Capital requirements, non-performing loans, down-ratings and fines are causing severe bank credit austerity.

Sir, Henny Sender writes: “A world awash with dollars is rapidly being replaced by a dollar-scarce world” “Pain for those most in debt looks certain to become more severe” August 26.

Yes, and that dollar scarcity will, as is, primarily generate a contraction of bank credit. Consider what is happening:

Regulators are increasing capital requirements, which put banks lending capacity under pressure.

More non-performing loans and credit down-ratings of borrowers put additional strain on the banks.

And to top it up there are the fines. The recently reported fines of $260bn for the largest 25 banks, when calculated for a leverage of 15 to 1 results in about 4 trillions less bank-credit availability.

But when Sender writes: “It is still not sure how the pain will be distributed though”, I would tend do disagree.

If bank regulations keep the risk-weighted capital requirement component, there is no doubt of who are going to suffer the most; that will be those who generate the highest needs of capital, namely “the risky”, like SMEs, entrepreneurs and the downgraded.

Since those risky already are perceived to generate much expected losses, they will generate much less “unexpected losses”, and so we should lower the capital requirements for banks when holding these assets.

Sir, if austerity has to be imposed, I much prefer that to be government spending austerity than bank credit austerity. Banks have to put up at least some capital (equity) while government bureaucrats need not to risk a dime of their own.

@PerKurowski

Greece: “I am not going to pay you”. Europe: “Then you’re out of the eurozone”. Greece: “So what?"

Sir, Sir Samuel Brittan writes that “The theory behind the euro was that the single currency would act as a harmonizing force”, “Why the eurozone will come apart sooner or later”, August 9.

I do not agree. To refresh my memory I went back to an article I wrote on the eve of the euro titles “Burning the bridges in Europe”. Reading it I conclude that, as I saw it then, it was very little about harmonizing something, and a lot about forcing Europe on Europe.

Brittan also believes that the most likely outcome is for “one or more of the peripherals to leave the eurozone” and links it to when Argentina “severed a supposedly unbreakable link with the US dollar”.

Again, I do not agree. Argentina was using a peso convertible to dollars, but the sustainable seigniorage value of for instance a new Drachma, should be so low that at least Greece would prefer to keep on using the euro, without asking for permission, which it does not have to do, just like Ecuador uses the US dollar without asking the US for permission.

PS. And by the way remember that the Greece mess was mostly caused by the Basel Committee, and European bank regulators, who approved that banks could lend to Greece against only 1.6 percent in capital, meaning allowing these to leverage their bank-equity, when lending to Greece, a mind-boggling 62.5 times to 1. Neither the banks, like those of Cyprus, nor Greece, could or should have been expected to be able to resist such temptations.

The confidence in the dollar and USA’s defense capabilities are as connected as they can be

Sir, when Sebastian Mallaby in “American power requires economic sacrifice”, July 7 discusses USA’s spending on defense he fails to mention one important related question namely… how much of the world’s clearly extreme confidence in the US dollar depends on the US conserving at least the appearance of omnipotence? My answer would be “much much more than what you think… this is really terrain where realpolitik reigns”. 

In this respect any defense savings that comes, for instance, from not fighting useless wars will be acceptable, but any saving that leads to a perception of a lessened military readiness of USA would become extremely expensive, as a result of the dollar being worth less, or the markets demanding higher interest rates to hold US public debt.

If not the dollar, then no other fiat currency either

Most of the world´s concern with the dollar is in fact not with the dollar itself but more of the “if not the dollar then what?” type, since, if looking at the forest and not the trees, makes it clear that no country´s fiat money stands a chance to survive a dollar failure. That is how globalized we have become… that is why some non US are even toying with the notion of supporting a tea party, no matter how doubly distant they feel from some of those partying there … no matter they serve corn on the cob instead of cucumber sandwiches… and others buy gold.

Let us suppose the US officially presented to the world the possibility of a 40% haircut on its debt. Would that be the same as an Argentinean haircut? No way José, since the day after the US would again find unwilling willing takers of US debt, and at quite low rates, because it would think that the day after the US imposed some debt ceiling that really became a real roof.

