Thursday, 19 February 2015

Could Greece sue the ECB?

One thing I've noticed about the European Central Bank (ECB) is that it likes to publish woolly worded documents and then brief its preferred interpretation of them to those who hang around in the lobby. Those then get written up and disseminated to become The Truth in the classic repeated assertion fashion by people who like to get paid and no doubt wined and dined, but not think too much.

Thus the ECB acts in a political fashion as the politically independent entity it is within the European Union.

But it is not legally independent. It is governed by statute and the treaty and importantly subject to the control and jurisdiction of the National Courts within each member state (ECSB Statute Article 35) and the European Court of Justice.

There is a provision within the Treaty (Article 340) that states: "the European Central Bank shall, in accordance with the general principles common to the laws of the Member States, make good any damage caused by it or by its servants in the performance of their duties."

So we come to the thorny issue of Emergency Liquidity Assistance (ELA) and the rules governing it. There is no lender of last resort function delegated to the ECB within the ECSB Statute, and that means that function is delegated to the National Central Banks (ECSB Article 14.4).

The preferred interpretation of the rules put out by the ECB is that the National Central Bank has to ask for permission before issuing ELA. That is not how the rules are written. Lender of last resort is a National Central Bank competency and  "Such functions shall be performed on the liability of national central banks and shall not be regarded as being part of the functions of the ECSB".

So when handing out ELA that is not something the ECB has any say over. What it does have say over is whether such an action interferes with the 'Objectives and Tasks of the ECSB'. So what the ECB asks for in this instance is data so that the governing council can decide if things are being interfered with.

Providing that data however is a bureaucratic nightmare, so the rules provide an option to the National Central Bank to allow it to ask the ECB for ELA clearance. It has to refer itself to the governing council to ask for that clearance. What the clearance does is absolve the National Central Bank of the requirement to report ELA transactions until the value exceeds the determined amount.

So the ECB can only direct the National Central Bank to stop making ELA payments if it finds, by vote of the council, that the action would be in breach of the 'objectives and tasks of the ECSB'. Of course if they do that then they collapse the payment system in that member state. Yet Article 3.1 of the ECSB statute states that one of the 'basic tasks' of the ECSB is 'to promote the smooth operation of the payment system'.

It is not within the jurisdiction of the ECB to complain if commercial banks decide to purchase forms of government debt on the open market, or if a national central bank managing those commercial banks considers such debt to be perfectly sound for the purposes of its local operations even if the ECB doesn't for supranational purposes. Those are commercial decisions made by those entities.

IANAL, however I would submit that should the governing council of the ECB decide to withdraw ELA from any member state they are in breach of their duties under the statute of the ECSB and therefore liable for any damage caused to the member state. And they can be sued for that in the national court of the member state concerned.

Tuesday, 17 February 2015

Greece and the Art of Liquidity

The war of words with Greece is hotting up. The spin is so great I'm surprised nobody has been sick yet. It's like a fairground waltzer gone mad.

There have been at least six arbitrary deadlines that have come and gone all of which individually signalled 'The End' for Greece and all of which had no effect whatsoever.


Because it is all political rhetoric attempting to frighten the Greek people who, as usual for a people under threat, have doubled down and backed their elected government against the bunch of unelected bureaucrats who have got rather too big for their boots.

Let's look at the reality of the situation. The Eurozone is, at its root, a three layered hierarchy of liability pegs that make the liabilities of all the members the same effective value - which we call the Euro.

Firstly you have the commercial banks in each country. Those all clear their payments via the local National Central Bank. The National Central Banks (NCB) then have an account with the ECB on the TARGET2 system. In return for that they agree to follow the ECB's missives over interest rates and quantities.

In Greece's case the NCB is the Bank of Greece, and it is currently issuing Liquidity Assistance to the Greek banks as deposits leave the Greek banks and go elsewhere in the Eurozone - via the TARGET2 system.

