Are we in a liquidity trap? (am I blind or is this another black swan?)
Liquidity traps are one of those obscure concepts hidden into macroeconomics books. Obscure enough to occupy some marginal comment only and disputed enough to be denied by the Austrian School of Economics. Ludwig von Mises would label them as myths. But, as mytical as a black swans that have recenty decided to come out of their closets and start teambuilding in the Thames, are we going to face this myth soon as well?
When Sir John Hicks thought of the IS-LM model, he already thought of liquidity traps somehow, but it was the first Baron Keynes (also known as John Maynard Keynes) who shaped the concept (did Ludwig von Mises need a better reason to label them as myths?).
The idea is simple. With the IS-LM model, cutting the interest rate is the scape from any recession, as we make more money available into the system to boost growth and employment. But, does more available money always equate more growth?
There’s a obvious limit to this: interest rates cannot be negative (hmmm, let’s leave it like this for a minute…) so there’s obviously a limit to monetary policies, that is when rates reach zero. Are we there yet? Well, the following table borrowed from Bloomberg can help:
Regardless of the fact that we are getting there, what if the rate where monetary policy became ineffective was not zero but higher? That’s in fact the idea behind liquidity traps. What if the banks and the firms -in short, people- became risk averse enough that they preferred the liquidity of cash to offering it to others at low rates?
In other words, what happens if the free-risk situation is no longer perceived as risk-free? How should this extra aversion to lending be rewarded?
The conclusion from Keynes was that there would be a point where monetary policies would be ineffective and the economy would remain trapped in recession. Then only fiscal policy, that would be a lot of government spending, would do the trick. But are we psicologically prepared for this extra spending and increased budget deficit and debt? Will the debt attract enough financing? Will the solution even deepen the liquidity trap by substracting even more money from the private sector?
There’s still a way to have negative interest rates and that’s thanks to inflation. After all with inflation our money inside the sock loses value every day. And an expansive monetary policy should raise inflation. (hmmm, look at inflation dropping and that other scary, even mytical word too: deflation) Even though, with a low enough interest rate, and with the current global scare, many people may choose to still leave it there.
Yes, a liquidity trap is a rare think. It may have happened in Japan long ago, even in the US in the previous recession (Krugman would say, and Reisman deny). May we already be into one?
Add comment 9 January, 2009
Back from Switzerland (and missing it already)
Back from Switzerland and missing it already. One week of skiing and cheese eating is not enough. I’m going to miss those great valleys, the Geneva Lake, the snow: Champery, Avoriaz, Morgins, Torgon, Chatel, the people, the order, the commitment to having the roads and the trains ready regardless of the weather (in Barcelona our distant-managed-from-the-capital trains just stop when it snows too much). Yes, I’m missing Switzerland already.
To my amazement I’ve discovered I speak an peu du French. We Catalonians are born bilinguals, breathing both Catalan and Spanish since we are born, so learning a third language is not that difficult as we are already wired for it. In my case my third language is English, which I am proud to say I am able to use it effectively. But when I was a kid, and TV channels were still a scarce resource, we lived close enough to the French border to watch French TV and Jean Paul Belmondo’s great action movies. (Catalonia spans a bit further north into France, cut by nation-states seeking natural limits, cutting that only a few countries survived: Switzerland is the most prominent example).
Sorry for the mental rambling. The fact is that I could understand French very well, and even managed to communicate. At the end of the week I even dared to make my first jokes in French 
Now, I have decided to improve my French. More things to do, still the same time. Business as usual for an MBA student. 
The great view is from Torgon, in the top of the Jorette piste. If you looked backwards you could see the Mont Blanc not that far aways, if you look down you can see the Genève (or Leman) Lake. The picture was not mine as mine wasn’t that good. On the other hand we had a lot more snow.
Now, time to work again. An airport and an MBA are waiting, so is my soon-to-improve French.
4 comments 7 January, 2009
Crowding out time (more wood from the forced lenders)
Yes, right now the governments are pouring a lot of money into the system. Is it working? Can it work? Ain’t we trying to extinguish this fire the same way it started?
A well known effect in macroeconomics is the multiplicator accelerator model: there is a multiplicative effect when new investments are introduced in the economy and the economy grows in a higher rate. The other way can happen too, as the resources leave the economy and the slump is also accelerated. We are suffering this effect now, catalysed with instruments such as banks that are monetary multiplicators per se.
If we wanted to stop and reverse this effect, introducing new resources into the system, how can we do that?
