I thought we had a good discussion going on the sad and sorrowful decline of sterling against the euro.
Here is a chart that might add something to the debate: it follows recent net flows of private debt securities. It went from a nice positive number in quarter 3 to a nasty negative number in quarter four. Thus, it would appear that those foreigners just don't want to buy our debt anymore.
So go on asteve, nick, mark, traderboy. simon, oldftb and others, tell me what is happening here. Nothing good, that is for sure.
L.O.C.
ReplyDeleteLoss of confidence
Absolutely right VADO. Housing market crash=economic recession, time to get out of sterling assets.
ReplyDeleteInteresting... what exactly does the most recent bar show? Does a negative number make sense? Is this disposal of securities previously foreign owned... or is it a net figure suggesting recent UK net investment in overseas debts?
ReplyDeleteThe graph also looks odd when compared with the European securitisation report "Winter 2008"
http://www.europeansecuritisation.com/pubs/ESFDataReport-0208.pdf
Looking at the total quarterly issuance for 2006 & 2007, we get
36;32;47;77;63;62;30;17 billion Euros.
This is very odd, if your figures are accurate, since you suggest that, for 7 of those 8 quarters, foreign investment measured in Sterling substantially exceeded total issuance measured in Euros according to the most credible source I can find. This is clearly a nonsense.
So, in summary - either there is some flaw in data in your graph, or we've uncovered something new and interesting.
N.B. My interpretation is that the latest BoE inflation report's graph of global securitisation is supportive of, but not conclusive about the data in the above document.
What's your source?
Asteve,
ReplyDeleteFirst, the source: the BoE, financial stability report, table 1.3.
The BoE probably got it from the ONS. It is from the balance of payments, therefore a net number makes complete sense.
The BoP has inflows and outflows, with domestic residents holding foreign assets and foreign residents holding domestic assets. When you add up everything coming in and subtract everything going out, you get a negative number.
On a more general point, I don't normally give my data sources, usually 'cos its boring. However, if at any time, anyone has a query about where the numbers come from, just ask. I will always name the source.
Alice
Sorry Alice,
ReplyDeleteI believe sterling is in terminal decline, but that's all I will say on this.
Except, whatever you do, do not, invest in sterling based products.
asteve,
ReplyDeleteSome further thoughts. The numbers in the chart do not show gross issuance of debt. Rather this the net flow of existing and new debt. This, again, can be negative.
Alice
;) It wasn't supposed to be a dig, but I hope you can see the apparent anomaly.
ReplyDeleteI presume you mean Chart 1.3 "Foreign portfolio investment in the United Kingdom and sterling ERI"?
If so, the BoE chart appears to be in US$ - while your graph states Sterling. This goes a long way towards reconciliation with the Euro figures I've been looking at.
So far, so good. The next thing to note is that, in addition to foreign portfolio investment, there will have been foreign direct investment. We won't have a clear picture unless we can look at both.
A potential explanation for the non-intuitive negative figure for the final quarter is that previous "portfolio" investment started to be actively managed... which caused it to be re-classified as "direct investment". This is, of course, just supposition... another possibility is that a sum was somehow transferred back into UK ownership. It appears to be reported as a gross figure.
I suspect that, by comparing the Euro denominated issue of securitised debt - subject to appropriate EUR/USD exchange rates for the quarters in question, we can infer the sum of foreign direct investment and national investment... If we could distinguish between foreign direct and domestic investment, we could establish a trend in the volatility of the markets for debt securitised against UK assets. My hunch is that there used to be little call for domestic investment in securitised debt - since domestic banks could simply choose to keep their own lending "on balance sheet" instead. Maybe the negative amount relates to securities now held by Northern Rock as a consequence using emergency financing from the BoE?
asteve,
ReplyDeleteOMG, you are right, it should be in USDs. I have just corrected it. I found the chart in the FSR and liked it. So, I quickly posted it.
However, I have the BoP on file. There are some interesting things there, which I could post in the coming couple of weeks.
Two subjects that will come up shortly are: oil balance and Net international position. The key point will be that the UK CA has some deep structural problems.
Alice
I look at this chart and I say "so what!". Go on, admit it Alice, this chart means nothing.
ReplyDelete(Now is a good time to buy!)
just read your exchange with asteve. So you now can tell the difference between a pound and a dollar - one is a coin, the other is a note.
ReplyDeleteVery sloppy.
Alice, Sometimes I know what I'm talking about... but only sometimes... I can't be trusted. :o)
ReplyDeleteComparing the figures between foreign direct investment and issuance would definitely be *VERY* interesting. If they correlate closely, having converted Euros/US$ then we have conclusive proof that, effectively, all investment in securitised debt has been exploitation of foreign investors. If we can keep an eye on foreign portfolio investment - and it remains low (and looks likely to remain low for GDP-releated reasons) it would give a basis to estimate gross mortgage lending in future (independent of any recession) and to make a prediction of minimum house price falls based upon transaction volumes and credit availability. This could prove to be the first house price inflation estimate with a transparent basis. ;)
The only snag I see is that UK residents may have pensions invested with European pension companies (AXA for example) and this might undermine our case that the investment really is foreign... in the traditional sense... not sure on that score.
London Estate Agent... the chart certainly doesn't mean nothing! Independent of scale, it clearly demonstrates an abrupt end to passive (long term) inwards foreign investment into the UK. This will prove devastating for anyone wishing to sell into UK markets... and, yes, that includes you... and it also spells a death-knell for quite a number of the city types that have, in the past, buoyed your market. Try not to have nightmares - I'm sure you'll adapt just fine. ;)
For my part, I confess to not knowing enough to comment. I'm just enjoying the debate.
ReplyDeleteNick
Nick... my boldest statement to date:
ReplyDeleteI think that securitisation explains the UK housing bubble. I think it will define the future for house prices and our national wealth. I *strongly* urge you to read the europeansecuritisation document I posted further up... and decide if you agree that securitisation has been the root of much of the problems introduced over the past decade.
Portfolio investment in UK debt (as found here by Alice) is almost identical - a measurement from a closely connected econometric.
asteve,
ReplyDeleteLet's see if I can get straight on the first principles here:
BEFORE
- Prior to securitisation, UK was a mostly self-contained market, meaning UK banks loaned to UK borrower who bought UK houses
- Therefore total loan value available to buy UK housing stock was restrained by the capital of UK banks and their capital adequacy ratios
- Debt service ability is limited by UK salaries
BUBBLE
- Securitisation allows loans secured on UK houses to be sold easily
- Foreign buyers represented much of the market for these MBS
- Therefore new capital from outside the UK entered into the system
- More new capital and therefore larger loan amounts were chasing a fairly fixed amount of housing stock
- House price bubble
- Debt service is still limited to UK salaries, which didn't go up
NOW
- Debt service limits breached, leading to default or at least default expectations
- Therefore mark to market losses
- Shut down of MBS market
- Foreign buyers no longer buy MBS so no net inflows into UK housing
- Total loan value able to chase houses trends back to how it used to be, with adjustments to clear out excesses of the bubble
Is that essentially what you're getting at? That securisation allowed new money to enter the UK to bid up houses, and now the process has stopped and/or reversed?
Nick
asteve,
ReplyDeleteAs ever thanks for the detailed comments. I've been thinking about these pier loans for a while, about how banks got caught cold with a ton of warehoused loans that they suddenly couldn't shift, and thus have tied up capital.
At the same time they have been pulling SIVs back onto balance sheet which ties up even more capital.
So really I agree that we've had a sudden freeze and that the BoE trying to swap out alot of these assets is the right idea (given their real constituents) but doomed to failure due to the magnitude of the problem.
I too have been wondering what happens when you come to refinance a loan and you have no bidders. It seems every generation learns that borrow-short/lend-long condemns you to bankruptcy the moment liquidity flees. What I hadn't really thought through was that all the banks would be in this position and thus unable to issue new loans.
Nick
Trying to take assets without any form of finance out of the equation is about the only thing the BoE can do... but this is not without massive risk... if it accepts one bad piece of paper, banks will be trying it on all the time... essentially allowing banks to "print money" for themselves at everyone else's expense. This is why the AAA 'good as cash' stuff has had massive haircuts... and is only a temporary swap.
ReplyDeleteUsually, if you take out fixed-term finance, and at the end of that term you need more finance but no-one will give it to you... you are insolvent... what happens is bankruptcy and a fire-sale of assets to repay creditors pence on the pound. With Northern Rock that stood to be a big problem... If the best bid for the £100bn assets had been two tubs of sauerkraut and a Camembert... you can probably imagine some rather angry retail depositors who've been short-changed by £20bn - and even more angry other banks who would likely become insolvent in a chain reaction. This is another reason for central bank intervention... to unpick the knitting - so that insolvent businesses can write off their losses without threatening the entire system.
