November 06, 2016
Sir, you write: “It is a puzzle why the Fed is so keen about raising US interest rates… Central banks should err on the side” “The prevailing case for caution by central banks” November 5.
Sir, may I say you keep on being fixated on the nominal real interest rates, unable to see the real real-nominal interest rates.
Would any serious economist discuss gas prices at the pump ignoring taxes? No!
Would any serious economist discuss milk prices ignoring various subsidies? No!
Then why have almost all serious economists, FT included, only been discussing low real interest rates on public debt ignoring the regulatory subsidies?
In 1988, the Basel Accord, Basel I, for the purpose of setting the capital requirements for banks, decided that the risk weight of the sovereign was 0% and that of We the People 100%.
That would hence mean that banks would be able to leverage much more their equity, and the value of any explicit or implicit government guarantees they received, with loans to the public sector than with loans to the private sector.
That would hence mean banks could obtain higher risk-adjusted returns on equity when lending to the public sector than when lending to the private sector.
That would hence mean that the interest rates of bank loans to the public sector included a regulatory subsidy.
That would hence mean that the subsidies for the access to bank credit by the public sector was to be paid by taxing the private sector with more restricted or more expensive access to bank credit.
And that should hence have meant that in order to know the real real-rate on public debt, to the nominal rates, we would have to add the cost of the regulatory taxes paid by the private sector.
That has not been done! All references to the interest rates of public debt have been limited to using the nominal rates. That has led experts like Lawrence Summers, Lord Adair Turner, FT's own Martin Wolf and many other, to argue that the public sector should take advantage of extraordinary low rates in order to finance public investments, like in infrastructure.
That is so wrong! If we include the economic cost of restricting the access to bank credit over the decade and around the world, for many millions of SMEs and entrepreneurs, the current real real-interests rates on public debt could in fact be the highest ever.
So, if the Fed, ECB or any other central bank, really wants to lower the interests in order to stimulate the real economy, then they should begin by asking bank regulators to take away those so costly subsidies of public debt.
Sir, You if anyone should know I have been raising this issue for a long time; in 2004 in a letter you published I wrote: “How many Basel propositions it will take before they start realizing the damage they are doing by favoring so much bank lending to the public sector (sovereigns)? In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits.”
But sadly my arguments have until now fallen on deaf ears. Perhaps I never managed to explain myself correctly in those thousands of letter I have written to FT over the years about the distortions that are caused by the risk-weighted capital requirements for banks.
But now, at long last, I might have been able to reach through, at least to the IMF. At the very end of the recent 2016 Annual Research Conference, none other than Olivier Blanchard, the former Chief Economist of the IMF, admitted that indeed more research was needed to better understand the underlying factors for the trend to lower public debt interests that can be observed the last 30 years; and that this trend might very well be explained to an important extent by current bank regulations.
I pray that translates, as fast as possible, into many of IMF’s PhDs and other researchers trying to figure it out. It is absolutely vital. Public debt usually serves as a proxy for those risk-free rates that so many of our market and financial decisions are based on.
We have all a responsibility towards our grandchildren to help our economies to navigate towards better waters and, if we are to succeed doing that, we need our compasses or GSPs to be functioning correctly.