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This has been bugging me for a while.

The theory goes that with a single currency, a major failing is the single interest rate, set centrally by the ECB.

This then goes on to assert that it means that basket cases like Greece get access to funds at the same rates as countries like Germany.

So it means that the relative risks of lending to Greece versus Germany are ignored. The cost of borrowing is the same even though one is the power house and the other is the basket case. This means that and even encourages countries like Greece to borrow beyond their means.

Except the cost of borrowing is not the same, as Spain's bond yields are flying upwards today. It is more expensive for them to borrow than Germany, and the same for the other over-indebted economies.

So clearly the cost of borrowing is not simply related to the central bank rate. Similarly over here, the cost of a mortgage isn't related to the the central bank rate directly.

The conclusion I came to is that the ratings agencies, which are basically America's puppets 1. do not actually forecast more than about a week into the future, and 2. conveniently ignore the UK and the US are partially cuplable for the borrowing mess by over-rating the creditworthiness of countries so that debt can be pimped, even if it is unsustainable.

But then I come to wonder 1. What the central bank rate is for, then 2. What the central bank is for, and 3. What difference the central bank rates make.

Can anyone fill in the bits that I'm obviously missing here.

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The answer to all questions is: cartelisation.

You have businesses involved in buying and selling money; the cost of that money is set by the cartel to avoid competition.

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But then I come to wonder 1. What the central bank rate is for, then 2. What the central bank is for, and 3. What difference the central bank rates make.

I asked exactly those questions a while ago.

1. The central bank rate defines the risk-free rate of interest for a currency. This imposes a floor on interest rates for any organisation sufficiently connected to have access to the central bank. Prior to 2006, at the BoE, this effect was given by everyone who had access having large debts to the central bank.. thus, at the end of each day, any spare cash was used to buy-back gilts from the central bank - and then these gilts would pay out their coupons overnight - then be surrendered back to the central bank the next morning to establish the cash to work with for the day. From 2006 onwards, the BoE runs reserve accounts and pays interest on them at the bank rate... and, in doing so, there's no need for its clients to scrabble to turn cash into bonds in order to collect their overnight interest. This floor on the "time value of money" provides the basis on which all real loan rates are established. LIBOR is the cheapest way to borrow funds - it requires you to be a bank; to be borrowing only overnight - and to want no more cash than other banks have 'spare'. LIBOR is (usually) close to the bank base rate - and longer-term lending and/or lending to less creditworthy parties necessarily cost a premium.

The central bank 'base' rate therefore offers a mechanism of control over the whole economy... Raising the base shifts cash-flow from the leveraged to the non-leveraged... and because the former tend to spend over a shorter timespan than the latter, this has the effect of slowing economic activity... in the short term. Cutting rates has the opposite effect - again, in the short term. In the medium-to-long term, it doesn't matter much what the base rate is... it's only when it changes that it has an effect.

2. The central bank has a number of responsibilities (ignoring, for now, the activities its detractors say are unethical.) One critical task of the central bank is to "provide liquidity" - this can be thought of as being a bit-like giving change... but rather than just breaking £10m 5-year bonds into £1m 5-year bonds... it also allows breaking of a £1m 5-year bond to allow some to be spent now... by 'transforming maturity'. The central bank also performs the task of being 'emergency lender of last resort' - so, if a commercial bank finds itself in trouble and unable to meet its end of day obligations... the central bank has a responsibility to step in to underpin confidence in banking - and buy some breathing space to unravel the mess and establish a longer-term solution. A sideline for the BoE is to establish monetary policy - which it does by aiming to meet targets set by the treasury... and its main tools are the base rate and the extent of provision of liquidity - and the premiums they charge for that service.Central banks used to be responsible for oversight of commercial banks - but, in the UK, at least, this all changed in ~1998 when the FSA was set up as a separate organisation for this purpose.

3. Central banks make a great deal of 'difference' - though it might well not be the difference you expect. A central bank is essential in order to establish and maintain a currency... and, where the central bank changes the base interest rate, this causes considerable short-term turmoil. Central banks are also interesting because they do the bidding of governments - they have no believable commercial rationale for existing... they don't (or aren't supposed to) seek to maximise profit, for example. The central bank is far less interesting than the government that controls it... but this, of course, makes the ECB so interesting... as it's not controlled by a single government... in spite of the fact that its actions will have considerable short-term political implications. I'd be very interested to establish the extent to which the ECB is truly independent... there will, inevitably, be political pressure to sway decisions one way or another... I'd be very interested to establish exactly how independent its directors can be... especially as they'll all, likely, have political and national affiliations that will lead to inevitable bias... even if not intentionally.

