Central Bank Easing No Longer Causes Inflation...Or Does It? [View article]
" that money does not evaporate into thin air. It has to go somewhere. Some of it is going to high-end works of art, but the vast majority of it is going into bonds, the stock market, and real estate."
Money can't "go into" art. Or bonds. Or the stock market. Or real estate. People can spend money to buy those things from people who already own them - then the former owners have the same money ,and the new owners have the same art, bonds, stocks, and real estate that the former owners had. No transaction in existing assets changes the physical quantity of existing assets, and no transaction in existing assets, at any price, uses up money. The money just changes hands.
The reason central bank easing has not led to broad inflation - and it hasn't - is that the total amount of broad credit outstanding is not moving higher rapidly. Only the narrowest money measures are. The reason broader ones are not is that there is no mechanical relationship or stable ratio or "gearing", between narrow money on the one hand, and broader forms of money or credit on the other. Between the two stands the entire private financial system.
The value of money depends on two items, its supply and the demand for it. The demand for money is not the amount of goods money it is supposedly chasing. The demand for money is actual demand for --- wait for it - money, and not other things. When people's preferences to hold short term risk free assets rises, their demand for money has increased. Whenever anyone places a sell order of anything, they are placing a buy order for money. The demand for money is not a constant - it is not even remotely a constant - nor does it move one for one with some quantity of physical goods.
If the supply of something rises sharply and its price does not move, you know to a demonstration that demand for that item rose, too. This is the case for *narrow* money, recently. It isn't for broad credit, particularly, simply because broad credit has not been moving appreciably. Some forms of it have increased while others have cratered, with no net movement to speak of, overall.
What is actually going on here is that people who incorrectly predicted that the general price level would soar due to monetary policy and growth of narrow money, are casting about for anything to avoid admitting that they were completely wrong in that prediction. If they just looked at what has been happening to the private financial system, and therefore to broad credit, since late 2008 - you know, the things official policy is actually a response to - they would see directly why they were wrong. To wit, that broad credit --- is not moving.
Why? Because the destruction of the capital of specifically financial firms is strongly deflationary. The total broad credit that can be outstanding at any time, is limited by the capital of specifically financial firms, times their desired leverage level. And blowing away trillions of the former does not make them want to raise the latter - nor would regulators let them. Making more of their assets, narrow money, does nothing to raise their capital. It prevents failures for liquidity reasons, at best. Broad credit still can't move until their capital does, and then no faster than their capital grows.
"You are fundamentally saying that to recapitalize, all current shareholders would get the buzz cut down to zero"
No, I am not even remotely saying that.
I am saying that to recapitalize, the bondholders should accept repayment of 15% of their present bond holdings in the form of new stock issued to them at book value. That would recapitalize the firms, put them in regulator compliance with Basel III, reduce the objective risk on the remaining 85% of the bond holders positions, and clear the way for top line expansion if the bank operators see that to be sound. The existing shareholders would face dilution - not to zero - but would end up owning shares in less indebted banks, with their major financial risks cleared away.
Everyone involved would be better off, whether they can see that or not (hint, many of them can't or don't) and the negative externalities the banks are currently pushing on all the rest of us, in and out of Europe, would also disappear.
The negative book per share is entirely due to buying back gobs of their own stock at prices well above book value. They have long since bought in their entire original equity, valued at book.
In the accounting, it a company buys 1000 shares of its stock at $200, and the book value per share is $100, $200,000 has to leave the asset side of the sheet as paid out cash. An equal offset must be made to the "liabilities and equity" side of the sheet, purely as a requirement of double entry bookkeeping. There is no liability being retired when a company buys in its stock, so the entire sum must be deducted from one of the equity accounts. The equity must therefore drop by all $200,000, even though the shares out only fell by 1000, not by 2000.
As soon as the cumulative total amount paid to repurchase stock above book value equals the previous book value, this process will drive the book equity account to zero - and as more is spent repurchasing stock, below it. This does not mean the company has no assets or those have no value. It means it has by then paid "less than nothing, net" to acquire all its future earning power. It has returned all its capital to its shareholders, and is returning more besides.
The right way to estimate the enterprise value of such a business is to capitalize its ongoing "owner earnings" (cash flow minus capital expenditures needed to maintain business position), then deduct all liabilities. The past-facing book value is simply no longer meaningful as a guide to what it is worth, because what it owns and earns no longer has any meaningful economic relationship to what it once paid to acquire its assets. It has paid less than nothing to acquire them, net of what it has returned to its owners.
The conversion of debt to equity is not "the mere movement of some numbers on a balance sheet". It is an actual resharing of risk among the creditors and the shareholders, and actually achieves an alignment with requirements coming from regulators *rapidly*, without waiting ten years for earnings to accomplish it.
