Central banks, when targeting, should start by making sure they are targeting the correct target; and the last thing they should do, is to promote distortions in the allocation of bank credit.

Sir, Marie Owens Thomsen writes: “Today, governments tend to run only budget deficits, making them rather structural. This leads to ever-rising debt levels and poses a potential policy dilemma. Thanks to the blissfully low rate of inflation, it is possible to ignore this fact. But should inflation hypothetically shoot up, it would quickly become apparent. Central banks could find themselves unable to raise policy rates enough to combat price increases without causing a debt sustainability crisis at home.” “Central banks need to be less dogmatic on inflation targeting” May 8.

Scary stuff, but even more so when one considers the following:

First, that the targeting of inflation is based on an entirely subjective measure of inflation. Just as an example it is based on the cost of renting houses but not the price of houses.

Then second, the artificially imposed risk weighted bank capital requirements, which among other much favor “safe” sovereign debt over “risky” loans to entrepreneurs and SMEs, is distorting the allocation of bank credit to the real economy, and sends out the wrong interest rate signals. For instance had the EU authorities not assigned a 0% risk weight to all Eurozone sovereigns, even though these were getting indebted in a currency that de facto is not their domestic (printable) one, Greece would never have been able to build up the exposures to German and French banks that doomed it to a crisis.

@PerKurowski

Cutting taxes by means of inflation adjustment vs. reducing regulatory subsidies to state borrowings?

Sir, Sam Fleming reports “The Treasury has been examining the merits of adjusting capital gains taxes for inflation” “White House push to cut taxes for rich faces thorny obstacles” August 3. 

Fleming points out that the “initiative could cost $100bn or more over 10 years” and “Estimates from the Congressional Research Service suggest as much as 90 per cent of the benefits would go to the top 1 per cent of households.

Steve Moore, a visiting fellow at the Heritage Foundation opines: “It would be good for the economy. This is something we as free market people have been talking about for a long time.”

I am for free-markets, and I defended with great enthusiasm even more extensive inflations adjustments when they were introduced in Venezuela some decades ago, clearly before its current anti-free market regime came to power.

That said I would now use this occasion to ask, are such inflation adjustments, which reduces tax income, really compatible with the 0% risk weight assigned to the quite sizable US debt for the purpose of the capital requirements for banks?

That 0% risk weighting, de facto subsidizes US public debt, and which, on the tune of some 21 trillion in debt, could easily represent $100bn or more over 10 years.

If I were to choose, both from fairness and a free market perspective, I would much rather cut the bank credit distortions in favor of the sovereign than the inflation adjustment.

Just for a starter that would allow all to see better what the real unsubsidized interest rate on government debt is, and that should be useful, except fro those who do not want that to be known. 

PS. With a 0% interest rate, a 2% inflation target, how can regulators argue a 0% risk weight for a sovereign? That is of course unless they are from Venezuela or Zimbabwe, and only think of honoring public debts in nominal terms with the printing machine.

@PerKurowski

Leonardo da Vinci, smiling, must be harboring great gratitude to the Fed and ECB for helping his Salvator Mundi to become so highly valued.

Sir, I refer to Josh Spero’s and Lauren Leatherby’s “Record price sparks hunt for Da Vinci painting buyer” November 17.

Surely Leonardo da Vinci wherever he find himself must be smiling and extending his deepest gratitude to Fed’s Janet Yellen and ECB’s Mario Draghi for their QEs and ultra low interest rates. That has allowed him see his Salvator Mundi valued at US$ 450 million much earlier than he could have expected.

And Janet Yellen and Mario Draghi and their colleagues must surely be smiling too. Since Dmitry Rybolovlev bought that painting in 2011 for $127.5m, its current price hints at being successful at reaching an inflation rate target they never dared dream of.

The art curious still do not know who the buyer is, but be sure the redistribution profiteers are also looking after these US$ 450 million to find out how that money escaped their franchise.

Since the latter will surely soon again be talking about inequality I take the opportunity to advance my usual question of: How do you morph such a valuable piece of art into street purchasing power again; that can be used for food and medicines, without the assistance of another extremely wealthy?

@PerKurowski

Risk-weighted capital requirements for banks favoring the sovereign, artificially lowers the neutral/risk-free rate

Sir, Chris Giles writes: One “fundamental problem in central banking is that estimates of the neutral rate of interest — seen as the long-term rate of interest that balances people’s desire to save and invest with their desire to borrow and spend — appear to have fallen persistently across the world.” “FT Big Read. IMF Meetings: Setting policy in the dark” October 12.

That has an explanation:

Banks are allowed by the regulators to hold less capital against loans to the government (sovereign) than against loans to the private sector.

That means that banks are allowed to leverage more with loans to the government than with loans to the private sector.

