Podcast: Philip Coggan's Paper Promises - Money, Debt and the New World Order

Below is the podcast of Coggan's book talk, and here is a good review of Paper Promises.

Speaker(s): Philip Coggan

Chair: Professor Christopher Polk

Recorded on 19 January 2012 in Sheikh Zayed Theatre, New Academic Building.

The world is drowning in debt. Greece is on the verge of default. In Britain, the coalition government is pushing through an austerity programme in the face of economic weakness. The US government almost shut down in August because of a dispute over the size of government debt.

Our latest crisis may seem to have started in 2007, with the collapse of the American housing market. But as Philip Coggan shows in this new book, Paper Promises: Money, Debt and the new World Order which he will talk about in this lecture, the crisis is part of an age-old battle between creditors and borrowers. And that battle has been fought over the nature of money. Creditors always want sound money to ensure that they are paid back in full; borrowers want easy money to reduce the burden of repaying their debts. Money was once linked to gold, a commodity in limited supply; now central banks can create it with the click of a computer mouse.

Time and again, this cycle has resulted in financial and economic crises. In the 1930s, countries abandoned the gold standard in the face of the Great Depression. In the 1970s, they abandoned the system of fixed exchange rates and ushered in a period of paper money. The results have been a long series of asset bubbles, from dotcom stocks to housing, and the elevation of the financial sector to economic dominance.

The current crisis not only pits creditors against debtors, but taxpayers against public sector workers, young against old and the western world against Asia. As in the 1930s and 1970s, a new monetary system will emerge; the rules for which will likely be set by the world's rising economic power, China.

Philip Coggan was a Financial Times journalist for over twenty years, including spells as a Lex columnist, personal finance editor and investment editor, and is now the Buttonwood columnist of The Economist. In 2009, he was awarded the title of Senior Financial Journalist in the Harold Wincott awards and was voted Best Communicator at the Business Journalist of the Year Awards. Philip Coggan is the author of the business classic, The Money Machine.

Naked Capitalism Uses a Single Data Point to Disprove Financial Repression

A post over at Naked Capitalism titled 'Why Is The Term “Financial Repression” Being Sold?' by the Roosevelt Institute's Matt Stoler purports to "fact check" a statement about the negative effects of financial repression.

That sounds useful, for as Stoler points out financial repression is much in the news these days. However, there's just one big problem: Stoler's fact checking consists of looking at just one country, the U.S.

Never mind that the Reinhart and Sbrancia paper about financial repression which Stoler references includes a 10-country data sample (and information about dozens of other countries), or that other studies on the effects of financial repression have looked at data from 20 or more countries. And Stoler clearly couldn't be bothered with checking to see that most of the research on financial repression has in fact focussed on its impact on economic growth in developing countries, and not advanced economies like the U.S.

Following Stoler's breathtakingly brief analysis of the single U.S. data point he concludes:

"So we see that the financial repression meme is at heart an aristocratic concept."

Sorry, Matt, but it's not quite that simple.

Who exactly are financial repression's winners and losers? As some of the commenters on Stoler's post note the not insignificant dose of inflation which accompanies financial repression hits everyone who saves money. Also, the large rentier may have additional means at his/her disposal to mitigate the effects of financial repression. However, the small rentier (aka 401K holders, pensioners, retirees on fixed incomes) may not easily be able to, for example, shift assets to Lichtenstein.

But there may be a more simple answer to this question of winners and losers. To work as intended financial repression depends on government rules and regulation. In short, this means that under a system of financial repression those who follow the law are the ones who are punished by the law. Sound like a place you'd like to live?

Video: Carmen Reinhart vs. Paul Krugman

This event occurred back in June but the video just surfaced.

Watch live streaming video from nytimesopinion at livestream.com

Recommended links

1. Why is Greece turning down the “bailout” (Tyler Cowen)

2. Circular commitments lead to a Ponzi economy (Letter to the FT). Here's the key quote:

If governments stand behind banks and banks stand behind governments and the central bank lends freely to both and also underwrites financial markets, then financial asset prices become completely detached from economic reality. In this “system”, the central bank implementing more quantitative easing is no different, in economic terms, from Bernie Madoff marking up his client accounts every month.

3. The Bailout That Busted China's Banks (WSJ)

4. Mr. Hoenig Goes to Washington (Simon Johnson)

5. Bond Dealers See Fed Holding Rate Near 0% at Least Through First Half of 2013 (WSJ)

6. Papandreou Is Right to Let the Greeks Decide (Spiegel)

7. Live European debt crisis coverage (BBC) and (Telegraph)

Video: Niall Ferguson Says Financial Repression Preventing Full-Scale Italian Bank Run

Niall's latest comments on the Eurozone crisis after the jump:

Video: Pimco's El-Erian Explains Financial Repression

Video: Carmen Reinhart on a Decade of Debt

Here is a link to audio only versions of Carmen's presentation and the Q&A.

