Geithner and the delicacy of Euro-Dollar diplomacy

Sep 16, 2011 15:57 UTC

The departure of US Treasury Secretary Timothy Geithner to Europe to rescue our allies from themselves marks a change in the economic relations among the NATO countries that bears scrutiny. In the past, the loosely-connected federation we call the European Union has managed to muddle along. But now we see overt funding subsidies for the EU via the Fed and the active involvement of Geithner in what ought to be a purely domestic fiscal discussion.

I suppose that kudos are in order for Geithner and Fed Chairman Ben Bernanke for finally responding to the EU funding crisis. Bernanke has been sound asleep at the liquidity nipple, not realizing it seems that the Fed supervisory personnel were instructing US institutions to sever credit lines with their EU counterparts. Since most of these banks are now effectively nationalized, the behavior of US regulators in New York seems especially self-injurious. Now we have replaced private funding for EU banks with central bank swap lines. Hoo-rah. This is not so much a rescue as it is a temporary subsidy.

Geithner has his work cut out for him. Having worked in the Federal Reserve Bank of New York in the currency area during the Plaza Accord, this author has some ideas on the financial and psychological efficacy of central bank intervention. The key thing for any central bank trading desk is not to pretend that you are the market, but instead to support market activity and to slowly help restore the flow of private credit in the markets. Unfortunately this lesson still seems lost on central bankers on both sides of the Atlantic.

My friend Achim Dübel of Finpolconsult in Berlin, is critical of the handling of the intervention by the European Central Bank. Referring to a recent research note by Goldman Sachs on the outlook for the EU, he asks:

Does GS have on its radar how distortive and damaging are the ECB interventions into periphery debt at 80 or 90 cents? The ECB bought Greek debt at those levels a year ago – average portfolio cost is estimated at 70-80 cents, where market prices are now 30 cents. Why are market prices now at 30 cents? Because the ECB had to stop buying. After looking into the abyss of Greek default, the ECB simply ran away.

In the case of Greece and now Italy, Dübel notes very aptly, the ECB has been buying bonds well above the true market. “Now they are doing the same with Italian debt as they did with Greece, and of course the ECB will run away again,” Dübel adds. “With the banks the intervention levels were far too high (haircuts too low), with the worst example of all being Ireland. In all these cases, ECB became an obstructionist force against restructuring, i.e. solving the problem.”

Now, it seems, we know why Axel Weber, the ECB’s German board member, resigned from the board in protest last year. Geithner needs to quickly figure out whether the core EU nations can begin to act in a more rational and purposeful way when attacking issues of solvency, both of banks and nations.

Lagarde recently warned that the egos of world leaders are putting the global economy at risk. This is a nice way of saying that none of the leaders of the G-20, elected or not, are in the mood to take the risk themselves of publicly confessing to the true scale of the problem of excess debt and shrinking demand facing each nation. But as Geithner goes to the EU to preach tough love to his European counterparts, he leaves a lot of unfinished business at home.

Geithner ignored President Barack Obama’s order to consider dissolving Citigroup, a new book by Pulitzer Prize-winning author Ron Suskind claims. The top four banks in the US remain on the critical list, even with bulging deposits and capital levels. So when Geithner lectures his EU peers on the need for prompt and purposeful action, he will need to season his advice with humility and an appreciation that the war against global deflation is far from won.


Astuga, I beg to differ. The way the EU has behaved over the last 2 years as each crisis comes and goes shows that member states are a very loose federation indeed. Given that they cannot agree amongst themselves or with the ECB or with Geithner shows that too.

Given the lack of any suitable solution on the table at the EU ministers meeting last week, Geithner merely put forward an idea that might cover middle ground. It seems that Geithner realises the gravity of the situation unlike our fellow Europeans. It does look like the EU is not going to listen to the markets (quote from Manual Barroso) until it is too late.

Merkel and Sarkozy pushed Europe into the Euro and now they have it they do not know what to do. They are responsible for 500m people in Europe and they all deserve better leadership than all of the EU bureaucrats have shown so far. Whilst the US has trouble too, at least they have a plan which is one thing that we sadly do not have.

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Are U.S. regulators worsening E.U. credit squeeze?

