Topic: Finance, Banking & Monetary Policy

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.

China: Money Matters

Contrary to what the doomsters have been telling us, China’s economy is not on the verge of collapse. As the Wall Street Journal’s man in Beijing (and my former student), Aaron Back, reported: “China’s economic growth accelerated in the fourth quarter of 2012.” Indeed, China’s fourth quarter GDP growth rate came in at a strong 7.9%.

What the doomsters and many other Pekingolgists fail to grasp is that money matters. Indeed, it dominates fiscal policy, and nominal GDP growth is closely linked to growth in the money supply – broadly measured.

China’s most recent acceleration in GDP growth did not catch me flatfooted, because China’s money supply has been surging (see the accompanying chart).

In fact, China’s M2 money supply measure is 9.7% above the trend level. Money matters.

Fannie Mae Employees Keep Fat PayChecks at Taxpayers’ Expense

Earlier this week the Inspector General (IG) of the Federal Housing Finance Agency released a report documenting the current pay levels of mid-level executives at Fannie Mae and Freddie Mac, those mortgage giants which contributed to the financial crisis and have so far cost the taxpayer over $180 billion.   Despite the bail-outs, it seems the GSEs are still a comfortable place to work, all at the taxpayers’ expense.

This chart, reproduced from the IG report, illustrates that the GSEs’ over 300 Vice Presidents actually got paid more in 2011 than 2010, with a median compensation of $388,000.  Those poor directors, of which there are over 1,650, had to make due on a median compensation of only $205,300.  For running two companies into the ground, these executives seems pretty well paid to me.

One of the arguments against cutting pay at Fannie and Freddie is that all the good employees will leave, ultimately costing the taxpayer even more.  First I question whether we want the same people running these companies that ran them into the ground.  Shouldn’t we be cleaning house at Fannie and Freddie?  Secondly, voluntary employee attrition rates since the GSEs have been taken over aren’t all that much higher than before their bail-outs.  If anything these rates are too low.  Again given their role in the companies’ failures, we should encouraging long-time Fannie/Freddie employees to leave, not stay.

I have long proposed that since the taxpayer now outright owns Fannie and Freddie, their employees should be paid like federal government employees (who are already over-paid).   To continue to allow the same people who stuck the taxpayer with a $180 billion bill to be paid lavishly, is to add insult to injury.

Where’s All the TAG Bank Lending?

The Senate is poised to vote on extending FDIC’s Transaction Account Guarantee (TAG) program, which offers government deposit insurance for bank accounts over $250,000.  I’ve written elsewhere why this program is a big bank bailout that benefits mainly large account-holders.

I suspect the banks that are lobbying for an extension of TAG are offering all sorts of claims that not extending TAG would hurt the economy by reducing lending.  Unfortunately for those banks there is little evidence that TAG resulted in any new net lending.

Before TAG was created, federal depositories (banks and thrifts), held about $8.2 trillion in total deposits.  They also held about $7.6 trillion in net loans and leases.  This makes for a ratio of about 93%.  Today that ratio is just above 70% (see chart).  While deposits increased during the crisis, and after the creation of TAG, by over $2 trillion, net loans and leases actually fell in $7.4 trillion.  Whatever banks are doing with all these extra deposits, one thing they aren’t do is much new net lending.

For the most part banks are using TAG deposits to either play in the derivatives market (think JP’s London Whale) or to purchase large amounts of Treasuries and Fannie/Freddie securities.  We would be far better off if this lending flowed to businesses rather than government.  Banks have also used TAG to reduce their subordinated debt, further decreasing market discipline.

Much of TAG came at the expense of the money market mutual funds (MMMF).  One of the reasons for Treasury’s MMMF guarantee program was actually to off-set the impact of TAG.  Now that the (explicit) guarantee of MMMF is gone, we should end TAG.  Shifting funds from MMMF to TAG has also resulted in significant disruptions to the commercial paper market, furthering harming business investment.  We should start eliminating the various government guarantees of the banking system, starting with TAG.

It Is The Same Banks that Repeatedly Get in Trouble

When the December issue of the Journal of Finance landed on my desk, it was almost like Christmas had come early.   Among the articles was an interesting examination of banks which failed (or were rescued) during the recent financial crisis (for a non-pay-wall working paper version see here).  The authors set out to ask a simple question:  how well does the performance of individual banks in 1998 predict their performance in the recent crisis? 

Recall in 1998 Russia defaulted on some of its debts.  It was generally believed (erroneously) that nuclear powers did not default.  Market participants did not take the news well, with a resulting flight to quality and spike in lending spreads.  Then Treasury Secretary Robert Rubin called it “the worst financial crisis in the last 50 years” (sounds a little familiar).

While the authors find that other factors, such as leverage and reliance on short-term funding, were significant predictors of failure, 1998 performance predicted well which banks got in trouble this past crisis.  This effect is likely capturing a variety of bank specific characteristics, such a firm culture, risk tolerance and management style. 

One of the central debates about financial crises is to what extent are shocks contagious, like a disease that spreads from one bank to another, or rather do shocks, such as recessions, separate weak firms from strong firms?  If the former then broad-based Geithner-Bernanke style rescues might be appropriate.  If however failures are limited to weak firms, then rescues keep these weak firms, with their dysfunctional cultures around. 

The results of this paper suggest to me the importance of allowing firms to fail, rather than resorting to bailouts.  One of the fundamental problems of our current bank regulatory regime is that it is subject to its own flawed theory of intelligent design.  If only enlightened regulators are given sufficient power, they can design the best system.  I believe reality is quite different.  Only by allowing the evolutionary sorting of banks, and their firm cultures, can we improve the stability and efficiency of our financial system.

Tarullo: No Return to Glass-Steagall

Finally, a senior banking regulator has acknowledged the so-called repeal of Glass-Steagall had nothing to do with the 2008 financial crisis. In a recent speech, Fed governor Daniel Tarullo noted that most firms at the center of the financial crisis in 2008 were either stand-alone commercial banks or investment banks, and therefore would not have been affected by the repeal. Tarullo also expressed concern that a reinstatement of Glass-Steagall would be costly for banks and their clients and would result in less product diversification.

Of all the myths underpinning the response to the 2008 financial crisis, one of the most persistent is that the repeal of Glass-Steagall was a major contributing factor. So Tarullo’s comments are heartening. But still, he misses out one key piece of the puzzle, namely, that multifunctional, diversified financial firms are not just more efficient and cost-effective than their more specialized counterparts; they are frequently more stable.

The banks that got into trouble in 2008 did so because they concentrated their risk in one kind of asset. The firms that did comparatively well throughout the crisis avoided this particular mistake and were able to come to the rescue, admittedly with some government assistance, of their ailing counterparts—think Wells Fargo or JPMorgan. Firms fail when they make bad investment decisions, regardless of their structure.