Tag: Steve Hanke

North Korea’s Economic Outlook: Cloudy with a Chance of Statistics.

During the past few weeks, North Korea has been the subject of outsized news coverage. The recent peacocking by Supreme Leader Kim Jong Un – from domestic martial law policies to tests of the country’s nuclear weapons capabilities – has successfully distracted the media from North Korea’s continued economic woes. For starters, the country’s plans for agricultural reforms have been deep-sixed, and, to top it off, I estimate that North Korea’s annual inflation rate hit triple digits for 2012: 116%, to be exact.

Unfortunately, the official shroud of secrecy covering North Korea’s official information and statistics remains more or less intact. But, some within North Korea have begun to shed light on this “land of illusions”. For example, a team of “citizen cartographers” helped Google construct its recent Google Maps’ exposition of North Korea’s streets, landmarks, and government facilities.  In addition, our friends at DailyNK have successfully been reporting data on black-market exchange rates and the price of rice in North Korea – data which allowed me to conclude that the country experienced an episode of hyperinflation from December 2009 to mid-January 2011. 

Yes, things may be getting a bit brighter in North Korea. According to recent reportage by Carl Bialik of the Wall Street Journal, statisticians from the U.S. and Europe are bravely making their way into North Korea to teach students basic statistical methods. These lessons may only represent material from an introductory stats course, but they are a step in the right direction, because they force students to at least think about analyzing data. Unfortunately, in North Korea, reliable data continue to be a scarce commodity.

While these developments in North Korea have hardly shaken the dismal economic status quo, one can only hope that they will start to bring about some much needed change . But, don’t hold your breath. If flamboyant basketball hall-of-famer Dennis Rodman’s recent “basketball diplomacy” mission to Pyongyang is evidence of anything, it’s that North Korea is more interested in scoring cheap headlines than it is in turning around its economy. Until North Korea begins to open up its markets and make transparency a priority, its economic prospects will be cloudy, at best.

Osborne Risks a Triple-Dip for the UK

U.K. Chancellor of the Exchequer George Osborne has resumed his saber-rattling over raising capital requirements for British banks. Most recently, Osborne has fixated on alleged problems with banks’ risk-weighting metrics that, according to him, have left banks undercapitalized. Regardless of Osborne’s rationale, this is just the latest wave in a five-year assault on the U.K. banking system – one which has had disastrous effects on the country’s money supply. The initial rounds of capital hikes took their toll on the British economy – in the form of a double-dip recession. Now, Osborne appears poised to light the fuse on a triple-dip recession.

Even before the Conservative, Osborne, took the reins of Her Majesty’s Treasury, hiking capital requirements on banks was in vogue among British regulators. Indeed, it was under Gordon Brown’s Labour government, in late 2007, that this wrong-headed idea took off.

In the aftermath of his government’s bungling of the Northern Rock crisis, Gordon Brown – along with his fellow members of the political chattering classes in the U.K. – turned his crosshairs on the banks, touting “recapitalization” as the only way to make banks “safer” and prevent future bailouts.

It turns out that Mr. Brown attracted many like-minded souls, including the central bankers who endorsed Basel III, which mandates higher capital-asset ratios for banks. In response to Basel III, banks have shrunk their loan books and dramatically increased their cash and government securities positions, which are viewed under Basel as “risk-free,” requiring no capital backing. By contrast, loans, mortgages, etc. are “risk-weighted” – meaning banks are required by law to back them with capital. This makes risk-weighted assets more “expensive” for a bank to hold on its balance sheet, giving banks an incentive to lend less as capital requirements are increased. 

Five years later, Osborne is attempting to ratchet up the weights on these assets. Indeed, he is taking another whack at banks’ balance sheets – and the result will be the same as when the U.K. Financial Services Authority first took aim at the banking system (under Gordon Brown). As the accompanying chart shows, the first round of capital requirement hikes (in 2008) dealt a devastating blow to the U.K. money supply. Indeed, it tightened the noose on the supply of bank money – the portion of the total money supply produced by the banking system, through deposit creation.

Not surprisingly, this sent the British economy spiraling into its first recessionary dip. The second hit to the money supply came shortly after the Bank for International Settlements announced the imposition of capital hikes under the Basel III accords, in October 2010. Despite numerous infusions of state money (reserve money) via the Bank of England’s quantitative easing schemes, these first two squeezes on bank money have put the squeeze on the U.K.’s total money supply.

This is the case because state money makes up only 16.3% of the U.K.’s total money supply. The remaining 83.7% of the money supply is made up of bank money. In consequence, the Bank of England would have to undertake a massive expansion of state money, via quantitative easing, to offset the U.K.’s bank money squeeze.

