Tag Archives: Currency

The power of the European Central Bank

With inadequate fiscal policy, monetary policy labors to compensate, creating damaging economic distortions in the eurozone market.
By Bercan Begley – The pandemic has left millions of Europeans out of work and many underemployed, their businesses partly closed. Yet some are flourishing as never before. For European bourses, it has been marvelous. As the price of stocks has climbed, so has the wealth of those who own them.

Never have we seen such a disconnect between the real economy, the home of democracy, and the financial markets, the domicile for capitalists. And one institution has been at the centre of it all—the European Central Bank.

The ECB is perhaps the most powerful yet least understood institution in the eurozone. It has the power to engender economic, social and political change. Following the global financial crisis, the bank embarked on an epic experiment in monetary economics.

Two levers

There are two macroeconomic levers: fiscal and monetary policies. Before the introduction of the euro, both largely belonged to European Union member states. With monetary union, monetary policy moved to Frankfurt, centralized in the headquarters of the new ECB. Fiscal policy, such as tax-rate formulation, belonged to member states, but under the Maastricht treaty’s Stability and Growth Pact the European Commission supervised.

The lead-up to the crash saw profound capital misallocation in the eurozone. Pre-euro, ‘currency risk’ tempered financial venture-taking. A Munich-based bank would undertake due deliberation before converting Deutschmarks into Irish punts, due to the variability of exchange rates. Currency volatility played a risk-mitigating role, moderating investment allocation. Foolhardy owners of financial assets bore their losses and had no compensating recourse to the political domain. more>

Why the EU needs interoperable digital wallets

By Lars Rensing – Recently, the news emerged that the EU Commission had proposed a new framework for the introduction of European Digital Identity. This framework proposal represents an interoperable EU digital ID, which will be produced by the individual Member States. These IDs will be linked to national digital IDs, and the announcement demonstrates how the EU is looking ahead by working to establish a European-wide digital ID system.

Something that will be included in this framework is the creation of a digital wallet, which will enable users to present their IDs digitally to access cross-border services. Digital wallets also help citizens regain control over their personal data. These wallets hold users’ digital identities, so they can then choose who they share information with.

However, the current production of these wallets will be the responsibility of each individual Member State, using whatever system they see fit. Using different systems for digital wallets could cause problems for citizens, though, when they need to access cross-border services or when they need to verify documents or identities with other member states. Making digital wallets and IDs as interoperable as possible, then, is essential. The proposed framework from the EU Commission needs to be interoperable, to ensure that the wallets created by each member state can interact with each other. more>

Tesla Sold Some Bitcoins

Also the deli, the first law of tax, a JPMorgan Bitcoin fund and Dogecoin vs. lottery tickets.
By Matt Levine – Tesla pulled a new lever to juice earnings in the quarter, generating $101 million in income from selling about 10% of its Bitcoin holdings.

Profit from the cryptocurrency and the sale of regulatory credits and tax benefits contributed about 25 cents to Tesla’s adjusted earnings of 93 cents a share, allowing the carmaker to beat Wall Street’s 80-cent average estimate, Dan Levy, an analyst with Credit Suisse, wrote in a note Monday.

That’s wonderful, my sincere congratulations to them. People want to be mad about this? There is a vague sense out there that it is somehow fraud to buy a thing, say you like it, and then sell some of it. For instance Dave Portnoy, who I guess is an investment celebrity now, used the words “pumps” and “dumps” to describe Tesla’s actions on Twitter, prompting Musk to reply that “Tesla sold 10% of its holdings essentially to prove liquidity of Bitcoin as an alternative to holding cash on balance sheet.” (Tesla’s “Master of Coin,” Chief Financial Officer Zachary Kirkhorn, also talked a lot about liquidity on the earnings call; Tesla decided to put a chunk of its corporate cash into Bitcoin and I guess needed to make sure that its money wasn’t trapped. A reasonable concern! “We’ve been quite pleased with how much liquidity there is in the Bitcoin market,” said Kirkhorn.) more>

Updates from McKinsey

The future of payments is frictionless—now more than ever
Amrita Ahuja, the CFO of Square, explains how the company’s payment platform and services have helped small enterprises stay afloat during the COVID-19 crisis.
By Amrita Ahuja – Cash is king when it comes to maintaining corporate liquidity. It is in a somewhat less prestigious position when it comes to fulfilling consumer-to-business transactions. The onset of the COVID-19 crisis and ongoing fears of infection have prompted consumers and businesses to rely more on digital and contactless payment options when buying and selling goods and services.

How have the past few months been, and what’s changed for Square as a result of the crisis?

