Posts Tagged stabilisation
In the past 30 years a great number of utilities in the developed world have been privatised. That trend seems likely to be reversed. Why? Because the ideology which drove the project—in particular, the notion that the private sector is always more efficient than the public sector—is collapsing. Effective public ownership is being reconsidered not just for the banking sector, but in rail transport, in water and power provision, in communications—in short, in a range of industries where large scale privatisation and deregulation over the past decades has been tried … and found wanting.
Banking provides the most dramatic example. Deregulation and demutualisation, particularly in the USA and Britain, led to a near-meltdown of the financial system in 2008 and, in consequence, a major and on-going recession—-in Britain, one longer than that of the 1930s. Willem Buiter, chief economist at Citi, argued in favour of taking the biggest banks into public ownership in 2009. Although there was a period of recovery after 2009, recession seems to be returning—and with it ominous signs of another financial and economic crisis, a ‘perfect storm’ potentially far more serious than that of four years ago.
After the banks were bailed out in in 2008, there was much talk of regulation. Today, new revelations and scandals (eg, Barclays’ fixing of LIBOR, HSBC’s money laundering) have again raised the issue of regulation and public ownership. While it is true that in the UK, the public owns two of the largest banks (RBS and Lloyds) and that Labour wants to set up a British Investment Bank, in reality almost nothing has been done to take effective control of the largest banks.
The simple truth is that the financial sector is too big and powerful to regulate effectively. In the US the sector’s ‘lobbying power’—the problem of regulatory capture —is now acknowledged on both the political left and right. And even if the biggest banks are broken up, as Professor Gar Alpervitz of the University of Maryland argues, it is likely that they will come back in even more concentrated form.
Britain is less transparent than the US, but few can deny the baleful influence of the City of London in emasculating the 2011 Vickers Report. Instead of calling for the physical separation of commercial and investment banking, Vickers called for ‘ring-fencing’—and then, only by 2019.
Typically, the argument against publicly-run banks is that they are inefficient; ie, that ‘civil servants cannot run banks’. But the key issue is not one of public efficiency—there are many well-run publicly owned or mutualised banks in the world. The issue is of private efficiency.
Can we afford not to take the largest players into public ownership, particularly if there is another financial crisis? The big private banks have cost the taxpayer trillions and brought about economic depression, resulting in a massive loss in output and jobs throughout the OECD. By speculating against sovereign bonds, private banks are a major player in the current Eurozone crisis. One might add, too, that these same banks have been a major driver of growing income inequality: tax havens have thrived and the culture of bankers’ bonuses has worsened since 2008!
Note that it is not being argued here that all banks should be publicly owned. But if banking scandals multiply, if the advanced economies continue to stagnate, if jobs are scarce and unemployment grows—and particularly, if the taxpayer is asked once more to bailout the banks in the wake of another financial crash—then it is a near certainty that within a decade, the largest banks will become public utilities.
Five years ago I wrote a book supporting the euro, but saying inter alia that Eurozone governance was fatally flawed and that a European Treasury was needed. Although not taken very seriously at the time, this view has today gained wide currency. Like it or not, a US-style Treasury is needed to guarantee states’ financial system and to effect fiscal transfers within the Eurozone. Yes, the Eurozone is a ‘transfer union’ and the sooner the rich countries face up to this reality the better. The alternative could be collapse of the euro, followed by financial chaos.
Intra Euro debt: Claims between national central banks (£bn)
source: M Wolf, ‘Intolerable choices for the Eurozone’ FT, 31 May 2011.
In a series of excellent pieces in the Financial Times, Martin Wolf has spelled out a compelling case for fundamental reform. The eurozone, Wolf reminds us, started life as a reincarnation of the gold standard. Eurozone member states were meant to finance a trade deficit by borrowing abroad; ie, by emitting their own central bank bonds. If markets were unwilling to buy these, a member-state would have no option but to find the money internally by means of a squeezing labour costs, or what is euphemistically termed ‘internal devaluation’.