The first temptation is, of course, to substitute this private money lenders for some other lenders that have no choice: the forced lenders. Yes, you guessed well. We are the tax payers. We are the forced lenders. Where private investors need trust to decide to participate, we simply have no choice.
Yes, you get the idea, our money, government’s money, gets poured down regardless the amount of trust present in the system. And the investors trust governments because they are backed by us: forced lenders.
But what happens when we pour all this money into the system? There’s another less known effect in macroeconomics, the crowding out effect. Government’s spending will substitute private initiative and occupy an even higher proportion of the economy. If the flow of money goes the way of the state, it won’t go the way of the private investors.
But then, being the state the lender and the backer of many securities, amidst this global scare, why should anyone not forced to invest in riskier assets? Investors will end up financing the treasury instead, and leaving the financial markets.
Where will the money come from to finance public companies? What will happen to suffering capital markets further short-circuited from the money flow? They might as well keeping go down the slope for a long time.
Yes, I am aware that to explain this crowding up effect, the IS/LM introduced by Sir John Hicks and Alvin Hansen needs higher interest rates that affect the unwillingness to invest to the private sector through an increased cost of capital. In the present situation, with lower costs of capital, the crowding out effect lacks the mechanism to happen.
But what if the present scare of capital turns into a similar mechanism to the increased cost of capital? What of the negative animal spirits? Can they make us disinvest from profitable companies and make them inviable? Couldn’t that make a crowding out effect too?
Meanwhile, but let me express my reservations about this stocking-more-wood process. More wood in the hands of the government, lower interest rates: more wood everywhere. Seems dangerous to my little me. Maybe our firemen should think of other options.
Add comment 10 December, 2008
Blogging from the Opera (blogging with Figaro)
Less than two weeks into an important milestone for the airport’s operational readiness and less than three weeks from my marketing and business environment exam, I find myself blogging from el Liceu, Barcelona’s opera house. Amidst this quagmire that my daily job has been turning into, I still could scape to enjoy Mozart’s The Marriage of Figaro. It really sounds strange in English instead of Italian’s: Le nozze di Figaro, ossia la folle giornata.
Yes, the second name for the opera is “the day of madness”. That’s how I live my days at work now. Trying to cope with unmatching requirements, trying to sync reality with political requirements. But, as I like to say, reality is too stubborn for that. And we always end up crashing with a concrete wall which we could have avoided. But that’s second nature to us, humans. Why is it that reality ends up resembling just another opera buffa?
Yet here I am. Everyone needs a place to hide. And that’s mine today. I even could open my computer in the bar in the basement, use my HSDPA connection and write this lines while sipping a coffee. Watch the old ladies ingest huge quantities of sugar and chocolate in different shapes and colours. Isn’t life nice after all?
The thing is that when I began the MBA I promised to reflect. And these latter days have been so amazing. So many different things happening from a global perspective, at work and even a personal perspective. And I don’t want to feel that the many things that flow around me just do that: flow. I need to capture some of them. I need to retain, absorb, think, grow.
They say that experience is everything, that you actually learn by doing. And that is a blatant lie. Well, you learn, true, but only in a mechanical way. As Figaro doesn’t actually learn about Almaviva until he actually sees him fishing in his waters, or Almaviva doesn’t learn about behaving until his infidelity is publicly exposed. The aristocracy depicted, ridiculised here didn’t learn on time to change. Until it was too late. Pierre Beaumarchais saw his play censored in France, only to be played in 1778, with the French Revolution almost at the doors…
You learn when you think about what you live. When you think of improving what you’ve already learnt to do mechanically. When you make it grow inside of you. When you go one step further to accepting what is already established, what is already known. When you apply something more than common sense. When you’re not scared of rethinking something that is already working (apparently).
When I give project management classes, I always stress how important is the “post-mortem” analysis at the end of the project to clarify not only what we have done well but also what we could have done better and what we have learnt from the experience. Now I feel that the end is too far, too late. It must be done now and again, in a continuous process of taking a step back, getting perspective, digesting, and then going in again with regained strengths that will not hold us back from stepping out of the comfort zone. Every manager should take some time to learn now and then.
And now, let’s enjoy this opera
Add comment 18 November, 2008
Thinking of Walter Bagehot (forgotten panics and not-so-forgotten bankers)
After a weekend in Henley closing the strategic marketing and global business environment modules, and endless talks about the capital markets, including a valuable late-hour conversation in the plane with an economist whose expertise are intangibles, I felt I needed to dwell on the past knowledge to gain some perspective on the issue.
