If true we are doomed

by on November 20, 2011 at 4:45 pm in Economics | Permalink

Paul Krugman points us to a very important, very recent paper by Hyun Song Shin (pdf), excerpt:

As we will see shortly, foreign banks’ US branches and subsdiiaries drive the gross capital outflows through the banking sector by raising wholesale funding in the US through money market funds (MMFs) and then shipping it to headquarters. Remember that foreign banks’ branches and subsidiaries in the US are treated as US banks in the balance of payments, as the balance of payments accounts are based on residence, not nationality.

The gross capital inflows to the United States represent lending by foreign (mainly European) banks via the shadow banking system through the purchase of private label mortgage-backed securities and structured products generated by the securitization of claims on US borrowers. In this way, European banks may have played a pivotal role in influencing credit conditions in the United States by providing US dollar intermediation capacity. However, since the eurozone has a roughly balanced current account while the UK is actually a deficit country, their collective net capital flows vis-a-vis the United States do not reflect the influence of their banks in setting overall credit conditions in the US. The distinction between net and gross flows is a classic theme in international finance, but deserves renewed attention given the new patterns of gross capital flows due to global banking.

p.s. It’s a somewhat neo-Austrian hypothesis.

Peter Douglas November 20, 2011 at 5:37 pm

OK, Tyler, as somebody who currently has quite a bit of money in an American brokerage money market account (yes, it’s uninsured, and no I can’t get it out and into an FDIC bank for a few more weeks) I am asking you to elaborate a bit on precisely WHY this means we are doomed. :) Gulp.

Ted M November 20, 2011 at 5:42 pm

from Krugman’s description:

“The Mark-To-Market Amplification Of Financial Distress

A nice phrase from my colleague Hyun Song Shin (pdf), describing what’s happening in Europe right now.

The paper covers much more ground than that, of course. This is the latest in a series of papers arguing that the U.S. shadow banking system consists in large part of … European banks. This suggests that the creation of the euro had large implications even in US capital markets; and of course it suggests that the financial fallout of the euromess could be very large here as well.

In short, the ECB could be in the process of destroying not just the euro, but the world.”

NAME REDACTED November 21, 2011 at 12:35 pm

Yes, mark to market accounting makes the task of banks: converting short term deposits into long term assets an impossible one.

Reg November 20, 2011 at 7:16 pm

Hmm, all my 401k is in MMFs, so better to put it in stocks or bonds? Ugh. It’s criminal that 401ks don’t offer cash as an option.

Matthew C. November 20, 2011 at 7:25 pm

Don’t worry, the US dollar is doomed too. . .

Reg November 20, 2011 at 8:30 pm

Maybe i’ll withdraw it all, pay the penalty, and buy booze and ammunition. That usually holds its value.

Erick November 20, 2011 at 9:56 pm

In a true collapse, wouldn’t booze lose most of its value? Alcohol is priced well above its cost of production due to a host of regulations and taxes. Society collapses, so do the regulations and taxes.

doctorpat November 21, 2011 at 8:53 pm

In a true collapse, the cost of alcohol production would skyrocket. Depending as it does on long distance trade of wheat, barley, wooden barrels, electricity etc. Also, good alcohol depends on time to age, and with collapse of society the discount rate will vastly increase, thus greatly increasing the cost of aging a 21 year old Whiskey.

ElamBend November 21, 2011 at 9:37 pm

reply to below: booze can be traded and has an excellent stored value, buy a case of booze now; btw, both also hold true for ammo

Bill November 20, 2011 at 5:55 pm

Well, it looks like if overleveraged European banks cut back on their lending, Uncle Ben will be lending/creating money to make up the difference. As European banks purchase fewer dollars with Euros as part of their lending, this will reduce demand for the dollar, just the demand for the Euro is declining.

Why are we toast? The Fed can create money.

dearieme November 20, 2011 at 6:17 pm

The simplest explanation of the doomsday design of the Euro system was that the key people were acting as agents of the USSR. Whether such people – if they existed – would have carried on with the plot after the collapse of the USSR, I wouldn’t know. I suppose if they hated The West enough they might.

I have no evidence at all for such speculation, though if the EU Commission weren’t thoroughly penetrated by the KGB I’d be astonished. Others might say “No, no, it was only the hubris of the Eurocrats”. Could be, but if so they can claim some sort of world record for stupid recklessness.

Chris November 20, 2011 at 7:55 pm

Simplest. I don’t think so. Awesomest. Hell yeah.

Tyler Fan November 20, 2011 at 8:23 pm

It’s Occam’s Razor applied to the financial crisis.

dearieme November 21, 2011 at 6:58 am

Nah, only to one aspect of the financial crisis. No simple explanation will do for the whole schemozzle. Hell, this explanation may have no merit even for the Euro. But one thing I know about the sort of ex-communists who crop up so often in European politics – one can be very certain that they once were communists – one cannot be so certain that they are “ex”.

IVV November 21, 2011 at 10:42 am

Simplest: Occam’s Razor.

Awesomest: Occam’s Katana.

doctorpat November 21, 2011 at 9:39 pm

Oh I am stealing that one.

