The Changing of the Monetary Guard

Joseph E. Stiglitz

05 August 2013

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NEW YORKWith leadership transitions at many central banks either under way or coming soon, many of those who were partly responsible for creating the global economic crisis that erupted in 2008 – before taking strong action to prevent the worst – are departing to mixed reviews. The main question now is the extent to which those reviews will influence their successors’ behavior.
 
Many financial-market players are grateful for the regulatory laxity that allowed them to reap enormous profits before the crisis, and for the generous bailouts that helped them to recapitalize – and often to walk off with mega-bonuses – even as they brought the global economy to near-ruin. True, easy money did help to restore equity prices, but it might also have created new asset bubbles.

Meanwhile, GDP in many European countries remains markedly below pre-crisis levels. In the United States, despite GDP growth, most citizens are worse-off today than they were before the crisis, because income gains since then have gone almost entirely to those at the top.
 
In short, many central bankers who served in the heady pre-crisis years have much to answer for. Given their excessive belief in unfettered markets, they turned a blind eye to palpable abuses, including predatory lending, and denied the existence of an obvious bubble. Instead, central bankers focused single-mindedly on price stability, though the costs of somewhat higher inflation would have been miniscule compared to the havoc wrought by the financial excesses that they allowed, if not encouraged. The world has paid dearly for their lack of understanding of the risks of securitization, and, more broadly, their failure to focus on leverage and the shadow banking system.
 
Of course, not all central bankers are to blame. It was no accident that countries like Australia, Brazil, Canada, China, India, and Turkey avoided financial crisis; their central bankers had learned from experience – their own or others’ – that unfettered markets are not always efficient or self-regulating.
 
For example, when Malaysia’s central-bank governor supported the imposition of capital controls during the East Asian crisis of 1997-1998, the policy was scorned, but the former governor has since been vindicated. Malaysia had a shorter downturn, and emerged from the crisis with a smaller legacy of debt. Even the International Monetary Fund now recognizes that capital controls may be useful, especially in times of crisis.
 
Such lessons are most obviously relevant to the current competition to succeed Ben Bernanke as Chair of the US Federal Reserve Board, the world’s most powerful monetary authority.
 
The Fed has two main responsibilities: macro-level regulation aimed at ensuring full employment, output growth, and price and financial stability; and micro-level regulation aimed at financial markets. The two are intimately connected: micro-level regulation affects the supply and allocation of credit – a crucial determinant of macroeconomic activity. The Fed’s failure to fulfill its responsibilities for micro-level regulation has much to do with its failure to meet macro-level goals.
 
Any serious candidate for Fed chairman should understand the importance of good regulation and the need to return the US banking system to the business of providing credit, especially to ordinary Americans and small and medium-size businesses (that is, those who cannot raise money on capital markets).
 
Sound economic judgment and discretion are required as well, given the need to weigh the risks of alternative policies and the ease with which financial markets can be roiled. (That said, the US cannot afford a Fed chairman who is overly supportive of the financial sector and unwilling to regulate it.)
 
Given the certainty of divisions among officials on the relative importance of inflation and unemployment, a successful Fed chairman must also be able to work well with people of diverse perspectives. But the next leader of the Fed should be committed to ensuring that America’s unemployment rate falls below its current unacceptably high level; an unemployment rate of 7% – or even 6% – should not be viewed as inevitable.
 
Some people argue that what America needs most is a central banker who has “experiencedcrises firsthand. But what matters is not justbeing there” during a crisis, but showing good judgment in managing it.
 
Those in the US Treasury who were responsible for managing the East Asian crisis performed miserably, converting downturns into recessions and recessions into depressions. So, too, those responsible for managing the 2008 crisis cannot be credited with creating a robust, inclusive recovery. Botched efforts at mortgage restructuring, failure to restore credit to small and medium-size enterprises, and the mishandling of bank bailouts have all been well documented, as have major flaws in forecasting both output and unemployment as the economy went into free-fall.
 
Even more important for a central banker managing a crisis is a commitment to measures that make another crisis less likely. By contrast, a laissez-faire approach would make another crisis all but inevitable.
 