You'll disgree with me on this one, but that's precisely why we need a gold standard and an end to fractional reserve lending.
ReplyDeleteGold convertibility gives the depositor an "out" at any moment by giving them the right to convert a sterling deposit into a hard liquid asset on demand
Elminating FRL (or at least cutting the ration from 9:1 down to 3:1) seriously reduces the ability and incentive for banks to overstretch.
Both together would hurt the profitability of banking but I don't see that as such a bad thing. They'd find a new equilibrium and if that means charging customers for accounts, well at least that's better than charging the whole nation via inflation.
Nick
Morning All,
ReplyDeleteI know very little about economics, but even I know that securitisation has been the root cause of the current problems?
Or more specific, grading of these securities?
Just thought I'd input my laymans view.
Andy
The euro now costs more than 80p,
ReplyDeleteI'm wondering how low sterling will go before we beg to be let in.
The thing about gold is the fact it is immutable.
ReplyDelete...meaning?
ReplyDeleteImmutable means "unchangeable" - or, in this context, in fixed supply... and - as such - the easiest commodity to monopolise. This is why the earliest currencies were gold... gold requires no communication to establish its rarity... it is a function of physics... though people at the time it was used as money had no reason to be sure about this.
ReplyDeleteIn a modern world, communication is not a limiting factor. There is absolutely nothing to stop any number of immutable systems being established without the cost of mining. The only reason to advocate gold as a currency is that you like the politics of those who happen to hold gold. The gold standard did not preclude fractional reserve banking - though it did limit government deficit funding - especially for wars etc.
Other properties of gold that I consider relevant are:
heavy; untraceable; easily stolen; subject to wear. None of these represent positives as a monetary standard, as far as I am concerned.
I recently posted a fair bit about this in response to Nick on a topic that has just dropped off the front page.
http://ukhousebubble.blogspot.com/2008/05/running-for-cover.html
"where the sum of all money in individual hands is challenged (and, in practice, overwhelmed) by money available as credit"
ReplyDeleteI agree and this has bothered me for a long time. I find FRL extremely undemocratic. I actually think democracy is a bad idea, but that's a different story.
FRL allows the government to spend money it doesn't have and for banks to charge interest on money they don't have. Because it helps both parties, it continues. The process, in broad strokes, goes like this:
- Government approves a hare-brained scheme to spend a ton of money it doesn't have, to buy votes. Let's call it a £1.5bn program;
- Let's say they've got tax revenue of £0.5bn. They don't want to raise taxes or cut other spending so they go to the treasury;
- Treasury issues £0.5bn in public debt, better called "deferred taxes". Let's say the market wouldn't support a full £1bn;
- So next the government goes to the BoE. They print the remaining £0.5bn.
At the moment the government spends the £1.5bn it gets full monetary value as it's the first time £1bn of it enters the economy. But once that extra £1bn get's deposited in bank accounts by the recipients, FRL turns it into £10bn and we get inflation.
Overly simple, but it's the basic process.
Nick
On democracy, there's a great quote... it goes: "What do you think about democracy?" ... "I think it would be a great idea." (The implication being that things claimed to be a democracy seldom are.)
ReplyDeleteOn a few technical points, fractional reserve lending does not allow the government to spend money it doesn't have. Government overspend is done by bond issuance (which is independent of fractional reserve banking) and is easiest with fiat currencies... but can be done independently of any commercial banking legislation. Similarly, commercial banks aren't able to charge interest on money they don't have - it is just that you have a different idea of what money should be than what money is defined as being in a fractional reserve system.
In your hyphen-breakdown, I'm with you right-up until you claim that the BoE "print the remaining £..." - because they do not. The treasury and the treasury alone is responsible for its deficit spending.
You're right that for every £1 of M0 expansion, commercial leverage yields ~£10 to £20 in M4 expansion... assuming current levels of support of and demand for bank loans. Things, of course, get interesting when the expanded M4 is subject to taxation... ;)
Does this chart explain why my holiday to Spain was so expensive?
ReplyDeleteAnonymous... Er... No.
ReplyDeleteThis one might, however:
http://www.exchange-rates.org/history/EUR/GBP/G
Well, strictly speaking FRL and money printing are two analytically separate things, but in practice they occur together.
