Haircuts, monetary easing and EU membership: what a week!

Reflecting on the Cyprus issues, it has stayed in Euroland in a formal sense, but with the troika its government has imposed exchange controls, which make a mockery of the idea of a single currency area, and required banks deliberately to repudiate a proportion of their deposit liabilities. This is straightforward in so far as it solves the basic arithmetic of debt and costs, but the partial wipe out of depositors was never part of the vision established in the early 1990s and one of the fascinating  features of the haircuts of deposits is the arbitrariness, with the extent of the losses depending on the location of the deposits (i.e., the name of the bank, because some banks have done better than others, and whether the deposits are with a branch in Cyprus rather than in another country), and the residence and nationality status of the depositors.

We can also regard Cyprus a game-changer in so far as the key Euroland nations, with Germany in the driving seat, decided to make an example of Cyprus, while doling out immense sums in the closing weeks of 2012 to Greece. In the Greek case large losses were inflicted on private sector holders of government bonds, including foreign private sector holders; in the Cypriot case large losses were inflicted instead on domestic bank depositors.

As for what lies ahead, a second game-changer may be the latest Japanese monetary easing. Japan has faced an extended period of deflation, and prices having fallen over many quarters on the GDP deflator measure. Previous Bank of Japan announcements of ‘stimulus’ have been misleading, because they have not led to any upturn in the rate of growth of the quantity of money, broadly-defined to include all bank deposits, which is the aggregate relevant to the determination of equilibrium national income and wealth in nominal terms, and hence to macroeconomic analysis more generally.

The equity and currency markets have moved in a manner suggesting that markets anticipate that this time it’s different, but so far the quantity of money has only wobbled a little in the upwards direction with the annual rate of growth of M3 having increased from 1%-2% or so to 3%-4% since autumn 2012, and the increase in one month (December) was above 0.5% (i.e., an annualised 6% plus). But now we have the promise of extremely large purchases of long-dated, meaning 30-40 year to maturity, government bonds by the central bank. These purchases will be mostly from the life insurance companies, i.e., from non-banks and therefore with a direct effect on broad money.

We should expect that if over the next year, Japanese broad money increases by, say, 10%, the Japanese economy will enjoy a strong cyclical boom because it is the scale of bond purchases at the long end from non-banks that matters most. However, three years of 10% broad money growth would result in inflation of 5% or more, with catastrophic effects on government bond yields, and certainly if we do now see a sharp upturn in broad money growth in Japan, it will be – if nothing else – a fascinating experiment in monetary policy. For monetarist there’s the point that the Bank of Japan concentrates in its announcement on the monetary base rather than the quantity of money, so we will need to watch the numbers month by month.

Meanwhile with a more domestic focus, it’s fascinating that a debate on EU membership between the director of the Britain for New Europe campaign group and Tim Congdon held last week under the auspices of Accountancy Age concluded with readers of Accountancy Age deciding that they didn’t believe that leaving the EU would harm the UK. We might expect that such readers are well-informed, high-income professionals, and it would seem that the UK public debate is moving towards withdrawal from the EU. Europhiles are very much on the defensive.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla