Russia, global lender of last resort? Will Russia bail out the hedge fund of the North …
A few years ago, analysts looking at the same data that Dr. Krugman highlighted started to call the US a hedge fund. It borrowed short-term in dollars, providing the world wit a safe liquid asset (or it was said) and used the proceeds to buy risky assets abroad — collecting a risk premium in the process.
That kind of hedge fund is has had a bad run recently. The US — viewed as a hedge fund — is structurally “short” the dollar and “long” global equities, as it borrows in dollars to buy assets abroad. It consequently did well when the dollar fell and global equity markets rose, and correspondingly did poorly when the dollar rises and global equities fall. Unless something changes, the United States net international investment position will deteriorate quite sharply this year.
The US as hedge fund metaphor actually never quite worked for the US — as the US was borrowing as much to finance a current account deficit (current consumption) as to finance the purchases of assets abroad. It actually was a better description of Europe (which also is having a bad week) in general and the Eurozone in particular. The Eurozone attracted large inflows and used the resulting inflows to finance equally large outflows, not a large current account deficit.
But no national resembled a high-living hedge fund quite as much as Iceland. Its big banks and big firms had enormous international liabilities and enormous international assets — at least in relation to Iceland’s small economy. And for a while, Iceland used the profits from its intermediation to live very well, running a large current account deficit. In that sense, it also resembled the US.
Suffice to say it is a very troubled hedge fund.
And it has apparently turned to Russia — yep, Russia — for emergency financial support. Iceland’s prime minister claimed to have no choice. Iceland’s friends, he claimed, all turned Iceland down (maybe they were too busy rescuing their own banks). The FT reports
Geir Haarde, Iceland’s prime minister, said on Tuesday that the country’s “friends” had not offered financial assistance to his country, forcing it to seek a capital injection from Russia.
Iceland earlier revealed that Russia had agreed to provide the country with a €4bn ($5.4 bn) loan as the crisis-hit country set about shoring up its foreign exchange reserves, although Russia’s deputy finance minister, Dmitry Pankin, later said no agreement had been reached. Iceland’s currency, the krona, rallied on the news wiping out losses made on Monday and earlier on Tuesday.
“We have throughout this year asked many of our friends for swap agreements and for other forms of support in these extraordinary circumstances,” Mr Haarde said. “We have not received the kind of support that we were requesting from our friends. So in a situation like that one has to look for new friends.” Iceland’s central bank said its Russian counterpart had provided €4bn on a four-year deal, with interest set at 30-50 basis points over the London interbank offered rate. The move follows discussions with other countries in the past few days and emergency legislation passed in Iceland on Monday night that allows the nationalisation of banks.
The central bank also said it would peg the island’s krona to a basket of currencies at a level of 131 per euro effective immediately, to restore confidence in the battered currency. “Iceland has never defaulted on its sovereign debt and will not,” said Mr Haarde on Tuesday.
On Tuesday Alexei Kudrin, Russia’s finance minister, told reporters “Russia takes a positive view of Iceland’s request for a loan and will determine the terms and conditions in negotiations.
It is a strange deal though, assuming there is actually a deal.
Iceland is a member of NATO. The US had an airbase there for a long-time — in large part to keep an eye out for Russia. During the cold war, the US would ever have allowed Russia to bail out a military ally. And Russia hasn’t traditionally thought of Iceland as part of its near-abroad either. Then throw if the fact that Russia is lending to support Iceland’s new peg — a peg that I assume will be a peg to a euro-heavy rather a ruble-heavy basket.
The possibility that countries with large reserves might displace the US, the G-7 and institutions like the IMF from their traditional role as the world’s financial crisis managers was one of the strategic changes that I discussed in my Council Special Report was . I am though still surprised by Russia’s move, largely because I assumed that Russia’s current financial troubles would keep it from financial adventures abroad. Russia’s reserves fell by $40b between the end of July and the end of September, though part of that comes from the fall in the dollar value of Russia’s euros and pounds. It almost certainly isn’t pegging to the ruble. Finally, Russia’s central bank has had its hands full — or so it seemed — managing Russia’s own crisis. Russia’s government recently indicated it would give long-term (not just short-term) financing to Russia’s big state banks. I guess Russia wanted to show it has enough reserves to play offense as well as defense.
