Tuesday, 30 September 2008
Despite the heaping pile of unknowns, several points seem clear to me. First, everyone can find something to dislike about the piece of legislature that died on the floor yesterday. Second, it was generally understood that the TARP was not going to be the singular cure to the ills in the housing and money markets.
Third, the "blame" for failing to adopt the plan can be shared all around. More Dems voted 'yay' than 'nay,' but Nancy Pelosi still failed to rally 1/3 of her troops and was evidently guilty of trying to ram the bill through knowing full well that most of the Republicans were not ready to accept it. Meanwhile, half of the Republicans voted 'no,' killing the plan and prompting markets to jump into the abyss.
Finger-pointing aside, what irked me most was the language used by certain members of the Republican party to justify their vote against the bill. We heard that this bailout was going to place us on the slippery slope to socialism (re: communism). We heard that the already borderline socialistic White House was now proposing Hugo Chavezesque solutions to economic difficulties. We heard much, much more.
This is infuriating because it is inflammatory, hypocritical, and quite simply wrong. In no way do such comments from the political leadership move the debate forward or help the American economy. Furthermore, as Jonah Goldberg argues, "Only now, when capitalism is in flames, does this fire brigade try to enforce the free-market fire codes without compromise." It's also wrong to suggest that Hank Paulson and Ben Bernanke are doing anything other than trying to find a solution that will allow American capitalism to thrive and for them to return to their respective day-jobs of guiding US fiscal and monetary policy.
A brief history lesson for the die-hard free-marketeers: it was the abominable living conditions of the Industrial Revolution which led Karl Marx to develop his theories; it was the Great Depression which fuelled the rise of fascism and communism and drove America and Europe to the adopt post-war government social programs which you so heavily criticize. Only when capitalism is healthy and regular citizens feel that they too can become rich does the American dream of free markets and individual liberty thrive.
So Congress has told Wall Street to drop dead. Fine. This is not the end of the world. But as I discussed below, the conventional wisdom has no place in unconventional times. When the politicians reconvene on Thursday, I sincerely hope that they leave their ideological baggage at the door.
Monday, 29 September 2008
There are two sentences that I will be keeping in mind as I continue to watch these events unfold over the course of the next couple of weeks. The first comes from J. K. Galbraith, who wrote in The Affluent Society that "In areas of large economic affairs, the march of events... has again left the conventional wisdom sadly obsolete." Although Galbraith penned this line in the late 1950s and was referring to something completely different, I think it's fair to say that the march of events continues uninterrupted, dislodging a lot of comfortably-held beliefs along the way.
Over the weekend, presumably exhausted negotiators reached a tentative agreement to buy up $700 billion in "troubled assets." The plan - which ballooned from 3 pages to 110 - also includes possible restrictions on pay for CEOs of firms who make use of the plan, as well as warrants (convertible into non-voting stock) for the government. The notion that the government could place restrictions on the pay of Wall St. executives is antithetical to the entire spirit of American capitalism, and represents a pretty enormous shift away from the conventional wisdom.
Meanwhile, over in the UK, Bradford & Bingley - a troubled mortgage lender - has been nationalized by the government. Whereas the nationalization of Northern Rock last fall made a big splash, it's unlikely that this B&B deal will dominate headlines for long.
That being said, not everyone has given up faith in the markets. If nothing else, this article in the Washington Post is a refreshing change from the usual headlines. It points out that small banks in America are weathering the storm quite nicely - in fact, their lending has actually increased. Alex Tabarrok, who references the above WaPo article, also makes a couple of other points worth reading (I consider Alex's own plan below).
The second sentence that caught my eye this week came from Barry Eichengreen, a Berkely economic historian and prolific writer. Adjusted somewhat, Barry points out that "Watchers tend to internalize the views of the watched." I thought that was interesting, because there's no doubt that the "watched" right now include first and foremost Henry Paulson and Ben Bernanke. Those two spent their week warning of impending financial meltdown. This, in turn, has been the story carried all week by the media. Because of the authority these two gentlemen command, I think it's fair to say that us "watchers" have mostly been convinced that the conventional wisdom is no longer viable. Whether this is actually true or not remains to be seen.
Moving on. Other upcoming events this week:
- Speaking of the behaviour of spoiled children, North Korea continues to move towards reinstating its nuclear processing plant in Yongbyon.
- Despite the power-sharing deal signed on September 15, Zimbabwe's leaders will continue to struggle this week to resolve the crisis of government.
- The Economist is reporting that "Russian warships set off to Latin America to take part in joint manoeuvres with Venezuela, for the first time since the cold war." (no link)
- Market gloominess will continue to impact the economy in various ways: oil drops below $103; East Asian markets are unimpressed.
- Arsenal is looking to rebound after a poor showing over the weekend: they play Porto in the Champions League on Tuesday.
Saturday, 27 September 2008
-US Congress debates $700 billion "Paulson plan". House Republicans opposed on principle and politics. Having lost his party, Bush's quacking becomes deafening.
