http://ageofdeflation.blogspot.com/2018/06/ignoring-only-solution-bad-bank.html?m=1
BoJ – Entering Negative Nominal rate territory
Only Course left to the Fed- Reverse Stance Sooner rather than Later
All that was feared and written about on 24th August 2015 in “Rescuing a Deflationary World”(http://ageofdeflation.blogspot.in/2015/08/rescuing-deflationary-world.html) has ominously come to pass with the US Fed inexplicably raising rates in a haste in December accompanied with a simultaneous JPY carry trade unwind along with the breakage of the USD->CNY carry trade and as illustrated earlier in this blog the world economy is now truly on its knees.
The moot question is did the US Fed really see the ghost of inflation in December when the entire world actually stood perilously on the brink of deflation? And now that it is clear that the world is indeed in THE AGE OF DEFLATION what, pray, does the FOMC plan to do in the next two months? Study the data? Analyze? What analysis do we expect the captain of the sinking Titanic to do and indeed what analysis is on offer? No, please also do not expect the economic situation to revert back to square one to status quo prior to the December hike, if this hike is reversed – only that the route and fallout of the blunder will be slightly bearable to manage and implement a fix.
Why does the US Fed have to be answerable for China, Japan, ex-Asia et al? Because post the SE Asian crisis in 1998, most Asian Central Banks have been maintaining a quasi dirty floating peg with the US$ using their respective FX reserves as the cushion to avert a repeat of the 1998 crisis and the result of this stratagem has been that post the 2008 crisis in the US when the US Fed slashed rates to almost zero, most Asian Central Banks obediently* cut their REAL RATES to ZERO as well. In some cases , without naming individual Central Banks, the real rates were maintained at fairly high negative levels for much of 2009-2011 fuelling a rather huge credit binge driven asset price rally.
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* The reason is fairly obvious- If an Asian country were to maintain a higher real rate of interest higher than that of the US, the export driven economy(most Asian economies are modelled on this in order to extract the purchasing power arbitrage or in other words the wage differential arbitrage between the Asian worker and the American worker) would suffer as capital flows would make the exchange rate move adversely and make its exports uncompetitive. The saving grace was and is the FX reserves which would be expanded to keep the currency from appreciating too much against the greenback and thereby keeping the export driven model intact. The immediate ‘obedient’ fallout is that if due to any reason the US Fed has to reduce its real rates to 0, the hapless Asian Central Bank has to follow suit and adjust its real rates at or below that 0 level which is what happened in the aftermath of the 2008 credit crisis.
During the “taper tantrum” in 2013, when market was trying to price in the probability of the US Fed hiking rates, some Asian economies with weak current account and low FX Reserves were faced with the prospect of either higher domestic interest rates to attract foreign fund flows or a depreciating currency to maintain the export growth led model or deplete their FX reserves or a mix of these mechanisms.
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In December 2015 when the US FOMC hiked rates in the absence of inflationary dangers, real US$ interest rates started progressively moving higher as deflationary dangers manifested itself strongly. True to script, economies having weak current accounts or low FX reserves have had to face a brunt either through depreciation of the exchange rate or by raising the domestic interest rates or by depletion of their FX reserves(not an option for most Asian Central Banks though) or by a combination of either of these mechanisms.
Now add China and the Commodities complex in an overleveraged# setting to the above and the global economic growth model ignites to the mess we see today- a mega tragedy unfolding.
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#Not that you do not know this simple fact that we live in an era of over-leverage…. but the recent chain of events should not leave any doubt on the matter. Will not venture into a name and shame exercise as to who or what caused this sorry state of affairs, which is an exercise best left for another time or to another person (*a HISTORIAN?). China is a classic basket case of people trying to game the economic model of the state using leverage as an instrument and creating vast misallocation of capital into unproductive or wasteful activity.Take copper for example- in China with its ample land bank, inventory holding costs were low. US$ funding cost was cheap and because the PBOC created an artificial band between which the Renminbi could appreciate/depreciate, you could misuse this to import huge amounts of copper using borrowed dollars and inventory it for a short time while more leveraged buying of the commodity raised international prices- and then you sell it off in the domestic market at a profit because the RMB would not be allowed to :
(a) appreciate against the US$ beyond the band ensuring higher international prices always resulting in higher domestic prices,
(b)depreciate against the US$ beyond the band ensuring savings in hedging cost on the US$ Liability(referred to as USD->CNY carry trade) resulting in assured bumper profits attracting higher participation in a self fulfilling cycle as copper prices in particular and commodity prices in general kept rising -funded by leverage.
