Saturday, December 31, 2011

ECB, NCBs, and arbitrage yet again

Tyler Cowen posts again on the theory that banks are using the ECB's new and broader facilities for arbitrage by buying risky sovereign debt, thereby driving interest rates down.

There is another explanation for the fall in rates, see my comment below:

The new ECB collateral rules dramatically increase the quantity of assets that banks can submit to the ECB in order to get ECB clearing balances. Bank loans are now allowed, so are lower quality ABS. This means that it is less likely that the national governments will have to guarantee local bank debt. This was a real problem in Greece and Ireland, for instance, for the local banks had run out of assets to submit to the ECB. Instead, banks were creating debts amongst each other and having the government guarantee these debts, before submitting them to the ECB as collateral.

Since private non-marketable debt can now be submitted to the ECB, governments will no longer be required to covertly bail out their banks by guaranteeing intra-bank debts. That means that euro government debt is now a lot safer, and explains why yields are falling. So you can use an ECB arbitrage theory to explain the data, but there are alternatives.

Interfluidity also chimes in on The Eurozone’s policy breakthrough? My comment below:

I think the ECB’s policy change is designed to stop the intra-European bank run currently in effect, and not to support various governments. The arbitrage bit that Cowen is writing about is either a red herring or simply incidental.

Because of the Eoro area clearing & settlement mechanism, banks subject to capital flight need to submit collateral to their NCB on a continuing basis to deal with a bank run.

By lending settlement balances for three years and, more importantly, accepting lower quality ABS and bank loans as collateral, the ECB is committing NCBs to averting all degrees of bank runs from member banks. Hopefully this flexing of its muscles is enough to stop the run.

See this older blog post too.

Friday, December 30, 2011

Asset shortages, scarcity of safe collateral

Have commented on a few blogs that bring up the meme of collateral shortages.

Commodity money: It's back! (and it sucks) at Macromania
Is the Fed our savior in financial regulation? at Marginal Revolution
Why the Global Shortage of Safe Assets Matters at Macro and Other Market Musings

The idea of a scarcity of shortage of safe assets is nonsensical to me.

I just don't think this can be a real issue. If the quantity of "safe assets" somehow collapses, then the prices of remaining "safe assets" will rise to meet the market's demand for safe collateral and stores of value. You can't have shortages in financial markets. Do you think you can?


The idea that there can be a shortage of good collateralizable financial assets sounds fishy to me. Prices for those assets will simply rise until their price is sufficient to meet the demand for good collateral. The same with an excess demand for money - prices will simply fall to meet that demand.

Monday, December 26, 2011

Saturday, December 17, 2011

Great Depression and the gold standard

David Glasner comments on a recent Deutsche Bank report in Deutsche Bank Gets It, Why Can’t Mrs. Merkel?.

I point out in my comment that the chart mislabels the dates upon which the various countries left the gold standard. Also, what about Holland, Poland, and Switzerland? I suspect they would show data entirely different from France, though they left the gold standard (or devalued) in the same month.

ECB and NCBs again

Tyler Cowen has another post on the ECB financing sovereign governments via loans... It is finally being recognized that the eurozone made a major policy breakthrough:

My thoughts:

I don’t think the key here is arbitrage and government monetary financing. It’s about a slow bank run that has been enveloping Southern Europe for a few years now. The mechanism which governs intra-Euro payments requires Greek/Italian etc banks to “solve” for the bank run by submitting collateral to their national central bank in return for settlement balances. Much of this is done overnight or on a weekly basis. By establishing 3 year operations, the ECB is telling the banks and the rest of the world that they will continue to meet the demands of anyone running on the Southern European banks for the next 3 years. That sort of commitment to the system might be large enough to stop the bank run.

It’s similiar to how, in the old days, banks suffering bank runs would often bring out all their cash and gold from the vaults and put it on display behind the bank teller so that depositors, seeing the actual backing assets, would turn away. The ECB is putting its cash on display.

Relevant link: see this older post

Wednesday, December 14, 2011

Gold lease rates, GOFO, gold

FT Alphaville commented on gold lease rates in Make your own (collateralised) gold standard.

My comment pointed to the fact that much of the conversation on negative lease rates is not considering the fact that storage costs are rising. These rising costs encourage gold owners to lend gold out temporarily so they save themselves the hassle of footing a hefty storage bill, and they may be so eager to avoid this bill that they are willing to pay others a fee to take on the burden. Thus negative interest rates.

Relavent links:

See Negative Lease Rates at Gold Chat

Sunday, December 11, 2011

China, CNH, CNY, Hong Kong, and yuan

FT Alphaville updates the offshore yuan story. See Chinese CNH – YOURS!.

There seems to have been a turnaround in the offshore market's blistering growth and the yuan's appreciation.

