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Buiter has concerns other than Dubai, warns of sovereign debt delusion

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By Edward Harrison of Credit Writedowns

Willem Buiter has just taken on a new role at Citi. The news of Willem Buiter’s role as Chief Economist at Citigroup comes via DealBook at the New York Times below. Afterward, I have some comments about Dubai contextualizing Yves’ recent post detailing a reluctance by the government to backstop Dubai World – something Buiter warns against.

Citigroup said on Monday that it has hired Willem Buiter, a professor at the London School of Economics, as its chief economist, effective January 2010.

Mr. Buiter will replace Lewis Alexander in Citi’s top economics post, in which he will head the firm’s economics research unit and join the management team of Citigroup’s Citi Investment Analysis and Research group.

“We are delighted that we have been able to attract a thought leader of Willem’s experience and track record to our global platform,” Andrew Pitt, the global head of Citi Investment Research & Analysis, said in a statement.

Currently a professor of political economy at the L.S.E., a well-known economics commentator and blogger and a consultant to Goldman Sachs, Mr. Buiter previously held posts at the European Bank for Reconstruction & Development and the Monetary Policy Committee of the Bank of New England.

“As one of the world’s most distinguished macroeconomists, Willem’s deep knowledge of global markets and economies, and emerging markets economies in particular, will be invaluable to our clients,” Hamid Biglari, Citi vice chairman, said in a statement.

I see this as a huge positive for Citi because it demonstrates that Citi is looking for fresh perspectives outside the mainstream. Buiter has been one of the finance bloggers most vocal in decrying the policies adopted before and during the panic in the global financial system.

Buiter correctly anticipated the potential for collapse in the Icelandic banking system. Since then he has warned other small open countries like Ireland and Dubai not to follow in Iceland’s footsteps in providing sweeping government backstops to bankrupt troubled institutions. This is what he terms the sovereign debt delusion (see “Too big to rescue” for more on this).

His most recent blog entry pointed out the relative insignificance of Dubai in the global system but it warns of the potential for sovereign default –especially in the Eurozone. He agrees with Credit Writedowns’ assertion that the US and the UK, as sovereigns that hold debt in their own currencies, are likely to try the inflationary route to mitigate the mounting debt burdens (see “Inflation: The strategy that dare not state its name”).

The massive build-up of sovereign debt as a result of the financial crisis and especially as a result of the severe contraction that followed the crisis, makes it all but inevitable that the final chapter of the crisis and its aftermath will involve sovereign default, perhaps dressed up as sovereign debt restructuring or even debt deferral. The Dubai World and Nakheel debt standstill and possible default is of systemic significance only because it may well be a harbinger of future sovereign financial distress, in Dubai and elsewhere.

From Dubai to Iceland, Ireland, Greece, Hungary, Italy, Portugal, Spain, Japan, France, the UK and the USA, the sovereign debt burdens have been at current levels during peacetime only on the way down from even higher public debt burdens incurred during wars.  Watching the public debt to GDP ratios rise to levels likely to reach or exceed 100 percent of GDP by 2014 is deeply worrying, especially with structural primary (non-interest) deficits as high as they are.  The political economy of fiscal burden sharing, inside nations and between nations, will be a major field of enquiry for economists and political scientists during the years to come. I am pessimistic in that regard about countries characterised by deep polarisation and political gridlock.  This includes nations as different as Greece and the USA.

It is clear that nations whose public debt is mainly denominated in domestic currency and whose central bank is either not very independent or can be make dependent by the government of the day are likely to choose inflation and exchange rate depreciation over default as a way out of fiscal-financial unsustainability.  That category would include the USA and, to a lesser extent, the UK.  Because the ECB faces 16 national governments and national ministries of finance, the power and independence of the ECB are much greater vis-a-vis any Euro Area member state than the power and independence of any central bank facing a single national government and Treasury.  That is regardless of the formal independence criteria laid down in laws, treaties or constitutions.

