After a brief hiatus I return to address a series of very specific and significant debates in international affairs and subsequently argue why they shouldn't really be our concern anyway. This week I cover the varied responses to the Global Financial Crisis - Europe v.s. The United States. To get you started, a series of obtuse-looking diagrams courtesy of the recent European Central bank publication "Extraordinary Measures in Extraordinary Times".
To begin, let us interpret this wonderfully colourful series of sonagrams the ECB appears to have provided - delivering an image of fiscal health from deep within the womb of the central monetary authority. At first glance all parties have broadened their balance sheets, however, the Eurosystem has done so to a substantially lesser extent than the US Federal Reserve and Bank of England. While the US Federal Reserve, and to a lesser degree the Bank of England, has massively increased the purchase of securities and bonds, the Eurosystem, constrained by the overlapping authorities of national governments and the European Commission, has had to make do with more targeted refinancing operations via specific lending institutions. So what do these differences mean for liquidity in the real economy? How tight are the bonds between on-paper liquidity and the flow of investment into national industrial output and employment growth?
The most significant outcome is that fiscal stimulus in the US has been much less direct than that within the Eurosystem. The increased buy back of US securities has only ever been an indirect approach to increasing liquidity. While liquidity has technically increased, the actual flow of funds from lending institutions to commercial investment is not guaranteed. In addition the vitiating impact of the international drain on US liquidity cannot be underestimated. Chinese accumulation of U.S. debt and security assets has steadily increased over the past decade – estimates of current Chinese holdings run as high as 40% of U.S. foreign liabilities. One should note that foreign purchases of U.S. Treasury securities began their rapid increase before the GFC – increasing from $156.8 billion in 2007 to $307.6 billion in 2008 (U.S. Department of Commerce, 2009). Such an increase was despite a drop in net foreign purchases of U.S. stocks from $182.4 billion to just $6.9 billion and of corporate bonds from $372.1 billion to $0.6 billion. Thus for some time the primary holders of US treasuries have been foreign institutions. As such, the present usefulness of a securities buy-back as a liquidity tool within the US economy is not nearly as great as it would have been even five years ago. This, in conjunction with the rather erratic behaviour of the United States government in deciding when and which institutions to refinance or purchase outright (intervening in the case of AIG, but not with Lehman Bros.), has certainly muddied the waters surrounding the true state of U.S. liquidity and its potential to effect economic recovery.
In contrast to the American response, European intervention has been moderated by both national governments and a developing body of legislature empowering the European Commission. Without the option of large-scale securities repurchases, a repurchasing strategy in the Eurosystem was restricted to the bonds market. As such direct lending agreements between national governments and financial institutions have been the primary tool of stimulus. Direct government aid to lending institutions has therefore had to occur in a much more transparent and calculated fashion than would appear to be the case in the United States. In an attempt to prevent competition distortions within the EEC, national aid measures (including the refinancing and restructuring of banks) have been subject to European Commission approval. On the one hand this has slowed the financial aid package response, on the other, the aid that has gotten through has been highly structured and specifically directed. This is because EC approval is dependent on the submission of detailed viability or restructuring plans by the state involved. In the case of more substantial restructuring or recapitalisation (any more than 2% of the bank’s risk-weighted assets) these plans include explicit reports containing “all the information necessary to evaluate the bank’s viability, the use of the capital received and the path towards exit from reliance on State support” (ECB). Thus while the Euro recovery package arguably pales in respect to that of the US in scale, its quality as a guarantor of return on state investment is high. In other words, the overall Euro strategy is low-risk, low return in contrast to a US strategy that is high-risk, potentially higher return.
Thus as you read over the rather dim growth forecast for the Eurosystem in the next year (between 0 and 1% by most accounts), and compare these to forecasts for the U.S. (between 2.5 and 3%), fret not. The Eurosystem’s more conservative stimulus response and recent rapid return to talk of austerity economics (hastened by Greece’s woes) is likely to promote a recovery that is solid in its foundations – something investors will, in time, be willing to open their pockets to. In addition Eurosystem private bond purchases and strict refinancing agreements under the eye of the EC are assets that guarantee long-term reimbursement for state aid packages. The European outlook for the next year is not great, but it is perhaps clearer than that of Great Britain or the United States when all details are accounted for. The swathe of securities now held outright by the US Federal Reserve may not age as well as the returns of Eurosystem bond repurchases and refinancing agreements – especially if a revaluation of the Yuan is a precursor for falling Chinese demand of US assets.
If I may dare suggest it, the law of highest return may not hold out against international investors’ scepticism of the ability of the US to recover assets committed to the recovery. Furthermore, predictions for the overall health of the US economy will naturally also effect the value of US financial assets. To this end, a second quarter of negative U.S. job growth certainly suggests what is going in one end (liquidity packages) is no guarantee of what will come out the other.
The US deficit financing is not nontransparent, it's very transparent for most international institutions, because it's inflation. I know from unofficial sources that in the past year they have printed about 3 billion dollars without any real cover...
ReplyDeleteThis is something that will never happen in the Eurozone as long as Germany has a strong say in the ECB. German tradition has always been to keep inflation at 0.