It is doubtful, however, that the British pound sterling would be able to withstand such a move. Indeed, there are more storm clouds brewing over Threadneedle Street. The sterling recently touched a 15-month low against the euro, and it has fallen 8% against the euro since late July. For the time being, at least, the pound’s tenuous position will likely put a constraint on any further significant expansion of state money, through quantitative easing. It appears markets simply wouldn’t tolerate it.

Accordingly, the only viable option to jumpstart the faltering U.K. economy is to release the banking system from the grips of the government-imposed bank-money squeeze. Alas, Osborne’s most recent initiative on bank recapitalization goes in exactly the wrong direction.

A Threadneedle Street Kerfuffle

On January 10, 2013, I penned a letter to the Financial Times, pointing out an error in its characterization of lending-of-last-resort operations. As the letter below describes, these central bank operations often do not go according to plan:

Sir, Your leader “Basel bends on liquidity rules” (January 8) asserts that: “Central banks can always provide liquidity, and while their facilities should not be a first resort for banks, the Basel Committee is right to signal it will incorporate access to them in its rules.”

You might have added: “But, central banks have a propensity to make a muddle out of what should be routine operations – like those associated with the provision of lender-of-last-resort liquidity.” The Bank of England provides the most recent evidence of this in what turned out to be a catastrophic government failure and arguably the start of the current financial crisis.

On August 9 2007 European money markets dried up after BNP Paribas announced that it was suspending withdrawals from two of its money market funds. This put Northern Rock – a profitable, solvent bank – in a liquidity squeeze. Northern Rock turned to the BoE for a relatively small infusion of liquidity.

This routine lender-of-last resort operation would have worked, according to the textbooks, but for a BoE leak to Robert Peston at the BBC. The BBC story broke on September 13 2007 and the next morning a devastating bank run ensued.

In a flash, Northern Rock went from being solvent (if temporarily illiquid) to bust. Indeed, it was government failure – the BoE’s bungled attempt to provide emergency liquidity – that transformed the Northern Rock affair from a minor, temporary liquidity problem to a major solvency crisis.

So, when it comes to central banks, there is often a wide gulf between the textbooks and reality. It’s time to close the book on Basel III and its liquidity coverage ratio, and to focus on fixing central banks, so that they can properly deliver liquidity, when needed, at a price.

Steve H. Hanke, The Johns Hopkins University, Baltimore, MD, US

To my surprise, what I thought was a simple factual clarification of a Financial Times editorial quickly drew the ire of none other than The Old Lady of Threadneedle Street. Indeed, Nils Blythe, the Bank of England’s communication director was quick to reply in the next morning’s FT:

Sir, In a recent letter (January 11) Professor Steve Hanke made the unsubstantiated claim that the Bank of England leaked information about a lender-of-last-resort operation at Northern Rock to the BBC. This claim is wholly untrue. As the governor made clear in evidence to the Treasury Committee of the House of Commons, the Bank wanted to provide support to Northern Rock covertly, precisely because of the risk of a run by retail depositors.

Prof Hanke also argues that Northern Rock was suffering “a minor, temporary liquidity crisis”. It is worth noting that even when it was supplied with abundant liquidity Northern Rock could not find a buyer and had to be nationalised. With hindsight it is clear that Northern Rock was an early example of the solvency crisis which gripped much of the banking sector in the following years.

Nils Blythe, Communications Director, Bank of England

To put it plainly, I am quite underwhelmed by Mr. Blythe’s argument and evidence. Although it would appear that his response is in line with standard central banking protocol, I found his letter quite concerning for two reasons.

Value of the Iranian Rial Hits an All Time Low

For months, I have kept careful tabs on the black-market exchange rate between the Iranian rial and the U.S. dollar. This is the metric I used to determine that Iran underwent a brief period of hyperinflation, in October 2012. And, using these data, I calculated that Iran ended 2012 with a year-end annual inflation rate of 110%.

Since the start of the new year (on the Gregorian calendar), the rial has displayed new-found weakness. Indeed, its value reached an all-time low of 38,450 rials to one dollar, on Saturday, February 2. As the accompanying chart shows, it is now trading at 38,250, moving the implied annual inflation rate to 121%, from its year-end value of 110%.

How can the IRR/USD rate be so volatile? After all, both the rial and the dollar represent nothing more than fiat currencies, without any defined value. At the end of the day, the value of a fiat currency is whatever value that fluctuations in the supply of and demand for cash balances accord to a scruffy piece of paper.

The markets for both the rial and dollar respond to conjectures about the ability of the respective governments to deliver on their stated “good” intentions. When it comes to Iran, these conjectures understandably generate sharp fluctuations in the value of the rial. Indeed, it is clear that Iranians do not trust their government to deliver economic stability. In consequence, the rial continues to tumble with increasing volatility, and inflationary pressures continue to mount.