Podcast: Carmen Reinhart on the Coming Financial Repression

Link to audio stream here.

Greece Can Legally Introduce Capital Controls Under EU Article 143

From Spiegel:

Contrary to earlier assumptions, restrictions on the movement of capital, which could be used to prevent Greek citizens from moving their money abroad (something that would endanger the country's banks), are now seen as being compatible with EU law. Article 143 of the Treaty on the Functioning of the European Union offers a loophole, in that it permits certain countries to "take protective measures."

The new line is not entirely uncontroversial, however. This became apparent at a meeting of the euro zone's deputy finance ministers last Monday, when the so-called troika of the European Commission, European Central Bank and IMF gave its report on the situation in Greece. 

The group was divided in the end. For the first time, there was a majority, led by the Germans, Dutch and Finns, that advocated pulling the ripcord on Greece. 

The southern countries, including France, were considerably more reserved. They feared that if funds were cut off for Greece, they could be next in line. 

Can someone please explain to me why so many Greeks still have their euros in a Greek bank? According to the latest official figures since Jan. 2010 Greek bank deposits have only declined by 20%. Assuming these figures are accurate (a big assumption) I would have expected the outflow to be much greater.

Keynes on Printing Money, and Do Loss-Suffering Central Banks (i.e., ECB, SNB) Need Capital?

Weimar Germany during the early-1920s hyperinflation

A 1924 quote from John Maynard Keynes reflecting on events in Weimar Germany and Lenin's Russia:

"A government can live for a long time, even the German Government or the Russian Government, by printing paper money." 

However, "In the last phase, when the use of the legal tender money has been discarded for all purposes except trifling out-of-pocket expenditure, inflationary taxation has at last defeated itself."

The above quote was excerpted from a 1997 paper by the IMF's Peter Stella titled 'Do Central Banks Need Capital?'

Can Central Banks Go Bust?

Technically speaking, the answer according to Stella is no, central banks do not require a capital buffer to absorb losses in the same sense that a commercial bank does. However, Stella states:

"Weak central bank balance sheets invariably lead to chronic losses, the abandonment of price stability as a primary policy goal, a decline in central bank operational independence, and the imposition of inefficient restrictions on the financial system to suppress inflation. 

...if society values an operationally independent central bank capable of attaining price stability without resorting to financial repression, the transfer of real resources to recapitalize the central bank becomes necessary when chronic losses are sizeable."

In other words, the overarching reason for central banks to hold sufficient capital is that it helps maintain confidence in the soundness of the central bank and the value of the currency it issues.

Has the ECB Become Europe's 'Bad' Bank?

As the European debt crisis has spread and intensified, central banks in Europe have been suffering heavy losses for over a year now.

The Swiss National Bank has reported losses in the tens of billions of swiss francs on its euro purchases over the past 12+ months. Whether or not the Swiss government will move to recapitalize the bank is unclear. So far as I know the Swiss central bank is unique among major world central banks in that it is publicly-traded with both government and private shareholders.

There has also recently been speculation that the relatively thinly-capitalized European Central Bank will need to be recapitalized again if it were to continue to suffer heavy losses on its purchase of European sovereign debt. The ECB recently began purchasing tens of billions in Italian and Spanish debt, which comes on top of the tens of billions in Greek, Irish and Portuguese debt it already holds. The prospect of the ECB needing additional funding is not sitting well with Germany and other rich European nations which will have to foot the bulk of the bill.

Interesting times in the world of central banking.

Gold Price: Full Steam Ahead to $2,000/oz.

Over a year ago, on May 6, 2010, this blog launched with a first post on the attractiveness of gold as an investment. On that day the price of gold was just under $1200/oz, and as it became clear that the Federal Reserve was about to embark on another large round of money printing, which later came to be known as QE2, I felt compelled to grab the keyboard and start typing (see articles tagged 'Gold' both here and on SeekingAlpha for further reference).

During this time it has been amusing to watch the professional punditry drone on about a  "gold bubble" and observe various blogger bets about how gold's run couldn't last. The biggest amusement of all, however, has been the disparaging remarks from those such as Berkshire Hathaway's Charlie Munger, who belongs to a group I've taken to calling the 'gold haters'.

Suggestions from credible policymakers, such as the World Bank's Robert Zoellick advocating a return to the gold standard, have lit a fire under the barbarous relic's price this past year. Today, with gold pressing above $1700, or nearly 50% higher in just over a year, I can't help but comment on how we've heard nary a peep of late from the anti-gold crowd.

