Client Advice - Crowding Out.

It's difficult if not protocol-breach for Asymptotix to disclose precisely who its clients are right now and what specific advice we give to them. Particularly in the context of what we do right now, all of our advice work is currently focussed on ‘impaired (or toxic) assets’, sensitive stuff with multi-legal entity stakeholders. We have to have some regard for our own NDA process! Often it is placing fortune as hostage to give one’s clients advice which can be construed as a warning! But that is what we did at the end of last year (2008). We predicted to one sceptical client that full-blown "crowding out" was not only likely but imminent. All of our analytics on Money Supply (components), the yield curve and some aggregate real factors were shouting “Crowding Out”! Unfortunately our vision has been reified, it seems clear. The consequence is that as hard as we try to put a price on toxic assets so as to allow bank lending to flow again – it has now become pointless.  As of last week there was no breathing space for less than the rock-stars of the private sector in the capital markets, as Keynes might have said: yields we're too low.

A statistical model cannot tell you where you are today

A statistical model can predict precisely where current evidence points you; two or three years out but it cannot tell you where you are today, you have to use your own assimilation of absolutely current evidence to do that. When only the Rock-Stars can afford to play, then you know the commodity is hellish expensive & difficult to obtain, right? In this case the commodity is cash and not only is the Government the Hall of Fame Rock God, its demand for the commodity (cash) is obsessive and addictive right now, swamping supply; asset holders, globally are scratching their heads as to how they will meet the supply of US Treasuries & UK Gilts, project forward even near term. The UK Government has thrown a scrap from its table to the securitisation process by offering to guarantee some RMBS issuance to the tune of fifty billion sterling this week. It’s like the addict giving you his needle! A drop in the bucket in terms of London’s recent annual presence in that activity and not enough to even tickle the UK housing market which needs Electric Shock Therapy. This is what we call Crowding Out, as Locke and Bagehot knew, in the end-game the Government is the biggest bully on the block, when the chips are down Westminster out-guns EC1, its been a long game that battle for supremacy between The City and Parliament in the UK, the seesaw changing relative position many times over the centuries. Right now the Government is the only player in town, in the Capital Markets, as elsewhere.

The phenomenon becomes define-able as full blown Crowding Out, when the private sector mouse can only sniff a morsel of the cheese. Crowding Out is a phenomenon of stocks not flows, no dynamic inference engine will tell you more clearly than the current numbers that the problem is in place. The banks couldn’t re-commence RMBS issuance even if 1) they wanted to and 2) there was an operational legal, regulatory and supervisory framework in place [which currently there is not] right now. The government is knocking back as much of the cash elixir as the private economy can throw off right now. The relative-statics tell you that, we don’t need dynamic confirmation.

PANIC DELAYED MORE WORRYING THINGS TO THINK ABOUT

The UK serious news programmes are chucking phrases such as “since the second world war” around, they are right, looking at Gilt issuance in the near term, it is analogous to standing beneath a pile of euros as high as the Eifel Tower & considering your job is to find people to give it to, for a while. Last Christmas we at asymptotix said the following, we thought rather gently, with some finesse; “Crowding Out may take off like a rocket? Having not been seen since the 1970s! With Central Governments issuing sovereign bonds there is less demand for net financial assets to be packaged.” Simple as that, The then Chief Economist and ‘acting-CRO’ (he didn’t know then that he was already ‘erstwhile’) at the client told us ‘we did not know what we were talking about’ & argued theoretically against even the existence of Crowding Out in this lengthy de-constructive piece below.

Crowding Out (The Cambridge-Keynesian Arguments that it does not exist)

Defined as: Governments borrowing by issuing bonds "to fund additional spending" [When actually it is for several reasons of which the above is only 1. The reasons are to maintain spending when revenue falls, to redeem bonds and pay debt interest thereby leaving GDP effect neutral, to provide lowest cost capital injection into economy, to soak up idle balances, to provide spending increase in shrinking economy].  Crowding out effect is defined as government debt 'crowding out' private companies and individuals from the lending market [but when we see private debt  has grown to 8 times Government debt, this effect idea is weak] and government borrowing tends to increase market interest rates [This is a long lag assumption that makes no sense because Government debt carries the lowest coupon rate and the simple idea assumes that new Government debt turns a borrowers market into more of a lenders market and is especially daft in the UK where debt yield projections have always shown a 30 year falling tail - unlike other countries - due to the higher prevalence of life & pension funds demand in the UK for long-dated government paper]. The problem is that the government can always pay the market interest rate, but there comes a point when corporations and individuals can no longer afford to borrow. [This is also a theory view without empirical grounding. One reason is that to buy gilts does not reduce borrowing capacity because gilts are the highest quality collateral and holders can borrow over 90% of face value and financial institutions can re-lend at higher rates and/or variously leverage their gilts holding.  Also, it is empirically consistent that private savings increase by the same % ratio to GDP that Government debt increases as a % ratio to GDP.]

Much of private sector debt has to be refinanced (rolled-over, renewed) at some time during the year.  Corporate debt issuance will be much lower than before 2007 when it had been rising, even startlingly high, for some years - one of the reasons prompting banks to grow assets by securitizing.  Yes, gov debt is being crowded in, insofar as interbank lending is occuring via the central bank and there is a hunger for genuine high-rated bonds to restructure fund portfolios and capital reserves, and because gov has to fiscally boost the recession economy, the effect of which should be to increase intra-private sector borrowing & lending above the level it would otherwise have been - a clear contradiction of the crowding out theory.

Ranting and Raving from the Grave

Crowding out theory is a neo-liberal monetarist theory without empirical evidence or observation designed to discredit Keynesian fiscal policy and also to further the case for smaller government - the usual loony idea that everything government does is anti-thetical to free capitalism and merely shackles the market from doing anything and everything more efficiently and more profitably at lower tax rates, and also as an opposition to any idea of central planning or interventionist steering or control of the economy.  Monetarists sought to reduce the Government's role to maintaining an inflation-neutral interest rate, a GDP neutral budget (balanced) as if then the economy would grow in perfect general equilibrium stability when maintained at inflation-neutral capacity utilization and unemployment rates (e.g. 2% inflation, 85% capacity utilization, 5% unemployment).  This notion of long run stability provided by free markets operating with informational efficiency, sufficiently liquid at all times, balanced & sustainable is all idealised, delusional, arch-conservative nonsense. Like many theories an effect: increased government borrowing & spending is theorized in an assumed balanced shock-free, non-turbulent, non-crisis, simple closed-system national (not global) economy.

RIGHT IN FRONT OF OUR NOSE AND BIGGER THAN THE DUTCH HOUSE

Crowding Out is happening in reality right now, before our very eyes, irrespective of what the Keynesian theory says. Maybe that’s one less ersatz chief economist & acting-cro around, who is so stupid that he inevitably makes a mess of everything & that is no bad thing! I feel happy given the lag in the correspondence now that it is after Easter, in disclosing this debate, since it maybe of practical use and interest to others.