"if you're arguing that it won't because of other myriad systemic issues"
On the contrary, I am arguing that is would have major, outsized real benefits. I am identifying it as the specific bottleneck, the leverage point where action can have the largest impact on the future macro trajectory of the whole European economy. Every other point of policy "pushing" is vastly harder and less able to get anything to happen, in comparison.
"We both fully concur on recapitalizing banks; we seem to disagree on how to do that"
Indeed. I think that it can be done very quickly, perhaps painfully for some interests but without great sacrifices, and consider it a standing policy scandal that it has not already happened.
"what other actions must accompany."
I think practically all the other requirements of European recovery (cyclical rather than secular) have already been met. Could they still improve their secular trends, sure. But this is the main item they are doing wrong - or rather, just not doing.
"I have no objection to converting some debt to equity"
So let's do it - if I'm right it will make a huge difference, and the cost is trivial.
"that won't accomplish anything."
I deny it utterly.
"Europe needs a full-on dose of fiscal injection"
They already have that. Spain has a deficit of 10% of GDP, and unemployment is still north of 20% and climbing. The ECB is already loose. You can argue they were late to it, but the present governor has pulled out the previous stops.
"If the private sector won't or can't generate loan demand"
Chicken and egg, there is plenty of latent even overdue demand but no confidence in the macro picture, for excellent reason.
"private banks won't lend money, whether they have nice balance sheets or not"
Non issue, they do not. And they can't lend money, won't has nothing to do with it. The regulators would seize them from breaking Basel requirements if they tried. Indeed, they are all presently on course to be nationalized for failing to meet Basel III requirements as soon as those come into force, and their only recourse so far has been to lobby governments not to enforce them yet. Without additional capital, it is suicide for any of them to expand in the slightest.
"up to the governments/ECB to take other actions to stimulate demand."
Government is the one destroying demand by holding Basel III over their heads. Basel III is sounder, long term, it is just cyclically galactically stupid without more equity to actually implement it. So get that equity, the Basel III nationalization spectre is exorcised, and the banks can expand.
"Take a look at the U.S., as an example."
Let's.
"created massive amounts of new money"
So has the ECB. The supply of narrow high powered Euros has grown by *more* since the crisis than the supply of narrow high powered dollars. Governments have run large deficits. But they did not do a TARP, their banks still have 30-45 times leverage instead of 10 times - counting leverage from *equity*. They only have 2-4 times counting leverage from total capital including long term debt.
"lots more was used to buy bad debts from the banks"
Wrong, only $80 billion - 0.5% of GDP - was used to buy bad debts from banks, in precisely 3 transactions, and at 50 cents on the dollar. Which buys actually made money by the time they unwound, so there was no gift of free capital to the banking system as a result of them. A reduction in risk at an important time, to be sure. But the US did not socialize losses on a massive scale for the banks. The only major losses the Treasury took were to support Fannie and Freddie, and that amounted to 1.5% of GDP - and the Fed earned more than that on its own emergency expansion.
"issuing massive amounts of new Government bonds"
True, and that mattered in 2009 to stop GDP from falling outright. It hasn't mattered nearly as much since. Spain hasn't exactly been running huge public surpluses, and a fat lot of good that has done them. The outcome of "stimulus" has been different because the US financial system has actually recovered, and the European one has not.
"the Fed's achievement of much lower rates has fostered the financing and re-financing"
The ECB accomplished the same in Europe for quality credits. But the wide credit spreads the US also saw in late 2008 and early 2009, have persisted in the EU periphery. In the US, those lasted until markets knew the banks would not fail. In the EU, they persist because markets believe the peripheral sovereigns may still fail - destroying their banks in the process. Those credit spreads - which *are* the peripheral crisis - cannot disappear until the market knows that (1) the banks will not fail and (2) the peripheral sovereigns will not default and force their losses onto the banks and private financial sector.
"I am arguing for a much more aggressive monetary and fiscal policy from Europe"
They have plenty but didn't fix their banks and that destroys the impact of everything they have tried to do. Everything. If the private financial sector continues to contract and there is no confidence in debt issued by banks or governments, then macro credit cannot expand, and governments can't even spend to stimulate. Can Spain double a public deficit already at 10% of GDP to raise domestic demand, when it is paying 6-7% on its debt already? It cannot.
The banks have to be fixed *first*. That is the whole point. Until that happens, every public policy measure is pushing on a string.
WMARKW - fair question, but asked and answered. The reason this doesn't just happen with voluntary transactions is the banks are trading at 2/3rds of book value, and the amount of conversion they require is 2-4 times the value of their existing equity. The stocks are not being bought even up to book, so that is hardly evidence of demand for 2-4 times as much, and trying to place that much more by just dumping new stock could drive the prices even lower. In addition, the macroeconomic benefit from all of them recapitalizing is not available as upside to just one of them going first; only one major bank going through the process would not move the needle on broad credit growth.