ReplyDeleteThe BoE credits the goverment a/c with the newly created £0.5bn, which it then spends (via a transfer from the govmt BoE a/c into the commercial banks' a/c of the recipient) which is then multiplied through FRL. The printing is inflationary but then the FRL multiplies it again. Importantly, the govt spends the money before the economy has adjusted to the inflation hitting the system.
I do mean the govt spends money it doesn't have because the money it spends is created out of thin air as a tax on all existing pounds.
Nick
Nick, I almost agree with all of the above... though I hope you can see why I objected to the idea that the banks are "printing"... additional leverage from banks does not introduce more money into the "real economy" without exactly equal debt. I think this is *crucially* important with respect to the relative growth of M0 and M4. Where M4 has grown faster than M0, the burden of debt has grown within the system - and fractional reserves have dwindled. This puts the banking sector at risk... and, as defaults grow forces banks to do rights issues... which, again, increase (only slightly) the ratio of debt to debt-free money in the non-financial economy.
ReplyDeleteThis is key to the argument that we are likely to see slowed expansion of M4 over the medium term. In the short term, M4 will expand, because - when depreciated financial assets are sold, even at a big discount, the new owner will still use leverage... and it will take time before debts are repaid... as those with credit take one-last punt on a bull market - perhaps with commodities; perhaps utilities... perhaps something I've not yet thought about.
As a simplified model, there are a few factors that affect future asset prices:
1. (Inflationary) The amount of government debt (i.e. 100% kosher reliable money - M0) which has been expanding fairly slowly - say at 5% or 6% - roaming free in the economy. [N.B. Curiously, this is harder to estimate post-2006... maybe this is coincidence... Alice, have you some good ideas for information sources?]
2. (Inflationary) The amount of Fractional reserve lending (M4-M0) which has been expanding rather more rapidly - say at 12 to 18%. This expansion reflects the additional private sector debt risk... which has, over the past few years, been mitigated by an exponential expansion in CDS issuance. Looking forward, the effects of the SLS and “pumped liquidity” will increase M4 in the short term... but this only permits trading at a price... banks can't directly profit from this new liquidity. Falling interest rates help here, but LIBOR is not falling with the base rates... and LIBOR is the elephant to the mouse of the BoE rate in terms of scale... since the penalty for borrowing from the BoE, rather than commercially, is significant.
3. (Deflationary) The level of taxes required to keep government debt expansion on target – both for net and gross amounts. N.B. Net matters most for the UK... it is most likely to change in the short term. Missing targets for national debt would push up the cost of government borrowing and impoverish British people. It is important to note that the targets for national debt are as a proportion of GDP. In a slowing world economy, this will seriously constrain M0 growth... and, remember, most borrowing will have been done with the expectation of continued rapid M4 growth.
4. (Deflationary) The will of banks to unilaterally reduce their ratio of credit risk to fractional reserve... a situation prompted/exacerbated by write-downs. There are three options:
a) Retain profits (small bonuses; small dividends) – not likely (not in the interest of the board of directors) and would only make a small dent in the problem over the next few years.
b) Sell off acquired assets to new independent owners... who will (almost certainly) need to buy them on credit... (Whoops, clang, risk aversion to big loans... plus... the assets anyone would want to sell are always the over-valued ones.) It might work – but it would drive down asset prices – and, hence, increase the system-wide problem.
c) Make a rights issue... Not a bad plan... embarrassing for the board of directors... biggest hurdle is plummeting share prices – which limit the maximum size of rights issue that can be achieved.
All of these appear to be in full-swing. M0 expansion doesn't explain property prices – and M4 expansion looks extremely risky... unless entirely new groups of affluent debtors emerge... which, frankly, seems unlikely.
P.S. In this context, "affluent debtors" would be synonymous with foreign portfolio investors - i.e. those with foreign assets who need to borrow against their Euros; Dollars etc. to invest in Sterling assets.
ReplyDeleteIt would be great to have a breakdown of this foreign investment by originating currency. That way we might infer the rate of contraction in gross outstanding portfolio investment from exchange rates. ;)
More data - direct from the ONS...
ReplyDeletehttp://www.statistics.gov.uk/STATBASE/tsdataset.asp?More=Y&vlnk=1550
I think we need some graphs to help appraise what is going on.
I'm specifically interested in HBWI, HLXY, HLXW & HBQC.
It would be very interesting to correlate these figures for the issuance of asset backed securities as recorded by European Securitisation.
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