Now that last bit is a nice metric for identifying a bubble. I presume it is possible to average it over a shorter timescale too? So if you see over, say, the space of two years, gross moves from the long-term average you can be pretty sure that something is going wrong?
Nice to see a wee bit of “heresy” that me n you were discussing 3 years ago finally appearing elsewhere, yogi!
IMO this is so obvious that I just don’t understand why the entire financial community so fervently believes the opposite.
I wondered if you’d remember that!
(Can’t have been much more than two years ago, I wasn’t ‘born again’ then…).
What we agreed on is still as valid today as it was then.
In fact, knowing a bit more (but only a teeny bit more) about Interest Rate Swaps, it seems even more mendacious that interest rates should be played around with. I can guarantee you now that there are people vastly underpricing the risk of upward rate movements and selling IRS that will bust them. The markets have derivatived central bank interest rates into a useless tool.
The ECB should be blamed more, for the banking crisis. They didnt anticipate the credit bubble in Ireland and other countries with a history of fiscal recklessness and they didnt do anything to mitigate it. EMU was badly managed, from a banking point of view.
In the US the Fed is getting a roasting, and may be stripped of some of its powers. But the ECB is getting away with the past failures.
BIS/IMF/World Bank,whatever,they are all part of the same group of bankers, the idea that an economist from one part of the banking cartel should criticise the policies of the other is frankly preposterous,and although correct should be treated with the contempt it deserves.
Anyone reading the pin,or with a modicom of financial sense would know these bubbles were stoked deliberately,do you think the ECB didn’t realise what was going on in Ireland or countries like Lithuania? Of course they did,but now its too late,they have got both countries ruined and in debt to them with no way out.Welcome to the EU peoples.
Bubbles don’t bother me.
Profligates can gamble their little heads off 'til the cows come home as far as I’m concerned.
It’s the fucking bailouts that drive me spare - which low/zero interest rates are symptomatic of.
The problem is the banks now control governments, so when bubbles get out of control,the government AND the banks take control of the economy to ensure the bubbles dont burst,so saying bubbles dont bother you is a contradiction,since the inevitable baillouts are part of the same problem - **banks having too much power and influence.
Ah - but there’s the rub!
It’s not the government AND the banks, it’s the banks FULL STOP
I’m firmly in the “Lampost Justice for Bankers” camp.
Just tell me where and when…
Interesting stuff here.
However, Yog, when you say that markets have now rendered interest rates useless, I assume you only mean capital markets?
Interest rates are still, however, an important tool to stoke demand in a credit-based economy by luring people to take on large amounts of debt and increasing the velocity of money in an economy, particularly when we’re in a deflationary cycle.
Not really, I mean credit markets in general (the shadow money system). The amounts that Central Banks have on offer, even with their extraordinary measures, are dwarfed by the rest of the money sloshing around the system. All of it looking for inflation beating returns or 6% whichever is lower ( ). By this I mean that pension funds rely on being able to grow at 6% to meet their future obligations. The reckoner for insurance is lower, but still high relative to inflation targets. So we have all this money that is looking for people to borrow it. And many have done. In vast amounts (by this I mean credit institutions that would normally price their money in reference to central bank interest rates). In times of scarcity (like the credit shock we’ve just seen), those rates go through the roof. In times of surplus (like the preceding boom) those rates are too low.
Central Banks have limited ability to act against the weight of money going in one direction or the other. We can see this by SVRs at the Irish banks. Interbank money is expensive for Irish banks at a time when it is cheap for other more solvent banks (as judged, for example, by euribor). Why? Because credit protection prices are high for Irish banks. The same is true for different governments within the eurozone. So there is no level price of money even within a currency zone. Ostensibly similar assets (say a three month repo backed by ABS) are wildly dissimilar in price between an Irish bank and a German one, despite the obvious failings in many German banks. Other than acting in their role of lender of last resort, Central Banks can do nothing about this. Even in their last resort role, they are constrained by the terms they can offer, they have to offer them to everyone and not just to the few who need them. So they are busy giving money to banks that don’t need it and who can immediately lend it out at a profit when what they are trying to do is provide liquidity support to insolvent or near-insolvent banks to give them time to be worked out.
Eventually these distortions of giving free money to some banks will destroy the banking system, as the easy money raises the risk-taking ability of the banks. This is the effect the shadow banking system had with its cheap money during the previous too-low interest rates and the boom. Banks were able to borrow money in carry trades, hedge the risk in hopelessly mispriced derivatives and lend almost without regard to risk. As long as the ‘public’ price of money (which is all that the Central Bank rate is now) exceeded their cost of funding, they could coin it in and take risks - if you are making a 2% margin versus a previous 1% margin, your ability to take on risk has just doubled.
Really what Central Banks should be doing, and what Sidewinder and I talked about a while ago, is standing into the wind. They should have a minimum cost of money, beyond which the price of money from a Central Bank should never go. They should almost never vary interest rates - they should keep them in a range of 3-7% (or some such). They should use QE and QT (Quantative Easing and Quantative Tightening) as their main tools, that is when there is excess liquidity, they should soak it up - increasing capital requirements, storing that capital in the Central Bank, selling assets that they ‘create’ and not performing liquidity operations. When their is insufficient liquidity, they should buy back their assets, reduce capital requirements etc.
