Wealth Inequality & Growth a response to Paul Krugman

The financial bubble of the last decade created the housing bubble and along with it the financial crisis with its ramifications along all sectors of the economy and the world at large. Specifically in the US,  already overextended consumers had an unprecedented negative wealth effect to contend with both from a reduction in the value of more liquid assets such as stock holdings but more importantly the collapse in the value of their homes to such a level that more than 50% of all mortgage holders were effectively underwater on what constitutes most probably their biggest lifetime investment. In other words, if they were to liquidate at any time and sell their home they would be short on the amount owed to the bank. Interestingly, most (close to 85%) of these negative equity mortgages were being serviced and non delinquent indicating that owners were willing to adhere to mortgage payments on expectation ( I would contend) of an improvement in their home values.

More importantly however, is what this has meant to the underlying level of demand in the economy and what the government should have done to reinvigorate it. Understandably the FED and government gave precedence to the stability of its financial system as its first and foremost priority for without a solvent banking sector the US and the world for that matter would have experienced an apocalyptic depression. All emphasis then on the financial system which was successfully revamped and returned to health with the FED’S dramatic actions including aggressive QE, still with us today. It was hoped that the salvation of the money lending institutions would also have secured the necessary lending to households and businesses to remobilise the economy; to no avail. On the one hand the banks were in no mood to expand their balance sheet in an environment of conservative restructuring and a consumer already underwater and on the other a consumer faced with negative equity in a defensive mode with a focused purpose, to increase the savings rate and deleverage. It is evident that in such a setting unless balance sheet restructuring takes hold final demand will at best be weak.

How was inequality exacerbated from the above phenomenon? Saving stockholders at the expense of debtors clearly transferred wealth from debtors to creditors. The US population was asked to bailout the financial system by dramatically expanding the US’s budget deficit and the FED’S  balance sheet reinvigorating both bond  and stock prices but without a commensurate knock on effect on the weakest and largest part of the population. This has meant that the ultimate driver of demand the consumer did not receive any direct help to a healthier balance sheet. He was left to the unforgiving effects of the market forces of adjustment. In other words, the consumer would only return to his usual habits if any or all of the following could take place & in such a magnitude so as to substantially improve his balance sheet and its prospects: A rise in home values, debt deleveraging and forgiveness with its accompanying increase in the savings rate, world growth that would induce cash rich companies to substantially increase investment and employment to meet this growth in world demand.

Will reversing this inequality by pursuing policies aimed at creating the aforementioned conditions drive demand and ultimately consumption? Without doubt the liquidity effect aptly described by Paul Krugman is likely to play an important catalyst. I would in fact call it a wealth effect for it is households feeling good about returning to positive equity that should induce them to spend part of this windfall. This would in turn provide impetus to the cash rich companies to increase the utilisation of their existing factors of production and perhaps lead them to increased investment. The economic textbooks should then take over through the multiplier momentum.   

The above deals of course with wealth and not income inequality a more complex issue worth discussing in a different blog.

My comment on Frances Coppola's blog "Slaying the inflation monster"

Excellent article.

We have been living in an era of deflation since the 2008 financial crisis with inflation vigilantes worsening the situation from central banks to inflationary hawks by not allowing for the cleansing effects of slightly higher inflation/expectations and a redistribution of income from creditors to debtors. The result, historically low long term yields unable to boost economic growth and employment, economies mired in slow growth and a debt overhang which may take decades to write down to manageable levels if policies remain unaltered. The QE embraced by most central banks of indebted countries does help but should be reinforced without half measures and the threatening fear of higher inflation for it is no more than fear for as long as long term bond yields do not predict otherwise and to my knowledge till very recently, they have been showing the exact opposite.

In fact Central Banks should aspire to create market induced sustainably higher long term yields for its this indicator which should lead us to expect stronger growth.  

A comment to Paul Marshall's Opinion on the FT about Central Banks seeing beyond inflation

In response to this article http://t.co/vZKJRdXm on the FT my take:

There are two routes not mutually exclusive but complimentary at redistributing wealth from creditors to debtors: 1- The pursuit of increased inflationary expectations & 2- Debt forgiveness. It is inevitable that both will ultimately be chosen to improve the faltering household balance sheets and regenerate consumer demand. Central banks, like in Japan's case, should embrace higher inflationary expectations but more importantly structure a mechanism that will work equitably towards the path to debt forgiveness.

Η ΕΥΤΥΧΗΣ ΑΛΓΕΒΡΑ ΤΗΣ ΕΠΑΝΑΓΟΡΑΣ.

Η απάντηση μου σε άρθρο του Κυρίου Βαρουφάκη στο Protagon

1-Οτιδήποτε μειώνει το χρέος μας χωρίς να αυξάνει τις υποχρεώσεις μας είναι θετικό. Μπορεί κάτω από 20 δισ ευρώ μείωση να σας φαίνεται άνευ ουσίας αλλά για εσάς φαίνεται πως το χρήμα δεν έχει πλέον αξία. Μην υποτιμάτε οπιαδήποτε μείωση.

2- Η μείωση μας φέρνει πιο κοντά στην βιωσιμότητα του χρέους καθώς εκτός των άλλων οι αποδόσεις των ομολόγων μας υποχωρούν.