A top contender to succeed Bernanke is Fed Vice Chair Janet Yellen, one of my best students when I taught at Yale. She is an economist of great intellect, with a strong ability to forge consensus, and she has proved her mettle as Chair of the President’s Council of Economic Advisers, President of the San Francisco Fed, and in her current role.
 
Yellen brings to bear an understanding not just of financial markets and monetary policy, but also of labor marketswhich is essential in an era when unemployment and wage stagnation are primary concerns. (A classic article that she co-authored remains, many years later, on my list of required reading for Ph.D. students.)
 
Given the fragile economic recovery and the need for continuity in policyas well as for confidence in the Fed’s leadership and global cooperation based on mutual understanding and respectYellen’s steady hand is precisely what US policy making requires. President Barack Obama is supposed to appoint senior officials with the “advice and consent” of the US Senate. Roughly one-third of Democratic senators have reportedly written to Obama in support of Yellen. He should heed their counsel.
 
 
 
Joseph E. Stiglitz, a Nobel laureate in economics and University Professor at Columbia University, was Chairman of President Bill Clinton’s Council of Economic Advisers and served as Senior Vice President and Chief Economist of the World Bank. His most recent book is The Price of Inequality: How Today’s Divided Society Endangers our Future.


Did China Just Fire The First Salvo Towards A New Gold Standard?

by Tyler Durden

on 08/04/2013 22:19 -0400



In a somewhat shockingly blunt comment from the mouthpiece of Chinese officialdom, Yao Yudong of the PBoC's monetary policy committee has called for a new Bretton Woods system to strengthen the management of global liquidity. In an article in the China Securities Journal, Yao called for more power to the IMF as international copperation and supervision are needed. While comments seem somewhat barbed towards the rest of the world's currency devaluers, given China's growing physical gold demand and the fixed-exchange-rate peg that 'Bretton Woods' represents, and contrary to prevailing misconceptions that the SDR may be the currency of the future, China just may opt to have its own hard asset backed optionality for the future; suggesting the new 'bancor' would be the barbarous relic (or perhaps worse for the US, the Renminbi). Of course, the writing has been on the wall for China's push to end the dollar reserve supremacy for over two years as we have dutifully noted - since no 'world reserve currency' lasts forever.




Over the last two years, we have noted:
"China Takes Another Stab At The Dollar, Launches Currency Swap Line With France",
 
"BOE and the PBOC announced a currency swap",
 
"Australia And China will Enable Direct Currency Convertibility",
 
"World's Second (China) And Third Largest (Japan) Economies To Bypass Dollar, Engage In Direct Currency Trade",
 
"China, Russia Drop Dollar In Bilateral Trade",
 
"China And Iran To Bypass Dollar, Plan Oil Barter System",
 
"India and Japan sign new $15bn currency swap agreement",
 
"Iran, Russia Replace Dollar With Rial, Ruble in Trade, Fars Says", "India Joins Asian Dollar Exclusion Zone, Will Transact With Iran In Rupees", and
 
"The USD Trap Is Closing: Dollar Exclusion Zone Crosses The Pacific As Brazil Signs China Currency Swap"
 
As a reminder, we noted here:

The question why China has been scrambling to internationalize the CNY has nothing to do with succumbing to Western demands at reflating its currency to appreciate it and thus to push its current account even lower in the country with the shallowest stock market and the most bank deposits (i.e., most prone to sudden, abrupt bursts of inflation), nearly double those of the US, and everything to do with preparing the world for the "final monetarism frontier", which will take place when the BOJ's reflation experiment fails, and last remaining source (at least before Africa, but that is the topic for another day) of credit formation - the PBOC - finally ramps up.

As we pointed out a few days ago when we discussed the accelerating Chinese credit impulse and its soaring 240% debt-to-GDP ratio:
 
What should become obvious is that in order to maintain its unprecedented (if declining) growth rate, China has to inject ever greater amounts of credit into its economy, amounts which will push its total credit pile ever higher into the stratosphere, until one day it pulls a Europe and finds itself in a situation where there are no further encumberable assets (for secured loans), and where ever-deteriorating cash flows are no longer sufficient to satisfy the interest payments on unsecured debt, leading to what the Chinese government has been desperate to avoid: mass corporate defaults.