Waruihito December 1, 2011 at 10:33 am

Weirdest: Occam’s Ocarina.

Alan November 20, 2011 at 9:14 pm

The simplest explanation of the doomsday design of the Euro system was that the key people were dementors. Whether such people – if they exist – would have carried on with the plot after the publication of The Prisoner of Abkazan, I wouldn’t know. I suppose if they hated muggles enough they might.

I have no evidence at all for such speculation, though if the EU Commission weren’t thoroughly penetrated by dementors I’d be astonished. Others might say “No, no, it was only the hubris of the Eurocrats”. Could be, but if so they can claim some sort of world record for stupid recklessness.

dearieme November 21, 2011 at 6:55 am

But the USSR existed and did indeed have many agents abroad. There were many things the USSR was bloody awful at, but at least two it was gdod at – the other was propaganda. Such as “anyone who suspects we have effective agents abroad must be a lunatic” – that sort of thing.

JonF November 21, 2011 at 4:39 pm

Why would these agents still be doing their dastardly work decades later? Who’s been paying them all these years? People whose paymasters have ceased to exist tend not to do that job any longer, if only because they need to find another way to keep a roof over their head and food on their table.

dearieme November 21, 2011 at 6:30 pm

Good God, do you think the KGB had ceased to exist in the years when the Euro was designed? It could, under whatever new initials it had adopted, pursue Russia’s interests – pretty similar to the USSR’s; it could blackmail people over their earlier service; it could even call on whatever non-pecuniary motivation its agents, fellow travellers and useful idiots had.

DW November 20, 2011 at 7:13 pm

Stupid Germans…

Michael Lewis was right!

Rob November 20, 2011 at 7:24 pm

Can anyone explain this for the non-finance experts among us?

DW November 20, 2011 at 7:35 pm

Others here are better at this than I, but I read it as: Euro banks bought tons of MBS and other assets, flooding our system with liquidity, to what degree is hard to tell from the abstract.

We didn’t count this properly so didn’t realize this was happening.

A possible corollary: the absence of such inflow tightens the money supply.

Everyone agree with that? I know real experts lurk here, but perhaps not on Sunday night.

Andrew M November 20, 2011 at 8:57 pm

That seems plausible; and it would also explain why asset markets (housing in particular) in the US rose and fell in the last decade.

But it’s also just a fancy way of saying that stupid Germans (as per Michael Lewis) aren’t buying Mortgage-Backed Securities any more. That’s hardly news.

nigel November 21, 2011 at 11:00 am

>>Euro banks bought tons of MBS and other assets, flooding our system with liquidity<<

And apparently did so with cash they borrowed in the US ?

anne November 20, 2011 at 8:06 pm

Seriously, Tyler, would a short summary sentence have been that hard with a title that sensational?

Tyler Cowen November 20, 2011 at 9:29 pm

More on this coming tomorrow! I’ve been working through this paper and another one, hold tight!

anne November 21, 2011 at 9:55 pm

Okay – thank you – I will be checking back. I learn a lot from this site, even if I only understand about a quarter of what you post. :-)

ad*m November 20, 2011 at 9:58 pm

“There is nothing complicated about finance. It is based on old people lending to young people. Young people invest in homes and businesses; aging people save to acquire assets on which to retire. The new generation supports the old one, and retirement systems simply apportion rights to income between the generations. Never before in human history, though, has a new generation simply failed to appear.”

“The monster is the burgeoning horde of pensioners in Germany and other industrial countries. It is easy to change the financial system. The central banks can assemble on any Tuesday morning and announce tougher lending standards. But it is impossible to fix the financial problems that arise from Europe’s senescence. Thanks to the one-child policy, moreover, China has a relatively young population that is aging faster than any other, and China’s appetite for savings vastly exceeds what its own financial market can offer. ”

from http://www.atimes.com/atimes/Global_Economy/JE20Dj05.html

David Goldman aka Spengler has been writing about this since 2000. Just keep working.

TGGP November 20, 2011 at 10:02 pm

How far can one believe anything “Spengler” writes?

derek November 20, 2011 at 11:25 pm

Only as far as he has been right.

ad*m November 21, 2011 at 1:57 pm

TGGP,

I know, and you called that correctly. In fact there are no numbers to support his argument, and all data seems to come from Iranian resistance groups. It is murky there.

Razib is probably the worst to link to, as this journalist pretending to be a scientist has shown himself to be petty, emotional, and eager to expose people’s identities after promising to guard pseudonyms. I know he has star status in the HBD world, but believe from me, a scientist publishing genetics papers, that pulling together abstracts and figures does not a scientist make.

Back to Spengler, he makes predictions, has arguments for those predictions, they are often correct, and finally and most importantly, inform the discussion. In addition he has been putting his money where his mouth is. That is why he is widely read and cited, not because people ‘believe’ him. I strongly suggest people reading this evaluating him themselves.

IVV November 21, 2011 at 6:23 pm

Actually, didn’t something like this effectively occur with the population crash as a result of the Black Death? If so, there’s hope for the youth of tomorrow–if they’re lucky enough to be born.

doctorpat November 21, 2011 at 9:44 pm

There have been many, many times in history when ” a new generation simply failed to appear.” So this line is simply ignorance or hyperbole.

