Every week more liquidity is injected into the global banking system by the US Federal Reserve and the European Central Bank. The average interest rate paid for overnight reserves in the US has been well below the 5.25 percent per year that the Fed still publicly says is its target.
But the market for overnight reserves now appears to be divided into three segments. Banks known to be healthy can borrow at much less than 5.25 percent. But banks facing possible liquidity problems -- which the Fed wants to be able to borrow at 5.25 percent -- are borrowing from the Fed itself at 5.75 percent, as are a few big banks that want more liquidity but don't believe they could get it without disrupting the market.
Such a difference in the prices charged to "regulated banks" in financial markets is a sign of a potential breakdown. To date, the premiums charged are small: for an overnight loan of US$100 million, even a one-percentage-point spread in the interest rate is only US$3,000. That reflects the small probability that the market is assigning to the occurrence of a full-blown financial crisis with bankruptcies and bank failures. In normal times, however, there is no such premium at all.
The fact that there is even a small liquidity crunch for banks implies larger liquidity crunches for less intensively regulated financial institutions, and even greater liquidity crunches for manufacturing and real-estate companies. It is hard to imagine that manufacturers are not now postponing orders of capitals goods, and that new home sales in the US are not dropping right now.
How does the Fed deal with such a situation? Gingerly. A decade ago, former Fed chairman Alan Greenspan likened his problems of monetary management to driving a new car, having it suddenly stop, opening the hood, and not understanding a thing about what he saw. The changes in finance had been that great.
The Fed's actions have involved what former Fed governor Larry Meyer calls "liquidity tools," as opposed to interest rate-based monetary policy. The Fed hopes that it can handle the current situation without being forced to rescue market liquidity by cutting interest rates and thus giving what it fears would be an unhealthy boost to spending. The Fed still hopes that liquidity and confidence can be restored quickly, and that this summer will serve future economists as an example of how de-linked financial markets can be from the flows of spending and production in the real economy.
I think that the Fed is wrong: The fallout from the current liquidity panic means that a year from now we are likely to wish that the Fed had given a boost to spending this month.
The reason is that healthy spending and production no longer depend only on the soundness of the banking system and public confidence in its stability. Nowadays, the banking system is much larger than the set of institutions formally called "banks" that are intensively regulated by central banks and treasuries.
A bank, at bottom, is something that (a) takes deposits, (b) provides loans, (c) pretends to its depositors that their money (its liabilities) are more liquid than its assets, (d) collects net interest as a result, and (e) gets away with it almost all the time. The deposits can be individuals' paychecks and the loans can be to small businesses. Or the deposits can be consumer paper issued by KKR Atlantic Financing, and the loans can be CDO sub-prime mortgage tranches that KKR Atlantic holds in its portfolio. Or the deposits can be investments in D.E. Shaw's funds and the loans can be the complex derivatives that make up D.E. Shaw's portfolio.
In all these cases, the liability holders -- i.e., the depositors -- have been promised liquidity, yet that promise cannot be kept if it is ever doubted. It is being doubted now.
Central banks should not focus only on keeping markets liquid. In the future, even liquid markets will be willing to intermediate fewer transactions than they were two months ago. So central banks must also focus on how the fall in the volume of money flowing through financial markets will affect spending, and on how much they should cut interest rates and expand money supply to offset these effects.
J. Bradford DeLong is an economics professor at the University of California at Berkeley. He was assistant US Treasury secretary during the Clinton administration.
Copyright: Project Syndicate
US president-elect Donald Trump on Tuesday named US Representative Mike Waltz, a vocal supporter of arms sales to Taiwan who has called China an “existential threat,” as his national security advisor, and on Thursday named US Senator Marco Rubio, founding member of the Inter-Parliamentary Alliance on China — a global, cross-party alliance to address the challenges that China poses to the rules-based order — as his secretary of state. Trump’s appointments, including US Representative Elise Stefanik as US ambassador to the UN, who has been a strong supporter of Taiwan in the US Congress, and Robert Lighthizer as US trade
A nation has several pillars of national defense, among them are military strength, energy and food security, and national unity. Military strength is very much on the forefront of the debate, while several recent editorials have dealt with energy security. National unity and a sense of shared purpose — especially while a powerful, hostile state is becoming increasingly menacing — are problematic, and would continue to be until the nation’s schizophrenia is properly managed. The controversy over the past few days over former navy lieutenant commander Lu Li-shih’s (呂禮詩) usage of the term “our China” during an interview about his attendance
Following the BRICS summit held in Kazan, Russia, last month, media outlets circulated familiar narratives about Russia and China’s plans to dethrone the US dollar and build a BRICS-led global order. Each summit brings renewed buzz about a BRICS cross-border payment system designed to replace the SWIFT payment system, allowing members to trade without using US dollars. Articles often highlight the appeal of this concept to BRICS members — bypassing sanctions, reducing US dollar dependence and escaping US influence. They say that, if widely adopted, the US dollar could lose its global currency status. However, none of these articles provide
Bo Guagua (薄瓜瓜), the son of former Chinese Communist Party (CCP) Central Committee Politburo member and former Chongqing Municipal Communist Party secretary Bo Xilai (薄熙來), used his British passport to make a low-key entry into Taiwan on a flight originating in Canada. He is set to marry the granddaughter of former political heavyweight Hsu Wen-cheng (許文政), the founder of Luodong Poh-Ai Hospital in Yilan County’s Luodong Township (羅東). Bo Xilai is a former high-ranking CCP official who was once a challenger to Chinese President Xi Jinping (習近平) for the chairmanship of the CCP. That makes Bo Guagua a bona fide “third-generation red”
RSS