Roubini Interview and Dollar Seigniorage

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The Temptation Of Dollar Seigniorage

Written By:  Kosuke Takahashi

From: Asiatimes

TOKYO – As the United States seeks to finance its ballooning budget deficits by printing more US dollar bills, Japanese economists are increasingly concerned that the excessive use of dollar seigniorage by US financial authorities will further shake confidence in the US currency at a time when the world lacks an alternative globally accepted currency.

The US government projects that even without the forthcoming US$825 billion fiscal stimulus package, the national budget deficit to September 2009 will be $1.19 trillion, the biggest since World War II, or 8.3% of gross domestic product (GDP). This amount is likely to grow as the US government continues to rescue failed parts of the economy. How will the US cope with its enormous and growing debt obligations?

Therein lies the issue of the dollar’s international seigniorage as a savior for the US national interest.

Seigniorage is the revenue that a government raises by printing money. Suppose it costs one dollar to print a US$100 bill. As long as the world deems this bill worth $100, the US government receives the revenue of $99 every time it prints out a $100 bill (the difference being an approximation of the costs related to producing the bills) and circulates it to the markets at home and overseas. This is a perquisite of the US under the present world currency system. Neither Europe nor Japan, among other major economies, can enjoy the benefits of seigniorage globally because the euro and the yen have not become international settlement currencies.

“The US is the only nation in the world, as the key currency nation, to have privileges to earn huge seigniorage,” Iwao Nakatani, a renowned economist in Tokyo, wrote in his recent best-selling book Why did capitalism self-destruct?, which is sparking a debate in Tokyo, the financial center of the world’s second-biggest economy, over United States-led global capitalism.

“If the FRB [Federal Reserve Board] or the US government issues dollar bills and spreads them abroad, that’s sufficient to earn enormous seigniorage – as long as people around the world see the dollar’s value as stable,” he wrote.

In the book, Harvard-educated Nakatani made a “confession” by saying he had been doing the wrong thing, surprising many Japanese by indicating that what he had learned in the US had proved harmful to Japanese society. The easing of regulations and the liberalization of markets in Japan had brought about an American-style widening disparity between Japan’s haves and have-nots and an accumulated discrepancy between society’s winners and losers, he pointed out.

Nakatani had been an ardent advocate of globalization and national structural reforms since the early 1990s under the Morihiro Hosokawa and Keizo Obuchi administrations. Nakatani’s strong support of global capitalism later influenced reform policies conducted by popular former prime minister Junichiro Koizumi, a symbol of Japan’s reformist policy, from 2001 to 2006.

Bernanke’s views on seigniorage

It’s intriguing to note what Federal Reserve chairman Ben Bernanke, then Princeton University economics professor, said about seigniorage. He wrote in his Macroeconomics textbook, co-authored with Andrew Abel, that the government can print money when it cannot (or does not want to) finance all of its spending by taxes or borrowing from the public. In the extreme case, imagine a government wants to spend $10 billion (say, on submarines) but has no ability to tax or borrow from the public. One option is for the government to print $10 billion worth of currency and use this currency to pay for the submarines.

If you replace the word “submarines” with “bailout funds”, that will mirror the present US situation.

Bernanke and Abel continue: “Governments that want to finance their deficits through seigniorage do not simply print money but use an indirect procedure. First, the Treasury authorizes government borrowing equal to the amount of the budget deficit, and a correspondent quantity of new government bonds are printed and sold. However, the new government bonds are not sold to the public. Instead, the Treasury asks (or requires) the central bank to purchase the $10 billion in new bonds. The central bank pays for its purchase of new bonds by printing $10 billion in new currency, which it gives to the Treasury in exchange for the bonds.”

This is what the Bernanke Fed is thinking of doing in the coming months and years. It has already snatched up a big chunk of soured mortgage-backed securities guaranteed by beleaguered mortgage-guarantors Fannie Mae and Freddie Mac. Bernanke has also said the Fed may buy “longer-term Treasury or agency securities on the open market in substantial quantities”, using the Fed’s balance sheet and money-creation authority to aid the ailing US economy.

The latest Fed data showed the monetary base jumped to more than $1.7 trillion this month, more than double from around $840 billion in August – a vertical takeoff in the supply of dollars.

Temptation of seigniorage

The US economy has benefited from seigniorage by printing dollar bills to finance a huge current-account deficit, for which the trade imbalance is by far the greatest reason. This enabled Washington to take its expansionary monetary and fiscal policy amid ballooning debts.

Unlike Japan, China and Europe, among other nations, the US did not have to tap the market of its own goods and services desperately. Simply put, by just printing money, it could get whatever it wanted from abroad, even without any cash on hand. Instead, the spread of the US debt bubble overseas enhanced the networking power of dollar hegemony, which in return boosted the power of dollar seigniorage. This is all debt-forgiveness resulting from the dollar key-currency system.