Nothing will happen until the ECB takes a vote at the governing council to suspend Liquidity Assistance to the Greek banks, gets a two third's majority and the Bank of Greece obeys that instruction. There is no guarantee that it will, or will be allowed to by the Greek government, in which case the Greek banks can carry on clearing Greek payments like have before via liquidity assistance from the Bank of Greece.

The only actual sanction the ECB then has is to turn off TARGET2 clearance access and effectively remove the peg between German Euros (let's be honest about who is in charge here) and Greek Euros. At which point Greek Euros start to float.

And all that means is that for a Greek to pay a Spaniard they would have to exchange Greek Euros for German Euros via a third party transaction. Since the transactions are currently well matched, that's a nice little profit opportunity for some enterprising financial organisation.

Of course if the ECB pull the plug, then all the ECB imposed restrictions on the Greek central bank disappear at the same time. The Greek clearing system carries on as before and as we know from MMT a central bank issuing its own liabilities can maintain the banking system pegged to those liabilities for as long as it wants.

But I doubt that will happen. When it comes to pressing the big red button I suspect the bureaucrats will get very cold feet. Particularly if the Greeks are politic enough to assign a few names to that decision rather than allowing them to hide behind the decisions of a committee.

Which then leads to the other side of the whipping table. The so called 'running out of money' argument. Again this is so naive as to be laughable.

It helps if you realise that governments effectively spend bonds.  Then it all becomes clear. There is never an issue with Greece paying anything for as long as their paper is exchangeable for Euros. And there are a couple of very important drivers that make that likely to happen.

Firstly the IMF needs repaying. When you repay the IMF you have to pay them in their currency - the SDR. So what you do is take a bunch of Euros and ask the IMF for some SDR. The IMF then ring around those countries who hold the SDR in issue and get somebody to sell some for Euros. They always can because there are 'market making' requirements in play. The end of that transaction is that some countries have Euros, and the paying country has a deficit which it fills by selling bonds for those very same Euros (possibly via intermediate transactions within the Eurozone).

The IMF has its own liability back and the asset and the liability disappear in a puff of accounting logic (onto the allocation list on the IMF balance sheet in this case). Along with the income stream attached to that asset.

Secondly the ECB is about to undertake €60bn of QE every month starting 'no later than March 5'. What that means is that the overall system will become short of income earning assets as government bonds are drained by the central banks. Greece may be excluded directly from this process for the time being, but importantly it is the only government in the Eurozone that is on an expansion footing. Everybody else is busily digging their own graves by reducing deficits and other such nonsense and so is issuing as little as possible.

So that leaves new Greek government bonds as pretty much the sole source of anything resembling an interest rate in the whole Eurozone. It will be a very interesting test of 'liquidity preference' to see whether all this money that costs banks money to hold on deposit will stay there or whether they will be tempted by the Greek offering.

In other words it ain't over until the Fat Lady fails to show up at the bond auction.

Plus there has to be somebody prepared to press the nuclear button at the ECB - which is very likely to result in the end of the organisation and everybody's job there.

If I were Greece I'd push them all the way this time. There is nothing more to lose other than the chains that bind the nation.

Let's see how brave the bureaucrats are when their job is on the line rather than the countless millions in Greece and across the continent.

Thursday, 22 January 2015

Eurozone QE - making a bad problem worse?

So after much gnashing of teeth the ECB has finally capitulated and is going to start buying government bonds from the market in a desperate attempt to be seen doing something useful.

Of course they have swallowed the line that somehow this is going to increase bank lending across the continent and generate a 'wealth effect'. Of course it isn't because they have their causalities completely the wrong way around.

However the string pushing will no doubt continue until morale improves.

But there is an 'interesting' artefact about to happen due to the way they are planning on structuring their purchases.

The ECB is going to purchase €60bn of government bonds per month "on the basis of the ECB’s capital key". Which is the amount subscribed by the various national banks. In other words on a strict market value basis, the percentage of funds allocated to each country's government bonds will be determined by the capital share ratio.

