Friday fun: Bill Gates drinks Berlusconi's milkshake

Bill Gates announced today that the Bill and Melinda Gates Foundation will spend $10bn over 10 years on developing vaccines for the world's poorest countries. They aim to vaccinate over 90% of children in these countries, and could save over 8.7 million young lives as a result. Gates and his wife are arguably the greatest philanthropists of modern times, using their wealth and influence to address some of the world most under-resourced problems.

Gates also has a sharp sense of humor, as evidenced by the following shot he took at epic blowhard, sometimes assault victim and eternal IPE Journal whipping-boy Silvio Berlusconi:

'Rich people spend a lot more money on their own problems, like baldness, than they do to fight malaria...Dear Silvio, I am sorry to make things difficult for you, but you are ignoring the world's poor.'

In other words, 'I drink your milkshake.'

According to FP Passport, Italy's foreign aid budget was approximately 0.11% of GDP in 2009, one of the lowest in the developed world and half its 2008 amount. This contrasts starkly with the amount of money Berlusconi spends on his own image, which my conservative estimates put at 4,000% of his GBI (gross Berlusconi income).

The Italian premier has grabbed headlines in Italy this week for a disappearing, then reappearing, then disappearing head of hair. The bald Berlusconi is a known purveyor of the art of hair restoration, but the country is gripped by his latest, some might say insufficient, attempts at scalp renewal (I might exaggerate a tad, but it's my blog, so it must be true).

In contrast, Bill Gates spent a great deal of his time and money this week helping the world's poorest and most vulnerable.

Quick hits and pink picks: US GDP Surges

After a busy busy week, I am happy to get back to the blog today and hit on a few points I missed while drowning in Excel hell...

-Hot off the presses: US GDP surged a whopping 5.7% in Q4 2009, the best quarter in over six years, and driven by companies ramping up production to overcome thin inventories amid rising consumer demand. Consumer spending, which accounts for over 2/3 of US economic activity, expanded by a better-than-expected 2%. I'm not even going to make a comment about a job-less recovery, as these are really strong numbers, unless I just did...

-Bernanke wins reappointment, which Simon Johnson believes is the beginning of the end for financial reform. While I disagree (though I imagine the difference in our expectations is only a matter of degree), Johnson's post is great on the strength of the following sentence:

And now we can look back over 20 years and be honest with ourselves: Alan Greenspan contends for the title of most disastrous economic policy maker in the recent history of the world

-The FT has you covered for all things Davos. It's been striking just how little coverage the World Economic Forum has received this year. I wonder if our appetite for it has diminished due to a credibility gap, or if there has been a conscious effort by the WEF to keep a low profile?

-Chavez orders the central bank to 'burn the hands' of currency 'speculators' by selling dollars to strengthen the Bolivar by some 30% in unregulated trading. Massive capital flight complicates his plans.

-FP Passport asks the question we've all been wondering: 'Did Romania's president use the occult to get reelected?"

-Greece is offering investors a large yield premium on its upcoming bond issue, an event deemed 'absolutely critical' to market sentiment and the government's efforts to reign in the budget.

-Are you an English hooligan? Planning on watching your boys lose to the mighty mighty US in person this World Cup (jk)? Denied!

Too Big To FAIL

In the past week there has been plenty of analysis on the Volcker Rule - largely by people more knowledgeable than myself. Most, it appears, agree with the notion that we need to do something to prevent the capitalist pirates on-board S.S. Too Big To Fail (pictured right) from sailing around and holding the rest of our economic flotilla hostage. Most also seem to agree that this proposed "something" is better than nothing.

Much of this is speculation, however, since we lack the necessary details to make a final judgment - details which will apparently be left to that venerable institution known as the US Congress. If the healthcare bill is anything to go by.... nevermind.

But let's back up a bit. Because while I have made it clear that Volcker's vision sounds - at first glance - to be quite compelling, I am still struggling with some of the key concepts. Well, one key concept actually: too big to fail. Volcker's plans rest on the notion that commercial banking has a privileged place in our financial system. We depend upon our banks for the day-to-day running of the economy, the argument goes, so we cannot allow them to act like hedge funds on the side. Fair enough.