“Should the US Federal Reserve have properly managed money supply, being conscious of the role of the world’s central bank, today’s financial crash should have avoided,” Nakatani wrote. “But in reality, Alan Greenspan, who had served as Fed chairman for a long time, gave top priority to economic upturn and accommodated the housing bubble. The dollar’s oversupply continued. This is the root cause of today’s financial crisis.”

The US dollar has strengthened against other major currencies, with the notable exception of the yen, in the past months, even as the country has been at the epicenter of the deepening financial crisis. Many currency analysts see risk reduction among investors causing the money that US financial firms had invested in the world to be repatriated to the homeland, triggering dollar-buying.

But that dollar strength may not last. Once people around the world start to think an excessive dollar supply will diminish the value of the currency, they may start selling dollar-denominated assets all at once, causing devastating damage to the world economy. This is why world leaders such as Japan’s Prime Minister Taro Aso have repeatedly expressed support of the dollar in the international financial system, easing people’s lingering concern over the greenback.

Early signs of the worst scenario for the US are already beginning to show. International demand for long-term US financial assets fell in November as foreign investors sold Treasury, agency and corporate debt, a government report showed on January 16. Net selling of all long-term assets in November was the most since August 2007, as investors sold bonds issued by Fannie Mae, Freddie Mac and other government-sponsored enterprises for a fourth month in the past five.

“For the moment, governments around the world are supporting the dollar key-currency system,” said Masaki Fukui, senior market economist in Tokyo at Mizuho Corporate Bank Ltd, a unit of Japan’s second-largest financial group by market value. “But there is still a deep-seated structural problem, causing some concern. We can never say a dollar crisis won’t come.”

When risk aversion begins to abate, as will happen at some point, the Fed needs to act quickly to drain excessive dollar supply, or money supply. Otherwise, the dollar will be doomed and hyperinflation and economic bubbles will occur once again, which could lead to a recurrence of the global financial crisis.

Should the US give in to the temptation of dollar seigniorage, as it has done in the past, loosening money to feed debt bubbles, investors are well advised to diversify their currency positions to hedge against dollar risk. This could be yet another catalyst for undermining dollar hegemony, which the US for sure does not want to see happen.

Kosuke Takahashi is a Tokyo-based journalist.

Is the U.K. an Iceland 2? No but there are serious financing risks ahead. Also: BBC News TV and Radio Interviews.

Written By: Nouriel Roubini

From: RGE Monitor

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I am in London for a few days and I was recently interviewed by BBC News TV and Radio about the state of the U.S., U.K. and global economy (links to these interviews are below in this piece). While in London I was repeatedly asked by media and financial sector folks whether the UK was an Iceland 2, i.e. whether it would end up having an insolvent government and country. The statements this week the by famed investor Jim Rogers – that the UK was essentially kaput and that investors should dump UK assets and the pound sterling – were widely reported here in the UK and caused a stir at the time when the economy was officially declared in a recession, when the pound is falling, when most UK banks look as insolvent as their US counterparts and when some people are starting to wonder whether the UK may need to go and beg the IMF for a bailout.  Indeed most UK banks will be formally or informally nationalized with a significant fiscal cost of their bailout at the time when the fiscal deficit will surge because of a severe recession.

So what is the risk that the UK will be Iceland 2? Let us discuss next this issue in more detail:

In many ways the UK looks more like the US than Iceland: a housing and mortgage boom that got out of control; excessive borrowing (mortgage debt, credit cards, auto loans, etc.) and low savings by households; a large and rising current account deficit driven by the consumption boom (and private savings fall) and the real estate investment boom; an overvalued exchange rate; an over-bloated financial system that took excessive risks; a light-touch regulation and supervision system that failed to control the financial excesses; and now an ugly financial and economic crisis as the housing and credit boom turns into a bust. This will be the worst financial crisis and recession in the UK in the last few decades.

Iceland had the same macro and financial imbalances as the US and the UK but the Icelandic banks were both too big to fail and too big to be saved as their losses were much larger than the government capacity to bail them out. Thus, in Iceland you have a solvency crisis for the banks, for the government and for the country too leading to a currency crisis, systemic banking crisis and near sovereign debt crisis.

The US has also a busted banking system and an insolvent household sector (or part of it) but so far the sovereign has the willingness and ability to socialize such private losses via a vast increase in public debt.

This week in the UK investors started to worry that the UK government looks more like the Iceland one than the US: having banks that are too big to be saved given the fiscal/financial resources of the country.

But in principle the UK looks more like the US: the public debt to GDP is relatively low (in the 40s % range) and thus the sovereign should be able to absorb fiscal bailout costs and additional fiscal stimulus costs that may eventually increase that debt ratio by as high as 20% of GDP. Note that during WWII the UK public debt to GDP ratio peaked well above 150% and the UK government remained solvent.

