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Tuve el placer de visitar la Universidad Francisco Marroquín (UFM) en Guatemala el pasado mes de Febrero e impartir unas charlas sobre moneda y banca; lo que me permitió conocer mejor a sus estudiantes así como los programas que desarrollan en las áreas de economía y finanzas. Es una universidad muy exitosa y totalmente independiente del gobierno, lo que le da la autonomía financiera y profesional para seleccionar sus alumnos, profesorado y los programas que ofrece a los mismos. Solo así se puede ser realmente responsable como institución y aspirar a la excelencia académica.

Una de las ventajas de operar en un país donde el Estado no ha crecido tanto como en la vieja Europa es que da oportunidades a la iniciativa privada para innovar y prosperar de maneras difícilmente previsibles ni controlables por el regulador; aunque sólo sea porque no tiene una maquinaria administrativa lo suficientemente desarrollada como para poder intervenir de manera más activa (no es porque no quiera es porque no puede!). Esto ha sido una bendición para quienes pusieron en práctica en su día, y lo continúan desarrollando y expandiendo en la actualidad, el proyecto de una universidad independiente y comprometida con la educación y formación de personas libres y responsables de sus decisiones, en una una economía de libre empresa. Acostumbrado a vivir en países donde el Estado ‘llega a todo’, fue un gusto comprobar cómo proyectos distintos e innovadores pueden desarrollarse y asentarse de manera tan exitosa. Como la UFM, la Universidad de Buckingham es una institución verdaderamente independiente del Estado, que no por casualidad está a la cabeza de la excelencia docente en el Reino Unido.  He trabajado 14 años en una universidad estatal y desde 2012 en Buckingham y puedo dar fe de las diferencias entre ambos ‘modelos’ institucionales; uno representativo de una universidad altamente burocratizada donde se desincentiva la innovación, y el otro donde la iniciativa individual y la buena docencia son premiadas.

Entrevista sobre dinero y banca central

Durante mi estancia en la UFM, Luis Figueroa y yo mantuvimos una entrevista sobre moneda y banca central; en concreto, hablamos de la posibilidad de tener un sistema monetario sin un banco central estatal y de como reformar la política monetaria a la luz de los errores que condujeron a la crisis financiera de 2007/08. Aquí podéis encontrar el contenido completo de la entrevista para el canal online ‘NewMedia UFM’: http://newmedia.ufm.edu/video/es-posible-un-sistema-monetario-sin-banca-central/. Para aquellos interesados en el tema, podeis leer mi entrada en el blog del mes pasado sobre la viabilidad de un sistema monetario con un banco central privado (entrevista con Standard and Poor’s).

Como siempre, los comentarios y críticas sobre el contenido de la entrevista serán muy bienvenidos.

Juan Castañeda

 

 

 

On March 2nd (Fundación Rafael del Pino, Madrid) I had the pleasure to join a panel on the future of the European Banking Union (EBU) (and on Brexit) with very distinguished colleagues and friends: Jose Manuel Gonzalez Paramo (BBVA and former member of the ECB Executive Committee), David Marsh (OMFIF, London) and Pedro Schwartz (UCJC, Madrid) (see the video of the seminar here). During the  event I also had the opportunity to launch in Madrid the book I co-edited last year on the European Banking Union. Prospects and Challenges (Routledge). The book is a collection of essays on the EBU by central banks’ analysts, academics and practitioners from different jurisdictions. Each of them addresses the topic from a different perspective, either legal or economic, and highlights the pros and cons of the EBU as well as its expected challenges over the next few years.

It is obvious to all now, but also to many experts at the time of the launch of the euro, that the institutional architecture of the euro was, at the very least, weak and incomplete (see some of the articles in the 1990s written by W. Buiter, C. Goodhart, P. Schwartz, T. Congdon or G. Wood, amongst others). No currency union has survived for long without a political union or a supranational Treasury, with enough powers and policies to back the currency. And this is particularly true in the case of an area, such as the Euro area, which is far from being a flexible and fully functioning monetary area. You may want to check out the results of the research report just published by the Institute of International Monetary Research on the measurement of the integration of the euro area or its ‘optimality’ as a single currency.