China, India? Good luck Warren Buffett, but we do not have all that much money to afford the luxury of trying.

In truth, if we would still use fiat money, then the Dollar II would still be better positioned than all other.

A proposal for strengthening the sustainability of the dollar as an international reserve currency

Sir I refer to the recent discussions on international reserve currencies.

There are only two possibilities for an international reserve currency, it is either backed by something physical or it is backed by some sort of metaphysical faith. In the latter case it would be really hard to envision an international organization being able to substitute for a nation in generating the required faith, since that would really have to mean it becomes stronger than any country. I ask, except for in some global citizen´s dreams, when will the IMF or even the United Nations mean more than, for instance, the USA? The SDR´s recently being much re-discussed are based on a predetermined mix of some countries, and as an average, it all finally depends on the how the individual members of the basket do.

And so the fact is that, for the time being, the world has deposited its faith in the USA, which on its currency declares in its turn having deposited its faith in God. And that´s it! While the music plays, as someone recently spoke about a different situation, you have to keep dancing, no matter how untenable it all can seem to be… that is of course unless you want to try to create chaos by decree.

Meanwhile if there is anything we could do, that is to discuss how the faith in the currency of a country could be better harbored, so as not to provoke some of the difficulties for the trusted country, which could provoke the world losing its trust in it earlier than necessary.

In this respect I believe that the most important part to achieve more sustainability is to make a clear distinction between the long term faith in a country and its economy, and the short term faith in its government, perhaps with a sort of a Chinese wall.

Since even the safest harbor can become dangerously overcrowded the US should think of having the Fed collecting a toll from anyone wanting to anchor in their safe-dollar harbor, and not pass along that toll to the US government by means of lower interest rates on its debt, and as is currently the result. That safe-haven toll would align much better the incentives, especially for the US citizens, because no citizen would like to have his government´s finances subsidized by foreign interests. It would in fact be an effective way to combat the safe-haven resource curse.

There would be no problem in having the Fed later sharing the revenues of the toll with the government but those revenues would then be seen as being generated by the strength of the nation and not by the strength of the government.

How many ounces of gold richer am I?

Sir when reading Gregory Meyer and Henny Sender report that “Paulson starts gold fund amid record prices” November 19, and all of the rest noises or sounds on gold, I cannot but help questioning how long it is going to take before we ask our private investment bankers inform us not only of the returns produced in dollar or euro terms, but also of the returns measured in ounces of gold.

We´re stuck in an unsafe to be dollar safe-haven, most probably waiting for the Dollar II.

Sir Martin Wolf writes that “The rumours of the dollar´s death are much exaggerated” October 14, but the discussions have really been about who could take over some of the dollar´s job so that it would not die of a heart attack. And the dollar´s job is not an easy one, as it has the USA suffering from the curse of exporting safe-haven permits, which creates few jobs of that sort the world likes to qualify as “real sustainable” jobs, while importing products produced by real jobs abroad.

Will the dollar suffer the agony of a slow death or fade away like a soldier? Not likely, once the rumour of the safe-haven is having become dangerously overcrowded starts, death will be swift. Strangely though, as things currently stand, the most likely heir of the dollar would be the Dollar II.

The US suffers from the safe-haven curse

Though both Roger Altman “How to avoid greenback grief”, and Wolfgang Münchau “The case for a weaker dollar” October 12, are very right in their comments they are, for the time being, sorry to say, somewhat irrelevant.

The US is currently suffering from a safe-haven curse, which has the world buying dollars not really because of monetary parameters but more as parking permits to what they perceive is one of the few safe havens to whether out the storm. All of us who come from resource cursed nations, in my case Venezuela, know how difficult it is living with a curse, not least the fact that even though we know those resources are finite, and investors will wake up one morning suddenly thinking the dollar safe-haven to be unsafely overcrowded, there is little to be done until that happens. Just like no one stopped until they had chopped down the last tree on Easter Island.