The practical implication of this is that the ECB will not monetise the government debt and deficits of small European Area member states.  Only Germany can really push the ECB around, partly for historical reasons, partly because it is the largest and most powerful Euro Area and EU member state and partly because of the geographic reality that the ECB is on its territory – in the final analysis the German government can order a siege of the Eurotower …

For small peripheral European nations, the threat of sovereign insolvency is therefore a real one, unless EU fiscal solidarity can be relied upon to bail them out.  When Ireland was about to be swept away by a wave of global financial mistrust triggered by the Irish government’s decision to guarantee effectively all liabilities of its banks, the then German Finance Minister Steinbruck made the amazing statement (which he obviously had not checked with his coalition partners, his Chancellor or his voters) that the Eurozone countries would not let one of their own go into default.

The year that has passed since then has made this implicit commitment to a Eurozone, let alone an EU cross-border sovereign bail-out rather less credible.  All EU sovereigns are, to varying degrees, in fiscal dire straits.  We may well see in the next few years the first sovereign default by an old EU15 country since Germany defaulted on its debt in 1948.  If the travails of Dubai wake us up to that possibility, they will have done some good.  Sovereign defaults are not acts of God.  They are the result of choices.  If we continue to play the political game in a business-as-usual mode, there could be quite widespread sovereign debt restructuring throughout the advanced industrial world.  If we grow up, we can avoid the worst.

I agree with Buiter’s sentiments. The best post I wrote on this topic was in February called “The European problem.” Despite asset market increases, the situation remains critical. Ireland, Greece, Spain, and Portugal are the clearest examples of countries which are storing up major trouble – and without the currency escape hatch – which makes these countries more akin to states like California, Michigan, or New York than the U.S. Sovereign credit ratings have been cut repeatedly in Ireland, Portugal and Greece.  Back in March, everyone was talking about this. But, somehow these concerns have faded from view as equity markets have risen. The exogenous shock in Dubai brought the reality back into the spotlight.

The same is true in the Baltics despite their sovereign currencies because of the Euro currency peg. Here too credit ratings are being cut. This is the reason I continue to be more concerned about Eastern Europe than I am about Dubai. Yes, there could be a butterfly effect with Dubai here but contagion risk is more acute in Eastern Europe where large banks have much greater exposure than in Dubai. I see Dubai as Buiter does – a tempest in a tea pot; the real action is in Europe.

So, hats off to Citigroup for getting Buiter onboard. His blog at the Financial Times, aptly titled Mavercon because of the unconventional ideas he often floats, demonstrates he will bring some critical new thinking to the organization.

Source

Citigroup Hires Buiter as New Chief Economist – DealBook

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward

16 comments

  1. Doug Terpstra

    Marla Singer at ZeroHedge has a sorta scary post about the Dubai butterfly wings flapping: “Is The Fed Facing Margin Calls From European Banks?” AIG and taxpayers may once again be reamed by Euro banks, thanks to Benny and Timmy. Ain’t global casino-ism grand?

    http://www.zerohedge.com/article/fed-facing-margin-calls-european-banks

    Re Dubai: There is an appropo proverb warning about the fool who builds his house (of cards) on sand. That place is Vegas on steriods in the most inhospitable climate and resource-challenged place on Earth; WTF were they thinking?

  2. ndk

    You’ve got to be kidding me; it’s totally irrelevant whether Citi hired Buiter or not. He’ll bring fresh insights, just like Steve Roach brought fresh and critical insight to Morgan Stanley, or David Rosenberg to Merrill? Please.

    I don’t believe it makes a whit of difference where Buiter’s writing; I’m just glad for his contributions to the global discourse.

    I’d also object to the conflation of inflation and monetization. Preserving the solvency of some dead actors is independent of the ability to and process of generating meaningful inflation in an economy.