But merely separating the two activities into "can be allowed to fail" and "can't be allowed to fail" doesn't really address the problem. Much of the financial turmoil originated in the shadow banking sector: entities engaged in "bank-like" activities (originating loans, re-packaging and securitizing debt) that did not have the level of regulation that commercial banks do OR any of the deposit insurance that keeps things secure (detailed explanation available here). When things went tits up, investors fled the shadow banking sector for, you guessed it, the heavily insured mainstream banking sector. Presto, credit crunch.

So again, the question comes down to how splitting apart the riskiest behaviour of our banks is going to prevent a future crisis of this nature. Poor banking regulation was certainly a problem, but so was the fact that a huge financial industry was created outside the regulatory system. It had no safety valve, no backup whatsoever. Volcker's plan does not appear to address this. If anything, it might make this line of business more profitable.

How can we be so sure that only deposit-taking institutions are systemically important (re: too-big-to-fail) enough to protect? The answer is that we can't. Maybe I've been listening to the top financial regulator in my country too much, but it seems the very act of identifying too-big-to-fail creates its own problems.

So I guess my concern with the Volcker Rule is not what it is proposing for deposit-taking institutions, but what it is not proposing for everyone else.

(Update: the top central bankers in both the UK and EU have vocalized their (qualified) support for the reform proposals - good to see the old boys network holding firm, eh whot?)

Things that do not mix: HD television and the US Congress

Enough said.

I'm now HUGE in Lagos

The venerable BBC World Service has a daily show called 'World Have Your Say,' where listeners and panelists from around the world call in to discuss a topical issue in global affairs. It streams live at 1800 GMT daily on the BBC World Service (here), and has its own blog where you can also post comments live on the air (here). You can also download each episode on iTunes (presumably the next day). Though I suspect it might be harder in China...

Today's topic was 'Google, China and the nature of free information.' I called in, as I have occasionally done in the past, and for the first time: I made it on air!

This was exciting. My two points were classic IPE, even if they were delivered in a very nervous and slightly convoluted manner: 1) what appears to be a commercial dispute is part of a broader escalation in tensions between China and the West, as the West realizes that its 30-year assumption that China's economic integration would be followed by political convergence with Western and democratic values is false, and 2) China risks setting a dangerous precedent that undermines the foreign investment critical to their economic development and ascent up the value-added chain.

If you ever wanted to put a voice to the words on these fine pages, you now can. Check it out!

UPDATE: Here's the podcast, I'm at the 24th minute mark.

Weekend Remainders

A few links for your Sunday reading pleasure:

-As I mentioned on Sunday, China is suddenly likely to allow the renminbi to appreciate in 2010, breaking its de facto peg to the dollar. The FT analyzes.

-Dave asked a good question on the comments page of my Bernanke post below: what's up with Tim Geithner? Volcker apparently drank his milkshake in the White House banks debate, and then Geithner goes on television essentially undermining his president's proposals. Paul Krugman isn't happy about that.

-Looks like Bernanke might have the votes for confirmation after all. Simon Johnson started an interesting, short-lived movement to draft Paul Krugman for the job, but this was quickly snuffed out by Krugman himself.

-The Haitian government believes the earthquake will cut GDP by a whopping 25%.

-Seed Magazine looks at science as diplomacy.

-Obama's first year in statistics.

-Futurists in Britain predict new legs for all, especially troops and football stars.

-NYC's own Vampire Weekend debuted at #1 on the US Billboard charts with their new album 'Contra.' They played New York's Bowery Ballroom on Tuesday, a hometown celebration of sorts, and I was there. Fun was had by all.

Friday Fun: Creationism

There has been an awful lot of heavy IPE material to work through on the blog this week - we're clearly in need of a break. A guilty pleasure to ease the mind, perhaps. Now let me think: what would be an easy target to poke fun of.... ah yes: creationism.