3-Οι τράπεζες όταν έχουν σύνολο 15 δισ στο χαρτοφυλάκιο τους πως κουρέυονται με 14 δισ, όπως λέτε, όταν το χρέος τους αγοράζεται με 35%; Μάλλον λάθος κάνετε. Πρώτον οι τράπεζες αγόρασαν τα ομόλογα που κατέχουν κάτω από την τιμή που τους προσφέρεται άρα έχουν και όφελος από την πώληση.ΔΕΝ ΚΟΥΡΕΥΕΤΑΙ ΚΑΝΕΝΑ ΚΑΙΝΟΥΡΓΙΟ ΠΟΣΟ.Το μόνο που χάνουν είναι την υπεραξία σε μία ενδεχόμενη μελλοντική  άνοδο των τιμών των ομολόγων. Γιαυτό θα ήταν εύλογο η συμμετοχή των ξένων στην επαναγορά να είναι μεγάλη έτσι ώστε οι Ελληνικές τράπεζες να συμμετάσχουν με μικρότερο ποσοστό για να επωφεληθούν από την βελτίωση της μελλοντικής αξιοπιστίας της Ελλάδας. Ούτως η άλλως οι τράπεζες μπορούν εφόσον το επιθυμούν να ξαναμπούν στην αγορά να τα επαναγοράσουν.

Buying up Greek government debt

It has been suggested that the Eurozone might look at the possibility of loaning the Greek government an amount as high as 10 billion euros via the ESM or otherwise  to purchase Greek government debt at a discount in the market and retire it. This could reduce Greek debt by approximately 20 billion plus accruable interest if this exercise is carried out at today's market rates close to 35% of face for 10 year maturities. The benefit would of course be greater for longer maturities as it would trade at a greater discount.

There have been some sounding comments by various bloggers as to whether owners of Greek debt may be willing to part with their holdings at these depressingly low prices and of course many others acknowledging it would be mere stupidity and that under this spectrum it is futile as no one will sell at these levels. 

Prices of Greek government bonds are determined on a daily basis by continuously changing market dynamics at bond dealing rooms at banks & other financial intermediaries. The current price ( if its 35% of face for 10 year instruments) is therefore a price at which willing buyers and sellers exchange these as of this writing. The fact the EZ may pre-announce the possibility of such a program implies that market expectations automatically will shift & improve and thus market participants may only now be willing to sell their holdings at continually higher prices automatically lowering yields and improving Greece's borrowing costs. As prices rise the Greek government pays more for its own debt that it buys and thus the bond holders also receive more so the effective government gain is reduced but equally Greece's position in the market improves. 

It is therefore nonsensical to suggest, as some have, that there will be no sellers simply because prices will rise to the level that sellers will become willing. There is of course the possibility of prices rising by such an amount as to make the whole exercise futile, but then the Greek government would have benefited by considerably lowering its debt yields without having spent one penny.

This is a measure long overdue.   

My comments on Krugman's post http://krugman.blogs.nytimes.com/2012/10/01/euro-counterfactuals-wonkish/?smid=tw-NytimesKrugman&seid=auto#comments

Capital flows from the core to the periphery induced by low interest rates, low inflationary expectations, a misconception of a globalised & perpetually growing world economy, all unquestionably contributed to the worsening of the trade imbalances in the periphery. What the euro achieved was to significantly worsen the trade imbalances which periphery countries were already experiencing. The chart below is a case in point for Spain. The same would apply for the rest of the GIPSIIS.

 

On the devaluation front if wages were the instrumental factor affecting trade imbalances I would agree but it is a lot more than this. Each country has its own comparative advantages and it must thus allocate resources to highlight these advantaged sectors. This way it creates import substitution and also advances its export sector. In countries such as Greece were the inefficient and corrupt government sector still controls a large share of GDP, efforts should be directed at privatising as a source of efficiency, as a way to reduce debt  as well as an injection of much needed scarce capital. Finally a protagonist role must also be played by the surplus countries whose economies benefited the most by the euro. They must increase local consumption through government and or private initiative so as to absorb increased imports from the periphery and contribute to rebalancing. The consequential loss of domestic sales can be made up by the fruits of their new investments in the productive process in the periphery. Even more to their liking if their investments are centred in export oriented industries they will do what they have been doing so successfully at home knowing that their effort stabilises their existence.

A comment on Krugman's post http://t.co/cjajR3v5

 

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I do agree that the Euro problem is mainly a BOP one which has since transformed into a major fiscal problem as a result of the deepening economic downturn and the sudden shut down of low interest capital flows on which the peripheral countries were so much dependent.

In this respect, the peripheral countries should redirect resources both public and private to the production of goods and services aimed for both local consumption to replace imports and the export market to sustain growth in earnings.If this can be accelerated through the privatisation process it should be done for as long as the investor has a viable long term investment plan in place to create a product and or service which can compete in terms of quality and price in Internatioanal markets.

Equally redundant public sector services which do not add anything to this creative process should be shut down or transformed into production units for its furtherance.

The surplus countries on the other hand should strive to increase consumption thereby accelerate the absorption of imports and provide investment capital and know how to the periphery to incentivise their production.

This will also allow the substitution of part or all of their total exports lost to imports in their local market to exports from the periphery.