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China’s Central Bank is Becoming the Developing World’s “Payday Lender”

by Benn Steil and Elisabeth Harding October 22, 2024

With the developing world’s growing use of costly and opaque “payday loans” from China’s central bank, the IMF and World Bank need to demand far greater transparency from Beijing.

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Monetary Policy

Benchmarking the Fed’s Dual-Mandate Performance

The Fed has a dual mandate to pursue price stability and maximum employment. How should these be defined? In January, the Fed set itself a long-run inflation target of 2%, while in June the midpoint of Fed board members’ and Reserve Bank presidents’ long-run unemployment predictions was 5.6%. Our figure above shows actual inflation and unemployment performance relative to these targets going back to 2002. What stands out is the divergence that opens up, particularly on the unemployment front, after Lehman Brothers failed in September 2008. The sum of the deviations reached its peak in July 2009, as shown in the small box in the upper left of the figure. Though it has since declined fairly steadily, it is still well above zero – zero being a benchmark for fulfilling the combined mandate. This suggests that the Fed’s doves should continue to hold the upper hand. Federal Reserve: Objectives in Conducting Monetary Policy Federal Reserve: Longer-Run Goals and Policy Strategy Hilsenrath: Gauging the Triggers to Fed Action Mallaby: Show Some Real Audacity at the Fed

Blog Post by Greenberg Center for Geoeconomic Studies August 2, 2012 Geo-Graphics

Europe and Eurasia

More Evidence That LIBOR Is Hazardous to Economic Health

Central bankers necessarily spend a great deal of time studying economic and market data that they believe to be forward-looking indicators of the economy’s health. One such is the so-called “LIBOR-OIS spread” – the spread between the London Interbank Offered Rate (the rate at which major banks can supposedly borrow from each other, unsecured by collateral, for three months) and the Overnight Indexed Swap rate (which reflects market expectations of the overnight unsecured rate over a three-month period). LIBOR is generally higher than OIS because of liquidity and credit risk (the risk that the borrowing bank will default on a loan). European Central bank (ECB) board member Benoît Cœuré, echoing thoughts expressed by Alan Greenspan and others in the past, recently referred to the LIBOR-OIS spread as “a standard measure of tensions in unsecured markets.” It goes up when such tensions go up, and down when such tensions go down. The LIBOR-OIS spread can be low, however, even when banks are in appalling financial health. How is this possible? The problem starts when the government begins tracking such a measure to determine whether it needs to do something. The reason is that when statistical measures are targeted for policy purposes they tend to lose the information content that recommended them for that role in the first place. This common pitfall in economic policymaking has been termed “Goodhart’s Law,” having been first articulated by British economist and former Bank of England Monetary Policy Committee member Charles Goodhart back in 1975. Could Goodhart’s Law be at work with the LIBOR-OIS spread? We believe so. In March, after the ECB ended its Long-Term Refinancing Operations (LTRO), which provided banks with over €1 trillion in 3-year 1%-interest loans, the LIBOR-OIS spread continued the downward trend it started on after the program was launched last December – as shown in the main graphic above. By Cœuré’s logic, this indicated that LTRO had succeeded in addressing earlier worries about the ability of major European banks to attract vital funding. But look what happens to the price of 5-year credit default swaps (CDS) on the members of the LIBOR bank panel after LTRO ends – it soars. A huge, and highly unusual, gap opens up between the CDS price and the LIBOR-OIS spread. The small box in the upper left of the graphic shows that CDS prices and the LIBOR-OIS spread were highly correlated over the two years to the start of LTRO, but that this relationship collapses thereafter. This indicates that whereas banks are happy to lend to each other for three months, given that they’re now awash with ECB cash, the end of LTRO combined with a renewed deterioration of Spanish and Italian sovereign bond prices led to rapidly revived fears of bank defaults within 5 years. In other words, the LTRO policy intervention significantly reduced the information content of the LIBOR-OIS spread. CDS prices are now a more valid indicator of the health of the eurozone banking system – which is poor and deteriorating. Cœuré: The Importance of Money Markets St. Louis Fed: The LIBOR-OIS Spread as a Summary Indicator Financial Times: ECB Emergency Aid Is"No Silver Bullet" Chrystal and Mizen: Goodhart's Law—Its Origins, Meaning and Implications for Monetary Policy

Blog Post by Greenberg Center for Geoeconomic Studies July 16, 2012 Geo-Graphics

Europe and Eurasia

More Evidence That LIBOR Is Manipulated, and What It Means

Barclays’ admission that it deliberately understated the interest rates at which it could borrow between September 2007 and May 2009 suggests grievous flaws in the widespread process of using LIBOR (the London Inter-Bank Offered Rate) as a benchmark off which to price commercial loans, mortgages, and other forms of lending. Our figure above illustrates this by comparing LIBOR with so-called NYFR (ICAP’s New York Funding Rate), the operative difference between the two being that NYFR is based on anonymous reports from major banks. Normally LIBOR and NYFR are closely aligned, yet a huge gap opened up between the two rates in September 2008, at the time of the Lehman Brothers and AIG crises. During that month in particular, a bank revealing publicly that it could only borrow at elevated rates naturally put itself at risk of suffering a bank run or lending halt. It should not be at all surprising, therefore, that banks would be less honest about their rate reports when their names were attached to them. A Golden Rule of market practice and regulation should surely be never to trust prices – and certainly never to encourage actual transactions using such prices – when they are formulated not by supply and demand in competitive markets but according to what self-interested parties would like others to believe them to be. Financial News: Questioning LIBOR MacKenzie: What's in a Number? The Economist: Banksters Reuters: ICAP to Launch U.S. Rate Alternative to LIBOR