Sadly, most of such times were also associated with social collapse.

Tyler Fan November 20, 2011 at 8:34 pm

One theory of the financial crisis is that it was precipitated by a “savings glut.” This “This American Life” episode entitled “The Giant Pool of Money” articulates the “savings glut” theory pretty simply and persuasively: http://www.thisamericanlife.org/radio-archives/episode/355/the-giant-pool-of-money
The Princeton paper hypothesizes that a “banking glut” rather than a “savings glut” led to the crisis. If so, the true size of the disaster hasn’t been accounted for yet.

NAME REDACTED November 21, 2011 at 1:15 am

Yes, this is what happens when people don’t have enough babies.

JonF November 21, 2011 at 4:46 pm

What do babies have to do with it? From an economic POV they are the equivalent of retirees, since they are consumers who do not produce– perhaps more so since retirees often do some useful work (in unpaid sectors), and many of them contribute capital to the economy even if they no longer contribute labor.
Moreover a true birth dearth would be at least partly self-correcting. We would see very tight labot markets, rock bottom unemployment and upward pressure on wages, which would in turn generate higher tax returns, and also induce some people (retirees or other non-workers) to re-enter the labor force. This actually happened in the late 90s. Yet we see nothing of the sort, anywhere, not even in Japan which is farthest down this demographic path. This suggests that demographic factors are not behind the economic problems of the modern world.

Frank November 20, 2011 at 8:36 pm

I call BS:

One must distinguish between net capital flows and the intermediaries’ flows. If someone wants to lend to US borrowers, that someone will figure out how to do it, whether a US bank, a European bank, or a North Korean bank. If fewer wish to lend to US borrowers, we’ll have to borrow less. That’s what interest rates are for!

derek November 20, 2011 at 11:28 pm

And suddenly the very low interest rates that the Treasury is borrowing at to fund it’s $1.3 trillion deficit and roll over it’s $14 or so trillion existing debt goes above 6%, and it is the end of the world as we know it. I don’t quite know what you are disagreeing with.

Bill November 21, 2011 at 9:44 am

derek, Those are just words, not reality.

JWatts November 21, 2011 at 11:47 am

Ok, how about this?

Treasury rates go up above 6% and the US government has to pay an additional $500 billion per year in interest payments.

maguro November 20, 2011 at 9:01 pm

I sure picked a bad week to stop sniffing glue!

elmer November 20, 2011 at 9:55 pm

It’s never a good week to stop sniffing glue.

DK November 20, 2011 at 10:39 pm

Given the news lately, no upcoming week seems bad for starting to sniff glue on a regular basis.

somethingblue November 20, 2011 at 11:10 pm

Clearly Reg up-thread should be putting his money in glue.

Reg November 20, 2011 at 11:31 pm

Good call. Time to go watch Mad Max and The Road for more investment ideas.

Highgamma November 21, 2011 at 12:06 am

“It’s coming right at us!” (Jumps through window.)

Ah, Lloyd Bridges. We miss you.

notkevinnealon November 21, 2011 at 1:29 am

Get a hold of yourself!

sdrateci November 21, 2011 at 10:55 am

So, after multiple readings, one wild, plain English guess for why, if true, we’re “doomed:”

The only people providing liquidity to Americans are European banks, which are all about to go bankrupt.

Is that right?

JonF November 21, 2011 at 4:48 pm

Except that doesn’t sound right. There’s no money coming in from Asia?

Nahuel Pan November 21, 2011 at 11:42 am

Does this mean that the Fed is the european banking system lender of last resort?

Frank H November 23, 2011 at 2:57 pm

Appears to me that a credit contraction in the US caused by Euro banks deleveraging or reducing their exposure in US shadow banking system is not the real story. These loans (assets) already exist on the books of Euro banks. The real story will be the result of Euro banks dumping these assets or being forced to mark them down – when the US Feds are obliged to fully guarantee money market mutual funds since these funds still have lots of exposure to Euro banks.

Charles R. Williams November 30, 2011 at 6:44 pm

The European banks have a substantial market share in US banking because they can operate with more leverage than American commercial banks. If US money market funds stop financing European banks they will dump dollar denominated assets. Unlike MBS in 2007-8 these assets are solid. Somebody will buy them and they will have to finance the purchase with some kind of deposits. This will be the money market “deposits” that now finance the European banks. What then might prevent alternative banks from taking up the slack? What would stop American banks from raising the capital needed to take market share from European banks? This is the issue and if American banks cannot raise that capital we will be paying the price for our failure to seize the banks in 2008-9 and recapitalize them.

Dave December 1, 2011 at 3:49 am

I don’t get it. Is the “shadow” so great that a QE3 wouldn’t cover it? It seems that the doom-can might just be able to be kicked on down the road, right?

michael stefko December 2, 2011 at 9:38 am

reply to jon f — the difference this time may be that we have “newborns”–robots/computers doing a lot more work than multiple humans can = growing unemployment. There are “lights out” machine tool factories working overnight with NO human workers!

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