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October 23, 2009

Economist's View - 4 new articles

"Bernanke: Smaller Banks Not Necessarily the Answer"

Ben Bernanke does not want to lose "the economic benefit of multi-function, international (financial) firms," so he is hesitant to break large banks into smaller sized institutions. I don't have much problem with the economics, if there are efficiencies that come with bank size we should exploit them, especially if breaking up banks into smaller entities does little to reduce systemic risk but instead simply fragments the problem into many more pieces (though I'd still like to know where the minimum efficient scale is, anything larger than that is unnecessary). Obtaining resolution authority for banks in the shadow system is also very important, so I don't disagree with the emphasis on this in Bernanke's remarks.

But there seems to be the view that if they have resolution authority, higher capital requirements, etc., that will make the probability of a major breakdown small enough so that the expected benefits of size outweigh the expected costs. While I agree that obtaining resolution authority and other regulatory change is extremely important, I wouldn't bet my house, or housing and asset markets more generally, that this will eliminate the chance of a major breakdown, or make the chance small enough to justify huge, powerful, market-dominating institutions.

I would like to see more effort to measure and regulate connectedness within the system (which can be very high even with banks broken into smaller pieces) since that would add another layer of protection, the degree of leverage should come under scrutiny as well, and I would also like to see more attention to the political risks (e.g. capture of legislators and hence regulation) posed by large financial firms:

Bernanke: Smaller Banks Not Necessarily the Answer for 'Too Big to Fail' Dilemma, by David Wessel, WSJ: Mervyn King, governor of the Bank of England, says the solution to banks that are "too big to fail" is to have smaller banks. But Ben Bernanke, chairman of the U.S. Federal Reserve, says he isn't convinced that's the best answer.
Mr. Bernanke ... said he would prefer "a more subtle approach without losing the economic benefit of multi-function, international (financial) firms." ...
Mr. Bernanke suggested alternatives such as higher capital requirements against bank trading books, higher capital for "systemically important" institutions and a congressionally created process for coping with failing big financial firms in ways other than bankruptcy or bail out.
He also expressed interest in what have been dubbed "living wills" — plans that big banks would have to maintain for winding down their operations.
The goal, Mr. Bernanke said, is to reduce "the artificial incentives for size" — including the incentive to grow large so that government bailouts are anticipated — so that financial firms instead grow to a size that is economically valuable in a global economy populated by large multinational companies.
The Fed chairman did emphasize that supervisors should have the authority and willingness to tell the management of a large institution, where appropriate, that it cannot expand unless it improves its management and risk-management capabilities.
Both in answering the question and in his prepared text, Mr. Bernanke again beseeched Congress to act soon to give regulators "resolution authority" to cope with the imminent collapse of a big financial firm other than a bank, and to address other vulnerabilities in the regulatory regime exposed during the crisis.

Paul Krugman: The Chinese Disconnect

"China is stealing other peoples' jobs":

