By John Cassidy, author of How Markets Fail and a staff writer at the New Yorker
Behind his white beard, Federal Reserve chairman Ben Bernanke has a wry sense of humour. On reading his recent speech to the American Economic Association, in which he defended the Fed’s actions during the housing bubble, I initially suspected it was a practical joke. Rather than conceding that he and his predecessor, Alan Greenspan, made a hash of things between 2002 and 2006, keeping interest rates too low for too long, he said the Fed’s policies were reasonable and the main cause of the rise in house prices was not cheap money but lax supervision.
Searching in vain for a punch line, I was reminded of Talleyrand’s quip about the restored Bourbon monarchs: “They have learned nothing and forgotten nothing.” Mr Bernanke is far smarter than Louis XVIII and Charles X, two notorious boneheads, and has done a good job of firefighting. But his unwillingness to admit the Fed’s role in inflating the housing and broader credit bubble raises serious questions about his judgment.
Very hawkish speech from Tom Hoenig today. He worries that staying too low for too long will generate financial stability risks and misallocation of resources as well as inflation risks.
In doing so he more or less explicitly rejects Bernanke’s weekend claim that keeping rates low after the dotcom bust had little or nothing to do with the housing and credit bubbles.
The current disagreement does not concern whether or not Iceland will repay. They have already agreed to repay €20,887 to the British and Dutch governments per head (the governments have already repaid depositors, in full and to a maximum of €100,000, respectively).
Indeed, the President has just reaffirmed this on Newsnight. No, the disagreement concerns the maximum liability and state guarantee of repayments. A potted history follows.
Two loan agreements were signed on 5 June 2009 between Iceland’s Depositors’ and Investors’ Guarantee Fund and the Icelandic state on the one hand, and the UK and Dutch governments on the other. In addition, a special settlement agreement was concluded between the British Financial Services Compensation Scheme and the Icelandic Guarantee Fund. These loan agreements were meant to conclude the Icesave issue.
The deal, agreed under English law, arranged loans from the UK and Holland, agreeing Iceland would repay them in 32 equal instalments starting on 5 June, 2016 and ending 5 June, 2024. Repayments would be fixed at 5.55 per cent. Maximum annual payments would be based on the growth of the Icelandic economy, fixed at a baseline year (effectively £2.35bn to the UK and €1.33bn to the Netherlands). The minimum deposit guarantee of €20,887 was in accordance with EU directive 94/19/EEC.
Sharp-eyed observers are zeroing in on a chart (below) used by Ben Bernanke in his address to the American Economic Association at the weekend that appears to show the optimal interest rate based on a forward looking Taylor rule with a PCE measure of inflation was zero in early 2009 – and not a negative number.
This appears to conflict with earlier studies – including an internal Fed staff analysis I wrote about last year – that used modified Taylor rules to show that the optimal interest rate in early 2009 was well below zero – for instance, minus five per cent. Such analysis supported the case for large scale asset purchases as a proxy for negative rates.
Export-dependent Japan wants the carry trade back, apparently. A carry trade involves borrowing in a cheap currency to invest in one with a decent rate of return. The cheap currency of choice has been, for years, Japan. Recently there was much excitement that the mantle was passing to the USA. But Gillian Tett says Japan is fighting back.
The Japanese want the yen to be borrowed because it increases the quantity of yen and decreases its price. A lower yen means Japanese exports become more attractive internationally.
UPDATE at 18.53: Icelandic timeline
UPDATE at 17.23: The Icelandic President talks to Newsnight
An avoidance of responsibility, or democracy in action? Analysis of the Icelandic President’s declaration to the people suggests the latter, with the words “people”, “passed”, “referendum” and “nation” occurring frequently. Conversely, the terms “international”, “British”, “Dutch” and indeed “Icesave” are rare.
The President has vetoed a second round of legislation to repay British and Dutch governments for their (advance) reimbursements to Icesave account holders in their countries. (NB. Terms had largely been agreed on 5 June, 2009, under which the Icelandic Guarantee Fund would repay depositors €20,887.) The President has asked for a referendum on the issue, saying: “The people are the supreme judge of the validity of the law”.
This is perhaps unsurprising. But three things stand out.
The top news from today’s European Commission confidence indicators is the surge in economic optimism at the end of last year, which seemed widespread across the continent. The British mood brightened particularly sharply. With even Spain – where unemployment is dire – reporting a steady improvement, the survey offers suport for the “tide-lifts-all-boats” theory.
The other good news for the European Central Bank is that the eurozone public may be starting to believe in inflation again.
As expected, the Bank of England has just kept interest rates on hold at 0.5 per cent and left the target of asset purchases at £200bn.
There was no statement from the Monetary Policy Committee. This was as everyone expected – the first of many boring rates meetings at the start of 2010 (with the possible exception of next month).