Tuesday, 31 August 2010

ECB, inflation, debasement, or...

I have just read a very interesting article from the ECB, which I recommend to read. It somehow clarifies the strategy foreseen by the ECB to get out the current crisis. Inflation and rolling debt is not an option - reassuring. I have highlighted below interesting parts and also made some references to the Finnish Economy through the usual charts.

"Household indebtedness rose substantially – in some cases, doubling relative to the 1980s – reaching historically unprecedented levels and exceeding 100% of disposable income in many advanced economies. Increased indebtedness meant that households were increasingly stretched to cover their commitments and therefore less resilient to adverse shocks."
"Leverage also increased for non-financial corporations leading to an overall expansion of balance sheets and a change in their structure. As a result, debt-to-GDP ratios for non-financial corporations in the euro area and the US increased in the past ten years from roughly 65% to 75-80%."
"The crisis suddenly brought to a halt the progressive accumulation of private debt. Partly as a result of large-scale stimulus measures, but also reflecting the impact of the automatic stabilizers and, to a more limited extent, the cost of supporting the financial system and the implicit liabilities of guarantees to the banking sector, leverage has started increasing in the public sector."

"The key challenge for stability and growth over the coming decade is to ensure a progressive reduction in the debt overhang and strengthening of the balance sheets of banks, households, firms, governments and central banks."

B- Options for reducing the debt overhang

1. Inflation? Nope
2. Living with the debt? Nope
3. Growing out of the debt? Yep

1. Why not Inflation?

"A recurrent suggestion for solving a debt overhang is the creation of surprise inflation. Again, let me clearly dismiss this type of action. The history of the debasement of money through hyperinflation has been disastrous everywhere.

Even before reaching extremely high levels, surprise inflation produces an arbitrary redistribution of wealth and creates a burden for the unprepared, especially the weakest."
2. Why not living with the debt?

"What about the option of “living with the debt”? Some have suggested to ignore existing financial imbalances “for the time being” and focus only on the short term. Rather than pressing on with the deleveraging process, more spending could be encouraged to sustain growth in the short term."

"I believe that adopting this view would be very dangerous for our economies. There is a very clear example of the consequences of choosing to live with the debt: Japan in the 1990s. The “lost decade” in that country was the result of allowing the banking system to remain fragile over many years. "

Please have a look also to FinnVera, a framework to support "Zombie" company

"So the option of ‘living with the debt’ indefinitely is not a solution to the challenges currently facing policy-makers, nor is it a means to ensure sustainable economic recovery. We must focus on policies to address the debt overhang.

3. Growing out of debt

The most appealing solution to the debt overhang is clearly to achieve strong economic growth. Strong growth produces higher income and wealth, thus increasing the net worth of households and firms and reducing their leverage.

... Robust economic growth also boosts government revenues and reduces expenditure, especially when large automatic stabilizers are in place, thus leading to a rapid reduction of the government debt-to-GDP ratio."


Andrew said...

obviously they are referring to hyperinflation rather than inflation.

Finland is likely to have to restrict lending and maybe raise taxes to prevent the nordics relative strength from creating more distortions while the ECB fights other fires, where if required these measures can be easily reversed no matter what the ECB is doing.

By the way on the topic of high unemployment how does that fit in with the demographics of a rapidly aging population and shortage of workers in the near future?

HousingFinland said...

"By the way on the topic of high unemployment how does that fit in with the demographics of a rapidly aging population and shortage of workers in the near future?"

I should point you toward Japan ... if you were thining it implied high inflation - that is not the case. In case of Japan, they have been fightinh deflation over a decade.

"Finland is likely to have to restrict lending"

Considering the level of price reach by housing, considering the average income in family - I'm not sure if they have to restrict lending as it will shrink by itself.

my point is that Trichet considers a slow deleveraging of all players with debt level becoming sustainable - in that sense there is no way to go back to pre crisis model and whish to have financial bubble. So what I see is prices - housing, stock market coming back to decade back level. For the stock, it has already happened since it redjust faster it could also revisit 2 decade back level (that could bad for pension fund considering the liabilities they have in their hand)

Anonymous said...

1. Inflation? Nope
2. Living with the debt? Nope
3. Growing out of the debt? Yep

your analysis on them is not yet convincing, no bone and no meat...

