Central Banks in Liquidity Action...Not Solvency Action

Here we go again!

The central banks acted yesterday and the markets went wild!  Six central banks acted in concert to make sure that European banks…and others…could get dollars if they wanted them.

This is a liquidity action!

It is an act to keep the flow of short-term funds flowing in world financial markets…just as these six central banks did after the Lehman Brothers failure. 

Once again, the definition of a liquidity crisis is that there is a short term need for “buyers” in a market because, for the short term, the “buyers” that are usually there are not there.  The “sellers” want to sell assets and obtain dollars.

“Buyers” without dollars are not what is wanted.  So the central banks are making sure that there are plenty of dollars available so that the “sellers” can sell their assets.

The emphasis, however, should be on the short-term nature of a “liquidity” crisis. 

The fundamental problem is still the solvency problem facing several of the sovereign nations of Europe. (See my post from yesterday, “European Debt Must Be Restructured,” http://seekingalpha.com/article/310994-european-sovereign-debt-must-be-restructured.)

Providing liquidity to the market will not resolve the solvency problem.  As almost everyone except the officials in Europe know, the efforts of the last two years or so to treat European debt problems as a “liquidity” issue has resulted in the situation we now find ourselves in. 

As in the past, central bank action has gotten a favorable response from stock markets around the world.  In the past, the quick, dramatic response to the central bank action has been followed by a retreat.  If nothing is done on the sovereign debt restructuring need, the stock markets will, in all likelihood, retreat once again.

The word out is that this liquidity action on the part of the central banks gives the officials in Europe some time to deal with the restructuring. 

But, the restructuring is also only a short-term response for eventually the eurozone must deal with the whole question of how the fiscal affairs of the eurozone will be handled.  The concern is that restructuring of the debt without reforming how the nations of the eurozone discipline their fiscal affairs just creates a situation in which fiscal irresponsibility can survive into the future.

Revising how the eurozone conducts its fiscal affairs, however, cannot be done overnight.  Yet, the financial markets must be given some kind of credible assurances that fiscal discipline will be forthcoming before they will really settle down. 

This seems to be the unknown…for the single currency framework will not last without the eurozone achieving some kind of fiscal unity.  Is this what Germany is holding out for?

So, is the problem going to be resolved now…or, are we just going through another cycle?

I still am not convinced that the Europeans, at this stage, possess the backbone to do what is necessary!

Oh, and once all these dollars get out into world markets…will they be withdrawn once the “liquidity” crisis is over?

The Fed: Still In A "Hole"!

There are articles all over the place discussing the possibilities for what Fed Chairman Ben Bernanke is going to say at his late August speech at the Federal Reserve Conference in Jackson Hole, Wyoming.  Last year, of course, Bernanke announced QE2.  And, for the next ten months we lived QE2. 

The question is…what is Bernanke going to spring on us this year?

Listen to this…”what is Bernanke going to spring on us this year?”

Ben Bernanke is considered to be one of the most creative economists in the world.  He has basically improvised his way through the last three years or so in a way few others could.

But, this is the central bank we are talking about.  Historically, central banks have been the promoter of stability.  Central Banks have been predictable.  Central banks have attempted to reduce uncertainty.

And, maybe this is a clue to the situation we face in the world today.  Maybe things are not what they once were.  Maybe central banking must change…must create a new “business” model”.

Central banking after World War II was different than it was before the 1930s.  Benjamin Strong, President of the Federal Reserve Bank of New York, Montagu Norman of the Bank of England, Emile Moreau of the Banque de France and Hjalmar Schacht of the Reichsbank were what central banking was all about during the 1920s and early 1930s.

But, the world was on the gold standard back then, international capital flows were restricted, and the world was moving from economies based on agriculture to economies based on industrial manufacturing.  “Country” banking, Fed Districts, and the Fed’s discount window dominated central banking in the country.  

The world after World War I was different from the world after World War II and the central bank had to develop a new model. 

Post-World War II, the responsibilities of the central bank changed and grew.  The objectives of central banks also changed.  Whereas the primary responsibility of central banks before this time had been to be the “lender of last resort” to the banking industry, it now took on new responsibilities.  First, under the influence of Keynesian thinking, central banks became responsible for achieving high levels of employment.  Then, after the work of Milton Friedman and the Monetarists, the Fed added price stability as another goal of monetary policy.  Thus, the Fed entered the manufacturing era with three goals, being a lender of last resort, achieving low unemployment, and keeping inflation under control.

