If we want public debt to protect citizens today and tomorrow, it behooves us to make sure it cannot be too easily contracted.

Sir, I refer to John Plender’s “The virtues of public debt to protect citizens” FT February 7, 2022.

Sir, as a grandfather I do fear debt burdens we might impose on future generations, but I’m absolutely not an austerity moralist. I know public debt is of great use if used right but also that the capacity to borrow it a reasonable interest rates (or the seigniorage when printing money), is a very valuable strategic sovereign asset, especially when dangers like war or a pandemic appear, and which should therefore not be irresponsibly squandered away.

In 2004, when I just finished my two-year term as an Executive Director of the World Bank, you published a letter in which I wrote “Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. How many Basel propositions will it take before they start realizing the damage, they are doing by favoring so much bank lending to the public sector?”

1988 Basel I’s risk weighted bank capital requirements decreed weights of 0% the government and 100% citizens. It translates into banks being allowed to hold much less capital - being able to leverage much more, with loans to the government than with other assets.

Of course, governments, when their debts are denominated in the currency they issue, are, at least in the short-term and medium term, and in real terms before inflation might kick in, less risky credits. But de facto that also implies bureaucrats/ politicians/apparatchiks know better how to use taxpayer’s credit for which repayment they are not personally responsible for than e.g., small businesses and entrepreneurs. And Sir, that I do not believe, and I hope neither you nor John Plender do that.

Such pro-government biased bank regulations, especially when going hand in hand with generous central bank QE liquidity injections, subsidizes the “risk-free” rate, hiding the real costs of public debt. In crude-truth terms, the difference between the interest rates sovereigns would have to pay on their debts in absence of all above mentioned favors, and the current ultra-low or even negative interests they pay is, de facto, a well camouflaged tax, retained before the holders of those debts could earn it.

But of course, they are beneficiaries of all this distortion, and therefore many are enthusiastically hanging on to MMT’s type Love Potion Number Nine promises.

@PerKurowski

Do credit ratings stop capitals from going where they should?

Sir Arturo Cifuentes in “Credit of the big rating agencies under fire”, September 12, explains very well some of the problems that arise from that many market participants do not know what the credit ratings really mean. Also and although Cifuentes does not fully enter into that very delicate terrain of explicitly wondering whether the bank regulators who enforce the use of these ratings know what these mean, he at least dares to ask the question of “Under the current regime, is it safe to determine capital requirements? , and for this he should be commended.

Now, having been very critical of how we have substituted the no matter how technically correct still limited vision of a few credit rating agencies for the real biodiversity of criteria of a free market, the most important question we need to ask about the credit ratings is not so much in reference to the calculation of the capital requirements of the banks, but on how these credit ratings can influence the directions of the capital flows in the world. It is of course bad if banks do not have enough capital but let us remember that it is far worse if capitals do not go where they can best deliver results.

The explanation lies also in the absence of the normal “shavings”

Sir, I would absolutely side with Martin Wolf when he favours the “saving glut” (the US as a helpful consumer bumper) over the “money glut” (the US as an abusive imperial money printer) in “Who are the villains and the victims of global capital flows” June 12, as the main explaining factor for the compression of risk spreads and financing of the robust growth of US consumption. 

Having said that I would like to remind that there are many more characters to this story. Over the last decade, much the result of the Basel regulators’ efforts to drive out banking risks from banking, many of the financial risks have gone into hiding, frequently with the help of derivatives and credit rating agencies, and the world has therefore not suffered as many of the financial shavings that crisis and bankruptcies traditionally produce. 

You might mention Enron and the likes but the fact is they add up to almost nothing when compared to the tsunami dimensions of the flows. At the end of the day we will perhaps find much of the global capital flows evaporate into hot air when risks begin to show their face again and as perhaps has already started with the subprime mortgages in the US.

PS. Martin Wolf's http://blogs.ft.com/wolfforum/2007/06/villains_and_vi.html#comments does not any longer appear. I wonder why.