For those who thought that popular delusions and manias were a thing of the past, like the Tulips in XVII Century Amsterdam, not possible in the age of information and the knowledge economy, now we have two manias to prove otherwise.
The Pokemon craze has quietly waned, but the Bitcoin is now raging with the prospect of getting some official recognition by the Chicago Mercantile Exchange (CME). The first game consisted on searching hidden toys for pleasure. The Bitcoin consists on searching for a computer code hidden in a mathematical algorithm. But because the code is promoted as being money (a cryptocurrency) some people are getting crazy about the possibility of getting rich quickly.
So, will Bitcoin end quietly like Pokemon? Probably not, given the money involved.
Should the authorities do something about this madness? Some would say no, with the argument that people must learn from their own stupidity.
Personally, I would agree with that if the Central Banks had not been given the monopoly of issuing money. But since they have it, Central Banks are responsible to guarantee that the money in circulation is not false. So, I have denounced their inaction in this post.
Should the government do something about it? Yes. If, as most people say, Bitcoin is used regularly by criminals to hide their transaction and money laundering, then the government has a unique to opportunity to tax those criminals. Moreover, its quite easily done! It simply needs to tax any purchase or sale of Bitcoins against any legal currency or other type of asset by 50%.
So, what are Central Banks and Governments waiting for? To create a major financial crisis? Let’s hope not!
Showing posts with label European Central Bank. Show all posts
Showing posts with label European Central Bank. Show all posts
Monday, 11 December 2017
Saturday, 15 September 2012
Why the IMF therapy is not working in Ireland
After a remarkable economic success based on market capitalism, Ireland has drifted back into misery since the crisis of 2008 and risks turning into a Southern European type of state capitalism. Back in January 2011 we explained in this blog (see here) why the IMF program for Greece’s external adjustment would not work. Some of the reasons given then apply equally to Ireland (or Spain for that matter).
First, the Troika misdiagnosed the situation as a liquidity problem while in fact Ireland and Greece faced a solvency problem (albeit of a different nature).
Then, they treated the problem of excessive leverage in the wrong way. The two major mistakes in Ireland were the conversion of private debt into public debt and the reliance on internal devaluation to deleverage. It is easy to see why both policies were wrong.
Ireland had a typical situation faced by a family with irresponsible children that took excessive debt to pay for gambling losses at the Casino (or in its case to speculate in real estate). An obvious option to erase gambling debts was to default on the casino loans (in the case of the Irish real estate bubble the British and German banks). They could be charged with allowing bets that the gambler could not pay. One alternative would be to demand a debt restructuring involving partial debt forgiveness and a longer repayment period, so that with the help of family and friends (i. e. grants by national and EU institutions in the case of Irish borrowers) they could repay the remaining debt without damaging the credit of his family. Another alternative would be to ask the casino to accept an IOU without a redemption date (in case of the British and German banks accept money printed by the ECB).
Yet, the casino owners decided instead to force the collection of their loans from the children’s parents (i.e.Irish government). To save its reputation the family promised to honor the debts by putting them in their business balance sheet (the state budget in the case of Ireland). However, the debts were so huge that they would necessarily cripple an otherwise successful business (economy). It is easy to see why.
First, such an increase in leverage would bar the firm from market financing. Second, it would be forced to halt all modernization and maintenance investments. Finally, it would force the family to downsize by selling some of the best assets. Combining these three measures would inevitably lead to a lower competitiveness, declining productivity and a depressed local economy. As expected, in the last four years, investment in Ireland more than halved in real terms, while domestic demand declined by about one third.
However, the recourse to internal devaluation only made things worse. Imagine that the clientele of the parents business was mostly local (i.e. produced non-tradable goods in economists’ parlance). Therefore, cutting the wage of their workers would reduce its sales proportionally and reduce further the firms’ debt capacity.
Moreover, reducing nominal contracts in the labor market without a concomitant reduction in credit markets would inevitably lead to an increase in non-performing loans (which in 2011 indeed rose from 12% to 20%).
