Topic: Finance, Banking & Monetary Policy

Financial Deregulation? Don’t Bank on Brexit

On June 23, Britain voted by a margin of 52 to 48 percent to leave the European Union (EU). Much ink has already been spilled on the policy implications of that vote and, indeed, its long-run consequences may prove quite profound. When it comes to financial regulation, however, it is difficult to see any significant changes emerging in the short- to medium-term. There are a couple of fundamental reasons for this.

The first stems from the fact that the British financial sector is desperate to maintain its current access to the European Economic Area (EEA), also known as the “single market.” As things stand, a process known as “passporting” allows British financial firms to do business throughout the single market, whether on a cross-border basis or by establishing branches, without having to get separate regulatory approval in every jurisdiction. This arrangement is important to the industry and — given that financial services produce 8 percent of the UK’s output — the British government is likely to make its continuation after Brexit a priority.

But how can they bring that about? The most straightforward path is for Britain to leave the EU, but remain a member of the EEA. This approach, often referred to as the “Norway option,” would see Britain exit the EU’s centralized political institutions, while still participating fully in its “four freedoms” — that is, the free movement of goods, services, capital, and people. There is much to commend such a settlement, as I’ve written before. But if it did come to pass, Britain’s financial sector would clearly be subject to EU rules in much the same way as it is now.

There’s also a political problem with EEA membership: namely, it wouldn’t allow the British government to pursue its stated aim of controlling immigration from the EU. That suggests that the obvious alternative — a bilateral, post-Brexit trade treaty — might be the more likely outcome of Britain’s eventual withdrawal. Such a treaty could, theoretically, protect the British financial sector’s passporting rights. However, the quid pro quo for market access of that sort would undoubtedly be regulatory equivalence — that is, the European Commission would have to deem British regulation equivalent to EU rules before any passporting could take place. The handful of existing EU directives that provide “third country” financial firms access to the single market work in precisely this way. Ultimately, then, there are unlikely to be any major reforms to British financial regulation so long as the British financial services industry maintains access to the single market.

Paul Romer as Chief Economist of the World Bank Is Great News

Paul Romer becoming chief economist at the World Bank looks quite promising for economic development. 

In a 1990 explanation of new growth economics, Paul Romer and Robert Barro wrote, “If government taxes or distortions discourage the activity that generates growth, growth will be slower.” 

Speaking about the “Mauritian Miracle” at a 1992 World Bank conference, Romer emphasized that  “income and corporate tax rates were halved in 1983 (from about 70 to about 35 percent).” He also noted that free-trade zones allowed “unrestricted, tariff-free imports of machinery and materials, no restriction on ownership or repatriation of profits, [and] a ten-year income tax holiday for foreign investors.”  

Romer’s new growth economics should prove quite compatible with a timely rediscovery of the many global success stories with supply-side reductions in marginal tax rates and tariffs in the 1980s and 1990s in countries as diverse as Botswana, India, Chile, New Zealand, China, Ireland, Singapore, Mexico and more recently Turkey and Eastern Europe.  

A Monetary Policy Primer, Part 6: The Reserve-Deposit Multiplier

In my last post in this series, I observed that an economy’s “base” money serves as the “raw material” that commercial banks and other private-market financial intermediaries employ in “producing” deposits of various kinds that can themselves serve as means of exchange.

Multiplier2If they could do so profitably, these private intermediaries would, by making their substitutes more attractive than base money itself, collectively gain possession of every dollar of base money in existence. In some past monetary arrangements, most notably that of Scotland before 1845, banks came very close to achieving this ideal, thanks to the their freedom to supply their customers with circulating paper banknotes as well as with deposits, and to the fact that between them these two substitutes could serve every purpose coins might serve, and do so more conveniently than coins themselves.

All save a handful of commercial banks today are, in contrast, able to supply deposits only, so that only base money itself can serve as currency, that is, circulating money. The extent to which national money stocks have been “privatized,” in the sense of being made up mainly of private IOUs of various kinds rather than officially-supplied base money, has been correspondingly limited, as has the extent to which private money holdings have served as a source of funding for bank loans.

More Unconstitutional Executive Branch Actions

Imagine that your company’s board chairman, against the wishes of the board of directors and in contravention of the corporate charter, hires an interim CEO. Despite that illegal action, the interim CEO disciplines you in some manner. Would that discipline be any more legitimate if, two years later, the board finally agrees to hire the CEO, who then retroactively approved his own previous actions?