Relevant Links:
Offshore renminbi – an updated primer from HSBC
NDF discount reflects tighter yuan liquidity from Credit Agricole
Yuan's Rise Is Out of Steam from WSJ
Hong Kong Yuan Deposits Drop for 1st Time Since October ’09 from Bloomberg

MMT, history of thought, Locke, Berkeley, chartalism, free banking, and cooperative banking has a post on MMT's openness and political neutrality. See A Clarification on Political Openness.

Heteconomist: "I prefer to see MMT as an open framework (basically an understanding of the monetary system and national accounting) within which – or out of which – various policy approaches could be developed and pursued."


I’m no expert, but I decompose the monetary component of MMT into chartalism and endogenous money. These ideas are so old… you can go back centuries to find the origins of chartalism in Locke and Berkeley (money as a ticket, agreement, or sign). Endogenous money’s roots traces to the banking school of the 19th century. MMT doesn’t own these individual ideas… they are diffused into the general body of economics.

There are no intrinsic reasons why the ideas of Locke, Berkeley, and the banking school need be associated with a particular political slant.

The chartalist version of Locke/Berkeley’s token theory of money surely appeals to big government types on the left and right. This is because it finds in the all-powerful state the basis of the entire monetary system.

But you can have endogeneous money + Stateless Locke/Berkeley token money. The political form of this, on the left at least, would be social credit and the cooperative banking movement. On the right it would be some form of free banking.

So in sum, I wouldn’t idealize MMT as being a neutral super structure on which to drape your policy prescriptions. There is politics at the core of the chartalist rendition of Locke/Berkeley.

ECB, NCBs, collateral, capital key, Target2, and intra-eurosystem credit

Two comments on The Money View. One on Perry Mehrling's The IMF and the Collateral Crunch and the other on Daniel H. Neilson's Is there an ECB?

Neilson links to the erroneous Tornell/Westerman piece. My comments on this are in a previous post. In short, Karl Whelan's Worse than Sinn clarifies the issue. Sterilization by the Bundesbank is not happening. 

Merhling and me discuss the nature of the transactions conducted between borrowing NCBs and the lending ECB.

Perry, I can't find any explicit reference to whether intra-Eurosystem credits are collateralized or not.

But I still think not. Collateral is posted by a borrower to a lender to protect the lender should the borrower default. Then the lender can collect the collateral instead.

But ECB losses are dealt with in a specific way. See bottom of

In short, if the ECB suffers a loss on a loan to an NCB then that loss is allocated to all NCBs according to the ECB's capital key.

The March 2011 Bundesbank report describes this:

"An actual loss will be incurred only if and when a Eurosystem counterparty defaults and the collateral it posted does not realise the full value of the collateralised refinancing operations despite the risk control measures applied by the Eurosystem. Any actual loss would always be borne by the Eurosystem as a whole, regardless of which national bank records it. The cost of such a loss would be shared among the national banks in line with the capital key."
So it would be redundant or unecessary for an NCB to post collateral to the ECB for ECB credit, since in the case of non-payment the ECB has a claim on all NCBs to make up the loss.

That being said, I don't think this necessarily changes the thrust of your post.

LOLR, ECB, and "too complicated for people to complain about"

Interesting post on Marginal Revolution, What is the difference between LOLR to banks and LOLR to governments?

Cowen: “Is this transfer of the subsidy to the sovereign a bug or a feature of the plan? Perhaps this is how the EU/ECB, viewed for a moment as a consolidated entity, will circumvent EU law to finance troubled governments. Is it possible that by changing collateral requirements they can alter the flow of funds to governments in a discretionary, ever-changing, and relatively non-politicized fashion? Does this satisfy the “too complicated for people to complain about” provision?”


Good post. It is probably a feature, not a bug, and it is surely “too complicated for people to complain about,” at least for now.

This isn’t a new thing, though. The ECB has been lightening up collateral requirements for a few years now, presumably in part to finance weak governments through the back door. Remember when the ECB broke its rules and began accepting BBBminus-rated collateral?

Relevant Link:
Peter Garber, Deutsche Bank. The Mechanics of Intra Euro Capital Flight

Saturday, December 10, 2011

MMT, Fed Treasury Accord, and overdraft facilities

I entered the fray at a couple of MMT blogs.

There was some interesting discussion concerning consolidation of the Treasury and central bank, and how MMT portrays/misportrays the actual institutional details of modern central banking in order to make their message easier.

Between Depression and Hyperinflation at Winterspeak.
From the comments: technical details on MMT at Winterspeak.
The General and the Specific in MMT at

Even with the BoE, the old way by which it could lend directly to government - via its "ways and means" advance/overdraft facility - has been effectively neutered. That facility was frozen in 1997 and has since been almost completely repaid. The upshot is that MMT can't look to the BoE as an example of its idealized "consolidation", and it can't give policy recommendations as if these institutional rigidities didn't exist.