Similarly the income of the ECB, which will quickly include a very large amount of bond income, is also distributed by the capital key.

The problem is that 10 year German Bunds are at a yield of 0.54% and Greece is 9.22%, with the others in between. And that means that when you add up the income from the bonds Germany will be contributing relatively less to the pot and Greece relatively more. Which when it is split out again as a distribution according to the capital key means that Greece will get back less income than it paid to the ECB in bond income and Germany will get more.

In other words the design of the ECB QE scheme will remove interest income from the private sector paid for by the tax revenue of the member states and then move that tax revenue from the smaller states to the German state - who will then save it.

That means the Germans are likely to have to issue less bonds, whereas the smaller states have to issue more and the dynamic may magnify as the months progress.

Whether the effect is significant I don't know. But it certainly isn't the correct way around.

Friday, 2 January 2015

UK Sectoral Balances - Q3 2014

I've updated the spreadsheets with the latest UK Q3 data from the national accounts and as we can see the domestic private sector is almost in balance with a greater %age of GDP in the error residual than net saved by the domestic private sector:
Even more strongly than last quarter each sector within the domestic economy is running a 'balanced budget' - leaving the government sector to provide the offset for foreign net savings in Sterling. Obviously it is important to point out that these are aggregate figures, and that can hide a lot of the specific detail. Because the aggregate is so enigmatic at the moment we would have to delve deeper to see what is going on.

Source: Office of National Statistics, tables RPYH, RQAJ, RQBN, RQBV, RPYN, RPZT, RQCH, DJDS (Seasonally adjusted Net Lending/Borrowing per sector plus residual error) and YBHA (Gross domestic product at market prices, seasonally adjusted). Data and calculations are available online

UK Private Debt Levels - Q3 2014

I've updated the UK sectoral data spreadsheets with the Quarter 3 data and the public debt graph now looks like this:
That's right. Pretty much identical to last quarter, which means that the credit accelerator function has leapt back into positive territory - just:
So the trend is broken, and we'll have to wait far too long for more data to see what happens - or delve deeper into the underlying figures.
Source: Office of National Statistics. Private sector debt based on tables NLBC, NKZA, NNQC, NNRE, NNXM, NNWK, NLSY, NLUA, NJCS and NJBQ (Lending and securities per sector, not seasonally adjusted) scaled by BKTL (Gross domestic product at market prices, not seasonally adjusted). Data and calculations are available online

Tuesday, 16 December 2014

Russian Roulette

The Russian authorities are following the neo-classical, 'sound money' playbook by the letter right down the drainpipe.

It didn't work for Argentina.

It didn't work for Turkey

So let's do the same thing all over again and expect a different result. What was that definition of insanity again? Something about truth by repeated assertion and thereby constantly misattributing a quote.

Currency markets are very simple. It's raw supply and demand. There are no market makers and every open trade has to be settled with delivery of the currency at 10pm GMT every day.

That means you have to get hold of the real thing and give it to somebody else or get out of the market. So the actual final liquidity in the market that allows things to move comes from people actually changing what they hold over a daily basis. Those playing Contracts for Differences and throwing 'forward next' are just greasing the daily wheels with liquidity. Overall net short positions from an aggregator still have to be delivered. You have to supply roubles and take US dollars. That means getting the roubles in the first place and is an obvious control point in the system.

The overall effect of the current crisis is that the rouble currency area is shrinking. Currency areas are not necessarily the size of the country that owns the currency. They can be bigger or smaller than an individual country. What size they are depends upon how the country uses the monopoly power of the currency to influence activity.

In Russia you are getting 'dollarisation' where people are giving up their rouble savings to hold USD. That expands the USD currency area into Russia and shrinks the Rouble currency area. And it is also the supply of those roubles the shorters need to cover their delivery positions.