The reference to the classical gold standard (1870s – 1913) as a comparison with the current euro standard deserves some attention. We should be aware of the differences between both standards: the gold standard was indeed a monetary union, where member economies fixed their currencies against gold; whereas the euro standard is a currency union, where countries get rid completely of their national currencies and adopt a single currency for all. The latter is much more rigid and demanding during a crisis, since member states have no room to alter the parity of the currency (there is no national currency!), nor to abandon the parity on a temporary basis. Under a currency union member countries have effectively no central bank of issue, as this function has been fully delegated to a supranational central bank. We have experienced since 2008 how demanding this monetary system becomes under a crisis, much more a severe financial crisis, as countries have no other option but to cut costs and prices in an effort to regain competitiveness (the so-called ‘internal devaluation’). This is an option to sort out the crisis, but it has proven to be a painful one our economies (and even more, our populations) seem not to be ready to implement or even to accept.

In a nutshell, the EBU implies the following (more details on the presentation here):

  • The establishment of the European Banking Authority (EBA), which overseas the implementation of the new (much higher) Basel III banks’ capital ratio and the new liquidity ratio across the EU.
  • The establishment of a single banking regulator under the ‘Single Supervisory Mechanism‘ (SSM) for big banks or transnational banks in the Eurozone (around 80% of all), in the hands of the European Central Bank in Frankfurt. In addition the new Single Resolution Mechanism (SRM) has been stablished to deal with the recovery or resolution of a bank (see more details below).
  • According to the new EU Recovery and Resolution Directive (RRD), every bank must draft a resolution plan to be approved by the regulator, in order to resolve the bank if needed be in an orderly and timely manner. In addition, should a bank under the SSM need to be resolved, the government will not use taxpayers’ money in the first place. Actually the resolution or recovery process is going to be handled by the SRM. And only when the bank’s shareholders and creditors’ money has been (mostly) exhausted (so they have absorbed losses of at least 8% of the total liabilities), the bank can benefit from other sources of funding to pay its debt or conduct other operations (such as the Resolution Fund, see below). This is what the literature calls a bail-in rather than the bail-outs of the banks with taxpayers’  money we have seen in the recent crisis.
  • In addition, all member states have agreed to guarantee the deposits up to 100,000 euros per person per bank (however there is not yet a pan-EU deposit guarantee scheme but national schemes).
  • Finally, the EBU would not be complete should we not pay attention to the role of the ECB and the National Central Banks as the lenders of last resort in the Euro area. Modern central banks (particularly since the 19th century, but also earlier in the case of the Bank of England) were established to support the banks in case of a liquidity crisis. If a bank is solvent but illiquid, and thus cannot pay its deposits temporarily, the bank can always request extraordinary lending to the central bank (as W. Bagehot put it in his famous 1873’s seminal book: unlimited lending but always against collateral and at a penalty rate). However, this competence is still in the hands of the National Central Banks in the Euro zone which, provided there is no objection of the ECB, can lend money to the national bank in crisis at request. This division of competences between the ECB and the National Central Bank should be better coordinated so no banking crisis is artificially ‘hidden’ or postponed under the provision of liquidity by the national central bank.

The ‘Euro 2.0’

As Jose Manuel Gonzalez Paramo put it, the European Banking Union is a sort of ‘Euro 2.0‘ as it comes to remedy (at least some) of the Euro 1.0 institutional problems and weaknesses. In this regard, I agree it is an improvement as it helps to create a more consistent and credible institutional setting (*); however it does not tackle important aspects I will just briefly mention below:

  • First of all, the EBU and the new Resolution Fund (paid for by the banks, its amount will be no less than 1% of banks’  guaranteed deposits) will not be completed until 2024. So, should a banking crisis occurs in the meantime the banking sector will not have enough funds to pay for the banks’ liabilities on its own or to fund and implement the decisions made by the SRM.
  • Secondly, if a bank needs to be assisted and finally resolved, a complicated coordination between many actors of divorced nature and aims (political, national and supranational) is required in a question of days/hours. Of course the test to this procedure will come when we experience the next banking crisis (see more details on chapter 2 by T. Huertas, see book mentioned above).
  • But finally and most importantly, in my opinion, the EBU does not resolve the fundamental problems of the Euro zone; which are the abysmal internal asymmetries amongst member states in terms of competitiveness, public finances or costs (see some measurements here), as well as the actual lack in internal and cross-border flexibility as regards labour and good and services markets. Just a view of the asymmetries in Target-2 member states’ balances is as striking as self-explanatory.