Aug 5, 2011 15:41 UTC

“Our purpose is to lean against the winds of deflation or inflation, whichever way they are blowing.” -William McChesney Martin Jr., Chairman, Board of Governors of the Federal Reserve System

During his tenure as Chairman of the Fed from 1951 through 1970, William McChesney Martin Jr. saw the transition from America at war, with the government controlling much of the economy, to a peace time economy where wider financial ebbs and flows were possible.  His experience in confronting both inflation and deflation during his term is instructive today.

The carefully managed, low-interest rate policy which the Fed maintained during WWII ended under Martin’s predecessors, Mariner Eccles and Thomas McCabe.  These two Fed Chairmen defied President Harry Truman and raised interest rates to forestall inflation.  Even when the Chinese Red Army attacked American military forces in Korea, the Fed under Chairman McCabe stood its ground and eventually won its independence from the Treasury in 1951.

Martin was picked by Truman to replace McCabe and thereby bring the Fed to heel.  Instead Martin proved to be an independent man who helped make the central bank independent as well.  Martin, for example, defied President Lyndon Johnson and raised interest rates in the 1960s.  See Robert Bremmer’s 2004 book, “Chairman of the Fed: William McChesney Martin Jr., and the Creation of the Modern American Financial System.”

But Martin recognized that the Fed ultimately could not prevent Congress from funding spending with debt and thereby fueling inflation, Alan Meltzer wrote in his classic “A History of the Federal Reserve.” That judgment has been proven correct in today’s market volatility, which is driven by the excessive accumulation of both public and private debt.  But withdrawing liquidity from solvent borrowers risks a repeat of the Bear Stearns and Lehman Brothers failures.

Were he alive today, Martin would probably argue that the Fed should continue to encourage lending to solvent banks and thereby keep the financial system liquid and functional.  I suspect that his successors, like Arthur Burns and Paul Volcker, would agree.  But instead U.S. regulators are apparently encouraging American lenders to reduce credit risk exposure to E.U. banks and corporations, effectively exacerbating the liquidity crisis that has been hitting European markets in recent days.

The head of the credit risk book at one of the largest French banks told me yesterday that his institution has seen a one-third reduction in the volume of credit available from U.S. counterparties.  He directly attributes this change to advice to U.S. banks from American regulators.  The market veteran notes that long-term credit is unavailable for most E.U. banks, increasing pressure on short-term funding pressures in the dollar/euro market.

American officials apparently want to avoid another “AIG situation,” in the words of one well placed banker, thus reducing credit lines to E.U. banks is seen as a way to reduce systemic risk.  But in fact just the opposite may be the case.  The regulators may be fomenting a systemic risk event by going against the advice of Chairman Martin and most of his contemporaries.

Another market observer points to U.S. derivatives dealer banks reducing exposure to E.U.  banks because of continued worries about the PIIGS implosion.  But one wonders how much these particular data points weigh on the credit markets compared with the impact of low or no interest rates on risk taking.  When Bank of New York announces that it will charge large customers for deposits, it begs the question about current Fed rate policy.

I believe that the Fed needs to let the cost of funds rise to restore yield and risk taking to dollar assets, but at the same time make clear to the markets that the volume of credit available to solvent borrowers is unaffected or even increased.  The contraction of money and credit on both side of the Atlantic is the key issue that should have the attention of policy makers.  As Carl Weinberg of High Frequency Economics said on Bloomberg Radio this morning, nothing good comes from contracting credit and money markets.  But low interest rates is driving deflation, in my view.

To the extent that regulators at the Fed, OCC and FDIC are encouraging U.S. banks to arbitrarily reduce credit lines to their E.U. counterparts, that behavior needs to end now.  The chief threat to the global markets remains deflation as debt levels are reduced to practical levels.  Next week, Fed Chairman Ben Bernanke and his colleagues at other agencies needs to make clear in a very public way that the U.S. central bank is not taking steps to make things in the money markets a lot worse than they need to be.

Why the US debt crisis is a good thing

Jul 27, 2011 15:29 UTC

I must politely disagree with Felix Salmon of Reuters, Ben White at Politico and others who wring their hands and fret about the undoing of the world in the prospective debt default by the US. The damage is done, Felix declared on I have heard similar views from many friends and colleagues, but I must disagree.