I see the relation between them as the following:

A. Inflation --- help ---> Living with debt

B. Living with debt --- help ---> Growing out of debt

C. Growing out of debt --- increase ---> inflation

D. Growing out debt --- increase debt taking and thus increase ---> living with debt

Yes, very unfortunately, the people have learned and addicted to "stealing but doing not real work." Now, it is so clear a problem because everyone in the world has learned and addicted to the "stealing." Then, what can people "steal?!"

HousingFinland said...

1. Inflation? Nope
2. Living with the debt? Nope
3. Growing out of the debt? Yep

your analysis on them is not yet convincing, no bone and no meat...

That's not my analysis, it is the one from ECB that I have highlighted in this post - if you have not noticed the analysis is few line below.

Regarding that what is your opinion since I am not sure if I understand your argument.

Anonymous said...


I believe, like US, Euro zone (including its central bank) will take all those three approaches together. I am not sure if they can succeed yet. But, I know that can make all happy while not at the same time.

One result is sure: only a few can make money but most will lose at last.

Andrew said...

Allowing house prices to correct via market forces is the same short sighted methodology that got us into the current mess.

The ECB clearly said years ago it was up to the likes of ireland and greece etc to adopt fiscal policies to ensure sustainable growth and they are saying the same thing now.

Finland has plenty of power to restrict property lending. Leadership is needed rather than wishful thinking.

The ECB is also saying that they dont see a conflict between extraordinary policy actions to support banks and rising interest rates. Potentially inflation could rise steeply in Finland with lower than required interest rates while the banks carry on lending anyway due to the exstraordinary policy actions to support bank lending.

Why you are still relying on your banker chums to give economic stability is beyond me.

HousingFinland said...

@Andrew "Why you are still relying on your banker chums to give economic stability is beyond me"

;-), well What I tried it highlight is the fact a powerful central banker - Mr Trichet - is not willing to commit mistakes of the 70's, that is allowing inflation to get out of control - I'm not talking about hyper inflation (this of course would be disastrous) - I'm referring to high inflation, >5% <15%.

Secondly, the market is highlighting that the world is deflationary (US Bond Rates, German Bund rates, French rates, Japan rates etc.. ).

Thirdly we have had a massive credit expansion that lasted over two decades that simply burst in the past 2-3 years. So thinking that credit will return as it was in the past is foolish.

Finland to me is the Japan of the 90's - an ageing population, a housing bubble, low interest rates and export oriented economy. Mr Katainen could of course, like mandrake, give the illusion that inflation is a threat and that economical growth is resuming thanks to its tactical - magician - skills.

Last but not least, the worst is in front of us - and not very far. I think it could unfold this winter or beginning of next year. Anyway any substantial shock could be catastrophic since fiscal and monetary stimulus have almost be consumed.

Andrew said...

You have been ranting for a few years about the collapse of the finnish housing market and it is still going up and your solution is to allow the market to deal with it while the ECB does its best to keep it going ever higher.

Somebody has to be a leader here and it might as well be me if nobody else is up to it.

HousingFinland said...

Andrew, I consider that the housing market is not the stock market - it doesn't readjust overnight. When you have a run-up of prices, the mindset on people change slowly - they tend to extrpolate , but it change it is usually hard to reverse (>4-5 years).

Well you start to believe that price will keep on going or at best won't readjust. It could be a good sign to me that we are at about the top :-)

As I said the risk are far too big at the moment. I understand that a lot of people were on the sideline but now with the "economy brightening" the level of risk perceived by the population has drastically been reduced(see the consumer confidence for that) - so people are buying at crazy price and lenders are providing crazy loan, regulators are too scared to fade a "virtual" recovery and politicians are concentrating in the next election, winning heart and softening the souls.

In any case, there is a good thing about that, if housing price were to go down, inflation threat will be flirting with the zero boundary.

Housing price going down may not necessarily be caused by higher interest rates (see japan, see late 2008) or higher unemployment (this will be only an accelerator) ... but it could be caused by a return to normal, where the supply "price" will go back a more rational demand "price" at a time when the people have repriced the risks and people are aware that past growth is never to be achieved ...for long

HousingFinland said...

