Month: July 2012

The Devil is in the Principles

Twenty years ago this summer, Europe’s currency arrangement, the ERM, began to tear apart. Fixed exchange rates last as long as the markets fear that central banks can out-buy the sellers. The Bank of England ran out of reserves in September, making George Soros famous, and the system broke up in the middle of 1993. There was no buyer of last resort for the weaker currencies.

 

Under EMU the sovereign bond market plays the role of the forex market. There is no buyer of last resort for the weaker sovereign bonds. The unwillingness of the ECB to play this role means that Spain and Italy can be forced out of the market. Their total bond stock is approaching €3 trillion. Ongoing deficits and rollovers mean their gross issuance could not conceivably be financed by official lenders.

 

So they must be kept in the market or the crisis enters the endgame. The ECB has suspended its SMP (Securities Market Programme) which bought sovereign bonds in the secondary market. It pursued this programme in half-hearted fashion, worrying in public about the quality of the bonds it was buying. Sterling would have crashed out of the ERM more rapidly if the Bank of England had gone around bad-mouthing the quality of the sterling it was supporting back in 1992.

 

Selling sterling to the Bank of England, if the latter possessed unlimited reserves, would have been a mug’s game. Selling Spanish or Italian bonds to somebody with unlimited stocks of Euros would be suicidal.

 

The Brussels summit has opened the way for the ESM to buy bonds in the secondary market, so the ECB has been replaced with a buyer whose balance sheet constraint is known. This is actually a retrograde step. The ESM could quickly become Bank of England Mark II if a sizeable bond market run re-emerges.

 

Nobody in their right mind will short an asset into the Central Bank against money. They cannot run out of the stuff. Nobody can operate a credible reverse tap in the Spanish and Italian bond markets except the ECB, or some agency with unlimited facilities at the ECB.

 

Some useful decisions were taken at Brussels last week but the crisis will persist until this central issue is addressed. Spain and Italy cannot pay more than 4%, or maybe 4.5%, and retain debt sustainability. A reverse tap operated by the ECB places credit risk on its balance sheet and extends the moral hazard (liberally available to European banks) to Mediterranean governments. So the fiscal compact must be implemented and the political commitment problems resolved.

 

The devil is never in the details. The devil is in the principles.   

Gas interconnection, decision made

I blogged earlier about the draft decision of the CER on the pricing rules for the gas interconnectors.

The decision is now final. I find the document hard to read, because it assumes that you are familiar with the draft decision, and it rambles between the actual decision, decisions that might have been, justification of the decision, and responses to comments to the draft decision. This is what I think was decided:

  1. The interconnector will be moved, legally, from offshore to onshore.
  2. Interconnector capacity will be auctioned.
  3. There is a reserve price for the auction.
  4. The reserve price is the long-run marginal cost.
  5. If the auction does not cover the costs of the pipe-formerly-known-as-the-interconnector, the difference will be split over ALL gas suppliers.

I am not sure whether there will really be an auction, or whether the reserve price will always hold.

The contentious point, however, is the long-run marginal cost. This implies that Bord Gais will have a guaranteed income on its assets.

Instead of forcing BGE to take a hit on what might turn out to be a bad investment in interconnection, the CER forces gas consumers to make up the difference.

This is wrong in principle. It is a transfer from gas users to the owners of BGE. And it distorts competition.

We’re different, roysh? The decoupling of the Dublin property market

Today sees the launch of the fiftieth Daft Report, with a commentary by yours truly. To mark the occasion, and to mark five years of Ireland’s property market crash, Daft.ie and the All-Island Research Observatory at NUI Maynooth, have launched a property value heatmap tool. In a companion post to this one, I outline the tool, how it works and what it tells us about Ireland’s property market crash.

In this post, though, I’d like to highlight what’s in the report itself. The principal finding from Q2 was that conditions in the Dublin market do indeed look to have improved considerably since the start of the year. This has happened at a time when conditions elsewhere in the country are pretty much unchanged. It seems the decoupling of the Dublin property market from the rest of the country has already begun.

Continue reading “We’re different, roysh? The decoupling of the Dublin property market”

Get them while they’re hot (or cold): Heatmaps of property values in Ireland now available

As I note in the companion post to this one, today sees the launch of the fiftieth Daft Report, with a commentary by yours truly. To mark the occasion, and to mark five years of Ireland’s property market crash, Daft.ie and the All-Island Research Observatory at NUI Maynooth, have launched a property value heatmap tool. In this post, I’ll give an outline of what the tool is and does, and what we can learn from it.

Continue reading “Get them while they’re hot (or cold): Heatmaps of property values in Ireland now available”

Wolfgang Münchau states the obvious

Well, it seems obvious to me at any rate: here. If the EFSF/ESM still doesn’t have enough money to deal with Italy and Spain, then we are still in multiple equilibrium territory: if the markets don’t panic, they will be right, and if they do panic, they will also be right.

Don’t get me wrong: this was a good summit that made some important intellectual breakthroughs. But there are only so many things that one summit can do, and we have had so many bad summits that it isn’t clear to me that the system can now deliver the many needed reforms in time.