-South African President Thabo Mbeki resigns after being pushed out by ANC leadership. ANC deputy president Motlanthe assumes caretaker presidency until likely election of Jacob Zuma next year. Markets initially panic following Trevor Manuel resignation, stabilize on his backtracking.
-Suicide bombing kills 53 people and wounds over 200 at Marriott Hotel in Islamabad. Occurs amid rising tensions between US and Pakistan over US military incursions into Pakistani territory. Reports indicate that the two sides have exchanged fire in recent days.
-Barack Obama and John McCain hold first presidential debate in Oxford, Mississippi. Latest polls...
-Washington Mutual fails. It is the largest bank failure in US history. JPMorgan quickly buys assets, affirms status as Wall Street's only shining light. Bradford & Bingley, UK's largest mortgage lender, expected to be nationalized on Sunday.
-FBI reportedly conducting formal investigation into 26 cases (including Fannie, Freddie, Lehman, and AIG) of possible fraud related to collapse of US mortgage industry.
-Survey/data indicate the Eurozone has fallen into recession.
-Goldman Sachs and Morgan Stanley transform themselves into "bank holding companies", marking the death of the broker-dealer model. Banks submit themselves to significantly greater regulation in order to survive independently.
-Paul Newman, iconic American actor and philanthropist, dies at 83 in Connecticut.
-Zhai Zhigang becomes first Chinese man to walk in space.
-New York City's Yankee Stadium hosts final game. New York Yankees baseball team is vacating 85 year-old "house that Ruth built" for new $1.6 billion stadium across the street.
-Bruno invades Milan's Fashion Week.
Friday, 26 September 2008
By Tuesday afternoon, the country was in the midst of a full-scale political crisis (and possibly on the brink of a financial crisis). 14 ministers resigned over the manner of Mbeki's ousting, including Trevor Manuel, the world-respected finance minister who is widely credited with South Africa's macroeconomic success. So spooked were the markets by Manuel's reported departure, that the Rand sank 3% in less than an hour. When Manuel's press secretary publicly stated his willingness to serve on, the Rand bounced back. But the shock of his departure illustrated just how unstable South Africa's macro success is. It also signalled a period of political instability in Africa's largest economy.
The ANC has dominated South Africa's political scene since the fall of apartheid. Under Mbeki's leadership (which to many extends back well into Mandela's presidency- Mbeki essentially ran the economy as Mandela's deputy), the party embraced liberal macro policies and fiscal discipline. Manuel's stewardship of the economy isolated the influence of the trade unions and old revolutionary communists that dominate the ANC's rank and file, satisfying foreign investors and an emergent (but tiny) black middle class.
But Mbeki's ANC has always been an uneasy alliance. Zuma's resurgence has been driven by a revolt of sorts by the trade unions and rural base. He carries the torch for the old school ANC, concerned with equity and workers rights rather than macro stability and foreign capital. Mbeki and his liberal policies had become so detached/isolated within the ANC, that his ousting was probably inevitable. While he was playing peace-maker in Zimbabwe, Zuma loyalists were orchestrating his demise. Unless the legal proceedings against Zuma return with a sense of legitimacy, he will assume the presidency next year, and the party base will expect a return to the ideological roots of the revolutionary years.
Zuma will have to be attendant to the interests responsible for his rise to the presidency. They want greater spending (difficult given ZA's already troubling deficits and reliance on foreign capital), a renewed focus on jobs and equity (desperately needed), and the abandonment of an inflation-targeting monetary policy (potentially disastrous). But few doubt he will fully reverse Mbeki/Manuel's macroeconomic policies. Zuma himself has been at pains to assure foreign investors and business leaders of his commitment to austerity and monetary discipline.
The real risk to South Africa is a political split within the ANC. This is more likely than it was last fall, when the party seemed united behind Zuma. While woefully unpopular, Mbeki's ousting reeked of revenge and opportunism, and the resentment over this spread beyond the former president's allies. Archbishop Desmond Tutu (Nobel laureate and South Africa's moral authority) was widely quoted as warning, "The way of retribution leads to a banana republic". The mass resignation of ministers was largely protocol (and a show of loyalty to Mbeki), but the former president's allies are unlikely to passively fall in line behind Zuma.
More importantly, the ideological split that has festered beneath the surface of the ANC has now burst into the open. This may be harder to reconcile than old grudges.
Whatever the ultimate outcome of this leadership struggle, South Africa's post-apartheid stability is in real trouble.
Thursday, 25 September 2008
My favourites are: muliebrity, oppugnant, and niddering. I challenge anyone to use a word off of that list during conversation tomorrow.
Also, isn't agrestic also the name of the suburb in the teevee show Weeds? I wonder if that's intentional irony. Either way, that must surely count for popular usage.
UPDATE: here's an interesting video of Ed Rondthaler that reveals the irrationality of the English language. The confusing nature of English is apodeictic, but I still think the sort of rational spelling he proposes would take some of the fun out of it all.
