TVHE

So it seems the ECB is going to go out and buy government bonds.  I don’t quite agree with this description of what is happening to be honest:

“They are not cranking up the printing presses,” said James Nixon, co-chief European economist at Societe Generale SA in London. “This is a much more targeted, surgical approach. They buy the duff stuff that no one in the market will touch.”

The point is to buy stuff that would otherwise be good, but is only struggling because of the crisis – not to actually buy duff stuff.  The intervention is supposed to prevent a run on good assets – not to keep bad assets in business.  Of course, in practicality they will have to buy some duff stuff, but saying that this is the goal is an exaggeration.

Still, this isn’t my main point.  My main point is that sovereign debt is a different beast to private debt.  If the ECB starts buying up government bonds, and there is no plan to get government budgets under control in the medium term, then the result is high levels of inflation – and probably the collapse of the Euro Zone.  The second point doesn’t concern me – the first point does.

With private debt we had a response when effective interest rates exploded upwards.  Will we get the same response from domestic governments in Europe?  I don’t know.

The EU has decided it arbitrarily needs to protect the value of the euro.  Specifically:

We now see herd behavior in the markets that are really pack behavior, wolfpack behavior

Relevant picture:

Shirt source.

My question as a New Zealander who has experience the vicious swings in currency myself – why protect the value of the euro?  The euro is falling to help buffer the painful adjustment Europe is about to go through given their banking crisis, and they want to waste money trying to prevent this?  I don’t understand. Note: Krugman seems to feel a similar way.

Were inextricably linked.  A quote that illustrates this to me strongly came from a Bloomberg article today.  The ECB decided to tell the countries that have high soverign debts to go to hell, and now that they aren’t going to take on the risk themselves private investors aren’t willing to and are selling.

This makes sense, previously people purchased the junk on the basis that someone else would pay for it – high return low risk!  Now that they have to face the real risk profile they are like “f**k that”.  However, Bloomberg (or at least David Kovacs) stated:

The reason the market is horrified now is Trichet said it’s not even being discussed. Smart investors are basically selling risk(y) assets

No s**t.  An asset appeared low risk, and now it is high risk, and the expected return is (at most) unchanged – so the risk adjusted return is lower.  No wonder they want to sell.

Now we are in a crisis, and if there is a run on good quality debt because of concerns we have to do strange things – sure.  But we need to come up with a system that rips this moral hazard out of the system.  It is the moral hazard that helps to drive crisis after crisis ultimately.

In a chart on the Rates Blog today they point out that the money stock (note not really the money supply, depending on how you define it) in the Euro Zone is declining.  The indication then is that “Europe looks bad”.

However, the money stock is also dropping in Australia and New Zealand.  If there were figures for the US, I suspect we would see some contraction there as well.

Does this mean economic activity is taking a sharp turn downwards?  Not necessarily – we may be seeing a sharp uptick in the velocity of money or a movement in reserves as global interest rates tick up.  Furthermore, remember that growth in the money stock in many countries ACCELERATED in the middle of the great financial crisis – so to be honest, it is hard to tell exactly what is going on with these figures.

Overall, falling money stock (in conjunction with an easing in borrowing statistics) suggests we should be cautious – it looks like deleveraging is happening.  However, it is not a clear indicator of where the economy is directly going – if relative prices in the economy are adjusting then activity could still be rolling along nicely.

The raging capitalist nation of Sweden has stated that they are against government bailouts for manufacturers (ht Econlog):

“Voters picked me because they wanted nursery schools, police and nurses, and not to buy loss-making car factories,” Enterprise and Energy Minister Maud Olofsson told Swedish public radio.

Very cool.

In other news I caught wind of a World Bank paper that said New Zealand was more protectionist than Europe – these are crazy times we live in

Check out Spain (ht Calculated Risk):

Just 135 new housing starts in the last quarter of 2008, and not a single one in December: That was the combined output in terms of housing starts for the G-14 group of Spain’s biggest developers

Yikes.  We are just under about 3,500 – and it looks like we could slump under 3,000 over the first quarter of the year.  But 135 housing starts is madness!