At that point it will be up to the PBOC to do what the Fed, the ECB, the BOE and the BOJ have been doing: remove any pretense of money creation via the commercial bank complex (even if these are merely glorified government-controlled entities), and proceed to outright monetization of de novo created assets, thus flooding the system with as much money as is needed to preserve the illusion of growth. Naturally, with the Chinese stock market having proven itself to be a horrible inflation trap (and as a result the bulk of new levered money creation goes into real estate), the inflation explosion that would result would be epic.

And that, in a nutshell, is the reason why China is doing all it can to prepare for the moment when capital flows will soar once the PBOC no longer has the option to extend and pretend its moment of entry into the global reflation race. Yes, it will be caught between a rock (hyperinflation) and a hard place (a very hard crash landing), but the fact that neither of those outcomes has a happy ending will hardly stop the PBOC from at least preserving the alternative. That alternative will of course be to be ready and able to hit the switch when the BOJ's printer burns out, and someone else has to step in and fill its shoes in the global "money creation" strategy, which sadly is the only one the world has left.

Finally, the question then will be not if, or how long, the US Dollar will remain the world's reserve currency, when even the Developed world is forced to admit the PBOC's monetarist primacy over the Fed, but just how much unencumbered gold one has to hedge against what will be the final, global bout of hyperinflation, the one spurred by every single DM and EM central bank is forced to print for dear fiat status quo life, or else.


August 4, 2013 4:17 pm

 
Oil markets: The danger of distortion
 
Governments are deliberating whether to impose more supervision, writes Ajay Makan
 
Curved pipes in oil field©Alamy
Warped system: oil prices are notoriously hard to track and some companies do not co-operate with the price reporters
 As Opec ministers gathered in Vienna in May to discuss the oil market, one man stood out. On the terraces and in the lobbies of the grand hotels favoured by members of the oil producers’ cartel, Jorge Montepeque was holding court.
 
A Guatemalan-born US citizen with a fiery temper and sharp tongue, Mr Montepeque is the architect of the system that now underpins global trade in oil. In Vienna he was his ebullient self, stopping at tables to swap gossip between meetings. But for Mr Montepeque this was no normal Opec gathering.

Two weeks earlier the European Commission had swooped on offices across Europe in pursuit of any evidence of price fixing in oil markets. Along with the oil majors BP, Royal Dutch Shell and Statoil, and the Dutch trader Argos Energies, officials raided the Canary Wharf headquarters of Platts – the price reporting agency where Mr Montepeque has worked for decades.
 

The raids earned the oil market comparisons with Libor, the discredited interest rate rigged by some of the world’s biggest banks for years. They came as governments were already weighing direct supervision of the unregulated trade in physical oil. And they have added to fears among some participants that the market is only likely to become more opaque, if traders stop co-operating with price reporting agencies.

Platts, a relatively small cog in New York-listed McGraw-Hill Financial, proudly calls itself an organisation of journalists. Yet Platts has more importance to the giant energy companies, trading houses and investment banks that trade oil than any other media organisation.

Platts reporters monitor bids and offers for products from the blends that make up Dated Brent – the international crude benchmark – to jet fuel. Each day they publish prices or “assessments” that are used by traders to price oil deals worldwide.
 
A Platts assessment underpins the Brent futures market, used by airlines to protect against price moves and by hedge funds to speculate; the British government uses Platts assessments to calculate taxes on oil producers; and ultimately Platts’ prices play a part in the cost of petrol at the pump.

Traders say that gives Mr Montepeque great power.

“You need to have a dialogue with Jorge. If you don’t, he could keep you out [of the oil market] forever,” says an executive at a large Swiss-based commodity trading house.

Platts executives, who responded on his behalf, acknowledge Mr Montepeque’s outsize profile but play down his actual power: “No one would deny that Jorge is a big personality in the oil market but decisions do not rest with one person,” says Dan Tanz, head of editorial.