And who better than Walter Bagehot and his Lombard Street. I’d rather externalise the explanation on who’s Walter Bagehot using Wikipedia, but it suffices to say that he was the chief editor of the Economist, as well as a banker, and had studied mathematics and philosophy. What’s more interesting, that was in 1873.
1873 was also a year of panic: another crisis that lasted for four years (roughly like the 1929s’ depression), beginning with a mortgage crisis, another link worth externalising to the Chronicle Review. (Thanks to Brisebois )
Many will see analogies between what has happened in the past and what’s happening today. Even though, we tend not to care about what happened so long ago (or maybe not that long) and good lessons are simply forgotten. We could know so much if we simply didn’t collectively forget!
Because, in times of panic, what should a central bank do? Bagehot thought “that it must in time of panic do what all other similar banks must do; that in time of panic it must advance freely and vigorously to the public out of the reserve.”
But still a conditions for the intervention: “first that these loans should only be made at a very high rate of interest. This will operate as a heavy fine on unreasonable timidity, and will prevent the
greatest number of applications by persons who do not require it. The rate should be raised early in the panic, so that the fine may be paid early; that no one may borrow out of idle precaution without paying well for it; that the Banking reserve may be protected as far as possible.”
Where should we stop? “that at this rate these advances should be made on all good
banking securities, and as largely as the public ask for them. [...] But if securities, really good and usually convertible, are refused by the Bank, the alarm will not abate, the other loans made will fail in obtaining their end, and the panic will become worse and worse.”
“The only safe plan for the Bank is the brave plan, to lend in a panic on every kind of current security, or every sort on which money is ordinarily and usually lent. This policy may not save the Bank; but if it do not, nothing will save it.”
After all, some things could be done much better, but doing nothing leaves us all worse off. Guess what, the alternative was also tried a lot of years before, in the panic of 1825, also another long-lost panic, when “the Bank of England at first acted as unwisely as it was possible to act. [...] The reserve being very small, it endeavoured to protect that reserve by lending as little as possible. The result was a period of frantic and almost inconceivable violence; scarcely any one knew whom to trust; credit was almost suspended; the country was [...] within twenty-four hours of a state of barter. Applications for assistance were made to the Government, but [...] the Government refused to act…”
Ring a bell, maybe?
Add comment 30 October, 2008
The ant, the grashopper and the interest rates
I sincerely wished I could write about something else, but these days I’ve been spending a great deal of the time I don’t have absorbed by the financial markets.
And I’ve come to think of Aesop’s fable (click here for the Wikipedia entry): the ants and the grasshoppers, and the way they would have related to interest rates.
Since the ants are the hard-working ones in the fable. They are the ones that build the real economy, the ones that have their savings in the bank, in the safest financial products. On the other hand the grasshoppers don’t really worry about working hard, they are prone to risk and they aim for quick profits, regardless of the consequences.
Okay, now with the interest rates. Reasonably low interest rates benefit the ants because they can access funding with a reasonable price and still get a basic return for their savings while keeping them safe for the future. After all they are risk-averse creatures.
But if the interest rates go too low, close to nil, then it’s the time for the grasshoppers. Who cares about saving, who cares about the long term while short term is cheaper and you can still carry-trade. Short-term benefits are in order, even castles in the sand if they can be sold somehow, and when there’s no limit to the castles in the sand you can build, there’s no limit to growth. Screw Kondratiev!
In the end, it seems that the ants will end up saving the grasshoppers, just like in the fables. Lesson learned… or is it not?
4 comments 3 October, 2008
Hallowed are the American taxpayers…
Hallowed are the American taxpayers
as they are the ones that will pay this huge bill,
Hallowed is the American Treasury
as it will acquire junk assets in the name of the Americans,
Hallowed are the international creditors
cos they will get increased risk premiums from a riskier debt,
Hallowed are the Feds
pushing forward a plan they don’t know if will suffice,
Hallowed is the growing debt
it will at least double in the forthcoming years,
Hallowed is the forgotten Laffer Curve
now supposed to work better if turned downwards,
Hallowed is the non-interventionist state
that implements socialist ideas in times of distress,
Hallowed are the big investment banks
allowed to merge to hide their shortcomings and ignominies,
Hallowed are the plunging assets
as they will be allowed to survive with their old values in the balance sheets,
Hallowed are the short sellers
sinners never repented from what they did in 1929,
no longer allowed to arbitrate or cover risks,
Hallowed are the politics
for they will still adore the taxes,
Hallowed are we all
for we will long feel the ripple effect of short-sighted politicians and unelected officials.