We’re taking it a day at a time. We serve merchants, who we call sellers, and individual consumers. And we know that this has been an incredibly trying time for everyone, where a lot of people’s livelihoods have been in question. The first thing we did was focus on our employees and their health. We shut down our offices on March 2. We wanted to do right by our communities and do our part to halt the spread of the virus. We took an all-hands-on-deck approach to understand what was happening in our customers’ businesses and what was happening in our own business. Every single day in March and April felt like a year, frankly, in terms of our understanding and how fast things were moving. We ran through scenarios, and asked ourselves, “OK, if the situation resembles a V, or if things look like an L, or if it looks like a U, what does that mean for us and our ability to serve our various stakeholders, employees, customers, and investors?”

We’ve had to be fast and clear with our communications during a time in which there are still so many unknowns. It was important to own up to this uncertainty and yet not downplay the severity of the situation. We met far more frequently with the board than the typical quarterly cadence. We held an update call with [investment bankers and analysts] outside the typical earnings cadence. We suspended our formal guidance to Wall Street, but we actually shared more information about the real-time views that we were seeing in our business across a number of different metrics and geographies. And with employees, we had a far more frequent and transparent mode of communication. We were sending weekly email updates, we built comprehensive and regularly updated FAQs, we set up a Slack channel for questions, and we held biweekly virtual all-hands meetings. We didn’t know everything, but we had a process for learning things over time and communicating them transparently. Ultimately, that has served us well, in terms of motivating our employees, serving our customers, and giving stakeholders a clear understanding of where we are as a business and how we are proceeding. more>

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Updates from Chicago Booth

How can banks create safe money? Balance competition
By Áine Doris – A conundrum underscores the banking system: banks issue liquid deposits but at the same time supply loans to finance illiquid projects, such as startups. In doing this, they expose themselves to liquidity risk—the kind that can lead to bank runs. It’s a precarious way to build a banking system.

Chicago Booth PhD candidate Douglas Xu tackles this liquidity paradox in a model that identifies two market failures or “inefficiencies” that regulators and policy makers need to keep in balance to reduce systematic risks.

Banks have long occupied a critical role in the creation of money. In today’s global economy, governments create only 3 percent of the money exchanged for goods, products, and services: the paper money and coins issued by central banks or monetary authorities whose trustworthiness or integrity underscore their value. Banks create the rest of the world’s cash—a staggering 97 percent.

From early record-keeping tokens to today’s deposit taking and loan making, banks have long been in the business of issuing money-like assets in one form or another. These assets function as credible payment media and thereby facilitate the kinds of activities and transactions that drive economic fluidity and growth.

But these assets bring inherent risk. Xu created a framework that captures the way that banks create money in the economy and integrates two key concepts: banks’ intrinsic vulnerability to illiquidity, and the so-called money-multiplier effect—the chain of transactions created when a bank makes a loan that generates a concomitant deposit elsewhere in the system. Put simply, loans generate a fresh supply of deposits. more>

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The politics of currencies

Adam Tooze argues that worrying about the euro exchange rate and a non-existent inflation enemy in Europe must give way to fiscal and monetary demand boosts.
By Adam Tooze – On September 10th, as they waited for the European Central Bank press conference, market actors and financial commentators held their collective breath. The eurozone sovereign-debt markets were calm, the Pandemic Emergency Purchase Program has ample headroom and the euro-area economy was showing signs of recovery. Yet the anxious question hanging over the event was whether ECB officials would mention the euro’s recent appreciation against the dollar—and, if so, what words would they use?

It may sound odd, but for a central bank to talk about exchange rates is at odds with the prevailing model of central banking in advanced economies. The central focus of that regime is price stability, which is to be achieved by inflation-targeting. Originally, the aim of the central bank was to keep inflation, as measured by a battery of domestic price indices, below 2 per cent per annum. Fear of inflationary overshooting is increasingly obsolete, though it lingers in some parts of Europe. The main concern today is to ensure that inflation stays reasonably close to 2 per cent, so there is not a slide into deflationary territory.

The exchange rate is left to be decided by the daily flux of trillions of dollars in the foreign-exchange markets. If a central bank is doing its job in stabilizing domestic prices, it ought to have nothing to fear from the currency markets—or so the theory goes. If all central banks adopt similar price-stability targets, then there should be even less reason for destabilizing currency movements.

It is not just unnecessary to target exchange rates. Not doing so is a concomitant of the basic logic of central-bank governance since the 1980s—the depoliticization of money. For national central banks to openly discuss exchange rates risks politicizing international financial relations. more>

Hard truths about the eurozone crisis

There has been little honest reflection within the European Commission about the eurozone crisis. Until now.
By Adam Tooze – It is not often one finds European officials quoting significant moments from pop culture, let alone an outgoing director-general for economic and financial affairs—the European Commission’s most senior economics official—quoting Ridley Scott’s Blade Runner. But that is how Marco Buti introduces a recent piece summing up his period in office between 2008 and 2019.

Buti’s contribution is significant as personal reflection but also because it raises the more general question of how the EU and its institutions will commemorate the tenth anniversary of the eurozone crisis.