You don't get it. The central bank issuing narrow money does *not* cause the broad supply of credit to increase, when the banking sector is *broken*. The banking sector *is* the transmission belt between central bank policy / actions and actual broad credit. They *cannot* get the Euro to decline in value, equals they cannot get the general price level across Europe to rise, as long as private financial sector credit continues to crater. Adding liquidity will not make it happen. Broad credit is not created by narrow money liquidity alone. Broad credit *also* requires sufficient financial firm (bank especially) *capital*. In the case of Europe, specifically *equity* capital, since they actually do have enough long-term debt style "capital".
Official policy doesn't get to just pick to have inflation or higher prices or a growing broad money supply, because they know or think they want or need those things. There is an actual technical requirement, beyond policy choices, to get it to happen. That actual technical requirement is that broad credit actually move higher when the central bank adds narrow money. Which it flat has not, does not and will not, when the banks are broken and cannot expand their own balance sheets.
The private financial sector dwarfs the official ones, and changes in broad credit dwarf changes in narrow money, because narrow money is - wait for it - narrow, and only a few percent of total Euro credit outstanding. To get the full broad money aggregates, not the narrow ones, moving higher, it is emphatically not enough to increase the growth rate of the narrow money aggregates. They have already done that, since the current central bank head took over. But it has not cured double digit unemployment, or weakened the Euro, or meaningfully raised total Euro credit outstanding.
And I am telling you *why* it hasn't. The specific bottleneck. There isn't enough bank equity for bank top lines to move and still comply with Basel III. All the narrow money ease in the world will not make them expand without such additional equity. Adding narrow money does not increase their equity, it just shifts their asset mix toward cash, which makes them liquid but doesn't change their net worth at all.
Eurozone official policy it not just ECB monetary policy. Money has been loose, but credit regulation has been tight - new Basel III requirements. At the same time, populism has pushed the politicians to dump credit losses onto the banks. The banks are beat to heck, trading at 2/3rds book value, with 2-3% equity layers. They will not get broad credit growth until they recapitalize the banks.
First, the yellow journalist Fed bashers have deliberately fostered confusion between the small Maiden Lane operations of late 2008, and the large MBS position initiated in QE1 in 2009 and later. The latter position is all in agency MBS, meaning items underwritten by Fannie, Freddie, or Ginnie Mae, after the former 2 were nationalized, and thus are fully guaranteed by the US treasury for payment of contracted interest and principle. Those securities have traded above par the entire time the Fed has owned them, and it has a large unrealized capital gain on them. The size of that position is $1.1 trillion.
The only "toxic" securities that were every on the Fed's sheet were the $80 billion in the Maiden Lanes of 2008, from the Bear, AIG, and Citigroup transactions. Those were not bought at face, but at steep discounts, around 50% of face value. They also had a structure in which a bank counterparty (in the AIG case, the US Treausry as effectively the receivor) stood ahead of the Fed for any losses on the portfolios, the Fed was senior. Because of the steep discount at which the securities went into those, they eventually worked out at a profit, and the Fed's position in the remainder is down to under $1.5 billion. Overall it turned a profit in the low single digit billions on all 3 Maiden Lanes combined, and that whole thing is over by now.
If you look at the Fed's latest Factors Affecting Reserve Balances, you will see the tiny position left in the Lanes. If you read any of its reports on their resolution you can track all of it in detail. I know this stuff because I've read its statements every month, none of it is esoteric.
The reason for the impression otherwise, abroad in the world, is the following. During 2008 when the Maiden Lane transactions were occurring, those opposed to the Fed ideologically or to those transactions specifically, saw them as a dangerous precedent and predicted that the Fed would take losses for the banking system. It didn't, and by the spring of 2009 it was clear it wasn't going to lose on those transactions, but the opposition did not acknowledge that. The impressions left by the press campaign against the Fed actions in the crisis remained, in 2009, as the Fed initiated the separate QE I purchase of agency MBS. The critics shifted to criticizing that, some on the grounds of its sheet size effect, others more cynically shifting their allegation of "toxic security" purchases to agency MBS that had never lost any of their owners a dime. There was always a new possible future fear to latch onto - most recently, it is that maybe interest rates will rise and cause mark to market portfolio losses.
But the Fed's actual profits in the entire period tell the tale. It was earning $30 billion a year before the crisis, and it earned $88 billion last year. Its profit increases alone since its emergency operations of late 2008 come to over $175 billion - more than enough to pay for all TARP costs.
Why A Stock Market Bubble Is Forming Right Now [View article]
"You think unbridled capitalism is a positive? Really? Seriously?"
Yes. Really and seriously. You know what this site is about, right? It isn't Workers World Daily or the Chairman Mao Fan Club. It is Seeking Alpha - dedicated to the belief that intelligence and insight can and will produce dramatically superior investments and create new wealth by doing so. That is what the title means.
