The Great Debate

– John Kemp is a Reuters columnist. The views expressed are his own –

The volume of excess reserves commercial banks are holding with the Federal Reserve System has declined by $275 billion (31 percent) over the last five weeks, in what could be the first sign of stabilization within the core of the banking system (https://customers.reuters.com/d/graphics/RESBAL.pdf).

Reserve holdings are still at exceptionally high levels, but a clear downtrend has emerged since the start of the year.

Average holdings in the week ending Feb. 11 ($603 billion) were $58 billion lower than the previous week ($662 billion) — the lowest level since the middle of November last year, and well down from the recent peak ($878 billion) at the turn of the year.

There has not been any offsetting increase in commercial banks’ other assets (Treasury securities, private securities and commercial credits) over the same period. So lower reserve holdings seem to be a sign of reduced fear and increasing confidence, as the immediate sense of crisis passes and banks feel comfortable holding lower liquid balances.

– John Kemp is a Reuters columnist. The views expressed are his own –

Every budding economist is taught the distinction between nominal variables (expressed in terms of contemporary cash values) and real variables (adjusted for inflation and expressed in constant-dollars).

An oil price of $50 per barrel in 1980 is not the same as an oil price of $50 a barrel in 2009 because inflation has steadily eroded the purchasing power of the currency in the intervening years. Moreover, economists are taught that real values are more important than nominal ones — because “money is a veil” (to use the phrase of the Austrian economist Joseph Schumpeter).

– John Kemp is a Reuters columnist. The opinions expressed are his own –

Yields on long-term U.S. Treasury debt continued to surge higher yesterday as the market braced for a future upturn in inflation and a tidal wave of long-dated issues that will be needed to fund the bank rescues and the emerging stimulus package.

Yields on three-year notes are up by around 47 basis points from their mid-December low. But yields on ten-year paper have soared 82 points and rates on the 30-year long bond have surged 114 points. Long-bond rates have retraced more than half their decline since the autumn (https://customers.reuters.com/d/graphics/USTREAS.pdf).

Back-end yields would probably have risen even further were it not for persistent hints the Federal Reserve is thinking about buying longer-dated issues to cap them. But the market has started to call the Fed’s bluff.

– John Kemp is a Reuters columnist. The opinions expressed are his own –

Like a Byzantine emperor, a U.S. president’s every public move is scripted to send signals about his priorities to Congress, the electorate, business, and the vast federal bureaucracy that will actually be responsible for formulating and implementing decisions in his name.

Presidential politics is a theatrical performance in which the president takes a small number of important decisions personally, but is responsible for setting the tone and direction for many smaller ones that will never reach his desk. If he can reach out to voters and businesses he can also reshape national priorities.

– John Kemp is a Reuters columnist. The views expressed are his own –

The international system of bank regulation, epitomised by the Basle II process and the light-touch principles-based regulation of Britain’s Financial Services Authority (FSA) has comprehensively failed.

In too many instances, light-touch principles-based regulation with an emphasis on banks’ internal risk controls turned out to be no effective regulation at all.

– John Kemp is a Reuters columnist.  The views expressed are his own –

UK Prime Minister Gordon Brown’s call today for a new G20 charter of principles on financial regulation  reflects an emerging consensus among policymakers that, once the immediate crisis has passed, the regulatory framework must be fundamentally redesigned.

In particular, policymakers are concerned with how to correct the basic moral hazard problem in which bankers have an incentive to extend too much credit, while private firms and households have an incentive to take on too much debt.

– John Kemp is a Reuters columnist.  The views expressed are his own –

The last eighteen months have witnessed a revolution in financial regulation — if by that we mean a fundamental reconstruction, total change or turn round from the previous orthodoxy occurring in a relatively compressed time.

In particular, the sheer scale of recent policy interventions in the banking system is throwing up very uncomfortable questions about the government’s role in the economy, centered on its function as the ultimate re-insurer of risk and its function via the central bank as “lender of last resort” (LOLR) to the banking system.

-- John Kemp is a Reuters columnist. The opinions expressed are his own. –

The United States and the United Kingdom stand on the brink of the largest debt crisis in history.

While both governments experiment with quantitative easing, bad banks to absorb non-performing loans, and state guarantees to restart bank lending, the only real way out is some combination of widespread corporate default, debt write-downs and inflation to reduce the burden of debt to more manageable levels. Everything else is window-dressing.

To understand the scale of the problem, and why it leaves so few options for policymakers, take a look at Chart 1 (https://customers.reuters.com/d/graphics/USDEBT1.pdf), which shows the growth in the real economy (measured by nominal GDP) and the financial sector (measured by total credit market instruments outstanding) since 1952.

– John Kemp is a Reuters columnist. The opinions expressed are his own –

For the world monetary system, the financial crisis which erupted in the summer of 2007 is a cataclysmic shift that will prove every bit as significant as the outbreak of the First World War (which heralded sterling’s demise as a reserve currency) and the suspension of gold convertibility in 1971 (which marked the end of bullion’s monetary role).

The crisis marks the passing of an era in which the U.S. dollar has been the world’s undisputed reserve currency for making international payments and storing wealth.

– John Kemp is a Reuters columnist. The views expressed are his own –

The global slowdown is hitting China’s modern manufacturing base in Guangdong province especially hard. Deputy governor Huang Longyun on Thursday warned a news conference “the situation is grim” and the manufacturing hub around Pearl River Delta is bearing the brunt of China’s slowdown.

Guangdong’s burgeoning factories have supplied most of the cheap manufactured items flooding world markets in the last five years. They have also been the source of most of the marginal demand for crude oil, refined products and other raw materials. The province’s slowdown will therefore have profound effects on global markets and prices in 2009.