This type of leveraged buying of commodities could not continue for ever as you ultimately need a willing and liquid buyer at the other end- which was ultimately found wanting because sooner someone realized that there was only so much requirement of wires to be extruded from the copper, and the rest had to be inventoried due to the limitation of actual end use.
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While we allow deleveraging to work its way through the system, what is required is a semblance of order and stability which can be used to gain time to resolve the rebalancing issues at hand. Had always maintained that the US Fed was mounted on a rather wild and fast horse in its quest to “normalise” rates and it has erred by a big margin and the time has come to either bailout of the Titanic by reversing course or if it still sticks to the “hike” bandwagon the boat will sink from hereon alongwith the entire bandwagon.
Anupam K Mitra
Urgency of Creating a Bad Bank or The National Asset Management Co.(NAMCO)
The government today discussed the possibility of creating a Bad Bank or National Asset Management Co.(NAMCO) as per press reports available on the web http://economictimes.indiatimes.com/news/economy/policy/pm-narendra-modi-discusses-plan-to-set-up-a-national-asset-management-company/articleshow/48872058.cms
This is a welcome step. A few pointers that should be pertinent to discuss right away since the proposal is now getting seriously looked at as a very urgent measure to shore up the economy and derisk the NPA laden banking space.
1. Bad Banks have provided relief in the past to economies suffering from a credit meltdown post bursting of asset bubbles such as Germany (1980s), China (1990s), Sweden(1992),Ireland(2009),Netherlands(2011), Spain(2012), Portugal(2014), Latvia(2010).
2. Bad banks, in theory, operate on a short time frame project workflow basis for recovery of bad assets; while the good bank can continue to operate on a process driven manner and continue with the job of financial intermediation and credit allocation. The absence of bad assets on the books of good banks allows the good bank to concentrate fully on the evaluating credit proposals without the dead weight of past bad assets.
3. In practice, the threat of moral hazard is very real and the implementation must be such that it does not allow bad lending practices attain official sanction by the “Bad Bank” bailout. Also, small borrowers and small ticket lending that have gone bad must be kept out of the Bad Bank so that enough time is given to small borrowers to recover and repay.
4. So, Bad Bank is to be created out of the non-performing assets of the banking industry at book value or market value whichever is a fair price for the buyer(Bad Bank) and the seller(Original Bank). Needless to say, the original banks have to immediately recognize the value lost post default or due to non-repayment of the loan. But that is a given, or else shy would any investor put money in a Bad Bank and take the risk of losing capital because there is no certainty that defaulter/ borrower will repay the loan in the future.
5. The investor in the Bad Bank can be a private investor, original bank, or the Government or a combination of the three. Any model can work provided a workable and practical model of regulation and laws is put in place quickly and effectively. Even a model where the original bank forms a subsidiary bad bank at an arms length can work as evidenced by CitiBank recently in the US which has successfully implemented this model in the backdrop of the 2008 credit crisis. But the challenge in such cases is strong and effective regulatory oversight and regulatory framework.
6. The Bad Bank is not a going concern with a long life time like normal banks. It is at most a 4 – 5 year project where the investor is interested in recovering the money from the defaulters in a project management sense of business and exiting the business or handing it over to traditional banks who may be interested in buying the now-healthy not-so-Bad Bank.
That said, the creation of Bad banks will require new legislation- but examples in many nations abound as stated earlier above. These nations including Spain and Ireland had to undergo a thorough legislative law making and regulatory rule making before Bad Banks could become a reality and the challenge in the face of urgency is that these tasks be completed with great urgency.
Why should we display so much urgency? The global macroeconomic environment is nothing to be comfortable about, and ditto is the current state of our domestic banking system. If we are comfortable with dribbling the buck , then we can just stick around with the status quo and pray to God to make things better. But if we want to address the fact that every year 1 million young people are joining the workforce, then we can’t just dribble- we must advance the game plan proactively to the next level without waiting for some crisis to goad us into action.
Rescuing a Deflationary World
We have had the very unusual spectacle of Asian Central Banks hypnotized by the snarl of the market cobra unleashing its fangs. While it is a natural human reaction to be thus mesmerized into inaction by a Cobra in the wild, there is little room for further inaction by Asian Central Bankers who stand similarly transfixed by an asset market collapse.
We had in a an earlier post (http://ageofdeflation.blogspot.in/2015/08/tantrum-not-us-fed-ahead.html) examined the chances of a USD,CNY and JPY carry trade unwind simultaneously as 1 in 31 and had cautioned that these odds are not so remote- all it needs is some senseless chores by guys with hands on monetary levers. And it has happened too soon for comfort. The US Fed seems hell bent on hiking rates at the same time when CNY and JPY carry trades are bursting. Now that’s a sure recipe for disaster.