Prices in the oil market are notoriously difficult to track. Trade is fragmented into hundreds of different blends of crude oil and regional markets for refined products, such as petrol and diesel.

Individual reporters at companies such as Platts are responsible for assessing many thinly traded markets at the same time. Traders can choose which transactions to report and, with billions of dollars at stake, there is a strong incentive to fix prices.

“The game of having a leveraged position in the futures market and then trying to change the Platts price by a few cents is as old as the market itself,” says one trader.

Some companies do not co-operate with price reporters at all. If no transactions take place in a market on a given day reporters have to estimate prices based on quotes, introducing a subjectivity to the process that is unpopular with regulators after Libor.

Mr Montepeque is credited with bringing order to a market that had previously relied even more on judgment. He designed what is known as the “Platts window” in Singapore in the 1990s, before introducing it to the European and US markets.

As global director for market reporting in London, Mr Montepeque continues to oversee and fine tune the methodology and, with colleagues, reviews applications from traders wishing to submit prices.

In the window – a tightly controlled 30-minute period at the end of the dayauthorised companies electronically submit bids and offers to Platts reporters. If those bids are met, a company has to trade. Platts is free to publish all data.

“Let’s be clear – the window is more rigorous, more transparent and more accurate than what went before,” says one veteran trader, who is otherwise critical of Mr Montepeque.

But Mr Montepeque’s system is now at the centre of a European Commission competition probe. Pannonia Ethanol, a Hungarian company, has complained that it was denied access to the window for ethanol trading, and at least two of the raids focused on ethanol market records, according to people familiar with the situation.

Platts declines to say why Pannonia was refused entry to the window but says the application process is clear-cut and clearly communicated to candidates. Companies already active in the window would have been consulted on whether Pannonia had a record of trading ethanol, but traders cannot veto new entrants.

. . .

In addition to examining access, investigators are looking for evidence of price rigging. This might involve attempts to move a price up or down by just a few cents, for example, by submitting unrealistic bids or offers or concluding transactions away from the prevailing price. Platts says its price reporters disregard prices unrepresentative of the market, making it hard for contributors to manipulate its assessments.

Still, regulators’ scrutiny of the physical oil market has been growing ever since oil prices hit record levels in 2008. The Commisison investigation has also drawn the glare of the press.

Under instruction from the G20, Iosco, an umbrella body of market regulators, published a code of conduct for oil-price reporting agencies last year. Companies such as Platts are now undergoing their first external audits by accountants.

The European Commission is working on separate proposals, which are set to be far more radical. A draft leaked in June would make both traders that submit quotes and the reporters that publish them legally liable for any losses in derivative markets resulting from incorrect prices. The formal proposal is expected in September.

All this is forcing price reporters to change. Platts will soon publish requirements for access to the window for the first time.

Platts has become much more process-oriented and we recognise the need to evidence that to our stakeholders, including regulators,” says Mr Tanz.

Trading oil is not for the faint-hearted. Single companies may be responsible for selling the entire output of a single country. The resulting power and wealth breeds confidence.

Price reporters have a certain swagger, describing how their window allows complex markets to operate.

Unlike virtually every other commodity market, it is simply not possible to create a standardised trading environment for physical oil,” says Dave Ernsberger, the global director of Platts’ oil business who was brought in to temper Mr Montepeque’s abrupt style.

A common gripe among traders is that there is no way to appeal when they disagree with a published Platts’ Price. The same goes for Platts’ ability to exclude a party from the window in a process known as “boxing”. Boxing cannot only impair a trader’s ability to transact in a given market – as some counterparties prefer to trade within the window to influence prices – it can also raise questions about a company’s solvency.

At the height of the financial crisis Platts restricted the access of both Goldman Sachs and Morgan Stanley to the window, with Mr Montepeque arguing that oil companies did not want to trade with banks. The move added to concerns about the banks’ creditworthiness when they were already under huge pressure.
 