    In other words, prices are sticky, and monetarism has been appropriately quiescent for years. Once it returns with meaningful supporting data, I will welcome it with open arms, but until then, the rescue of insolvent organizations, be they banks, GM, or Ireland, should be understood as such: rescues, not inflation.

    1. Edward Harrison Post author

      I don’t follow you on the conflation of inflation and monetizing debt. Inflation of the money supply is the definition of inflation. Whether it manifests itself in asset or consumer prices, the inflation is still there.

      And Buiter is deriding bailouts – that has nothing to do with inflation. It has to do with the socialization of losses and national solvency.

      1. ndk

        If we take a quick jaunt to humble Wikipedia, it or the cited publications would show your definition is not the generally accepted one: “In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.”

        Anyway, I’m not at all convinced we can even accurately measure money supply anymore. The discontinuation of M3 was, in my mind, merited. If you do trust the numbers, the only place money supply is growing is in state and government credit (PDF warning).

        But I do agree: the loss of sovereign solvency is a really horrible issue. It’s been my fear from day one that we’re pitching the sovereign and taxpayer’s balance sheets in a futile defense of the oligarchs’ balance sheets, which were improperly inflated in the first place.

        Still, when Buiter writes, “it is clear that nations… are likely to choose inflation and exchange rate depreciation over default as a way out of fiscal-financial unsustainability,” I just can’t agree.

        I contend it’s absolutely possible to ruin sovereign credit without triggering a general rise in the price of goods and services — or even in the broader money supply.

        Just look at qualitative easing. Monetizing bad debt doesn’t necessarily do anything to cause meaningful credit creation or raise the general price level of goods and services; it just puts a ton of bad debts onto the government, and creates huge reserves at private banks. With a money multiplier below 1, the transmission mechanism is temporarily dead.

        The money multiplier and private credit creation are just so vastly powerful that it’s almost impossible to step in. Krugman did a good blog or two on this back in January ’09, if I recall — the magnitude of intervention required to replace even a fragment of the private sector’s credit creation — but I can’t find it now.

        Inflation is really, really hard to create inorganically and efficiently in a large, modern, open, complex economy.

        1. Siggy

          Have you ever considered the fact that monetizing bad debt is a form of inflation? Have you ever considered that the money supply consists of two primary components: the circulating currency plus demand deposits which arise when loans are made. Does it occur to you that when a loan is not repaid that there has been a reduction in the money supply?

  3. Asparagus

    Buiter’s commentary has been about the good of the society and the economy. Citibank is beholden to it’s shareholders, ie, the share price. Are the share price and society aligned…

    I have a bad feeling about this relationship.

    1. ab initio

      I wish it were true that Citi and Goldman are beholden to their shareholders. If one looks at the financials it seems the insiders are taking out much of the profits in wages and bonuses – compensation. They then also get call options on the stock.

      Shareholders get to play the casino.

  4. PH

    I guess Buiter is concerned about bailouts until he gets one of his own. How can he be taken seriously while he is on Citi’s payroll?

    1. Edward Harrison Post author

      The same could be said about the SEC’s new risk man Rick Bookstaber. While one can doubt either man’s motives for taking the job, I look forward to seeing them add different voices to those organizations.

      ndk is right, though, about what the chief economist’s voice has meant with Roach and Rosenberg – not a whole lot. The same was true at the IMF and World Bank with Stiglitz, Rajan and Simon Johnson.

      But, of course, analysts who don’t toe the party line are sometimes forced out which means that on the margin there may be some benefit.