Briefly stated, the effect of the "credit crunch" is that banks/financial institutions are not lending money to other banks/financial institutions. Moreover, they aren't lending to firms, government organizations, individuals, etc... This means that all sorts of things - funding new enterprise, getting a new mortgage, getting a student loan - has become more difficult or impossible. In short, the financial gears that keep our economy running smoothly are grinding to a halt.
Why did this happen? Again, briefly stated, banks made mortgage loans to people with poor credit ratings (or people with poor credit history took on loans they couldn't afford, depending on how you look at it). These are the sub-prime mortgages. When the housing boom slowed, mortgage rates went up and many of these people defaulted on their payments. Some mortgage lenders went bankrupt and banks lost large sums of money.
Furthermore, banks used credit derivative "vehicles" that packaged sub-prime mortgages with higher-grade assets to spread the risk. These bundles of asset-backed securities were then sold on to other financial institutions. When the value of these securities came into question following the housing collapse, more losses and uncertainty ensued.
That's a painful oversimplification of things. But basically the double-shot of large write-downs and uncertainty about the value of assets has left credit markets dry. As Alex explains, banks are the bridge between savers and borrowers. Those bridges are now collapsing. The US Treasury plan is to prop up those teetering bridges; Alex's alternative solution is to encourage savings and thus increase the flow of credit across the bridges that are still structurally sound. He proposes a tax holiday on contributions to an Individual Retirement Account for a year, with the governenment matching a certain amount as well.
Cool idea, but I'm not sure that it will do the trick. The problem is, saving today means forgoing consumption today - that's bad news for an economy facing a recession. Also, as Keynes pointed out, it does not necessarily mean consumption later: uncertainty about the future economy means people may save to have liquidity (assets that are easily accessible/convertible to money) as insurance against economic misfortune. Money saved in liquid assets doesn't automatically increase demand for 'producible' goods that lead to more employment and a stronger economy. In other words: a penny saved does not equal a penny earned.
Also, if the real problem is uncertainty - financial institutions hoarding liquidity and refusing to lend to one another - it's really not clear how an increase in savings will help. Then again, Alex is infinitely more knowledgeable than I am, so I've probably missed something here.
(Photo courtesy of http://www.lewrockwell.com/)
Wednesday, 24 September 2008
Bold leadership or shrewd stop-gap? Discuss...
It could safeguard irresponsible bankers’ jobs, while doing little to stop troubled mortgage debtors from being thrown out of their homes. It seeks to invest massive power in a treasury secretary with a lifelong loyalty to Wall Street. The banks with the worst assets (ie, those which have made the worst decisions) could receive the most help. Most disturbing, the taxpayer will be funding an enormous, ill-defined programme, without any stipulation as yet that the banks who orchestrated the mess will pay a penalty.Martin Wolf:
The fundamental problem with the Paulson scheme, as proposed, is then that it is neither a necessary nor an efficient solution. It is not necessary, because the Federal Reserve is able to manage illiquidity through its many lender-of-last resort operations. It is not efficient, because it can only deal with insolvency by buying bad assets at far above their true value, thereby guaranteeing big losses for taxpayers and providing an open-ended bail-out to the most irresponsible investors.Luigi Zingales:
If banks and financial institutions find it difficult to recapitalize (i.e., issue new equity) it is because the private sector is uncertain about the value of the assets they have in their portfolio and does not want to overpay. Would the government be better in valuing those assets? No. In a negotiation between a government official and banker with a bonus at risk, who will have more clout in determining the price? The Paulson RTC will buy toxic assets at inflated prices thereby creating a charitable institution that provides welfare to the rich—at the taxpayers’ expense. If this subsidy is large enough, it will succeed in stopping the crisis. But again, at what price? The answer: Billions of dollars in taxpayer money and, even worse, the violation of the fundamental capitalist principle that she who reaps the gains also bears the losses.24/7 Wall St:
What has become clear is that Treasury plans to purchase bad assets from banks at prices very near their original value. The risk to taxpayers under this program would be tremendous. If housing prices continue to fall, so will the value of the paper the government has purchased. Under this set of circumstances the public could be at risk for underwriting the great majority of the Treasury's purchases and never having a chance to recoup their investment.Let me add my own two cents. Here's how Section 8 of the original proposal reads:
Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.Excuse me? This gives an enormous amount of discretionary power to the US Treasury and its boss. Given the sums of taxpayer's money involved, oversight is absolutely necessary. Paulson responds.
On a related note, does anyone else think Henry Paulson sounds like a professional wrestler?
Tuesday, 23 September 2008
(Update, Sep 30 - An earlier version of this essay included a specific Tory promise on immigration that was incorrect and has been removed. The full Conservative platform has not yet been released. I'm using press releases, the 2006 platform, the 2007 throne speech, and the National Post article which lists all promises made thus far. It's all we've got, people).
The humble scribblers here at le Journale have made a conscious effort to avoid commenting on the ups and downs of election campaigns, but exceptions are made for issues relating directly to international political economy. Earlier, Rory took issue with the suggestion that a certain US VP candidate's lack of international experience was not a significant matter, or worse: an asset. He argued that it's simply not acceptable for the executive branch of government to be out of touch with global issues when so many of our greatest challenges don't respect national borders. Agreed.