But, having said that, let us not forget that, on the positive side, once the curse is lifted, a lot of new opportunities arise and so we do not necessarily have to be so pessimistic about the future of the US.

On a separate issue I would also recommend Mr. Altman that he performs a stress test on the willingness of the US tax payer to pay for the current public debt being contracted; he might find it even weaker than the current outlook for US consumer spending.

Bumpy roads indeed!

Sir Martin Wolf writes that “Big bumps lie ahead on the road to recovery and reform” October 7. Though I sort of agree, on most, for me the biggest real bump for recovery is that of not knowing yet what kind of growth is sustainable, given the two bottlenecks of oil and climate change. Some countries could resume growing as if these constraints do not exist, but that might very well not take us where we want to go. Yes, we want to stimulate the world, but we also want it to take off in the right direction.

Then of course we have the problem with the monetary system, most particularly for the US, the exporter of the currency the world most trusts in lieu of other alternatives, and that therefore has to live with the safe-haven curse. All of us who come from resource cursed nations know there are serious difficulties living with a curse, not the least the fact that those resources are finite, and though we know that one morning investors might wake up finding the safe-haven unsafely overcrowded, there is little to be done until that happens. Just like they could not stop until they had chopped down the last tree on Easter Island.

But where I might disagree completely with Wolf is when he quotes Andrew Smithers arguing to “force banks to raise the needed capital and if they cannot, let government provide it” if with this he implies he believes public bank capital is the same as private bank capital. What we most need in term of reforms is to eliminate any bureaucratic interference with the risk and capital-allocation mechanism of the market, like those of the minimum capital requirements for banks based on perceived risk of default. What is most needed, especially in the “comfy” countries, is for a banking sector willing to take risks on those few willing to take risks.

Martin Wolf’s savings are not much different from China’s or Germany’s

Sir Martin Wolf referring to the surpluses of countries China and Germany writes “they cannot have both safe foreign assets and huge surpluses”. Why not? It is obvious that persistent surpluses do create special difficulties but these are faced by all investor, even Mr Wolf if he runs a surplus. “It is in Beijing’s interests to lend Geithner a hand” June 10.

In fact had it not been for the misguidance produced by the credit rating agencies or the regulators intervening in the risk allocation process of the market by way of the minimum capital requirements for banks, the system could have kept on working for a very long time until other factors would have become important on the margin.

For instance, just a couple of years ago many were analyzing what would happen to China when they ran out of their labour surplus and salaries were not any longer so competitive. Sadly now we won’t know this for quite some time.

Wolf considers “China’s decision to accumulate roughly $2.000bn in foreign currency reserves... a blunder” What did he himself do? Spent it all? Kept it in pounds? Did he also blunder?

There is a zero capital requirement for banks on AAA public debt

Sir, some define systemic risk simply as the risk of collapse of an entire financial system or entire market, as opposed to risk associated with any one individual entity, but, that is in fact more the result of the systemic risks that originates from the interdependencies and the failures of the system itself.

John Taylor, in “Exploding debt threatens America” May 27, writes that he believes the debt projected level of US debt to be systemic. Yes indeed, the debt could be so large that it could bring us an awful inflation but, what really propels it as a systemic risk, is not so much its size but the fact that the current minimum capital requirements for banks, in the case of public debts rated triple-A, is an astonishing zero. This not only subsidizes the growth of public debt but also leaves the system totally unprotected.

This type of systemic risk led us to the precipice of the badly awarded mortgages to the subprime sector ,just as it will help to lead us to the precipice of governments too much in debt.

The safe-haven is always in the eyes of the beholder

Sir you conclude “Dollar worries” May 23 with “currency traders are pricing in the tail risk that the US will be forced to resort to the printing press”. Sir whether forced or not the fact is that with the Fed’s quantitative easing they are already using the printing press, a lot.