I consequently wouldn’t characterize this move as “stabilizing.” It may help Iceland — but it also destabilizes the world’s existing architecture for crisis management. The IMF has plenty of cash. It could have been at the center of an international effort to support Iceland, though the Fund’s rules and Iceland’s small size likely would have implied that the other Nordic countries and perhaps all of Europe would have needed to lend along side the Fund.
Or, I guess, Norway could have used its sovereign fund to bailout Iceland’s government and its banks —
Certainly lots of countries (Russia, Kuwait, Australia) have been using their sovereign funds to support their domestic banks recently.
Nor is Iceland the only small country with lots of external debt. Dubai looks rather like a real-estate heavy hedge fund … with lots of short-term liabilities and long-term, rather illiquid assets. I would bet though that it will turn to Abu Dhabi rather than Russia for help.
Suffice to say the world is changing rapidly …
brad. iceland is not just a simple hedge fund. it is a ponzi scheme. icelandic banks been selling the same assets to each other at ever increasing prices and booked profits. they then used these paper profits to borrow money. when the world had a first round of doubts about iceland, it quickly arbitraged the EEC deposit protection scheme, establishing its internet banks everywhere they could. they also tapped their central bank which is run by a connected party (pm is on a payroll too, btw) and repoed each others’ paper with the ECB. now they are getting destroyed and the whole island will have to go bust to pay for the excesses of 20 people that were behind the scheme. iceland will go into history as an unprecedented scam. this awkward situation with the russian loan being announced and then denied by the russian deputy minister is a case to point. the world has become so naively stupid even the most outrageous facts don’t flash red anymore. well, nevermind, that sucker is not coming back, thanks god!
bsetser: I consequently wouldn’t characterize this move as “stabilizing.” It may help Iceland — but it also destablizes the world’s existing architecture for crisis management.
What existing architecture for crisis management?
Architecture, such as it existed:
– crisis loans to governments come with conditions and go through the IMF (there are some exceptions to this, but it was the basic architecture of the global response to the emerging world’s crisis)
– national central banks are the crisis lenders to the banks they regulate. this has created some difficulties, as some regulate banks with big fx books. but the use of the swap line let European central banks borrow dollars to lend to their banks.
It ain’t a great architecture, but it is what we have …
you might throw in the tendency of dollar pegging economies add to their dollar reserves and indirectly provide unconditional financing to the US to the overall archictecture.
I’m not an expert on Iceland, but I think they have to have money to eat. I don’t think there’s much farming there.
I wonder if Norway, Britain and Canada will get a bunch of boat people from Iceland ala the Cuban boat people who went to Florida in the late 1970s.
How many days until the early warning radar station and related equipment Russian equivalent to the US missile-shield begin to arrive in Rejkavik?
The US has made a very significant miscalculation in the political calculus on this issue. For a mere 4 billion Euro it may have lost the locus of geo-political control in the North Atlantic. Were the CIA asleep while all this was going on?
charlie, Iceland is in the middle of north Atlantic and its residents looove herring. They’ll survive. In any event, there’s only about 350,000 of them…so even if they did decide to reverse Eric the Red’s footsteps, I’m not sure if anyone would notice.
Brad, the Russian aid was pretty surprising to me, and I suppose is another example of modern financial realpolitik, wherein erstwhile Communists find that an open chequebook wins them more influence than a thousand copies of Marx, Enghels, and Mao ever did.
A smart move, as the collapse of the Western banking system should ultimately spell the end of the BW institutions as the axis of crisis management and economic diplomacy; it’s hard to see EM counties giving a moment’s thought to the IMF and WB when the US and Europe are caught up in the same sort of crisis that EM made it through 9-10 years ago…
Macro man — I think you are right re: the “IMF/ WB/ G-7 axis” of crisis management, at least when it comes to the emerging world. But I would have expected that this axis would have had one last gasp of glory for NATO countries with BoP problems … i.e Iceland and the Eastern European countries with large CADs.