So what should Asian Central Banks do now that a simultaneous unwind of carry trades is in motion? Simple – ease monetary conditions domestically and let their respective currencies depreciate. Coupled with a possible weighing in of Govts’ Fiscal support in the form of either Infrastructure investment or tax breaks for manufacturing and Services, the situation is imminently manageable.
And what should the US Fed, BoJ and PBoC be doing? Firstly, the US Fed should stop playing the pantomime with the public. Every kid in primary school knows that his/her dad earns a lot less than 8 years ago- a wage deflationary spiral. So notwithstanding the Obama jobs boom, the take-home pay is deflating as efficiency gains outstrip hiring effects. So the lack of inflation is not surprising and the Fed should stop behaving as though if a rate hike does not go through in September it would mean a major loss in credibility. Secondly, the PBoC should finally achieve the lower bound in its targetted monetary policy rates to beat off a very likely deflation over the next 3 – 6 months. Thirdly the BoJ has to stabilize the Yen and ensure that the JPY does not overly strengthen against the US$ in order not to crush off the yen carry trade with precisely the wrong synchronous effect. The watchword here is stability. Reduce volatility. If the market must go down, let it go down 2% in a day for 5 days, rather than 10% in 1 day.
Bad Bank/Good Bank
Now for some long term fixes- QUARANTINING of banking assets in Asian countries with pent-up credit booms now laid bare by an implosion into Non Performing Assets. The urgent need is for segregating banking assets into Good assets and Banking assets that have turned bad must be quarantined into a Bad Bank . It is important that there is a clear demarcation of bad assets into the single “Bad Bank” which will have separate recovery targets and capitalization. The rest of the “good banks” could only then function better with better credit targeting and allocation without the haunting fear of the ghosts of the past which irrationally constrains credit /raises cost of credit even to deserving borrowers with clean records.
Government Investment into Non deflationary Infrastructure creation
In an era where every private entity is deleveraging, the State cannot also simultaneously deleverage. To rationalize take a simple case: In a closed economy, where there are only two agents, you and me, my spending is your earning and your spending is my earning. The entire world is a closed economy. If everybody is deleveraging, if unemployment is high, wherefrom economic growth will come? Hence the State has to invest in infrastructure such as Education, transportation, Tourism and the like that are inherently non-deflationary by borrowing at these historically low rates of sovereign bond yields.
After forceful public investment lifts the economy from the deflation, the private sector develops the ‘animal spirits’ to restart investment- borrowing and hiring picks up. In this stronger phase of economic growth the private sector is more efficient than the public sector. Now here is where Keynes writings did not resolve issues because he wasn’t around to witness the decadence of public enterprise in the 1970’s in the US/UK, and indeed in much of the globe including the USSR. However it was getting very obvious that in the 1970’s, the size of the public sector was inefficient, gigantic and it was trying to borrow money from the same public resulting in crowding out of the more efficient private sector. The need of the hour then, was to cut down the size of the government and restrict the role of the state to only those areas where no other actor could qualitatively contribute. That’s where Reagan and Thatcher came in, in the 1980’s. But this is 2015. The situation is different. We are entering a global deflation. The only way out for a global recovery to gain ground is that Governments globally borrow massively and invest directly in the productive sectors of the economy. Roosevelt’s “New Deal” needs to get replicated and for that to happen we need to really ignore traditional thinktanks like the IMF that had messed up in Latin America in the 80’s and S.E. Asia in the late 90’s and are now looking to repeat the same errors in 2015. Those who hold Reagan and Thatcher in great esteem can come in later, say in 2017, if by that time the global economy has been safely pulled out of the woods, and the private sector is getting back its mojo. By all means then-in 2017, dismantle the government and cut down upon activities that the private sector can do better. There will be lethargy on either ends of the economic cycle. Functioning democracies can tackle this type of lethargy and rent seeking on either ends of the cycle provided institutions are allowed to function the way they ought to.
Of Global FX Devaluation Wars and Zero Sum Games
Tantrum Not ! US Fed Ahead !
Avoiding Chinese Collapse and a Simultaneous JPY carry trade Unwind
Around 33 months back the Shinzo Abe backed BoJ initiated a rapid JPY depreciation that resulted in an absolute move of 50% weakening of its currency against the USD. The resolve that the Abe backed BoJ has displayed in the face of diminishing marginal benefits to the real Japanese economy has encouraged the Yen carry trade once again with borrowers borrowing in Yen and converting to USD and investing in various assets classes globally.