Do you have any idea where the rates would be if it had not been for the quantitative easing? It sure puts a big question mark when it needs to recur to quantitative easing in order to sell itself as a safe-haven. The greatest mistake made by the US government and Congress in their current handling of the crisis is that they might have taken the world’s wish for a temporary safe-haven as a wish for a permanent home.

Behind our backs bank regulators in Basel decided that lending to a triple-A rated government required zero bank equity while lending to an ordinary non-rated private company required 8 percent... and the governments loved it... wouldn’t they? The markets though requires x percent return for lending 100 to triple-A rated governments and y percent return for lending exactly the same 100 to a non-rated private company all without any reference to capital requirements.

Therefore though you can subsidize governments and temporarily confuse the market by means of arbitrary regulations in the long term you cannot simply instruct markets to behave as if a dollar lent to the government is any different than a dollar lent to a private company. Having then to reduce the current implicit subsidy to the governments contained in the minimum requirements for banks will also put further pressure to increase the interest rates on public debt... just when the world seems least to afford it.

The gorilla is there in the room roaring and pounding his chest... let’s pray we’ll never have to pay him off, informally, over the counter, with some gold coins.

Risk is risk is risk!

Sir David Walker with “America’s triple A rating is at risk” May 13 gives new evidence on how dangerously the world has got itself trapped by some erroneous concepts about risk. Of course, America’s triple-A rating is always at risk, there is no absolute quality or anything inherently permanent with a credit rating, this no matter how much the financial regulators want us to think so.

That the US, and the dollar are in trouble, that there can be no doubt about, but the truth is that the US and the dollar could still remain for a very long time the most de-facto triple-A in the world, because, at the end of the day, risk is always relative, except of course, when we really reach the end of the day.

Now on the rest of David Walker’s message I could not agree more. Last year, during the annual meeting of the World Bank and the IMF, I went around asking “how are we going to pay for it all?”, and proposing a new generation of taxes, such as taxing income from protected intellectual property rights, only to be met with a “what is he talking about?”

China would collapse too if it loses faith in the dollar.

Sir Andy Xie is of course right saying that “If China loses faith the dollar will collapse” May 5 but he should also remember that because of the Ying-Yang relation between China and the US, if so happens, China would also collapse. We are all riding on an illusion where we need to feel sorry for him who gets off to early and sorry for him who gets off to late…never before with respect to currencies have the “In God we trust” seemed so appropriate.

The safe-haven must recycle its waters.

Sir you write of the need to “Reopen the taps of global finance” May 1, but that must surely be the responsibility of the current borrower of last resort, the USA.

Ricardo Hausmann, during the spring meetings of the World Bank, at a conference titled “Latin America and the Global Crisis: Towards a Rapid Regional Recovery” argued that the US should take on debt and relend to the world. Hausmann, coming from an oil rich country must have remembered that this was exactly what the oil countries did during the 1974-79 oil bonanza when foreign bankers virtually forced credits on them… and the oil exporting countries recycled and imported and recycled and imported... until.

But is this politically viable? Perhaps not, but even so there are major troubles brewing down the line.

First the US, as the safe-haven par excellence, cannot expect to crowd out the rest of the world from the financial markets, for a lengthier period, without its own waters becoming stale or even having the rest of the world starting to think in terms of sabotaging that safe-haven.

Second if the US, in order to reflate its own economy and which might also help to stop the world from deflating too much, for a while, does so by investing only in its own back-yard, then the returns from those overcrowded back-yards will not be sufficient to repay what will be owed, and so the US taxpayer will start to seriously object having to become the taxpayer of last resort…and with that, again, waive bye, bye to the sweet dollar safe-haven.

Let us not forget that in truth the dollar bill should have imprinted on it “In the American Tax Payer We Trust” but that the US Mint, more pragmatic, more marketing minded and much wiser preferred the much more fundamental “In God We Trust”.

The dollar is the whole world’s s.o.b.

The last of my 15 letters that the Financial Times published before I was silenced was the following dated October 4, 2006 and which said the following.