Brad, very interesting post. Your spelling and proofreading are ghastly, however.
You raise a great question: Whatever happened to the IMF?
[...] dos aspectos mais curiosos é a emergência da Rússia como emprestador de última instância. Brad Setser comenta, e vê sinais de que FMI e Banco Munidal já [...]
Brad, I think it just goes to show you that we are now firmly in “every man for himself” territory…just look at to-ing and fro-ing in Europe.
The time for “women, children, and allies with ginormous BoP issues first” has come and gone, alas…
Brad,
What is so surprising? Russia and the US are playing an innocent game of tit for tat. The US makes a lousy political investment in Georgia and Russia replies by making an equally lousy , but this time financial investment in Iceland. Following the logic of the game (the Russians invaded Georgia after the US investment) Russia probably expects the US now to invade Iceland (part of its empire). Once that happens it will send the State Yacht to monitor the situation and a submarine to provide relief to victims of the occupation.
Anyway, 4bn seems to be a little to little to make a difference. As far as I know, Iceland has never been a great souvereign risk, and I have difficulty imagining anyone with a brain investing a lot there. How on earth could these Icelandic banks borrow so much money? If there was ever a justification for using haircuts it is this one.
you guys had better lend schwarzenegger the $7 b – before china does – because that’s part of the empire too. and keep an eye on the independence movement in “jefferson state.”
Ahhh… the IMF: screwing the poor and imposing US dollar seignorage since 1944…
They’ll survive. Realpolitically Island is Denmark. In the 1970s Mogens Glistrup suggested that the Danish defence force be replaced with an answering machine saying “We surrender” in Russian. Realpolitically the german ex chancellor Gerhard Schröder had no problems joining four ex Stasi officers while working for Putins Gazprom.
They’ll survive as slaves. Better red than dead will be their leitmotif. Or in modern english: Better a slave than a dead man.
bsetser: It ain’t a great architecture, but it is what we have …
What we had. The credit crisis is far too large for the IMF to handle, and the IMF was never set up to address a financial implosion in the developed world since such as thing was never supposed to happen.
For emerging markets, most of them would prefer to eat molten lead than take money from the IMF since that money has come with conditions that were more painful. The response of emerging markets has been to build up their own reserves.
Macro Man: Brad, the Russian aid was pretty surprising to me, and I suppose is another example of modern financial realpolitik,
The cynic in me figures that Russia must have had a lot of exposure to Iceland and they are really saving their own skins.
I personally think the entire situation is Nuts!!
From Asia Times,
Chinese Prime Minister Wen Jiabao pledges to bailout the United States
http://www.atimes.com/atimes/China_Business/JJ08Cb01.html
The US is expected to issue more Treasuries to raise the funds, and China is expected to be a big buyer. Hong Kong’s Chinese-language Ming Pao Daily reported at the weekend that the Chinese government plans to buy at least $200 billion worth of new US Treasuries. A PBoC spokesman declined to confirm this.
“We must help the US to help ourselves,” a Chinese government official said. “We do not want to see the collapse of the US financial system, which would be disastrous for us too.” Premier Wen, on the sideline of a visit to the United Nations, has pledged all coordination and assistance to help the US out of its current predicament.
Right now, buying government-backed treasury bonds may be the safest way for China to make outbound investments. “We believe the United States is a country with good credit,” Wen said in an interview with CNN last month.
Hence the Chinese government will have to continue managing the country’s $2 trillion and growing, foreign reserve. That means China will have to continue buying US Treasury bonds.
According to the US Department of Treasury and Federal Reserve, China by the end of July this year was the second-largest holder of US Treasuries, at $518.7 billion, next only to Japan’s $593.4 billion. China accounted for 19.38 % of the total $2.676 trillion foreign holding of US Treasuries.
The People’s Bank of China (PBoC) statement wrote, “China and the United States have common interest in stabilizing financial markets.”
the Chinese government plans to buy at least $200 billion worth of new US Treasuries
Can that be enough? Is it really a statement of support?
