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Three myths about EU’s economic response to the COVID19 pandemic

Daniela Gabor

On Monday 15th, 2020, I took part in the Public Hearing on COVID19 responses at the European Parliament’s ECON committee. This is the text of my introductory remarks.

 

The COVID19 pandemic confronted EU members with symmetric shocks and profound deflationary forces. In response, governments are running large budget deficits. Their borrowing costs remain low because central banks have acted as public guarantors of confidence.

I would like to unpack three myths about the COVID19 response in Europe.

Myth 1: central banks have overstepped their mandate with disproportionate interventions in government bond markets, undermining fiscal rules.

This argument, as expressed in the Karlsruhe ruling, implies that it is imperative to return to the pre-crisis status quo: a division of macroeconomic labor whereby the ECB targets price-stability, whereas Member States conduct fiscal and economic policies in a manner consistent with European rules.

Through a macro-financial lens, this argument is simply wrong. If we ask how private financial structure and macroeconomic policies interact*, it becomes clear that evolutionary changes in European finance have joined monetary and fiscal policies at the hip. The pre-crisis division of macroeconomic labor is a fiction that we can no longer afford to sustain.

Consider the largest money market for European banks and institutional investors, the €7 trillion repo market. Two out of three euro borrowed through repos use sovereign bonds issued by euro-area members (Germany and Italy the largest) as collateral. Private credit creation —the bread and butter of the ECB’s operations —fundamentally relies on sovereign bonds, and so on fiscal policy. Higher sovereign yields make private credit more expensive. In turn, the repo market creates, and can easily destroy, liquidity for governments, influencing their borrowing conditions and, ultimately, fiscal-policy. In the Euroarea, it creates an exorbitant privilege for Germany: in crisis, banks run to German bunds because these preserve access to collateralised funding. This is why leaders of ‘periphery’ euro countries watch the spread to German bunds nervously.

The ECB did not intervene in sovereign-bond markets because it worried about debt sustainability. As President Lagarde noted in the European Parliament hearing in early June, intervention was needed to effectively support private credit creation, and the transmission mechanism of monetary policy. Improvements in financing conditions for governments, much decried in some European circles, are not a policy target but a side effect of the repo-based sovereign debt order that the founders of the Euro put in place.

But the Euro founders did so without appreciating its complex political ramifications, in particular the structural pressures on central banks to intervene in sovereign bond markets. Given the growing public debt/GDP ratios, and the possibility of renewed pressure on vulnerable sovereigns, it is imperative we rethink this order.

For this, we need to update the institutional framework that governs the relationship between central banks and governments. So far, central banks have improvised through unconventional policy measures, but on terms that they control. In so doing, they entrench a democratic deficit that encourages anti-European sentiment. In the Euroarea, monetary union needs to be accompanied by fiscal union not on grounds of ‘solidarity’, but because the alternative is a disorderly exit from the Euro, particularly if the chorus demanding post-pandemic austerity becomes stronger.

Myth 2 Europe has well-functioning institutions – like the ESM – to provide a safety net for sovereigns in times of crisis.

The Almunia Report on the EFSF/ESM programmes in Greece highlights serious weakness in the institutional mechanisms for backstopping Member States in times of crisis. The ESM put excessive emphasis on fiscal consolidation, with significant social costs for Greek citizens, lacked strategic objectives and prioritized the interests of ESM members over those of Greece. Harsh and counterproductive conditionality for sovereigns stands in clear contrast to the generous support for private finance, as for instance extended by the ECB.

Even if the Almunia recommendations would be enacted in a timely fashion, a reformed ESM can at best alleviate some of the burden of higher public debt. It cannot effectively respond to the cyclical liquidity pressures created by the financial structure described above, particularly as public debt burdens grow across Europe. Equally important, it would not create the fiscal space necessary for Member States to respond counter-cyclically to shocks, and to prioritize green public investments, including public health infrastructure.

This is why the European Commission’s plans for grants under the EU Next Generation are an important first step towards creating an effective European response. But are these enough.

Myth 3 The pandemic recovery plans of the European Commission are ambitious enough.

Bruegel estimates that only a quarter from the grants envisaged in the Next Generation EU will be spent over 2020-2022**. National fiscal policies will have to shoulder the burden of recovery. The EU can and should be more ambitious, prioritizing a green recovery.

It is encouraging that the Commission has reaffirmed its intentions to reserve 25% of EU spending for climate-friendly expenditure. Its efforts should be amplified by pre-crisis commitments to green central banks and to promote sustainable finance in Europe.

Take the ECB. Its support to market actors comes without environmental, tax- or payout-related conditionality. In practice, the ECB continues to subsidise high-carbon activities, and in doing so, it reinforces climate-related risks to financial stability. Its objectives can be recalibrated within the existing treaty framework, as follows***:

  • The ECB should start to love ‘brown inflation’. In its current version, the Harmonised Index of Consumer Prices ignores the carbon footprint of goods and services. Greening the HICP would take the bite out of the price-stability mandate, while rendering it more consistent with the ECB’s secondary objective.
  • The ECB should green its monetary policy operations, by removing the preferential treatment to brown assets, and where it judges necessary, by promoting green financial instruments. These two measures should go hand in hand to avoid greenwashing, and would constitute an effective measure to reorient private finance towards sustainable activities.
  • The Euroarea should institute an open and recurrent process at the highest political level to specify which ‘general economic policies in the Union’ the ECB is required to support. Article 11 of the Treaty on the Functioning of the European Union already mandates ‘environmental protection’. Specifying such protection in relation to the full portfolio of central-bank activities—considerably broader than monetary policy proper—would provide political legitimacy for an unconditional ECB backstop of green public investment. This circular arrangement would amount to a substantial gain in fiscal sovereignty in the euro area.

In parallel, the European Commission, with support from the European Parliament, should accelerate its work on the Renewed Sustainable Finance strategy. A well-defined taxonomy for green and brown activities, and prudential measures guided by the taxonomy, would ensure that private financing of brown activities does not undermine the public investments in the green recovery.

Thank you for your time.

——–

 

* See Gabor, D. (2020) Critical macro-finance: a theoretical lens. Finance and Society 6(1): 45-55.

**See Darvas, Z. (2020) Three-quarters of Next Generation EU payments will have to wait until 2023. https://www.bruegel.org/2020/06/three-quarters-of-next-generation-eu-payments-will-have-to-wait-until-2023/

*** See Braun, B., Gabor, D. and B. Lemoine (2020) Enlarging the ECB mandate for the common good and the planet. Social Europe. https://www.socialeurope.eu/enlarging-the-ecb-mandate-for-the-common-good-and-the-planet

Mercados emergentes precisam de controle de capital para evitar catástrofes financeiras

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Traduzida por Carolina Alves.

Todos os países estão atualmente enfrentando a ameaça sem precedentes de uma crise global da saúde, recessão econômica e colapso financeiro, simultaneamente. Mas, ao contrário dos países ricos, os mercados emergentes (EMs) não têm autonomia política necessária para enfrentar essas crises. A hierarquia global de moedas coloca EMs na periferia dos mercados financeiros globais, expondo-os a paradas súbitas de fluxos de capital causadas por gatilhos como a crise COVID-19. Imediato controle de capital, coordenado pelo FMI,è necessário para evitar um desastre financeiro

Em uma crise financeira global, há uma pressa em manter ativos líquidos denominados em moedas seguras, especialmente dólares americanos. Isso permite ricos países responder a crises com as necessárias ferramentas fiscais e monetárias. O oposto é verdadeiro para os EMs. Desde o surto de COVID-19, investidores internacionais retiraram grandes quantias de ativos dos EMs, causando uma depreciação dramática da moeda, especialmente aqueles expostos à queda dos preços das commodities.

Na última década, ampla liquidez global impulsionada por bancos centrais de países ricos, juntamente com a demanda sustentada por ativos líquidos, levou a enormes fluxos de crédito e investimento de capital nos EMs, onde os títulos e as bolsas de valores cresceram por volta de 15 trilhões para 33 trilhões de dólares americanos entre 2008 e 2019. ‘Economias de fronteira’ e EMs corporações emitiram volumes substanciais de dívida em moeda estrangeira. Com o G20 incentivo, os EMs abriram seus mercados de títulos em moeda nacional para investidores internacionais. No que foi denominado a segunda fase da liquidez global, novos instrumentos e instituições financeiras, como fundos internacionais e fundos de investimento abertos negociados em bolsa (ETF), possibilitaram a fácil negociação global de EMs ativos, consolidando a ilusão de liquidez.