Then things changed during this time period.  The global economy became a reality and capital became mobile throughout the world, the gold standard collapsed, and fixed exchange rates gave way to floating exchange rates.  The manufacturing economy gave way to the information age.  Large domestically orientated banks became global behemoths and financial innovation (allowed by the advances in information technology) came to dominate the financial scene. 

Toward the end of the twentieth century, the environment shifted.  Money easily flowed where it wanted to.  We had the high tech bubble of the 1990s and the explosion of securitization.  We saw countries brought to their knees by the international capital markets.  France was certainly the most noticed instance of this but the United States also felt the “end of the stick” and this led Treasury Secretary Robert Rubin to convince President Bill Clinton to get the budget under control.  The fiscal policy of the Clinton administration “bailed out” Alan Greenspan for the time as Fed Chair constantly waited for the substantial increase in productivity to come from the advances in information technology. 

,

The 2000-2001 recession came followed by Greenspan’s fear of a further deep recession which resulted in a lengthy period in which the target Federal Funds rate was kept at 1.00 percent for an “extended period of time.”  The housing bubble resulted accompanied by a bubble in the stock market.  It seems that in the new financial environment, funds could flow effortlessly around the world and create bubbles where ever the opportunity arose.

Chairman Bernanke came along and Bernanke, an “inflation hawk”, raised interest rates and kept a lid on the banking system until the “crash” came.  The Fed kept the “punch bowl” away from the economy for too long. 

This story is leading up to this point.  Bernanke’s effort at “inflation targeting”, which over stayed its welcome, was the last effort to conduct monetary policy under the “old”, post-World War II monetary regime.  Everything since that time has been improvisation and innovation.

This puts us right where we are today.  There is no current model of central bank operations that can explain what the Fed…and the European Central Bank…and the Bank of England…and so forth…are doing…or will do. 

We are in a new age…the information age.  It became apparent over the past ten years that money…credit…finance…was just a subset of information.  Money, credit, and finance, are really nothing more than 0s and 1s that can be “sliced and diced” anyway one can want.  And, a buyer can be found for these “sliced and diced” pieces of information. 

The large banks and other large financial institutions understand this.  So do many of the manufacturing giants of the past 60 years or so.  General Electric was at one time earning three-quarters of its profits from…its finance wing.  And, what about GMAC and General Motors?  And, the list goes on. 

We have gotten to the point where a huge proportion of the economy is represented by the finance industry…both in terms of income and in terms of employment. 

The manufacturing age is fading.  Yes, we still need manufacturing, but we also still need agriculture.  The world moves on.  Where is employment going to be in the coming years and what kind of training are these workers going to require.  The problem in the United States seems to be a misfit between where the jobs are and how the workforce is trained. But, we are talking about banking and about the Federal Reserve and about monetary policy. 

To me it is evident that things have changed in the financial industry.  Over sixty percent of the commercial banking industry in terms of assets are in the hands of twenty five banks, and most of the activities of these banks are nowhere near what the activities of commercial banks were fifty years ago.  And, most of this difference can be related to the advances in information technology.

And, my prediction for the next five years…you will hardly know what banking is in five years.

Where does that leave Mr. Bernanke and the Fed?  My guess here is that the Fed is going to have to go through changes in its “business model” just as most other institutions are doing.  The conduct of monetary policy in the future will be different than it is now, just as the conduct of monetary policy in the last half of the twentieth century was different from that in the first half. 

I don’t know how monetary policy is going to be conducted in the next decade or so, but my guess is that it will be different.  The Fed is in a “hole” and must find its way out of the “hole” and not dig the “hole” its in any deeper.     

The "Next Greece" Again

The New York Times business section carries the headline, “Traders Turn Attention to the Next Greece”: http://www.nytimes.com/2010/03/04/business/global/04bets.html?ref=business.

“Is Spain the next Greece? Or Italy? Or Portugal?”

Sounds vaguely similar to another article on the topic, my post of March 1, “Where is the Next Greece?”: http://seekingalpha.com/article/191242-where-is-the-next-greece. But, the subject is in the air these days.

The New York Times article wades into the issue of whether or not the “banks and hedge funds” should be doing what they are doing.

“Indeed, some banks and hedge funds have already begun to turn their attention to other indebted nations, particularly Portugal, Spain, Italy and, to a lesser degree, Ireland.” Aha, the PIIGS, of course without the G.