Sorry for the mental rambling, forgive me my rantings, but it’s been a hell of a week… time to change the subject though…
1 comment 22 September, 2008
Lehman’s fall (or the necessary and dangerous road back to rationality and who will pay the bill)
Yes, you already know it. Lehman Brothers one and a half century of reign has ended ominously. As every corpse, it needs a hole in the ground to be buried. The problem here is that this hole is $600 billion big.
On my last post I was writing about the twins and their attempted rescue. Now we are seeing a glimpse of the real problem, that won’t stop here. AIG, brutally exposed to credit fault swaps, is going to be the next one. Who said this was going to be brief? One year of crisis, and we are still going down. The echos of ‘29 are beginning to ring into the monetary authorities’ ears. But that’s another matter…
Remember when I wrote about the end of cheap money fifteen months ago? There was a graph there worth rescuing now.
Just a quick reference: M2 and M3 are common metrics or measures for money. M2 referred to domestic economies, M3 included the money that had been refuelling the economy, making stocks soar, gone into funds, hedge funds, private equity or debt. Money that, let’s say, was not 100% based on real needs of the economy but bets over bets over bets, all of them based in the perpetuation of the economy growth. Well, it didn’t.
Let’s say it another way: there was an excess of financial products relative to demand. Call it excess of offer, overcapacity, inflation, yet another bubble… Some of the products were simply traded between themselves, a huge casino where they grew interconnected, multiplied their correlated risk, while the real investors did not have a say, while the real investments were non-existent. The blue curve went too far from the red curve.
Now that the party is over agents will have to adjust accordingly. If they must be evaluated again based on the real price of their assets, things will get very ugly, very very ugly. Valuations might as well halve, employment in the financial sector will drastically be reduced as well.
What about the hero and saviour here? Well, it has been mangling with the system, saving the twins… sorry their creditors at the expense of their shareholders, never realising the road ahead was too bumpy. They have now… and it’s too late.
The great thing about capitalism is the freedom to do whatever you want with your money. When things are fine you deregulate, explore new skies, advocate for a minimum involvement from the state. I never saw any of them coming to society and saying… “wait, we want to contribute more, we want to raise that tax 20%, as our benefits have soared thrice, and give back some of our benefits to the society that has made it possible”. Nope at all. Instead it was all thanks to them. They gave us some lectures about corporate social responsibility, spent a lot of money in green branding, spent some more on carbon footprint rhetorical, and simply took the money away.
But when things get grim, the same capitalists and economic liberals are no liberals any more. The benefits were private, the losses socialised. Overnight, those same successful liberals become advocates of communism and claim that it’s not their fault: that the context is bad, the cojunture unmanageable, that volatility is impredictable, uncertainty more uncertain than ever and that the complexity that they proudly created should have been regulated from the first day. Sad, very sad.
Notwithstanding the evidence against them, we are out of options. It’s the taxpayers the ones that will have to pay the price of the party, and remember: the wealthy, those who have been irrationaly and exhuberantly gaining in this game, are the ones whose fiscal charges were reduced because they were creating growth, benefits and employment. How is that for assimetry and moral hazard?
After all this, and the suffering that will entail, there’s still hope: it’s called the survival of the fittest. But I’ll write about it another day…
Add comment 16 September, 2008
Freddie Mac and Fannie Mae (Houston we’ve got a problem)
Even the most important (and supposedly liberal) economy in the world has its contradictions. And in this continuous deleveraging process that it’s suffering two huge pieces have fallen. Well, in fact, they have not fallen but been saved by the bell, at the last minute, by the American taxpayers. Or maybe not?
Let’s go step by step. This kind of operations are called nationalisations all over the world (and bringing them under government’s control in the US). Now the shareholders and the debtors of Freddie Mac and Fannie Mae have a problem. But the deleveraging process had to stopped somehow, somewhere. And that line was worth defending.
Avoiding the discussion about moral hazard, six months ago I was writing about the Financial weapons of mass destruction unleashed in the US (the party is over) and also about The new cycle of capital recovery (who’s financing your debt now?) Let’s use the same ideas now to seek coherence in the present situation.
Let’s summarise the whole reasoning and see where it leads to:
- Freddie Mac & Fannie Mae’s shareholders (and many other shareholders and creditors too) have lost a lot of money, true. We still haven’t seen that in the news, but a lot of sovereign funds must have lost fortunes. The time will come when they’ll have to account for them.
- Taxpayers will have to pay a lot of money now, true.
- The consequences could be worse if the taxpayers didn’t intervene, so it’s worth doing it, true. This line should not be crossed.