That means that banks can earn higher risk-adjusted returns on equity with loans to the government than with loans to the private sector.

That means that banks, when compared to what they would have done in the absence of these distortive regulations, lend more to the government and less to the private sector; especially to the “riskier” part of it, like unrated SMEs or entrepreneurs.

That means there is a downward pressure on the interest rate on loans to the government, and, since these signify for the most a reference of the risk-free rate, that pulls all rates down from what should be their ordinary level.

And when that regulatory pulling down of rates is topped up with central banks with their QEs loads of government debt, the drop in the “risk-free” floor rate becomes truly important.

Sir, IMF and central bankers have been blind for a very long time to the distortions produced by the risk weighted capital requirements for banks.

Now and again they seem close to understanding it, like last November during IMF Research conference, but then they lose themselves again.

I guess, as Upton Sinclair Jr. said, “it is difficult to get a man to understand something when his salary depends upon his not understanding it.”

Now the real problem for me with central bankers goes way beyond this issue of the neutral interest rate.

My problem is that central bankers never resolved anything, they just kicked the 2007-08 crisis can forward, and basically left in place the distortions that produced it. So therefore a new crisis, could be an augmented one, just lurks around the corner. Great job guys!

And of course, with respect to central bankers pursuing an inflation marker, like in a greyhound race these pursue an artificial hare, I can’t but agree with Daniel Tarullo’s “Essentially you are setting policy on things you don’t know and can’t measure and then reasoning after the fact”.

@PerKurowski

Central banks that only want banks to harvest what’s “safe” and not sow what’s “risky”, do not deserve any credibility

Sir, you write “central banks have resorted to ever more ingenious methods to convince a sceptical public that they still have the ability to create inflation”, “The growing challenge to central banks’ credibility” September 24.

Excepting those loving the current inflation in the values of assets, what sceptical public do you identify as wanting the core goal of central banks to be achieving higher inflation?

And as for their tools to obtain that “core goal” you mention the failures of QEs and low interest rates, and seemingly want them to dig deeper into negative interest rate territory.

No Sir! Any central banker that does not speak out against the risk weighted capital requirements for banks, that which have banks only refinancing the safer past and not financing the riskier future, do not deserve any credibility. Moreover they should be publicly shamed.

PS. Not only criminals and tax-evaders, but also ordinary people can beagainst restrictions on cash

@PerKurowski ©

While central bankers ponder moving their targets, we should ponder the need of moving them out.

Sir, I refer to your “Central bankers ponder moving the goalposts” August 26.

Stock and bond markets are important but the banks are most often the financiers of the first stages of growth. So while regulators, with their risk weighted capital requirements, insist in distorting the allocation of bank credit to the real economy; impeding sufficient flows to what has been deemed as risky, like SMEs and entrepreneurs, there is no chance in hell that QEs, negative interests or whatever else central bankers might concoct will work.

Some want to make up for the regulatory risk aversion by designing special financing facilities, for instance to SMEs. That’s would be the wrong way, that would just make everything more complicated and even less transparent.

Frankly, when I read about what options central bankers are pondering, it all sounds like a Lilliput and Blefuscus debate, 2% or 4%, break the egg on the larger or on the smaller end. Perhaps, if they cannot get their act together, and before they take us further up the huge mountain of debts they talk down as quasi-debts, we should seriously ponder the need to move them out. 

Inflation targets, nominal value of GDP and such, means little for most on Main Street. For instance, as a grandfather, I would welcome some central bankers that would target future employment rates, in decent jobs of course; and were willing to index their respective retirement plans to my grandchildren’s success, and to the value of the pension and retirement plans of those of their generation.

Sir, the independence of central bankers, cannot signify they are not to be held accountable for what they do.

@PerKurowski ©

FT, why do you keep mum on the greatest austerity of all; the bank regulation ordered credit-risk-taking austerity?

Sir, you write: “Given huge disparities in the bloc, this is no time for more austerity” “A tentative upturn in the Eurozone economy” May 4.

And yet you keep mum about the most serious austerity of all; the risk-taking austerity imposed on banks by regulators and who have these not financing more the riskier future but mostly refinancing the for the rime being safer past.

And truly idiotic it is. Basel II assigned a risk weight of 20% to AAA rated assets and 150% to that rated below BB-. That is like a nanny telling the children to beware of the ugly and foul smelling and embrace more the nice looking gentlemen who offer them candy.

When you have seen how much stimulus has been thrown at the economy without it responding with any seemingly sustainable strength don’t you get curious about why? Or is it that you believe that as long as ECB’s Mario Draghi manages to hit an inflation target everything is going to be fine and dandy?

PS. Here again is an aide memoire on other regulatory stupidities.

