News:
European banks flock to ECB's free money (Bloomberg)
The European Central Bank has a responsibility to keep the
banking system functioning, and it has decided to do that by offering
banks very cheap long term loans. In fact these loans are so generous
that Bloomberg and others have described them as "free money".
Of course there is no such thing as free money, free money is just a
magic trick that shuffles the money about, and if you watch what is
going on carefully enough you see it just a sleight of hand trick that
benefits one at the cost of the other. In this case what we are really
talking about is a transfer of wealth to European banks from everyone
else. This kind of operation is inequality promoting because "the ripped
off lied to little people" don't have the skill to hedge against
inflation, nor exploit financial anomalies, and the spread between their
mortgage rate and the "risk free rate" widens dramatically. Italy is
famous for its historical use of negative real rate inflationary policy, and
it's also famous for wealth inequality. But the situation today is much more
serious, because back in the 1970s before financial liberalization this kind of
policy did somewhat negatively effect the wealthy, whereas today it's purely
beneficial. So this
action is like giving the rich a money printing press, and shutting the
little people out of the party, and increasing the margin the rich earn
on the little people's loans. You can hear them all outside screaming as
we pop open the champagne bottles, and we lean out of the window and say
"don't worry it will trickle down!". Those of us who run hedge funds in
Switzerland are laughing all the way to the bank, but the journalists
and politicians who are supposed to represent the people's interest and
are now breathing a sign of relief at the stabilization of the banking
system don't think about the long term picture. They don't realise that
the trickle down is an illusion, it's actually a completely trickle up
operation that is just making things vastly worse.
Newspapers complain that austerity costs jobs, they say look at the USA
- it's growing at 2%-3% per year racking up debts instead of
implementing budget cuts, so stimulus is the logical choice. That's
typical of democratic decision making, there is no though for the
future, whatever feels good is the "logical choice". A word that
is suddenly fashionable in the West today is "pragmatism",
but in a world in which everyone is using a sort of moral compass to
make decisions pragmatism is a disaster, because the power of pragmatism
depends on the ability to see far into the future. For example, Stalin
called himself a pragmatist, and he did get very good short term
results, but if you look very far ahead, his terror destroyed both the
communal idealism and the professionalism of the Russians, so when the
pressure was lifted by Khrushchev everything rapidly unravelled. How can
we describe modern economic policy? There are two policy leavers, fiscal
policy and monetary policy, and two targets, inflation and growth; and
when policymakers think about these targets they are thinking no more
than about a year into the future; and none of their forecasts work, nor
do they have real idea how much they should pull these levers. Do you
see this is a recipe for disaster?
The crisis reminds me of story told by Plato. The Great Philosopher
Tharles was walking along one day studying the stars looking upwards
when he fell into a pit. An attractive and witty Thracian serving girl
jeered at him for being so eager to know the things in the sky that he
couldn't see what was before him at his very feet. It's a joke about
philosophers who are so long sighted and starry eyed they come across as
bumbling idiots or mat hatters in ordinary conversation. Yet the crisis
today brings to mind another vision. It makes me think of great
statesmen crawling in the dirt, studying the consistency of soil through
microscopes like the medieval doctors who studied stool samples. They
turn an inch to the left and an inch to the right looking for the
optimal path, but the crisis just keeps getting worse. A Thessalian
witch screeches why didn't you Emperors of Wisdom turn left three hours
ago, can't you see you're driving the mule train into a volcano. There's
a yell from the crowd "the emperors are wearing no clothes", then a hail
of laughter, then a sudden violent shift in the mood.
From an old article of mine:
Figuring out how to handle both the insolvency of Fannie and Freddie, and
major banks such as Lehmans, is one of the major issue of today. Personally I do
not approve of the UK's Northern Rock Nationalization which protected unsecured
bond holders and is likely to cost the tax payer money. At the same time
allowing Lehman's to fail was absurd because the FED could have saved it and
made a profit by writing off both the shareholders and bond holders during a
compulsory nationalization...
What I would be tempted to do is start
nationalizing failing banks, writing off both shareholders and bond holders,
which would cascade through the entire banking system, but would leave ordinary
depositors protected. As a result the government would end up taking possession of almost
the entire banking system for nothing, and in ten years time it could sell all
the banks back to investors, meanwhile lending would not shrink because the state owned banks would not have to cut
risk. What I am describing is a slightly more aggressive version of the 1991/92
Swedish banking rescue, yet there is an even more radial option available -
don't re-privatize. Some
have suggested the power to create new money, which is an integral part of the fractional
reserve banking system, is simply too dangerous to be left in private hands, and we
need a largely state owned banking system.
In Plato's Republic one of the financial reforms Socrates suggested was choosing
the market traders, the financial intermediaries facilitating the efficient
exchange of goods, from amongst the least warrior like and least quick witted
members of society. Socrates wanted the financial system to be as simple and
boring as possible. For example, instead of targeting inflation or growth I
would consider setting interest rates to prevent financial anomalies such as the
currently negative real rate for cash which is so hopelessly out of line with
rising real asset markets and which consequently drives inequality and
inefficiency. Socrates even said the commodity prices should be stable and
shouldn't fluctuate, so goods simply run out in times of shortage instead of
rising in price, and I think that he has a point here we are missing today.
Now if your goal
is to make the financial world boring, for example much more like the way it was
from the 1950s up until the 1980s, the innovative vibrancy and risk appetite of the private sector is the
very antithesis of your needs, and a state owned financial system is the ideal
solution.
Was the starry eyed visionary Socrates right? Think about his suggestion made
2,500 years ago that "we choose financial traders from amongst the least warrior
like and least quick witted members of society".
In Jan 2009 Lord Turner said: "the years running up to 2007, too much of the
developed world’s intellectual talent was devoted to ever more complex financial
innovations, whose maximum possible benefit in terms of allocative efficiency
was at best marginal, and which in their complexity and opacity created large
financial stability risks"
How amazing is that? That's what I call long sighted.