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The Government’ s Faustian Bargain with the Banks.

The Government’ s Faustian Bargain with the Banks.
14 Jan 2010
JR Max Wheel

The press is littered with comment on banker’s pay. Stephen Hester’s defence at the Commons Select Committee reveals just how distorted the logic has now become.

Bailing out the banks was clearly required to avoid the loss of depositor funds and a corresponding economic implosion. What was missing was the quid pro quo.

The argument started with Northern Rock where after its nationalization the focus was in protecting taxpayer’s money. This has now spectacularly misfired when extended to the other quasi state owned banks. Hester rightly points out that the Government is now the prisoner of the market.

If the market chooses to reward bankers at ludicrous levels, then in order to preserve quality staff RBS has no choice but to pay the going rate. This follows from the expectation that the taxpayer will (ultimately) be repaid the funds used to bail out the banks as with Northern Rock. This however is to compare apples and pears, RBS and Lloyd’s Banking Group were not nationalized despite enormous sums being provided in emergency capital and asset and liquidity support systems.

Hester argues that his level of remuneration (approx £9.6m over 3 years) would be recognised even by his parents as being excessive. It is, but crucially not so in the parallel universe that is the global banking merry-go-round. Governments on both sides of the Atlantic missed a major opportunity to re-align remuneration with reality in their near panic to stop the banks’ collapse. Nothing material has been extracted in return from the banks in return, who also continue to sit on over-valued assets, having done little to tackle the toxic debts traded so widely. This is inexcusable. Take a look at the growing row over complex mortgages (option ARM- or option adjustable rate mortgages designed ostensibly to cope with borrowers with highly variable incomes) in the US. The state of the US housing market is still so volatile that it is a time bomb under the now heavily concentrated banking system and which could easily be transmitted to the UK and other markets.

It used to be argued that the evolution of capitalism was the replacement of owners by professional managers. This has proved wide of the mark in the financial sector, the Government’s may technically own a majority stake but the real owners appear to be the over-rewarded bankers, whose political and economic clout is undeniable. This system must be broken up or the too big to fail danger will revisit us sooner than we think. It is in the nature of fractional reserve banking to provide via leverage huge returns on successful trades. These have little to do with individual skills in the most part and a great deal to do with the nature of our banking system. It is not enough to see whether a division has performed well or ahead of budget as Mr. Hester argues but a great deal to do with whether the banks will be permitted to try to grow their way out of trouble. In which case expect more bonuses, the blame for which can be firmly placed at the feeble reaction of Government and regulators to exert a serious grip when the system was on its knees.

Regulation – the wrong debate

By Graham Reid & JR Max Wheel
16 November 2009

14 Months after Lehman’s collapse, neither national nor international agreement has been reached on future financial regulation,.
Why not? Because nearly all debate has been with the wrong agenda and Darling’s proposed Financial Services Bill merely perpetuates the attack on Banks and Bankers without proposing solutions to any of the serious issues.
What is needed is real leadership not political posturing. What problem ever got solved by arguing about the details before agreeing the objective?
The real debate starts with “who should do what?”
G20 should accept the fact of a global financial industry and focus on getting agreement on a principles based macro-prudential framework, not the detail, to underpin day-to-day regulation at National level. They have been long on rhetoric but short on implementation. Why? Because there is no framework in place to ensure that agreed policies are followed through. This failure to allocate responsibility is the major cause of delay.
They require an agency to carry out their decisions. This could be newly created or an enhanced IMF with teeth to impose sanctions. FX manipulation by individual countries or blocs should also be within their remit hence they should move towards national currencies being measured on a purchasing power parity basis to an agreed global monetary standard to include a mix of major currencies and a basket of commodities. This effectively stops Governments from gaming and debasing their currencies.
Central Banks and National Governments (or supranational for the EU) should concentrate on setting their national rules and reporting demands within the agreed principles, albeit bearing in mind the desire to remain competitive internationally, and ensuring regulation is a dynamic process.
They should authorise banks and all major financial institutions, including insurance companies given the overlap between product areas thereby giving them real teeth to impose sanctions or close them down if so required. Banks head-quartered in a particular country should have the absolute responsibility to ensure compliance of all divisions even those working in another jurisdiction.
Most countries have far too many regulatory bodies with conflicting responsibilities, notably the US and UK. They have failed in their primary duty; a serious cull and radical overhaul must be made.
Whether you need super regulators is a moot point – very difficult to achieve and frankly more problem that it is worth if national regulation is effective. Information and statistics need to be up streamed from national levels to the macro-prudential level. This means targeting actual or potential bubbles not avoiding them and would be a first step to restoring sense.
We must not forget that the US will have spent 12% of GDP propping up the financial system and the UK over 13%! Money supply growth and velocity of circulation are still very weak or falling despite this huge injection of public money – something is wrong and expectations of inflation and deflation remain finely poised. The first essential of currency is that it is a means of transaction and a store of value. Restoration of sound money must be a core aim of policymakers. There are serious signs of loss of confidence in the fiat money system.
As G20 are the self-appointed economic policemen they must additionally address problems associated with asset bubbles, trade and fiscal imbalances, and to force the vital issues of trade reform that WTO is incapable of doing.
Taking specific examples shows how misguided the debate has become
The UK Government has given highly conflicting directives; lend more but rebuild the capital base, retain competiveness but don’t pay bonuses for outperformance, restrain foreclosures but clean up bad debts.
All countries would regard protecting the national economy and taxpayers to be of paramount importance whilst ensuring a vibrant financial sector giving fair reward to customers, employees and investors alike. If this mantra is followed, sensible regulation follows more easily and Government intervention on employment contracts becomes an irrelevance.

