Category: Economics

Italian private debt is quite low and yesterday I mentioned that Italian homeowners don’t have much in the way of mortgages.  David Henderson then asked a good question:

“Were more Italians to take out mortgages on their houses to buy government bonds, for example, Italy could eliminate its interest-payment problem.” How is that good news? The government would still have to pay interest on this debt.

The Italian government has high debt and productivity is not going up any time soon.  We can expect a mixture of lower government spending and higher taxes, otherwise the country defaults, maybe the country defaults anyway.  Ideally “they” would like to send equity in Italian homes to bondholders in lieu of making the interest payments.  Italy doesn’t do a good job collecting taxes and the economy already has lots of distortions, so pulling wealth out of homes would in principle be a way to go.  A CDO tranche instead of an interest coupon, so to speak.  One can imagine the Italians borrowing more against their homes and sending the money to their government as a tax, or accepting lower transfer payments from the government, and that would implicitly serve as a way of paying off the bonds with fractions of homes.  Of course that probably won’t happen.

Italy is house rich, somewhat cash poor, and has a miserable recent history of growth.  If you look at the wealth side of the balance sheet, you can easily work up a heady optimism for Italy.  If you study public choice theory, it is harder to do so.  How many people in that country are either paid to do the wrong thing, or paid to do not so much at all?  TGS reigns.

Italy’s privileges and distortions are so often so local, and so concentrated in inefficient professional services, that it is hard to imagine clearing them up quickly in the form of a big bang, in the way that say New Zealand or Chile or Thatcher’s England did.  And even those successes took some time to pay off and underperformed for years.

Note that if Italy could credibly be expected to grow a mere 2 pct. a year — maybe less — the entire eurozone crisis probably would be messy but manageable.  It’s not.

File under: non siamo cosi’ ricchi come pensavamo di esserlo!

The EU seems to have that in mind but here is the problem with that idea:

Distressed European Union banks that tap national governments or the region’s €440bn rescue fund for capital will be subject to state-aid penalties, involving compulsory restructuring or – in the worst case – orderly wind-downs…

The proviso – consistent with EU state-aid rules applied throughout the crisis – is likely to discourage banks from seeking public assistance and spur them to shrink their balance sheets instead, raising the danger of a credit crunch, bankers say.

Bloomberg: Federal employees whose compensation averages more than $126,000 and the nation’s greatest concentration of lawyers helped Washington edge out San Jose as the wealthiest U.S. metropolitan area, government data show.

The U.S. capital has swapped top spots with Silicon Valley, according to recent Census Bureau figures, with the typical household in the Washington metro area earning $84,523 last year. The national median income for 2010 was $50,046.

I hear this argument a lot, but I don’t quite understand it.

Let’s start with a contrast, namely that Ecuador, El Salvador and Panama all use the U.S. dollar.  It is unlikely that lowers the value of the dollar and since it boosts the demand for currency it may even strengthen the dollar a bit, though of course there is a Fed offset on the currency supply side.  The U.S. may have a partial geopolitical commitment to these countries, but it has to do with location, the Monroe Doctrine, and the drug war, not  with their currency choice per se.

So why does it lower the value of the euro to have Greece use the currency?  The simplest reason is that Greek participation, and involvement of the other periphery countries, creates a real chance that the eurozone will blow up, partially or fully.  (El Salvador does not pose a comparable threat to the dollar.)  Fair enough.  But then it cannot be argued that the lower currency value means Germany can/will stop such a blow up.  In equilibrium those are inconsistent conjectures.  For the blow up option to lower the value of the euro, the blow up option must be real and if that is not a real risk now when is it supposed to be a real risk?

Another option is to claim that the the participation of the periphery countries in the eurozone raises the expected rate of price inflation in the eurozone.  First, it’s not clear this is true and it has not been true so far.  Second, it is not obvious why the euro should become weaker before that higher inflation arrives.  Third, if German export prices are equally flexible it doesn’t give us a weaker real exchange rate for Germany, which was the original supposed benefit.  Fourth, if German export prices are not flexible we have an overshooting model, which a) implies the low real exchange rate for Germany goes away over time, and b) implies that far more real exchange rate volatility is predictable than is actually the case.

A related question is whether solving the eurozone crisis, for ever and ever, with a neat nifty eurobond (or whatever ha-ha) also would remove Germany’s supposed real exchange rate advantage.

My analysis has not exhausted the options but perhaps you see the problem.  I have not yet heard a coherent version of the argument.  The simplest answer, and the answer most likely to be correct, is that the euro is lower in value, to the benefit of German exporters, but only because there is very real chance of a crack-up, and this is a reason why a crack-up might happen, not a reason why a crack-up will not happen.

Ultimately, the conjectures have to add up.

From Terrence Hendershott, Charles M. Jones, and Albert J. Menkveld, I am a little slow reporting on this paper:

Algorithmic trading (AT) has increased sharply over the past decade. Does it improve market quality, and should it be encouraged? We provide the first analysis of this question. The New York Stock Exchange automated quote dissemination in 2003, and we use this change in market structure that increases AT as an exogenous instrument to measure the causal effect of AT on liquidity. For large stocks in particular, AT narrows spreads, reduces adverse selection, and reduces trade-related price discovery. The findings indicate that AT improves liquidity and enhances the informativeness of quotes.

Here is also the Kirilenko paper, both are discussed here.  I have not had time to read and assess these, but since I’ve covered the topic before, this brings you more up to date.

Let’s have the banks and the governments shore up each other:

I am afraid that the leaders are contemplating some inappropriate steps. They are talking about recapitalising the banking system, rather than guaranteeing it.

A fair enough point, but where will the money come from to do that?

In exchange for a guarantee, the major banks would have to agree to abide by the instructions of the ECB. This is a radical step but necessary under the circumstances. Acting at the behest of the member states, the central bank has sufficient powers of persuasion. It could close its discount window to, and the governments could seize, the banks that refuse to co-operate.

The ECB would then instruct the banks to maintain their credit lines and loan portfolios while strictly monitoring the risks they take for their own account. This would remove one of the main driving forces of the current market turmoil.

The other driving force – the lack of financing for sovereign debt – could be dealt with by the ECB lowering its discount rate and encouraging countries in difficulties to issue treasury bills and prompting the banks to subscribe.

Um…if it all is a liquidity crisis, this might work, public choice problems aside.  Otherwise it is calling for possibly insolvent banks to prop up not only the real economy but the governments too, which in turn will guarantee the banks, which by the way now have to keep on making bad loans.