“The role of such traders has become increasingly controversial in Europe and the United States. The Justice Department’s antitrust division is now examining whether at least four hedge funds colluded on a bet against the euro last month.”

The same concern has been expressed over short sales.

Little concern was expressed about the debt policy of nations, states, municipalities, businesses and consumers when they were piling on massive amounts of debt to their balance sheets.

Of course, nations, and others, have good reasons for loading up with debt. It stimulates the economy and everyone wants prosperity and full employment. Well, don’t they?

Everyone wants businesses to prosper. Everyone wants everyone else to own their own home.

All good reasons for piling on debt.

But, when do “good intentions” spill over into “foolish behavior”?

And, in an environment where excessive amounts of credit are being pumped into the economy (thank you again Federal Reserve)n to spur on housing or some other “good”, shouldn’t it be expected that “extra-legal” means will be used to “get the credit out”.

But, when does serving “societal goals” become fraudulent and hurtful?

The problem in both cases is that there is a very blurry line between the “good” and the “bad”. On the upside, of course, emphasis is placed on the “good” being done, and the “bad” is alluded to but quickly dismissed. A common theme in such periods is that “Things are different now!”

On the other side, however, great pain takes place. One can certainly sympathize with those who live in Ireland, and Spain, and these other countries.

This, however, is just where “moral hazard” raises its ugly head. There is a downside to the excessive behavior of nations, states, and so on! There is pain on the other side of the pinnacle.
And, eventually the pain must be paid for. Bailing out those that used excessive amounts of debt just postpones the situation and usually leads people to behave just the way they did before the crisis. That is, the lesson learned is the one can behave badly and, if there is the threat of sufficient societal pain, little or no cost will be carried forward because of the previous un-disciplined behavior.

The problem is that those in power get mad at the bankers and the hedge funds and try to prohibit them in some way from moving against those private or public organizations that are financially weak. But, in doing so they are taking away a tool that can be used to enforce discipline on those who have lived excessively. The same applies to short selling.

We have seen behavior like that exhibited by the “banks and hedge funds” in the past. The last time these predators were called “shadowy international bankers”, many of whom were pictured as living in Switzerland. In that time the “ bankers” attacked the currencies of profligate nations. France, under the leadership of François Mitterrand, is perhaps the best known example of such a situation. Mitterrand, the socialist, had to pull back from his grand plans and became a believer in fiscal discipline and an independent central bank. Similar cases are on record.

It is disconcerting to see the increased efforts to reduce or eliminate financial tools that help to bring discipline to the market place. If these investment vehicles get punished or face harsh controls and regulations then the world is so much the worse for it.

Yes, I agree, at this stage it looks like the strong are kicking the weak member of the party. But, in these cases we forget that many benefitted greatly on the upside, particularly the politicians that promoted goals and objectives that were underwritten by the undisciplined use of debt. And, the central banks were prodigal in underwriting this credit inflation.

And, now the piper is calling in the debt.

It is a rule of life: those in power that create a given situation are often the most vocal opponents of those that respond to the consequences of what the powerful have created. If you create an inflationary environment fueled by excessive credit expansion then, sooner or later, the price must be paid.
Greece, Spain, Italy, Ireland, Portugal, England, and others are now facing the downside of so many years of “good intentions.” Let’s not just blame, or punish, the “bankers and hedge funds” for creating the situation we now face

Who is going to be the next Greece?

This seems to be the major question asked by most commentators in most media outlets. Is it going to be Spain? Japan? The U. K.? Italy? Portugal? Just who might it be?

Might it be California? Or New York? Or some major city?

Who are the hedge funds attacking this week? Where is the bailout going to come from? What about the IMF, what role is it going to play? And so on and so forth?

As far as the United States is concerned, thank goodness for all the attention being paid to the problems being experienced by these other countries, and states, and cities. At least others governmental units are getting the headlines about the debt problems going on in the world, and not the U. S. government.

And, the nice thing about the problems going on in the rest of the world is that investors still consider the dollar and dollar-denominated securities to be the least-risky of the lot. Flee to the dollar! Flee to U. S. Treasury securities!

Sometimes it is good to rank things on a relative basis. The person who receives a grade of D can save his own self-respect and place in the world when compared with the rest of the class who received a grade of D-. Doesn’t say much, however, about the whole class.