      1. M.G. in Progress - The Unbearable Lightness of Being an economist

        As I can see Rick Bookstaber is going to work in an organization with mission “to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation”. Definitely what he wrote can be of great use as an adviser.
        In the case of Buiter and Citigroup it’s a bit different as Citigroup is supposed to be a private institution, almost nationalized, but with a clear orientation to profit. Really I want to see Prof. Buiter at work in the Global Investment Committee when they discuss plutonomy related investment strategies and similar issues.
        Unless the purpose is that Buiter advises Citigroup on how to become a “good bank” which deal with narrow banking…

  5. S

    Cherrypicking favorite posts by Buiter is selective analysis at best. This is a guy who not a few days ago decried gold as a relic in defense of debasement – that same malevolent debasement he so decries. I simply ask which is Buiter: do you want to liquidate the banks or do you want to bail them out? His argument that you can do both and preserve the balance sheet of the sovereign is the stuff of newspaper editorials, politics and aacedemic delusion. He might have more credibility if he didn’t sprinkle his anorexic populism with wild eyed keynesian delusion. Witness those articles on negative interest rates and the uselessness of cash. Though it does make perfect sense he would be for the abolishment of cash with his broadsides against the PM market.

    Calling this guy a maverick is a serious diservice to the spirit of the word. He is a typical Keynesian hack with a self congratulatory propensity to outrage with discredited ideas that rest on the fringe, but well within, his academic (standard)orthodoxy. There is nothing new and refreshing about his perspective other than the framing.

  6. MarinusWA

    I have to say that I’m quite surprised at this.

    So I expect Buiter to either start carrying the “What’s best for Citigroup” line or to be let go within three months.

    Fingers crossed for neither.

  7. i on the ball patriot

    Right on cue …

    Tool of Pernicious Greed (Citibank), hires a tool of Vanilla Greed (Buiter), to paint a little respectability on its evil slutty body. The ever hopeful marks ooh and ahhh in unison …

    Meanwhile … the neocon global financial coup, with its goal of a two tier ruler and ruled world with the ruled in perpetual conflict with each other, continues unabated as; GS arms itself, four cops are gunned down in Seattle, minarets are banned in Switzerland, mortgage fraudsters continue to feed scamerica, Obama sends in more troops, food stamps surge and get privatized in Texas and Indiana, etc. etc., and et fucking cetera …

    Deception is the strongest political force on the planet.

  8. Swedish Lex

    1. Bailouts of euro-states by other euro-states will/would beocme a crucial point in the EU’s political development, almost as important as the purely economic ramifications. One scenario is that the EU takes a step back and lets the IMF do the lifting and impose conditions. Alternatively, the EU (ECB, the other Member States) would intervene in different ways, some of which will be mentioned in the Treaties, others will be pure Realpolitik where those providing the help impose strict, political, conditions. This could lead to de facto EU fiscal integration however outside the realm of EU law, which opens for interesting perspectives. Another point is of course in the difference of treatment of euro-state and of non euro-states by e.g. Germany and France.
    2. As regards Dubai, the bigger issue must be the future prospects of hotels, casinos,condos and whatever other tacky infrastructure they have invested in there and not the 60 bn or whatever debt the Dubai World has. If people stop believing in the miracle and start buying into Dubai as an empire built on sand, then the A 380s of Emirates will start flying empty to one of the largest airports in the world not far from 6-star hotels offering 50% discounts to cover only the basic costs. In that scenario, I can think of at least ten large listed global companies that have invested in Dubai that will suffer as will their banks and investors.
    3. Buiter. I have enjoyed his contrarian free-thinking approach. Now that he has become a mercenary, I will re-wind my meter to zero and judge him on the merits, taking into account that his paymaster is a zombie.

  9. M.G. in Progress - The Unbearable Lightness of Being an economist

    1. And the first step is to start issuing EU bonds. The case of a sing EU bond issuance is stronger now than ever.
    http://mgiannini.blogspot.com/2009/03/my-name-is-bond-european-union-bond.html
    2. We cannot and should not build cathedrals in the desert just because we do not know wher to put the money (excess of liquidity and savings glut)
    3. I agree but the corollary is that in his new position truth stating is impossible as he wrote and consistency will be hard.
    http://mgiannini.blogspot.com/2009/11/plutonomy-and-good-bank-for-citigroup.html

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