Os EMs agora são confrontados com uma parada repentina de capital, pois as condições globais de liquidez apertam e os investidores fogem do risco: a exposição aos EMs continua sendo uma estratégia de alto risco/alto retorno, a ser liquidada em tempo de crises. Consequentemente, os EMs enfrentam severo ajuste macroeconômico exatamente no momento em que todas as ferramentas disponíveis devem ser usadas para combater a crise de saúde pública apresentada pelo COVID-19. Alguns países podem ser forçados a implementar uma política monetária restritiva na tentativa de manter o acesso ao dólar, enquanto a ação fiscal pode ser restringida pelo medo de perder o acesso a mercados globais. É improvável que as reservas cambiais forneçam ‘colchão de segurança’ suficiente em todos os países.

Há uma necessidade urgente de ação para impedir que essa crise chegue a proporções catastróficas nos EMs. Apesar de pedidos de ação de longa data, ainda não existe credor internacional de última instância. Os únicos instrumentos atualmente disponíveis são empréstimos dos FMI e linhas de swap cambial temporárias entre bancos centrais. Os empréstimos do FMI normalmente impõem ajustes fiscais, o que seria desastroso nas condições atuais. Os Fed está pronto para fornecer dólares americanos a um punhado de bancos centrais: entre os EMs, apenas o México pode acessar as linhas de swap do Fed sob as disposições do NAFTA. Durante a crise financeira global de 2009, o acesso foi concedido apenas ao Brasil e à Coréia do Sul. Mas EMs, no G20 e além, são agora muito mais importantes para o económico crescimento mundial. O fracasso deles, ou de um grande quase-soberano tomador de empréstimo, poderia desencadear um contágio significativo.

Nos pedimos uma ação decisiva para restringir os fluxos financeiros atualmente transmitindo a crise aos EMs. Controles de capital devem ser introduzidos para reduzir a fuga de capitais, para reduzir a falta de liquidez causada por sell-offs nos EMs mercados, e para impedir quedas da moeda e preços dos ativos. A implementação deve ser coordenada pelo FMI para evitar estigma e evitar contágio. As linhas de swap cambial devem ser estendidas para incluir EMs, e então garantir o acesso ao dólar americano. Finalmente, concordamos com as recentes medidas fornecendo uma maior provisão de liquidez pelo FMI usando os Direitos de Saque Especiais (DSE) – mas isso deve ocorrer sem a imposição de ajuste fiscal pró-cíclico.

A crise que se desenrola é uma das mais graves na história econômica. Nós deve garantir que os governos possam fazer todo o possível para proteger seus cidadãos. Em nossa economia globalmente integrada, ações coordenadas são necessárias para minimizar as restrições externamente-impostas às economias emergentes, que por sinal enfrentam a tripla ameaça de pandemia, recessão e crise financeira.

Los Países Emergentes Y En Desarrollo Necesitan Controles De Capital Para Prevenir Una Catástrofe Financiera

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Una version corta de esta carta fue publicada en  Financial Times, el 25 Marzo

2020.

Traducido al español por: Jimena Sierra y Federico Suárez

(con el apoyo de Daniela Gabor y Luis Eslava)

Actualmente, todos los países enfrentan una amenaza sin precedentes. Esta amenaza es tanto el producto de la crisis de salud global, como de sus efectos en términos de recesión económica y colapso financiero. A diferencia de las naciones ricas, sin embargo, los países emergentes y en desarrollo (PED) carecen de la autonomía política necesaria para enfrentar estas crisis. La jerarquía monetaria global coloca a los PED en la periferia de los mercados financieros globales, lo cual los sobreexpone a choques repentinos causados por fenómenos como la crisis del COVID-19. La Reserva Federal de los Estados Unidos ha anunciado que prestaría hasta USD 60 mil millones a los bancos centrales de México, Brasil, Corea del Sur y Singapur. Aunque bien recibidos, esta línea de crédito no es suficiente. Se necesitan controles inmediatos de capital, coordinados por el FMI, para evitar un desastre financiero.

En una crisis financiera global, hay una urgencia por mantener activos líquidos en monedas seguras, especialmente dólares estadounidenses. Los países ricos pueden responder a este reto con las herramientas fiscales y monetarias necesarias. Sin embargo, esto no es posible, para los PED. Desde el estallido de la crisis de COVID-19, los inversionistas internacionales han retirado grandes sumas de los activos de los PED, lo que ha llevado a una depreciación dramática de la moneda en estos países, especialmente en aquellos que están ya sobreexpuestos debido a la caída de los precios de sus commodities.

Durante la última década, la amplia liquidez a nivel global impulsada por los bancos centrales de los países ricos, junto a una demanda sostenida de activos líquidos, ha direccionado enormes flujos de crédito e inversión en acciones hacia los PED, donde los mercados de bonos y acciones crecieron aproximadamente de 15 billones a 33 billones de dólares entre 2008 y 2019. Las ‘economías de frontera‘ y las corporaciones de los PED han emitido cantidades sustanciales de deuda en moneda extranjera. Con el apoyo del G-20, los PED abrieron sus mercados debonos en moneda nacional a inversores internacionales. En el marco de lo que se ha llamado como la segunda fase de liquidez global, los nuevos instrumentos y las nuevas instituciones financieras, como los fondos internacionales y los fondos de inversión cotizados en bolsa (exchange-traded funds (ETFs) eninglés), han facilitado la negociación global de los activos de los PED, dando lugar a una ilusión de liquidez.

Los PED ahora se enfrentan a un choque repentino por el endurecimiento de las condiciones de liquidez global y debido a que los inversores buscan huir del riesgo: la exposición a los PED sigue siendo una estrategia de alto riesgo y alto retorno, que deja de ser tractiva en tiempos de crisis. En consecuencia, los PED se enfrentan hoy a un severo ajuste macroeconómico precisamente en el momento en que todas las herramientas disponibles deben usarse para contrarrestar la crisis de salud pública causada por el COVID-19. De esta manera, algunos países pueden verse obligados a endurecer su política monetaria en un intento por retener el acceso al dólar estadounidense, mientras que las acciones fiscales pueden verse limitadas por el miedo a perder el acceso a los mercados mundiales. Sin embargo, es poco probable, que las reservas de divisas amortigüen de manera suficiente a todos los países. Esto tendría profundas consecuencias para la economía global: los PED, tanto aquellos que están en el G-20 como fuera de este, son hoy en día mucho más importantes de lo que eran hace una década gracias al crecimiento económico y la expansión de los mercados a nivel global. Frente a estos retos, el fracaso de una acción internacional que facilite préstamos soberanos o cuasi-soberano podría desencadenar en un efecto dominó con consecuencias devastadoras a través del planeta.

Existe una necesidad urgente de actuar para evitar que esta crisis alcance proporciones catastróficas en los PED. A pesar de décadas de discusiones y advertencias, todavía no existe un prestamista internacional de última instancia. Los únicos instrumentos disponibles actualmente son los préstamos del FMI y las líneas de intercambio de divisas entre bancos centrales. Sin embargo, los préstamos del FMI suelen imponer ajustes fiscales, lo cual sería desastroso en las condiciones actuales. La Reserva Federal de los Estados Unidos, por otro lado, está lista para proporcionar dólares estadounidenses a un puñado de bancos centrales: el problema es que entre los PED solo México, Corea del Sur y Brasil pueden acceder a estas líneas de intercambio de la Reserva, por un monto de hasta USD 60bn. No obstante, estos acuerdos ad hoc excluyen una gran proporción de las necesidades de los PED de liquidez en dólares.

Debido a lo anterior, hacemos un llamado a tomar acciones decisivas para restringir los flujos financieros que actualmente están transfiriendo la crisis a los mercados emergentes. Deben introducirse controles de capital para restringir la salida repentina de flujos, reducir la falta de liquidez provocada por las ventas generalizadas de activos en los mercados de los PED y detener con esto las caídas de los precios de las monedas y de los activos nacionales. La implementación de las medidas que se adopten debe coordinarse por el FMI para evitar la estigmatización y prevenir un contagio generalizado. Las líneas de intercambio de divisas deben extenderse para incluir más PED, a fin de garantizar el acceso a dólares estadounidenses. Finalmente, coincidimos con los llamados recientes al FMI para proveer una mayor liquidez, utilizando derechos especiales de giro (DEG), sin generar con esto la imposición de ajustes fiscales pro-cíclicos.