Well, Jeffrey Simpson has pointed to a similar worrying trend up here in Canada: the current election campaign is proceeding along as if the rest of the world doesn't exist. Normally I would insert a self-depreciating joke about how the rest of the world doesn't know Canada exists, but this is patently untrue: Canada is regularly referenced as a model for immigration, health care, multiculturalism, internationalist foreign policy, environmental issues and the like. The sad part is, most of these stereotypes do not hold up well to scrutiny. Canada has one of the worst greenhouse gas emissions rates per capita, our foreign relations have been on a downward trend of late, as have our trading relations and levels of foreign aid. Meanwhile, with the effects of the American recession seeping across the border, the importance of attracting international investment and workers to maintain growth and innovation is more important than ever.
So, with that in mind, I'm going to dig into the policies of the two parties most likely to win the election - the ruling Conservative Party and the rival Liberal Party - to examine the future outlook for foreign countries, firms, and citizens who expect to be dealing with the Canadian government over the next few years. Today's themes will be immigration and trade.
Canada's ability (and willingness) to attract foreign workers represents a huge economic advantage over the United States. The American H-1B temporary working visas are capped at 65,000 per year (!), which makes doing business in the United States considerably more challenging. This has led firms like Microsoft to re-locate north of the border. What are the two main political parties promising to do about immigration?
Conservatives: Quite frankly, not much. By and large, multiculturalism doesn't jive well with the Conservative's emphasis on 'Canadian values,' but to ignore the fact that immigration is a driving force in the competitiveness of the Canadian economy also doesn't fit with their message of economic responsibility.
Liberals: This party has always had a strong emphasis on attracting new immigrants and on the benefits of multiculturalism. Their promises include a new program to facilitate temp workers and international students gain residency, as well as a re-tooling of our immigration points system to emphasize the skilled trades.
Verdict: Liberals look stronger.
Quick facts: exports account for roughly a third of Canadian GDP; 80% of those exports are destined for the (slumping) US economy. Exports are mainly from the automotive, aircraft, telecommunications, oil, gas, and agricultural sectors.
Conservatives: In the past year under the Conservative government, Canada has successfully negotiated free trade agreements with Columbia and the European Free Trade Area. That's good. The Prime Minister has also managed to sour our economic relations with China. That's bad. The party has produced protectionist rhetoric that vows to defend the agricultural community but also a promise to re-assert leadership on free trade negotiations with the Americas, East and South Asia.
Liberals: The party platform includes only three paragraphs on trade, most of which lacks any concrete commitments. Unlike the Tories, the Libs at least give a nod to multilateral WTO negotiations; like the Tories, they also promise to make 'Canadian values' of human rights and corporate social responsibility central to trade negotiations.
Verdict: Both parties are strong on free trade in principle; both violate this principle in practice. The edge goes to the Conservatives.
Monday, 22 September 2008
Sunday, 21 September 2008
After passing through one of the worst - and most interesting - weeks of the credit crisis so far, I’m curious to see how the market reacts after having the weekend to mull it over. As the crisis in debt markets has progressed, the
In my view, the more important question is what precedent this sort of action sets for the future. There are a lot of legal, jurisdictional and practical difficulties associated with the proposal, the outline of which was leaked late last week. For instance, is the US Treasury going to buy up the bad debt from non-American firms as well? If they’re systemically important, why not? For that matter, shouldn’t other affected governments be contributing as well? It appears as though firms must have their HQ located in
In fact, this jurisdictional ambiguity is the sort of thing that led to the creation of the Basle Committee on Banking Supervision following a series of bank collapses in the 1970s. The BCBS began initially through bilateral US-UK talks that expanded to include other countries. Since
Anyway, I’m getting ahead of myself - there will be plenty of other interesting developments this week.
- For instance,
’s ruling (in coalition) Liberal Democratic Party will be selecting a new leader on Monday. Whoever is chosen will become Japan ’s next Prime Minister. Japan ’s Labour Party Conference began today and will continue until Wednesday. Unlike Britain , this will probably not result in a new Prime Minister, but that hasn’t prevented the media from discussing the possibility at length. Japan
- Tensions between the
United Statesand continue over the cross-border raid conducted by US Special Forces that resulted in civilian deaths. Pakistan
- The NHL hockey preseason has begun.
So, I’m happy.
UPDATE: See this list of economists shouting 'no!' to the Treasury's plan.
Fun with Metaphors: The current financial situation is a stack of dishes that requires a Jack Bauer policy approach from the Fed and a $700 billion bailout plan from the US Treasury that will work like a drunk man at the slot machine.
Just Noise: Andrew Sullivan and Naomi Klein debate the nature of the financial crisis on Bill Maher's show. Klein is unconvincing; Will.i.am watches from the sidelines.
Shameless National Promotion: Canadian Business has published a list of the top 40 cities in which to do business in Canada. Half of the top 10 are in Quebec, including the top 3. Vancouver is last. The Kitchener-Waterloo area comes fourth, leading Ontario as a "hotbed of entrepreneurial activity" and home to the Blackberry, international think tanks and several universities. Meanwhile, foreign readers are shocked to learn that Canada even has 40 cities in which to do business.