- So we do it, we nationalise Freddie Mac and Fannie Mae. Done. And to avoid moral hazard their shareholders must have an important loss, otherwise the system would be asymmetric. Or did any companies volunteer to share their big gains not so long ago?
- Shareholders and debt holders of those companies must be unhappy and worried about the soundness of the American economic system, reasonable. Wouldn’t you after losing that much? They’ll think twice before investing again in the US. Sensible thought, and yet that’s where our problems begin.
- Taxpayers are paying. I said that in number 2. But, can they afford the bill? The US is a country with a huge fiscal and commercial deficit, so it depends on foreign inflows of capital. Just follow the previous links to my half-year-old articles to see more.
- The taxpayers only have two ways to pay the bill: increasing taxes or further going into debt. I don’t see any of the presidential candidates advocating for higher taxes so I assume it will be the second option. The treasury will have to emit further debt, and not in small quantities. I’m approximating here but, these huge numbers are in order of the current debt volume. In other words, the US debt might be doubling because of these nationalisations.
- Doubling the debt volume means a lot about a country’s ability to repay it: it roughly halves the quality of the debt. We know that the US debt is a high quality debt, but that quality will subsequently be slashed down.
- The world has a few very important lenders, mainly Asian countries. Need I say which one? But they are not that enthusiastic with investing in the US any more. The foreign inflows into the US economy have been steadily declining in the last months.
Now for the conclusion, do we really expect the international lenders to go and help the same country that has given them important losses? Could we have an “holistic” response to keep the international lenders happy without incurring in moral hazard? Will they, after the negative experience, keep buying increasing quantities of worse quality debt?
The equation is something like this:
- ↓↓↓ availability of capital in the markets
- ↑↑↑ losses lenders and investors have suffered
- ↓↓↓ their predisposition to invest again
- ↑↑↑ increase in US debt needed
- ↓↓↓ decrease in the US debt quality
Well, there’s no easy exit to this cycle. The US will be pressured to compensate the international lenders of their loses if they want to keep capital inflows going. But isn’t that strikingly close to the definition of moral hazard? Notwithstanding, which are the other options to keep the flow going?
The deleveraging process is not quite over yet. And the US treasury is constrained between a series of conditions that cannot be all met at the same time. But worse of all, the whole country’s economy virtuous circle is broken and has turned into a vicious one. The economy is not sustainable any more. Houston we’ve got a problem.
On a positive note, there are more sides to this story. Two ideas:
- The US are the main market for those that are financing them. That means that, at least, they are financing a nation that is giving them back part of their finance and holding the activity of their industry. While this cycle exists, things won’t be so grim.
- Other economic areas don’t have this vicious circle, but are falling into stagflation instead. Even with its shortcomings, the US is still a growing economy. There are not that many around. The solvency of the US economy is still holding. And they have the resuscitated dollar.
And another Damocles sword:
- Is this the end of the intervention over Freddie Mac and Fannie Mae? Will these funds be enough? That depends on the still falling value of their assets and their growing insolvencies when people won’t be able to repay their mortgages. Who knows how much money will still have to be injected… and where else.
7 comments 9 September, 2008
The holidays are over (still here after a busy summer)
Another year is over, and I’m left cold sober. That’s how a song from Queen begins. In my case it has been an interesting but feverish year. I’ve done so many things that I can’t recall them all.
My first year in the Henley MBA is over. I have passed all three exams and I feel relieved, I had my doubts that I’d pass them all. Henley Management College has just become Henley Business School in the University of Reading. That means a lot for the future prospects of the school as it will make new additional resources available to reach new heights. It’s good news.
We had a workshop about global business environment and strategic marketing. I especially liked the first part, reflecting about the global economy and how the different economic areas in the world compare, and the current macroeconomic trends.
Later, reflecting about it, I envisioned myself as an agent of globalisation. After all I had been a few days earlier seeking business in Delhi. I can’t write much about it but Spanish companies do need to go out and compete, and who is going to do that if it is not ourselves?
Yes, that’s the Taj Mahal as captured by my mobile phone. That was one outstanding moment of the summer. I will never forget this image.
In the meantime things are on track for Barcelona’s new terminal. The building is almost complete and we are testing the first systems. The last sneak peek is from one of the busiest commercial areas. A few systems are already installed and the first system trials will begin in one month. Below is an image of the first screen ever working there, still on the floor although the support structures are already installed.
The bottom line: I’m still here. I’ll keep you appraised
Add comment 18 August, 2008
