Thursday, October 30, 2008


On the day we wake up to the most negative US Federal Reserve base rates ever remembered ('negative' after inflation, about 150bp-350bp less than the rate of inflation depending on how you calculate it) that so reminds us of Japan's response to its crisis of the early '90s (see essays below from much earlier) and as the Bank of England decides whether to drop the base rate by 150bp or more - but not so far that if the US $ now falls a bit sterling won't rise) our news media continues to bellow back-seat driver advice on matters that surely deserve whole academic theses. Lord Lawson says tax cuts are not the solution; it is too late for a Keynesian fiscal boost, best just to drop the UK's 4.5% bank rate. The Daily Telegraph opines that the Bank of England's MPC in the driving seat "but didn't know the Highway Code!" and "Bank of England acted too slowly" to cut interest rates. yet, somewhere we all know these rate cuts are not proportionately passed through to household and corporate borrowing rates. Government is meanwhile using a mix of carrot and stick to tell the banks as firmly as can be done not to accelerate foreclosures. What they do not appreciate is that they are talking to computer systems that are hard, maybe impossible, to readjust to new policy or changing strategy? Human judgment has mostly gone from the heart of traditional banking.
Elsewhere in the forest of crashing newsprint, few articles attracted as many comments in the FT site as Willem Buiter's "Making monetary policy in the UK has become simpler, in no small part thanks to Gordon Brown" (26 October), which proceeds to heap blame on the Prime Minister when he was in charge of the country's finances. Most comments continue in this orduring tone, plus laying additional blame on transatlantic cheap money and Basel II regulation of banks (for being either weakly or ineptly implemented). I agree with the last point and know what I’m talking about in painful detail (I’ve just been looking at a bank were £billions of transactions were not risk-accounted because the accounting system had only a fraction of the headings and data fields required. The failed data was sent to people who no longer worked at the bank and so nothing was done!) A banker and trader called AJGS in the FT from one of the UK clearing banks castigates accountants and risk managers for incompetence. On this, I repeat my view Basel II is conceptually competent and comprehensive, far more so perhaps than we deserve or than banks are capable of digesting; it was only half implemented when crisis struck. The bits that had not been done required economists to become involved. Until a year ago the prevailing fear among top bankers (accountants) was that if they gave way to economists they’d take over the running of the banks. What accountants had not appreciated is that banking was being taken over by mathematicians! Consequently, none, I repeat none, of the major banks succeeded in building adequate economic capital models whereby they could model for economic shocks, which is the hard-core central objective of Basel II regulation! Mathematical risk models now appear discredited and bankers, however fearfully, are forced to give economists their due - maybe?
As for cheap money, between dollar and Euro base rates in a period of subdued consumer price inflation, what choice was there for the sterling? If the UK led in experiencing recession before the EU (current GDP also estimated officially as negative) that is entirely because of how closely tied it is to the USA economy and financial services. When someone called J.L. in the FT site says Gordon Brown “ploughed his own furrow” that is not so; he followed all the prevailing theories of the day (privatisation, central bank so-called ‘independence’, long term non-inflationary growth, whatever was the fashion in the US and among New Keynesians so-called). As for the Euro, the European Commission’s own economists knew in the late '90s it would be a disaster for at least the first five years until 2005 or so, but a similar disaster if they did not do it or postponed doing it, so they decided to proceed in the hope that we'd all learn something and do better after 2006. US and UK recovery after 2001 was faster than expected largely because the Euro zone remained weak (fiscal tightening to squeeze 10 currencies into the Euro toothpaste tube knocked about $500bn off growth and cost 5 million jobs against trend). There was not a sustainable economic argument from the UK’s point of view that joining the Euro would have been good in the medium term. That said, arguments either way only offer marginal benefits net of gains and losses. Gordon took the entirely sensible view that unless there is unquestionably significant benefit for the UK, worthy of all the trouble and cost, there’s no point in joining.
Back to where we are today - whatever the UK did in credit boosting the economy with fast rising house prices, running historically high trade deficits and paying for this by selling mortgage backed securities to foreign investors, was also followed by Ireland, Greece, Spain, Netherlands and others. France and especially Germany shied away from similarly boosting domestic demand hoping instead to rely on export-led growth, which can also be a chimera. The most prudent economy of all by far, however, was Italy with the least expansion of bank credit. This did not stop it from being the first into recession! Case dismissed; Gordon reprieved for lack of compelling evidence?

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