There are two problems here. One is that squeezing wages may have an unacceptably high political cost. While it is true that cutting aggregate demand sufficiently will balance the books at some (very much) lower level of national income, the patient may stop breathing as a result. (For example, Ireland has now experienced four years of recession and the young are emigrating in droves.)
The second problem is the banking system. Since private credit died up after 2008, the ECB (and the Bundesbank) have acted de facto as the Eurozone’s lender of the last resort, both in buying the sovereign debt of the periphery’s Central Banks and helping Europe’s large private banks to do so. Indeed, the accompanying figure illustrates the unnerving symmetry between Germany’s position as chief central bank creditor and the growing indebtedness of the Eurozone periphery—unnerving because the Germans are indirectly financing the periphery through the banking system rather than through explicit fiscal transfers. Although this has helped peripheral states to weather the storm, what happens if peripheral countries default?
Many commentators (including myself) believe that some form of default is now inevitable—but default could have dire consequences too. The insolvency of periphery governments would almost certainly threaten the solvency of debtor country central banks, leading to large losses for creditor country central banks (eg, Germany), which national taxpayers would need to shoulder. Doubtless this is a major reason for Signor Smaghi’s implacable opposition to default. And in the absence of support from the ECB and other creditor central banks, the threat of default by Greece or Ireland would hasten contagion and paralysis. Banks would not want to rink continued lending to any potential defaulter, credit would seize up and, ultimately, the existing financial transfer mechanism would collapse.
The options for the eurozone are narrowing. Either default will result in weaker countries leaving the eurozone—a lengthening list as contagion and financial collapse spreads—or the eurozone must undergo radical reform. This means tearing up the current system under which Greece and its banking system depend on selling sovereign bonds to the market and establishing in its place a Eurozone Treasury which would, like its US counterpart, guarantee the integrity of the Eurozone’s financial system as a whole. Needless to say, other key reforms would be necessary (true e-bonds, smaller trade imbalances) which I shall not dwell on here.
All this boils down to a single basic point: Europe already has a central bank ‘transfer union’, but it is under growing threat. Either Europeans bite the bullet and accept the need for true fiscal union and economic governance, or they can stand aside and watch the Eurozone disintegrate. Just as in the case of climate change, it’s too late to think that we can merely wish for the best and ‘muddle through’.
1 See George Irvin, Regaining Europe; an economic agenda for the 21st century, London: Federal Trust, 2007.
3 See http://ftalphaville.ft.com/blog/2011/05/10/564346/roubinis-guide-to-a-greek-debt-restructuring/.
Understanding basic macroeconomics is important, and what’s more, it’s easy. Without macroeconomics, we can’t hope to understand the ‘budget cuts’ debate. Yet one of the most difficult issues to put over to the voting public is precisely the question of whether budget cuts are necessary? The typical voter thinks they are—-and that in hard times, everybody (households and governments alike) must tighten their belts.
‘It’s only common sense’ you may think, but the common sense tells us the earth is flat. In truth, if the economy is to grow when households tighten their belts, governments must spend more, not less. Moreover, this follows from basic macroeconomic principles—about which more below. But first, how did we get into this mess?
Bailout and recession
Everybody agrees that in the run-up to the credit crunch in 2008, the main Western economies, starting with the USA and the UK, had been on a spending binge. Ordinary folk who wanted to spend more than their income re-mortgaged their houses in the expectation that the endless rise in house prices would pay for ‘lending to myself’. As we know, the process was fomented by bank lending for new houses as ‘teaser’ rates, rates which mysteriously doubled or trebled soon after the mortgage was granted to buyers who had precious little income and no collateral. Banks could do this because they could bundle and resell these mortgages in the form of collateralised debt obligations (CDO), thus passing on the risks to others.
