On QE, overproduction and the economics of a negative carry universe.
In the run up to last week’s announcement of more QE from the Bank of England there have been a couple of interesting posts on FT alphaville talking about “negative carry universes” and why banks are finding it so hard to make money recently, and why despite all the money being pumped into them we’re still not seeing any increase in lending.
For one there’s a bit of a confusion amongst a lot of people about what the point of QE really is and what base money and central bank reserves really are, but let’s leave that to the side for now (important as it is to understand).
What I found really interesting was the post suggesting that the reason we’re in a negative carry universe is not that banks made mistakes, but that we’re seeing a fundamental restructuring of the underlying economy, away from scarcity and towards abundance.
“what if the banking crisis is less about bad lending decisions and more about overly successful investment? (We appreciate this is not conventional thinking, and that many will find this idea sacrilegious, but please run with our hypothetical scenario — just for fun.)
As the Fed puts it, this means the economy has dropped below its potential.
Yet there is something different about this overcapacity problem compared to others in previous recessions. As the Fed wrote in 2009, this one seems to be driven by a supply (or happy) shock is not restricting productivity”
Why does this matter to banks? Well, banks are supposed to operate, and create a profit, by matching people who want to lend short term and borrow long term. That is savers want to maintain their liquidity (access to their money) but people and companies want to borrow on a longer scale to invest in production or property and so on (and you don’t want your bank to suddenly recall its loan on no notice or apply for a new one every week). Normally the yield curve slopes upwards over time, so interest rates for long term loans are higher than short term loans – you pay a higher rate on your mortgage than you get on a current account – and so the bank makes a profit off this difference in rates. This is positive carry.
But since the credit crisis this hasn’t always worked as it should.
“When there is a uniform liquidity crunch it results in higher interbank rates (cue Liebor madness), since banks compete with each other ever more aggressively for funding…
The hope was that this was a system-wide liquidity crisis not a system-wide insolvency crisis. Provided the central bank could tide banks over with liquidity in the short-term..
Unfortunately it soon transpired that liquidity was not enough to bridge the short-term funding gap. Banks also needed to be recapitalised in order to stay solvent.
Again, this was justified because it was hoped that upon recapitalisation and with liquidity support banks could soon reset and become profitable again, being able to support themselves.
Yet, this failed to happen.
More QE was attempted on the belief that the system still needed more liquidity.
Yet this too failed to help.”
And so we end up where we are now.
“The battle is no longer about liquidity but about preventing the negative carry universe from impairing bank profitability forever. Indeed, unless a positive carry is re-established banks will never be able to support themselves, for they will never be able to make money according to the old model.”
So how does fit in with the first story I mentioned about over-production?
Another way to look at the normal functioning of banks is to think of it as them borrowing money from the future to invest in future goods by paying for production today.
“balancing tomorrow’s shortage of goods against today’s relative under supply of money. So by extending credit at your own risk (shorting money) on the hope that it leads to the increased production of goods. We call this process investment lending.”
Basically money will grow over time and goods will be used up, unless we use future expectations of money to invest to create more goods.
And here we come to the underlying problem. Banks didn’t get into trouble because they made bad decisions (though they probably did make bad decisions) – the corollary of which is that given support and better decision making everything will work out – but because the underlying future distribution of goods and money is changing.
“As our charts attempt to explain, this could be because in a negative carry universe — one in which goods, collateral and assets are expected to permanently outnumber money in the future — bank profits can only be achieved through pariah practices rather than lending. Banks are ironically encouraged to destroy capacity, disincentivse investment, borrow money from the economy rather than lend it, and hoard wealth. All phenomenons we are currently seeing. All phenomenons which are economically destructive.”
In the end maybe we’re not just seeing a crisis of financial management but a real crisis of over-production; automation and increasing productivity are increasing supply, stagnating wages and personal debt can no longer maintain demand to keep up and opportunities for productive investment are disappearing.
“A man who has produced, does not have the choice of selling or not selling. He must sell. In the crisis there arises the very situation in which he cannot sell or can only sell below the cost-price or must even sell at a positive loss….
As Mill says purchase is sale etc., therefore demand is supply and supply demand. But they also fall apart and can become independent of each other. At a given moment, the supply of all commodities can be greater than the demand for all commodities, since the demand for the general commodity, money, exchange-value, is greater than the demand for all particular commodities, in other words the motive to turn the commodity into money, to realise its exchange-value, prevails over the motive to transform the commodity again into use-value…
Crisis is nothing but the forcible assertion of the unity of phases of the production process which have become independent of each other.” Marx – Theories of Surplus Value, Ch 17