Edited by A.steve

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This has been bugging me for a while.

The theory goes that with a single currency, a major failing is the single interest rate, set centrally by the ECB.

This then goes on to assert that it means that basket cases like Greece get access to funds at the same rates as countries like Germany.

So it means that the relative risks of lending to Greece versus Germany are ignored. The cost of borrowing is the same even though one is the power house and the other is the basket case. This means that and even encourages countries like Greece to borrow beyond their means.

Except the cost of borrowing is not the same, as Spain's bond yields are flying upwards today. It is more expensive for them to borrow than Germany, and the same for the other over-indebted economies.

So clearly the cost of borrowing is not simply related to the central bank rate. Similarly over here, the cost of a mortgage isn't related to the the central bank rate directly.

The conclusion I came to is that the ratings agencies, which are basically America's puppets 1. do not actually forecast more than about a week into the future, and 2. conveniently ignore the UK and the US are partially cuplable for the borrowing mess by over-rating the creditworthiness of countries so that debt can be pimped, even if it is unsustainable.

But then I come to wonder 1. What the central bank rate is for, then 2. What the central bank is for, and 3. What difference the central bank rates make.

Can anyone fill in the bits that I'm obviously missing here.

Oh dear - you need an essay! The basket cases have borrowed too cheaply until now! They have had a base rate which is stupid and which their own bank or ECB can lend at as the lowest or 'base' rate. There's no real money left - so it's all blowing up and the rating agencies are not to blame - just reporting it after the event really! Italy is already a bad risk aren't they? Who would lend to them when they cannot service the interest let alone repay anything?

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The answer to all questions is: cartelisation.

You have businesses involved in buying and selling money; the cost of that money is set by the cartel to avoid competition.

The cost as denominated in what, and competition from whom?

Oh dear - you need an essay! The basket cases have borrowed too cheaply until now! They have had a base rate which is stupid and which their own bank or ECB can lend at as the lowest or 'base' rate. There's no real money left - so it's all blowing up and the rating agencies are not to blame - just reporting it after the event really! Italy is already a bad risk aren't they? Who would lend to them when they cannot service the interest let alone repay anything?

Ah, but how have they borrowed too cheaply? Because of the single currency, apparently. It means that even basket cases can borrow funds at the same rate as Germany. Except it doesn't. So I don't see what that has to do with the Euro/single currency. We all trade with each other here in GBP, but the cost of borrowing - indeed whether we can borrow - depends on a forecast of our ability to repay based in part on our own history.

Now if the ratings agencies are meant to be some kind of "giant Experian" (UK credit reference agency) then they would have factored in the fact that Greece was a basket case back as far as 2007, and thus, the cost of borrowing for Greece should have been higher than it was, if indeed it was lent any money at all past a certain point.

Yes, they covered up and lied about their economy, but it should not have been rated highly and certainly should not have had access to cheap funding. Indeed, the ratings agencies do report "after the fact", as you say. It isn't really a forecast. It's just a statement of what everyone else can obviously see. But then that's useless as a tool to set lending rates which have to be based on future ability to pay.

You could then argue that no lenders have to go on what the useless CRAs say, and could make up their own mind. Except that certain types of investors, typically pension funds, do indeed have to go on what the CRAs say and buy AAA rated bonds. And the CRAs seem to have positioned themselves a bit like DJs who remix tunes did - in the end, the DJs became the big names despite not actually producing the tunes themselves. Even the apparent threat of a downgrade of a country which everyone can see is basically bankrupt anyway seems like a major event.

I then thought that this [the cheap borrowing] might have been because Greek banks had access to their funding via the single ECB bank rate at the same rate as Germany. But then, it isn't the case that the banks in a country are the only ones lending within/to that country - indeed if it were, then there would be no "contagion".

As to "who would lend to them when they cannot repay" - well the whole thing started off with the securitisation of mortgages in the US, a significant enough chunk of which were indeed to people who would never have been able to repay. So, this is pushing debt that cannot be, or more kindly, is highly unlikely to be repaid.