First the debate over the budget, pathetic as it may seem, represents an increase in the intensity of the public discourse over the nature of the American economy. Debate is good. It is the essence of checks and balances, the key feature that separates American democracy from the authoritarian states of Europe and Asia.

For too long Americans have been on auto pilot, relying upon elected representatives and various flavors of hired agents in Washington and on Wall Street to manage our money and our nation. It’s time to start paying attention again.

Second and more important, the debate over federal spending and the tradeoff between higher taxes and greater fiscal discipline begins a larger discussion about the nature of the American political system. After 80 years of borrow, spend and inflate to finance the Cold War, Housing Bubbles and the rest of the world’s growth needs, the US economy has reached an endpoint. The experiment in corporate statism begun by FDR in the 1930s and extended through and after WWII has brought us to the brink of insolvency.

Political gridlock in Washington means not only an end to growth in government spending, but also that we are no longer willing to serve as the overdraft account for the world in terms of demand for imported goods and services. As I noted in my 2010 book Inflated, the US has bailed out the no growth states of Europe three times since WWI. Each time our allies in western Europe have defaulted on their debts. Bring the US troops in Europe home, I say, right now.

Asia, likewise, has grown at the expense of American jobs, the bitter legacy of owning the world’s reserve currency. As the US reins in spending and the monetary excesses that created the illusion of economic growth since the 1980s, an illusion funded with inflation and vast amounts of public debt, our ability to bail out the EU will fade. Remember George Washington’s warning about “European entanglements.”

But the third and most important side effect of the fiscal crisis in Washington is that people around the world will start to diversify both commerce and financial transactions out of dollars and into other currencies. Far from being a threat, I welcome such an evolution. The less of world trade and finance that flows through dollars, the less easy it will be for the Treasury to issue debt or for the Fed to monetize this borrowing on the backs of US consumers and businesses via steady, unrelenting inflation.

Of course Nobel Prize winning economist Paul Krugman rightly notes that a reduction in federal spending will result in pain for many Americans. But what he fails to tell these Americans, especially low income working people he pretends to love, is that the cost of the borrow and spend policies advocated by second generation New Dealers is persistent inflation, a diminution of purchasing power that is just as surely killing the hopes and dreams of all Americans.

I have long argued that a low growth, low inflation environment is better for the working people that the manic, boom and bust cycles caused by big federal deficits and following accommodative Fed policies to make this all seem to work in a nominal sense. Alan Greenspan, after all, was at best a tool; a cog in the machine.

Americans need to understand that we face not a mid-cycle slowdown, to paraphrase the economist Richard Alford, but a post-stimulus adjustment to economic reality. Think post WWII in fact. If this crisis helps to break the cycle of debt and inflation, that is a big plus for America’s long term prospects.

The right choice for Americans is to say no to ever more debt and to instead embrace debt reduction and restructuring of insolvent banks and markets to restore economic solidity. Both in the EU and the US, debt levels by governments and consumers must be reduced to restore national and personal solvency, and thereby start the great growth game all over again.

Do Americans have the courage to make the tough choices, cut spending and also generate more revenue, and thereby set an example for the world? I think the answer is yes, but it may take some time. That is why I am in no hurry to pass the new debt ceiling. A few days or weeks of pain will raise the political temperature in Washington even further and bring all Americans into the proverbial kitchen for a long overdue family discussion about money. And that is a very good thing.



The Author should recognize the pattern of cut, retrench, attempt to restructure and final collapse that brought about the end of the Soviet Union after its disastrous term in Afghanistan.

The fall of the USSR brought about the break up of its territory, the collapse of it creaking social support system and opened the door to years of chaos and economic power grabbing by insiders in the emerging political order.

The trick for the aspiring oligarchs here will be finding the insiders that somehow manage to keep their heads and influence in what will no doubt be a very “fast paced and exciting environment” for the most treacherous and greedy bastards one could possibly imagine.

They will simply never be able to set foot outside their armored limousines and securely gated compounds without armed escorts.

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