs for white Christian native-born London workers?

How divisive can you get?  British workers are demonstrating against workers from elsewhere in the EU – Italian and Portuguese workers are currently at the centre of a rather disgusting series of altercations at UK oil refineries, gas terminals and power stations, following a dispute at Total’s oil refinery at Killinghome in Lincolnshire, where an Italian engineering company was bringing its own staff from Portugal and Italy for a egnineering construction project.

Under British law, conforming to EU Treaty obligations, there are no jobs earmarked for British workers in Britain.  With the exception of some transitional arrangements for workers from new member states and a few jobs where nationality still matters for national security or similar reasons, any EU worker can compete freely with any other EU worker in any EU country.   So Italian and Portuguese workers can be brought in to complete a contract in the UK if this makes commercial sense to the contractor, just as British workers can compete, individually or as part of team of workers, under the excellent Posted Workers Directive, for jobs and projects in the rest of the EU.

I feel some sympathy for British workers who, because of the poor state of the British educational system, and the lamentable state of foreign language education in particular, are less competitive outside the UK than workers from elsewhere in the EU are in Britain.  But that is another argument (if one were needed) for doing something about educational standards in British (and more specifically in English) secondary schools, not an argument for denying workers from elsewhere in the EU the right to compete for work in the UK.

The protectionist tide in Britain is rising.  £2.3 bn worth of state aid to the British-based car manufacturers is unlikely to be the last state aid with protectionist consequences.  Britain has company, of course, with the US, France, Germany and Sweden among the countries announcing measures to prop up their automobile manufacturers.

Financial protectionism is on the rise everywhere.  This is partly the inevitable result of the belated discovery of the truth that cross-border banking must be severely restricted as long as regulation, supervision and tax-payer-financed bail-out support for banks is arranged at the national level.  The post-crisis world will no longer have cross-border branch banking, with the foreign branches controlled by the parent,  its depositors guaranteed by the parent, home country regulation and supervision and no independent capitalisation.  Instead we will have just independently capitalised and financially ring-fenced subsidiaries  (no Lehman UK last-minute raid by the failing parent on the local kitty), with host country regulation and supervision, deposit guarantees provided by the host country and with fiscal bail-out support provided by the host country Treasury or by no-one.

Beyond this unavoidable re-nationalisation or repatriation of cross-border banking and cross-border financial intermediation generally, there have been other, quite unnecessary manifestations of financial protectionism, in the UK and elsewhere.  In the UK, banks involved in the government’s recapitalisation scheme, or benefiting from the ever-expanding range of liquidity facilities and guarantees provided by the Bank of England and the Treasury, are being pressured to lend to SMEs and to households and to exercise patience and leniency in their dealings with over-extended residential mortgage borrowers.  It is clear – not surprisingly as the British tax payer is ultimately underwriting all these schemes – that only lending to British SMEs and British households and forbearance vis-a-vis British residential mortgage borrowers is expected and demanded.   And the banks are responding.  Foreign lending by British banks is way down.  So, of course, are foreign deposits in, loans to and investment in British banks.

The world is engaged is an accelerated form of financial de-globalisation.    With banks short of capital and having to retrench, their foreign activities will be the first to suffer and the ones to suffer most.  Government pressure and conditionality re-inforce the natural tendency of headquarters to withdraw the legions from the periphery of the empire to defend Rome when the barbarians are at the gate.  It doesn’t help, of course, when the barbarians are already inside the gate.

The hypocrisy and chutzpah of politicians knows no bounds.  In Davos, UK prime minister Gordon Brown – the same man who launched the ‘British jobs for British workers’ missile and who leads a government that is brow-beating British banks to favour domestic lending over foreign lending – pontificated about the dangers of protectionism in general and the need to stand up to financial protectionism in particular.  He is right to be worried about financial protectionism.  The coming re-patriation of cross-border banking will affect London more than any other financial centre.

Monetary policy

Given the dismal prospects for real economic activity and the sharp decline of inflation everywhere, the task of the monetary authorities in the US, the Eurozone and the UK is really rather easy: set the official policy rate at zero and engage in large-scale quantitative and qualitative easing.

The Fed is doing this.  The UK and the Eurozone are behind the curve.  Indeed, the Eurozone is now getting so far behind the curve that, if the ECB were on an Olympic race-track, it would be looking itself in the back.