A.Steve - many thanks for your detailed explanation. I'm not questioning your interpretation, but posing a few more points:

I asked exactly those questions a while ago.

1. The central bank rate defines the risk-free rate of interest for a currency. This imposes a floor on interest rates for any organisation sufficiently connected to have access to the central bank. Prior to 2006, at the BoE, this effect was given by everyone who had access having large debts to the central bank.. thus, at the end of each day, any spare cash was used to buy-back gilts from the central bank - and then these gilts would pay out their coupons overnight - then be surrendered back to the central bank the next morning to establish the cash to work with for the day. From 2006 onwards, the BoE runs reserve accounts and pays interest on them at the bank rate... and, in doing so, there's no need for its clients to scrabble to turn cash into bonds in order to collect their overnight interest. This floor on the "time value of money" provides the basis on which all real loan rates are established. LIBOR is the cheapest way to borrow funds - it requires you to be a bank; to be borrowing only overnight - and to want no more cash than other banks have 'spare'. LIBOR is (usually) close to the bank base rate - and longer-term lending and/or lending to less creditworthy parties necessarily cost a premium.

Just to clarify, though - after the Norther Rock debacle, Mervyn got his own way, and now the banks can receive loans directly from the BOE in secret - so although the above is conceptually what's meant to happen, and the BOE doesn't actually have any money itself (nor does the ECB which has apparently "purchased" a number of bonds just yesterday) then the BOE has an infinite licence to print money into existence, and thus the daily closing requirements are pretty irrelevant in this respect because that check/balance has now been removed and which banks fail is now entirely in the hands of the BOE, and not backed by any kind of market checks?

The central bank 'base' rate therefore offers a mechanism of control over the whole economy... Raising the base shifts cash-flow from the leveraged to the non-leveraged... and because the former tend to spend over a shorter timespan than the latter, this has the effect of slowing economic activity... in the short term. Cutting rates has the opposite effect - again, in the short term. In the medium-to-long term, it doesn't matter much what the base rate is... it's only when it changes that it has an effect.

I'd have to ask why, though. We know the economy is based on anything but sound money, but what I don't quite get is why this is some sort of credible, honourable task. Would we not be better off without this, shall I call it, interference?

2. The central bank has a number of responsibilities (ignoring, for now, the activities its detractors say are unethical.) One critical task of the central bank is to "provide liquidity" - this can be thought of as being a bit-like giving change... but rather than just breaking £10m 5-year bonds into £1m 5-year bonds... it also allows breaking of a £1m 5-year bond to allow some to be spent now... by 'transforming maturity'. The central bank also performs the task of being 'emergency lender of last resort' - so, if a commercial bank finds itself in trouble and unable to meet its end of day obligations... the central bank has a responsibility to step in to underpin confidence in banking - and buy some breathing space to unravel the mess and establish a longer-term solution. A sideline for the BoE is to establish monetary policy - which it does by aiming to meet targets set by the treasury... and its main tools are the base rate and the extent of provision of liquidity - and the premiums they charge for that service.Central banks used to be responsible for oversight of commercial banks - but, in the UK, at least, this all changed in ~1998 when the FSA was set up as a separate organisation for this purpose.

3. Central banks make a great deal of 'difference' - though it might well not be the difference you expect. A central bank is essential in order to establish and maintain a currency...

I'm still not sure I understand why that is so. Would it be more accurate to say "A central bank is essential in order to establish and maintain a debt based monetary system?"

and, where the central bank changes the base interest rate, this causes considerable short-term turmoil. Central banks are also interesting because they do the bidding of governments - they have no believable commercial rationale for existing...

No, that's the bit I was getting at, I think :)

they don't (or aren't supposed to) seek to maximise profit, for example. The central bank is far less interesting than the government that controls it... but this, of course, makes the ECB so interesting... as it's not controlled by a single government... in spite of the fact that its actions will have considerable short-term political implications. I'd be very interested to establish the extent to which the ECB is truly independent... there will, inevitably, be political pressure to sway decisions one way or another... I'd be very interested to establish exactly how independent its directors can be... especially as they'll all, likely, have political and national affiliations that will lead to inevitable bias... even if not intentionally.

So with what did the ECB buy the bonds yesterday - the answer would appear to be "the value of future labour and productivity pulled forward from the future". Except that doesn't seem to fit any of the rules above anyway.

