Saving & Lending At The Zero Bound

Saving and lending at the zero bound is marked by two characteristics — rising savings but stagnant lending:

Loans vs Deposits since Lehman

This tallies with the data on savings as a percentage of GDP against base rates that I noted in April:

mises

The fact that the Fed has pushed large quantities of liquidity out into the system and kept interest rates at zero while failing to lift the systemic appetite for credit shows that the Fed can take the horse to water, but can’t make it drink.

Perhaps the weakness in credit appetite is symptomatic of the fact that there is so much pre-existing debt in the system that people and businesses are struggling to pay off?

US-Private-Debt-as-a-Percent-of-GDPIf that is the case then if the Fed would turn the monetary hose onto expunging debt — i.e. have a private debt jubilee — then monetary policy at the zero bound might become effective again in stimulating credit appetite.

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Helicopters Grounded?

Having recently uncovered in its own research that quantitative easing is enriching the richest 5%, and the British economy still mired in the doldrums even in spite of hundreds of billions of easing,  the Bank of England announced last week that it was grounding its fleet of helicopters dropping cash onto the big banks and suspending the quantitative easing program.

Yet, this may not be the end for British monetary activism.

Anatole Kaletsky wrote last month:

This week an even more radical debate burst  into the open in Britain. Sir Mervyn King, governor of the Bank of England, found himself fighting a rearguard action against a groundswell of support for “dropping money from helicopters” – something proposed by Milton Friedman in 1969 as the ultimate cure for intractable economic depressions and recently described in this column as “Quantitative Easing for the People.”

King had to speak out because the sort of calculations presented here last summer started to catch on in Britain. The BoE has spent £50 billion over the past six months to support bond prices. That could instead have financed a cash handout of £830 for every man, woman and child in Britain, or £3,300 for a typical family of four. In the United States, the $40 billion the Fed has promised to transfer monthly, with no time limit, to banks and bond funds, could instead finance a monthly cash payment of $500 per family – to be continued indefinitely until full employment is restored.

Has the Bank of England stopped one program in anticipation of beginning another? Will be the Bank of England begin to inject cash directly to the public, bypassing the banks?

It is more than possible.

Could this mean some kind of debt jubilee? That is less likely — policymakers seem to remain fixated on demand and consumption, when the greatest obstacle to economic activity is the total level of debt.

Global Japan & the Problems with a Debt Jubilee

Bill Buckler critiques the notion of a debt jubilee:

The modern “debt jubilee” is characterised as “quantitative easing for the public”. It has been boiled down to a procedure where the central bank does not create new money by buying the sovereign debt of the government. Instead, it takes an arbitrary number, writes a check for that number, and deposits it in the bank account of every individual in the nation. Debtors must use the newly-created money to pay down or pay off debt. Those who are not in debt can use it as a free windfall to spend or “invest” as they see fit.

The major selling feature of this “method” is that it provides the only sure means out of what is called the global “deleveraging trap”. This is the trap which is said to have ensnared Japan more than two decades ago and which has now snapped shut on the whole world. And what is a “deleveraging trap”? It is simply the obligation assumed when one becomes a debtor. This is the necessity to repay the debt. There are only three ways in which a debt can be honestly repaid. It can be repaid with new wealth which the proceeds of the debt made it possible to create. It can be repaid by an excess of production over consumption on the part of the debtor. Or it can be repaid from already existing savings. If none of those methods are feasible, the debt cannot be repaid. It can be defaulted upon or the means of “payment” can be created out of thin air, but that does not “solve” the problem, it merely makes it worse.

The “deleveraging trap”, so called, is merely a rebellion against the fact that you can’t have your cake and eat it too. So is the genesis of the entire GFC. Debt can always be extinguished by means of an arbitrarily created means of payment. But calling that process QE or a Debt Jubilee doesn’t (or shouldn’t) mask its essence, which is simple and straightforward debt repudiation.