At the ECB, a special branch of voodoo monetary theory has been developed that sees insurmountable problems and dangers associated with getting the official policy rate below some value that is well above the zero floor set by the zero nominal interest on currency.   The exact location of this mysterious liquidity trap lower bound has never been revealed, but on the basis of the stammering, incoherent and incomprenhensible statements in this regard from Jean-Claude Trichet, Jurgen Stark, Gertrude Tumpel-Gugerell, Lorenzo Bini-Smaghi and Ives Mersch  (to name but a few), it appears to be migrating south slowly from around 2.00 percent.

The ECB’s blabbering about a possible liquidity trap above a zero percent nominal interest rate is complete and utter nonsense.  The only floor, if there is one at all, is the zero floor.  There are no conceptual or operational problems operating monetary policy with a zero official policy rate.  Even at the Bank of England there are some operational types who argue that they cannot conduct overnight operations with Bank Rate at zero.  What they mean to say is that they cannot continue to implement overnight operations with their arcane, unwieldy and unnecessary existing management procedures.  All they have to do instead is the following.  During what is now called a reserve maintenance period (i.e. between scheduled MPC rate-setting meetings), accept, 24/7, any amount of overnight deposits from banks at a zero rate and/or lend, 24/7, any amount overnight to the banks at a zero rate against the highest grade collateral (UK sovereign debt instruments or better).  That is what it means to set the risk-free overnight nominal interest rate at zero.  If the Bank of England’s staff cannot do it, I volunteer to do it for them, against a small fee.

Once at the zero floor, quantitative easing and qualitative easing are the only instruments open to the central bank.  Both quantitative easing (increasing the base money stock by purchasing government securities) and qualitative easing (purchasing private securities outright, including possibly illiquid private securities and/or private securities subject to substantial default risk)  without increasing the monetary base, can also be pursued when the official policy rate is positive, of course.  Indeed, at this conjuncture, I consider qualitative easing (what Bernanke calls credit easing) to be more important even than getting the official policy rate to zero as soon as possible.  Of course, there is no reason not do do both if you can.

In the UK, quantitative easing is not terribly urgent, because longer-term government rates, while higher than they were at the end of last year, are still rather low.  The key problem are the availability and cost of credit to the private sector, as reflected in part in the large spreads of private interest rates over the corresponding maturity government and central bank yields.  The Bank of England should therefore engage in qualitative easing (spread hunting) on a large scale.  The asset purchase facility (APF) is designed to do just that.  The Bank buys private securities (high-grade, supposedly, but I doubt whether there are many of those left).  The Treasury sterilises the resulting increase in the monetary base by issuing Treasury Bills and deposits the proceeds in its account with the Bank of England (a liability that is not part of the monetary base). The Treasury gives the Bank of England an indemnity, currently up to £50 bn, to insure it against any losses it may make on its purchases of risky private instruments.

The amount is clearly too small.  I expect to see it go up to £300 bn before long, and it may well reach £500 bn, as the socialisation of finance proceeds.  Clearly, well before that point the sterlisation of the increase in the monetary base will also stop, and the Bank of England will engage in a combination of quantitative and qualitative easing: increasing the monetary base (‘printing money’) as the counterpart of the purchase of private securities, under an indemnity from the Treasury.

The ECB, after being the leader of the pack in fighting the liquidity crunch – it accepted as collateral in its repos and at the discount window anything that did not move and a few things that did – has become the laggard as regards the outright purchasing of private securities (qualitative easing).  It is even reluctant to engage in significant quantitative easing.

There are no obstacles to quantitative easing by the ECB/Eurosystem to be found in the Treaties.  The ECB/Eurosystem is banned from lending directly to national governments and from buying government securities directly in the primary or new issues market, but there is nothing to stop it from purchasing all the govenment securities it wishes in the secondary markets.  All it takes is a decision by the ECB’s Governing Council.

The question as to how much of each government’s debt instruments to buy is something it should not take longer than 5 minutes to decide. The obvious solution is to first decide how much in toto to buy and then to determine the shares of the debt instruments of each of the 16 national governments in the Eurozone, by setting these equal to their (normalised) shares in the capital of the ECB.  Whether these shares should refer to market value or notional/face value can be decided by the flip of a coin.