The EBU adds consistency and predictability to the supervision and resolution of banks. In this sense, it is an improvement. It also makes banks pay for the losses before applying any other funding, even less taxpayers money; but we are yet to see the robustness of the new institutions established as well as the political commitment to the bail-in option in reality. The EBU is in my view another ‘patch’ on the euro’s structural weaknesses.

 

Juan Castañeda

Notes:

(*) However more consistent, I do not think this type of euro currency, very much centralised and linked to an increasingly powerful supranational State, is the best we could have established to preserve the purchasing power of the euro; I will elaborate further on the alternatives in next posts.

Within the launch event of the new MSc in Money, Banking and Central Banking (hosted by the Institute of Economic Affairs in London, 13th March, 12:00-14:00), I will be delighted to introduce two of the teaching staff of the programme, Professors Tim Congdon and Geoffrey Wood, who will be discussing the major topics covered in the programme: such as policies aimed at achieving price stability and financial stability, as well as the current debates on alternative central banks’ strategies and the effects of tighter bank regulation in a post-crisis era. A key question is to assess whether central banks should shrink their balance sheets and, if so, the strategy to do it so economic recovery is not harmed by a shortage in the amount of money. Ins this regard, the US Fed’s Quantitative Tightening policy in recent months will be discussed (see a more detailed analysis here: http://www.mv-pt.org/monthly-monetary-update) along with other alternatives.

This is a new MSc focused on how money is created in modern economies and on how changes in the amount of money affect prices (all prices, consumer and asset prices!) as well as income along the cycle. In addition emphasis is given to the functions, operations and monetary policy strategies of major central banks, so we can understand better the way monetary policy makers actually make a decision. Surprisingly enough, this very classical approach to money and central banking has become quite distinct and unique,  since monetary analysis has been labelled as ‘out-fashioned’ and has somehow been disregarded in the last two decades. The MSc is offered by the University of Buckingham and you can find more on the programme and how to apply here: https://www.buckingham.ac.uk/humanities/msc/money-banking .

Places for the launch event are still available. Should you want to attend RSVP to enquiries@mv-pt.org or call Gail Grimston on 01280 827524. For those who will not be able to make it we will be recording the presentation and the debate and upload it on the Institute of International Monetary Research‘s website (http://www.mv-pt.org/index).

All welcome!

Juan Castaneda

launch-msc-invite

 

El 2 de marzo de 12 a 14 horas en la Fundación Rafael del Pino (Madrid) tendré la oportunidad de participar en un coloquio con Jose Manuel González Páramo (BBVA, moderador), Pedro Schwartz (UCJC) y David Marsh (OMFIF) sobre cómo afectará Brexit a la Unión Bancaria Europea y a los servicios financieros que presta la llamada ‘City’ de Londres.

El tema, mejor dicho, los temas que hay sobre la mesa son verdaderamente complejos. Pero por supuesto que pueden tratarse de manera asequible para no especialistas; si hay algo que realmente me disgusta en Economía es cuando especialistas en la materia se enzarzan en un debate utilizando un lenguaje innecesariamente oscuro que no entiende nadie (algo que ocurre con demasiada frecuencia, casi de manera generalizada, con los artículos académicos en Economía …, lo que no les hace mejores sino más alejados de la realidad e incomprensibles). En concreto, seguro se tratará de cómo la salida del Reino Unido de la Unión Europea (UE) afectará a los servicios financieros que Londres, como plaza financiera de referencia en Europa, presta tanto a países como a empresas financieras y no financieras en el continente. Uno de las ideas que sostendré en el debate es que si Londres ha sido durante décadas (siglos) una plaza eficiente en la prestación de tales servicios, que por supuesto cumple con la regulación financiera Europea, por qué no debería seguir haciéndolo? Desde una perspectiva puramente económica, la cuestión no admite controversia: es eficiente y beneficioso para las dos partes aprovechar las ventajas competitivas que cada uno puede aportar en el comercio de bienes y servicios. Esto es algo que un estudiante de primero de Economía debería saber.

