A bad move

John Quiggin59 Comments

The Rudd government has made its first big mistake in handling the financial crisis. The just-announced proposal to guarantee bank accounts up to $20 000 is worse than useless. Given that lots of people hold more than $20 000 in individual bank accounts, they have an obvious incentive to diversify, which means large scale withdrawals. The possibility of this turning into a run is far from remote. Turnbull’s suggestion of $100 000 is better, but the only serious option is an unlimited guarantee.

Update Some good news on this. Once we have a guarantee of $100K or more in place, the extra liability associated with an unlimited guarantee will be modest, while the gain in simplicity will be substantial, and the argument for exercising direct control over bank lending will be unanswerable. Of course, as a colleague pointed out in the course of email discussions on this point, the real problem is the banks’ reliance on overseas borrowing. I’ll be discussing some proposals on this before too long I hope.

We are all socialists now

John Quiggin47 Comments

A couple of days ago, I thought my call for full-scale nationalisation of the banking sector would remain beyond the pale of political acceptability for at least a week. But in today’s paper I read the following, very sensible assessment

Inevitably, the US, Britain and Europe are going to end up with nationalised banking systems in one form or another, and with governments guaranteeing not only their deposits but probably all their liabilities. The nationalisation will be a temporary emergency measure. But for some time at least the systemically important banks effectively are going to be public utilities and must be regulated accordingly.

This taxpayer rescue of banking systems opens up a new and potentially very important avenue for unfreezing bank lending and restoring the flow of credit. If governments effectively control the banks, what is to stop them from demanding that they start lending again?

And what wild-eyed socialist wrote this? Alan Wood in the Australian.

Meanwhile, calls for a guarantee of bank deposits are gaining force.

Of course, none of this constitutes a shift to socialism in any meaningful sense of the term. But it does mean, for quite some time to come, the end of neoliberalism (or free-market liberalism or whatever you want to call the set of ideas centred on the proposition that markets can do a better job than governments in managing risks of all kinds). The question of what will replace neoliberalism has come up so suddenly, and in such chaotic circumstances, that no-one has a clear answer. I’m confident that the response must be broadly social democratic, but there are a lot of details that need to be filled in.

Note The spam filter has been rejecting comments because of the ci*lis problem in the post title. I’ve fixed that, but commenters will probably need to asterisk the S word (Soci*lism) to avoid the filter.

State capitalism on the instalment plan

John Quiggin67 Comments

With the financial meltdown accelerating in the wake of the US bailout, and the recognition that many more failing banks will have to be nationalized, the British government is moving to get ahead of the game by offering equity injections across the board. But already this seems inadequate. Now that the taboo on nationalization has been broken, wouldn’t it make better sense to for the UK (and others) to nationalize the whole sector? With full control, governments could then ensure the resumption of interbank lending at least among their own banks. This would provide a feasible basis for co-operative moves to re-establish international markets.

For this week at least, such an idea is beyond the range of political acceptability. But it’s striking to look back a month and realise that in that period the US government has become the main mortgage lender, the guarantor of the short term money market, the effective owner of the world’s largest insurance company, the potential future owner of much of the banking sector and now the purchaser of last resort for commercial paper. Since the reluctance of banks to buy commercial paper must reflect a significant probability of default, it seems inevitable that some of this commercial paper will end up being converted into claims on the assets of defaulting issuers, extending the scope of nationalisation beyond the finance sector and into business in general.

This kind of instalment-plan nationalisation seems to offer the worst of all worlds. At some point, a more systematic approach will have to be adopted, and given the rate at which markets are plummeting, the sooner that point comes the better. This isn’t the return of socialism, but it certainly looks like the end of the kind of financial capitalism that has prevailed for the last few decades.

Iceland

John Quiggin9 Comments

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.

The decline of the dollar

John Quiggin45 Comments

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.

Irony

John Quiggin39 Comments

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.