A “debt jubilee” is the latest attempt to make a silk purse out of a sow’s ear. It is the latest pretense that we CAN print our way to prosperity, but only if we do it in the “right” way.

Well, he’s right  — it is the latest attempt to make a silk purse out of a sow’s ear. But that’s the hand we’ve been dealt. I’ve always said I would have preferred it if markets had been allowed to clear in 2008, if prices had fallen of their own accord to a sustainable level, and if all the junk and bad debt had been liquidated. Painful — but then there would have been no deleveraging trap at all.  In a truly free market debts that can’t be repaid, aren’t.

Yet that’s not the world we have; we have a world where central bankers are prepared to engage in unlimited liquidity injections, quantitative easing, and twisting — pumping new money into the financial system to keep the debt serviceable.

It’s like central banks’ efforts to stabilise markets and the financial system put the wider economy into an induced coma following 2008 in order to prop up the financial sector and the huge and exotic variety of credit assets created in the boom years. With the debt load sustained by the efforts of central bankers, the wider economy is left in a deleveraging trap paying down debt that in a free market would have been repudiated long ago.

This process not only enriches the financial sector by propping up bad debt that would otherwise be liquidated, but also transfers purchasing power from the productive sectors to the financial sector via the Cantillon effect. Meanwhile unemployment remains elevated, industrial production remains subdued, the West remains fragile to trade and resource shocks, wages and salaries are at an all-time low, and total economic activity remains depressed.

So this is a painful and unsustainable juncture — truly a sow’s ear of a situation. The deleveraging trap is a catch-22; while debt remains excessive, economic activity remains subdued, and while economic activity remains subdued, generating more production than consumption to pay down debt is extremely difficult. As we have seen in Japan — where the total debt load remains above where it was 1991 — fundamentals can remain depressed for years or even generations.

Certainly, the modern debt jubilee isn’t going to cure the culture that led to the excessive debt. Certainly, it won’t wash away the vampiristic TBTF megabanks which caused the GFC and live today on bailouts and ZIRP. Certainly, it won’t fix our broken political or financial systems where whistleblowers like Assange are locked away and fraudsters like Corzine roam free to start hedge funds. And certainly it won’t wash away the huge mountain of derivatives or shadow intermediation that interconnect the economy in a way that amplifies small shocks into greater crises.

We are, I think, passing through a strange phase of history where a myriad of ill-designed and heavily-leveraged economic planning experiments are failing.

The modern debt jubilee would at least provide some temporary relief for the debt-ridden wider economy, instead of the financial sector. Instead of pumping money solely to the megabanks — and the costs of deleveraging such a huge debt bubble means that more easing is inevitable, eventually — pumping to the public would also negate the problem of transferring purchasing power to the banks via the Cantillon effect.

It’s not going to save us from the wider problems — imperial overstretch, bailout culture, deindustrialisation, job migration, financial and political corruption, etc, etc, etc — but it would still be much better than the status quo.

The biggest problem with the modern debt jubilee, though, is that Wall Street and the financial sector are greedy and will likely fiercely resist any such efforts. And the financial sector holds lots of political leverage.

The cost of the status quo is a perpetually depressed economy and global Japan. That will be painful.

But on a long enough timeline, the survival rate for everything — even reinflated debt bubbles — drops to zero. 

Could be a long wait, though.

The Shape of the Debt Reset

I was asked recently by Max Keiser who benefits in the case of a debt reset, and when we should expect such an event to occur.

I don’t think I answered it as comprehensively as I should have. I talked a little about the fact that events leading up to such an event could be extremely messy and its impact unpredictable, and so it is hard to say who will benefit, although we can expect the powers-that-be  — and particularly the Wall Street TBTF banks — to try and leverage events for political and financial gain. And of course, all three kinds of debt reset — heavy inflation, liquidation or an orderly debt jubilee — would look very different.

Here’s the problem:

The crisis in 2008 was one fuelled by excessive total debt. As society became more and more indebted the costs of servicing debt became proportionally higher, which has made it harder for countries to grow. Instead of individuals and businesses investing their income or growing their business, a higher and higher proportion of income becomes taken up by the costs of paying down debt.

