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Wednesday, July 28, 2010

Quantitative Fantasy Doesn't Work

In 2009 governments reached for the cheque book and issued billions of so-called quantitative easing, to re-fund the balance sheets of insolvent banks.  Many people thought that this act of money-printing would alone lead to higher inflation.  But as the money was already lent out, and the point at issue was that the assets purchased by the borrowers no longer covered their debts, there was little increase in the money supply to push inflation.

On the contrary, while Wall St was bailed out, folks on Main Street found a sharp reduction in people willing to lend them money, and indeed most decided to pare down their debts anyway and start saving for once.  Money supply in the US is estimated to be falling by over 7% per annum, as banks and businesses lend less and less to each other, and people worry about job security.  Governments can issue money, but. if risk perception keeps people from lending and borrowing, there is little the government can do about it.

The current strategy is not to issue yet more money which has not fixed the problem, but instead to work on the market psychology, to try to persuade participants not to perceive risk.  The European Bank Stress Tests were merely an opinion offered by the EU that property prices will not fall in value in the next two years, so that European banks can value their loan books at full value.

Ergo European banks are not at risk.  

Ergo people might as well buy risky assets, borrow and lend to each other once more, thus recreating economic growth and saving government revenues and politicians' reputations.

The only problem is that reality is not stacking up with the lovely fantasies being propagated.  Property prices are unlikely to rise, or stay level across Europe.  Consumers are less confident in the US and Europe than they were, despite all these reassurances.  In fact the best way to get markets moving once more would be to allow prices to fall.  That way people would want to invest once more at prices they see as reasonable, not at credit boom inflated levels.

The insolvency of banks who lent too much is not an obstacle to recovery, but the path. A dose of reality would command far more respect than the issuance of false information from authorities desperate to avoid taking a financial bath.


WSJ -  Reality could also be sensed lurking around a data produced by the European Central Bank. This shows that lending to businesses slowing down and lending criteria tightening in the second quarter of the year. The key factors in leading the banks to tighten their credit policy, explains the ECB, are constraints on the banks' own access to funding and their own liquidity management.
Mr. King echoed the problem. "The gradual improvement in credit conditions that was evident earlier in the year seems to have come to a halt in recent months," he said.
Against this background, to race to ratchet up the capital and liquidity requirements on banks would be foolhardy. So the restraint at Basel is to be welcomed but not seen as a signal of good times ahead.
Basel 3 is being presented as yet more economic goodies from the candy store.   The second credit crunch approaches. 

2 comments:

AntiCitizenOne said...

The bond-defaults of insolvent banks would be highly deflationary, so Governments could print money to bail out depositors and the "bad apple" banks would be removed from the economic barrel.

tapestry said...

Bankers were restricted by regulation, and instructed to spread their risks by packaging them and selling them on, under Basel 2.

Their leaders were willing to assume greater and greater risks in pursuit of bonuses, permitted by governments and encouraged by shareholders, and Hayward-style they stopped thinking about longer term risks. The end of the line is when the risks come home, and, like with BP, all detonate at once.

Governments will have to assume the banks' losses. There is no one else. If banks are allowed to fail, it would create panic.

The primary risk is the property market. In the USA prices are down by about 40% so far, while in Europe, no one wants to admit that prices are too high and have to come down. People believe in a never-ending rise in prices, and don't want to give up the fantasy.

When they do, that will expose the banks, whose liabilities are mostly property-backed. Only in Ireland has the process really started, and governments are in terror of that happening on a wider scale. So they give us quantitative fantasy stories to keep the situation locked up as long as they can.

It's like we all need to face it, but are unable to do so. I can understand why they want people to believe all is OK and get back to borrowing, lending and consuming, but it ain't gonna happen.

The property issues are only the start of the process. The endgame is sovereign insolvency and default. Greece is the first in line.

Never has the world been faced with so many and such large debts on such a massive scale. I'd like to blame the banks, but in truth Gordon Brown, Blair, Bush and Clinton were in a position to do something in time but chose not to....not to mention the EU and OWG government fantasists.