La crisis que se esta desarrollando actualmente es una de las más graves en la historia económica. Debemos asegurarnos que los gobiernos puedan hacer todo lo posible para proteger a sus ciudadanos. En nuestra economía global e integrada, se necesita una acción coordinada para minimizar las restricciones impuestas externamente a los países en desarrollo y emergentes, ya que estos se enfrentan hoy a una crisis triple: la pandemia, la recesión económica y una crisis financiera.

 

 

The World Bank’s new Maximizing Finance for Development agenda brings shadow banking into international development – open letter

Last month, central bankers and politicians around the world remembered the global financial crisis and the lessons learnt in its wake. The consensus goes at follows: we have done a great deal to reform banks and protect tax payers from their aggressive risk taking but we haven’t done enough on shadow banking. At this point, the consensus fragments. Central banks claim that they need more power to deal with systemic risks stemming from the shadows, whereas politicians worry about the moral hazards involved in future rescues of shadow banks like Lehman.

We are all the more concerned that the same authorities have been actively promoting shadow banking in the Global South. Under headings such as Billions to Trillions and the World Bank’s new Maximizing Finance for Development (MFD) agenda, the new strategy for achieving the Sustainable Development Goals is to use shadow banking to create ‘investable’ opportunities in infrastructure, water, health or education and thus attract the trillions in global institutional investment.

Bringing shadow banking into development doesn’t just promote the privatization of public services, but may usher in permanent austerity along the lines of ‘privatizing gains, socializing losses’. More fundamentally, it seeks to re-engineer poor countries’ financial systems around capital markets that can attract global investors. This deliberate re-engineering of financial systems threatens progress on the SDGs. We call on governments and international institutions gathering in Bali for the WB/IMF, G20 meetings and the Global Infrastructure Forum to take a step back and assess carefully the developmental impact of the MFD agenda.

The MFD agenda will be tested in infrastructure, with plans spelled out in the “Roadmap to Infrastructure as an Asset Class”, under Argentina’s G20 presidency. These plans promote shadow banking in two ways.

First, the World Bank plans to use securitization to mobilize private finance. The WB would bundle infrastructure loans, its own or across the portfolios of multilateral development banks, issue senior and junior tranches to be sold to institutional investors with different risk appetites. Securitization, we learnt from Lehman’s collapse, is a shadow market easily prone to mis-incentives, aggressive leverage, aggressive promotion of underlying loans onto customers that cannot afford them. It generates systemic interconnectedness and fragility. Yet none of these issues have been addressed in the MFD plans. Instead, the MFD, through the so-called Cascade Approach, asks poor countries to use scarce fiscal resources and/or official aid to ‘de-risk’ bankable projects, by for instance providing guarantees/subsidies for demand risk or political risk. Since the WB will retain a share of the junior tranche, poor countries may easily be pressured to keep up de-risking payments or guarantees, even if it means cutting essential social spending.

Second, the MFD agenda doesn’t just express an ideological preference for private provision of public goods. It also purports to change poor countries’ financial systems around liquid capital markets that can attract global institutional investors. But the WB’s recipe for engineering liquidity in local securities market requires the promotion of the same shadow markets (the repo and derivative markets) that turned Lehman’s collapse into a global financial crisis. It is also a recipe for reduced policy autonomy. As the IMF recognizes, encouraging poor countries to join the global supply of securities exposes them to the rhythms of the global financial cycle over which they have little control, as shown by recent events in Argentina.

We call on the World Bank Group to recognize that the preference for the private sector should not be automatic, but rather chosen only when it can demonstrably serve the public good. When it meets this test, we call for the WBG to develop an analytical framework that clearly sets out the costs of de-risking and subsidies embedded in the MFD agenda in a way that allows a broad range of stakeholders, including civil society organizations and other public interest actors, to closely monitor results as well as fiscal costs in order to ensure transparency and accountability.

Should the MDBs adopt the proposals for securitization of development-related loans, it should first develop a credible framework that protects the SDG goals from the systemic fragilities of shadow banking. But this will not be enough. To ensure that it does not shrink developmental spaces and that is advances sustainable development, the MFD agenda should only be adopted in conjunction with (a) a well-designed framework for project selection that is aligned with the global sustainable development goals and the Paris Agreement; (b) a careful framework for managing volatile portfolio flows into local securities markets and (c) a resilient global safety net.

List of signatories

Daniela Gabor, Professor of Economics and Macrofinance, UWE Bristol

Ewald Engelen, Professor of Financial Geography, University of Amsterdam

Daniela Magalhães Prates, Professor of Economics, University of Campinas, Brazil

Gunther Capelle-Blancard, Professor of Economics, University of Paris 1 Pantheon-Sorbonne

Pablo Bortz, Professor of Macroeconomics, IDAES-National University of San Martín, Argentina

Kevin Gallagher, Professor of Economics, Boston University

Alicia Puyana, Professor of Economics, FLACSO Mexico

Laurence Scialom, Professor of Economics, University of Paris Nanterre

Jayati Ghosh, Professor of Economics, Jawaharlal Nehru University, India

P. Chansrasekhar, Professor of Economics, Jawaharlal Nehru University

Ilene Grabel, Professor of International Political Economy, University of Denver

Cornel Ban, Reader in International Political Economy, City University

Carolina Alves, Girton College and Faculty of Economics, University of Cambridge.

Jérôme Creel, Associate Professor of Economics, Sciences Po, Paris.

Kai Koddenbrock, Interim Professor of International Political Studies, University of Witten-Herdecke, Germany

Nuno Teles, Professor of Economics, Federal University of Bahia, Brazil

Marco Veronese Passarella, lecturer in Economics, University of Leeds

Jesus Ferreiro, Professor of Economics, University of the Basque Country UPV/EHU

 Elisa Van Waeyenberge, Senior Lecturer in Economics, School of Oriental and African Studies, UK

Phil Mader, Research Fellow, Institute of Development Studies, Sussex.

Manuel B. Aalbers, Professor of Economic Geography, KU Leuven/University of Leuven, Belgium

Cédric Durand, Associate Professor of Economics, Université Paris 13

Sandy Hager, Senior Lecturer in International Political Economy, City University London

Ben Fine, Professor of Economics, School of Oriental and African Studies, UK

Galip Yalman, Assoc. Prof. Dr. (EM), METU

Hansjörg Herr, Professor of Economics, Berlin School of Economics and Law

Vincenzo Bavoso, Lecturer in Commercial Law, University of Manchester

Kate Bayliss, Senior Research Fellow, University of Leeds

Melissa García-Lamarca, Postdoctoral researcher, Universitat Autònoma de

Barcelona, Spain

Andreas Nölke, Professor of International Political Economy, Goethe University

Duncan Lindo, Research Fellow, University of Leeds

Brigitte Young, Professor of International Political Economy, University of Muenster, Germany.

Christoph Scherrer, Director, International Center for Development and Decent Work, University of Kassel

Hans-Jürgen Bieling, Professor of   Political Economy, University of Tübingen

Eve Chiapello, Professor of Economic Sociology, EHESS Paris

Dr Caroline Metz, University of Manchester

Birgit Mahnkopf, Prof. Em. of International Political Economy, Berlin School of Economics and Law

Alessandro Vercelli, Professor of Economics, University of Siena

Susanne Soederberg, Professor of Global Development Studies, Queen’s University

Ipek Eren Vural, Associate Professor, Department of Political Science and Public Administration, Middle East Technical University, Ankara

Yamina Tadjeddine, Professor of Economics,  Université de Lorraine

Thomas Wainwright, Reader, School of Management, Royal Holloway, University of London.

Anders Lund Hansen, Associate Professor Department of Human Geography, Lund University

Malcolm Sawyer, Emeritus Professor of Economics, University of Leeds, UK

Jeff Powells, Senior lecturer in economics. University of Greenwich

Raquel Rolnik, University of São Paulo – Brasil.

Jo Michell, Associate Professor, University of the West of England

Jan Kregel, Professor of Economics, Levy Economics Institute

Irene von Staveren, Professor of Pluralist Development Economics, International Institute of Social Studies, Erasmus University Rotterdam

Stavros D. Mavroudeas, Professor (Political Economy), University of Macedonia

Ray Bush, Professor of African Studies and. Development Politics, University of Leeds

Lucia Shimbo, Professor of Architecture and Urban Planning, University of São Paulo.

Sérgio Miguel Lagoa, Assistant Professor, ISCTE- Instituto Universitário de Lisboa, Lisboa

Carlos Rodríguez González , Professor, University of the Basque Country (UPV/EHU)

Ingrid Harvold Kvangraven, Lecturer in Politics, University of York.