According to the rule book there are no counterparty restrictions in what would be structural outright purchases by the ECB/Eurosystem.  The instruments have to be marketable and satisfy high credit standards, to be assessed using ECAF rules for marketable assets.  For marketable assets to be eligible as collateral, they must be rated at least BBB- (reduced from A- at the beginning of the crisis).  I assume (it is not stated explicitly in the ECB’s manual) that the same creditworthiness criteria apply to marketable securities purchased outright.  This means that even the recently downgraded government debt of Greece, Spain and Portugal is eligible, as well as the soon-to-be-downgraded sovereign debt of Ireland.

As regards outright purchases of private securities (sterlised or non-sterilised), the reluctance of the ECB/Eurosystem is understandable.  This issue brings out a yawning gap in the ECB/Eurosystem edifice: the absence of clear fiscal backing of the ECB/Eurosystem for losses incurred in the conduct of monetary policy and liquidity operations, including the outright open market purchases of private securities that the ECB/Eurosystem should be gearing up to do very soon.

For losses incurred in the normal market operations used for monetary and liquidity management by the Eurosystem (which are implemented in a decentralised manner by the national central banks (NCBs) of the Eurozone), there is the rule that such losses are shared by all the NCB’s in the Eurosystem in proportion to their relative shares in the capital of the ECB.

For losses incurred because of an NCB acting as lender of last resort towards one or more specific banks in its jurisdiction/country, the national Treasury of that country would have to indemnify the NCB in question.  Indeed the NCB would only act as lender of last resort to assist specific institutions as an agent of the national Treasury, and not in its capacity as a member of the Eurosystem.  A prior commitment by the national Treasury to indemnify the NCB for any losses incurred during a lender-of-last-resort-operation would be required before the NCB could engage in such an action.

The structural outright open market purchases of private securities by the ECB/Eurosystem involved in qualitative easing would also be performed bilaterally by the NCBs, but since they are aimed at unclogging financial markets and enhancing liquidity in the Eurozone as a whole, the fiscal backing should be provided by the fiscal authorities of the Eurozone jointly.  The 16 national fiscal authorities of the Eurosystem must, as soon as possible – and preferably immediately – provide the ECB/Eurosystem with an indemnity of, say, €500bn to begin with, to enable to ECB to engage in qualitative and/or combined qualitative and quantitative easing in the very near future.  Again, the shares of each of the 16 national Treasuries in the aggregate indemnity should be determined by the (appropriately scaled) NCB shares in the ECB’s capital.

As alternative to such a binding, ex-ante Eurozone fiscal burden-sharing rule for ECB/Eurosystem losses incurred as a result of quantitative and qualitative easing operations, would be the creation of a Eurozone-wide fund that would indemnify the ECB/Eurosystem.

Fiscal policy

Effective fiscal stimuli involving increased government deficits can only be provided by governments with fiscal credibility, that is, governments that can cut taxes and increase public spending now and credibly commit themselves to future tax increases and public spending cuts of equal magnitude.  The relentlessly procyclical behaviour of most fiscal authorities in Europe and North America during the past decade means that in the north Atlantic region, at the beginning of the crisis, only Germany and Spain had any significant fiscal credibility and spare capacity.  As far as I can tell, the US and the UK have little if any.

In the emerging market universe, China and Brazil have some fiscal elbow room.  Few other countries do.

This means that the contribution of fiscal policy to the recovery of global demand will (a) be limited and (b) have to be modulated according to national fiscal spare capacity.  That means little if any fiscal stimulus in the USA and the UK and a large fiscal stimulus in Germany and China.  Germany is being dragged, reluctantly, towards the Halls of Reason.  The US and the UK seem intent on expansionary fiscal actions that are likely to more than exhaust their government’s credibility capital.  These fiscal actions by the US and the UK will also re-invigorate the underlying global imbalances that provided some of the combustible material that caught fire on August 9, 2007.


We can go down in history as the generation that created the Great Depression of the Noughties.  Just keep on beating the protectionist drums.  Keep on the footdragging that prevents effective qualitative and quantitative monetary policy easing in the Eurozone and the UK.  And go ahead with unsustainable fiscal stimuli in the US, the UK and elsewhere that will spook markets, push up long-term interest rates and raise the spectre of sovereign default by countries not belonging to the group of usual suspects.  Yes we can!  I hope we won’t.

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