Educated opinion on current global fiscal crisis ..

New Zealand Herald, Wednesday March 19, 2008

By Brian Fallow



Stiglitz: US fiscal measures 'too little too late'

The United States financial crisis will get much more serious,
the Federal Reserve has little ammunition left and the kind of measures that
would help are unlikely to appeal to the Bush Administration, says economist
Joseph Stiglitz. Stiglitz, who won the Nobel prize in economics in 2001, is
a former chief of the Word Bank and chaired President Bill Clinton's council
of economic advisers. He was in Auckland yesterday to deliver a seminar at
the University of Auckland Business School.

The financial markets have been calling for the Federal Reserve
to slash the Fed funds rate by another 100 basis points overnight to 2 per
cent. The bank has also in the past week implemented further sweeping moves
to boost liquidity and bailed out Bear Stearns, a large investment bank.
"The Fed can keep the system from collapsing but it can't get the banks to
lend - to each other or to the market," Stiglitz said.

His recipe would be to stem the bleeding from the bottom by
bailing out the people who have been encouraged to take out injudicious
loans but now face losing their homes.

He thinks it is unconscionable that the shareholders of Bear
Stearns will walk away with US$250 million ($310 million), especially if the
remaining assets of the bank turn out to be garbage.

"We have mechanisms to
bail out the system without bailing out the banks,"

he said.

Stiglitz expects the situation to get much more serious as a
vicious circle develops with banks husbanding their resources, restricting
lending and deepening the downturn. A series of interest rate cuts and
liquidity-boosting moves by the Federal Reserve and other central banks has
so far failed to persuade markets that they have touched bottom.

Some commentators such as Paul Krugman have started to worry
about the risk of a Japanese-style liquidity trap where interest rates get
so low that monetary policy ceases to have any traction. Calls for the US
Government to take action have intensified. But the only fiscal measures so
far - notably a US$150 billion stimulus package - were too little, too late
and badly designed, Stiglitz said. The Bush Administration had vetoed more
effective moves, like increasing unemployment insurance to stimulate demand.
It might be useful to have a public body buying up property left
vacant by the housing market collapse in order to underpin house prices, he
said. But that idea had been vetoed too.

Stiglitz's latest book is a scathing attack on the Iraq war and
puts a figure of US$3 trillion on its ultimate cost. He sees parallels
between Washington's Iraq adventure and Wall St's innovations which have led
to the current turmoil in the financial markets: a kind of recklessness and
hubris, a readiness to offload costs and risks on to other people, and an
indifference to the human cost. "There are a lot of parallels."

FOCUS ON INFLATION 'A MISTAKE'

The Reserve Bank's exclusive focus on curbing inflation is a
mistake, says Joseph Stiglitz. "It's exactly the wrong mandate, especially
at this juncture," he said. "In a small open economy quite often raising
interest rates is counter-productive because it induces a flood of capital
into the country and doesn't have the dampening effect it would have in a
closed economy."

It is also ineffectual if the inflation is imported, like when
it reflects high international prices for oil and food. "Raising New Zealand
interest rates will have no effect whatsoever on Saudi oil production."
Stiglitz prefers the US Federal Reserve's dual mandate which
includes employment (and by extension economic growth) alongside inflation.
He also questions the wisdom of having almost all the country's banks
foreign-owned, seeing it as a potential risk to stability in the supply of
credit if the parent banks get into difficulties. "I don't think countries
should turn over control of the supply of credit to international markets."
He is not advocating a return to an insular economy. "But at
least part of the system should be deeply rooted at home." The current
devaluation of the US dollar might be necessary, in light of the large trade
and current account deficits the US had built up, but it had the effect of
spreading a lot of the cost of adjustment to other countries, Stiglitz said.
"US problems do become the world's problems."

John Bishop’s call (letters 24th March) to reintegrate the supervision and regulation of banks into the Bank of England is correct, but another department also needs to be brought within the Bank, the Debt Management Office (DMO). The DMO has the power to determine exactly the level of liquidity (that is balances at the Bank of England) of the banks. When liquidity is needed all the DMO has to do at the moment is to underfund the government’s huge borrowing requirement and the banks become awash with liquidity.

The Financial Statistics, Table 4.2A, show that in September 2007 the Bank of England decided to increase the compulsory deposits of the banks by £10,000,000,000, nearly a 50 per cent increase. Ideally the Bank should have had the power to instruct the DMO to underfund by the amount required, but it seems that instead the problem was dealt with by the Bank of England lending the banks that sum, using market operations to achieve it. So the Bank of England lent the banks a sum which it then accepted back as deposits. This of course sounds crazy until one realises that the lending rate of interest was higher than the rate on the deposits, so the difference became effectively a tax on the banks, that yet another ‘Stealth Tax’.

Because the DMO overfunded the National Debt, it was inevitable that the banks did not have the cash to lend to Northern Rock, an excellent bank with an extremely sound balance sheet but whose creditworthiness had, according to the report of the Treasury Select Committee, been inadvertently prejudiced by the BBC which linked the Northern Rock’s need for a standby credit, a routine operation in the circumstances of the activities of the DMO, with the Subprime Crisis in the US. The Northern Rock had no sub-prime lending as it was passing all borrowing enquiries of that nature to Lehman Brothers, as was at least one other mortgage bank.

I need not inform your readers of who was responsible for creating the current incompetent system of monetary management. They will surely need only one guess.

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There is no subprime crisis here - yet. Our banks have had to provide for losses in America caused by what looks like the biggest fraud of all time, but no increase in British loans going bad. Northern Rock's finances were in great shape, with a lower than average impairment experience but it ran into trouble because of what the BBC said. Yes it had a standby facility at the BofE but no doubt the cause of that was the BofE's sudden dedcision to increase the compulsory reserve by 50 per cent. There would have been no problem if the BofE had had the power to instruct the DMO to hold back on funding to the tune of £20bn.

However The FSA has decided to don sackcloth and ashes, but really it is not to blame for the fiasco. Everyone has been talking rubbish on the BBC a few minutes ago, showing how rare is the understanding of how the credit system works. Perhaps we should offer them all a course, starting with invention of shubati.

No-one seems to realise that 'liquidity' comes from government debt and nowhere else. If the government has no debt, as in Australia, it has to buy assets from the banks to create a debt to them, but in the US and the UK this line of action is not needed.

What happened at Bear Stearns is that the banks took $10bn from it to increase their own liquidity. That put Morgan in a position to buy Bear Stearns on the cheap as it had the liquidity to cover the deficit. Presumably Morgan had not been bled of liquidity in the way the British banks have been.

Geoff Gardner

Britain is subsidising the US by £20bn. a year but in turn is receiving £50bn from others.

'Liquidity', that is credit balances owned by banks at the FED or BofE , are government debt, so if liquidity is short, let some of the government deficit go unfunded until the banks have the cash they need, and if some banks are still short the others will have a lot and must lend it to them or go without interest. Surely this is far better than the present crazy system where the FED or BofE lends to the banks at 6.75 per cent so that the banks can have the compulsory reserves of cash which earn them only 4 per cent. It could of course be another of Gordon Brown's 'Stealth Taxes'.