What I don't get is why if Greece, Italy and Portugal all default on their debts, that's the end of the EUR. If three people in our village default on their debts, that isn't the end of the pound. It just means that I probably have more of it, and they have less of it.

Watching this whole slow motion car crash would be hilarious if it were not 1. So predictable, 2. So serious and 3. So obviously bound to fail. Country A has no money. Ah, we'll consolidate that with Country B's money. Country B has no money - let's go get it from Country C and so on. Except of course in the debt based fiat system almost nobody has any money anyway. "But where did all the money go?" Well, it never really existed anyway. The maths show that such a debt based system will implode eventually and I wonder whether we're at that point now or if it can be staved off for another decade.

I guess I'd then have to end on the question: just why are all the countries so enslaved to the debt based fiat system, and when they all get together, is there any serious conversation along the lines of "Why don't we all just collectively tell them [the bondholders] to eff off?" and I'd guess the answer is that given the differing positions of different countries Greece would love that, but Germany would not. And so on.So we all square up to one another - hello protectionism and tarrifs.

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A.Steve - many thanks for your detailed explanation. I'm not questioning your interpretation, but posing a few more points:

Just to clarify, though - after the Norther Rock debacle, Mervyn got his own way, and now the banks can receive loans directly from the BOE in secret - so although the above is conceptually what's meant to happen, and the BOE doesn't actually have any money itself (nor does the ECB which has apparently "purchased" a number of bonds just yesterday) then the BOE has an infinite licence to print money into existence, and thus the daily closing requirements are pretty irrelevant in this respect because that check/balance has now been removed and which banks fail is now entirely in the hands of the BOE, and not backed by any kind of market checks?

Question away, as far as I'm concerned... I aimed to say as little that is controversial as possible. There's definitely political mileage in focussing on permitting secret loans... though I set less store by this than you seem to have done. It wasn't that long ago that everything that any central bank did was secret... and it makes sense that a bank borrowing from the lender of last resort would need to be confidential - as, otherwise what might be a shortfall of a few million might result in credit being withdrawn on tens of billions - and, in doing so, create the systemic failure that the central bank is tasked to avoid. Extraordinary actions will need to be done discretely to avoid assuring a minor problem doesn't transform into a major one. If central banks are to act unethically, it isn't likely to be in the context of these emergency loans - it's far more likely that the central bank would do subtle things to sway risk in favour of preferred banks... There have been murmurs that the Fed helps-out JP Morgan and Goldman - though, personally, I think that's just a consequence of the size and relative success of those banks. I'll leave it to others to try and convince one way or the other.

I'd have to ask why, though. We know the economy is based on anything but sound money, but what I don't quite get is why this is some sort of credible, honourable task. Would we not be better off without this, shall I call it, interference?

I'm still not sure I understand why that is so. Would it be more accurate to say "A central bank is essential in order to establish and maintain a debt based monetary system?"

Well - if we're to have any kind of monetary system... we need a central bank. We'd need a central bank if it's purely based on debt - like modern fiats - or if we backed it with something physical like oil or metals. Personally, I think that separating money from tangible assets was a major step forward for humanity - vastly simplifying and facilitating trade. There are a lot of problems that come hand-in-hand with this, however... and I'm not trying to argue that central banks have approached these concerns how I'd prefer. For example, I don't like that our central bank was tasked with targeting CPI - which is far too narrow a measure of inflation for sane monetary policy.

So with what did the ECB buy the bonds yesterday - the answer would appear to be "the value of future labour and productivity pulled forward from the future". Except that doesn't seem to fit any of the rules above anyway.

What I don't get is why if Greece, Italy and Portugal all default on their debts, that's the end of the EUR. If three people in our village default on their debts, that isn't the end of the pound. It just means that I probably have more of it, and they have less of it.

When you think of central banks 'buying' assets, what really happens is sort-of unnerving. Yes - the ECB just placed its purchases on its balance sheet - and paid for them with the loan that balances the bond on their balance sheet. This is exactly the same as a commercial bank would do if it bought the bonds... so there's nothing special about the central bank in this case - it's operating just like any bank. It doesn't consume its purchases - it just assumes the risk that they might not pay out... which, of course, is mitigated entirely if their balance sheet always grows faster than the bond yields.