It is obvious that the policy of switching the debt burden from the private to the public sector only made things worse in Ireland. What we said about Greece applies equally to Ireland. It has only three options: a) to force a significant hair-cut on its bond-holders, b) to receive a major grant from other EU countries, or c) a mix of both. None of these is a pleasant solution but there is no other way out.
First, the Troika misdiagnosed the situation as a liquidity problem while in fact Ireland and Greece faced a solvency problem (albeit of a different nature).
Then, they treated the problem of excessive leverage in the wrong way. The two major mistakes in Ireland were the conversion of private debt into public debt and the reliance on internal devaluation to deleverage. It is easy to see why both policies were wrong.
Ireland had a typical situation faced by a family with irresponsible children that took excessive debt to pay for gambling losses at the Casino (or in its case to speculate in real estate). An obvious option to erase gambling debts was to default on the casino loans (in the case of the Irish real estate bubble the British and German banks). They could be charged with allowing bets that the gambler could not pay. One alternative would be to demand a debt restructuring involving partial debt forgiveness and a longer repayment period, so that with the help of family and friends (i. e. grants by national and EU institutions in the case of Irish borrowers) they could repay the remaining debt without damaging the credit of his family. Another alternative would be to ask the casino to accept an IOU without a redemption date (in case of the British and German banks accept money printed by the ECB).
Yet, the casino owners decided instead to force the collection of their loans from the children’s parents (i.e.Irish government). To save its reputation the family promised to honor the debts by putting them in their business balance sheet (the state budget in the case of Ireland). However, the debts were so huge that they would necessarily cripple an otherwise successful business (economy). It is easy to see why.
First, such an increase in leverage would bar the firm from market financing. Second, it would be forced to halt all modernization and maintenance investments. Finally, it would force the family to downsize by selling some of the best assets. Combining these three measures would inevitably lead to a lower competitiveness, declining productivity and a depressed local economy. As expected, in the last four years, investment in Ireland more than halved in real terms, while domestic demand declined by about one third.
However, the recourse to internal devaluation only made things worse. Imagine that the clientele of the parents business was mostly local (i.e. produced non-tradable goods in economists’ parlance). Therefore, cutting the wage of their workers would reduce its sales proportionally and reduce further the firms’ debt capacity.
Moreover, reducing nominal contracts in the labor market without a concomitant reduction in credit markets would inevitably lead to an increase in non-performing loans (which in 2011 indeed rose from 12% to 20%).
It is obvious that the policy of switching the debt burden from the private to the public sector only made things worse in Ireland. What we said about Greece applies equally to Ireland. It has only three options: a) to force a significant hair-cut on its bond-holders, b) to receive a major grant from other EU countries, or c) a mix of both. None of these is a pleasant solution but there is no other way out.
Tuesday, 16 August 2011
The Euro Zone Bond Debate: Can we have a common treasury without a common budget?
The debate on whether an European Agency (some kind of Euro Area Treasury department) should replace the Euro Zone countries in financing a substantial share of each country’s public sector borrowing requirements (some suggest a minimum of 60%) has gained new momentum since leading German business groups called for the issuance of Euro Zone bonds in defiance of the official German position.
The centralization of the debt issuing function in the Euro Zone is seen by many (including George Soros) as a solution for the current sovereign debt crisis as well as a way out of the intrinsic weakness of a Monetary Union built without a corresponding budgetary policy. Indeed, the later is the only convincing reason to argue for joint Eurobond issues and the debate should focus on its pros and cons.
Indeed, the European Union has already a long history of joint debt issues. Through the European Investment Bank it finances a non-negligible share of infrastructure projects in Europe. Through the European Commission it has also made several issues to finance specific programs of industrial restructuring and balance of payments support, the most recent being the EFSF mechanism to support the adjustment programs in Greece, Ireland and Portugal. However these issues were for limited purposes and for limited amounts. The centralization of the public sector borrowing requirements is an entirely new game.