Ewa Karwowski, Senior Lecturer in Economics, Hertfordshire Business School, University of Hertfordshire

Anamitra Roychowdhury, Assistant Professor in Economics, Jawaharlal Nehru University

Hannah Bargawi, Senior Lecturer in Economics, SOAS University of London

Natalya Naqvi, Assistant Professor in International Political Economy, London School of Economics and Political Science

Firat Demir, Professor of Economics, University of Oklahoma, USA

Gilad Isaacs, University of the Witwatersrand, South Africa

Rohan Grey, Cornell University

Yannis Dafermos, Senior Lecturer, UWE Bristol

Kamal Mitra Chenoy, Professor, Jawaharlal Nehru University

Anuradha Chenoy, Professors, formerly Jawaharlal Nehru University

Kathleen McAfee, Professor, International Relations, San Francisco State University

Jan Priewe, Prof. Em. Economics, HTW Berlin, Germany

Piotr Lis, Associate Professor in Economics, Poznan University

Yavuz Yasar, University of Denver

Joscha Wullweber, Professor of International Politics, University of Vienna

Paula Freire, Santoro, Urban Planning Professor, São Paulo University

Manfred Nitsch, Professor emeritus of Economics, Freie Universität Berlin

Bunu Goso Umara, Borno State Public Service, Nigeria

Barbara Fritz, Professor, Institute for Latin American Studies, Freie Universität Berlin

Sally Brooks, Research Fellow, University of York

Danielle Guizzo Archela, Senior Lecturer in Economics, UWE Bristol

Feyzi Ismail, SOAS University of London

Florence Dafe,
 Fellow in International Political Economy, Department of International Relations, London School of Economics and Political Science

Alan B. Cibils, Professor of Political Economy, Universidad Nacional de General Sarmiento, Buenos Aires, Argentina

Rama Vasudevan, Associate Professor of Economics, Colorado State University

José Caraballo-Cueto, Associate Professor, University of Puerto Rico at Cayey

Debarshi Das, Associate Professor, Economics, IIT Guwahati, India

Genarro Zezza, Associate Professor of Economics, University of Cassino, Italy

Sara Stevano, Senior Lecturer in Economics, UWE Bristol

Dirk Bezemer, Professor of Economics of International Financial Development, University of Groningen, Holland

Barry Herman, Visiting Scholar, The New School for Public Engagement

Bruno Bonizzi, Lecturer in Political Economy, University of Winchester

Servaas Storm,  Senior Lecturer, Delft University of Technology, The Netherlands

Mona Ali, Associate Professor of Economics, State University of New York at New Paltz

Ajit Zacharias, Senior Scholar and Director, Distribution of Income and Wealth Program, Levy Economics Institute of Bard College

Vincent Guermond, Queen Mary University of London

Susan Engel, Senior Lecturer, Politics & International Studies, University of Wollongong
Australia\
Erdogan Bakir, Associate Professor of Economics, Bucknell University, USA

 

Shalu Nigam, Freelance researcher, activist and and advocate, India

Jo Walton, Research Fellow, University of Sussex

Redge Nkosi, Exec Director and Research Head at Firstsource Money (Researchers in Money, Banking & Macroeconomics),  South Africa

Sabri Öncü, Chief Economist, Centre for Social Research and Original Thinking

Fulya Apaydin, Assistant Professor, Institut Barcelona d’Estudis Internacionals

Daniele Tori, Lecturer in Finance,  The Open University

Erkan Erdil, Professor of Economics, Middle East Technical University

Robin Broad, Professor of International Development, American University, Washington DC USA

Giulia Zacchia, Sapienza University of Rome
Carolyn Sissoko, PhD, JD
Siobhán Airey, Marie Skłodowska-Curie Research Fellow, University College Dublin, Ireland
Radha Upadhyaya, Research Fellow, IDS, University of Nairobi
Maria Dyveke Styve, University of Bergen, Norway
Mange Ram Adhana President, Association For Promotion Sustainable Development, India
Carolyn Prouse, Assistant Professor of Geography, Queen’s University

Lorena Lombardozzi, Lecturer in Economics, The Open University

Andrea Lagna, Lecturer in International Management and Innovation, Loughborough University

Nick Bernards, Assistant Professor, University of Warwick

Ismail Lagardien, The University of Witwatersrand School of Governance

Nicolas Pons-Vignon, Senior Researcher, School of Economics and Business Sciences, University of the Witwatersrand

Bonn Juego, Postdoctoral Researcher in Development & International Cooperation, University of Jyväskylä, Finland

Pal Tamas, Hungarian Academy of Sciences, Social Science Research Centre, Hungary

 

If you wish your name to be added, please email your institutional affiliation to daniela.gabor@uwe.ac.uk, we will continue to update the list of signatories.

Should we fear the robots? Automation, productivity and employment

Special session at the British Academy of Management conference

Monday 3 September, 12.30-14.00, Room 2X242

Bristol Business School, UWE, Coldharbour Lane, BS16 1QY

A panel discussion on productivity, automation and employment, with

Frances Coppola, Finance and Economics Writer

Daniel Davies, Investment Banking Analyst

Duncan Weldon, Head of Research, Resolution Group

Chaired by Jo Michell, UWE Bristol.

Since the 2008 crisis, UK productivity has stagnated. At the same time, fears are growing that robots will challenge humans for an ever wider range of jobs. This panel brings together leading economists to discuss these apparently contradictory trends – and what should be done about them.

This is a special session so all are welcome. Conference registration is not required.

The full conference programme can be downloaded here

For more details please contact Jo Michell on jo.michell@uwe.ac.uk

 

 

 

Lira’s Downfall is a Symptom: the Political Economy of Turkey’s Crisis

Guest post by Ümit Akçay (Ph. D., Berlin School of Economic and Law) and Ali Rıza Güngen (Ph. D., Turkish Social Sciences Association)

Turkish Lira lost almost 45 per cent of its value against the U.S. Dollar in 2018. The losses accelerated notably in recent months and particularly in the second week of August, which included the two days in which Lira lost the most against USD since the 2001 crisis.

Suddenly, it became “all about Turkey” as the Bloomberg commentators said and many pundits expressed their opinions about the reasons as well as the dire consequences of a currency crisis.

The first stage of the international financial crisis in 2008-09 was followed by the Eurozone crisis (2010-12). Increasing volatility in the markets of global South, which began by 2014 can be seen as the third stage in such a periodization. We believe that the downfall of Turkish Lira against this background is a symptom of macroeconomic problems and the policy responses of the last decade. In other words, Turkey’s 2018 crisis occurred as a combination of the impact of the tightening global dollar liquidity conditions, the choices of policymakers particularly in recent years and the inability to formulate a new economic model to overcome the crisis of accumulation, unfolding right now in Turkey.

Impact of the financial tightening

The world’s biggest financial crash in the 21st century turned into then Eurozone crisis by 2010. In these years, the policy response by the Central Banks of the core capitalist countries helped periphery achieve high rates of growth. The capital inflows initiated a short-lived economic boom in Turkey and the country was the second fastest growing one in the world, following China during 2010-11. The AKP governments benefited from cheap credit period until 2013 and strived to spread further the financial modes of calculation among its electorate.[1]

A low interest rate policy was key to the neoliberal populist model of Erdoğan. Its limits were first tested with the end of Fed’s quantitative easing that marked the end of the capital bonanza. As economic growth slowed after 2013, throwing into question the model of neoliberal populism, the agenda of AKP shifted towards a new model with developmentalist elements.[2] The idea of transition to a presidential regime was put on hold, as economic policy makers started putting more effort in devising alternative mechanisms for finance and hybrid development strategies. Policy makers underlined the need to deepen Islamic bond markets and draw in the savings of households to the financial sector, by enabling the creation of new investment instruments. Islamic think tanks questioned central bank independence and targeted central bank’s sole objective of providing price stability. Accordingly, consultants of then Prime Minister (and President from 2014 onwards) and policy makers wanted to create deepener financial markets to help corporations with financing problems on the one hand and devised strategic incentives to key sectors producing intermediary goods in order to minimize current account deficit, on the other hand. This brand of import substitution lacked a detailed plan, but the idea behind the industrial policy by the AKP governments was related to enabling high value added production and minimizing import dependency in key sector. These attempts however, did not structurally transform the economy in a few years.

Thus, the recovery of advanced capitalist countries pushed Turkish authorities to pursue new bottles for putting their old wine. The tightening of financial conditions for periphery would make it harder for the Turkish firms to find cheap sources of finance. We see that the similar concerns are now voiced over the emerging market contagion, though the exposure to dollar drain by many peripheral countries are more manageable than Turkey. 

