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The Greek tragedy: nemesis before catharsis

Posted by Tim Congdon in News Archive | 0 comments

Since 2009 Greece has been a barometer of the Eurozone’s continued viability. The rake’s progress of the four years to early 2009 had been remarkable. It had run current account deficits (relative to GDP) of 7.6% in 2005, 11.4% in 2006, 14.6% in 2007 and 14.9% in 2008 or, over the four years combined, of about 50% of GDP. The big external creditors included international banks, particularly European banks, which had acquired large holdings of Greek government debt and made loans to Greek banks. The extra debt could be serviced in the long run only if Greece reduced its current account deficit substantially. A devaluation against the currencies of its main trading partners was  therefore  sensible,  in  order  to  motivate  the  necessary  switch  of production  towards  exports.  Unfortunately,  as  a  member  of  the  Eurozone single currency area Greece could not devalue. It could leave the Eurozone, but that would shatter the geopolitical dreams of the Eurozone’s architects in Germany and France. For them the single currency area was a permanent structure which foreshadowed ever-increasing economic and political integration in the European Union. As devaluation within the Eurozone was impossible, the focus of the policy drive to improve Greece’s financial position was on the budget deficit. The Eurozone   sovereign   debt   crisis   escalated   in   early   2010.   Since   then negotiations have been held between international bodies (usually “the troika” of the European Commission, the European Central Bank and the International Monetary Fund) and the Greek authorities, about targets for the reduction of budget  deficits  and  public  debt.  The  Greeks  have  repeatedly  missed  the targets. Fiscal austerity and the implosion of the banking system have been associated with a drop in real GDP of almost a quarter in five years. The GDP decline has further pushed up the debt/GDP ratio. This note examines the latest developments. Although the budget deficit numbers have been better in 2012 than in 2011, the macroeconomic trauma is so severe and unrelenting that Greece must leave the single currency area as soon as possible.  

What will happen to UK money growth without QE?

Posted by Tim Congdon in News Archive | 0 comments

The Bank of England’s quantitative easing scheme added at least £150b. (and probably closer to £200b.) to the quantity of money (i.e., the M4 broad money measure, dominated by bank deposits) in the eleven months from early March 2009 to end-January 2010. Although this did not lead to a significantly positive rate of money growth, it did prevent a large contraction in M4 and so averted a recession worse than that actually recorded. The announcement of QE was soon followed by a remarkable surge in asset prices, an unusually positive swing in business optimism and output-raising plans, and an end to the big job losses seen in late 2008. Along with QE, the very low level of interest rates was crucial in this spectacular improvement, not least because it reduced wealth-holders’ desired ratio of interest-bearing money to assets and expenditure. But the Bank has now announced that QE will be put on hold, presumably for at least a couple of months. What will happen to UK money growth without the Bank’s asset purchases? And what is the implicit message for UK asset prices and economic activity? The analysis here suggests that – without QE – UK broad money will be roughly flat in the first half of 2010, i.e., any change will be small and probably within a minus 2% - plus 2% band at an annualised rate. Since very low interest rates will continue to discourage agents from holding interest-bearing money, economic conditions should not be too bad. However, above-trend growth and meaningful falls in unemployment are not to be expected. (Also relevant in constraining the UK economy is a still unhelpful international environment, with the Eurozone’s banking and financial difficulties intensifying.) Fortunately, the Bank’s statement included the sentence, “The Committee will continue to monitor the appropriate scale of the asset purchase programme and further purchases would be made should the outlook warrant them.”  

The economic consequences of bank-bashing

Posted by Tim Congdon in News Archive | 0 comments

Since summer 2007, and particularly since September 2008, banks have been bashed by governments and regulators. Part of their punishment is that they are being asked to do the impossible and then blamed when they cannot deliver. In particular, they are being required – even instructed – by officialdom to attain two or more supposedly desirable outcomes, even if these outcomes are mutually incompatible. The worst example – related to the paradox of excessive bank regulation discussed here on 14th September – is that banks have been told that they must simultaneously,

  1. i. raise their capital/asset ratios to make their businesses safer, and
  1. ii. increase their lending in order to boost spending and the economy.
As ought to be obvious, increases in lending by themselves lower capital/asset ratios. i. and ii. are inconsistent. True enough, banks can try to raise more capital. But there are limits to the amount of bank capital that financial markets are prepared to supply. After all investors want to have a decent return on their funds. Does someone need to point out that – if the return on capital is given – the more capital a bank keeps for each £ of lending, the higher must be its loan margin? Again obviously, the higher are loan margins, the lower are households’ and companies’ demands for bank finance, and the lower is new bank lending. Bluntly, government, regulators and central banks around the world are in a muddle.  At any rate, the latest UK data show that banks’ unused credit facilities are still going down, with the fall in August amounting to almost £20b. (i.e., almost 7% in one month). This will not make it easier for the Bank of England to maintain a positive rate of money growth.  

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