Banks agree to global levy- a pebble in the pond?

The weakness of the nation state
30 January 2010
The banks’ apparent agreement on a future global levy, drawn through gritted teeth in Davos seems to indicate that at last that some are beginning to get the message. Better than nothing or the lesser of two evils – agree to a plan over which they might have some influence or have it thrust upon them by politicians using the popular backlash, which for once seems to have stiffened their resolve.
Amongst many disconnects brought about by globalisation is one that goes to the heart of economic orthodoxy-free trade, whether as understood by David Ricardo or originally state-sponsored, later private buccaneering by the English or Dutch East India companies. Economic policy making remains resolutely national, whilst the modern transnational corporation thinks and acts in a totally different manner. They are quoted on a variety of major exchanges; their capital is owned by institutional and retail investors from across the globe. They have the power to switch production and hence real capital and jobs between countries almost at will and are in effect, and irrespective of their founding origins, citizens of no country and hence not controllable by national governments, since they cannot be said to hold national interests as being paramount or even relevant.
This is at the core of the debate about bank regulation, since getting serious global agreement and perhaps more importantly policing it, is still virtually beyond reach. This is especially important in respect of banks or better put, global financial corporations, since this picks up the highly influential shadow institutions due to their ability to influence direction of capital flows through information, “ownership” of the means of transmission, affecting prices from commodities to exchange rates.
This power of course is not limited to financial corporations, but applies equally to mining, oil and gas, timber, food and pharmaceuticals though to defence goods.
To some extent this explains the reluctance of bank leaders to recognise their responsibility in respect of the millions of individual actions and transactions, for which they are the means of expression/transmission, as well as their own proprietary actions.
National Governments, even ones as large and powerful as the US are left flat-footed in response. Only, it seems, do centrally –controlled ones have the necessary grasp on the levers of power, as in China. Smaller countries are simply steamrollered, Iceland, even the UK. This asymmetry is hardly new and has been extensively commented on mostly by opponents of globalisation. Business is global; therefore the decisions and actions taken by corporations are in the narrow sense entirely logical. However the concomitant problems are also global, whether this means the felling of forests, strip mine land degradation or financial meltdown.
There is a gulf between the legislative reach of nation states and the largely weak supranational organisations. This might have been acceptable in a less economically interconnected world, although we now understand how much this means in terms of eco-systems. It is now extraordinarily vital for leaders to look beyond narrow interest and realise just how disenfranchised national governments have become, let alone their hapless citizens and equally how mega corporations bear wider responsibilities- bankers accepting the notion of a levy is a start, but I suspect it may be seen as a process which can be influenced, an entirely logical response, as argued.
Bodies like G20 must restore some symmetry in we are to avoid a repeat of the Great Recession and create an appropriate management architecture.