Historically in a free market system, these kinds of credit bubbles have ended in liquidation of the entire bubble and all the bad debt. However the Fed’s money printing since 2008 (much like the Bank of Japan’s money printing in the 90s) has done just enough to keep the debt load serviceable.

The worrying thing is that Japan — which experienced a very similar series of events in the 1990s — remains in a high-debt, low-growth deleveraging trap. While the USA has managed a small decrease in indebtedness since 2008, it could take a very, very long time — Steve Keen estimates up to 15 or 20 years — for the debt level to fall to a level where strong organic GDP and employment growth is possible again. In my view, it is more likely (especially considering the Japanese example) that (with continued central bank assistance) there may be no long-run deleveraging at all, and that we may have entered a zombie cycle of reinflationary QE followed by market decline and deflation, followed by more reinflationary QE, etc. 

The point that I didn’t really emphasise to Max Keiser is just how beneficial a debt reset — so long as society comes out of it in one piece — will be in the long run. As both Friedrich Hayek and Hyman Minsky saw it, with the weight of excessive debt and the costs of deleveraging either reduced or removed, long-depressed-economies would be able to grow organically again. Yet after years of stagnation, a disorderly liquidation or inflation would surely be accompanied by financial, social and political chaos. And the cost of kicking the can and remaining in a deleveraging trap — as Japan has done (and as the US is now doing) — can have serious social consequences, such as elevated long-term unemployment, a deterioration in skills, diminished innovation and decreased entrepreneurialism.

I think this underlines the importance of trying to achieve the effects of a debt reset in an orderly way before nature forces it upon us again, and before we have spent a long time stuck in the deleveraging trap with a huge debt load relative to GDP, elevated unemployment, and very low growth. The least unfair way of doing this would seem to be the modern debt jubilee advocated by Steve Keen — print money, and instead of pumping it into the financial system as per QE, use it to write down a portion (say, $6,000) of each person’s debt load, and send out cheques up to an equal amount to those who are not indebted. Unlike with quantitative easing, because everyone gets the same quantity of new money, nobody receives a disproportionate transfer of purchasing power via the Cantillon effect, as happens not only with quantitative easing but also with more traditional monetary policy operations such as interest rate cuts, which are strongly correlated with disproportionately strong growth in the financial sector and bank assets. And the inflationary impact of the new money would be shared equally by everyone — rather than screwing pensioners or savers — because everyone would receive the same amount.

This is obviously not ideal, but it is surely better than remaining in a Japanese-style deleveraging trap.

Yet while most of the economic establishment remain convinced that the real problem is one of aggregate demand, and not excessive total debt, such a prospect still remains distant. The most likely pathway continues to be one of stagnation, with central banks printing just enough money to keep the debt serviceable (and handing it to the financial sector, which will surely continue to enrich itself at the expense of everyone else). This is a painful and unsustainable status quo and the debt reset — and without an economic miracle, it will eventually arrive — will in the long run likely prove a welcome development for the vast majority of people and businesses.

The Eminent Domain Mortgage Heist?

Matt Taibbi:

Something very interesting is happening.

There’s been so much corruption on Wall Street in recent years, and the federal government has appeared to be so deeply complicit in many of the problems, that many people have experienced something very like despair over the question of what to do about it all.

But there’s something brewing that looks like it might be a blueprint to effectively take on the financial services industry: a plan to allow local governments to take on the problem of neighborhoods blighted by toxic home loans and foreclosures through the use of eminent domain. I can’t speak for how well the program will work, but it’s certaily been effective in scaring the hell out of Wall Street.

Under the proposal, towns would essentially be seizing and condemning the man-made mess resulting from the housing bubble.

I approach the issue and constitutionality of eminent domain — government seizing of property in exchange for whatever the government defines as just compensation — very suspiciously. While I am altogether hostile to the idea of government being able to declare that what is yours is not yours, it has recently become a device for government to transfer private property from one private owner to another.