And it was not just mortgages but car loans, credit card loans and loans of every description that were bundled and resold. When the bubble burst, banks and other financial institutions—not just in the US and the UK but throughout the OECD—found themselves with loads of dodgy assets on their books. Moreover, households and even firms—traditionally society’s savers—were seriously in the red. Had it not been for the quick action of governments, the world’s main economies would have seized up, and we would now be in a far deeper depression than experienced in the 1930s
Recession and budgets
As we now know, business did not stop dead—but it slowed sufficiently to throw the OECD economy into a slump. It was only at the end of last year that a glimmer of growth reappeared—even so, it is currently questionable whether we’ll continue to grow, or whether there will be a second contraction or ‘double dip’. Moreover, it is governments that are the big debtors now. Why? It’s not because they lent too much money to the banks. Rather, it’s because the credit crunch threw the ‘real’ (ie, non-financial) economy into reverse gear. As economic growth slows and unemployment rises, two things happen to government finances. First, tax receipts decline quickly; secondly, governments must spend more on unemployment benefit and the like. It is this—not lending to the banks per se—which creates the so-called ‘black hole’ in government finances, the deficit.
The other important feature of a recession is that households and firms (ie, the private sector) spend less and save more. In Britain, for example, the private sector has moved from spending more than it earns to spending less than it earns; ie, from deficit to surplus. Economic actors in the private sector who previously were in massive debt—both households and firms—are paying down debt, or ‘deleveraging’ as they say in financial circles. And here is where the basic principles of macroeconomics come into the picture.
The Savings Balances
For those readers who have ever done economics, you’ll remember things like Y = C + I + G + (X-M). Or perhaps you won’t, because nothing so puts off the ordinary reader as a bit of algebra. So I’ll spare you the algebraic definitions and derivations of the savings balances. You’ll simply have to take it on faith that, at any moment in time, the sum of the private and public sector surpluses (the difference between income and spending) must equal the external current account, or what is commonly know as the extenal balance. Economists and national accountants write this in shorthand: (S-I) + (T-G) = (X-M).
Put most simply, the sum of the two internal balances—those of the private and public sectors—must equal the external balance. It should be intuitively obvious, for example, that if we import more than we export, the country’s external balance must be in the red. This in turn means (by definition) that, internally, either the private or the government sector (or both) must be in the red to a corresponding degree—since internally we are spending more on imports that we are earning from our sale of exports. In order to carry on doing so, we must borrow from abroad.
This is in essence what economists mean when they say that the USA’s trade deficit with China can only be sustained by China agreeing to hold an ever growing pile of dollar denominated IOUs, typically US Treasury bills. And of course, if (for the sake of argument) China refused to hold more dollars, adjustment would take the form of a devaluation of the dollar and US economic contraction. At some point, the contraction in US income would shrink US imports enough to re-establish external balance.
Now what happens if a country (say, Germany) wants to run an external surplus? Clearly, the above logic dictates that either the private or public sector (or both) must spend less than it earns. In essence, it is for this reason that German wages have been held flat for so long and pari passu why Angela Merkel wants the public sector to move from deficit to a balances budget. Perfectly rational? In normal times perhaps, but these are not normal times.
Next, for simplicity’s sake, let’s assume that the economy is already in external balance and we’d like it to stay there. If the private sector is being thrifty and spending less than it earns (which is true at the moment), then if things are to remain in balance, the government must do exactly the opposite; ie, it must run a deficit if national income is not to fall. If government does not use a deficit to offset the private surplus, national income and employment must fall, dragging down tax receipts until a counterbalancing deficit exists.
The fact that government tax receipts fall and social outlays rise when national income falls helps the economy—-it provides what are known as ‘automatic stabilisers’. Since the 1930s, all advanced economies have relied on such stabilisers to cushion their economies against business cycles and other shocks.
The problem at present is that Angela Merkel, like David Cameron, is trying to override the automatic stabilisers by insisting on large cuts to balance the budget quickly. Such cuts are almost certain to prove counterproductive, all the more so because if all advanced countries cut their budgets at the same time, this results in the export of deflation—the present-day equivalent to the beggar-my-neighbour competitive devaluations of the 1930s.
None of the above is particularly ‘Keynesian’; rather, what I have set out is the logic of basic national accounting identities. It’s time our leaders learned a bit more about macroeconomics.