Currency Wars and the urgent need for a stable reserve currency

January 10
By Graham Reid & J R Max Wheel

In recent weeks ahead of the next G7 meeting and January jamboree in Davos, world leaders and finance ministers are increasingly exercised over gyrations in major currencies and the unwillingness of surplus countries to expand demand and permit currency appreciation, a prerequisite for sorting out the global imbalance issues that have dogged the global economy.

President Sarkozy has called for an end to “currency disorder”.

Dominique Strauss-Kahn, the managing director of the International Monetary Fund, restated his view that a new global currency might evolve out of the Special Drawing Right, the Fund’s in-house unit of account. “In a globalised world there is no domestic solution,” he told a forum.
A former IMF chief, Michel Camdessus, said time was of the essence to embark on reform of the global monetary system.
Chinese central bank governor Zhou Xiaochuan has proposed that an expanded SDR could eventually replace the dollar as the global reserve currency.
Joseph Stiglitz’s UN expert panel said an SDR-based reserve system “could contribute to global stability, economic strength, and global equity” and “would be feasible, non-inflationary, and could be easily implemented.”
The UN Conference on Trade and Development (Unctad) 2009 report called for the creation of a new global reserve currency. While calling the dollar-based system a “confidence game” of financial speculation, the UN called for a new global reserve bank to manage the new currency.
The latest is Canada’s Jim Flaherty whose role is important as Canada avoided the worst of the excesses and it is to host the next round of G7 meetings in February and the G20 summit in June.

The writers have long held the (minority) view that the US economic hegemony is over and with it the exclusive role of the US$ as the world’s reserve currency. We have argued that an enhanced role for the IMF and the SDR is essential to prevent currency manipulation by Governments whether by apparent indifference or outright refusal to allow appreciation in a new game of beggar thy neighbour by the major economies.

It is not a new concept. Hang-sheng Cheng, Fed Reserve Bank of San Francisco, wrote an article “Emerging SDR standard?” in 1975 addressing the issue of currency swings when floating exchange rates were a novelty. It points out what it is obvious but which should be taken on board by policy makers again as they tear up their textbooks. Depreciating a currency will obviously make exports cheaper and imports more expensive, but more importantly reduce real incomes and increase domestic inflation, assuming a reasonably open economy.

One landmark effort to “manage” exchange rates was the Plaza Accord of 1985 when a fierce squeeze instigated by Mr. Volcker led to major $ appreciation and ballooning of the US current account deficit, especially with Japan. Coordinated action by the major Central Banks lead to a 51% decline in the value of the US $ against the yen.. The World has moved on since then, for Japan, read China. The chances of another Plaza Accord look very remote. Hence a new standard is needed, the SDR can and should in our view fulfil this role.

The Chinese Government amongst other dissatisfied bodies has openly argued for an SDR standard: whilst this reflects a substantial degree of self interest given the volume of claims denominated in US$ and held as reserves, there is a serious issue behind this call.
A global economy must have a global standard of reserve asset. The US$ cannot usefully provide this any longer, except as part of a wider basket of currencies and possibly commodities.

Each time this is mooted, it is argued that this cannot be achieved. The arguments are part technical, it is a unit of account not a currency, it would have to have liquid spot, forward and futures markets, a proper yield curve like major currencies. The other and far more serious objection is political. Carnegie-Mellon Professor Bennett McCallum addressing the Cato Institute Shadow Open Markets Committee in April 2009 argued that it was foolish to hand over control to the IMF and by extension to the UN, “based on its political structure, which would reduce US influence”. Attempts to try to influence or force surplus countries into currency appreciation are doomed to failure.

This is precisely what is needed; a global system cannot rest on the naked self-interest of a single country. The G20 effort to increase SDR issuance deserved half a cheer, it now needs to look seriously at this alternative to stop countries’ blatant attempts at manipulation and to expand the currency basket to include the currencies of all the significant trading nations as a minimum. One final point: use of an SDR standard would imply an implicit subsidy from surplus to deficit countries. That might just focus minds of the unwilling participants.

Beware of Greeks bearing “gifts” – debts?