The central bank didn't pay with the value of future labour... if anything, it's the other way around. The bonds were issued by the government with the implicit promise to tax people to pay back the loan. Where the central bank is "buying" the bonds this allows the government to kite its debt (i.e. avoid making good on its promise to tax its people to repay the sovereign debt.) These interventions to "buy" bonds are the opposite of paying with anything from the future.

In order to explain why a sovereign default is so damaging, you need a shift of perspective. Right now, you think of cash (in a bank account) as being "real money" - and bonds as being IOUs that relate to "real money" that was paid to get them in the first place - and that they must pay out on maturity. That's not wrong, but it's better to think of sovereign debt as being the 'real money' and the cash in bank accounts being mere tokens to mediate access to the 'real money'.- with this (at least equally valid) world view, it turns most popular perceptions on their heads. An IOU direct from the government is better than an IOU from a bank - and an IOU from a bank is what makes up cash. From this perspective, QE and the actions of the ECB "buying bonds" takes on a rather different form. The bonds themselves are the money - and then, when bought (assuming it was at a sensible price) this does nothing more than shift rock-solid capital from commercial bank balance sheets to the central bank's. The upshot of this is to concentrate risky assets (as a proportion of the balance sheet) for commercial banks... no-longer do commercial banks have a raft of low-risk assets to use to settle debts - they're now tied up where the government owes its central bank.. which it owns. In the private sector, however, banks end up being forced to consider the riskier assets they have on their balance sheets... the only ones it has left... and this forces the trade of otherwise illiquid assets... which helps with price discovery. The price that will be discovered is likely far lower than the model price... and, in that sense, quantitative easing actually accelerates the contraction of commercial bank balance sheets - and this reduces the money supply to the private sector.

In the event of a sovereign default, it's game-over for the currency... the problem is that if the state defaults, no-one will lend it money - and if it has its own currency, it will become worth a lot less in a global context. Where the government can't borrow internationally meaningful currency, it's private sector will suffer an epic setback... and this will, in turn, severely limit tax take - causing a vicious cycle. The Eurozone is slightly different - as one nation defaulting would not necessarily cause a systemic failure... so Greece on its own need not be terminal for the Euro - but if Italy, Spain, Portugal and Ireland go the same way... it's hard to imagine much confidence remaining in the Euro... and this would probably prompt a radical shake-up.

I guess I'd then have to end on the question: just why are all the countries so enslaved to the debt based fiat system, and when they all get together, is there any serious conversation along the lines of "Why don't we all just collectively tell them [the bondholders] to eff off?" and I'd guess the answer is that given the differing positions of different countries Greece would love that, but Germany would not. And so on.So we all square up to one another - hello protectionism and tarrifs.

The problem isn't so much that we use a debt-based fiat system - but, rather, that some countries opt to finance their activities by borrowing... while others eagerly lend in order to suppress their own currency - leading to vibrant export potential that creates lots of economic activity and keeps the public employed. If every country balanced its books and refrained from manipulating its exchange rates, there'd be a level playing field on a global basis... though hardly anyone in a position of power wants that. Of course, there's also a problem with over-leveraged commercial banks - but, I'd argue, that happens to no small extent because the public at large become overly optimistic when the government regularly spends significantly more than it receives as income.

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Would it be worth pinning this thread? Or, alternatively, someone writing and pinning a similar thread on CB interest rates and their basic mechanisms?

It's a central and important question, but not very intuitive IMHO.

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Question away, as far as I'm concerned... I aimed to say as little that is controversial as possible. There's definitely political mileage in focussing on permitting secret loans... though I set less store by this than you seem to have done.

I'm not sure I see the difference between propping up a bank in secret and propping up, say, Habitat, Roseby's, Focus or anything else in secret. Or indeed at all... 100 lines "I must stop thinking we have anything like faintly capitalist economies".

It wasn't that long ago that everything that any central bank did was secret... and it makes sense that a bank borrowing from the lender of last resort would need to be confidential - as, otherwise what might be a shortfall of a few million might result in credit being withdrawn on tens of billions - and, in doing so, create the systemic failure that the central bank is tasked to avoid.

Isn't that shortfall what capital adequacy ratios are supposed to guard against, and had the banks not paid out so much in bonuses in the run up the the "credit crisis" they would not have needed bailing out - that's what Mervyn King seemed to think. I'll come to the systematic failure shortly :)

Extraordinary actions will need to be done discretely to avoid assuring a minor problem doesn't transform into a major one. If central banks are to act unethically, it isn't likely to be in the context of these emergency loans - it's far more likely that the central bank would do subtle things to sway risk in favour of preferred banks... There have been murmurs that the Fed helps-out JP Morgan and Goldman - though, personally, I think that's just a consequence of the size and relative success of those banks. I'll leave it to others to try and convince one way or the other.

