Group items tagged

Richard Koo (2003) coined the term “balance sheet recession” to characterise the endless travail of Japan following the collapse of its real estate and stock market bubbles in 1990. The Japanese government did not act to repair the balance sheets of the private sector following the crash. Instead, it chose a policy of keeping bank rate near zero so as to reduce deposit rates and let the banks earn their way back into solvency. At the same time it supported the real sector by repeated large doses of Keynesian deficit spending. It took a decade and a half for these policies to bring the Japanese economy back to reasonable health.

At the time, a majority of forecasts predicted that the economy would slip back into depression once defence expenditures were terminated and the armed forces demobilised. The forecasts were wrong. This famous postwar “forecasting debacle” demonstrated how simple income-expenditure reasoning, ignoring the state of balance sheets, can lead one completely astray.

No region of the world has benefited more from cross-border banking, yet these achievements are now at risk

The threat to cross-border banks comes not only from their deteriorating balance sheets in the face of lower sovereign-debt quality and weaker growth prospects, but also from the policy response itself.

a European solution must take account of the network of foreign subsidiaries across Europe.

The euro itself was a leading cause of this crisis by ushering in a remarkably swift convergence in interest rates, which had the effect of directing too much capital into countries that formerly had had to pay high interest rates. This undermined the competitiveness of these countries through inflation and gave rise to huge deficits in their current accounts.

The euro is not suffering from a mere confidence crisis that can be resolved by assuaging the markets; it is experiencing a profound balance‐of‐payment crisis that is being prolonged by the expansion of public financial aid.

Since autumn 2007, long before the official bail‐out initiatives began, some of the crisis‐hit countries have replaced dwindling private capital imports and capital flight with their money‐printing presses (Target credits).

This coincided with the bubble years in peripheral Eurozone countries (2003-07). The effect of this is that Germany accumulated large net claims on Eurozone countries, which at the end of 2011 amounted to €634 billion.

These current account surpluses did not lead to TARGET2 claims during the bubble years because the counterpart of these surpluses were increasing claims held by (mainly) German banks against the other Eurozone countries.

the German banking system was lending the money to other Eurozone countries to allow them to buy surplus German products – a highly risky affair.

But the reforms often fail to work. The Spanish law is intended to promote restructuring of viable firms but in practice most insolvencies end in liquidation after lengthy court proceedings.

High household debt helps explain why the Netherlands, along with Italy and Spain, remained in recession in the second quarter of 2013 even as the euro area in general embarked on recovery. Dutch GDP this year will be 2% lower than in 2011 and more than 3% below its previous peak, in 2008.

it illustrates the malign effect of high debt when house prices fall

The reason is not hard to fathom. Hobbled by severe damage to private and public-sector balance sheets, and with policy interest rates at or near zero, post-bubble economies have been mired in a classic “liquidity trap.” They are more focused on paying down massive debt overhangs built up before the crisis than on assuming new debt and boosting aggregate demand.

The sad case of the American consumer is a classic example of how this plays out. In the years leading up to the crisis, two bubbles – property and credit – fueled a record-high personal-consumption binge. When the bubbles burst, households understandably became fixated on balance-sheet repair – namely, paying down debt and rebuilding personal savings, rather than resuming excessive spending habits.CommentsView/Create comment on this paragraph

US consumers have pulled back as never before.

As King struggled with the crisis, he concluded that the biggest vulnerability was the solvency of the banking system itself. The crash wasn’t just a liquidity squeeze caused by toxic assets; the problem was that big banks around the world were undercapitalized and, in many cases, insolvent.

King pushed the banks to recapitalize and, later, to accept more regulation. This upset a financial elite that, as King says, was the only sector of the British economy that had escaped the market revolution of the Margaret Thatcher years.

Its full name is more than a mouthful. Trans-European Automated Real-time Gross Settlement System is better known as TARGET2 for short. It is the behind-the-scene payments system that conveniently enables citizens across the euro area to settle electronic transactions in euro. And at just over €500 billion, its TARGET2 claim on the Eurosystem is also the largest and fastest growing item on the Bundesbank’s balance sheet, as well as a source of much misunderstanding and debate.

The allocation of TARGET2 balances among the seventeen national central banks, which together with the ECB make up the Eurosystem, reflects where the market allocates the money created by the ECB. The fact that the Bundesbank has a large TARGET2 claim (asset) on the Eurosystem, while national central banks in southern Europe and Ireland together have an equally large TARGET2 liability, simply reflects that a lot of the ECB’s newly created money has ended up in Germany. Why? Because of capital flight.

Since the euro eliminated exchange rate risk among its member states, Germany has invested a substantial portion of its savings in Europe’s current account deficit countries. Some of those savings are now returning home. That’s the capital flight.

