Ferguson on Krugtron

A fun show is breaking out. Niall Ferguson on “Krugtron the invincible.”

Paul Krugman, for a while now, has been lambasting those he disagrees with by trumpeting their supposed “predictions” which came out wrong, and using words like “knaves and fools” to describe them – when he’s feeling polite. These claims often are based on a rather superficial, if any, study of what the people involved actually wrote, mirroring the sudden narcolepsy of Times fact-checkers any time Krugman steps in to the room. Niall has lately been a particular target of this calumnious campaign.

Niall’s fighting back. “Oh yeah? Let’s see how your "predictions” worked out!“ Don’t mess with a historian. He knows how to check the facts. This is only "part 1!” Ken Rogoff seems to be on a similar tear. (and a new item here.) This will be worth watching.

As regular blog readers know, I don’t think science advances by evaluating soothsaying. You make good unconditional predictions with very badly wrong structural models, and very good structural models make bad unconditional predictions.  The talent of predicting and the talent of understanding are largely uncorrelated.  The judgmental forecasts of individuals are poor ways to evaluate any serious economic or scientific theory.  I carefully don’t make “predictions” for just that reason. So, I don’t regard this cheery deconstruction effort as a useful way to show that Krugman’s “model,” whatever it is, is wrong. I also can’t see that anyone but the devoted choir of lemmings is paying much attention to Krugman’s mudslinging any more.  But it is nice that Niall and Ken are taking the effort to ask the great doctor if perhaps he also doesn’t need a bit of healing; perhaps they will force Krugman to go back to actually writing about economics. 

Update: Benn Steil Chimes in, this time on the Baltics, Iceland, and the supposed wonders of currency devaluation.

Rogoff on UK Defaults

Ken Rogoff wrote a very interesting FT oped on UK finances (FT original, Rogoff webpage if you can’t see FT.)

The issue: Should we worry about huge sovereign debts of advanced countries? Or was the only problem with fiscal stimulus that it was not big enough?


A little history:

Yes, from the 1800s until the first world war, the UK was a global superpower that commanded vast colonial resources and investments. Over long periods, these foreign assets yielded returns well in excess of interest on debt. But comparing government debt ratios back then, when the UK was a massive net creditor, to debt ratios today, when British foreign liabilities exceed foreign assets, is utterly misleading. Moreover, back in the 1820s, the UK was pioneering the industrial revolution; things are not quite the same today. Back then, the UK did not have to worry about pension liabilities or existential threats to the banking system that could require massive injections of cash to fix. …

During the 1930s, Britain defaulted on debt to the US accumulated during the first world war and its aftermath. …

It is often stated that after the second world war the UK debt reached almost 250 per cent of gross domestic product and was brought down merely through growth and inflation. This is a myth …

Then there is the high-inflation era of the 1970s – another de facto default. Last but not least, what about the UK’s serial dependence on International Monetary Fund bailouts from the mid-1950s until the mid-1970s? This is hardly a country with an indestructible credit status. …

Being a UK bondholder has had its ups and downs.

Looking forward, an important point: a country needs to be substantially below its ultimate borrowing limit, or it loses its ability to fight crises going ahead.

..a euro collapse would have triggered a stampede out once investors realised that the UK banks and trade would be savaged, a flexible currency notwithstanding. In that scenario, UK leaders would have been forced to close massive budget deficits almost overnight. That would have been truly catastrophic austerity. …

We now know the euro did not collapse. [yet – JC] With 20-20 hindsight, yes, the UK could have borrowed more. But we do not have hindsight at the moment decisions have to be taken. 

Kan and Carmen Reinhart have been at the receiving end of Paul Krugman’s tender commentaries lately, and I’m interested to see Ken taking up the issue. Krugman likes to lambaste people for “predictions” that he imagines they made which didn’t come out. On the euro blowing up, Ken seems to be offering a taste of his own medicine, made more bitter by the fact that Krugman actually did say what Ken says he said:

…This was the big call – the one that everyone was focusing on. To state that credit risk was gone by 2010 is ludicrous. None other than The New York Times columnist Paul Krugman prognosticated the euro’s early demise regularly from April 2010 to July 2012. His big call has turned out – so far – to be dead wrong.

I will be curious if we see more of that from Ken. Stay tuned.

Cyprus and Resolution Authority

Holman Jenkins has a revealing Cyprus update in today’s Wall Street Jounal. For those of you who haven’t been following the news, Cyprus’ banks failed, borrowing huge amounts of money and investing it in Greek debt (yes).  Cyprus was bailed out by the EU after a chaotic week, including an agreement that large depositors would lose some money, called a “bail-in.”


Since us economists have been saying that unsecured creditors and uninsured depositors should lose money when banks fail, it was sort of a watershed moment. I expressed some reservations at the political, discretionary, and chaotic nature of the bail-in. It turns out I underestimated that nature.

From Holman:

A few weeks ago, the Central Bank of Cyprus published a curious set of “clarifications for the better understanding of the resolution measures.” The principle of a bail-in—that uninsured creditors should suffer losses before taxpayers are on the hook—turns out to contain a few lacunae. “Financial institutions, the government, municipalities, municipal councils and other public entities, insurance companies, charities, schools, and educational institutions” will be excused from contributing to the depositor haircuts, though insurers later were removed from the exempt list.

