"If money isn't loosened up, this sucker could go down" - George W. Bush warned in September 2008

Friday, May 14, 2010

Really great links - Liquidity is solvency - Balance sheet contamination - Fiscal policy and current account -

Paul McCulley - PIMCO - Liquidity is solvency - "A banking system is solvent only if it is believed by the public to be a going concern. By definition, if the public’s ex-post demand for liquidity at par proves to be equal to its ex-ante demand, a banking system is insolvent because a banking system ends up, at its core, promising something it cannot deliver."

Mohamed El-Erian - PIMCO - "More than anything, the story of the last few years has been one of serial balance sheet contamination. Initially, private sector balance sheets were expanded well beyond sustainable levels, aided and abetted by financial innovation, the degradation of lending standards, and short-termism. Subsequently, too many balance sheets deleveraged simultaneously, threatening a global depression and forcing governments to step in with their own balance sheets to arrest an increasingly disorderly process.
        Last weekend’s drama in Europe is yet another illustration of this phenomenon. Policymakers are now forcefully using the balance sheets of the EU (ultimately Germany) and ECB to compensate for the debt excesses in the periphery (particularly Greece) and the related overexposure of European banks.
        As societies start to worry even more about public finances – and this is inevitable – it will become even more difficult to sequentially deploy new balance sheets in order to sustain the levels of debt and deficit that currently prevail… that is, unless there is yet another healthy balance sheet that can stealthily take on this debt for a while.
        Some argued during the Forum that central bank balance sheets could still be used for this purpose. This view was bolstered by the ECB’s recent response aimed at calming markets and safeguarding the euro. Others warned that markets and politicians (and voters, some of whom have already signaled their disdain) would consider this yet another form of inadvisable financial alchemy, thereby limiting the feasibility, desirability and effectiveness of this approach over the medium term.
        I am inclined to side with the second group in warning against the long-term implications of additional steps to turn monetary authorities (with revolving balance sheets) into fiscal agencies (with more permanent exposure to dubious assets). An even larger-scale use of central bank balance sheets, if it were to materialize, would provide only a temporary respite, and the collateral damage and unintended consequences would be serious, including the impact on inflationary expectations."

S. M. Ali Abbas, J. Bouhga-Hagbe, A. J. Fatas, P. Mauro, R. C. Velloso - Fiscal Policy and the Current Account - "This paper examines the relationship between fiscal policy and the current account, drawing on a larger country sample than in previous studies and using panel regressions, vector autoregressions, and an analysis of large fiscal and external adjustments. On average, a strengthening in the fiscal balance by 1 percentage point of GDP is associated with a current account improvement of 0.2–0.3 percentage point of GDP. This association is as strong in emerging and low-income countries as it is in advanced economies; and significantly higher when output is above potential."

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