The Chinese Disconnect, by Paul Krugman, Commentary, NY Times: Senior monetary officials usually talk in code. So when Ben Bernanke ... spoke recently about Asia, international imbalances and the financial crisis, he didn't specifically criticize China's outrageous currency policy.
But he didn't have to: everyone got the subtext. China's bad behavior is posing a growing threat to the rest of the world economy. The only question now is what the world — and, in particular, the United States — will do about it.
Some background: The value of China's currency, unlike, say, the value of the British pound, isn't determined by supply and demand. Instead, Chinese authorities enforced that target by buying or selling their currency in the foreign exchange market — a policy made possible by restrictions on the ability of private investors to move their money either into or out of the country.
There's nothing necessarily wrong with such a policy, especially in a still poor country whose financial system might all too easily be destabilized by volatile flows of hot money. ... The crucial question, however, is whether the target value of the yuan is reasonable. ...
Many economists, myself included, believe that China's asset-buying spree helped inflate the housing bubble, setting the stage for the global financial crisis. But China's insistence on keeping the yuan/dollar rate fixed, even when the dollar declines, may be doing even more harm now.
Although there has been a lot of doomsaying about the falling dollar, that decline is actually both natural and desirable. America needs a weaker dollar to help reduce its trade deficit, and it's getting that weaker dollar as nervous investors, who flocked into the presumed safety of U.S. debt at the peak of the crisis, have started putting their money to work elsewhere.
But China has been keeping its currency pegged to the dollar — which means that a country with a huge trade surplus and a rapidly recovering economy, a country whose currency should be rising in value, is in effect engineering a large devaluation instead.
And that's a particularly bad thing to do at a time when the world economy remains deeply depressed due to inadequate overall demand. By pursuing a weak-currency policy, China is siphoning some of that inadequate demand away from other nations, which is hurting growth almost everywhere. The biggest victims, by the way, are probably workers in other poor countries. In normal times, I'd be among the first to reject claims that China is stealing other peoples' jobs, but right now it's the simple truth.
So what are we going to do?
U.S. officials have been extremely cautious about confronting the China problem, to such an extent that last week the Treasury Department, while expressing "concerns," certified in a required report to Congress that China is not — repeat not — manipulating its currency. They're kidding, right?
The thing is, right now this caution makes little sense. Suppose the Chinese were to do what Wall Street and Washington seem to fear and start selling some of their dollar hoard. Under current conditions, this would actually help the U.S. economy by making our exports more competitive.
In fact, some countries, most notably Switzerland, have been trying to support their economies by selling their own currencies on the foreign exchange market. The United States, mainly for diplomatic reasons, can't do this; but if the Chinese decide to do it on our behalf, we should send them a thank-you note.
The point is that with the world economy still in a precarious state, beggar-thy-neighbor policies by major players can't be tolerated. Something must be done about China's currency.

"The Death-Defying Dollar"

Barry Eichengreen says the dollar isn't dead yet:

The death-defying dollar, by Barry Eichengreen, Commentary, Project Syndicate: The blogosphere is abuzz with reports of the dollar's looming demise. The greenback has fallen against the euro by nearly 15% since the beginning of the summer. Central banks have reportedly slowed their accumulation of dollars in favor of other currencies. ...
The first thing to say about this is that one should be skeptical about ... predictions ... concerning the near term. Our models are, to put it bluntly, useless for predicting currency movements over a few weeks or months. ...
Over periods of several years, our models do better. Over those time horizons, the emphasis on the need for the US to export more and on the greater difficulty the economy will have in attracting foreign capital are on the mark. These factors give good grounds for expecting further dollar weakness.
The question is, Weakness against what? Not against the euro, which is already expensive and is the currency of an economy with banking and structural problems that are even more serious than those of the US. Not against the yen, which is the currency of an economy that refuses to grow.
Thus, for the dollar to depreciate further, it will have to depreciate against the currencies of China and other emerging markets. Their intervention in recent weeks shows a reluctance to let this happen. But their choice boils down to buying US dollars or buying US goods. The first option is a losing proposition.
In the longer run, Opec will shift to pricing petroleum in a basket of currencies. ... It hardly makes sense for it to denominate oil prices in the currency of only one of its customers. And central banks, when deciding what to hold as reserves, will surely put somewhat fewer of their eggs in the dollar basket.
Beyond this, the dollar isn't going anywhere. It is not about to be replaced by the euro or the yen, given that both Europe and Japan have serious economic problems of their own. The renminbi is coming, but not before 2020, by which time Shanghai will have become a first-class international financial center. And, even then, the renminbi will presumably share the international stage with the dollar, not replace it.
The one thing that could precipitate the demise of the dollar would be reckless economic mismanagement in the US. One popular scenario is chronic inflation. But this is implausible. ... There may be a temptation to inflate away debt held by foreigners, but the fact is that the majority of US debt is held by Americans, who would constitute a strong constituency opposing the policy.
The other scenario is that US budget deficits continue to run out of control. Predictions of outright default are far-fetched. But high debts will mean high taxes. The combination of loose fiscal policy and tight monetary policy will mean high interest rates, sluggish investment, and slow growth. Foreigners – and residents – might well grow disenchanted with the currency of an economy with these characteristics.
Mark Twain ... once responded to accounts of his ill health by writing that "reports of my death are greatly exaggerated." He might have been speaking about the dollar. For the moment, the patient is stable, external symptoms notwithstanding. But there will be grounds for worry if he doesn't commit to a healthier lifestyle.

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