That there are billions of human beings alive at all it a product of capitalism. That any of them have any wealth beyond grinding poverty is a product of capitalism. Before there was any capitalism, the entire human race was less than a tenth its present number, and every single one of them lived in grinding poverty. Capitalism didn't "condemn" them to that, it is how they were born, and how mankind had lived since before the dawn of recorded history. There has never been an epoch or place that wasn't in grinding poverty, that didn't owe its not being so, to capitalism.
And your ingratitude toward it indicts you, not it...
"lenders are risk averse for genuine business reasons, not balance sheet fragility."
Both, it is a bad equilibrium, and entirely typical of deflationary periods, and removing the financial capital roadblock is essential to any lasting recovery. Just as fixing the banks didn't cure unemployment overnight in the US, but did let us end outright falling GDP and rising unemployment, so in Europe they have to fix their financial sector to get to square one.
"The only way that issue is going to be addressed, in export-centric Europe, is by driving down the value of the euro"
Export led recovery is a horrible model for 25% of world GDP. It can work for small bit players when the core is expanding, that is about it. But if they do want to lower the Euro, guess what? Ending deflation is the only way to even start. When people expect the probability of massive public sector defaults and major banks or entire national banking systems collapsing outright, is non-zero, they are not going to expect rising inflation - because there isn't going to be any.
I continue to be amazed at how hard this apparently is for people to just "get", but massive destruction of specifically financial capital is strongly deflationary, and the only cure for it is (1) end such losses and (2) increase such capital. Depreciating the Euro during a massive deflation of private financial sector credit, is not going to happen. And private financial sector credit cannot grow - at all - when banks are leveraged 30 to 40 to 1 (equity terms), and have regulatory requirements staring them in the face that demand 10 or 12 to 1.
The rest of the world is not going to ride in an save Europe, either by buying its exports or by deflating harder than it does. It needs to fix its financial sector, stat. The entire educated financial world has been screaming as much to anyone who would listen for at least 3 years straight, and all we've seen in response is temporary half measures from the core, and outright public sector defaults from the periphery.
marketwatcher23 - nonsense, its "shareholders" receive a statutory 6% dividend on their original contributed capital, and everything else it earns above expenses is paid to the US treasury annually. The former amounted to $1.6 billion dollars last year, the latter to $88.4 billion. The "private" bank shareholders received less than 2% of the income. Some "owners".
"would force the Governments/ECB to pony up all the funds"
No, it wouldn't. Not even remotely. Deutsche Bank bondholders hold $960 billion in bond securities. If $160 billion of them, or 1/6th, are forceably converted to equity, the public side doesn't need to put up a single dime.
And the lack of "demand for loans" is entirely circular, because there is no net new credit entering the system. If there were, for the best potential investments, it would put additional factors to work and raise both aggregate demand, and with it loan demand. Right now credit is clearly being rationed by risk category - that is why we see epic spreads combined with low rates for the highest credits. That is not a sign of low total credit demand, but of rationing, picking off the best credits not the highest offered rates, due to risk aversion by the lending side.
"unless there are some sizable incentives. I'm not entirely sure where these are going to materialize"
Well here is one - the government will not seize your bank and nationalize it, if it is properly capitalized with a sufficient equity layer to meet Basel III standards. Otherwise, it will, and will make the swap by force.
How's that for an incentive?
The EU has been way, way too slow on all of this...
It is really true. A bank that has a 10% equity cushion is objectively less likely to be seized by regulators, for starters. Or in other ways to have creditors asserting their rights disrupt its activities as a running business. Similarly, a bank with a 2% equity cushion cannot make balance sheet top line decisions based on likely profitability - it must manage the entire bank with a view to avoiding any dip in that thin equity cushion.
If the largest EU banks were undercapitalized even taking their long term debt into account, then I would agree with your assessment, but a case like DB shows that is not the issue. Its long term debt plus equity is 50% of non-cash assets. That is not undercapitalized, if long term debt is capital. They don't need more of that to be adequately capitalized. They do need more of it to be equity.
There may be weaker peripheral banks for whom the issue is total capital, not how thin the equity component of it is. But the issue for the core money center ones is the one I've discussed, above.
The "capital losses" concern is about the interest rate risk on the Fed's bond portfolio. They don't have any losses, they are $200 billion in the black, but long term interest rates are at record lows. They own a $1.14 trillion portfolio of MBS, and $1.77 trillion of treasuries, most in a note ladder from 3 to 10 years maturity. The duration on the former is about 4-5 years, on the latter 5-6 years; the former also has negative convexity (prepayments slow if rates rise, so their average life rises when rates do). Add it all up and their interest rate sensitivity is somewhere around $150 billion per percent.
Meaning, if rates rise 1% across the board instantly, the market value of the portfolio drops $150 billion, as a one-off. Their past gains cover about the first 1.3% move higher, because that is the rate they bought the stuff at, roughly. Their carry income can cover continually higher rates at about 0.5% per year, maybe 0.6% per year at the outside. If rates move higher than that, faster than that, then they will have mark to market capital losses on the bond portfolio, purely due to interest rate risk.