In these days of electronic reporting it should be (and clearly was around the time of Lehmanns) possible to see how and where money is flowing to and what the real (market - both visible capital and shadow) price of money is. Central Bankers are not sitting in some bunker waiting for telegrams from the South Sea to tell them that the Bubble has burst. They can easily see when the market price of money falls below their desired rate. They can see when the price of risk (evidenced through credit derivative swaps, for example) has fallen too low.
Finally, I think that IRS are an abomination and should be abolished. If you have an asset with an income tied to something, you should bear the risk of that income stream. If you don’t like the risk, either don’t give the loan or sell the asset. The smoothing of risk takes away the necessity of analysis. (Perhaps this applies to most/all derivatives?).
I realise in my rant I haven’t come close to answering you! Excellent more rants - “gin-wallah, one gin chop-chop, punka-wallah, punk faster”
“Interest rates are still, however, an important tool to stoke demand in a credit-based economy by luring people to take on large amounts of debt and increasing the velocity of money in an economy, particularly when we’re in a deflationary cycle.”
Well, yes and no. They are only useful to those banks that have money. They are a reference rate. They’re not the prime reference rate, as I said above. Euribor is more important. The unmeasured shadow bank rate is more important still. You could even say that competitive deposit rates are more important than that.
Irish people may be taken in by ‘never been a better time to buy’, but most europeans are buying fixed rate over longer terms than two years. It’s funny that it’s us, the US, the British and the Spanish that’ve had the biggest busts; us with our variable rates and all (with a 30% decline in sterling, there’s not much doubt about the UK bust, the initial problem areas and the continuing main problem areas have been in the variable rate mortgages, not the fixed rate one, though the bust is now so severe there is economic advantage in walking away from even a cheap fixed rate).
Anyway, back to the point. Cheap money is no use if there is no credit circulating. Credit does not circulate because the ECB makes money cheap. Credit circulates because it is looking for a home. The velocity of money is dependent on the money that is borrowed being spent on something that will generate a return for someone else who will then spend it on something further. If you are buying an asset from someone who has a loan from a bank which is in hock to a foreign credit institution, and the person you are buying from is not going to make money from the transaction, the velocity of the money is near zero. The foreign credit institution is not going to make any money either because it has to pay back someone else. That’s what debt deflation is all about.
Interesting post, YM. I’ve been coming to the view myself that central banks and other regulatory organs like the fed act simply as homeostats in the economic system. They observe a behaviour or phenomenon in the system, and they change an input to try and bring it back to its mean. I’m starting to think they don’t even take a long term view. Rather, just act in the here and now to stabilize the system. Maybe they’re right? It’s such a complex, non-deterministic (probabilistic) system that really, there’s nothing more they can do?
Ah yes, apologies! We almost constitute a cabal now!
Very interesting reply.
I think your proposed additional tools of QE and QT are now here to stay.
In the next growth cycle, rates won’t be able to up over 5%-7% - anywhere. Not just in the US, where it would cripple the debt-laden consumers, but also here in the Eurozone, where Ireland, Spain, Greece and maybe Portugal would default. Here in Sweden, I see the same problem - too many took on too much debt at low rates with unrealistic future expectations of interest rates.
So what will be the solution to tame inflation (if it ever comes from all that money sloshing around)?
I guess quantative tightening will be used. I have no idea how this will look if the inter-bank markets get going again. Even if their spreads are 1-2% above the repo rate, it is possible that money supply could grow from them. Ok, Irish, Spanish and Greek banks will need all their funding from the ECB for the foreseeable future (as you mentioned their funding costs with CDS are too high), but what happens if the Germans/Dutch/French get drunk on cheap credit and the inter-bank market is open? How do you turn off the taps then?
This is where the nature of the operations that Central Banks take is going to have to change. Instead of raising interest rates (which the market will just ignore, given the amount of global cash that is sloshing around (they’ll just build new carry trades)), they’ll have to use different methods. The moves that countries like Brazil have made recently are interesting - trying to prevent the slosh coming into the country.
But it probably won’t be enough. The eurozone is big enough that the slosh can be generated internally. A good dose of a winter flu that killed off over-50s would do it. So what CBs need to be able to do is lock up money in sterile instruments, as I said above “increasing capital requirements, storing that capital in the Central Bank, selling assets that they ‘create’ and not performing liquidity operations.” You can add to that decreasing interest paid on assets in the deposit facility. But these sterile instruments do not exist. Banks will, no doubt, be extraordinarily unhappy about this, but it is the price they are going to have to pay for being bailed out.
Don’t get me wrong, I hate young people - October 19th
A good dose of a winter flu that killed off over-50s would do it.
You’re consistent, I’ll give you that.
Hey, if you can’t be a misanthrope on the internet, where can you be?
Typed from his bunker, surrounded by gold, beans and shotgun shells.
In the next few years, it will be very hard for the ECB to increase capital reqs on irish/greek/spanish banks, the liquidity operations look like they’ll be in place in the medium term (2-3 years), and I don’t see restrictions on capital flows in/out of Eurozone. A tobin tax might do it.
The chinese had been quite successful in “sterilizing” the surplus cash they generated - by buying up treasuries. No they’re freeing up credit, probably causing another bubble. The trouble with sterlizing instruments is that they more difficult to set by committee than adjusting the repo rate, and probably more prone to political interference.
But you’re probably right that they’re the only instruments that will be used in the next wave of tightening the money supply, as they won’t be able to raise rates to squeeze inflation that may come in a few years.