When it came to revisiting the global financial crisis, Brussels did not hold back. In August 2017, to mark the tenth anniversary of its onset, the commission issued a statement blaming the spillover to Europe on the United States and giving itself credit for prompt action to stave off the worst. The press release was however issued on August 9th—anniversary of the failure of the French bank Paribas’ US property funds.

Subprime and Lehman could be safely blamed on the US. What, however, will the European institutions make of the ten-year anniversary of the eurozone crisis and its various phases between 2010 and 2015?

Last year, addressing the European Parliament on the 20th anniversary of the introduction of the euro, the then commission president, Jean-Claude Juncker, admitted there had been a lack of solidarity with Greece. He acknowledged there had been ‘reckless austerity’ (l’austérité irréfléchie). But he had the gall to suggest that the commission had succumbed to the influence of the International Monetary Fund, as though the agenda of austerity and ‘structural reform’ had been imposed from outside.

The traumatic history of the last ten years deserves better. more>

The approaching debt wave

By Kaushik Basu – Over the last decade, the world economy has experienced a steady build-up of debt, now amounting to 230 percent of global GDP. The last three waves of debt caused massive downturns in economies across the world.

The first of these happened in the early 1980s. After a decade of low borrowing costs, which enabled governments to expand their balance sheets considerably, interest rates began to rise, making debt-service increasingly unsustainable. Mexico fell first, informing the United States government and the International Monetary Fund in 1982 that it could no longer repay. This had a domino effect, with 16 Latin American countries and 11 least-developed countries outside the region ultimately rescheduling their debts.

In the 1990s, interest rates were again low, and global debt surged once more. The crash came in 1997, when fast-growing but financially vulnerable East Asian economies—including Indonesia, Malaysia, South Korea, and Thailand—experienced sharp growth slowdowns and plummeting exchange rates. The effects reverberated worldwide.

But it is not only emerging economies that are vulnerable to such crashes, as America’s 2008 subprime mortgage crisis proved. By the time people figured out what “subprime” meant, the U.S. investment bank Lehman Brothers had collapsed, triggering the most severe crisis and recession since the Great Depression.

The World Bank has just warned us that a fourth debt wave could dwarf the first three. Emerging economies, which have amassed a record debt-to-GDP ratio of 170 percent, are particularly vulnerable. As in the previous cases, the debt wave has been facilitated by low interest rates. There is reason for alarm once interest rates begin to rise and premia inevitably spike.

Among emerging economies, India is especially vulnerable. In the 1980s, India’s economy was fairly sheltered, so the debt wave back then had little impact.

Today, India’s economy is facing one of its deepest crises in the last 30 years, with growth slowing sharply, unemployment at a 45-year high, close to zero export growth over the last six years, and per capita consumption in the agricultural sector decreasing over the last five years. Add to this a deeply polarized political environment and it is little wonder that investor confidence is rapidly declining. more>

The Finnish Basic Income Experiment – Correcting The Narrative

By Jurgen De Wispelaere, Antti Halmetoja and Ville-Veikko Pulkka – The Finnish government’s refusal to extend or expand the experiment may not come as much of a surprise once the budgetary implications are taken into account but it nevertheless amounts to one more disappointment amongst those closely watching how the experiment is progressing. And disappointments have been plentiful with this project.

After a promising start, the first blow came when the Sipilä government ignored most of the suggestions and recommendations of the research consortium led by Kela (the Social Insurance Institution of Finland) and charged with preparing the experimental design — incidentally, appointed by the very same Juha Sipilä.

The design now being rolled out is much more limited than many had hoped for. Repeated requests for additional budget or postponing the starting date were ignored. Much-needed coordination between the different ministries involved was not forthcoming. The government also delayed appointing the team charged with evaluating the result until the experiment was well into its second year – with detrimental effects for any attempt to gain a more comprehensive insight into the experiment’s wellbeing effects. more>

Fiscal Policy Remains In The Stone Age

By Simon Wren-Lewis – Or maybe the middle ages, but certainly not anything more recent than the 1920s. Keynes advocated using fiscal expansion in what he called a liquidity trap in the 1930s. Nowadays we use a different terminology, and talk about the need for fiscal expansion when nominal interest rates are stuck at the Zero Lower Bound or Effective Lower Bound.

When monetary policy loses its reliable and effective instrument to manage the economy, you need to bring in the next best reliable and effective instrument: fiscal policy.

The Eurozone as a whole is currently at the effective lower bound. Rates are just below zero and the ECB is creating money for large scale purchases of assets: a monetary policy instrument whose impact is much more uncertain than interest rate changes or fiscal policy changes (but certainly better than nothing). The reason monetary policy is at maximum stimulus setting is that Eurozone core inflation seems stuck at 1% or below. Time, clearly, for fiscal policy to start lending a hand with some fiscal stimulus.

You would think that causing a second recession after the one following the GFC would have been a wake up call for European finance ministers to learn some macroeconomics. Yet what little learning there has been is not to make huge mistakes but only large ones: we should balance the budget when there is no crisis. more>