Most of that is pay me now or pay me later, however. A bond held to maturity doesn't care much what happened to rates in the meantime, and actually earns slightly more if rates move up instead of down (because the interest on the interest is marginally higher). You can earn 3% on a smaller principle or 2% on a higher principle; if you own the same bonds you get the same income in dollars, either way, and as long as they don't have permanent credit losses, the principle all comes back by maturity.
But they could certainly post such declines in an interest-rates-rising scenario. Inside the Fed, some are concerned that the administration and congress have gotten used to getting $75 and $85 billion a year checks from the Fed, and it won't send them any if rates are moving higher, it will retain interest earnings to offset bond price drops. They don't think this has any real effect on their ability to conduct monetary policy any way they like, but they do worry about the perceptions and PR it may bring, when it eventually happens. The Fed basher crowd will run around saying the Fed is losing billions and is broke and is a disaster and whatever, when nothing much is actually happening, but a bond portfolio weathering a one-time uptick in interest rates.
Which, to be clear, has not happened and is not now happening. But they are already worrying themselves about the PR side of things when / if it does.
Yes I am confident they can, because they can. But then the operative phrase is "anytime they want" - and as of yet, they don't "want". Looking at trailing CPI, there is little reason why they should.
Central Bank Easing No Longer Causes Inflation...Or Does It? [View article]
Money can't "go into" art. Or bonds. Or the stock market. Or real estate. People can spend money to buy those things from people who already own them - then the former owners have the same money ,and the new owners have the same art, bonds, stocks, and real estate that the former owners had. No transaction in existing assets changes the physical quantity of existing assets, and no transaction in existing assets, at any price, uses up money. The money just changes hands.
The reason central bank easing has not led to broad inflation - and it hasn't - is that the total amount of broad credit outstanding is not moving higher rapidly. Only the narrowest money measures are. The reason broader ones are not is that there is no mechanical relationship or stable ratio or "gearing", between narrow money on the one hand, and broader forms of money or credit on the other. Between the two stands the entire private financial system.
The value of money depends on two items, its supply and the demand for it. The demand for money is not the amount of goods money it is supposedly chasing. The demand for money is actual demand for --- wait for it - money, and not other things. When people's preferences to hold short term risk free assets rises, their demand for money has increased. Whenever anyone places a sell order of anything, they are placing a buy order for money. The demand for money is not a constant - it is not even remotely a constant - nor does it move one for one with some quantity of physical goods.
If the supply of something rises sharply and its price does not move, you know to a demonstration that demand for that item rose, too. This is the case for *narrow* money, recently. It isn't for broad credit, particularly, simply because broad credit has not been moving appreciably. Some forms of it have increased while others have cratered, with no net movement to speak of, overall.
What is actually going on here is that people who incorrectly predicted that the general price level would soar due to monetary policy and growth of narrow money, are casting about for anything to avoid admitting that they were completely wrong in that prediction. If they just looked at what has been happening to the private financial system, and therefore to broad credit, since late 2008 - you know, the things official policy is actually a response to - they would see directly why they were wrong. To wit, that broad credit --- is not moving.
Why? Because the destruction of the capital of specifically financial firms is strongly deflationary. The total broad credit that can be outstanding at any time, is limited by the capital of specifically financial firms, times their desired leverage level. And blowing away trillions of the former does not make them want to raise the latter - nor would regulators let them. Making more of their assets, narrow money, does nothing to raise their capital. It prevents failures for liquidity reasons, at best. Broad credit still can't move until their capital does, and then no faster than their capital grows.
Doomed Europe [View article]
No, I am not even remotely saying that.
I am saying that to recapitalize, the bondholders should accept repayment of 15% of their present bond holdings in the form of new stock issued to them at book value. That would recapitalize the firms, put them in regulator compliance with Basel III, reduce the objective risk on the remaining 85% of the bond holders positions, and clear the way for top line expansion if the bank operators see that to be sound. The existing shareholders would face dilution - not to zero - but would end up owning shares in less indebted banks, with their major financial risks cleared away.
Everyone involved would be better off, whether they can see that or not (hint, many of them can't or don't) and the negative externalities the banks are currently pushing on all the rest of us, in and out of Europe, would also disappear.
IBM: A Disaster In The Making [View article]
In the accounting, it a company buys 1000 shares of its stock at $200, and the book value per share is $100, $200,000 has to leave the asset side of the sheet as paid out cash. An equal offset must be made to the "liabilities and equity" side of the sheet, purely as a requirement of double entry bookkeeping. There is no liability being retired when a company buys in its stock, so the entire sum must be deducted from one of the equity accounts. The equity must therefore drop by all $200,000, even though the shares out only fell by 1000, not by 2000.
As soon as the cumulative total amount paid to repurchase stock above book value equals the previous book value, this process will drive the book equity account to zero - and as more is spent repurchasing stock, below it. This does not mean the company has no assets or those have no value. It means it has by then paid "less than nothing, net" to acquire all its future earning power. It has returned all its capital to its shareholders, and is returning more besides.