The causes of downfall

One narrative of the Turkish crisis attributes the chaos in the currency markets to the “one man rule” consolidated last year. Accordingly, Erdoğan’s grasp of absolute power, symbolized by the 2017 constitutional referendum and his electoral success in 2018 elections, made Turkey rely on one man’s decisions and skirmishes. New presidential powers of the President inevitably made things worse, suffering from democratic retrenchment during the state of emergency. The spat with Trump is well located in this narrative, as a final episode.

The mirror image of the dissident argument is voiced by the Islamo-fascist cadres. Using the escalation of tensions with the U.S. as an alibi, these policymakers portray the recent crisis as an extension of the “economic war” launched by the West. Otherwise, it is suggested Turkey is on its glorious path to become a leading economy in not only her region but also on the global stage.

Neither perspective underlines the impact of recent economic measures upon the Turkish turbulence. Since 2013, the Turkish economy has faced a bottleneck, which paralysed the top level AKP cadres. As we mentioned above, current account deficit continued to grow and the level of financial deepening was not enough to overcome the dependency of the economy to capital inflows for new investment as well as rolling over debt. The 2016 coup attempt and the contraction of the economy in the third quarter of the year added insult to the injury.

This bottleneck can be resumed as follows: attracting capital inflows requires increasing interest rates. This however would stifle domestic demand in medium term as well as result in economic activities further losing pace. One, albeit limited response, was the state-sponsored credit expansion of 2016-17. In turn, falling interest rates would provide an incentive for domestic consumption, but it will result in further depreciation of Lira. Depreciation of TL would also mean increased burden for corporations heavily indebted in foreign exchange. Thus, this bottleneck has also been a manifestation of a deep-rooted crisis of capital accumulation regime of Turkey.

The cost of postponing interest rate adjustment and renewing state sponsored credit expansion became much more notable in 2018, when TL continued to depreciate despite a 5 per cent interest rate hike (see Figure). The FX liabilities of the real sector reached 339 billion USD by May 2018. Before the elections in June 2018, current account deficit to the GDP ratio exceeded 6 per cent and the money needed to rollover private and public sector debt for the coming 12 months surpassed 180 billion USD. The desperate search for new funds did not yield any result and the portfolio flows financing the deficit economy of Turkey lost pace by 2018.

Screen Shot 2018-08-16 at 12.36.48

Turkish Lira gained some ground in the third week of August but the level of depreciation against USD from the 6th of August to the 14th was above 25 per cent. Stagflation is ahead and thousands of firm will go bankrupt as the FX liabilities cannot be managed against the backdrop of this depreciation.

What’s next?

We believe that the capital accumulation regime in Turkey, which benefited from capital inflows in 2002-07 and 2010-13 came to a definite end in 2018. AKP was successful in managing the ensuing social tensions by resorting to increasingly authoritarian techniques. By suppressing labour organizations, deferring strikes, assuming partial costs of the newly employed staff in particular and intervening into the economy via bypassing the parliament in general, policy makers served the major business groups as well as the SMEs under the state of emergency (July 2016 to July 2018). It seems that they can no longer go on as they used to.

Entertaining new-developmentalist ideas in the post-2013 era, such as selective incentives to the sectors producing intermediary goods did not result in a detailed road map for overcoming the crisis, which was then at the doorsteps. Since rapid growth continued thanks to capital inflows and the construction sector did not lose its steam, the policy makers relied on doing more of the same. It is partly because of the fact that the collapse of the economy in late 2008 was managed easily; the top level economic managers do not have a model or economic package for the coming months. They seem to rely on the regime’s tools to suppress mass discontent, praying that foreign capital will flow into wage-suppressed sectors and Turkish corporations will take huge steps in due course to produce technology intensive products. Keeping fingers crossed, however, will not be sufficient to have an easy access to a new path of prosperity and high economic growth.

In a nut shell, the recent currency crisis of Turkey clearly shows that Erdoğan government is at a crossroads now. Erdogan may choose the ‘more of the same’ option and implement a standard IMF type stabilization programme that has been demanded by the dominant capital fraction in the ruling block. This option requires elimination of the most ‘zombie firms’ that were bailed out by the government after 2016 contraction. Of course, it will come with a huge political cost in the wake of the local election that will be held in March 2019.

Alternatively, Erdoğan may follow a new-developmentalist framework and initiate a kind of import substitution industrialization strategy. We should underline that there is no clear blueprint or a concise plan for a new-developmentalist project, although there are some initial attempts and ad hoc initiatives of various ministries. A full-fledged transition to a new developmentalist path would require a more substantial change in the ruling block against the interest of currently dominant fraction of capital, and a change in the mode of integration of the Turkish economy in financialised globalisation which may necessitate to impose capital controls.

Thus, Turkey’s current problems are far more complicated than the increasing interest rates or Erdoğan’s ideological approach as suggested by the international media outlets. The currency crisis now set the country as a stage for further socioeconomic turbulences. The opposition in Turkey has to struggle not only against Erdogan’s authoritarian populist rule, but also technocratic neoliberal authoritarianism, creeping in IMF’s structural reform suggestions.

Ümit Akçay (Ph. D., Berlin School of Economic and Law) and Ali Rıza Güngen (Ph. D., Turkish Social Sciences Association)

 

[1] Güngen, Ali Rıza (2018) “Financial Inclusion and Policy-Making: Strategy, Campaigns and Microcredit a la Turca”, New Political Economy, 23 (3): 331-347.

[2] Akçay, Ümit (2018) “Neoliberal Populism in Turkey and Its Crisis”, Institute for International Political Economy Berlin, Working Paper No: 100/2018, http://www.ipe-berlin.org/fileadmin/downloads/working_paper/IPE_WP_100.pdf

 

Graph showing UK public sector net borrowing

Labour’s economic policy is not neoliberal

At what point does over-use of a term as an insult render it meaningless? Richard Murphy tested the boundary yesterday when he accused John McDonnell’s economic advisor James Meadway of delivering “deeply neoliberal, and profoundly conventional thinking”. This was prompted by a negative comment James made about Modern Monetary Theory (MMT).

In response, Richard posted a list of MMT-inspired leading questions which, wisely in my opinion, James declined to answer. Richard then accused James – and by implication Labour – of not standing up to “the bankers” (including Mark Carney) and remaining wedded to conventional/mainstream/neoclassical/neoliberal thinking (Richard seems to regard these as equivalent terms). Labour is therefore signed up, in Richard’s view, to deliver “more Tory economic policy” and “more austerity”.

This is, to put it politely, nonsense.

At the heart of the debate is the decision taken by Labour, early in Corbyn’s leadership, to adopt a fiscal rule. This commits a Labour government to balancing the books on current spending with a rolling five year target, subject to a “knockout” when interest rates are close to zero. The rule has been a source of contention since it was announced. (I expressed misgivings about its announcement.)

My preference would be for a bit more wriggle room. The two dangers that must be balanced when setting fiscal policy are insufficient demand and private sector unwillingness to finance public deficits. Insufficient demand results in unemployment or underemployment, weak wage and productivity growth, and inadequate social provision. The dangers on the flipside are unsustainable borrowing costs and, particularly if this is countered using the power of the central bank, inflation. The relative weighting given to financial market conditions and inflation in the UK is almost always too high. But this doesn’t mean the correct weight is zero, as less-sophisticated advocates of MMT sometimes appear to think.

The first danger arises when the desired saving of the private sector exceeds private sector investment. In such a situation, achievement of “full employment output” requires a government deficit – give or take the current account. Standard macroeconomics largely assumes this problem away by arguing that, outside of the zero lower bound, interest rates can always be set at a level which will induce the optimal level of demand. Consequently, monetary policy is the only tool required. I disagree with this view: I think it’s quite possible for economies to be demand-constrained and thus require fiscal demand management across a range of possible interest rates.

But on balance I think the fiscal rule has enough flexibility to allow a Labour government to maintain sensible levels of aggregate demand. In any recession in the foreseeable medium-term future it is hard to imagine that interest rates will not be cut to near zero. In this case the rule will be suspended and fiscal policy can be used “with all means necessary”. Second, the rule doesn’t preclude significant increases in government investment spending – a central part of the Labour policy programme. Government investment spending is likely to have strong multiplier effects and should help to rebalance demand in the UK’s consumption-driven economy. Finally, the rolling five year window allows for adapting the pace of current spending to negative economic shocks.

I can also see good political reasons for the rule. It provides an immediate rebuttal to those who try to perpetuate the deeply dishonest but highly successful Tory strategy of depicting Labour as the party of fiscal irresponsibility. As I understand it, the rule was formulated by Simon Wren-Lewis and Jonathan Portes, two highly credible progressive economists. Simon has been one of the most consistent and articulate critics of Tory austerity. To accuse them, as Richard is doing, of “delivering neoliberal thinking” is ludicrous.