As usual jiggling around with interest rates will not sort this situation out. This is now a quantity and qualitative situation that requires you to make the rouble more scarce. Paying people more interest from the central bank or issuing more bonds is not the way of making something more scarce. I find it bizarre that central banks cling to the jiggling interest rate myth when the evidence around them is clearly demonstrating that that particular lever is not connected to anything useful, and probably never has been.

Shrinking currency areas need to either stop shrinking or have less currency in them. You need more demand or less supply.

The insights from MMT show that exports are a real cost and imports are a real benefit. The sanctions in place are stopping imports coming into the country. So there is no need for the exports. Russia should just turn the taps off, which would bring Europe to its knees in a second. That they haven't done that suggests that Russia has the same problem as Argentina - the country is actually run by an Oligarchy that prefers to operate their export industry mostly in a foreign currency. So actually you can discount the entire oil and gas industry as a different country almost - operating largely outside the Russian currency area.

The shortage of food and basic items brought about by the sanctions should be solved using a simple wartime approach - rationing. If there isn't enough buckwheat to go around, then you can't use price to resolve the distributional struggle. You'll end up with starvation and riots and stockpiling of food. So assuming you care, then you'd ration the real goods for which there is a shortage and work at relieving the supply shortage. Set a price limit and a quantity limit. Start issuing ration coupons. And ban imports of Leah Jets, etc. You don't need luxury goods when the country hasn't enough food.

In terms of financing the Russian Central bank has to narrow the scope of Russian banks. Any lending to settle currency transactions in roubles should be banned. The Central bank should bar itself from directly intervening in the currency markets. And it should not be doing swaps into USDs, but offering to settle foreign debts for needed commodities - like buckwheat.

In addition it should be offering financing in roubles to pre-pack administration proposals for any important business crippled by foreign currency debt. That forces losses onto foreign creditors in foreign currencies - as well as Russian USD holders. If you get moaning from foreign creditors blame the currency war. Then perhaps they'll put political pressure on their own central bank to act and stem the losses.

Beyond that the fiscal authorities need to start taxing in Roubles more - preferably the oil and gas pipelines. And then turning them off if they don't get paid. The power play in Russia determines whether that is viable. Beyond that taxing USD accounts held at Russian Banks in roubles would help eliminate balances in those accounts as would a financial transaction tax on roubles (offsetable against real activity).

Get the supply of roubles down, and the demand up - using the monopoly power of the government over the currency area. There are probably other things that could be done just as soon as you take the correct viewpoint.

And please let's can this idea that if you just set the interest rate at a particular level everything will magically calm down. People are not robots.

Thursday, 11 December 2014

How to eliminate the UK deficit - the trick revealed.

Magic RabbitIn the UK Labour has revealed how the trick will be done. How they will eliminate the deficit in the UK.

They will do it in the classic Labour fashion by...

...redefining the term deficit.

From now on when they refer to 'deficit' they mean the deficit on the current budget. Which of course means that any shortfall caused by private sector excess saving will be matched by government spending that can be classified as 'investment'.

A clever trick - if it can be pulled off. The problem of course is with the definition of 'investment', which generally doesn't include investment in human capital.

And that means that the expenditure will be on capital assets and intellectual property (or yet another fudge to redefine the term 'investment').

The increase in investment spending should bring down unemployment and increase the tax take which will close the deficit unless there is a sudden change in savings behaviour.

Of course as MMT warns, that approach is 'pump priming' at the high skilled/high capital usage level of the economy, which, if there isn't sufficient taxation or planning controls to free up those construction and development resources, will lead to supply-side shortages and wage spirals.

Given that we are in a mini building boom and you can currently earn a king's ransom as a bricklayer then there might be some rocky roads ahead.

And once you have invested in something you generally have to do something with it - which often requires an increase in the current budget to staff out the service. Of course if you limit the investment to capital replacement and stuff used solely by the private sector (roads and council houses spring to mind) then you can avoid a current budget impact.

But I will give Ed Balls his due. He did slip this into the speech in January if you look hard enough.

And I missed it.