The right way to estimate the enterprise value of such a business is to capitalize its ongoing "owner earnings" (cash flow minus capital expenditures needed to maintain business position), then deduct all liabilities. The past-facing book value is simply no longer meaningful as a guide to what it is worth, because what it owns and earns no longer has any meaningful economic relationship to what it once paid to acquire its assets. It has paid less than nothing to acquire them, net of what it has returned to its owners.
Doomed Europe [View article]
The conversion of debt to equity is not "the mere movement of some numbers on a balance sheet". It is an actual resharing of risk among the creditors and the shareholders, and actually achieves an alignment with requirements coming from regulators *rapidly*, without waiting ten years for earnings to accomplish it.
"if you're arguing that it won't because of other myriad systemic issues"
On the contrary, I am arguing that is would have major, outsized real benefits. I am identifying it as the specific bottleneck, the leverage point where action can have the largest impact on the future macro trajectory of the whole European economy. Every other point of policy "pushing" is vastly harder and less able to get anything to happen, in comparison.
"We both fully concur on recapitalizing banks; we seem to disagree on how to do that"
Indeed. I think that it can be done very quickly, perhaps painfully for some interests but without great sacrifices, and consider it a standing policy scandal that it has not already happened.
"what other actions must accompany."
I think practically all the other requirements of European recovery (cyclical rather than secular) have already been met. Could they still improve their secular trends, sure. But this is the main item they are doing wrong - or rather, just not doing.
"I have no objection to converting some debt to equity"
So let's do it - if I'm right it will make a huge difference, and the cost is trivial.
"that won't accomplish anything."
I deny it utterly.
"Europe needs a full-on dose of fiscal injection"
They already have that. Spain has a deficit of 10% of GDP, and unemployment is still north of 20% and climbing. The ECB is already loose. You can argue they were late to it, but the present governor has pulled out the previous stops.
"If the private sector won't or can't generate loan demand"
Chicken and egg, there is plenty of latent even overdue demand but no confidence in the macro picture, for excellent reason.
"private banks won't lend money, whether they have nice balance sheets or not"
Non issue, they do not. And they can't lend money, won't has nothing to do with it. The regulators would seize them from breaking Basel requirements if they tried. Indeed, they are all presently on course to be nationalized for failing to meet Basel III requirements as soon as those come into force, and their only recourse so far has been to lobby governments not to enforce them yet. Without additional capital, it is suicide for any of them to expand in the slightest.
"up to the governments/ECB to take other actions to stimulate demand."
Government is the one destroying demand by holding Basel III over their heads. Basel III is sounder, long term, it is just cyclically galactically stupid without more equity to actually implement it. So get that equity, the Basel III nationalization spectre is exorcised, and the banks can expand.
"Take a look at the U.S., as an example."
Let's.
"created massive amounts of new money"
So has the ECB. The supply of narrow high powered Euros has grown by *more* since the crisis than the supply of narrow high powered dollars. Governments have run large deficits. But they did not do a TARP, their banks still have 30-45 times leverage instead of 10 times - counting leverage from *equity*. They only have 2-4 times counting leverage from total capital including long term debt.
"lots more was used to buy bad debts from the banks"
Wrong, only $80 billion - 0.5% of GDP - was used to buy bad debts from banks, in precisely 3 transactions, and at 50 cents on the dollar. Which buys actually made money by the time they unwound, so there was no gift of free capital to the banking system as a result of them. A reduction in risk at an important time, to be sure. But the US did not socialize losses on a massive scale for the banks. The only major losses the Treasury took were to support Fannie and Freddie, and that amounted to 1.5% of GDP - and the Fed earned more than that on its own emergency expansion.
"issuing massive amounts of new Government bonds"
True, and that mattered in 2009 to stop GDP from falling outright. It hasn't mattered nearly as much since. Spain hasn't exactly been running huge public surpluses, and a fat lot of good that has done them. The outcome of "stimulus" has been different because the US financial system has actually recovered, and the European one has not.
"the Fed's achievement of much lower rates has fostered the financing and re-financing"
The ECB accomplished the same in Europe for quality credits. But the wide credit spreads the US also saw in late 2008 and early 2009, have persisted in the EU periphery. In the US, those lasted until markets knew the banks would not fail. In the EU, they persist because markets believe the peripheral sovereigns may still fail - destroying their banks in the process. Those credit spreads - which *are* the peripheral crisis - cannot disappear until the market knows that (1) the banks will not fail and (2) the peripheral sovereigns will not default and force their losses onto the banks and private financial sector.
"I am arguing for a much more aggressive monetary and fiscal policy from Europe"
They have plenty but didn't fix their banks and that destroys the impact of everything they have tried to do. Everything. If the private financial sector continues to contract and there is no confidence in debt issued by banks or governments, then macro credit cannot expand, and governments can't even spend to stimulate. Can Spain double a public deficit already at 10% of GDP to raise domestic demand, when it is paying 6-7% on its debt already? It cannot.