While I'm on the domestic theme, bilingual readers might enjoy this absolutely hilarious video response to the Conservative government's recent decision to cut spending in the arts. The character in the bow tie is priceless. (Warning: offensive language, including the French word for 'seal.' Hat tip Paul Wells)
Wednesday, 17 September 2008
AIG is a counterparty to insurance, corporate, and financial transactions around the world. It passes the "Bear Stearns test" (interconnection) for government intervention better than Bear itself. Plus, as Hank Greenberg (former Chairman/CEO of AIG and the man who literally built the firm from scratch) has argued, AIG's problem is one of liquidity, not solvency (like Lehman's). It is thus understandable, and appropriate, for the Fed to step in.
But this latest intervention has raised fresh problems for the global financial system. Moral hazard has increased substantially because the criteria for a government bail-out is undefined and poorly articulated in the current environment. No one envies Bernanke, Paulson, and Geithner, and there is no formula for this terrible mess. But government bail-outs have been entirely subjective, and future ones are now impossible to predict. Greater uncertainty is lethal to the markets in their current state, and may lead other fragile financial institutions (namely Morgan Stanley and Goldman Sachs) to assume a safety net. This is dangerous if it leads these firms to refuse asset sales or other prudent (and, most importantly, timely!) actions to raise capital and shore up confidence in their books. Both AIG and Lehman have faced the havoc that just 24 hours of inaction/delay can bring.
Many thought that the bankruptcy of Lehman was a sign that regulators were confronting moral hazard head on. But within hours, moral hazard came back with a bang. Luckily, there are only a few firms left that would qualify as truly "too interconnected to fail".
_ _ _ _ _ _
UPDATE: Demonstrating how quickly things are changing, Reuters is reporting that Morgan Stanley is "weighing" a merger with a commercial bank. This would obviously negate much of the comment above, as it would appear banks are finally accepting the inevitable.
Prediction: by Christmas, there will be no major, independent US investment banks left. The broker-dealer model is dead.
Tuesday, 16 September 2008
Basically, Beckett produced a simple metaphor to explain why same-month-year-ago comparisons don't explain what they are used to explain. Imagine thirteen mountaineers, all linked by rope, climbing a mountain in fog so thick that they are unable to see one another. Only the first and thirteenth mountaineer are allowed to call out their altitude. The presumption here is that so long as the first climber's altitude is higher than the last climber's altitude, they haven't yet reached the summit. By extension, once the two climbers call out the same altitude, they have reached the summit - however, the two climbers could also be at the same altitude if the first climber continued on past the peak and was already well down the other side of the mountain.
The implication for economic analysis is that when you hear something to the effect of "Growth in August was up 2.4% compared to growth in August of last year," you should pause and consider the implications. If we extend the metaphor, the economy could very well be climbing a small hill before slipping on the ice and falling off a precipice into a dark, cold cavern full of sharp rocks (too much?). Instead, a 12-month moving average should be centered on the 6th month.
I have already been guilty of reproducing statistics on this blog that use this type of logic, so hopefully that will change. Also, the next time some obnoxious person at a cocktail party starts quoting statistics of this sort, you can take them down a peg or two. Can't say we're not looking out for you.
Monday, 15 September 2008
The key developments:
-Regulators, executives of financial institutions, and government officials have been huddled in lower Manhattan all weekend trying to prevent the collapse of the US financial system. Efforts to find a buyer for Lehman Brothers failed, with both Barcalys and Bank of America pulling out of talks. Barclays reportedly pulled out after the US government refused to take on the risk of Lehman's balance sheet until the deal closed (no taxpayer money will be committed).
-Lehman Brothers has just filed for bankruptcy. The bank is reported to have refused to devalue its assets below a certain level, essentially insisting that the bank is in better shape than everyone thinks. Some might interpret this position as a negotiating strategy, but in retrospect it appears to have been insanity, as the bank was forced to file for bankruptcy late Sunday evening. The 158-year old firm wasn't as interconnected as Bear Stearns, and was therefore allowed to fail.
-Bank of America has agreed to buy Merrill Lynch for around $50bn. Merrill Lynch was expected to be one of the next banks in the short-seller's sights, and once it became clear that Lehman would fail, Merrill CEO John Thain moved quickly to protect the bank. BofA now rivals Citigroup for the title of largest financial institution in the world.
-The US Federal Reserve has greatly expanded its lending facility and taken the unprecedented step of accepting equities as collateral.
-10 global investment banks have pooled $70bn into a lending facility to inject liquidity into the markets. Any of these banks are eligible to borrow up to a third of the facility.
All major markets around the globe are significantly down in the futures markets (many Asian markets are, thankfully, closed for holiday on Monday). A strategist on CNBC World just said that the global bear market is now entering "legendary" territory (measured by % decline).