"You have been ranting for a few years about the collapse of the finnish housing market and it is still going up"

Well I started this blog one year before the financial crisis and the struggle we currently witness. Back in 2007 - people were euphoric.

My scenario is and has been that the risk are great up to and including 2011. So past this date my views will be invalidated if price were to go higher or were to be stable.

For one reason or another I'm somehow confident that the scenario, centric on this blog, will unfold.

Time will tell - and we will witness that pretty soon.

Andrew said...


You never seem to understand me. If house prices could go up forever i would not be suggesting leadership is needed to manage them.

You keep talking about politicians lying about growth and inflation and yet now you are talking about high confidance and a brightening economy.

Conditions are reported to be euphoric in Germany and where Germany goes Finland is likely to follow.

HousingFinland said...

"politicians lying about growth and inflation"

"high confidance and a brightening economy"

This two are linked. Lying is not the word I would use but insteqad misleading. Politiciand , economists that uses media to emphasis erroneous perspective that leads ultimately to higher confidence - cause and effect phenomenon.

I said that because the peak of optimism is always coincidating with the start of a crisis i.e 2000, 2007 and now.

That's all I'm saying.

Make no doubt, i do not see the economy brightning as the current effect are only technical - call it a dead cat bounce.

Andrew said...

Finland is in the fast lane while your buddies try to save their chums.

Anonymous said...

Nordea should find a new head economist ... I mean providing an explanation such as "People are also buying now because interest rates are low and they prefer to own rather than rent" in order to explain that there are no bubble ... is almost incompetent ...

Bubble, or no bubble? Economists differ on Finland's property market

Finland's Finance Undersecretary Martti Hetemäki has warned that a property bubble is imminent -- and the collapse of the market as house prices continue to climb.

But Martti Nyberg, head economist of Nordea Bank, disagrees that there is a housing bubble. He says that there are good reasons for the rise in prices. For one, they had declined during the recession and are now coming back. People are also buying now because interest rates are low and they prefer to own rather than rent. The cost of borrowing is also smaller now for families -- only 8% of a family's income goes to loan servicing now compared to about 25% in the 1980s and 1990s.

Antti Suvanto of the Bank of Finland also does not believe that there is a housing bubble, though he thinks that the property market is becoming a little overheated, primarily because of the low interest rate and the lower servicing costs of debts. But he emphasizes that people should exercise caution about borrowing. “The pace of rising prices and the willingness to borrow money are not a good combination with the prospects for the economy,” he says. “No boom years are on the horizon, so there is also a risk of incurring too much debt.”

HousingFinland said...

@Eric "People are also buying now because interest rates are low and they prefer to own rather than rent"

The head economist at Nordea is only stating facts: Interests are low and Finns prefer buying than renting.

The head economists will only support the Nordea business whih is to provide loan that ultimately allow them to gain market share in a very competitive envionrment and of course provide fatty profit to shareholders.

One has to remember that in Feb 2009, Nordea almost collapsed, had they not raise capital though share offerings at very generous level to shareholders and of course supported by unlimited guaranty by government and central bank.

... And housing had not readjusted in full force, I'm just wondering if in the next wave Nordea survives. Maybe they will merge with Sampo to create a Nordic bank - too big to fail?

Anyway, I think recently Nordea changed or reshuffle its head economist ... for maybe lacking vision pre crisis..

Mickey said...

All this very rational analysis being unveiled, I've never hoped so much for the bubble to be true when I see advertisements of 50m2 flat in Matinkylä shown at more than 240 k€ popping up, i.e. close to 5000€ per m2, especially when the selling price is justified by the coming 2015 subway. (If everything goes fine I would like to add)

Anonymous said...

@Mickey You can buy 60+ sq. m. appartment in Lauttasaari for less than that.

Household debt may be higher than ever, but also household assets are higher than ever ie. people have more money to spend than ever, which could be another reason prices continue to rise.

I would not count on houseprices to collapse in Finland anytime soon, for the reasons the author himself points out but also because of other factors like the one above.

Additional factor is increasing population in the metropolitan area, so demand remains high.

At most I could see a lack of interest in houses costing over 400K as less people will be able to afford them. If you live in a 2 room old appartment flat in metropolitan area I don't much will happen in the price.