One major difference – Spain has a large over-supply of property (like the US), NZ doesn’t.  However, we definitely have pretty restrictive lending conditions for builders at the moment …

On this fine Waitangi day, Marginal Revolution mentions that Ireland is actually cutting spending in the face of a deteriorating economic climate.

Tyler Cowen gives a few reasons why this may be the way to go for Ireland:

A few things are worth noting.  First, a small open economy has a harder time making fiscal stimulus work.  Second, a small open economy often has to worry more about its credit rating.  Third, a small open economy offers a tougher testing ground for macroeconomic “field experiments” because there are more confounding external factors

Looking solely at the first point, it is “harder to get the stimulus to work” because of “leakage”. Fundamentally, some of the stimulus will lead to an increase in production overseas (through rising imports) rather than greater production at home.

This matters because the purpose of the stimulus is to increase “domestic production” to increase employment to its natural rate.  If all the stimulus does is increase imports then it doesn’t do this.  (Although I would note that if it did solely increase imports, the exchange rate would depreciate, which should lead to some substitution from imports to domestic production)

For small open economies the idea of a fiscal stimulus may become a “prisoner’s dilemma” where all the countries are best off if everyone stimulates but there is the potential for an individual country to “free-ride” by taking the stimulus from overseas and not stimulating themselves.  In this case, each country will individually choose not to stimulate – and they will all end up in a situation where output is stuck below potential (this has been mentioned before by Paul Krugman etc – does anyone have the links, I can’t find them )

Protectionism is a scary thing during a global downturn. A bunch of nations trying to “protect” their own interests can turn a bad situation into a worse one.

New Zealand wants to fight off what it sees as protectionism – namely subsidies for dairy farmers in Europe. However, although there is too much protectionism out there I’m not sure our argument against this set of policies is watertight.

If we think that the current shock to dairy prices is temporary, and that dairy prices will come back when the current massive increase in supply works through the system, then it makes sense for Europe to temporarily subsidise farmers in the face of a MASSIVE CREDIT CONSTRAINT.

Industries all around the world are struggling to sort out their cash flow because of a freeze up in lending. If the firms are still profitable given the expectations of future prices, then it makes sense for domestic government to prevent the industries from failing.

Do you think this type of intervention is defendable – discuss

I noticed that the British government rejected the idea of a “wage subsidy” that was put forward by unions (who would have guessed ). Now, whenever a government outright rejects an idea I usually ask myself the question “how could that idea have worked” followed by “would that idea have worked”. In this case there is definitely a how, and it might even work in the current situation.

Just before I began writing my ideas I saw this post on Econlog on a “smart stimulus”. In the post they support the idea that cutting the employers share of payroll tax would solely give money to employers (as wages are sticky). This money would both support employment by lowering the relative price of labour (which is too high given the shock to productivity), and it would incentivise “business activity” by increasing profits.

Ok, well I agree with the possibility of the idea that has been discussed at Econlog – but I need to look at it in more detail before I can say whether I would support it “in the current situation”. Lets try that:

Read more…

So the British are increasing the international departure tax, and stating that it is an “externality tax”.  What spectacularly wrong-headed logic.

The externality they are talking about is “carbon emissions” – now as long as they tax the fuel that airlines use the externality is accounted for, as the carbon emissions stem from fuel use.  Adding a tax on top of an efficient externality tax is not efficient.

The real reason the British government is doing this is straight out protectionism – they believe that the impact on “outflows” from Britain will exceed the impact on tourist “inflows”, a factor that would improve net exports and help to “protect” the retail industry in Britain.  Beyond this, the increase in tax is also a simple tax grab – one that taxes tourist industries the rest of the world over.

No wonder we in New Zealand are unhappy (*, *)