Sunday, 14 September 2008
This journal reported earlier that inflation was probably going to be a temporary, one-year hit, but this is a bit surprising. This development may also shore up Ben Bernanke's position against the inflation hawks* on the Fed Open Market Committee, who have been pushing for interest rate hikes for some time - hikes which would increase the cost of borrowing and dampen the rebound capacity of the American economy. In a nutshell, the hawks believe that the Fed's current low rate of interest is enough to fuel inflationary expectations; if Krugman's interpretation of bond rates is accurate, then the market disagrees. The Fed meets again on Tuesday so stay tuned for that.
Unfortunately, the specter of inflation is still haunting much of the rest of the world like that nearly-headless Harry Potter character. Instead of stimulating export growth, the plummeting pound sterling has so far only raised the prospective costs of imports for the UK. Meanwhile, the European Central Bank is also struggling with entrenched inflationary expectations as Germany's largest trade union is setting itself up for the largest pay hike in 16 years, to the tune of 7 or 8%. What higher inflation in Europe will mean for the rest of the global economy is something worth considering closely.
*This post is the first of many appearances by Harold, the inflation hawk. His brother, Pete the deficit hawk, has been vacationing in the tropics for a while, with dire consequences.
Thursday, 11 September 2008
Wednesday, 10 September 2008
OPEC surprised markets this morning by announcing a 520,000 bpd cut in production. This reflected the concerns of certain members (Iran, Algeria) over the recent decline in commodity prices amid falling demand and the unwinding of financial positions. However, reports are that almost immediately the Saudis (who opposed the cut) were assuring markets that they would not abide by the decision.
This internal split is many years in the making, and reflects the competing interests/viewpoints within the cartel (essentially, Saudi v. all). Because of the Saudi position, markets largely shrugged off the announcement, believing that the kingdom would maintain current production levels.
These developments got me thinking: Does OPEC really matter anymore?
Since the oil shocks of the 1970’s, OPEC has been the dominant actor in the global oil markets. Currently, OPEC produces approximately 40% of global supply, and possesses about two-thirds of the world’s proven reserves. OPEC has also historically provided the spare capacity required to respond to demand spikes and shocks to the global system.
However, in recent years the cartel’s market power and influence has waned. Official statements like the one this morning have failed to calm traders, stabilize record price volatility, or move markets. Two particular measures of OPEC’s influence highlight its declining influence: as a provider of global spare capacity, and as a price setter.
As non-OPEC production growth has failed to keep up with accelerating global demand, OPEC has increased production to cover the shortfall. As a result, the cartel’s spare capacity has diminished. Most OPEC members (with the exception of Saudi Arabia) are now producing at near total capacity. In an environment of heightened political instability in oil producing regions, poor refining capacity, and robust Chinese and Indian demand growth, OPEC lacks the short-term flexibility to stabilize volatile prices. This decreases its authority and influence in the global market.
Like spare capacity, OPEC’s ability to set the price of oil has declined markedly. A number of factors have contributed to this change:
First, rapid demand growth across the developing world has increased supply concerns. The emergence of powerful new consumers in Asia has compounded fears that decades of underinvestment will result in a significant supply shortfall in the coming years. OPEC’s capacity to meet this rising global demand is in doubt.
Second, the growth of both regulated and unregulated over-the-counter exchanges has led to a massive increase in the amount of so-called “paper-barrels” traded. Consequently, financial speculation has become an important driver of the spot price. This diminishes the impact of OPEC production/quota changes on short-term prices. For example, Saudi Arabia’s recent announcement that it was increasing production by 700,000 bpd barely registered on the exchanges.
Finally, political instability in the Middle East has had a significant impact on the price of oil over the past 5 years. Instability in Iraq and Lebanon, the Iranian nuclear issue, and the threat of terrorism have all contributed to record price volatility. OPEC’s inability to ramp up production in response to politically-related price spikes affirms its diminished capacity.
While no longer the market mover it once was, OPEC remains the single most important actor in the global oil market. The fact that the cartel possesses the majority of the world’s proven reserves guarantees its staying power. Non-OPEC production is forecasted to decline rapidly, as alternative fields are geologically complex and difficult to operate. Russia, the world’s second-largest oil producer, last year witnessed its first year-on-year production decline in over a decade. The key challenge OPEC faces in the coming years may be its own internal disagreements, as reportedly playing out today. Despite these differences, the Saudis have always exercised leadership by adjusting their own production disproportionately to accommodate the self-interested actions of other members. As long as the Saudis retain the will to lead, overall unity should prevail.
Thus, while it no longer dictates the global oil market, OPEC remains an important actor whose influence should increase again in the coming years.
The date alone deserves a post. Here are some assorted links on stuff that's interesting:
Why Libertarians Should Vote for Obama, part I - by Alex Tabarrok. This is brave, although it has been clear to many of us that the Republicans since Reagan have been all about 'big government,' just of a different sort.
The US budget deficit for fy 2008 will be $407 billion, or twice that of last year. Wee!
Normal businessmen, or tunnel businessmen? - the underground economy between Gaza and Egypt.