@PerKurowski ©

What? “ROE is not a meaningful measure of performance”? If you are a shareholder it sure is.

Sir, Oliver Ralph writes: “Most big banks use their own assessments of risk when calculating RWAs, and there is no clarity about how they do so. “Flawed return on equity metric will not be shaken off easily” November 17.

There might not be clarity about the “how they do so” but there is no doubt about the why they do so. It is to lower the equity requirements, so that they can earn as high as possible expected risk-adjusted returns on assets. Just like kids would promote the nutritional value of ice cream and chocolate cake and negate steadfastly that of broccoli and spinach.

Of course the return on equity ROE is one of the most important measures they are and good luck to anyone trying to raise capital saying it isn’t so. Oliver Ralph is perfectly clear when stating “Ignore it at your peril”.

Bank ROE has of course mutated as an information tool. Nowadays it is very difficult to establish how much of it is produced from real banking… how much from over-leveraging banking, and how much from pitifully bad risk weightings.

Suffice to see the zero percent risk weights for sovereigns. Those sovereigns who in our face announce inflation targets so that can repay us with currency worth less… those which already mention the need of increasing taxes in order to repay their debts.

@PerKurowski ©

Interest rates must go up… but that must also be compensated eliminating the distortions of bank regulations.

Sir I refer to Sam Fleming’s “Fed loses ‘patience’ and opens way to first rate rise in a decade” March 19. All the hullaballoo, by so many actors, around the Fed’s intentions, as if it was all up to the Fed to make the economy work, is just mind-blowing. 

I have no doubt interest rates should be increased, considerably, because rates lower than what the authorities are targeting the inflation rate, in your face, isn’t natural, in any financial market.

But, in order for that not to cause excessive recessionary impact, absolutely all the regulatory discrimination against the fair access of “the risky” to bank credit needs to be eliminated.

Please regulators, let the SMEs, the entrepreneurs, the start-ups ride to the rescue of our real economy, before its too late... these "risky" borrowers never ever caused a major bank crisis... as bankers are more than enough scared of their credit risk. 

How? There are different options… here is a link to one I suggested for Europe.

@PerKurowski

The haircuts that will result from the mother of all market riggings... will be staggering.

Caroline Binham writes about the Bank of England’ “potential rigging of money market auctions”, “BoE embroiled in fraud probe of crisis-era liquidity moves” March 5.

Sir, whatever those rigging could have been, they must be really minuscule when compared to the mother of all riggings; that which occurred when regulators rigged bank regulations in favor of the sovereigns, to the extent of considering some of these infallible.

Sir, when a sovereign takes on too much credit, it will either pay you back a fraction, this is known as a regular haircut, like that Greece wants to do; or give you a negative interest rate haircut, like Germany does; or give you an inflation haircut, as that which they officially target; or give you a tax increase haircut (we citizens hold de-facto CoCos of our sovereigns); or give foreign currency based investors, a devaluation haircut, like that currently given by the Euro. And there might even be other haircuts I have missed.

And so, giving many sovereigns a zero risk-weight for the purpose of setting the capital requirements for banks, defies all rationality, and can only be explained in terms of the regulators rigging the regulations; whether for ideological reasons or only to ingratiate themselves with their bosses, the governments.

The consequence of a zero risk weight is that banks are able to leverage their equity immensely when lending to the sovereign and so, guaranteed, banks will lend the sovereign too much at too low interest rates… and so the consequential sovereign haircuts, in any which shape or form they come, will be staggering large.

Especially so when governments are, by for instance Martin Wolf, egged on to take advantage of “favorable market conditions for public borrowings”, in order to take on major infrastructure projects.

What flight to quality? To dangerously overpopulated safe havens?

Jonathan Wheatley quotes Stuart Oakley, global head of EM foreign exchange trading at Nomura: “The point of QE is to inflate the real economy. But instead of driving growth it is creating asset bubbles”, “Emerging bubble”, February 16.

How could it be otherwise? The growth of the real economy depends much on allowing the real economies’ “risky” risk-takers, like SMEs and entrepreneurs, to do their job. And that has been blocked by capital requirements for banks that force equity scarce banks to hold more equity when lending to the “risky” than when lending to the “safe”.

And the article speaks about “Flight to quality”. What quality? The usually safe havens, those usually used by widows and orphans, are now being dangerously overpopulated by banks following the instructions imparted by regulators.

Wheatley also refers to “while the yield on the benchmark US Treasury bond has fallen from 6 per cent in 2000 to less than 2 per cent today, the returns sought by many US public pension funds have barely changed at about 8 per cent.” And Sir, if you consider that “less than 2 per cent”, in light of a by the Fed declared inflation target of 2 per cent, then buying those bonds would amount to a sort of prepaid pre-accepted haircut, which could be something prohibited for pension funds to do.