In principle, a central Treasury Department for the Euro Zone makes sense. Indeed, that is what happens within national governments where debt issuance by local, state or regional governments is often supplemented by grants, borrowing and guarantees provided by the Ministry of Finance or National Treasurer. However, the later are usually granted under nationally agreed budgetary policies and often require the setting of borrowing limits. These are often the source of frequent disputes between national and sub-national governments that occasionally end up in blackmail by separatist movements.
In a Union like the Euro Area, which is taking the first steps towards a future political unification, a simple setting of borrowing limits by a central Treasurer (no matter how well designed they are) is more prone to such separatist threats because there is no national solidarity. These separatist threats would be a permanent risk undermining the credit standing of the central Treasurer and would become a burden for the remaining members.
To some extent national solidarity can be substituted by common interest in joint spending. For this reason, tying a large share of joint debt issues to the financing of centralized spending in common policies needs to be considered as an essential part of a monetary union package.
Although the experience of common policies in the EU is nothing to write home about (e.g. agriculture) it does not mean that it cannot succeed in areas like transport infrastructure, security (defense and policing), research and population policies (health, education, migration, etc.).
The only certainty is that, like a stool, a solid monetary union also needs three legs – a monetary authority, a treasurer and a spending authority.
The centralization of the debt issuing function in the Euro Zone is seen by many (including George Soros) as a solution for the current sovereign debt crisis as well as a way out of the intrinsic weakness of a Monetary Union built without a corresponding budgetary policy. Indeed, the later is the only convincing reason to argue for joint Eurobond issues and the debate should focus on its pros and cons.
Indeed, the European Union has already a long history of joint debt issues. Through the European Investment Bank it finances a non-negligible share of infrastructure projects in Europe. Through the European Commission it has also made several issues to finance specific programs of industrial restructuring and balance of payments support, the most recent being the EFSF mechanism to support the adjustment programs in Greece, Ireland and Portugal. However these issues were for limited purposes and for limited amounts. The centralization of the public sector borrowing requirements is an entirely new game.
In principle, a central Treasury Department for the Euro Zone makes sense. Indeed, that is what happens within national governments where debt issuance by local, state or regional governments is often supplemented by grants, borrowing and guarantees provided by the Ministry of Finance or National Treasurer. However, the later are usually granted under nationally agreed budgetary policies and often require the setting of borrowing limits. These are often the source of frequent disputes between national and sub-national governments that occasionally end up in blackmail by separatist movements.
In a Union like the Euro Area, which is taking the first steps towards a future political unification, a simple setting of borrowing limits by a central Treasurer (no matter how well designed they are) is more prone to such separatist threats because there is no national solidarity. These separatist threats would be a permanent risk undermining the credit standing of the central Treasurer and would become a burden for the remaining members.
To some extent national solidarity can be substituted by common interest in joint spending. For this reason, tying a large share of joint debt issues to the financing of centralized spending in common policies needs to be considered as an essential part of a monetary union package.
Although the experience of common policies in the EU is nothing to write home about (e.g. agriculture) it does not mean that it cannot succeed in areas like transport infrastructure, security (defense and policing), research and population policies (health, education, migration, etc.).
The only certainty is that, like a stool, a solid monetary union also needs three legs – a monetary authority, a treasurer and a spending authority.
Thursday, 16 June 2011
The IMF/EU/ECB bailout for Portugal: Banking Sector Reform
The IMF/EU/BCE banking sector reforms are aimed at enhancing the resilience of the banking sector “by increasing capital requirements through market-based solutions, supported by a fully funded capital backstop facility. Safeguards to help ensure adequate banking system liquidity are strengthened. ”
The key measures include: a) require banks to raise their core Tier 1 capital to 9 percent by end-2011 and 10 percent at the latest by end-2012. Banks are supposed to raise the necessary capital through the market, with the exception of CGD which will raise the money by shedding assets (mostly its insurance business). The Government will also set up a contingent cash facility of €12 billion to rescue banks in trouble; b) increase by €15 billion (to €35 billion) the Government guarantee fund for bank bond issues which can be used for ECB refinancing; c) bring the BPN case to a close; and d) improve the Central Bank supervision system as well as the Deposit Insurance mechanism.