The banks have to be fixed *first*. That is the whole point. Until that happens, every public policy measure is pushing on a string.
Doomed Europe [View article]
They are in a bad equilibrium.
Doomed Europe [View article]
Official policy doesn't get to just pick to have inflation or higher prices or a growing broad money supply, because they know or think they want or need those things. There is an actual technical requirement, beyond policy choices, to get it to happen. That actual technical requirement is that broad credit actually move higher when the central bank adds narrow money. Which it flat has not, does not and will not, when the banks are broken and cannot expand their own balance sheets.
The private financial sector dwarfs the official ones, and changes in broad credit dwarf changes in narrow money, because narrow money is - wait for it - narrow, and only a few percent of total Euro credit outstanding. To get the full broad money aggregates, not the narrow ones, moving higher, it is emphatically not enough to increase the growth rate of the narrow money aggregates. They have already done that, since the current central bank head took over. But it has not cured double digit unemployment, or weakened the Euro, or meaningfully raised total Euro credit outstanding.
And I am telling you *why* it hasn't. The specific bottleneck. There isn't enough bank equity for bank top lines to move and still comply with Basel III. All the narrow money ease in the world will not make them expand without such additional equity. Adding narrow money does not increase their equity, it just shifts their asset mix toward cash, which makes them liquid but doesn't change their net worth at all.
Eurozone official policy it not just ECB monetary policy. Money has been loose, but credit regulation has been tight - new Basel III requirements. At the same time, populism has pushed the politicians to dump credit losses onto the banks. The banks are beat to heck, trading at 2/3rds book value, with 2-3% equity layers. They will not get broad credit growth until they recapitalize the banks.
Is A QE Exit Really Scary? [View article]
First, the yellow journalist Fed bashers have deliberately fostered confusion between the small Maiden Lane operations of late 2008, and the large MBS position initiated in QE1 in 2009 and later. The latter position is all in agency MBS, meaning items underwritten by Fannie, Freddie, or Ginnie Mae, after the former 2 were nationalized, and thus are fully guaranteed by the US treasury for payment of contracted interest and principle. Those securities have traded above par the entire time the Fed has owned them, and it has a large unrealized capital gain on them. The size of that position is $1.1 trillion.
The only "toxic" securities that were every on the Fed's sheet were the $80 billion in the Maiden Lanes of 2008, from the Bear, AIG, and Citigroup transactions. Those were not bought at face, but at steep discounts, around 50% of face value. They also had a structure in which a bank counterparty (in the AIG case, the US Treausry as effectively the receivor) stood ahead of the Fed for any losses on the portfolios, the Fed was senior. Because of the steep discount at which the securities went into those, they eventually worked out at a profit, and the Fed's position in the remainder is down to under $1.5 billion. Overall it turned a profit in the low single digit billions on all 3 Maiden Lanes combined, and that whole thing is over by now.
If you look at the Fed's latest Factors Affecting Reserve Balances, you will see the tiny position left in the Lanes. If you read any of its reports on their resolution you can track all of it in detail. I know this stuff because I've read its statements every month, none of it is esoteric.
The reason for the impression otherwise, abroad in the world, is the following. During 2008 when the Maiden Lane transactions were occurring, those opposed to the Fed ideologically or to those transactions specifically, saw them as a dangerous precedent and predicted that the Fed would take losses for the banking system. It didn't, and by the spring of 2009 it was clear it wasn't going to lose on those transactions, but the opposition did not acknowledge that. The impressions left by the press campaign against the Fed actions in the crisis remained, in 2009, as the Fed initiated the separate QE I purchase of agency MBS. The critics shifted to criticizing that, some on the grounds of its sheet size effect, others more cynically shifting their allegation of "toxic security" purchases to agency MBS that had never lost any of their owners a dime. There was always a new possible future fear to latch onto - most recently, it is that maybe interest rates will rise and cause mark to market portfolio losses.
But the Fed's actual profits in the entire period tell the tale. It was earning $30 billion a year before the crisis, and it earned $88 billion last year. Its profit increases alone since its emergency operations of late 2008 come to over $175 billion - more than enough to pay for all TARP costs.
Why A Stock Market Bubble Is Forming Right Now [View article]
Yes. Really and seriously. You know what this site is about, right? It isn't Workers World Daily or the Chairman Mao Fan Club. It is Seeking Alpha - dedicated to the belief that intelligence and insight can and will produce dramatically superior investments and create new wealth by doing so. That is what the title means.
That there are billions of human beings alive at all it a product of capitalism. That any of them have any wealth beyond grinding poverty is a product of capitalism. Before there was any capitalism, the entire human race was less than a tenth its present number, and every single one of them lived in grinding poverty. Capitalism didn't "condemn" them to that, it is how they were born, and how mankind had lived since before the dawn of recorded history. There has never been an epoch or place that wasn't in grinding poverty, that didn't owe its not being so, to capitalism.