Hablaremos también de la union bancaria Europea, y de lo que implica e implicará en los próximos años en lo que se refiere a la regulación y, si fuera necesario, la liquidación ordenada de un banco en una futura crisis bancaria. Se trata de un conjunto de nuevas regulaciones e instituciones aprobadas por todos los países de la UE que tratan de paliar alguno de los fallos observados en las respuestas que los Estados Miembros dieron a las distintas crisis bancarias nacionales en la reciente crisis financieras. Y, aunque no muchos lo sepan, el Reino Unido, aún no siendo parte de la zona del Euro, como miembro de la UE sí ha tenido que cumplir con parte de la regulación que acompaña a la union bancaria Europea.

El evento también servirá para presentar el libro, ‘European Banking Union. Prospects and Challenges’ (Routledge), que hemos editado G. Wood D. Mayes y yo mismo. Se trata de una colección de capítulos que tratan de cómo se ha diseñado la union bancaria, su definición y funcionamiento, así como de algunos de los aspectos que en opinión de algunos de los autores puede poner en peligro su efectividad y viabilidad. Aquí podéis encontrar un resumen del libro, así como más información sobre los temas de los que trata:

‘Recent failures and rescues of large banks have resulted in colossal costs to society. In wake of such turmoil a new banking union must enable better supervision, pre-emptive coordinated action and taxpayer protection. While these aims are meritorious they will be difficult to achieve. This book explores the potential of a new banking union in Europe.

This book brings together leading experts to analyse the challenges of banking in the European Union. While not all contributors agree, the constructive criticism provided in this book will help ensure that a new banking union will mature into a stable yet vibrant financial system that encourages the growth of economic activity and the efficient allocation of resources.’

Quedáis invitados todos!

Juan Castañeda

Broad money growth (M3, Shadow Government Statistics) in the US keeps on decelerating since the end of 2015. As reported in the latest Monthly Monetary Update (Institute of International Monetary Research, IIMR), ‘In the final quarter of 2016 US M3 grew at an annualised rate of 2.2%. This follows on from a mere 0.9% in the three months to November, the slowest annualised quarterly growth rate in over five years. 2016 ends with US broad money growing at an annual rate of 4.0%, which is respectable, but down on 2015’s figure of 4.3%. In mid- 2016, the figure was 4.5%. The subsequent slowdown in broad money growth has been primarily caused by “quantitative tightening” ‘.

money-growth-us

 

 

 

 

 

 

 

 

Source: January Money Update, IIMR

 

What is ‘Quantitative Tightening’? As stated in the IIMR’s January money update cited above ‘ (…) “quantitative tightening” (i.e., the reversal of quantitative easing) when it allows its stock of asset-backed securities to run off at maturity. The Fed can use proceeds from the maturing ABSs to reduce its cash reserve liabilities to the banks rather than to finance new, offsetting purchases of securities.’ (See the January Monetary Update, IIMR). What we do not know yet is whether the Fed has intentionally pursued such a monetary contractive policy, or rather it is just the (indeed surprisingly unnoticed) consequence of the fall securities in its balance sheet when they reach maturity. As far as I know the Fed has not made a public policy announcement in this regard nor committed to such policy.

Why does this matter? Well it does matter when the medium to the long term correlation between money growth and nominal income is acknowledged. Of course it is not a mechanical or a one-to-one correlation,  and indeed time lags should be taken into account; anyhow in an environment where the demand of money is fairly stable, changes in the rate of growth of money do translate into changes in nominal income. Table below shows such empirical relation in the US in the last five decades:

nominal-income-and-money-us

 

 

 

 

 

 

Source: January Money Update, IIMR

 

Thus should this weakening in money growth in the US continue in the next quarters it will most likely have an impact on economic growth forecasts. This is subject to several caveats though; the new US administration has already announced a profound change in bank regulation which may well ease the pressure put in the midst of the Global Financial Crisis on small and medium size banks particularly to expand their balance sheets. If this materialises in the near future, the creation of more bank deposits in the economy could offset the monetary contractive policy followed by the Fed in the last few months, intentionally or not.