Relevant link:
The Treasury-Fed Accord: A New Narrative Account by Hetzel and Leach

Liquidity options, liquidity premium, natural interest rate, TIPS, and inflation swaps

Commented on David Glasner's Once Again The Stock Market Shows its Love for Inflation:
The only problem here is the one that we talked about in a previous post (Unpleasant Fisherian Arithmetic) concerning the liquidity premium that assets carry. The reason for the rising TIPS spread could be (though not necessarily must be) that the liquidity premium on treasuries is shrinking relative to that of TIPS, and therefore TIPS are rising in price relative to Treasuries. This makes it hard to pass judgment on the hypothetical rate of return on capital.
 Anyways, you have already commented on this problem in your paper: “One possible cause of distortion in the yield on TIPS bonds and in the TIPS spread during the autumn 2008 financial crisis is that the yield on conventional Treasuries was depressed because of a liquidity premium. Even though the ex ante real interest rate was likely negative, because TIPS bonds were perceived as much less liquid than conventional Treasuries, TIPS bonds could not be sold unless they were discounted, so that their yields rose well above the (unobservable) ex ante real rate on holding real assets.”
 We were talking in the comments of the “Unpleasant Fisherian Arithmetic” post about how one could measure liquidity. I thought a bit about this. If there were a market for financial products, say options, that managed to price the pure value of an underlying asset’s liquidity premium, then you would be able to measure the value that the market placed on assets’ relative liquidity premiums and, from there, get a better idea for what portion of an assets total return is provided by an own-rate and what is provided by a liquidity premium. These sort of financial assets don’t exist, but if they did they would probably be sort of like credit-default swaps… more like liquidity-guarantee swaps.
Note that is follows from a previous comment I had concerning the impossibility of computing the natural rate of interest because liquidity interferes. See Unpleasant Fisherian Arithmetic

David responded:
Have you looked at how the Cleveland Fed tries to extract the inflation expectation from the TIPS spread?
I responded:
 I looked at it this morning. It seems to me that the Cleveland Fed is using alternative measures to extract inflation expecations given the problems posed by illiquidity in TIPS markets. They are including the inflation swaps market. In an inflation swap, one party pays a fixed interest rate, the other pays the inflation rate.
 Apparently swap markets didn’t suffer as much as TIPS markets did from liquidity problems in 2008, and for that reason the Cleveland Fed is using swap rates as one of their main indicators of inflation expectations.
 That being said, swaps are still traded contracts and bear some sort of liquidity premium, so it is still empirically impossible to back out a real rate without knowing what that premium is.
 For your records, here is the quote page for the 2 year USD dollar inflation swap spread:
The Cleveland Fed discuss their methodology here.

Bagehot, Liquidity Insurance, and LOLR

Commented at Macromania on "On Bagehot's Penalty Rate".
 I think you have captured an inconsistency in the Bagehot principle. If the guiding rule is to lend at a penalty rate, then during a liquidity crisis how can the central bank ever fulfill its duty as lender of last resort? The rate that the market requires will rise but the penalty rate will rise even more, such that the central bank effectively prices itself out of the market. After all, if you can transact with the market at x%, why transact at x+1% with the LOLR? Some liquidity provider that is.
 At the same time, I'm sure we can all agree that the job of a LOLR is to provide liquidity, not set market prices.
 I think the problem here is that we haven't learnt how to properly understand and measure liquidity, and therefore can't price it and provide adequate liquidity insurance policies. Central banks certainly aren't great at it. Because their tools are so blunt, as an unfortunate by-product of acting as LOLR they clumsily prop up asset prices. And that gets everyone angry, and justifiably so.
 The best solution would be to devolve the provision of liquidity insurance to the market. Financial products would be developed to provide superior measures of liquidity, and the prices of liquidity for various assets would become public. Taxpayers would no longer have to worry about subsidizing sloppy efforts to provide liquidity to those who may not have paid the market price for the benefits the Fed provided them.
Some relevant links:

Liquidity Options by Golts and Kritzman
Liquidity and risk: liquidity as the value of an option to sell at the market price at WWCI (see bob's comments in particular)

Target2, ECB, and Euro NCBs

Commented at FT Alphaville on How Germany is paying for the Eurozone crisis anyway:

There are some good bits in the VOXeu article, although I have a few quibbles.

"“that the Bundesbank will soon exhaust the stock of securities that it can sell to fund further loans to the Eurosystem.”"

The Bundesbank doesn’t need to fund its loan to the ECB by selling off assets. Effectively, German banks are deserting the PIIGS banks in droves. Reserves are flowing from the accounts of PIIGS banks at their domestic PIIGS NCBs to the German reserve accounts at the Bundesbank . Thus the Bundesbank’s reserve accounts (a liability to its domestic banking system) are rising even as its credit to the ECB (an asset on its balance sheet) rises. This is more or less automatic. So in order to balance a rapidly increasing credit item to the ECB, the Bundesbank doesn’t need a declining quantity of assets to act as the balancing mechanism; increasing reserves held at the Bundesbank will do the trick. There is nothing to exhaust. They don’t have to sell their gold.

Note that I think Karl Whelan's rejoinder "Worse than Sinn" available here is the best rejoinder to the FT Alphaville post.