That was one of my concerns about the secrecy aspect.

Well - if we're to have any kind of monetary system... we need a central bank. We'd need a central bank if it's purely based on debt - like modern fiats - or if we backed it with something physical like oil or metals.

I'm still not sure I see why.

Personally, I think that separating money from tangible assets was a major step forward for humanity - vastly simplifying and facilitating trade.

Certainly agree with that bit. I don't have to offer to wash the windows of the local petrol station or offer something else of "value" in order to acquire some petrol from them.

There are a lot of problems that come hand-in-hand with this, however... and I'm not trying to argue that central banks have approached these concerns how I'd prefer. For example, I don't like that our central bank was tasked with targeting CPI - which is far too narrow a measure of inflation for sane monetary policy.

The remits of the BOE were/are - if I can get this right - to control inflation and to protect the stability of the economy, or somesuch. However as you say, given that the government can manipulate what inflation is by deciding on the basket of goods used to calculate it and then manipulating that at will, that remit is a poisoned chalice and had to fail - because the BOE cannot "protect the stability of the economy" from government spending among other things. You could see actually see Mervyn King realising the trap he'd fallen into.

When you think of central banks 'buying' assets, what really happens is sort-of unnerving. Yes - the ECB just placed its purchases on its balance sheet - and paid for them with the loan that balances the bond on their balance sheet. This is exactly the same as a commercial bank would do if it bought the bonds... so there's nothing special about the central bank in this case - it's operating just like any bank. It doesn't consume its purchases - it just assumes the risk that they might not pay out... which, of course, is mitigated entirely if their balance sheet always grows faster than the bond yields.

I'd thought that quantatative easing was about lending money to banks at a rate at which they could not have obtained themselves, so that they could then buy government bonds so we didn't have to go the markets and experience price discovery. What I don't understand is how what appears to me to be the same candle can be burned simultaneously at both ends for any prolonged period and how it can be anything other than very dangerous. After all, why don't we just do it once a month anyway recession or not.

The central bank didn't pay with the value of future labour... if anything, it's the other way around. The bonds were issued by the government with the implicit promise to tax people to pay back the loan.

Promise, yes. But promises can be broken, and indeed they have been and are, at a sovereign level. Until very recently, house prices had never fallen in the US. Now they have. The UK has never before technically defaulted on its debts.... surely anything can be defaulted on. What puzzles me is why there is any notion at all that sovereign debt is risk free.

Where the central bank is "buying" the bonds this allows the government to kite its debt (i.e. avoid making good on its promise to tax its people to repay the sovereign debt.) These interventions to "buy" bonds are the opposite of paying with anything from the future.

In order to explain why a sovereign default is so damaging, you need a shift of perspective. Right now, you think of cash (in a bank account) as being "real money" - and bonds as being IOUs that relate to "real money" that was paid to get them in the first place - and that they must pay out on maturity. That's not wrong, but it's better to think of sovereign debt as being the 'real money' and the cash in bank accounts being mere tokens to mediate access to the 'real money'.- with this (at least equally valid) world view, it turns most popular perceptions on their heads. An IOU direct from the government is better than an IOU from a bank - and an IOU from a bank is what makes up cash. From this perspective, QE and the actions of the ECB "buying bonds" takes on a rather different form. The bonds themselves are the money - and then, when bought (assuming it was at a sensible price) this does nothing more than shift rock-solid capital from commercial bank balance sheets to the central bank's. The upshot of this is to concentrate risky assets (as a proportion of the balance sheet) for commercial banks... no-longer do commercial banks have a raft of low-risk assets to use to settle debts - they're now tied up where the government owes its central bank.. which it owns. In the private sector, however, banks end up being forced to consider the riskier assets they have on their balance sheets... the only ones it has left... and this forces the trade of otherwise illiquid assets... which helps with price discovery. The price that will be discovered is likely far lower than the model price... and, in that sense, quantitative easing actually accelerates the contraction of commercial bank balance sheets - and this reduces the money supply to the private sector.

