An Essay for the EU summit June Twenty Twelve
MEMO TO EU POLICY MAKERS SUMMIT JUNE TWENTY TWELVE
HERE WE GO AGAIN / TIDYING UP ASYMPTOTIC ORPHANED IDEAS / TIME TO LISTEN
Getting the European response to this financial crisis right is the responsibility of the European Commission and arguably it is the failure of Europe to position itself in a credible manner to world capital markets which is the main cause of this critical point at which we find ourselves this week. It is well understood in economics that recessions via fiscal drag enlarge the responsibility of state or public sector institutions in the economy, the public sector becomes relatively more significant as a default function of recessions (examples are crowding out) but there are others; The route cause of the Liquidity Trap remaining around so long in Europe has to be somewhere in the Euro m3/m4 corridor; (to state the bleedin obvious); its in the transmission mechanism; Europe is having a bank-capitalization mini-crisis.
If the banks can't manage their balance sheets then no matter how much "LIQUIDITY" the politicians create the banks can't get it to us! These screwed up bank balance sheets are just like blockages in the monetary pipeline; exacerbated by freefalling equity prices. It's going to take innovative and imaginative management, some thinking to fix this crisis and it cannot be done without an external context of political assuredness and governance which is blatantly lacking right now.
Capital market liquidity is disappearing faster today than has ever been seen in history & in a sort of qe in reverse that disappearance has the consequence that narrower money (i.e. cash on the street) is disappearing just as quickly but with a 3 month or so lag; i.e. the tide goes out in capital markets first as a predictor of lack of cash on the high street. this is largely a result of the increased relative presence of public authorities and central governments in capital markets than historically what we economic-technicians refer to as ‘crowding out’ & essentially QE and LTRO are attempts to antidote that, ironically this is facilitated by ‘round tripping’ or allowing securities markets players to get their slice before it trickles down to you guys on the street.
Risk and uncertainty (& thus lack of cash) in European capital markets are further exacerbated / intensified today by the obvious indecision and lack of clarity from “the people in charge”; public authorities who have dominant positions as participants both in capital markets but also as the economy on the street goes of a cliff public authorities have a much bigger presence in all forms of everyday life. Mixed signals, public disagreements & over complex organisational structures of public institutions is simply completely unacceptable today. Our leaders in central authorities in Europe simply do not seem to recognize they are quantitatively required to be relatively more responsible, decisive & imaginative than is normal historically!
Take for example the over complex layering of the governance institutions for European banking, insurance and accounting standards. It is without question "unprecedented" in fact 'unprecedented' doesn't quite do it. The Systemic Risk Board (ESRB) is an extremely powerful new "institution"; it overlooks everything including ESMA; which oversees capital markets, ratings agencies etc.. But the ESRB also overlooks the European Banking Authority (the EBA evolved from another ridiculous acronym CEBS) – these four letter acronyms denote large institutions full of highly paid suits in very comfortable offices. Angela Merkel has recently stated clearly that the EBA should be ripped up & re-started again in Frankfurt, its failures in Banking supervision are now legend; underestimating the capital requirements of every banking system in Europe. Institutionally one can’t afford to get capital estimates wrong, it’s an error which is potentially terminal not only for a bank, not only for a nation but for the citizens too.
Transparency in Financial Institutions cannot be achieved if the standards are so arcane that even a profession cannot get its head around the requirements. That seems to me to be a 'no brainer". The ultimate goal of EU Commission initiatives should be to restore Transparency to Financial Markets and Banking. That objective should be, if not to eliminate permanently systemic risk then to make it so transparent that informed investors can act without asymmetric disadvantage when making fully rationally informed decisions about capital deployment & also so that ordinary citizens can understand how safe their bank or their country actually is. The EU, the Commission has singularly failed to achieve that.
We have argued here at asymptotix that it doesn't make sense to have the EFSF and/or ESM i.e. the super-SPV, the Systemic Risk Board, the Crisis Management Framework, the EU ratings agency, the EBA all established as separate and different processes and entities. Particularly entities emasculated from direct interaction with the Capital Markets; add to that the older EU institutions of the EIB & the EBRD all maintained as independent institutions all in the end responsible to the European Commission and eventually to the European Parliament. There is only one winner in that plethora of "nodal fragmentation" of authority, power and effort (never a good thing for effectiveness and the delight of bureaucracy, of course)!! But the looser is the European citizen. The SPV is legally constituted as far as I can understand in a manner analogous to those which caused the credit crisis, does no-one else see the irony in this? Except that an SPV at arms length from the European Commission hardly requires legal constraints to ensure that it is bankruptcy-remote (it is only the citizens who may go bankrupt and the commission executives are the only people who are bankruptcy-remote, right?).
Under Rational Expectations, capital market participants; in search of simple clear messages of ‘Policy Rules’ as guidance and statements of intent regard that plethoric nodal fragmentation producing contradictory messaging as anathema. The capital markets loose faith in the central authorities of the EU who look witless and idiotic; compromised by massively elongated decision making processes but seemingly (and this is most important) so hubristic and pompous as to be completely unwilling to engage with global capital in a language which it understands. Going to the Capital Markets by a European sovereign right now (either short [3M] or long [5Y]) indicates desperation & the bond market supply participants know it! So, did not mismanagement at the EU level and the EFSF fiasco wreck confidence in the Euro sovereign market completely. The European sovereign debt market is in market-failure so bad that it almost doesn't exist. And now we know if you don’t have a sovereign bond market to provide capital to a member state’s banking system then you have no cash on the streets. The flawed structure of the EFSF, dreamed up in Brussels and promulgated by Van Rompuy & its total mismanagement caused this market failure.