Where to from here? As long as three key fundamental forces persist then the rise in the price of gold will continue unabated. Those forces are:

1. Low interest rates, a hallmark of the current program of financial repression, which is only just getting started and should extend for many years to come.
2. Continued central bank purchases of gold by countries such as South Korea, Thailand, Russia, etc.
3. More money printing, which we've seen in spades of late with Italian and Spanish bond buying, Bank of Japan and Swiss National Bank currency intervention, and the Fed's rumored QE3.

Continue reading the full article at SeekingAlpha here.

Video: Financial Repression in China

Victor Shih, Assistant Professor of Political Science at Northwestern University, on China's three trillion dollars of foreign exchange reserves. Shih discusses how China could run out of reserves pretty quickly in the event of a crisis.

Shih has collected data on banks and wealthy households in China, and he warns that the wealthiest 1% of households hold enough deposits in the banking system that if they start moving money out of the country, $3T could start to seem like a much smaller number.

Capital flight on the order of half a trillion -- that's no problem for China's banking system, Shih says, because China has the world's highest required reserve ratios, acting as cushion. But at around the $1T mark, the central bank would be forced into large-scale asset sales to avoid illiquid banks.

From INET

Investment Implications of Prolonged Financial Repression

Interesting read from Joe Roseman, former head of Moore Capital PM and Head of Macro Research, on the investment implications of 'prolonged financial repression'. Some highlights:

One of the issues that appears to have really confused economists is why corporates have steadfastly refused to participate in a new capital investment cycle? Why has new hiring been virtually non-existent? 

Standard econometric equations get this wrong because equations can’t think. Econometrics will look for the last time that interest rates were this low, looking at what worked before. 

I would argue that such equations do not have the requisite history built into them to recognise a period when three out of four cylinders in the engine of growth have been impaired. Econometric equations can’t think, but Sir Martin Sorrell of WPP certainly can. 

To quote Sorrell; “Most importantly, post-Lehman and the several corporate crises, we have seen a concern, or even fear, amongst Chairmen and CEOs and in the boardroom about making mistakes and a consequent emphasis on cost containment and unwillingness to add to fixed expenses and capacity.” 

Sorrell goes on to say that “Western-based multi-nationals are said to have over $2tr in cash on their balance sheets, but unemployment remains at stubbornly high levels, with only increases in temporary employment and limited expansion in fixed capacity in Western markets. Hence, a willingness to invest in the brand and maintaining or increasing market share, rather than increasing capacity and fixed expenses.” 

Governments don’t have the cash so print it. Households don’t have the cash so borrow it when they can. Banks don’t have the cash so skim it from savers. Corporates have the cash and just hoard it.

And the possible investment implications?

Not everywhere in the world has the same macro-impairment as the major Western economies, thereby allowing many corporates to develop growth strategies based outside of the G7. Having a cheap(er) currency certainly helps those companies. 

The market seemingly does not value cash sitting on the balance sheet highly. I wonder if that is a mistake. Cash, it is argued, offers optionality to the holder to take advantage of falling (asset) prices should they occur. On the same basis it may also be being undervalued on balance sheets.

I wonder if standard tests of “value” are missing the true value of the cash sitting on balance sheets? In a world where black swans are as common as starlings, having high net cash balances is a major plus. I also wonder whether that same optionality to use cash to buy cheap assets should also be valued higher.

In closing, he wondering whether the M&A department of foreign corporates would view weak currencies, like the pound or U.S. dollar, as an opportunity to acquire cash-rich businesses in the UK or U.S., respectively.

Full writeup here.

What's the Difference Between 'Financial Repression' and 'Macroprudential Regulation'?

Axel Weber and German Chancellor Angela Merkel

The most striking remarks made by former Bundesbank Chief and ECB frontrunner Axel Weber in a recent WSJ interview were his comments on the possibility of using financial repression to solve the Greek and wider European debt crisis:

“Ultimately, there will be a debate about financial repression. Take what we had in Germany — the Zwangsanleihe [compulsory loans introduced after World War I to help make reparation payments]. If voluntary contributions don’t add up, then the one tool that is still on the shelf is financial repression.”

To my knowledge, this is the first time a major senior policymaker (albeit one who recently stepped down) has publicly used the term 'financial repression'. As economist Carmen Reinhart and others have noted, the policies associated with financial repression are typically couched under the more benign, positive sounding 'macroprudential regulation'.

Update: News today emerged that Weber will become Chairman of Swiss megabank UBS, which perhaps explains the reasoning behind his choice of words.

Economic Newspeak

The term 'financial repression' was first coined in 1973 by two Stanford economists, and the word choice was intended to disparage developing economies which enacted what were deemed to be anti-competitive (and hence anti-growth) policies. In other words, the term 'financial repression' was invented with negative connotations in mind.