[...] Iceland is begging Russia for for a loan because no one else will give them one. [...]
Rien Huizer,
Two words: carry trade. With Iceland borrowing at 13% interest and Japan loaning at .5% interest, how much greed does it take to turn smart investors (public or private) into fools?
Iceland has a great deal of valuable natural resources. Global warming may make it even more valuable. It has the great advantage of being more or less hydrocarbon independent. It has innovative engineers, remember googles can potentially spring up from anywhere.
Russia is a oil producer with goodness knows how much untapped natural resources in its rapidly warming northern areas.
Better red than dead is a throwaway comment. Quite possibly Russia now has more moral capital than America.
Personally, to me, it is completely and obviously clear that America has squandered its moral capital and if this was added to its overall debt people would truely realise how dire things have become.
Russia now has more moral capital than America. You are right. This explains why Putin will help Chavez developing nuclear energy for peaceful ends.
I’m surprised to see such ugly Russia-bashing on this list. Folks, Russia is far from perfect, but it really is a bona fide democracy, with a reasonably free press and a vibrant civil society. It’s also one of the best-kept investment secrets of our time. After going through the ringer in 1991-1998, Russia’s economy is fundamentally sound today – they have one of the best-educated workforces in the world, 500,000 scientists, half a trillion in forex reserves, and their high-tech and electronics sectors are booming. If they did help out Iceland, this shows maturity, pragmatism and visionary leadership.
As for the IMF, it should be allowed to die a slow death. We have a multipolar world which needs a multipolar bailout. Pointing fingers and indulging in Cold War hysteria isn’t helpful – the Banks of China and Japan, the petro-states, Russia, the EU, the US, and the big sovereign wealth funds all need to work together to solve this crisis.
Not to forget the western drain of all those brave people searching a new hope.
Go Russia! Knock ‘em dead, Vlad!
BTW, we’ve got a fun discussion of maturity transformation going on over at Arnold Kling’s…
brad, i would like you to clarify me something. you have said in the past that Fed technically isn’t printing money. many economists, among them phelps (edmund, not michael) are saying that fed is printing money.. so what did you mean by that, and what are they saying. please, solve this puzzle for me.
ghastly seems a bit too strong to me, tho spelling certainly is my weakness. in any case, most of the errors should have been corrected.
gillies — clever comment. But it does highlight the need for the US to rise to the challenge of putting its own financial house in order.
rien – my guess is that this is much broader than georgia. US missile bases in eastern europe played a role. iceland was once thought to be strategically important by the US (read some old tom clancy novels …) so when russia saw a chance to make inroads in a NATO country it jumped — since the US hasn’t hesitated in the old Russian (or Soviet) sphere of influence.
that said, i do wonder how this will play in russia — making risky investments abroad when your own financial system is in trouble typically isn’t popular.
speaking of conditionality and strings… what do you think of Subramanian’s suggestion that China bailout the US
http://www.ft.com/cms/s/0/dd091644-946e-11dd-953e-000077b07658.html
“The Chinese government could offer to lend up to $500bn (from its current stock of $1,800bn) to the US government for the rescue of its financial sector”
But isn’t the issue as much about whether China buys the US debt going forward rather than whether China diversifies the composition of US assets by giving its treasuries to the us gov in exchange for other claims. Though perhaps I’m travelling too far down the thought experiment or completely mixing my metaphors
I think Subramanian is advocating the conditions that Subramanian would “tie” to Beijing’s aid, not the conditions Beijing would “tie” to Beijing’s aid. China hasn’t exactly embraced a social safety net at home (many have suggested it should create a stronger one to encourage consumption), so it seems unlikely to link its aid to one abroad — and most countries link their aid to conditions that assure their repayment rather than to expanded social protections.