The danger is that asset prices can get swiftly unhinged in China,as amply displayed this month and investors can go bust if at the same time the carry trade also implodes with JPY reversing course and appreciating swiftly.
This is a real danger as we saw over the last two weeks and it is now expedient that adequate controls are put in pkace by the Chinese authorities in the correct direction. One such area is obviously the interest rates set by the PBoC given the fact that CPI inflation is low at 1.4%. Interest rates should be a whole lot lower to discourage carry trade behaviour given the leverage already present in the system, not to mention the crimped CPI.
We have heard ample reports emanating from China of Authorities wanting to arrest short sellers. Can they also arrest a short seller sitting in London or Singapore or New York? The fact of the matter is that the previous week has seen more of the latter variety trying to implode the Yen carry trade along with the Shanghai Composite and the Shenzhen Indices simultaneously and create massive panic which can potentially throw the World into a greater Depression than 1929.
Last week there was a close to 80% probability that these short sellers might have succeeded-just almost.
The desirable outcome is that PBoC loosens up monetary policy and discourage the build up of the carry trade thereby reducing leverage levels. The benchmark 1 yr rate at 4.85% with CPI at 1.4% leaves a lot of room for PBoC to cut and improve financial stability. This must be followed by restoring normalcy in capital markets and reverse the brute force measures gradually and improve investor sentiment and restore confidence in fair regulation.
These above measures will take us to the desired outcomes which as highlighted above reassigns the probability of positive outcome to 80% while relegating the doomsday probability to under 1%.
Greece-Next Steps;Nothing to Fear
Greece-Next Steps; Nothing to Fear
What we need to fear really is fear itself-Roosevelt
While I am sorry for an extended hiatus from my blog due to other very urgent commitments, am glad to return with very encouraging turn of events of a clear Oxi to EU blackmail. The leak and final publication of the IMF report lays low German claims of alleged Greek perfidy. Post the Garibaldi like sacrifice by the ex Finance Minister, the responsibility is now completely in the court of the EU-krats. It is surprising to see that the autocracy is instead trying to turn the screws on Tsipras- the democratically anointed one.
Notwithstanding what the paid media is upto, the economic analysis in black and white is as follows-
Probability Tree diagram of the Next Steps
With only p=19% probability that bondholders woukd suffer an adequate haircut and Greece debt would be restructured suitably, the potential rebound and inflation in the Greek economy is a measly 1%. This includes the scenario of Greek default and drachmafication.
However if the probability of restructuring adequately increases to 50%, the potential rebound would imply inflation at 2.1%.
The response function is illustrated as follows:
Obviously chances for a sustained Greece recovery and preservation of the EU area with or without Grexit improves with a more mature German attitude.
But whatever the outcome, the Greek economy is bound to rebound from hereon unless Greece unwittingly accepts the same type of deal or an unimproved deal from creditors which will be a real blow to all the sacrifices made by the common citizenry.
So the important thing is to get a good restructuring or simply walk out with the drachma.
Greece-Next Steps;Nothing to Fear
Greece-Next Steps; Nothing to Fear
What we need to fear really is fear itself-Roosevelt
While I am sorry for an extended hiatus from my blog due to other very urgent commitments, am glad to return with very encouraging turn of events of a clear Oxi to EU blackmail. The leak and final publication of the IMF report lays low German claims of alleged Greek perfidy. Post the Garibaldi like sacrifice by the ex Finance Minister, the responsibility is now completely in the court of the EU-krats. It is surprising to see that the autocracy is instead trying to turn the screws on Tsipras- the democratically anointed one. The Bloomberg.com link below is a case in point-
Notwithstanding what the paid media is upto, the economic analysis in black and white is as follows-
Probability Tree diagram of the Next Steps
With only p=19% probability that bondholders woukd suffer an adequate haircut and Greece debt would be restructured suitably, the potential rebound and inflation in the Greek economy is a measly 1%. This includes the scenario of Greek default and drachmafication.
However if the probability of restructuring adequately increases to 50%, the potential rebound would imply inflation at 2.1%.
The response function is illustrated as follows:
Obviously chances for a sustained Greece recovery and preservation of the EU area with or without Grexit improves with a more mature German attitude.
But whatever the outcome, the Greek economy is bound to rebound from hereon unless Greece unwittingly accepts the same type of deal or an unimproved deal from creditors which will be a real blow to all the sacrifices made by the common citizenry.
So the important thing is to get a good restructuring or simply walk out with the drachma.
ageofdeflation 