In the event of a sovereign default, it's game-over for the currency... the problem is that if the state defaults, no-one will lend it money - and if it has its own currency, it will become worth a lot less in a global context. Where the government can't borrow internationally meaningful currency, it's private sector will suffer an epic setback... and this will, in turn, severely limit tax take - causing a vicious cycle. The Eurozone is slightly different - as one nation defaulting would not necessarily cause a systemic failure... so Greece on its own need not be terminal for the Euro - but if Italy, Spain, Portugal and Ireland go the same way... it's hard to imagine much confidence remaining in the Euro... and this would probably prompt a radical shake-up.

But a whole raft of States in the US have become bankrupt or hover close to it. Yet, despite this, I don't hear cries that a single currency was a daft idea for the US and what it needs is separate currencies per state because a single currency by definition could never have worked.

The problem isn't so much that we use a debt-based fiat system - but, rather, that some countries opt to finance their activities by borrowing... while others eagerly lend in order to suppress their own currency - leading to vibrant export potential that creates lots of economic activity and keeps the public employed. If every country balanced its books and refrained from manipulating its exchange rates, there'd be a level playing field on a global basis... though hardly anyone in a position of power wants that. Of course, there's also a problem with over-leveraged commercial banks - but, I'd argue, that happens to no small extent because the public at large become overly optimistic when the government regularly spends significantly more than it receives as income.

Surely, inflation is manipulated too. Given that real price inflation over here seems to be, I'd guess, somewhere in the region of about 18% I tend to imagine that to get an idea of what inflation might be in another country you take the figure their government comes up with and multiply it by at least 3. So I see the attraction of the single currency for investors who might be convinced they'll get something of some value back at the end.

Completely agree on the point about governments buying re-election by spending more than they earn. However I seem to come at this from a totally different perspective to the economics editors I'm reading.

Day after day I read of the unfolding crisis in the Eurozone.

Except it isn't. It's a problem for a small number of countries in the Eurozone who haven't run a balanced budget. But then we knew what countries they were anyway. Now if the whole system of price discovery worked at all, then the basket cases like Greece would not have been able to get the bond yields they did or perhaps sell as much as they did.

Every day there are calls for the ECB to buy bonds and bail out these countries. However, which "government" owns the ECB? Why is there a need to bail them out? I see no moral case; I see the economic case in that bondholders would be mightily cheesed off. So what? They were the ones doing the lending, and thus the ones taking the risk. The fact that there is risk seems to be one of those economic "surprises" we hear so much about.

I don't actually see any crisis. What I see are a number of over-indebted countries and a number of idiot creditors.

What then happens, when they ask for a consolidation/rollover/further loan is the same as what happens if I go to get a loan and I owe 100% of my annual income on credit cards - maybe I will get the loan, but at punitive interest rates.

So, no crisis. It did not happen "suddenly". We didn't wake up one day to suddenly realise that a number of countries couldn't manage their finances - we knew that anyway. And those countries now face crippling borrowing costs. Quite right too.

I just don't see that there's anything actually "wrong" with the current position. The concept of price discovery seems to be working now even if it didn't then, it just isn't producing favourable results. I see a group of Euro politicians and the ECB running around like headless chickens trying to find the solution which doesn't involve any consequences and realising there are none.

What I don't see is why Merkel doesn't just decline the calls, have a lovely holiday, and tell the ECB to shove off and leave it to Greece, Italy, whoever to negotiate it with their bond holders. I don't really see that it is any of her business or anything to do with her.

The debts are in Euros anyway so leaving the Euro won't help extricate these countries from their debt.

So if those countries actually defaulted outright and told their creditors where to go, then yes, their ability to sell bonds would be severely curtailed. For a while. Why is Merkel so bothered?

Now coming to systematic collapse: surely, if the banking system is leveraged then there is a risk of collapse. Rather like driving my car: if I drive at 100mph it doesn't mean I'll hit anything. What it does mean is that if I do hit something the conseqences will be much more severe than if I'd been going at 30mph.

Given that, and perhaps where this is coming to -

I think of money as being a "store of value" (point as above). At least supposedly. But, money has to be the slave to the system. What appears to have actually happened thanks to the global debt markets and leverage is that the system has become the slave to the money. Why, otherwise, would anyone seriously consider some sort of "Eurobond" idea socialising the lunacy of Greece with funds from e.g. Germany?

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  • 294 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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