In any case, China recently seems to have tightened its peg (there is now a market expectations of RMB depreciation), which rather suggests the US will get chinese financing unconditionally — which likely means China will finance the paulson plan rather than the subramanian plan.
incidentally, the US external deficit should soon start to fall sharply — so the US will (finally) have a somewhat reduced need for external financing.
thor. to the extent the fed financed its lending by selling treasuries, it wasn’t printing money — it was changing the assets used to back the money supply. more recently, the fed has expanded its lending, using funds that the treasury has raised by selling securities. that also isn’t technically printing money.
the only caution i would raise here is that i haven’t looked at everything the fed has done in the past week, and i am not sure that it hasn’t done some things that could be fairly characterized as printing money.
but in general, its increased lending has been “sterilized” by the sale of its existing portfolio and by the sale of new t-bills.
Yous all know wadda I tink. We shoulda buy Italy, and I couldn’t give a crap about Iceland.
But Casey does think Iceland would make a fine launching pad for Soviet ICBMs.
As far as valuable resources goes, they have lots of geothermal power and are excited about exporting it to lower Europe. What that takes is geothermal electric power plants and very long transmission lines. So this is a VERY long term plan, and would take LOTS of capital investment.
Almost sounds like a prospective that investment bankers put out for shareholders.
So’s it’s hard for me to figures what Russia is so excited about.
bsetser: China hasn’t exactly embraced a social safety net at home
China does have a big social safety net in the form of land. Most of the population is still rural, and anyone with a rural residency permit is entitled to a plot of land which they can farm. During the boom times it was suggested that farmers be allowed there land use rights for huge amounts of money in real estate. This was a bad idea as land holdings are the basic safety net for most of the Chinese population.
As far as Russia goes. My suspicion is that Russia is interested in bailing out Iceland for reasons other than ICBM bases. Iceland was a destination for a lot of money from Britain, and there are a lot of rich Russian expatriates in London that may be losing their shirts right now.
China has been bailing out the United States for the last five years at least. Also I doubt that China would want to impose any conditions on any bailout relating to US domestic policy since China really doesn’t care what policies the US follows as long as it doesn’t hurt China.
The only restriction on US aid that has existed is that the US not support Taiwan independence and continue to support the one China policy. Also, I do think that US dependence on China does have some geopolitical consequences. Taiwan got an arms package this week, but it was smaller than what had originally been proposed.
Fast-forward 12 months:
“President Obama Faces Putin over Icelandic Missile Crisis”
$4 Bn euro doesn’t look very much all of a sudden …
What are prospects of Gold and Silver? Somebody please advise
“The Chinese government could offer to lend up to $500bn (from its current stock of $1,800bn) to the US government for the rescue of its financial sector”
sell Alaska to the Chinese for a trillion dollars. a large part of bank recapitalization will be taken care of. No need for the Chinese to dictate any public policy in the US. Its not their style anyway.
But given the choice between the printing press and selling real assets, we know what the US will do.
Brad, I am a financial journalist in Moscow, as you know. Me and my friends think that Iceland bailout is just a corruption linked deal, nothing more. Twofish is right. Our financial powers are completely incompetent. They can not stop the interrnal financial crisis – the stock indexes are falling 20% a day, and they can do nothing! Absolutely nothing! The sistem of interbank lending is frozen. Panic as it was in 1998.
For what f**ing purpose they are bailing out Iceland? To position there missiles? How can it technically be accomplished then Iceland is still NATO country? Its impossible. This is just an awkward rationalization of this corruption linked deal. I am russian and I know the situation better, believe me:)
BTW, Brad. Can you give my magazine (one of the best in Russia, our only competitor is the russian edition of Forbes) an interview about current financial crisis? I will be your greatest debtor.
Quote of the Day from George Soros blames the Federal Reserve for US Financial Fiasco:
“The proposal from Hank Paulson, US Treasury secretary, for reorganising government regulation of financial institutions misses the point. We need new thinking, not a reshuffling of regulatory agencies. The Federal Reserve has long had authority to issue rules for the mortgage industry but failed to exercise it. For the past 25 years or so the financial authorities and institutions they regulate have been guided by market fundamentalism: the belief that markets tend towards equilibrium and that deviations from it occur in a random manner.”