15 February 2010
JR Max Wheel & Graham Reid
The Greek debt drama has shone a searchlight on the near complete absence of an adjustment mechanism in the Eurozone. Many of us remember the overtures of M. Jacques Delors in the 1990s to bring the UK into the €, which was rightly rejected. What we cannot dismiss is the fact that Delors correctly argued that EPU- political union or at least a fiscal arrangement was a necessary concomitant of EMU-monetary union. Certainly political union was never going to work for the UK but then much of the EU rhetoric is watered down to more practical steps of which a fiscal balancing mechanism was the minimum requirement.
It gives me little pleasure to recall arguments with Bank of Spain officials that this was a serious, even fatal flaw, nor the political expediency views of US diplomatic officials in London that we, the UK should be “in there” – the € that is.
The Greek economy is of course, as well-known, notoriously lop-sided since a good deal of its wealth- exactly how much is hard to measure, resides offshore, thus tax takes on the wealthy are minimal.
The use of cohesion funds to drag up the living standards of poorer Southern European countries as well as the Irish Republic was a perfectly legitimate policy, albeit one that was often subject to outright exploitation. This has now lead to what has been nicknamed “debt intolerance” which probably should be renamed debt tolerance, since it is always easier to keep borrowing than take the politically unpopular route of adjustment and fiscal prudence.
Once embedded in the psychology of politicians, this is almost irreversible, barring a situation like today.
The EU response to date has been nothing short of irresponsible in the extreme. One hopes that tomorrow’s meeting will bring some clarity, but thanks to the Lisbon and Maastricht treaties a “bailout” for fiscal incontinence is a no-no (article 125). Hence a political fix is almost a “given,” short of “booting” the Greeks out of the €, which would be unfair.
Why does it take so long to learn such lessons? Go back to 1925 and Britain’s ill-fated attempt to return to the Gold Standard at the pre-war parity. Keynes in an incisive and highly critical essay-“The Economic consequences of Mr. Churchill” pointed out the folly. An overvalued and inflexible exchange rate results in the only possible solution being that adjustment has to take place by a drop in real output and wages, short of there being a drop in the price of gold. The downward adjustment of real wages HAD to precede the drop in the cost of living to effect this change. This is clearly unacceptable, as is the increase in pension age, today’s new internal fix. The analogue today is the falling value of the € against most major currencies. This is not some happy coincidence, naturally leading to increased exports for Eurozone major economies through competitive devaluation. Many of the weaker or heavily indebted are energy deficient and rely on USD denominated commodities for essential imports.

Spain’s situation as a significantly bigger economy is even more worrying. Unemployment is approx 20% of the workforce, the Madrid Government is under serious pressure, and Spain’s largest banks embarked on an unprecedented investment foray into Latin America, where they own some of the biggest and most powerful banks from Argentina to Mexico. Given the alarming state of Spanish real estate and construction, always a major driver of growth in recent years, the consequences of any problems arising in Latin America will impact directly on them. Portugal and Ireland are also deeply mired in debt, So, is the whole Euro project edifice about to implode? If you listen to many hedge fund managers, yes it is a better than evens chance.
We have long argued that the Great Recession or whatever you wish to call it, would end up in currency wars, the modern day equivalent of beggar my neighbour policies of the 1930s.
It is not merely the Eurozone that demands a rethink and radical overhaul, it is the whole nationally based system of fiat money at stake. The US could claim that its post WWII economy enabled the USD to play the role of an international reserve asset currency. This is no longer the case since its national and international monetary interests have been diverging for years. We proposed (to considerable initial derision) a new SDR standard, which we will revisit in more detail in a further article setting out some practical steps along that stony path.

Addendum: Greek offshore economy.

It seems that at least one independent estimate puts the figure at approx 30% of the size of recorded GDP. According to The Observer, see Will Hutton article Observer:14/2/10, the shadow economy — i.e. the non-tax-paying element — runs at 30 per cent of the total: “Uncollected tax runs at 13.5 per cent of national output per year – more than the deficit. The Civil Service is over-manned and corrupt. Everyone mercilessly tries to profit at someone else’s expense.” If so that would up the level of GDP from approx $ 343bn(2008 nominal) to $445bn approx $102bn base on declared 2008 GDP That figure would have to be adjusted downawards by approx 6-7% due to the effects of the downturn.

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