This is what’s happened at the highest levels of government. When Congress created the Consumer Financial Protection Bureau (CFPB) as part of the larger Dodd-Frank financial reform, it specified that the director was to be appointed by the president “by and with the advice and consent of the Senate.” This placed what’s called an Appointments Clause limitation on the director’s position. Four years ago, President Obama named Richard Cordray the CFPB director—after Elizabeth Warren’s expected appointment met significant political resistance—during what the president erroneously believed was a Senate recess. (You’ll recall that the Supreme Court unanimously invalidated the National Labor Relations Board appointments Obama made at the same time.)

“Boss” Aldrich and the Founding of the Fed

America’s Bank, Roger Lowenstein’s 2015 book on the founding of the Fed, is, as I said in reviewing it for Barron’s, both well-written and well-researched.  Few pertinent details of the story appear to have escaped Lowenstein’s notice. However, in assembling and interpreting these details, Lowenstein appears not to have entertained the slightest doubt that the Federal Reserve Act, for all the political maneuvering that led to it, was the best of all possible means for ending this nation’s periodic financial crises.

Instead of turning a critical eye toward the 1913 Act, Lowenstein writes as if history itself were a reliable judge.  What it has condemned he condemns as well; and what it has favored he favors.  Consequently he treats all those persons who contributed to the Federal Reserve Act’s passage as right-thinking progressives, while regarding those who favored other solutions to the nation’s currency and banking ills as so many reactionary bumpkins.

That some strains of triumphalism should have found their way into Lowenstein’s account of the Fed’s origins is hardly surprising.  Though research by economic historians and others supplies precious little support for it, the view that the Fed has been a smashing success is, after all, a well-established element of conventional wisdom, and one that Fed officials themselves never cease to promote.  Nor have those officials ever devoted more effort to doing so than in the course of celebrating the Fed’s recent centennial.  Even a much more hard-bitten journalist than Lowenstein could hardly have been expected to resist setting considerable store by an institution so universally (if undeservedly) hallowed.

Still, one might have expected a note of skepticism, if no more than that, to have found its way into America’s Bank.  Lowenstein was, after all, writing about an institution that was supposed to end U.S. financial crises once and for all, and doing so in the wake of a crisis at least as bad, in many respects, as those that inspired its creation.  (Those who suppose that the Fed did all it could and should have done to combat the recent cataclysm are encouraged to read this, this, this, and this.)  He had, furthermore, encountered the many arguments — and most were far from being plainly idiotic — of pre-1913 experts who favored other reforms, as well as those of some of the pending Federal Reserve Act’s critics, who predicted, correctly, that it wouldn’t be long before its results would acutely disappoint those of its champions who sincerely yearned for financial and economic stability.

Why Are Interest Rates So Low?

Since the financial crisis of 2007-09, and especially in recent months, Europe and the United States have seen zero and even slightly negative short-term nominal interest rates, and sub-zero risk-free real interest rates.  In June I participated in a conference on “Zero Interest Rate Policy and Economic Order” at the University of Leipzig, organized by Gunther Schnabl (U Leipzig), Ansgar Belke (U Duisburg-Essen), and Thomas Mayer(Fossback von Storch Research Institute).  The topic faced participants with the need to make a key judgment call: Are ultralow rates the new normal, i.e. are they long-run equilibrium rates determined by market fundamentals, or are they so low because of ultra-easy monetary policies and other policies?  In Wicksell’s terminology, is the real “natural rate” currently below zero, or are central banks holding market rates below the current natural rate? We cannot directly observe the natural rate, but we can look for indirect indicators.

GE Capital: Smaller Is Just Better

Earlier this week, the Financial Stability Oversight Council (FSOC) removed GE Capital from its list of systemically important financial institutions (or SIFIs).  How big a deal is this?  Big.  And not so big.  And a little bit scary.  Let’s back up a bit to see why.

FSOC is a new entity created by Dodd-Frank.  Its members are the heads of the federal financial agencies, with the Secretary of the Treasury serving as Chair.  In comparison to other similar bodies, which only advise the president, FSOC has broad authority to act.  Chief among its tools is the ability to designate an entity as a SIFI, and to impose stringent oversight and regulatory requirements on it thereafter. 

The SIFI designation and attendant oversight have been promoted as a means to end Too Big to Fail.  Many people, myself among them, have questioned how labeling entities as systemically important and putting them under greater oversight can possibly end Too Big to Fail.  Isn’t a SIFI designation essentially the same as slapping a big “TBTF” label on the thing?  Well, here’s where GE Capital’s story gets scary.