But while even a huge fiscal bill of a bailout of the economy and of financial markets is in principle sustainable the UK government may soon face problems of financeability – rather than long-term solvency – of such larger deficits. Suppose investors worry about such solvency and start dumping pounds at an even faster rate, then: some government debt auctions may fail, spreads on UK government bonds may start rising sharply, the government may be eventually downgraded by the rating agencies, the expected capital losses from a pound depreciation may lead foreign investors to shun UK government bonds because of worries about losses from a weaker pound, and this vicious circle may eventually lead to a sharp increase in the cost of financing the large fiscal deficits and fiscal bailout costs and a sharp reduction in the willingness of domestic and foreign investors to finance such deficits.

Then, even if technically the UK government is solvent, near insolvency may be triggered by a financeability problem, i.e. the unwillingness of investors to increase their holdings of UK government debt and their failure to roll over debt coming to maturity. So an illiquidity crisis may eventually trigger a near insolvency crisis.

The problem is aggravated by the fact that most UK banks are not only near insolvent but they also have a significant amount of foreign currency liabilities whose real value is increased by the ongoing real depreciation of the British pound. It is true that those liabilities are in part matched by foreign currency assets (given the financial intermediation role that UK banks play). But some of those assets are not liquid and some of those assets have lost their market value because of the slaughter in global equity and credit markets.

So one cannot totally rule out the risk of a run on the cross-border uninsured liabilities of the banking system. And short of a credible government guarantee of all deposits/liabilities of the UK banking system one could not totally rule out the risk of a cross-border run on such liabilities. A run on domestic currency deposits can be managed by the Bank of England lender of last resort provision of pound liquidity; but a run on foreign currency liabilities of banks (well beyond their foreign currency liquid assets) could not be similarly resolved given the limited foreign currency reserves of the Bank of England and given the fact that the pound is less of an international reserve currency than the US dollar is.

Thus, the UK government faces massive risks: only a coherent and credible economic and financial rescue program can prevent a more severe financial crisis. The IMF would not even have enough resources to save the UK if a banking or sovereign liquidity/financing crisis occurs.  The UK can rely on increased dollar liquidity from swap lines with the Fed to cover the rollover risk of UK banks and allowed them to match US dollar liabilities with US dollar liquidity.  But the scale of such swap lines (effectively the US Fed playing the part of the IMF’s international lender of last resort) would have to be massively increased if a rollover crisis on UK cross-border liabilities were to occur.

So, at best, the UK faces an economic and financial crisis that will be as bad as the US one: a severe and protracted recession that could last two years with very weak growth recovery once it is over; a near insolvent financial system, most of which will be formally or informally nationalized; a large fiscal costs of budget deficits surging because of the recession and the bailout of financial institutions; a weakening currency that may risk a hard landing if the crisis is not properly managed.  A more dramatic run on the cross-border liabilities of banks, a run on the government debt and a hard landing of the pound can be prevented by coherent and forceful policy action.

A credible and consistent economic plan requires: very easy and unorthodox monetary policy (zero policy rates, quantitative easing and other unorthodox programs to thaw money markets and credit markets); a fiscal stimulus package that combines near-term easing with commitment to fiscal discipline over the medium terms; a coherent plan to clean up the financial system (triage between solvent and insolvent banks; takeover and workout of insolvent ones; recapitalization and clean-up of solvent ones with separation of good and bad asset and conversion of unsecured bank debt into equity to reduce the fiscal costs of the bailout); a plan to reduce the debt burden of the part of the household sector that is insolvent; a plan to stop a free fall of the housing market and of home prices including foreclosure forbearance.

This is the same set of policy challenges that the US faces. A coherent plan can ensure that the outcome is closer to the US (a still nasty and protracted economic and financial crisis, but one short of insolvency) rather than outright insolvency of the entire banking system, of the government and of the country as in the case of Iceland.

Here is my interview with BBC News’s TV Stephanie Flanders

Warning of ’severe and protracted’ recession

A professor of economics at the Stern School of Business at New York University has warned of ”a severe and protracted recession” in the UK.

Gross domestic product in Britain fell by 1.5% in the last three months of 2008 after a 0.6% drop in the previous quarter.

Professor Nouriel Roubini told the BBC’s Stephanie Flanders there were difficult times ahead.

Here is another clip of the interview with BBC News TV

Nouriel Roubini on recession Stephanie Flanders talks to New York University professor Nouriel Roubini on BBC World News

Here is the BBC Radio interview

The UK is expected to receive its worst output figures since 1990 later – and official confirmation the country is in a recession. Nouriel Roubini, professor of economics at the Stern School of Business at New York University, discusses fears about the fate of the economy.

Norman Finkelstein On The Atrocities Commited In Gaza

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