Financial repression in China - Control over the interest rate is resulting in negative real returns on deposits, slower growth of the commercial banking system, and other bad things.
Bad news for that new graduate degree.
Tuesday, 9 September 2008
Imagine, if you will, a classified ad that reads...
"For sale: a two-bedroom apartment in a Soviet-style 1960s apartment block in a mediocre neighborhood. Fourteenth floor, elevator last operated in 1990. Erratic plumbing, no maintenance in the past 22 years."
Asking price? 300,000 USD. Brand new single-bed apartments start at $1 million.
As you may have guessed, the driving force behind this property boom is oil, with diamonds coming in a distant second. Angola is now Africa's 2nd largest oil producer, with something to the effect of $30 billion worth exported last year (I'm citing Stephanie Nolen, the Globe's indomitable international correspondent, who is spending her week there). As expected, representatives from American, European, Russian and Chinese firms are pouring into the place trying to get a piece of the action and paying little heed to the longer-run implications of the country's recent transformation.
This is too bad because there is reason to be hopeful. This past weekend, Angola held reasonably fair parliamentary elections for the first time in 16 years. This is also the first glint of democratic shine since the country emerged from a 27 year civil war in 2002 - a conflict that the Americans, Chinese, Soviets and South Africans all played a role in exacerbating in one form or another. Moreover, there is huge potential for social progress waiting to be extracted from the oil fields and diamond mines of this coastal African country. 40% of the country lives in poverty (<$2/day) - 70% in Luanda itself - and the literacy rate is somewhere around 60-70%. If handled properly, the massive influx of FDI can lift many of these people from a perilous lifestyle of begging to one where they can apply their entrepreneurial spirit to grow and diversify the economy.
But there are many potential pitfalls along the way. That expensive property mentioned above? Most of it is occupied by squatters who are unlikely to have anything resembling a legal deed to their homes. This leaves them vulnerable to mass relocation programs that so far have displaced 20,000 people to the outskirts of the city. Moreover, many of the "suburbs" in Luanda are built on literal mountains of garbage that are susceptible to "trashslides" during the rainy season. Corruption is also a severe problem, with each member of the (re-elected) government owning parts of the joint-ventures made with foreign firms. The President's eldest daughter is the majority shareholder for about a dozen companies.
What should be clear from Nigeria is that oil wealth alone is not enough to create sustainable progress, not even when coupled with democratic elections. Unfortunately, I dont expect the foreign investors or governments to be pushing very hard for reform so long as they are reaping the benefits of this newly-peaceful arrangement. I say again: that's too bad, because it's partly neglect and narrow self-interest that left this country devastated for almost thirty years.
Monday, 8 September 2008
At approximately 9:30am Geneva-time, CERN (the European Organization for Nuclear Research) will send a beam of protons around the 17-mile long Large Hadron Collider. Over the next few weeks, protons will be accelerated to a speed of 7 trillion electron volts and then smashed together. The resulting conditions will be equivalent to a trillionth of a second after the big bang, and theories abound as to what will follow.
The physicists orchestrating this galactic roulette are hoping that the experiment will offer the most profound insight ever into our universe's origins. Others (and not kooks, rather well-respected physicists) believe that the machine will produce a tiny black hole a second, consuming us all. They have even sought legal injunctions to prevent the experiment (and save the world).
At best, our entire understanding of the universe will be turned upside down and the Higgs boson (or 'God particle') will be revealed. At worst...Armageddon cometh.
So here's a little essay I came across some time ago, but was reminded of by a recent conversation with a friend. Apparently, the internet has reached the point where one new blog is created every second. Thatsalottablogs. Admittedly, most of these blogs will be crap. But unlike the crap you find on television which has been vetted by marketing execs and focus groups, the crap on the internet is almost entirely home-made. Even better, what constitutes "crap" is a matter of subjectivity, so there's a much more democratic element to how people choose to use/waste their time on the 'net. Moreover, the creative potential inherent in the internet is almost too big to grasp. If someone has an idea and posts it on YouTube, it's possible to reach literally millions of people - take this absorbing video by Noah featuring an unreasonably addictive piece of music by Carly Commando.
So even if only a fraction of the stuff on the internet contributes to a better society in any shape or form, that's going to change our social landscape a great deal. At least, that's what Clay Shirky thinks is happening with what he calls our collective 'cognitive surplus:'
Let's say that everything stays 99 percent the same, that people watch 99 percent as much television as they used to, but 1 percent of that is carved out for producing and for sharing. The Internet-connected population watches roughly a trillion hours of TV a year. That's about five times the size of the annual U.S. consumption. One per cent of that is 100 Wikipedia projects per year worth of participation.The above quote doesn't do this essay justice: there is much, much more in the full text of Looking for the Mouse. Also, if you're feeling extra-lazy, there's a video version of the same talk if you scroll down the page here.
I think that's going to be a big deal. Don't you?
(image from scienceofdrink.com)
Foreign direct investment (inbound): Good
Current account deficit: Bad
Trade deficit: Catastrophic
Capital account deficit: Not used. Presumably bad.