George Soros, London Financial Times
China reacts to US financial crisis by stimulating Chinese domestic economy
http://www.atimes.com/atimes/China_Business/JJ09Cb01.html
As the US financial crisis started to spread late last year and early in 2008, Beijing stepped in to boost domestic consumption, reversing earlier tightening measures. The Ministry of Commerce introduced a pilot scheme entitling each rural family in Shandong, Henan or Sichuan provinces to a 13% government rebate on the purchase of up to two television sets, two refrigerators and two mobile handsets.
This was Beijing’s first initiative to boost domestic consumption by directly granting financial subsidies to consumers in rural areas, where populations have benefited less than coastal provinces from the country’s economic boom. Effectively, the government is taking money out of one pocket to put in another, as it also offers a 13% tax rebate for exports of home appliance items. Mainland media have speculated that Beijing might raise the export rebate rates to offset the effect of a stronger yuan.
The effect of granting subsidies to farmers who purchase these goods is to remove a policy bias towards exports and spur manufacturers.
With that in mind, Beijing is also seeking to improve the country’s social welfare and social security systems, extending them to cover rural residents. That should not only help boost consumers’ sense of security and reduce their need to save for hard times, but is also in line with Beijing’s goal of building an “harmonious society”.
This year, the Chinese government has also scrapped all agricultural taxes, increased subsidies on farm produce, ended fees for primary education across the country and introduced medical insurance in rural areas.
unokai — send me an email at bsetser at cfr dot org and we should be able to set up an interview
Brad,
What is your take on this proposal from Thaksin:
http://www.ft.com/cms/s/0/035db374-93aa-11dd-9a63-0000779fd18c.html
Seems like pure fantasy to think these countries that have built up trillions of dollars in USD reserves can magically convert their holdings into what is essentially other currencies without affecting the real value of these holdings.
This report, if accurate (note that the source is the FT), is extremely significant.
Basically, a substantial percentage of European CBs’ barbaric reserves are not the barbaric relic itself, but – um – barbaric receivables. Exact numbers are not known, but thousands of metric tons may well be outstanding in this market. Portugal, for example, once released its figure: 70% leased. If this market freezes solid and stays frozen, it could easily generate short-term demand comparable to annual production. Doh!
Also slightly notable is this. Now, the person quoted is a WGC shill, so one might want to take it with a grain of salt. But not an overly large grain, because the WGC crowd has spent approximately the last century insisting that the ol’ relic is an industrial commodity used to make bangles for Indian women, and anyone who says different probably has his own theories about the Kennedy assassination, too. Until about six months ago…
Hi Brad,
A concerted effort to slash rates by 50bp throughout the nothern hemisphere in the west.
Will this ameliorate the credit crunch? Banks mistrust to come off? Flight to safety to unwind?
Roubini thinks we needed at least 100bps now(meaning all CBs), along with 100% guarantee on bank deposits by all countries that have at least one bank within their borders.
Then rapid triage of the banking system. It’s easier than we think, if the money is available. The Fed has a unpublished bad bank list, and there is a private sector estimate on the web too. List about 160 US banks with shaky capitalization. Then we finally have banking Darwinism with the stronger ones left alone to survive, and what money we have left capitalizing those.
So I think we will be seeing more coordinated rate cuts.
The 3 month T-bill rate was 0.04% last week. What is left to cut? The Fed is pushing liquidity on a string. The problem isn’t liquidity across the US Economy; the problem is solvency for the maladjusted US Economy.
Federal Reserve has approached Canadian banks about buying some US “banking assets”. When Bernanke finally goes to Beijing to beg for money, then the US system will soon collapse. LOL.
DJC: The Fed is pushing liquidity on a string. The problem isn’t liquidity across the US Economy; the problem is solvency for the maladjusted US Economy.
The trouble with that view is that it isn’t a US problem. Right now we are in a global crisis. Fixing the US economy is something that will take years, and right now the focus is on keeping the world economy from falling apart.
Speaking of the IMF. There is something funny and sad about a report that calls for “decisive action” three weeks into a major crisis.