 

Juan Castañeda

 

 

 

This was the title of George Selgin (CFMA, Cato) talk at the Institute of International Monetary Research (IIMR) and the Institute of Economic Affairs (IEA) seminar, ‘Quantitative Easing. Triumph or Folly?’ (3rd Nov. 2016). The title of course evokes Ben Bernanke‘s words at the conference held in 2002 to honour Milton Friedman for his 90th birthday; in his speech Bernanke ended with some words that have resonated everywhere in the midst and the aftermath of the Global Financial Crisis in 2007-09: ‘Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.‘ True, banks’ deposits have not contracted (as it did happened in the early 1930’s) around 30% in the recent crisis, but broad monetary growth (M2) plummeted in 2009 and did have a subsequent impact in the extension, amplitude and the severity of the crisis.

The 1930’s crisis is the historical precedent used by George Selgin to judge the Fed’s response to the two major financial crises occurred since the establishment of the US Fed in 1913; the Great Depression and the Global Financial Crisis. Selgin resorts to well-established monetary theory to recommend an early intervention in monetary markets in case of a banking crisis occurs in order to prevent the payment system and financial markets from falling. And he does so by using Walter Bagehot‘s well-known criteria for central banks to act effectively as the lenders of last resort in a monetary system where the reserves are held by a single bank: (1) the central bank must act promptly and provide loans to illiquid but solvent banks with no limit (2) against collateral (assets that would have been used in normal times) and (3) at a penalty rate; that is an interest rate higher than the normal or policy rate.

Did the Fed abide by those criteria?

As you can surely tell by the title of his talk, Selgin is very critical with the lack of an effective response of the Fed in 2008, which ended up in a drastic fall in monetary growth in the economy in 2009 (see the rate of growth of US M2 since 2007 here). Normally banks’ deposits at the central bank are a sort of a restriction that constraint the potential expansion of their balance sheets. The Fed’s policy of increasing the remuneration US banks’ deposits (or excess reserves) in the midst of the crisis (at a time where there were not many profitable investments options for banks) turned those deposits at the Fed as an asset. In this new policy scenario US banks comfortably sat on a vast amount of cash at the Fed, and did get a profit for doing so; this indeed discouraged them from channelling the money lent out by the Fed to the economy and resulted in an ineffective threefold expansion in the US monetary base. This recent example helps to explain the lack of a mechanical connection between expansions in the monetary base and those in  broader measures of money (such as M2, which hardly grew, if at all, at the time).

Watch out George Selgin’s video with his talk in full here for further details. In a nutshell, according to Selgin it was a combination of bad policy measures which caused the Great Contraction and not an inevitable policy outcome. Enjoy the talk!

Juan Castañeda

 

As announced last month on this blog, you can find now the video of the IIMR 2016 Public Lecture given by Charles Goodhart (Financial Markets Group, LSE) available on the Institute of International Monetary Research website: http://www.mv-pt.org/2016-lecture-and-conference

Professor Goodhart, indeed a distinguished academic figure in monetary economics in the UK and a former member of the Bank of England’s Monetary Policy Committee, criticised many features of monetary policy-making both before and after the sharp global downturn of 2008 and early 2009. He also underlined some of the most important flaws in current macroeconomic models:

(1) The use of macroeconomic models with no money, nor a banking sector.
(2) No analysis of the monetary transmission mechanisms via the banking or the wider financial sectors.
(3) The assumption that there is a direct correlation between changes in the monetary base and changes in the amount of money.

In my view those flaws are yet to be properly addressed and if we could just agree on those very simple points we would make a major progress in current monetary economics! And we will very much reduce monetary instability and thus minimise the risk another financial collapse.

Just a final note on the Institute of International Monetary Research. Its main purpose is to demonstrate and to bring public attention to the strong relationship between the quantity of money on the one hand, and the levels of national income and expenditure on the other. The Institute has been established in association with the university of Buckingham and is heavily involved in the analysis of banking systems, particularly their role in the creation of new money balances. You can subscribe to its newsletter and publications here: http://www.mv-pt.org/contactus

Juan Castañeda

PS. The text with the lecture will be available soon at the IIMR website.