And your ingratitude toward it indicts you, not it...
Doomed Europe [View article]
"lenders are risk averse for genuine business reasons, not balance sheet fragility."
Both, it is a bad equilibrium, and entirely typical of deflationary periods, and removing the financial capital roadblock is essential to any lasting recovery. Just as fixing the banks didn't cure unemployment overnight in the US, but did let us end outright falling GDP and rising unemployment, so in Europe they have to fix their financial sector to get to square one.
"The only way that issue is going to be addressed, in export-centric Europe, is by driving down the value of the euro"
Export led recovery is a horrible model for 25% of world GDP. It can work for small bit players when the core is expanding, that is about it. But if they do want to lower the Euro, guess what? Ending deflation is the only way to even start. When people expect the probability of massive public sector defaults and major banks or entire national banking systems collapsing outright, is non-zero, they are not going to expect rising inflation - because there isn't going to be any.
I continue to be amazed at how hard this apparently is for people to just "get", but massive destruction of specifically financial capital is strongly deflationary, and the only cure for it is (1) end such losses and (2) increase such capital. Depreciating the Euro during a massive deflation of private financial sector credit, is not going to happen. And private financial sector credit cannot grow - at all - when banks are leveraged 30 to 40 to 1 (equity terms), and have regulatory requirements staring them in the face that demand 10 or 12 to 1.
The rest of the world is not going to ride in an save Europe, either by buying its exports or by deflating harder than it does. It needs to fix its financial sector, stat. The entire educated financial world has been screaming as much to anyone who would listen for at least 3 years straight, and all we've seen in response is temporary half measures from the core, and outright public sector defaults from the periphery.
Recapitalize. The banks. Yesterday.
Is A QE Exit Really Scary? [View article]
Doomed Europe [View article]
No, it wouldn't. Not even remotely. Deutsche Bank bondholders hold $960 billion in bond securities. If $160 billion of them, or 1/6th, are forceably converted to equity, the public side doesn't need to put up a single dime.
And the lack of "demand for loans" is entirely circular, because there is no net new credit entering the system. If there were, for the best potential investments, it would put additional factors to work and raise both aggregate demand, and with it loan demand. Right now credit is clearly being rationed by risk category - that is why we see epic spreads combined with low rates for the highest credits. That is not a sign of low total credit demand, but of rationing, picking off the best credits not the highest offered rates, due to risk aversion by the lending side.
Doomed Europe [View article]
Well here is one - the government will not seize your bank and nationalize it, if it is properly capitalized with a sufficient equity layer to meet Basel III standards. Otherwise, it will, and will make the swap by force.
How's that for an incentive?
The EU has been way, way too slow on all of this...
Doomed Europe [View article]
If the largest EU banks were undercapitalized even taking their long term debt into account, then I would agree with your assessment, but a case like DB shows that is not the issue. Its long term debt plus equity is 50% of non-cash assets. That is not undercapitalized, if long term debt is capital. They don't need more of that to be adequately capitalized. They do need more of it to be equity.
There may be weaker peripheral banks for whom the issue is total capital, not how thin the equity component of it is. But the issue for the core money center ones is the one I've discussed, above.
Is A QE Exit Really Scary? [View article]
Meaning, if rates rise 1% across the board instantly, the market value of the portfolio drops $150 billion, as a one-off. Their past gains cover about the first 1.3% move higher, because that is the rate they bought the stuff at, roughly. Their carry income can cover continually higher rates at about 0.5% per year, maybe 0.6% per year at the outside. If rates move higher than that, faster than that, then they will have mark to market capital losses on the bond portfolio, purely due to interest rate risk.
Most of that is pay me now or pay me later, however. A bond held to maturity doesn't care much what happened to rates in the meantime, and actually earns slightly more if rates move up instead of down (because the interest on the interest is marginally higher). You can earn 3% on a smaller principle or 2% on a higher principle; if you own the same bonds you get the same income in dollars, either way, and as long as they don't have permanent credit losses, the principle all comes back by maturity.
But they could certainly post such declines in an interest-rates-rising scenario. Inside the Fed, some are concerned that the administration and congress have gotten used to getting $75 and $85 billion a year checks from the Fed, and it won't send them any if rates are moving higher, it will retain interest earnings to offset bond price drops. They don't think this has any real effect on their ability to conduct monetary policy any way they like, but they do worry about the perceptions and PR it may bring, when it eventually happens. The Fed basher crowd will run around saying the Fed is losing billions and is broke and is a disaster and whatever, when nothing much is actually happening, but a bond portfolio weathering a one-time uptick in interest rates.
Which, to be clear, has not happened and is not now happening. But they are already worrying themselves about the PR side of things when / if it does.
I hope that helps.
Is A QE Exit Really Scary? [View article]