Traders can appeal against decisions but Platts’ compliance department only checks processes have been followed – its role is not to overturn decisions. Under pressure from Iosco, Platts will hand this compliance role to an external body by the end of the year. But many traders want a body that can overturn decisions.

“We want these [price reporters] to feel some kind of needle in their back, that somebody’s watching them, so they cannot do anything they want. These are private companies, they are unregulated, they are people who do not have to give an account to anybody of what they do,” says an executive at one energy company.


. . .

According to price reporters, the availability of oil prices itself is now at stake. In a document circulated among regulators in Brussels, a rival of Platts argues that traders will stop sharing quotes if the European Commission draft proposals are enforced.

Physical energy market participants would instead opt to trade privately ... that would mean a return to opacity in oil and other energy markets,” says London-based Argus.

In the absence of accurate physical prices, derivative markets would also be compromised, making it harder to hedge against price moves effectively.

An executive at a Swiss-based trading house says: “[Legal liability] would make people more cautious about submitting data and that would mean the prices you get are not the most accurate representation.”

Even rival regulators are cautious about Brussels’ approach. Alp Eroglu, who is leading Iosco’s reform process, said shortly after the Commisison raids on oil companies and Platts: “As regulators you need to punch but not kill. A big concern is that people will stop participating [in the window].”

The threat to the system can be overstated. The Commission may row back from its more radical ideas when it publishes its formal proposals in September. Any regulation would then have to be passed by the European parliament.

The Platts window has also proved remarkably resilient to the barrage of negative publicity. Co-operation with price reporters is the only way companies have of influencing published prices and that is something traders say they will not give up lightly.

Many oil producers also remain committed to the price-reporting model. Assessments directly influence government revenues in countries such as Saudi Arabia and Kuwait, which sell much of their output at prices derived from assessments by Platts or Argus.

In Vienna officials from Gulf states said they had no intention of changing the way they price exports. Some suggest regulators should keep out of the physical oil market altogether.

When Iosco published a report last year, Saudi Aramco shot back: “Lack of understanding permeates the document ... It appears [to] have been drafted by financial market regulators who have no genuine understanding of physical commodity markets.”

But for Mr Montepeque, these are trying times. Having resisted the attempts of energy companies, commodity traders and the governments of oil producers to limit his role in the oil market for more than a decade, it may be government action – and public opinion – that proves decisive.


Rate rigging: Libor comparisons go only so far


For politicians and pundits, comparisons between the alleged manipulation of oil prices and the rigging of interbank lending rates have proved irresistible.

“This problem has similarities with the benchmarks in the financial sector and with the investigations we are carrying out on Libor,” Joaquin Almunia, the EU competition commissioner, said after he ordered raids on oil majors and Platts in May.

Like Libor, which three of the world’s largest banks have admitted to rigging for several years, oil prices published by companies such as Platts are often based on quotes, rather than actual transactions.

And, as in the Libor scandal, regulators have targeted some of the most famous companies in the world. For Barclays and Royal Bank of Scotland, read BP and Shell.
 
But there, argue many in the energy industry, the similarities end.

Whereas banks’ Libor submissions did not represent commitments to lend or borrow, oil traders are required to transact if any bids or offers they submit to Platts meet willing buyers or sellers. That should discourage participants from submitting outrageous quotes in an effort to influence prices.

Another difference lies in the role of the price reporter. The British Bankers’ Association, which published Libor rates, took a trimmed average of submissions which was supposed to knock out off-market bids. Commodity price reporters portray this method as formulaic and say their reporters are instructed to actively consider whether every bid or offer represents the market.

Platts executives argue this distinction is crucial, and that it means oil prices are far less prone to manipulation than financial benchmarks.

Absent judgment you are left with a mechanical system which takes you into the world of Libor,” says Dan Tanz, vice-president for editorial at Platts, in an explicit rejection of the comparison that has infuriated many in the industry.

Whatever their differences, however, the energy and finance industries do now face a common challenge: finding a transaction-based method for assessing benchmarks, which will satisfy regulators’ demands for transparency in the aftermath of the financial crisis.

 
Copyright The Financial Times Limited 2013.