Aside from the straightforward inaccuracies, there is a deeper problem with Richard’s argument. He equates, as do some MMT advocates, radical or progressive policy with fiscal policy. There is no question that Labour’s economic programme would mark a decisive shift in macro management: it would be the end of austerity. (Austerity was never really about managing demand and debt, in my opinion: it was cover for the ideological aim of shrinking the state.) But the truly radical aims in Labour’s programme – although not yet fully fleshed out – are on the supply side: structural reforms, but not of the sort pushed by the IMF.

There is merit to this approach, in my view. Yes, the UK economy is demand-constrained. Aside from the direct human costs, austerity has almost certainly done long-run damage to the supply-side. It must end. But over the longer run the UK faces profound challenges from an ageing population, wide geographical disparities, and the potential risks and benefits of automation. It makes sense to focus on the supply side: to have an industrial strategy. A progressive supply-side policy is not an oxymoron. (I remain concerned about how such a programme can be reconciled with a hard Brexit, as some on the Left advocate.)

I have more sympathy with MMT than James. I see it essentially as a US-focused political campaign based around a single policy: the job guarantee. I am not convinced by the policy, but it is the focus of progressive economic and political action in the US. Stephanie Kelton has done an excellent job of debunking simple deficit scaremongering. But to claim, as Richard is doing, that rejecting MMT means accepting wholesale neoliberal orthodoxy is silly – as are several of the views that Richard attributes, without justification, to James.

The left deserves a better standard of economics debate.

The global dollar footprint – larger than you think?

Following a long and brain-fog inducing Twitter conversation (as one participant put it)  triggered by this excellent post by Brad Setser on the role of institutional investors in Taiwan’s indirect fx management regime, I remembered I had a pretty wonkish draft blog critiquing a BIS paper on fx swaps and missing dollar debt. In our twitter conversation, we were trying to work through the steps taken by Taiwanese insurance companies to hold USD assets while hedging fx risks, and the implications for BoP positions. The examples in the BIS paper are, I think, useful to order that sequence.

The BIS paper, by Claudio Borio and co-authors, argues that currency derivatives have allowed large volumes of Eurodollars to go missing from the balance sheets of financial institutions outside the US. If we were to properly account for this missing debt, then non-banks’ global dollar debt would double to USD 21 trillion. This is roughly equal to the value of global trade in 2017.  How do USD 10 trillion go missing?

The BIS paper builds on the following example the following. An investor wishes to buy foreign currency securities with domestic cash (the Taiwanese insurance companies in Brad’s post) but does not wish to run fx risk. That say Japanese (substitute Taiwanese if you wish)  investor  has three options:

  1. Spot + forward: buy USD spot with yen, use USD to purchase the US corporate bonds, and sell the same amount of USD forward.
  2. FX swap: swap yen for USD with a promise to reverse the transaction at a later point, purchase the US corporate bonds.
  3. USD Repo: keep the yen, finance USD corporate bonds by borrowing in the USD repo market, incurring outright debt.

The BIS paper warns that the first two strategies generate ‘missing debt’. Accounting rules demand repos to be recorded on the balance sheet do not impose the same recording requirements on fx swaps/forwards, except for mark-to-market values that capture the move in exchange rates[1]. This obscures the picture of global (dollar) liquidity, with serious implications for a future where central banks increase interest rates and unwind unconventional monetary policy measures.

The BIS paper provides a clear analytical framework for tracing how global dollar liquidity is created through cross-border interactions between banks and shadow banks, often in the underbelly of Eurodollar markets.

Yet I believe it is wrong in arguing that the global dollar footprint is larger than you think. Accounting conventions rightly treat repos as new debt because repos are special monetary instruments, shadow money created in the process of lending via securities markets. FX swaps are not. Treating fx swaps as hidden debt, as BIS does, leads to double-counting, while simultaneously it obscures the central role that private banks play in creating global dollar liquidity, wielding their power to create bank money via fx swaps and shadow money via repos.

Fx swaps are not new funding, repo is

The BIS paper illustrates the argument with balance sheets, where gross and net are carefully distinguished (figure 1). The gross shows rights and obligations to pay explicitly. In cases 1 and 2, the Japanese investor swaps Yen cash (C) for USD, with a promise to reverse the transaction later, that is, to pay back USD (Fx) and receive yen (F). Accounting rules render that promise invisible in net terms, simply showing on the balance sheet that the Japanese investor funds USD corporate bonds with net worth (E). In contrast, the repo promise to pay back USD (by repurchasing the corporate bonds) remains on the balance sheet.

These are three repo-like transactions with different collateral – yen cash (1&2), and USD corporate bonds (3) – raising USD funding for USD securities. The problem, BIS argues, is that only the USD repo is recognized on the balance sheet.

Figure 1 BIS illustration of fx swaps and repos, gross and net

Screen Shot 2018-05-03 at 14.38.08At first sight, this is a compelling argument, in Mehrling’s money view tradition that ‘an obligation to repay is a form of debt’. But not all obligations to pay are created equal or have the same monetary role.

Surprisingly, in the example above, there is no repo on the balance sheet. Instead of representing the repo as new IOU, the example shows the corporate bond (Ax) as a liability against yen cash (C). Yet repos are not strictly reducible to the collateral security because the corporate bond is an (encumbered) asset for the investor, financed via a new IOU repo liability (figure 2). If bank deposits are the money of financial systems organised around relationship banking, repo deposits are the money of global financial systems organised around securities markets.

Screen Shot 2018-05-03 at 14.39.15

The repo is a securities financing transaction structured legally as a sale and promise to repurchase corporate bonds, and in accounting terms as a new IOU issued to borrow cash against corporate bond collateral. Critically, the collateral securities do not leave the investor’s balance sheet. She marks these encumbered and books the transaction as financing. It is this separation between the legal and economic treatment of collateral that allows the Japanese investor to remain the economic owner of the corporate bond (Ax), entitled to (any) coupon payments and bearing the risks associated with it. The buyer of collateral treats the repo IOU as a cash-equivalent (a safe asset), whose par value is preserved by mark-to-market of collateral and margin calls. Accounting for repos on the balance sheet allows regulators and market participants to get a clear idea of the Japanese investor’s leverage (see the notorious Lehman’s Repo 105).

The fx swap does not have a similar monetary role. Compare the gross positions in the fx swap and repo in Figure 2. Both record promises to pay back USD. But there is no yen (F) asset at the investor’s disposal for the life of the fx swap – F simply records the yen that will return to the Japanese investor when the swap matures. In contrast, with the repo, the investor still has yen cash (C) at her disposal to invest in other assets. Only the repo gives investors access to new funding via money creation. In contrast, the fx swap involves (twice) exchanging IOUs already created by institutions other than the Japanese investor.

Is the difference here just (subtle) semantics? Through the swap, the investor gets the dollar corporate bonds that can be repo-ed. Is yen cash (C) in Case 3 different from the repo-able corporate bonds in Cases 1&2? Both can be used for further investment. Yet the investor can only use Ax it obtained via the fx swap if it repos it out. The now encumbered A*x remains on the balance sheet, and the investor has new cash against a repo liability (see Figure 3). It is the repo that generates additional balance sheet capacity from the unencumbered Ax. No repo, no leverage.

Screen Shot 2018-05-03 at 14.40.43

This matters more broadly for our understanding of money in modern financial systems. Monetary thinking going back to Keynes and Hayek via Minsky stresses that capitalism is a system characterized by continuous efforts to invent new liabilities that credibly promise par convertibility into money without state support. State support for par convertibility between private promises to pay (think bank deposits) and higher forms of money (banknotes, gold) is costly. It comes with constraints (bank regulation) and shifting price incentives (interest rate policies). It is against these constraints that capitalist finance constantly seeks to economize on money proper. In that sense, repos are the innovation of a financial system increasingly organised around securities markets and business models reliant on daily variation in the price of securities. Repos are shadow money that allows the Japanese investor to economise on her yen cash, to fund securities by issuing a new liability, shadow dollars. The moneyness of repo IOUs rests on an intricate process of collateral mark-to-market valuation that preserves par convertibility between repo deposit and bank deposits. While the fx swap may rely on similar margining practices to preserve the agreed exchange rate between the two currencies, at its core it is swap of assets, of IOUs created by someone else (yen for dollar cash).

