In most years when one finds that Christmas is only a week away then the amount of financial news is usually correspondingly thinner than usual but not in 2010! In fact this year there has been a flurry of action to match the equally unusual flurries of snow over the UK. If we start with America then it looks as though Congress has passed Mr. Obama’s tax cuts/stimulus programme so the comment I was asked yesterday about the size of borrowing around the world in 2011 looks sure to be somewhat higher than one might have thought only a month ago. In Europe we have European Union ministers at what would be a crisis conference if the term had not suffered from the same problem as the boy who cried wolf leaving everyone with at least a soupcon of ennui. The usual pattern has been for great plans to be discussed which then are either shown to be flawed or not actually agreed upon. However a point I have been making for some time (the poor creditworthiness of the European Central Bank) has been answered. By their actions rather than their words as to admit to the situation would lead to embarrassing questions about what was said previously!
The Euro zone increases the capital of the European Central Bank
Back on the 6th December I continued a theme of questioning the financial status of the ECB
the balance sheet of Europe’s central bank looks ever riskier to me and it is quite conceivable that we could be in an era where central banks as well as private-sector banks need bailing out.
And on the 14th of December I pointed out that some of the capital of the ECB which theoretically is 5.76 billion Euros has not in fact been paid and only 4.142 billion has actually been paid. As an aside it is sad to report that we live in a world where such things happen but let’s face it such events are hardly rare. By my maths only a 3% loss on its asset purchases would have left it without capital and by my maths it probably had more than that.
So it was no great surprise to me to read this yesterday on the ECB website.
The European Central Bank (ECB) has decided to increase its subscribed capital by €5 billion, from €5.76 billion to €10.76 billion, with effect from 29 December 2010…………From a longer-term perspective, the increase in capital – the first general one in 12 years – is also motivated by the need to provide an adequate capital base in a financial system that has grown considerably.
Throughout this crisis I have spotted some changes in the use of language for example “temporary” now seems to define a time period as long as you like and now 12 days away is the “longer-term”! We also have some interesting accountancy methods as some of this announced increase will not actually be paid at all and the part which is will be paid in three installments of which only one of 1,163,191,667 Euros is actually due on the date mentioned with the others due in 2011 or 2012. In case you are wondering why I have counted this to the last Euro it is because I think that the ECB might need it. So desperate might it be I will even mention the 84,220 Euros that central banks not in the Euro including the Bank of England will have to supply.
The first point is that the ECB badly needed some money to shore up its finances. Unfortunately in the way of things these days it will actually have less real capital on December 29th than it claims it has right now!But in a proper calculation it will be stronger. It claimed before the change it had 5.76 billion Euros and after the 29th of this month its paid-up capital will be 5.39 billion Euros with promises of further tranches of 1,163,191,667 Euros in 2011 and 2012. So overall a good move.
The next obvious question is will it be enough? This depends on the future scale of its asset purchases as if it continues with bond-buying on the recent scale it has established with its Securities Markets Programme then the answer in my view is likely to be no. I hope that the capital increase has come with a real plan which will mean that the SMP can be reduced in scale and better still stopped.
Just A Thought
One of the problems that led to the credit crunch was that private-sector banks did not have enough capital and furthermore that they turned out not to have the capital they claimed. As the ECB is in effect at times operating as a policeman, judge and jury you might think that these lessons might make it operate now in an ethically higher plain. Yet it has insufficient capital and claims it has more than it has repeating so quickly the errors of the last decade. When the next bank hits trouble and the ECB points out the error of its ways I wonder if the directors will have the chutzpah to say but you don’t have enough capital either……
Moodys has been busy
This particular ratings agency seems to be involving itself in a plan to either downgrade or threaten to downgrade as many nations in Europe as it can before christmas. We had Spain earlier in the week well now with dizzying speed we have a downgrade of Ireland and threats of downgrades for Greece and some German banks. Does Moodys map of the world only cover Europe?
Here we have seen quite a severe downgrade from Aa2 to Baa1 which is 5 notches. Let me apologise for the confusing litany of numbers and letter that the ratings agencies use I am afraid I have no control over it. There was also a threat of future downgrades. Those who will like this least in the short-term will be the officials at the Securities Markets Programme at the ECB as I guess they will now be busy today buying Irish bonds, no Christmas cheer or shopping for them.
Rather ironically Ireland had posted some positive growth figures yesterday although perhaps not quite as good as some had hoped. Her Gross Domestic Product rose by 0.5% in the third quarter and her more important but less reported Gross National Product rose by 1.1%. It is more important because it represents what she can tax. It at least reversed 9 successive negative quarters for real GNP. A trade surplus was also reported.
Greece and Germany’s banks get threatened
Here Moodys is threatening downgrades on the basis of likely changes. It is afraid of haircuts on Greek debt (hardly new news) but is also worried about the lack of clear plans for the period 2012 to 2014. In the case of Germany’s banks a new law is being introduced in January which makes many of them more risky for debt owners as the German regulator is taking more powers in this area.
I have written many times that we need to find a better system than the current ratings agency one. Unfortunately there is not one in sight apart from one or two plans which might manage the achievement of making things worse! Oh dear. In terms of the logic behind what Moodys has done this week I do not dispute it but I do wonder about the timing. If we take timing literally then after some apparent economic growth and the IMF releasing funds for Ireland she is in fact a little stronger just as this hits.
If Moodys was looking for something to occupy itself it could take a look at the Federal Reserve Bank of New York. We have seen the ECB implicitly acknowledge how can I put it some financial issues. However the Fed. hold a lot of US government and mortgage debt the price of which has been doing what recently? When you own nearly a trillion dollars of something and you see the yield rises and price falls we have over the last fortnight…….
UK Inflation Prospects
After generally disappointing across the board inflation figures from the UK,yet again there has been some more news on this front. According to the Automobile Association the price of petrol in the UK has hit an all-time high of 122.14p per litre on average. I discussed on Wednesday my thoughts on the influences of this as they are both inflationary and deflationary. Furthermore I introduced the subject of the fact that those to whom fuel is a cost of business such as driving instructors, taxi drivers and lorry drivers are in effect paying very high marginal tax rates.
Inflation Expectations: The Bank of England survey
Those on the Monetary Policy Committee who have been claiming that inflation expectations have not risen in the UK found a survey they sponsor disagreeing with them this week. Let me quote from it.
Question 1: Asked to give the current rate of inflation, respondents gave a median answer of 3.9%, compared with 3.6% in August.
Question 2a: Median expectations of the rate of inflation over the coming year were 3.9%, compared with 3.4% in August
Question 2b*: Asked about expected inflation in the twelve months after that, respondents gave a median answer of 3.2%, compared with 2.9% in August.
Question 2c*: Asked about expectations of inflation in the longer term, say in five years time, respondents gave a median answer of 3.3%, compared with 3.2% in August.
Every single answer given above is higher and I think that speaks for itself. However even on results which agree with what I think I would add that this is only a survey and it was one where 51% of respondents thought interest rates had change when in fact they had not. But still a clear message on inflation emerges.
A Speech By Adam Posen
Mr.Posen has given a speech in Essex explaining his views on UK monetary policy and he has some influence as he is on the Monetary policy Committee. I wrote an article back on the 29th of September explaining what I felt and indeed feel are the problems with his approach. So today I will keep it simple. He feels that inflation is likely to be well below target in two years time and that we need more Quantitative Easing in response. My reply is you felt that two years ago Adam. In an era of digital music and mp3 players younger readers may not know what I mean by sounding like a scratched record but older ones will. One day of course he will probably be right if you persist with anything long enough then eventually you will probably be right.