It took financial markets more than a year to realize the implications of Chancellor Merkel’s declaration, demonstrating that they operate with far-from-perfect knowledge

the financial markets began to realize that government bonds, which had been considered riskless, carried significant risks and could actually default. When they finally discovered it, risk premiums in the form of higher yields that governments had to offer so as to sell their bonds rose dramatically. This rendered commercial banks whose balance sheets were loaded with those bonds potentially insolvent.

“The current- account deficits of countries that have been under stress diminished over the last years considerably.”

Just two of 14 euro-zone government leaders have kept their posts in elections since late 2009 and extremists such as Golden Dawn in Greece are gaining support.

“The internal rebalancing in the euro area is progressing,” said Fels. “Some of them, especially Spain but also Portugal not to speak of Ireland, are regaining competitiveness.”

Expansion was, for lack of other options, financed largely through short-term loans.

since the onset of the global financial crisis, eurozone-based banks’ subsidiaries in emerging Europe have been reducing their exposure to the region. In 2009-2010, the European Bank Coordination Initiative – known informally as the “Vienna Initiative” – helped to avert a systemic crisis in developing Europe by stopping foreign-owned parent banks from staging a catastrophic stampede to the exits.CommentsView/Create comment on this paragraphBut, in the second half of 2011, the eurozone-based parent banks that dominate emerging Europe’s banking sector came under renewed pressure to deleverage. Many are now radically changing their business models to reduce risk.

How did this happen? As Kemal Derviş has pointed out, the cumulated current-account surplus of the Scandinavian countries, the Netherlands, Austria, Switzerland, and Germany is now around $500 billion. This dwarfs China’s surplus at its mercantilist peak of the mid-2000’s, when the G-7 (including Germany) regularly scolded the Chinese for fueling global imbalances.

The second exception is France. Over the last year, France’s external deficit deteriorated further, from a 2.4% to 3.5% of GDP. France now faces zero or negative growth in 2013, and seems to have reached the point at which it must reverse course on competitiveness or risk more trouble ahead.

But the debate about austerity and the cost of high public-debt levels misses a key point: Public debt owed to foreigners is different from debt owed to residents.

If foreign debt matters more than public debt, the key variable requiring adjustment is the external deficit, not the fiscal deficit. A country that has a balanced current account does not need any additional foreign capital. That is why risk premiums are continuing to fall in the eurozone, despite high political uncertainty in Italy and continuing large fiscal deficits elsewhere. The peripheral countries’ external deficits are falling rapidly, thus diminishing the need for foreign financing.

And the evidence confirms that the euro crisis is not really about sovereign debt, but about foreign debt.

Walking around town, my friend and I had noticed that almost every home had a pile of coal outside, soft dark chunks that people shoveled into stoves for cooking and heating. Thousands upon thousands of coal fires were loading the air with tiny dots of soot. Scientists have taken to calling these dots “black carbon,” and have steadily ratcheted up their assessments of its harm. In March, for instance, a research team led by a Mumbai environmental group estimated that black carbon and other particulate matter from India’s coal-fired power plants cause about 100,000 deaths a year.

A 31-scientist team from nine nations released a comprehensive, four-year assessment in January arguing that planetary black-carbon output is the second-biggest driver of anthropogenic (human-caused) climate change; the little black specks I found on my glasses and clothes have roughly two-thirds the impact of carbon dioxide.

The rule of thumb is that if a well leaks more than about 3 percent” of its methane production into the air, “natural gas actually becomes dirtier than coal, from a climate-change perspective,

If Greece still had its own currency, it could, in parallel, devalue the drachma to reduce imports and raise exports, cutting the 15 per cent of GDP trade deficit. The level of Greek GDP and employment might then actually increase if the rise in exports and decline in imports added more to domestic employment and output than was lost through raising taxes and cutting government spending. But since Greece no longer has its own currency, it is not free to follow this strategy.

Deposit flight from Spanish banks has been gaining pace and it is not clear a euro zone agreement to lend Madrid up to 100 billion euros in rescue funds will reverse the flows if investors fear Spain may face a full sovereign bailout.

Many banks are reorganising, or being forced to reorganise, along national lines, accentuating a deepening north-south divide within the currency bloc.

Since government credit ratings and bond yields effectively set a floor for the borrowing costs of banks and businesses in their jurisdiction, the best-managed Spanish or Italian banks or companies have to pay far more for loans, if they can get them, than their worst-managed German or Dutch peers.

Europe’s leaders now agree on a vision of what the EU should become: an economic and monetary union complemented by a banking union, a fiscal union, and a political union. The trouble starts as soon as the discussion moves on to how – and especially when – the last three should be established.

The 1992 exchange-rate crisis then tipped the balance. Once Europe’s exchange-rate system blew up, the southerners’ argument that Europe could not afford to postpone creating the euro carried the day.

The consequences have not been happy. Monetary union without banking, fiscal, and political union has been a disaster.CommentsView/Create comment on this paragraph