The Tyranny of Confusion: A Response to Prof. Djavad Salehi-Isfahani on Iran

In October 2012, I first reported that Iran had experienced hyperinflation. My diagnosis of Iran’s inflation woes has since drawn the ire of Prof. Djavad Salehi-Isfahani, who has written a series of blogs and articles disputing my analysis. Prof. Salehi-Isfahani, an economist at Virginia Tech, has employed a confused (and confusing) mix of half-baked methodologies and selected data to yield unfounded, preposterous claims. Specifically, he claims that Iran never experienced a brief bout of hyperinflation and that Iran’s inflation rate is much lower than the estimates reported by virtually everyone except Iran’s Central Bank. To borrow Jeremy Bentham’s phrase, Prof. Salehi-Isfahani’s claims constitute a series of “vulgar errors.”

What has puzzled me for the past few months is why Prof. Salehi-Isfahani has been so hell-bent on denying Iran’s inflation problems. But finally, in his most recent article in Al Monitor, he showed his hand, revealing his underlying thesis – the same claim propagated by the Iranian regime – that the sanctions imposed by the West have not inflicted economic damage on Iran to the extent that has been reported.

In his most recent blog, Prof. Salehi-Isfahani finally abandons his own confused attempts to calculate Iran’s inflation rate. For his readers, this is a relief, as the variety of methods with which he attempted to calculate inflation in Iran amount to nonsense – and not even good nonsense.

North Korea’s Hyperinflation Legacy, Part II

Following North Korean supreme leader Kim Jong-il’s death last December, many around the world had high hopes that his successor (and son), Kim Jong-un, would launch much-needed economic and political change. Unfortunately, in the months since the new supreme leader assumed power, little has changed for North Koreans outside of the small, communist upper class. The failed communist state has not delivered on its advertised economic reforms.

One thing it has delivered, however, is weapons, which have flowed through its illegal arms-trafficking pipelines. And, if that’s not enough, North Korea is planning another missile test  in the near future. But, as it turns out, the only thing that is certain to blast off is inflation.

In my recent blog post, I pointed out that one of North Korea’s communist legacies is hyperinflation (in addition to starvation). Indeed, hyperinflation may soon plague North Korea once again.

From what little data are available, it would appear that, in the span of six months, the price of rice has increased by nearly 130%. This is par for the course in North Korea, where the price of rice has increased by roughly 28,500% over the last three years (see the chart below).

 

 While the North Korean government worries about rocket launches and how to supply Syria with weapons, and while its archaeologists “discover” ancient unicorn lairs, its citizens’ food bowls are becoming quite expensive to fill. The supreme leader’s priorities, it would seem, are supremely out of whack.

Meet the Press, Check the Facts

This Sunday (2 December 2012), David Gregory hosted a lively session of NBC’s Meet the Press. The focus of Sunday’s program was the so-called Fiscal Cliff. Gregory rounded up many of the usual Washington suspects, including Treasury Secretary Timothy Geithner, and drilled them on their talking points.

Several times, in the course of Gregory’s questioning, he referred to President Bill Clinton’s tough 1993 budget deal. Throughout the broadcast, Gregory kept stressing the fact that the 1993 deal included defense cuts. For Gregory, those cuts were the flavor of the day.

This isn’t surprising. Indeed, most members of Washington’s chattering classes parrot the line that the economy boomed during the Clinton years because Clinton was the beneficiary of the so-called peace dividend, which allowed him to cut defense expenditures.

In fact, if we look carefully at the federal budget numbers, while Clinton did cut defense expenditures, as a percent of GDP, the majority of the Clinton squeeze came from non-defense expenditures. Indeed, as can be seen in the accompanying table, the non-defense squeeze accounted for 2.2 percentage points of President Clinton’s 3.9 total percentage point reduction in the relative size of the federal government.

Clinton squeezed the budget and squeezed hard, from all major angles. This was a case in which a president’s actions actually matched his rhetoric. Recall that, in his 1996 State of the Union address, he declared that “the era of big government is over.”

Clinton’s 1993 deal marked the beginning of the most dramatic decline in the federal government’s share of the U.S. economy since Harry Truman left office. The Clinton administration reduced government expenditures, as a percent of GDP, by 3.9 percentage points. Since 1952, no other president has even come close. At the end of his second term, President Clinton’s big squeeze left the size of government, as a percent of GDP, at 18.2 percent—the lowest level since 1966.

The table contains the facts. President Clinton knew how to squeeze both defense and non-defense federal expenditures. Indeed, he squeezed non-defense a bit harder than defense. Since 1952, the only other president who has been able to reduce the relative share of non-defense expenditures was Ronald Reagan. Forget the “peace dividend”—it’s all about the Clinton “squeeze dividend.”