“Sir, Martin Wolf’s “America could slow us down” (September 27) somehow ignores the possibility that just as the Americans did when they accepted the “In God we trust” printed on their bills as an act of faith when the dollar abandoned its convertibility into gold, the world is now willing to live with an “In America we trust”, at least while there is such a world shortage of better alternatives. If this is so, one could argue that we have still far to travel on the roads of the American current account deficit currently used by the world to dollarize since the fact is that, if you want to lay your hand on a dollar, you have to sell or give something for it. Frightening? Yes, but is not the world itself a frightening place that needs many acts of faith in order to make life bearable?”

Today, after all what we now know, and seeing the world still placing so much trust in the dollar I would probably want to rephrase it by paraphrasing Roosevelt saying “The whole world knows the dollar is an s.o.b but (at least for the time being) the dollar is the whole world’s s.o.b.”

You need to stress-test the American taxpayer first

Sir in “America’s fate is not in its hands” April 16, you mention the stress tests of the financial sector. Much more important than that would be to stress-test the American taxpayer.

What the US dollar bill really should state is “In the American Taxpayer We Trust” and so the more pragmatic Americans have printed the “In God We Trust” on it.

There is no way that the current American generation, having been brought up as the consumers of last resort in the world, would now turn around and accept to be the world’s taxpayers of last resort… at least not with the current taxes and any stress-test of them would show you that.

The US government should be much more conscious of this before launching itself on a fiscal spending stimulus binge which, if allowed by the markets, will build up its public debt to a totally unsustainable level.

That said I believe the market is going to say NO much earlier than that, since one thing is to be searching for a safe temporary haven and another quite different to be trapped in a permanent home.

And that is why, before the US Dollar loses its AAA rating, that the US, and the world, should work hard in developing a totally new generation of taxes that can be perceived as legitimate, that are aligned with the new global realities, and that interfere as little as possible with the functioning of a competitive economy.

Money, money, and money.

Sir Jeffrey Sachs is absolutely right when in “The Tarp is a fiscal straitjacket”, January 28, he urges for a “sound medium-term fiscal framework”. Since the markets quite often even when such a framework is spelled out do not believe in it, they have their statistically valid reasons for that, can you imagine how spooked they could get when asked by the stimulators to join a spending crusade without even hearing a word on taxes?

Indeed, since taxes seem to have reached a real low point in terms of credibility, having lost so much of their real progressiveness over the years, the first thing to do is to make a careful inventory of the supplies and to figure out how to get them to the troops, in time. As Prince Montecuccoli taught “To wage war, you need first of all money; second, you need money, and third, you also need money.”

The Fed Reserve needs many strong helping hands in order to prevent a dollar rout

Sir Mansoor Mohi-uddin gives us a “Five point plan for Fed Reserve to help prevent a dollar rout” January 13 and we do appreciate the intentions, especially since for the time being the undisputable role of the dollar in the international system represents much of the stability there is left in it, and we shiver to think what would happen if that pillar would yield.

That other countries will go down the route of quantitative easing and therefore “there will once again be no major alternative to the dollar as the world’s reserve currency” is, in any such scenario, of little consolation.

But the defence of the dollar is not solely a Fed responsibility. Sooner or later the market, in these days when the only thing it hears are on tax-rebates and stimulate-until-you-drop plans, will expect some indications as to how the American tax payer intends to help to pay for it all. Much as it hurts me since I come from an oil producing country an announcement of a dollar plus new tax per gallon of gas in the US would do a lot more to prevent a dollar rout than all the squirming of the Fed Reserve put together.

Do you belong to an unkown sect of Austrian economists?

Sir in “A plan to spend – and to pay it back” January 9 you admonish that “Congress should not commit themselves to fiscal consolidation too soon”. Are you joking? Don’t you know Congress is composed by politicians?

Also I cannot understand why you egg on the announcement of even larger stimulus packages knowing that these will come, in due time, if there is room for them. Could it be that you belong to a sect of extreme Austrians economists that want Obama to spell out the real figure so that the markets are spooked right away from believing the dollar is a safe haven?