The BIS paper recognizes this: ‘in case 3, the agent has the freedom to use the domestic currency cash to buy another domestic currency asset rather than having it tied up in a forward claim’. Precisely. With the fx swap, the investor has given up yen for USD, and will get it back at par when the swap matures. While the repo allows the investor to take position in dollar securities without prior funding, the fx swap does not generate additional balance sheet capacity, but rather, a series of transformations of the yen cash. If the investor had to borrow that yen cash via say commercial paper – it already had to leverage to get the yen it would swap for dollars. Counting the fx swap as leverage would be double counting.

What if the Japanese investor is a bank?

The BIS paper identifies three types of institutions in the fx swap/fwd markets: non-financial customers, financial customers and dealer banks. Dealer banks trading with financial customers generate the largest volumes (around USD 25.5 trillion), followed by interdealer (USD 25 trillion) and dealers trading with non-financial customers (USD 7.5 trillion). What changes if the investor above is a Japanese bank (see Pozsar for a money view discussion of the hierarchy of market-making in the fx swap market)?

Japanese bank swapping with a non-bank customer

Assume that a Japanese bank agrees an fx swap with a dollar-rich Japanese corporation (Figure 4). Its starting position, is yen cash – since this is the bank, cash means Bank of Japan reserves. The Japanese bank wields its power to create yen money in the fx swap market: in exchange for dollars, it creates a yen bank deposit for the Japanese corporation. It holds the dollars with its New York bank until it purchases the corporate bonds. The fx swap means a deposit swap a la Pozsar**.

 

Screen Shot 2018-05-03 at 14.56.18

On a net basis, the fx swap has expanded the balance sheet of the Japanese bank, and the yen money supply, solely because the bank uses its money creating power to execute the swap. When the swap matures, the yen money supply contracts. It is the money creation power of the Japanese bank that makes the fx swap and the repo equivalent in their impact on the balance sheet. In one case, Ax is funded with shadow dollars, in the other with new yen bank money.

Japanese bank with a US office swapping with US bank (interdealer)

 In this case, the Japanese bank’s office in the US swaps its yen cash (held in Bank of Japan reserves) for dollar cash (US Fed reserves), thus acquiring means of payment for the dollar corporate bonds (Ax). Note here that the fx swap involves swapping IOUs issued by central banks. FX swaps in this case means a reserve swap a la Pozsar.

Screen Shot 2018-05-03 at 14.59.10 

An example

Compare the behaviour of Japanese and Australian banks in dollar swap markets, pictured in the BIS paper and the graph below (which infers swap positions as residual once dollar net positions are extracted from banks’ balance sheet statements). Japanese banks are the largest borrowers of dollars via fx swaps, whereas Australian banks are among the largest lenders of dollars via fx swaps.

Screen Shot 2018-05-03 at 15.00.42

Japanese banks’ search for yield has increasingly targeted dollar assets. Rich with yen liquidity from Bank of Japan’s QE, they swapped yen into dollars to lend directly, through capital markets, and until recently, through (repo) interbank markets. With the reform of US money market funds in October 2016, Japanese banks have started to use repos for net funding of their dollar assets. In contrast, Australian banks’ dollar footprint, driven by carry trades, manifests as a form of match-book dealing in the repo-swap space. Australian banks first borrow dollars through (repo) interbank markets to lend these via swap markets in exchange for Australian dollars (AUD). This carry allows them to fund high-yielding AUD assets with cheap USD and hedge fx risk via the swap. Here the problems with the ‘fx swaps are functionally equivalent to repos’ argument become immediately apparent. Australian banks need to borrow USD first to swap into AUD.

Japanese banks’ growing swap positions raises another important, if mostly neglected question. How do their swap counterparts use their increasingly sizable yen holdings? BoJ paper identified several USD suppliers in the yen/usd swap market: sovereign wealth funds, reserve managers of emerging countries, asset managers. For these, there is a simple safe-asset arithmetic: yen obtained via swaps, even if placed in negative yielding Japanese government bonds, can provide similar or higher returns than US government securities. Yet BoJ worries that this is not a crisis-proof arithmetic. Dollar swap lenders are not a stable source of dollar funding. Taper-tantrum like tensions prompt reserve managers to shift their dollars from swaps to US Treasury bills or the Fed’s Reverse Repo Facility, whose immediate liquidity they require to defend their own currencies. Japan has already experienced sharp declines in inward bond investments when dollar swap lenders withdraw from the swap market. In a future where Bank of Japan reduces its footprint in the JGB market, the pro-cyclicality of fx swap-related demand will pose significant challenges.

In sum, fx swaps and repos are not equivalent transactions. At first sight, they seem to be the same animal: promises to pay at par supported by a similar process of preserving par via collateral management that creates mark-to-market funding pressures, firesales and liquidity spirals. The FX swap exposes investors to liquidity and rollover risk where the maturity of the asset purchased and the swap differ. The BIS is right to worry about such systemic issues, and what these imply for the Federal Reserve’s role in global dollar markets. But the similarities end there. Repos generate new funding for securities, whereas fx swaps do not, except when banks use their power to create settlement-money in the fx swap market.

* Henceforth, the text uses fx swaps as shorthand for both fx swaps and forwards.

**It is worth noting that although Pozsar shows fx swaps on the balance sheets of the various actors involved in the fx swap market, this is poetic licence. His discussion demonstrates clearly that fx swaps involve swaps of money proper rather than the creation of new liabilities.

[1] These are typically small, increasing to 15 % of notional amounts in moments of crisis.

MMT meets Rey’s dilemma: a balance sheet view of capital flight (coming soon to an EM country near you)

Recently, a colleague emailed with the following set of questions: ‘a balance sheet approach to defending currencies. Do you know literature that explains in detail the globally interlocking balance sheets between central banks, commercial banks and what happens when a national government has to defend its currency? What is the role of national and foreign reserves and how do they travel these balance sheets in the process of trying to defend a currency? I came back to this question when discussing the Swedish fight to defend the Dollar-pegged Krona in the early 90s and the promise of MMT? Most particularly we wondered to what extent national governments can just issue Krona and use them to buy foreign reserves or what sets the limits exactly to this attempt?’

My MMT friends do have answers to these questions (and they do spend a lot of time defending MMT from critiques that it doesnt consider balance of payment constraints to monetary sovereignty). I thought I would answer these questions a la Minsky, with balance sheets, since that’s how I teach my undegrad students about exchange rate management in emerging/developing countries. I teach by setting those questions within the broader conversations about global liquidity, global financial cycles and Rey’s dilemma – independent monetary policy is only possible if countries manage capital flows (capital controls).

  1. Start with an economy in autarchy: central bank issues reserves to banking sector for settlement purposes (banks pay each other in reserves), banks lend, create bank deposits in the process.

Screen Shot 2018-02-14 at 15.45.46

2a. Commercial bank borrows abroad from parent bank/interbank market (USD/EUR/JPY)

Screen Shot 2018-02-14 at 15.55.58

(this scenario played out in Eastern Europe before Lehman, when foreign-owned banks would borrow from parent/interbank markets – ending up with the Vienna Initiative)

2.b Commercial bank funding via fx swap with non-residents

Screen Shot 2018-02-14 at 15.55.16

Step 1 occurs where local banks are allowed to lend retail in foreign currency. If it looks like MMT 2.0, it is not exactly that – without legal restrictions, the only constraint on banks creating foreign money (eurodollars) is their foreign currency reserves (an exogenous money story a la monetarism).

Even with restrictions on the lending in foreign currency (skipping steps 1&2), banks typically intermediate non-resident demand for local currency bonds via fx swaps (see my paper here on growing appetite for EM securities as part of shadow banking reform agenda). This is big enough that BIS has recently proposed to approach fx swaps as missing debt. Note that this is a global liquidity story:  without capital controls, non-resident demand/bank borrowing abroad reflects funding conditions in US money markets (see Bruno and Shin’s risk taking channel of monetary policy).

3. Rey’s dilemma kicks in: central bank intervenes to stem currency appreciation (for mercantilist or macroprudential reasons)

Screen Shot 2018-02-14 at 15.05.09

For this commercial bank, the central bank’s policy rate is no longer a binding constraint, since it obtains local base money (reserves) by selling its fx liquidity to the central bank, rather than in the local interbank money market. When interest rate differentials are significant, this eases cost of funding (in the macro literature, this is part of the debate on the effect of financial globalisation on the effectiveness of inflation targeting central banks).  It’s global liquidity, not domestic liquidity, that determines short-term money market rates.