Blog Post by Greenberg Center for Geoeconomic Studies July 10, 2012 Geo-Graphics

Europe and Eurasia

"Iceland's Post-Crisis Miracle" Revisited

Back in July 2010, we produced a post examining the “Icelandic Post-Crisis Miracle,” as proclaimed by Paul Krugman. We showed that Krugman’s “miracle” was merely an artifact of comparing changes in Iceland’s real GDP with that of Estonia, Ireland, and Latvia since the strategically chosen 4th quarter of 2007. Why did Krugman choose the 4th quarter of 2007? Because starting with any other quarter would have ruined his story. Based on the GDP data available at the time he made his figure (which have since been revised), Iceland’s GDP had fallen a whopping 5 percentage points between Q3 and Q4. By starting his story in Q4 Krugman managed to lop that off, making Iceland look much better. We showed that the miracle story collapses as the starting date for the comparison is backed up. What we find is a simple story of large booms and busts in Estonia and Latvia, and much smaller booms and busts in Iceland and Ireland. Krugman’s post and our deconstruction are here and here. Recently, Krugman has produced a slew of new posts reviving his claims in different forms. Geo-Graphics readers have, not surprisingly, asked us to revisit the question of Iceland’s economic performance. Krugman produced this figure in a post on June 14, showing that as of the 1st quarter of 2012 Iceland had a better real GDP growth performance relative to its GDP peak than the three Baltic states (Latvia, Estonia, and Lithuania) and Ireland had relative to their various GDP peaks. “Looking at this,” Krugman asks rhetorically, “would you have expected that Latvia would be lionized as the hero of the crisis?” The answer is, of course, “no.” But Latvia only looks so bad because Krugman chooses to tell his story about post-crisis performance only in terms of how each country has performed since its peak. This makes little sense in the context of the IMF's 2009 staff report which concludes that Latvian "output exceeded potential by 9 percent" in 2007. (Updated 7/3/2012 2:04 p.m.) What if we decided to tell the story only in terms of how they have performed since their troughs – that is, how well they have recovered since they hit bottom? Here it is: We don’t yet have the Eurostat GDP data for Iceland in the first quarter of 2012, so we’ve plugged in data from the Icelandic government (as Krugman must have done). As can be seen, Iceland’s performance has only been on par with the bottom of the Baltic pack, Lithuania. Latvia’s performance has been better, and Estonia’s markedly better. Once again, Krugman has relied on a Potemkin-Village graphic to illustrate his wider claim, which is that Icelanders derive unambiguous net benefits from their government obliging them to hold and transact in a national currency that their trading partners will not accept. (80% of Greeks consistently reject going back to such a state.) Below we update the figure in our July 2010 Geo-Graphic, comparing Iceland’s economic performance with that of Estonia, Ireland, Latvia, and Lithuania going back to 2000. Iceland comes in tied for last with Ireland (for which 2012 Q1 data are not yet available) – well behind Lithuania, Estonia, and Latvia. Since 2009, those three have been growing strongly, while Iceland and Ireland have largely stagnated. Sorry, Virginia, there is no Icelandic miracle. Geo-Graphic: Post-Crisis Iceland: Miracle or Illusion? Krugman: Peripheral Performance Financial Times: Iceland: Recovery and Reconciliation Reuters: Baltic Countries' Austerity Lesson for Europe—Just Do It

Blog Post by Greenberg Center for Geoeconomic Studies July 2, 2012 Geo-Graphics

Monetary Policy

Gloomy Jobs Picture Is off the Fed’s Charts

When the Federal Reserve’s Open Markets Committee (FOMC) last met in April, the unemployment rate was on a declining path – having fallen to 8.2% in March from 9.1% the previous August. Against this backdrop, the Committee was modestly sanguine on prospects for job growth going forward. “The unemployment rate will decline gradually,” it predicted, “towards levels that it judges to be consistent with its dual mandate,” without need for new monetary stimulus measures. The two broken lines in the figure above show the upper and lower bounds of the “central tendency” of the Fed’s April unemployment forecasts – that is, the range of forecasts excluding the top and bottom three. The three dotted lines show the trend of the unemployment rate if the pace of the decline in the number of unemployed people in the three months prior to March, April, and May, respectively, were to continue. As can be seen by the May trend line at the top, the employment picture has clearly deteriorated since the FOMC met in April, and is above the most pessimistic of its “central tendency” forecasts. This suggests that there will be significant pressure from within the Committee for further easing when it meets this Tuesday and Wednesday, June 19 and 20. We believe this will take the form of extending “Operation Twist,” its program launched last September to push down long-term interest rates by buying long-term bonds using the proceeds of shorter-term bond sales. FOMC: April 2012 Meeting Statement Bloomberg: Fed Seen Twisting to Risk Management to Spur U.S. Growth The Economist: Shiny, New, Unopened & Unused Mallaby: The Fed and the ECB Should Be Trading Places

Blog Post by Greenberg Center for Geoeconomic Studies June 18, 2012 Geo-Graphics