In effect the dumb stupidity clear in the behaviour of the European Union and most clear at the apex of its decision making in its two ‘laurel and hardy’ presidents has in effect destroyed trust in central authorities throughout the European mainland. There is a MASSIVE democratic deficit at the apex of the EZ in Brussels. A key piece of evidence for this can be seen in the ‘flight to quality’ of bond market investors in assets of the UK government which has most distanced itself from everything Brussellois. There is no doubt in my mind that it is cascading down from the EU centre to the sovereign authorities of the EU member states of disrespect, disregard and distrust which has obviated the risk free nature of the sovereign debt markets in the individual nation states and thus by extension destroyed their banking systems for which they are so disparaged by the EU centre (in particular Mr Rehn) when in fact it is the EU centre which has caused the problems for the member states in the first place. There is a cabal of four or five total idiots at the head of EU policy making in whom the capital markets clearly have no faith whatsoever, that much is obvious; & that cabal seems totally unwilling to do anything about their lack of credibility and seem completely unaware of the implications of their shambling incompetence. Once capital markets have no faith in central authorities under standard Rational Expectations all hell breaks loose; we don’t need to engage in the complex mathematics of the private sector / public sector game theory which rational Expectations depicted we just need the headline today; capital markets have no faith in unelected European authority; Van Rompuy, Barroso, Rehn, Barnier & Junker! EU economic governance needs to be totally re-engineered, democratised and configured on a lean, agile and most of all comprehensible intuitional footing which direct engagement with capital markets, in short we need a European IMF, a Stablisation Bank.
Those Eurocrats failed to grasp the circular flow of money in capital markets: when "large" money (e.g. M4) declines so precipitously in a market in which YOU are a participant then if you have the authority it is a policy option to change / improve the institutional configuration which enables the flow of that capital; you can increase or decrease the hurdles &/or fuel pumps which that flow of capital traverses; THEREFORE!
In Europe: the asymptotix proposition is to create another institutional participant which consolidates all those supervisory and monitoring processes which are popping up on the whim of one commissioner or another. It is insane to compromise the independence of the Central Bank; the objective should be not to widen the central bank (ECB) balance sheet & compromise the central bank, dilute the currency; the Central Bank should be the Lender of Last Resort and the steward of the currency. The logical policy is to create another central/federal balance sheet, a new one at the European Institutional level.
If the system is financially or physically unconstrained we all know a twelve cylinder engine is better (in the sense it provides more oomph) than a four cylinder one! One basic conclusion to the mathematics of systems is that if you are physically unconstrained, adding another cog-wheel to a system (another ‘gear’ analogously) increases the velocity of transmission and makes the given stock more efficient thus a significant financial institution working alongside the Central Bank could certainly impact M4 (capital market liquidity) & M4 velocity thus effecting the trickle down to high street cash balances which QE and LTRO are intended to effect. As proposed recently why wouldn’t the Central Bank be the liquidity provider to that quasi-fiscal institution? As I have argued; make that Stabilization Bank (EMF) the locus of Euro bond ratings & banking supervision; take on board the technocratic leadership argument where it is appropriate. Economic governance in terms of political fiefdoms has been a disaster and has led to redundancy and confusion. Only such an institution as a Stabilisation Bank would be the locus of authority sufficient to right-down bank debt as is necessary if the EU is going to exit this crisis. Placing the burden of quasi fiscal support on the central bank implicitly challenges the banking system and the currency. If a Central Bank is to remain the 'guardian of a currency' then the limit of its activity is in Monetary Policy; it cannot engage in Fiscal or quasi fiscal activity; that is an over-simplification but boundaries need to be specified clearly. The reason for this (again oversimplified) is that Fiscal activity impacts Money Supply with a lag (balloons it); so if the Central Bank is the guardian of the currency it cannot at the same time act as an instrument of activity which undermines that currency.
In the summer of 2010 as a logical conclusion to our analysis of Herman van Rompuy's meandering response to the developing Eurozone economic crisis, asymptotix developed the idea of a European Stabilisation Bank; the basic concept is to leave the ECB to do its job (Monetary Policy) but to engage institutions like the EIB in common European fiscal support. Now in 2012 it seems we were way ahead of the game. And our 'viewing figures' in particular those by the European Commission further bear that out.
All that the asymptotix Stabilisation Bank idea is (was) about was to establish a kind of firewall in the transmission mechanism to allow the EU to buy time to engage in the Fiscal Union process. Instead we got the half cocked EFSF. The question that YOU should be asking yourself is; if the cadre (group) of people who designed the EFSF and left themselves exposed to criticism such as asymptotix can make but more than that caused this leg of the global financial crisis; if that set of people could not get the simpler step of establishing the monetary firewall sufficiently (mainly because they did not see it would be necessary) then could you trust them to architect EU fiscal union, could you trust them to find some whisky to drink on Islay? I don’t think so!