Ouch.
So the US is going short the dollar and long international equities during this past few weeks of massive transfusions, when the dollar rose and equities fell? We’re out another $trillion give or take, unless we can debase the currency and see the equity we’re holding rise at the same time?
Maybe I read Foreign Affairs and Lecarre novels too much Brad, but do you think Russia might be motivated by an interest in getting some leverage on Great Britain? I read that Iceland’s banks are not only holding personal savings for the English but have lent substantially to the high street. Thus by supporting Iceland’s banks for 8B, Russia gains economic leverage on those who would harbor Russia’s enemies like Berezovsky. Far fetched?
1 never shout “fire” in a crowded theatre.
2 never say ” don’t worry, here comes the fire engine” in a crowded theatre.
3 if you are in a theatre and the play gets drowned out by the arrival of all of the fire fighting helicopters from america, canada, britain, france, germany, italy, sweden, switzerland, and china, accompanied by cheering japanese – leave quietly by a side door saying as little as possible.
From Russian government RIA Novosti, US Dollar hegemony to blame for Global financial fiasco
http://en.rian.ru/analysis/20080924/117072937.html
In the light of the recent financial crisis in the USA, could the same thing happen now to the bonds issued by the American government, and could the country which has dominated the world for the last half century now enter history as a bankrupt state? And what can Russia do in the circumstances?
In America, this basic culture of debt is aggravated by the fact that other countries use the dollar itself as a reserve. This means that the United States can export dollars in order to pay for its imports without the dollar losing value. Other states also need dollars to buy key commodities like oil. The USA can therefore export paper currency almost indefinitely – the famous “deficit without tears” analysed by the great French economist, Jacques Rueff. Naturally, if the state itself encourages such a culture of debt by issuing unredeemable paper currency to pay for imports, and by accumulating such mountains of debt, then it is no surprise if the American financial markets themselves operate on the same basis. But the collapse of those markets is only a symptom of a much deeper problem, the basic insolvency of the American state itself.
What can Russia do about this? At first sight, Russia’s role in the international financial system does not seem very large. However, as a major exporter of hydrocarbons, her role in the world economy is actually very important. As the age of the dollar draws to a close, Russia will have to consider selling her oil and gas not in the devalued American currency, but instead in the euro used by most of her customers. It is surely unnatural for two geographical neighbours to do such large volumes of business using the currency of a distant and now ailing nation.
Economist Wolfgang Munchau: US Monetary Policy Errors Turning Credit Crunch into Depression
http://www.nakedcapitalism.com/2008/10/wolfgang-munchau-policy-errors-risk.html
Wolfgang Munchau in EuroIntelligence argues against conventional wisdom, which is that modern policy tools and institutional arrangements will keep the credit crisis from morphing into a depression. He contends that the policy errors, the result of political considerations, have been substantial. He also says that Treasury Secretary Henry Paulson devised the badly-flawed Troubled Assets Repurchase Program to benefit Goldman Sachs. Although this is a widely-held view, few financial commentators have been willing to say so in writing. He also discusses how EU member nations are wasting firepower rescuing institutions for competitive reasons when they should have been allowed to fail.
Michael,
Of course, carry trade. And hence musical chairs. If the dummies do not find a seat they do not deserve one.
Still, I love the politics and yes of course some russians must have had a bit of an exposure plus either plenty of collateral or good friends in Moskva. But I do like the fairytale that Russians came to the rescue (for selfish reasons hopefully- where would we be if even the Russians became irrational?) and hence the parallel with US/Georgia. These are times that you will be able to tell your grandchildrend about, cherish them!
gillies:
I think everyone now knows the theater IS on fire. So policy action is to send the fire trucks, or at least make siren noises if you don’t have dollars or euros, and turn on the sprinkler system.
The powers of the world do this all at the same time so there is no side exit. Then they think they can quench deflation, but sow the seeds for eventual inflation. Same as they did in 2002.