Can the contrast between 'financial repression' and 'macroprudential regulation' be viewed along the same lines as the difference between 'quantitative easing' and 'printing money'? The two monetary terms can mean approximately the same thing, although those who oppose Fed policies, like QE2, tend to embrace the use of the latter, which is arguably both more provocative and transparent to a broader audience.

This blog has in the past been highly critical of other examples of opaque, economic 'newspeak', such as Yale Professor Robert Shiller's argument that terms like 'bailout' should be replaced with ‘orderly resolution’ so that the voting public 'gets it'.

Financial Repression Redux

The latest from Carmen Reinhart and Co. on the return of financial repression has been published on the IMF's website here. If you're a little turned off by academic papers then you'll find this latest short, magazine-style piece much more appealing.

For more thoughts on financial repression, including how to protect oneself from it, see here.

Bill Gross Harps on Financial Repression

Picking up right where he left off last month, the Bond King's latest letter sounds-off on how financial repression is a bad deal for U.S. treasury investors.

Why Greece Will Default Soon, and What Happens Next

As the haze and rhetoric surrounding the Greek debt crisis begins to lift we can now paint a pretty good picture of what's in store over the next few weeks for Europe's seemingly never-ending debt saga.

The June 29 Deadline

The FT describes the latest details and deadline in the Greek debt endgame:

...pressure is building to have a deal done within three weeks because of an IMF threat to withhold its portion of June’s €12bn bail-out payment unless Athens can show it can meet all its financing requirements for the next 12 months. 

Officials think Greece will be unable to return to the financial markets to raise money on its own in March – as originally planned in the current €110bn package – meaning that the IMF is now forbidden from distributing any additional cash. Without the IMF funds, eurozone governments would either be forced to fill the gap or Athens could default. 

To bring the IMF back in, the new deal must be reached by a scheduled meeting of EU finance ministers on June 20.

The hard deadline may in fact be June 29, when a 12 billion euro ($17bn; £10bn) payment is due to be made to Greece, of which 3.3 billion euros would come from the IMF.

Driving the IMF's credible tough stance are hard lessons learned (and apparently not forgotten) in Latin America a decade ago.


Remembering Argentina

Paul Blustein has written two very insightful and accessible books on recent sovereign defaults and IMF bailouts. His first, titled The Chastening, details the 1997-1998 Asian financial crisis. His follow-up focussed on the financial crisis which struck Argentina's shortly thereafter, and is titled And the Money Kept Rolling In (and Out): Wall Street, the IMF, and the Bankrupting of Argentina. Both books are available in in the Good Books and Films section on the right side of this blog.

Continue reading the full article at SeekingAlpha here.

Video: Bill Gross on U.S. Financial Repression

Video: Financial Repression Coming to America?

Visit msnbc.com for breaking news, world news, and news about the economy

What is Financial Repression and How Investors Can Protect Themselves

Carmen Reinhart

Financial repression, a subject last widely studied in development economics circles in the 1970s-80s, appears to be making a comeback. Bill Gross dedicated his May investment letter to financial repression, and an article by the FT's Gillian Tett describes how both policymakers and investors are having to refamiliarze themselves with its tenets.

Just what exactly is the ominous sounding 'financial repression'? Below is an abridged definition from Reinhart & Rogoff's This Time is Different:

Banks are vehicles that allow governments to squeeze more indirect tax revenue from citizens by monopolizing the entire savings and payment system. Governments force local residents to save in banks by giving them few, if any, other options. 

They then stuff debt into the banks via reserve requirements and other devices. This allows the government to finance a part of its debt at a very low interest rate; financial repression thus constitutes a form oftaxation. Governments frequently can and do make the financial repression tax even larger by maintaining interest rate caps while creating inflation.

The 'Era of Financial Repression'

Carmen Reinhart and M. Belen Sbrancia recently published a paper which analyses the extent of financial repression among advanced economies in the post-World War II period. Here's Reinhart's and Sbrancia's updated definition of financial repression, which now includes pension funds along with banks in their list of domestic captives:

A subtle type of debt restructuring takes the form of “financial repression.” Financial repression includes directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter connection between government and banks.

They studied the post-WWII period:

In the heavily regulated financial markets of the Bretton Woods system, several restrictions facilitated a sharp and rapid reduction in public debt/GDP ratios from the late 1940s to the 1970s. Low nominal interest rates help reduce debt servicing costs while a high incidence of negative real interest rates liquidates or erodes the real value of government debt. 

And their key finding which has PIMCO's Bond King in a tizzy:

Continue reading the full article at SeekingAlpha here.