4. To regain monetary control, central banks issue own debt.

Screen Shot 2018-02-14 at 15.14.11

This operation is known as sterilisation: that is, ‘sterilising’ the impact of fx market interventions on domestic money market rates. Central bank issues own securities (or sells government bonds, or takes deposits) in order to absorb back the reserves it created when it paid for the fx liquidity it bought from banks. Note here that this does not solve Rey’s dilemma, since banks have full discretion over how much to place in central bank securities. Rather, for banks this is an attractive carry – borrowing cheap abroad, placing it in risk-free local securities (banks can hedge fx risk).

If you think this is a theoretical exercise, think again.

Screen Shot 2018-02-14 at 15.20.55

5. The limits to monetary sovereignty: global liquidity conditions tighten, capital flight ensues.

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In step 1, non-residents sell local securities – potentially triggering liquidity spirals if large, unregulated local repo market exists.  Note that by step 5, local banks with no direct links to global finance also start to suffer as interbank liquidity tightens. Cant the central bank mitigate this by reverse sterilisations, that is, by again insulating fx market interventions from domestic money market dynamics? The lessons from the 1997 Asian crisis, according to the IMF, is to segment domestic money markets, that is, to prevent local banks from lending to (non-resident) speculators:

Because a speculative attack requires the establishment of a net short position in the domestic currency, countries have employed a number of tactics to raise the costs of short positions. When sterilized intervention fails to stem capital outflows, short-term interest rates are allowed to rise, tightening conditions in financial markets and making it more costly for speculators to obtain a net short position by borrowing domestic currency. Frequently, however, an increase in short-term money market rates is transmitted quickly to the rest of the economy; it may therefore be difficult to sustain for an extended period, especially if there are weaknesses in either the financial system or the nonfinancial sector. When high short-term interest rates impose an unacceptable burden on domestic residents, countries may “split” the markets for domestic currency by requesting that domestic financial institutions not lend to speculators. Foreign exchange transactions associated with trade flows, foreign direct investment, and equity investments are usually excluded from such restrictions. In essence, a two-tier system is created that prevents speculators from getting domestic credit while allowing nonspeculative domestic credit demand to be satisfied at normal market rates. (IMF 1997)

Even if the central bank successfully protects local banks  from cross-border volatility triggered by global financial cycles, it can only defend the currency to the extent that it has foreign reserves. It will most likely not wait until it runs out. In the happy scenario, it draws on its swap lines to weather capital flight – but few central banks have that luxury (and ask yourself, how many will actually have it when Donald Trump needs to be consulted on this). The worst case scenario:  IMF/Troika/whoever will lend  – with heavy conditionality.

The future of money – UWE student takes for Bristol Festival of Economics (alongside mine)

Daniela Gabor

Last month, I participated in an excellent panel on the Future of Money at the Bristol Festival of Economics.  In preparation for the event, UWE undegraduate students taking my course on Economic Theory and Policy worked together to produce two-sided briefs on what they thought to be the most interesting questions for the future of money, and distributed them in advance of the panel.   These briefs provided a great background to our conversation, exploring questions of digital money, endogenous money (and its heretics) and shadow money.

Given that we are economists with a certain respect for the power of (fair) competition, we had a contest for the best brief. The quality was excellent, so I chose three out of the seven to be distributed (see Money1 (1), Money2 and Money3).  Given the size of the audience, we could have easily distributed the rest as well (see Money Brief 4 , Money Brief 5Money at a glance 6Money Brief 7).

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My opening remarks focused on shadow money. Read them below.

Modern controversies about money typically focus on two topics – the power of banks to create money and the threats to this power posed by crypto-currencies. We suspect banks of yielding too much political power, having convinced states to enter a social contract that makes bank deposits into the ultimate money of the financial system. Bank of England recently confirmed this suspicion, in a widely discussed paper that confirmed what heterodox economists – Steve Keen here a famous example – have been saying for a long time.

There is somewhat of a paradox in this. If we consider the regulations that central banks have introduced since the crisis, they have not sought to limit banks’ power to create money. Rather, the new rules introduce by the Basel committee, and by the newly created Financial Stability Board, want banks to issue more of traditional bank deposits, and less of a new type of money, that I will call shadow money.

What is this shadow money? It is money created by banks and other financial institutions through the mysterious universe of shadow banking. If we accept the argument that a society’s money reflects the way in which the credit system is organised, then I think the future is shadow money.

Shadow money is, like all credit money, an IOU. Bank money is an IOU through which the bank promises to pay you a pound of cash for each pound in our bank deposit. You trust the bank that it will convert the deposit into cash at par if you wish to. The difference, however, is that the IOU in shadow money does not rely on trust, but on collateral. When a bank issues shadow money, it issues an IOU backed by tradable securities like government bonds, or corporate bonds, or other securities issued in shadow banking, like the famous CDOs.

Let me give you an example. You and I keep some of our wealth in a bank deposit because we trust the bank, or the deposit guarantee behind it, and because it is convenient for our daily payment routines. This is not the case for a pension fund, or an insurance company or what we call institutional investors and their asset managers. For them, traditional bank money is not an attractive option. The deposit guarantee is too small for what they consider ‘pocket money’. So the bank says ‘look, I will issue you an IOU that gives you the same kind of safety a bank deposit gives a small depositor. To create that safety, I will give you government bond collateral. I still get the interest payments on that bond but I will allow you to become the legal owner of that bond so you can sell it if I go bankrupt’. See how this clever legal arrangement behind shadow money is also advantageous for the bank – it can now fund that government bond with an IOU held by the pension fund.

The issuer of that bond – the government in our case – is also benefitting. Surely if banks and shadow banks have an IOU that allows them to borrow from institutional investors, it creates more demand and more liquidity for their government bonds. Liquidity is the magic word for governments wanting low and stable funding costs to run fiscal policies (at least until we get an MMT-inspired government). The seductive appeal of liquidity  applies to securities markets and their issuers more broadly – what we have here is clever system of organizing credit creation via capital markets. And it’s a big system – the cyryto-currency universe is worth roughly USD 200 bn. Shadow dollars, shadow euros and shadow yuan together amount to USD 20 trillion. That is, 100 times more (remember I wrote this before the Bitcoin frenzy).

This shadow money sounds really safe, you may be thinking. Why would regulators seek to limit its creation? The politics of this shadow money is both exceedingly intricate and fundamental to modern financial markets. Shadow money comes with two words that keep regulators awake at nights: leverage and interconnectedness. Going back to my example, it often occurs that the bank would be an intermediary between the pension fund who wants a safe IOU and a hedge fund who wants to borrow more to buy more securities. The hedge funds issued shadow dollars to the bank, and the bank issues shadow dollars to the pension fund. In this way, collateral has changed hands twice, it belongs to the hedge funds, but sits with the pension fund in case of default. They are all interconnected, and dependent on the hedge funds’ leverage decisions. If something goes wrong with the hedge fund, then everyone else stands to suffer.We get runs on shadow money.

Indeed, if you look close at how the global financial crisis unfolded, it started as a run on shadow dollars triggered by the collapse of Lehman Brothers – the familiar Gorton and Metrick story that proved influential in shaping how regulators think about regulating global (shadow) banking.  The run then travelled to shadow euros, where it evolved quietly but powerfully to engulf what we now call ‘periphery countries’ under the impotent eyes of the ECB, forced by its mandate to use the wrong cure (looking at you L-TROs) and make the crisis worse. Yes, this crisis is not a simple story of naive investors, fiscally irresponsible governments and European politics unable to credibly enforce rules stoping these governments. It was a crisis of shadow euros, despite ECB protestations.  It may soon resurge again in China, who is liberalising the production of shadow money in a bid to attract foreign investors and further RMB internationalisation (paper coming soon).

The future of shadow money is uncertain. One thing we know is that it takes a lot of room for manoeuvre for central banks to expand their crisis framework in order to stabilise shadow money. It is not a coincidence that the only that has done so formally – the Bank of England – is led by Mark Carney, who is also head of the Financial Stability Board. Bank of England has now formally assumed role of market-maker of last resort for systemic collateral markets (very different from lender of last resort), the only solution to stabilise shadow money outside prohibiting it all together (something the European Commission nearly – and accidentally – proposed when it planed to slap an FTT on shadow euros). The FSB & Basel III rules constrain it – and so the Trump administration is quietly making plans to free securities markets from the shackles of international regulation. To reduce the Minsky-type vulnerabilities, significantly magnified in this new world, we need a social contract around shadow money. It wont be a panacea, but it will make life a bit easier. This is not a mere question of better plumbing – it goes to the heart of ongoing discussions about the welfare state, inequality and our capacity to collectively provision for an uncertain future through the state, rather than through markets.