Weak national currency: Bad
Rising house prices: Good
Falling house prices: Bad
Affordable houses: Good
Unaffordable houses: Bad
Free trade: Neutral
Unfettered free trade: Bad
Fair trade: Good
Buying local produce: Divine
Pay rises: Good
Low interest rates: Good
Communism: Very Bad
Saturday, 6 September 2008
- Internationally, one of the greatest booms of all times is finally coming to an end. Demand is falling throughout the world, and soon Russia will also be hit. This factor alone has brought the Western world to stagnation.
- Russia's main problem is its enormous corruption. According to Transparency International, only Equatorial Guinea is richer than Russia and more corrupt. Since the main culprit behind Russia's aggravated corruption is Putin, no improvement is likely as long as he persists.
- Infrastructure, especially roads, has become an extraordinary bottleneck, and the sad fact is that Russia is unable to carry out major infrastructure projects. When Putin came to power in 2000, Russia had 754,000 kilometers of paved road. Incredibly, by 2006 this figure had increased by only 0.1 percent, and the little that is built costs at least three times as much as in the West. Public administration is simply too incompetent and corrupt to develop major projects.
- Renationalization is continuing and leading to a decline in economic efficiency. When Putin publicly attacked Mechel, investors presumed that he had decided to nationalize the company. Thus they rushed to dump their stock in Mechel, having seen what happened to Yukos, Russneft, United Heavy Machineries, and VSMP-Avisma, to name a few. In a note to investors, UBS explained diplomatically that an old paradigm of higher political risk has returned to Russia, so it has reduced its price targets by an average of 20 percent, or a market value of $300 billion. Unpredictable economic crime is bad for growth.
- The most successful transition countries have investment ratios exceeding 30 percent of GDP, as is also the case in East Asia. But in Russia, it is only 20 percent of GDP, and it is likely to fall in the current business environment. That means that bottlenecks will grow worse.
- An immediate consequence of Russia's transformation into a rogue state is that membership in the World Trade Organization is out of reach. World Bank and Economic Development Ministry assessments have put the value of WTO membership at 0.5 to 1 percentage points of additional growth per year for the next five years. Now, a similar deterioration is likely because of increased protectionism, especially in agriculture and finance.
- Minimal reforms in law enforcement, education, and health care have been undertaken, and no new attempt is likely. The malfunctioning public services will become an even greater drag on economic growth.
- Oil and commodity prices can only go down, and energy production is stagnant, which means that Russia's external accounts are bound to deteriorate quickly.
- Because Russia's banking system is dominated by five state banks, it is inefficient and unreliable, and the national cost of a poor banking system rises over time.
- Inflation is now 15 percent because of a poor exchange rate and monetary policies, though the current capital outflow may ease that problem.
Friday, 5 September 2008
Given the number of classmates that just spent their summers researching the IPE implications of SWFs, I'm expecting a flood of comments/emails explaining to me what Germany's new law means for the relationship between investment, trade, and politics. While I'm waiting on that, I will point you to two editorials on the subject: the first by Paul Maidment over at Forbes, the second by the Economist. The cartoon in the 2nd link alone is worth the jump.
The Thai people are currently facing two unpalatable alternatives. On the one hand, the current Prime Minister, Samak Sundaravej, is a rural populist with a sharp tongue that has not been particularly effective since being elected about 18 months ago. Moreover, his cabinet, which includes many members of the previously-deposed government of Thaksin Shinawatra, hardly inspires confidence. His government has been labelled "a shambolic misadventure" by the Bangkok Post, given its failure to deal with the deteriorating economy, food price inflation and a radicalized opposition. But in all likelihood, the alternative is worse.
The rioting and protesting of the past week has been spearheaded by the People's Alliance for Democracy (PAD). Despite it's name, the PAD seeks a regression of democratic rights: resenting populist governments that cater to the urban poor, this group wants to limit voting, reduce the number of elected representatives to 30 and allow the rest to be appointed by business and trade organizations. Yikes. The Economist editorial staff refer to the PAD leadership as "[a] gruesome bunch of reactionary businessmen, generals and aristocrats." But what's even more worrisome is that the PAD has the support of elements of the urban middle class. This, as Gideon Rachmond points out, is yet another qualifier for the overly-simplistic theory that the rise of the middle class will necessarily lead to more democratic reform - something we have discussed before with respect to China. The fact is, ineffective or otherwise, Mr. Samak was elected in a reasonably democratic election. He should be "un-elected" only if and when the population has had enough.
A second, and related, problem facing Thailand is the economy. With the political turmoil exacerbating an economy already weakened by slowing export revenues, the Thai stock market has tumbled to a 19-month low. This economic downturn risks spreading to other East Asian markets, some of which are already showing worrying similarities with the trends that led up to the economic meltdown ten years ago. This may not be the doomsday scenario it appears to be from the headlines, but the volatile mix of political instability and economic weakness in a country as significant as Thailand is something to keep an eye on.
(For possible implications for the USD, see Rory's post below; thanks for the pointer, M)