The Parallax Brief


Unrepentant Subjectivity on Economics, Politics, Defence, Foreign Policy, and Russia

Redwood Supporter in Sense of Humour Shocker; the Pound

So coldly logical is John Redwood’s delivery that he has been dubbed “Mr Spock” in his time, but for one of his supporters at least, wit is not “a difficult, alien concept, captain.”

Responding to Redwood’s short blog on the pound’s latest fall, one poster drolly asked, “I wonder if we can persuade Obama to invade us in the name of ‘regime change’?”

Of course, he then went on to spoil it with a paragraph of right-wing invective about the UK going bust, his sterling savings being devalued along with the pound and me-me-me, but at least his opening gambit managed to raise a cackle from here in Moscow.

On this matter, I’ve been rather irritated by the right’s response to sterling’s drop. Although the phrase “strong pound” sounds very nice, in a chest out, chin up patriotic kind of way, it really wouldn’t be very beneficial in current times.  

A weak pound lowers the relative cost of British goods and raises the relative cost of foreign goods. This has three, extremely beneficial effects: First, British goods become cheaper in both the home market and export markets, materially aiding British companies. Second, encouagement to buy British will help rebalance the UK’s current account deficit. Finally, making foreign goods more expensive will bring at least a small amount of inflationary pressure to bear on the British economy. The Bank of England’s precipitous interest rate reductions, and the current yields on British gilts, give a pretty terrifying indication of just how very close we are to slipping into full blown debt deflation. Anything to encourage inflationary expectations in this environment can be considered A Good Thing.

In boom times, these factors might be negative, as they would likely fan the flames of inflation and discourage saving. And of course, much more of a drop, and investors may get frightened off British investments, and especially our gilts, making financing our current, essential-for-survival budget deficit more expensive — or perhaps impossible — which would be an outright Russia 98-style disaster.

But so far so good.

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Toxic Bank a Supine Move to Avoid N-Word.

Britain has become the first nation to attempt to resuscitate its banking system through the creation of a so-called ‘toxic’ or ‘bad bank’. The government hopes to transfer to an ‘aggregator’ those assets which are dragging the banks down, leaving the banks free to perform their usual economic duties, and, fingers crossed, leaving the tax payer with a nice profit once the world economy recovers from its economic heart attack.

The business community breathed a sigh of relief when it learned of the government’s plan, but is it a really good idea?

I’m afraid the obvious answer is no, it is not a good idea. The government should have bitten the bullet and nationalized all banks of systemic importance. It should have nationalized them back in October instead its of original bailout. And it should have nationalized them instead of this latest bailout. Ultimately, it’ll probably have to nationalize the banks anyway.

The government’s chosen alternative, the ‘bad bank’, in effect argues “even though the market says these assets are worth X, we are willing to pay Y,” because the only way the government can make these banks solvent again is by paying more than the market would. Of course, it hopes prays that in doing this it will finally purge the financial arsenic from the banking system’s blood stream, allowing for recovery, while getting valuable assets at an ultimately profitable price. But how likely is the government to be able to successfully second guess the market? And will this really prepare the ground for recovery?

Nobel Laureate Paul Krugman is skeptical:

“Now, maybe private buyers aren’t willing to pay what toxic waste is really worth… But should the government be in the business of declaring that it knows better than the market what assets are worth? And is it really likely that paying “fair value,” whatever that means, would be enough to make [the banks] solvent again?”

Krugman believes that the government, in effect, is handing the banks a huge stack of tax payers’ cash, while taking risks that the banks cannot.

“What I suspect is that policy makers — possibly without realizing it — are gearing up to attempt a bait-and-switch: a policy that looks like the cleanup of the savings and loans, but in practice amounts to making huge gifts to bank shareholders at taxpayer expense, disguised as “fair value” purchases of toxic assets.”

Clearly, something had to be done. The banking system is currently on life support, breathing only through the mechanisms the government provides. Last time things were this bad we tried turning off the machines, causing the Great Depression. Doing nothing, therefore, was not an option. But gifting the shareholders and management of the banks should not have been the first course of action.

Of course, a Labour government nationalizing banks is a public relations open goal for the Conservative Party, and this government is nothing if not supine, so perhaps we should have expected Brown and Co. to writhe and thrash a bit before succumbing to the inevitable.

But the sooner the government plucks up enough courage to use the N-word, and makes an announcement that it is nationalizing the British banking system for a strictly limited period of time, the better it will be for everyone.

Filed under: Economics, Politics, , , , , , , , , , , , ,

Time for RBS, HSBC, and LloydsTSB-HBOS to become British Sberbanks

News slithered uncomfortably down the wires yesterday that the British government had agreed to convert its GBP5 bn of Royal Bank of Scotland preference shares into ordinary shares, taking its stake in the beleaguered bank to 70%. RBS is now, effectively, a nationalized government bank.

Predictably, the denizens of the Right have savaged the decision. On his excellent blog, John Redwood, made some wholly rational points about the move:

“…RBS will announce losses of over £6 billion, or one third of the government capital… The government is now risking huge sums of money. Of course I hope they get the terms of the scheme right and that credit starts to flow again. Even if that were it happen, I will still worry about the high risk…”

Mr. Redwood is reasonable, but wrong. He is right to argue that we don’t really want the government to be risking our money. He is also correct to question, as he did earlier in his piece, whether the government should be dabbling in nationalization in this day and age. “Didn’t we,” Mr. Redwood and many others from the Right seem to be asking, “get past this in the 70s?”

But the Right is completely missing the point. In ordinary times, people like Mr. Redwood would be right. But these aren’t ordinary times. This process is not ideal, but given the alternatives, we must hold a pomander under our noses and plough ahead.

Willem Buiter, Professor of European Political Economy at the London School of Economics and former chief economist of the EBRD and member of the MPC, argues in his latest blog for the FT that the banks are:

“…dead banks walking, held up both by actual government financial support (directly through capital injections and indirectly through such facilities as the Special Liquidity Scheme and the Treasury’s guarantee on new bank debt) and through the anticipation of future government financial support.”

And he’s right. These banks would have gone bust but for implicit or tacit government support. We tried doing nothing and letting banks go bankrupt between 1929 and 1932, and it led to the Great Depression, so I would respectfully suggest that repeating that course of action would not necessarily be best for the country. This leaves us with two options: bail outs or nationalizations, of which nationalization is surely most desirable.

Nationalizing the banking system, along the Swedish model, would give us the best chance of defibrillating inter-bank lending, boosting credit provision, and, most important, would provide tax payers the best chance of getting a return on their investment in the long run, while avoiding moral hazard by wiping out current shareholders and the banks’ egregious management.

What the Right need to understand is that we who argue for nationalization aren’t communists, and would never countenance such actions in usual circumstances – even in a ‘normal recession’. But without government support, the British banking system will collapse, consigning the country to untold misery and hardship. None of us wants that. Given the remaining options, nationalization best fits the bill. And better nationalize now than try injecting capital, buying up bad debt – and generally throwing the kitchen sink at the problem in the hope of avoiding the inevitable – only to have to nationalize every major bank anyway.

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