There will be no haircut on the €9 billion ($11.8 billion) the European Central Bank injected, for political reasons, in 2012 to keep Cyprus’s Laiki Bank temporarily afloat—€9 billion that has now somehow become a liability of Bank of Cyprus depositors, whose losses are bigger as a result.
…
We should mention another possible offense, in a sense, against creditor priority in reports that certain connected customers withdrew funds just before the haircuts. A daughter and son-in-law of Cyprus’s president seem to make a good case that their transfer of €10.5 million to a London bank was a coincidence, but then they proffered a “voluntary haircut” anyway via a donation to a church fund for the poor. Hmm
…
we have to chuckle when legislators on Capitol Hill talk about ending “too big to fail"—as if there is any chance of stopping politicians from bailing out whatever institutions politicians decide their own interests require bailing out, or any chance of imposing legal order on what are invariably chaotic, highly politicized decisions in the heat of crisis.
…
Cyprus turns out to be a good template after all. Modern financial systems may be incompatible with the rule of law that mankind has labored so mightily to build over the centuries.

This all matters for our financial "reform.” Recall, lots of financial institutions were bailed out in 2008-2009, meaning really that their creditors were bailed out. (Normally, when an institution fails, who gets what is determined by bankruptcy law; the creditors become the new owners, the institution is suddenly recapitalized, and either continues or is carved up depending on what makes more sense to the new owners.)

On the theory that “bankruptcy doesn’t work for big banks” the Dodd-Frank law posits a “Resolution Authority,” composed of Administration officials, that will sit in the place of bankruptcy court and decide who loses money, with pretty much discretion to do what they want. To get paid off, make sure you persuade the “authority” that you losing money would be a “systemic” danger. It might help to have your campaign contributions up to date. I wrote about that danger in a Regulation article here.

The GM bankruptcy here is a small template. As Holman points out,  when politicians and political appointees have great power to decide who gets money and who doesn’t, watch out. Oh, no, I forgot; our political appointees are so much more uncorruptible than the Eurocrats that sort of thing can’t happen here. (That was a joke)

His last two paragraphs are better than anything I can write. Go read them again. My one disagreement: Modern financial systems are fine. Modern political systems have abandoned rule of law in favor of a monarchic rule by discretion of appointed bureaucrats. That is incompatible with any financial system.

ECB dilemma

It was announced yesterday that  Europe will have a new, central bank supervisor run by the ECB, much as our Fed combines monetary policy and bank supervision. Be careful what you wish for, you just might get it.

One big unified central agency always sounds like a good idea until you think harder about it. This one faces an intractable dilemma.

Here’s the problem. Why not just let Greece default?“ is usually answered with "because then all the banks fail and Greece goes even further down the toilet.” (And Spain, and Italy).

So, what should a European Bank Regulator do? Well, it should protect the banking system from sovereign default. It should declare that  sovereign debt is risky, require marking it to market, require large capital against it, and it should force banks to reduce sovereign exposure  to get rid of this obviously “systemic” “correlated risk” to their balance sheets. (They can just require banks to buy CDS, they don’t have to require them to dump bonds on the market. This is just about not wanting to pay insurance premiums.) It should do for the obvious risky elephant in the room exactly what bank regulators failed to do for mortgage backed securities in 2006.


Moreover, it should encourage a truly European market. Greek, Spanish, Italian banks failing is no problem if large international banks can swoop in, pick up the assets, and open the doors the next day. Bankruptcy is recapitalization.  Greece needs a national banking system as much as Chicago (same population) does.

All well and good. And all diametrically opposed to the ECB’s “crisis-fighting” agenda. The right arm of the ECB should be protecting the banking system in this way. But the left arm of the ECB is using banks as sponges for sovereign debt.

In trying to manage the sovereign debt crisis, the ECB has bought huge amounts of sovereign debt. It has lent  euros to banks that in turn have bought large amounts of sovereign debt (often, I gather, with not so subtle pressure from their governments).  It has lent more euros to the same banks to replace deposits that are quite wisely fleeing out of those banks.

How can the right arm protect the banking system from sovereign default, while the left arm wants to stuff the banking system with sovereign debt?

Converesely, how can the left arm do anything but print euros like mad, now that the right arm has responsibility for the banking system?  Lending to banks who buy sovereign debt was always excused by the idea that the bank shareholders bear the credit risk and national supervisors take care of that problem. Now it’s in the ECB’s lap. Politically, can the ECB really shut down national banks, stiff the creditors, and let them be taken over by big pan-european banks?

I bet on the outcome: print euros like mad, keep pretending sovereign debt is risk free, and prop up existing banks. Let’s hope I’m too cynical. For once.

Unraveling the Mysteries of Money

Harald Uhlig and I did a fun interview run by Gideon Magnus (Chicago PhD) at Morningstar. We talk about the foundations of money, fiscal theory, monetary policy, European debt problems, etc. Gideon framed it well, and Harald is really sharp. Somebody combed my hair. A cleaned up version of the interview appeared in the Morningstar Advisor Magazine (html) (A prettier pdf)



A link in case the video doesn’t work or doesn’t embed well (if you see “server application unavailable” the link usually still works), or if you want the original source.

The video starts a little abruptly, as it left out Gideon’s thoughtful introduction (it’s in the Magazine) and framing question:

Gideon Magnus: I want to discuss the value of money and the idea that money is valued similarly to any other asset. Are there really assets backing money? If so, what are they? John, please explain.

Bad Hair Day

A short interview by Betty Liu on Bloomberg TV: (if that doesn’t work a link). The ECB’s big bond buying program, how “sterilizing” won’t solve everything, and discussion of the WSJ Oped on the future of the Fed