The United States dollar, a currency under attack until the financial crisis of 2008-2009, once again finds itself gaining strength as the financial condition of other countries come under attack and their currencies come under selling pressure.

The value of the United States dollar, which was once again under attack in the late summer and fall of 2009, has risen by more than 6% against major trading partners since the beginning of December as investors “flew to quality.” The United States dollar has done even better against the Euro as it has risen by about 18% versus the Euro over this same time period.

And, what are central banks doing under these circumstances?

They are still primarily operating under the umbrella of “quantitative easing.” That is, the central banks cannot drive interest rates any lower so they continue to provide reserves to their own banking systems in order to keep those banking systems afloat.

For the vultures circling over the scene it seems to be banquet time. The big banks, the big hedge funds, and others seem to be prospering in this environment of close to zero borrowing costs. These organizations are earning record profits! Not so, of course, for the small- to medium-sized financial institutions that are hanging on for their lives.

There are no good solutions! Every path out of this situation is full of difficulty and pain. And the strong get stronger and the weak, weaker.


The problem faced by politicians is that they must appear as if they are being active in the attempt to resolve the problems that their countries are now facing. Yet, to increase stimulus packages only exacerbates already stretched budget deficits. But, to cut spending, because revenues are down due to the weak economic conditions, only causes greater misery and social unrest. The fiscal conservatives attack those that push for more economic stimulus; the social liberals attack those that push for more budget restraint.

The central bankers worry about what will happen when interest rates begin to rise and asset values and business expectations start to fall again.

The world is in a tough spot when the basic question being asked becomes “who is going to fail next?”

It seems as if all these countries (states and cities) can do is attempt to reach a balance between improving the fiscal discipline being demanded by investors and voters and between the safety-nets that need to be created to cushion the difficulties being faced by many of the people within their domains.

With no “good” solutions available, governments must “muddle through” as best they can. There is no panacea.

The thing that should be avoided, but, in the distress of the moment, will, in all likelihood, not be avoided, is to create programs or solutions that will not be helpful once the crisis period is over. Politicians and others tend to “rush in” during “crisis” times and create programs, rules, regulations, or laws. (As Rahm Emanuel has stated, ““You don’t ever want a crisis to go to waste; it’s an opportunity to do important things that you would otherwise avoid.”) Once on the books, however, these programs, rules, regulations, and laws remain in practice for a lengthy period of time, and, over the longer-run, many fail to achieve the positive effects that was desired when implemented.

It is important for leaders, in my mind, to appear as if they are in control during times like these. In essence, all of these leaders are heading “turnaround” situations. These leaders must be pragmatic in practice. They must re-establish discipline in all that is done under their watch. They must not be the slaves of some ideology.

What these leaders do will not be pretty, but they need to be strong in order to bring people behind them. These leaders need to build support and trust. The worst thing that they can do is to look as if they are not in control for the vultures will jump on this appearance and dominate events.

What do the markets seem to be saying in response to the efforts of current leaders?

The headlines we are now reading in the newspapers and hearing on newscasts indicate that governmental leaders are not in control. It appears as if the future is being driven by hedge funds and others who are taking advantage of the feeble conditions in the various political units around the world. No one seems to be in charge and no one seems to be rising to the task!

Foreign Central Banks and the Dollar

There is continual talk that, if not in the short run, at least in the longer run, foreign central banks, especially the European Central Bank, should cut interest rates. My question right now is “Why should they?” They have played by the rules. The United States hasn’t. For the past seven years, the United States government has gone it alone…in foreign policy…and in economic policy. It is not in the interest of other central banks to ease up on the disciplined monetary policy they have worked so hard to establish. There is also some resentment they must get over caused by the ‘go-it-alone’ policies of the United States.

Since 2001 the value of the dollar has declined against the Euro by more than 7% per year. This certainly should have been a signal to the US that the rest of the world thought something was wrong with its economic policy. But, the Bush Administration did nothing about it. Now, the chips associated with globalization and the absence of an energy policy are coming home. The rest of the world is strong enough economically and financially that the United States cannot act independently anymore.

The current activity is exactly why world markets react against the monetary and fiscal policies of a country that are not sound and disciplined and sell that country’s currency. Sooner or later that country is going to have to monetize more and more of its outstanding debt. That is what the Bush Administration is now doing. No wonder the value of the dollar continues to decline and the price of gold rises along with the price of oil. The United States is paying for its lack of discipline. However, the rest of the world is also concerned about the price it will pay for the past behavior of the United States.