Since the Portuguese banks were not exposed to the sub-prime crisis or to a real estate bubble, the measures seem enough to maintain the sector for about two years until it can access the wholesale market again. However, should the Portuguese sovereign debt crisis continue beyond that or should a restructuring take place before that then new measures will be needed.
Yet the program can be considered to be a missed opportunity to force a much needed streamlining and change of the business model of the Portuguese banks. These have been plagued by a chronic lack of capital (tolerated by the authorities) which was used to preserve the control of the banks in the hands of a few insiders; while disguising a low profitability in a cozy government protected market. Moreover, some of the banks have a dangerous maturity mismatch caused by a low deposit base and a high exposure to long term loans to the mortgage sector, PPPs, utilities and some equity stakes.
In order to avoid that banks carry out their deleveraging mainly through a reduction of credit to the non-state-owned corporate sector and the household sector, with major social and macro-economic consequences, the banks should be forced to change their traditional business model.
For instance, this could be easily achieved by limiting their equity stakes in public companies (contributing to provide liquidity to the stock market and reduce the many incestuous relations). Likewise the Government should recapitalize adequately the surviving state-owned enterprises to reduce the banks’ exposure to that sector. Most importantly, the Government should nationalize the PPPs to remove them from the banks’ balance sheet. This should be financed by a long-term loan from the EU EFSF/ESM.
In conclusion, the authorities need to be more creative because the success of the financial sector reform and fiscal stabilization are inextricably intertwined for the good and the bad.
The key measures include: a) require banks to raise their core Tier 1 capital to 9 percent by end-2011 and 10 percent at the latest by end-2012. Banks are supposed to raise the necessary capital through the market, with the exception of CGD which will raise the money by shedding assets (mostly its insurance business). The Government will also set up a contingent cash facility of €12 billion to rescue banks in trouble; b) increase by €15 billion (to €35 billion) the Government guarantee fund for bank bond issues which can be used for ECB refinancing; c) bring the BPN case to a close; and d) improve the Central Bank supervision system as well as the Deposit Insurance mechanism.
Since the Portuguese banks were not exposed to the sub-prime crisis or to a real estate bubble, the measures seem enough to maintain the sector for about two years until it can access the wholesale market again. However, should the Portuguese sovereign debt crisis continue beyond that or should a restructuring take place before that then new measures will be needed.
Yet the program can be considered to be a missed opportunity to force a much needed streamlining and change of the business model of the Portuguese banks. These have been plagued by a chronic lack of capital (tolerated by the authorities) which was used to preserve the control of the banks in the hands of a few insiders; while disguising a low profitability in a cozy government protected market. Moreover, some of the banks have a dangerous maturity mismatch caused by a low deposit base and a high exposure to long term loans to the mortgage sector, PPPs, utilities and some equity stakes.
In order to avoid that banks carry out their deleveraging mainly through a reduction of credit to the non-state-owned corporate sector and the household sector, with major social and macro-economic consequences, the banks should be forced to change their traditional business model.
For instance, this could be easily achieved by limiting their equity stakes in public companies (contributing to provide liquidity to the stock market and reduce the many incestuous relations). Likewise the Government should recapitalize adequately the surviving state-owned enterprises to reduce the banks’ exposure to that sector. Most importantly, the Government should nationalize the PPPs to remove them from the banks’ balance sheet. This should be financed by a long-term loan from the EU EFSF/ESM.
In conclusion, the authorities need to be more creative because the success of the financial sector reform and fiscal stabilization are inextricably intertwined for the good and the bad.
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