A couple of years ago, I wrote a piece in the Fin about the precarious economic situation in Iceland, a small country with a massive current account deficit. Now it appears, the full-scale implosion I talked about has come to pass. Rather startlingly, Iceland is looking to Russia for a bailout. Among the implications noted by Felix Salmon, the fall of the S&P index below the 1000 level it first reached back in 1997.
As I say in the article, Australia is much less vulnerable than Iceland. Still, it is now clear that the consenting adults theory of current account deficits has its limits. We’ll just have to hope that we are within those limits, and that we can turn the recent trade surplus into the beginning of a sustained reduction in our net foreign debt.
So many bizarre things are happening in global financial markets that it’s impossible even to keep up with the critical events (today for example, more European countries guarantee deposits, 1 per cent cut in interest rates, US Fed starts buying commercial paper), so I’ll focus on one thing that has struck me. A few months ago, the Australian dollar was close to parity with the US. Since then it’s become apparent that the US financial sector is essentially insolvent, and that the US government is relying on the printing press to meet its obligations, while, by any reasonable standard of comparison, the Australian economy looks remarkably sound. So, in their infinite wisdom the financial markets have sold off the Australian dollar (as of today, it’s worth about $US0.72).
In the current environment, a big devaluation is probably beneficial for the Australian economy. It more than offsets the decline in ($US-denominated) commodity prices we’ve seen so far.
Still, on any reasonable assessment, the movement in the market exchange rate is plain crazy. At this point, the claim (essential to the efficienct markets hypothesis) that market-determined asset prices represent the best available estimate of future values, and therefore that capital markets are the best available method of allocating scarce resources for investment can only be sustained on the basis of the kind of dogmatic belief that asserts that humans and dinosaurs shared the earth 6000 years ago.
Thanks to another conference (a big one, on infrastructure) I’m running far behind on everything. So here, a day late, is the Monday Message Board on Tuesday. Comments on any topic, civilised discussion, no coarse language.
We’ve all been strictly enjoined to avoid schadenfreude in the current crisis, and indeed few are likely to escape unscathed. Still I’m struck by a couple of examples of historical irony
* Ten years ago, I was debating representatives of the Dutch bank ABN-AMRO, who were pushing for the privatisation of ACT Electricity and Water (ACTEW). A couple of days ago, the Dutch operations of ABN-AMRO were nationalised
* British Bank Northern Rock was nationalised following a run by customers seeking to withdraw their money. Now, seen as safer than it’s competitors, it is being forced to limit deposits.
It’s time (a bit late again) for weekend reflections, which makes space for longer than usual comments on any topic. As always, civilised discussion and no coarse language.
I’m as tired as anyone of the poor performance of the site. I’m currently investigating a couple of options. One is to try to migrate to a different server with my existing host. This should improve things, but I can’t get much support with things like SQL databases, so I’m not sure if I’ll be able to do it. The second is to move the whole blog under the wing of Crikey. That would save a fair bit of effort for me, but I’m not sure how readers would feel about it. Any thoughts?
The analogy between the strategies that have made the financial sector so profitable in recent years and the martingale strategy in betting (keep doubling down until you win) have occurred to quite a few people. Jordan Ellenberg has an excellent article in Slate on the topic, in which I get a brief mention.
Both Ireland and Greece have now moved to guarantee all bank deposits, while the US bailout bill increases the FDIC guarantee to $250 000 for individual accounts at any institution (meaning that anyone willing to hold accounts at four different banks can have $1m guaranteed).
I’ve never seen the merit in the RBA stance of refusing to give an explicit guarantee, while allowing everyone to think that bank deposits are unconditionally safe. I suspect an explicit guarantee will be needed before long, and that it would be better to announce it now, before it is needed.
The quid pro quo, necessary for a whole lot of other reasons in any case, ought to be a tightening of regulation on anything a bank might do that would increase the risk of default. That includes owning high-risk subsidiaries, participating in innovative derivative markets, and taking on off-balance sheet contingent liabilities, among the factors that have contributed to recent collapses overseas.
Updated In the spirit of laissez-faire, I’d be happy to allow for competing unregulated and unsupported deposit-taking institutions. To avoid the danger of moral hazard, I’d require the following
(i) There should be a legislative prohibition on any form of support for these institutions from the government or regulators
(ii) Publicly guaranteed banks should be prohibited from having any dealings (loans, shareholdings, bond purchases and so on) with unsupported institutions
(ii) Customers should be required to sign and regularly renew an agreement stating that they are aware that there is no possibility of a bailout of deposits with these institutions
I’ve been at the Australian Conference of Economists for the last couple of days, talking about climate change. As we all worry about the collapse of the global financial system, the final report of the Garnaut Review reminds us that we have much bigger concerns in the long run (not only climate change, but nuclear proliferation and global poverty to name a few).