So the only questions left are by 2011 will commercial banks be offering structured mortgage backed savings accounts(CDS Squared), will home equity growth be the biggest wage earner in the household, are $2 trillion federal deficits OK, where does China get $2 trillion for our current account deficit, why is oil only $35 a bbl, and will we be talking about a national health care plan, better wages and working conditions for illegal immigrants, and finally doing something about the public school system?
We can only wait and see what the answers to these questions are. (I hope that Italy is the 51st state of the Union, but we should buy as much of Europe as we can afford.)
Edric Regula “Then rapid triage of the banking system. It’s easier than we think, if the money is available. The Fed has a unpublished bad bank list, and there is a private sector estimate on the web too. List about 160 US banks with shaky capitalization. Then we finally have banking Darwinism with the stronger ones left alone to survive, and what money we have left capitalizing those.
Sensible. Shrinking the financial system in the U.S. is necessary. However, letting Lehman fail created the unwillingness to lend.
I would like to seen Paulson face his real problem – which is, how to create the conditions that will make sound banks want to lend to each other.
ReformerRay:
The financial sector was whopping 20% of the S&P 500 by market cap. We fixed the market cap problem, but the companies are still here.
In the early stages of the banking crisis during the Great Depression banks did band together on a voluntary basis and pledge to support each other. But this quickly fell apart due to mounting pressures of deflating assets (due to too much systematic leverage in the first place) and eventual bank runs once the public figured it out.
So guaranteeing deposits may calm the public, and now it looks like TARP could be used for cash for equity deals with banks. Of course the success of it depends on the implementation.
They have been inconsistent with the treatment of IBs. Bear – yes, Lehman – no..and AIG ???? Haven’t even heard of the mortgage insurance guys lately.
Incidentally, the peg failed miserably. Lasted two days before it was abandoned. It was a basket peg instead of a Euro peg, but most importantly it was many months too late to matter or have a chance to stabilize the ISK.
you guys forgot to mention that the
stock markets in Russia are closed.
primordial dwarf
ReformerRay,
Letting Lehman fail did much more than create an unwillingness to lend (though it certainly did that, and we’ve seen how drastic that can be).
Tomorrow, 10/10/08 at 9:45 A.M. the CDS on Lehman debt will be settled. Current estimates are for (possibly via an auction) recovery rates of $.10 on the dollar from Lehman assets. If correct, that means the “insurers” of that debt – the companies (JP Morgan, Morgan Stanley, AIG) that have been making money taking payments to backstop Lehman leverage – would have to pay $.90 on the dollar.
This means they would have to produce $360 billion IN CASH TOMORROW. What are the chances of that being possible? What is going to happen when they can’t pay up (there’s another $50 trillion or so in CDS out there holding its breath)?
Secretary Paulson annouced today that he is going to interpret the “spirit” of the TARP (it sure ain’t in the language) to authorize him to give “around $300 billion” of the money that was supposedly for MBS purchases directly to banks (in exchange for equity warrants or preferred stock or something – he wasn’t specfic). There are only so many possible outcomes:
1. The estimates are wrong, and Lehman assets are going to cover much of the debt that will be settled. This determines the “degree of ugliness” we are about to experience.
2. The CDS settlement will be manipulated so that “30-year payment plans” or some other (increasingly common) Rube Goldberg evasion of immediate payment postpones the potential catastrophe. If I were King of the Forest, I’d declare a CDS Holiday; no settlements until we’ve stopped the panic and figured out how who wins and who loses (now, how do we do that?).
3. Treasury writes up to $360 billion in checks tomorrow to “re-capitalize” those banks and insurance companies that would be thrown into instant bankruptcy if they had to make good on their CDS. This one gets my money, because it follows the “squeaky wheel gets the grease” thought process that our genius Treasury Secretary and Fed Chairman have been employing up to now.
4. Complete nationalization of the existing U.S. financial system a la Fannie Mae and Freddie Mac – private ownership, but all the current liabilities are guaranteed until a sorting out process in the very distant future with promises of superior government control of all such financial transactions henceforth.
5. Armageddon. There will be no “financial system” left to save.