In Kelo v. City of New London (2005), the use of eminent domain to transfer land from one private owner to another private owner to further economic development was deemed to be constitutional. In a 5–4 decision, the Court held that the general benefits a community enjoyed from economic growth qualified private redevelopment plans as a permissible public use under the Takings Clause of the Fifth Amendment.

While seizing land with compensation to build a highway for public use is one thing, seizing property for the private profit of others is quite another. Yet many like Taibbi are heralding the potential of seizing underwater mortgages. I will consider any initiative to reduce total debt and deleveraging costs, as I believe that excessive total debt is the largest cause of today’s depression. But given the history, I have every right to be cautious and even suspicious.

Taibbi:

The plan is being put forward by a company called Mortgage Resolution Partners, run by a venture capitalist named Steven Gluckstern.

Here’s how it works: Mortgage Resolution Partners helps raise the capital a town or a county would need to essentially “buy” seized home loans from the banks and the bondholders (remember, to use eminent domain to seize property, governments must give the owners “reasonable compensation,” often interpreted as fair current market value).

Once the town or county seizes the loan, it would then be owned by a legal entity set up by the local government – San Bernardino, for instance, has set up a JPA, or Joint Powers Authority, to manage the loans.

At that point, the JPA [i.e. the taxpayer!] is simply the new owner of the loan. It would then approach the homeowner with a choice. If, for some crazy reason, the homeowner likes the current situation, he can simply keep making his same inflated payments to the JPA. Not that this is likely, but the idea here is that nobody would force homeowners to do anything.

On the other hand, the town can also offer to help the homeowner find new financing. In conjunction with companies like MRP (and the copycat firms like it that would inevitably spring up), the counties and towns would arrange for private lenders to enter the picture, and help homeowners essentially buy back his own house, only at a current market price. Just like that, the homeowner is no longer underwater and threatened with foreclosure.

First — why municipalities? Why not states? The answer is that while all states other than Vermont have some form of balanced budget amendment, and cannot so easily take on debt, municipalities can freely take on debt. How much? Well, it’s almost certain to be open to legal challenges by current mortgage-holders, and courts may end up forcing municipalities to pay far more than municipalities initially stipulate. But at whatever values the mortgages are seized at, there is no doubt that the taxpayer will end up holding a lot of new debt.

The biggest problem though, is surely the danger of corruption. How many municipalities will end up using these opaque procedures to enrich well-connected insiders? How many will buy junk at inflated prices, or seize and sell to a well-connected insider at far below value? Who polices such transactions? Where is the transparency? How do we make sure that this is not just an excuse for bad lenders to offload junk to the taxpayer at inflated prices and cream a profit when they were set to reap a loss?

Matt Taibbi admits:

MRP absolutely has a profit motive in the plan, and much is likely to be made of that in the press as this story develops. But I doubt this ends up being entirely about money.

“What happened is, a bunch of us got together and asked ourselves what a fix of the housing/foreclosure problem would look like,” Gluckstern. “Then we asked, is there a way to fix it and make money, too. I mean, we’re businessmen. Obviously, if there wasn’t a financial motive for anybody, it wouldn’t happen.”

And you can restructure all you like, but many underwater homeowners with a serious income shortfall will still not be able to pay their mortgages. Who carries the can? If the mortgage has been  sold on then the loss will be on the new owner. In reality this is far more likely to be the taxpayer. Simply, the taxpayer may well end up carrying the can for a whole lot of bust mortgages.

What Taibbi — who usually has a very good sense of moral hazard — and MRP effectively seem to be considering is not only the continuation and expansion of Kelo, but also potentially the transfer of liability from bust irresponsible lenders to the taxpayer. While this is sure to enrich the bureaucracy and well-connected insiders — and admittedly, while it may help some underwater homeowners — it seems incredibly risky for the taxpayer.

While debt-forgiveness is one way out of the debt trap, we should be careful and recognise that many so-called debt-forgiveness schemes may instead be dressed-up scams and frauds that end up enriching special interests while putting the taxpayer deeper into a hole. 

