Thursday, December 22, 2011

Krugman Admits He Was Wrong

Well, he is subtle about it, but it's there.

An NYT colleague of his, Floyd Norris, has forced Paul Krugman into admitting he missed what the ECB is up to. Norris writes:
In recent weeks, the new president publicly insisted the central bank would never do any of the things that Germany opposed. The bank would not drastically step up its purchases of Spanish and Italian government bonds. It would not directly finance European governments. It would not backstop European rescue funds or print money that the International Monetary Fund could use to bail out governments.

It would do only what central banks normally do. It would lend to banks.

It turns out that may be enough to stem the European crisis for at least a few years, and go a long way to recapitalizing banks in the process.

That fact only became clear on Wednesday, although Mr. Draghi announced his intentions on Dec. 8, when the central bank said it would offer to lend money to banks for three-year terms, in unlimited amounts, at a very low rate.

In reality, it was an offer banks could not refuse. They will initially pay the central bank’s official rate of 1 percent. But if the bank lowers the rate in coming months — as it is widely expected to do — the rate on these loans will drop as well.

There is no limit on what the banks can do with the money. But there is an obvious, virtually risk-free, option. A bank can buy short-term securities of its own government and pocket the difference — up to four or five percentage points — for the life of the securities.
So how does this nail Krugman? Because he didn't see what was coming when Draghi, Bernanke, and even the Chinese, rolled a boulder down the financial mountain. This is what I wrote on November 30:
The world's central banks have just announced a program to print huge amounts of money via dollar swaps and Paul Krugman doesn't understand why it is a big deal. He writes: 
So this looks to me like a non-event. Yet markets went wild. Are they taking this as a signal that substantive actions — like the ECB finally doing what has to be done — are just around the corner? Are they misunderstanding the policy? Was this cheap talk that nonetheless moved us to the good equilibrium? (If so, not enough: Italian bonds still at more than 7 percent).
A very strange day. 
It usually takes months to prove Krugman clueless. This time it will take just a little more than a week. The swap announcement is the first step in a major money printing plan. Or do you think Geithner and the President had European Council President Herman Van Rompuy over to the White House on Monday, along with European Commission President José Manuel Barroso, and High Representative Catherine Ashton, because they are great conversationalists over tea?
December 9 is the day the European Central Bank will announce its new money printing plan. You heard it here first. Krugman is clueless or mystified, whatever. I guess in this context it's pretty much the same thing.
I am, I have to say, somewhat mystified. Of course the Fed will make dollar liquidity available to other central banks as needed; that was never in question, because Bernanke doesn’t want to be the man who destroyed the world to save a few pennies. And reducing the interest rate on those loans seems to me to make virtually no difference; it was a trivial charge anyway.
Eh, so I was off by 12 hours, but this is what I wrote on December 8 in the EPJ Daily Alert:
Reuters is running with a leaked ECB story that the ECB may loosen collateral criteria to give banks greater access to cheap cash and offer longer-term loans. Reuters said the leak comes from "three euro-area officials" with knowledge of the deliberations.
This looks to me like the bazooka being put in place and that it is going to be used. 
The next day in the Alert, I wrote:
the ECB appears willing to back up EZ debt via the back door, as it has agreed to accept more types of debt securities from banks in discount operations. This could prove to be a very profitable arbitrage for banks, as they could buy high yielding paper off the market and have it financed by the ECB at low rates.

Floyd Norris has finally figured all this out (wait let me look at my calendar) 23 days after my first post advising that a printing plan was in place. On the same day that Krugman said he the November 30 news was a  "a non-event."  Let me spell this out: C-L-U-E-L-E-S-S.

But it's his NYT colleague's piece that has forced Krugman (subtly) to admit he was wrong. He writes:
A number of people have asked me for my reaction to Floyd Norris’s piece today on Europe. It’s a good summary of the argument many people are making about why the European situation looks less dire right now than it seemed a few weeks ago.

Regular readers may recall that I and others were adamant that it was essential for the ECB to step in and buy the debt of troubled governments, to head off what looked very much like self-fulfilling panic. The ECB refused to do that, and many of us took that refusal at face value — but the argument is that in reality it did the functional equivalent, lending very large sums to banks with sovereign debt as collateral, so that it was in effect doing the purchases we wanted, but laundering those purchases through banks...

The bottom line seems to be that Mario Draghi is a consummate eurocrat. I’ve always kind of enjoyed talking to eurocrats, who always seem to be implying something they aren’t saying; in this case he may have managed to say one thing while doing something else, and the thing he actually did was just what people like me have been urging.

So they’re subtle, these Europeans are...
Hey, Paulie, I don't think they are the only subtle ones.

(Thanks to Bob Murphy for tipping me off to Krugman's post)


  1. Krugman is always wrong, so this is a "dog bites man" type of story. Nothing shocking here...

  2. Banks won't buy additional bonds with this due to Risk Mgmt & higher capital requirements... I am skeptical it will work. All it will do is to reinflate the global carry trade..the EURUSD is not likely to go anywhere either.

    Remember, in order to reflate housing the FED eased and everything went up except housing.

    Sae=me thing with this, perhaps it will buy some time for Italy, Frace & Spain to default in an "orderly" fashion i.e stop the jumps in yields.

  3. So this looks to me like a non-event. Yet markets went wild. Are they taking this as a signal that substantive actions — like the ECB finally doing what has to be done — are just around the corner? Are they misunderstanding the policy?

    Looks like Krugman is the one who misunderstood the policy. Not because he's an idiot, but because those Europeans are tricky.