Chart of the Day: The smoking gun showing how the ECB wrecked the Spanish economy
The other Edward posted a thorough analysis of the situation in Spain this weekend. I recommend that piece, Rescue Me, highly. Here’s a chart that caught my eye.
The other Edward writes:
Well one thing should be clear by now, part of the responsibility for the situation lies with the ECB who applied (as they had to) a single size monetary policy even though this was clearly going to blow bubbles in the structurally higher inflation economies. And so it was, Spain had negative interest rates applied all through the critical years, and now we have the mess we have.
Back in 2006 inspectors at the Bank of Spain sent a letter to Economy Minister Pedro Solbes complaining of the relaxed attitude of the then governor, Jaime Caruana (the man who is now at the BIS, working on the Basle III rules) in the face of what they were absolutely convinced was a massive property bubble. Their warning was ignored.
Negative real interest rates aka easy money have recently been re-labelled financial repression. Now in the aftermath of a property bubble, they are seen, not as emblematic of central banks’ blowing bubbles, but of central banks stealing net interest income from savers to bail out debtors.
Think of it this way, just after the Euro came into being, the German economy was in what I labelled a soft depression due in large part to Germany’s own post-unification credit excesses. So the ECB decided to prop up the German economy with low interest rates, rates that produced negative real interest rates and housing bubbles in Ireland and Spain. This was a policy designed to "bail out" the indebted German economy. We called it easy money then because it allowed massive speculation to be funded by cheap loans in credit markets. Now that the bubbles have popped, easy money has morphed into financial repression. But the goal is the same as it ever was: to "bail out" the indebted by ‘repressing’ interest income that creditors can receive.
The interesting bit about this policy is that economic policies right across the indebted developed economies have been extremely favorable to creditors in bailing financial institutions out of their lending excesses at taxpayer expense. Yet, at the same time, creditors are being savaged by the sharp downturn in net interest income due to the easy money policy we are now calling financial repression.
To me, these two policies are the signature hallmarks of our post-financial crisis economic policy making. And the two policies are in direct conflict with one another.
A couple months back I wrote a couple posts about how the economy needs a bubble (https://bit.ly/Hg6jCH) when interest rates are held below the growth rate of an economy. One point I might add to this post, is that the groups of creditors benefiting from bank bailouts and being hurt by financial repression may very well represent different groups based on income/wealth. IMO, this is an important distinction for understanding the political motives behind each policy and assessing any likely changes to policy down the road.
Bubbles are not necessary, but they are loved by the incompetent. It makes investing easy. Governments get easy rising tax revenue from asset bubbles and without the need to raise taxes. It is all illusory. Look at the impact on regional Spanish governments. Now that prices are falling they are finding tax revenues are collapsing.
Real wealth comes from manufacturing and providing services. That was outsourced since the 80’s and only Germany, France, maintained that policy in Europe. They still have big manufacturers. Ultimately the only beneficiaries of bubbles are banks who make more loans on rising asset values at apparently no risk. This has been shown to be false the world over yet we still persist.
Financial repression has been policy for years. What would be better is a cap and collar on interest rates for central banks and then governments will have to act fiscally outside these limits. So if a central bank deems a market to be over heating it should raise interest rates, but before they get too high they should trigger governments to raise taxes or cut spending, all before the economy overheats. When the economy slows they should do the reverse but all with in a framework of relatively stable interest rates. The problem though has been monetary orthodoxy that said fiscal policy was irrelevant.
A government does not need to raise tax revenue in order to spend in its own currency. Limiting interest rates to any range will not alter that fact.
You are correct that real wealth stems from production. Unfortunately current laws in the US skew relative prices to encourage the private sector not only to spend on current consumption rather than invest, but to spend from borrowing rather than income. These laws combined with low interest rates, govt-backed banks (and GSEs) and large deficit spending created a massive private credit bubble. Similar situations happened throughout Europe, except most of those countries do not spend their own currency.
The solution to this problem is to reduce the incentives for private borrowing, break up the big banks, end creditor bailouts, remove the Fed’s employment mandate and let the government adjust the deficit to stem inflation.
Ending the bias towards lending by withdrawing tax breaks would end the benefits of speculation. Breaking up the banks again is good, but completely impractical with governments captured by the banking system. I saw a good link from iNET re total lending including private lending being capped at 100% of GDP which would end bubbles but also raise criticism of crowding out. Though many european governments had low debt levels prior to the crisis. Even the UK had debts of 40% to GDP which rocketed after the crash decimated tax revenues.
The cap and collar would have been effective in stopping Greece or the other PIIGS from having over expanded borrowing if followed. There would have been avoidance but capital controls would have stopped by passing of such rules. So while the ECB set rates of 3% it could have imposed a bigger surplus on Ireland or capped its lending to eliminate the bubbles.
As for the Fed;’s employment mandate they should never have had it as that is most effective if done by congress by fiscal policy not monetary policy. It was not as if they even paid lip service to it. High unemployment suits banks because it keep inflation low.
One of the problems is that no government will stop the party once it is going so when it all turns to tears they will deny responsibility for the bubbles. There need to be tougher rules on bank leverage and total debt, including government debt during normal times so that the government can stimulate the economy when times get bad. Leverage now is still so much higher than it was at this stage in the thirties so consequently much of the impact of any stimulus simply re-inflates the bubbles and little actually boosts the economy.
Another thing to consider other than the strength of past inflationary forces are what were it’s outlets.
Is it the same in Spain/Europe as it apparently was in the UK that the targeted inflation rate didn’t include housing?
It’s like squeezing on a balloon while you inflate – is it surprising it distends in the places your not applying pressure?
The problem here of course is that distension wasn’t cause by air but credit – parceled up and sold on – governments can’t afford to let it deflate and “banking centric” policy responses have so far just preserved the distortion.
Sadly, because of politics and the state of conventional economics I can only see the powers that be doubling down on this approach – I’m not a Keynesian or MMTer but I don’t see monetary policy being very effective in the current predicament.
I think that the US includes owners equivalent rent. Which does not fully include housing inflation. As wages were stagnant rents were seriously constrained by them except at the higher end, so with lower interest rates lower rents could be maintained, even as the bubble inflated. It hid the impact of the bubble.
Owners equivalent rent has actually been a major factor pushing up inflation over the past few years, even as housing prices have tumbled nationwide.
The trouble with monetary policy at this point, is that the strengths are in alleviating financial liquidity problems and encouraging housing purchases through the long end of the curve. As the Fed is apparently starting to recognize, credit is not constrained by bank liquidity but rather by outstanding household debt. Monetary policy, which acts primarily as an asset swap, has no mechanism by which to increase private sector income, force credit writedowns, or lower rates on outstanding mortgages/loans.
Rents shot up in the aftermath of the crisis as there were in sufficient homes available. Many foreclosures have been kept off the market to hold prices up and many sellers are also holding off because of market conditions.
This was always a debt crisis and the fact that Fed monetary policy has reached it limits was clear to see. Also write downs would show up any weakness in the banks and the stress tests were part of that charade.
Many borrowers are excluded from lower rate mortgages because they are in areas or have insufficient equity in their homes to put up in exchange. These will be the ones that have held on but will be squeezed out as interest rates rise.
Also add in that bankruptcy laws are very one-sided now and student debts will be a problem in future, yet that is being ignored for now.
Can’t disagree with any of that. Doesn’t inspire confidence in a timely resolution to any of these issues.
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