H/T to @MoiraCathleen

Death by Hawkery?

Joe Wiesenthal presents an interesting case study:

These two charts basically explain everything.

The first chart shows the yield on the Swedish 5-year bond.

As you can see, it’s absolutely plummeting right now.

chart

Image: Bloomberg

Now here’s a look at its neighbor, Finland, and the yields on its 5-year bond.

chart

Image: Bloomberg

Basically they look identical all through the year up until November and then BAM. Finnish yields are exploding higher, right as Swedish yields are blasting lower.

The only obvious difference between the two: Finland is part of the Eurozone, meaning it can’t print its own money. Sweden has no such risk.

This is a narrow version of something that much of the media picks up on earlier last week that UK gilts were trading with a lower yield that German bonds, a reflection of the same principle: In UK the government can print. In Germany, it can’t.

Yes — investors are happier with the idea of buying bonds which may be debased by money printing, than they are with the idea of buying bonds which may be defaulted on because the sovereign cannot print. But there is another element at play here, which may be much bigger.

Easing, of any sort won’t solve the underlying global problem — as explained by Reinhart and Rogoff in better detail than I have ever done — of excessive debt levels. By conducting QE (i.e. taking sovereign debt out of the market) governments are simply artificially contracting the supply, and in my view pumping up a debt bubble.

It’s important to consider Japan here — yields in Japan are as low as ever, and creditors are still taking their pound of flesh. That can’t be a bubble, can it? Creditors aren’t losing their money? Well, it depends how you define return on investment. Investors in Japanese bonds may be getting their money back, but Japanese society is slowly being strangled by a lack of organic growth and a lack of any real kind of creative destruction. Wages and living standards fall while unemployment rises. So Japan has become zombified, and in theory similar cases like the United States and Britain should follow down the path of death by slow Keynesianism (they won’t, because they are far more combustible societies than Japan, but that is another story for another day).

In light of all that, while the Teutonic monetarist hawkery may superficially look stupid, if we look at the resulting Euro-implosion as a potential trigger to crash global markets, burst the global bond bubble, trigger a cascade of AIG -esque events, culminating in the breakdown of the global financial system, a debt reset, and a new global financial order well then it’s really quite clever. Ultimately, a debt reset is what is needed to effectuate new organic growth and new jobs, and to clear out the withered remains of umpteen bubbles that have been created in the last twenty years through easy money.

I doubt that the stern bureaucrats at the ECB are anywhere near as clever or far-sighted as this (their most significant concern appears to be sound monetarist economics) but there is quite possibly genius in this stupidity.

So — rather than death by hawkery, I foresee rebirth.

Of course, on the other hand the “hawks” may just end up printing like their American counterparts.

Christine Lagarde: “There is Still too much Debt in the System”.

From the IMF:

There is still too much debt in the system. Uncertainty hovers over sovereigns across the advanced economies, banks in Europe, and households in the United States. Weak growth and weak balance sheets — of governments, financial institutions, and households — are feeding negatively on each other, fueling a crisis of confidence and holding back demand, investment, and job creation. This vicious cycle is gaining momentum and, frankly, it has been exacerbated by policy indecision and political dysfunction.

And she’s right — but with debt-issuers not interested in taking haircuts how can we reduce total global debt? How about growth?

From Zero Hedge:

A brand new study released by the World Economic Forum (WEF) in collaboration with McKinsey (which is a must read if only for its plethora of charts which we are certain will be used and reused in thousands of posts and articles over the next year), finds that while global credit stock doubled from $57 trillion to $109 trillion in just 10 years (from 2000 to 2010), it will need to double again to an incredible $210 trillion by 2020 in order to provide the necessary credit-driven growth (in a recursive way, whereby credit feeds growth, and growth requires additional credit issuance) for world GDP to retain its current growth rate.

So the plan is additional debt, to fund growth, to pay down debt? How is that working out?

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