I'll turn things over to A. A. Gill, via the February edition of Vanity Fair. Gill visits the creationist museum in Kentucky and proceeds to dismantle it in short, choppy sentences. A sample:

What is truly awe-inspiring about the museum is the task it sets itself: to rationalize a story, written 3,000 years ago, without allowing for any metaphoric or symbolic wiggle room. There’s no poetic license. This is a no-parable zone. It starts with the definitive answer, and all the questions have to be made to fit under it. That’s tough. Science has it a whole lot easier: It can change things. It can expand and hypothesize and tinker. Scientists have all this cool equipment and stuff. They’ve got all these “lenses” and things. They can see shit that’s invisible. And they stayed on at school past 14.

A nuanced discussion, this ain't. Enjoy!

Missing: Willem Buiter

One voice is notably absent, to me at least, from the debate over the Obama banking sector reforms: Willem Buiter's. If ever there was a moment for Buiter's unrivaled insight, especially on two topics he wrote so passionately about- bloated banks and central banking, it is now.

For those unfamiliar with Buiter, he's not dead. Rather, he assumed the Chief Economist position at Citigroup this month (he also remains at a little school Dave and I know something about), a move that forced him to end his influential blog at the FT called Maverecon. While he assured his readers that he would continue to speak out on the important issues of the day, he recognized his new position would in truth limit his ability to do so. Buiter once called his new employer 'a conglomeration of worst-practice from across the financial spectrum,' and I'm sure he sees his current role as a step towards fixing that. So it is not surprising that he is silent on an issue that affects the very foundation of the firm he now serves.

But it's a real shame.

Bye-Bye Bernanke?

The fate of Ben Bernanke's confirmation is getting a lot of play in the US media today. Momentum for his reappointment has slowed considerably over the past few weeks, and he is losing Democratic votes by the day. The Democratic leadership is reportedly 'scrambling' to shore up Bernanke's support, but it's possible that Ben's candidacy is dead in the water. That is remarkable to me.

President Obama's new banking proposals have opened another front in the Bernanke battle, and many, like Simon Johnson, are appropriately calling on Ben to clarify his position on these reforms. There is a growing lack of confidence in Bernanke's conviction to take the fight to the banks, and without picking up that mantle in a public and convincing manner, Bernanke might be done at the Fed.

Stay tuned, this is snowballing fast.

Some initial thoughts on the Obama's banking sector reforms

As Dave covered yesterday, Paul Volcker finally emerged from his (large) broom closet in the White House as the major force behind Obama's new banking sector reforms. To recap, the US president proposed two new reforms to end 'too big to fail' and limit the proprietary trading operations of banks. His proposals will: 1) prohibit banks from owning, sponsoring or investing hedge funds, private equity funds or proprietary trading operations for their own profit, unrelated to servicing their customers- the so-called 'Volcker Rule;' and 2) prevent the further consolidation of the financial industry.

On the surface these reforms mark a dramatic departure from the administration's standing approach to financial sector reform (fairly benign). But before we get ahead of ourselves with excitement, it is important to recognize the considerable obstacles to these proposals ever becoming law, and examine whether what sounds good in theory is actually inadequate in practice. A few thoughts:

-Obviously we are a bit light on the very critical details. For instance, how exactly will the administration prevent further consolidation in the industry, or end 'too big to fail' as we know it? By limiting the size of individual firms through a cap on assets under management or deposits? Or by applying robust anti-trust scrutiny to any future mergers and acquisitions of financial firms? It seems the administration has collapsed two very different and tricky issues into one concept: limiting systemic risk. You can cap a bank's size, and therefore risk to the system, through higher capital adequacy requirements, but this doesn't address the off-balance sheet activities that were the real systemic threat during the crisis. You might reply that the Volcker Rule would largely resolve the off-balance sheet problem, but it seems the administration has very consciously linked the prohibition on these activities to the prevailing bank-holding company model. Remember, all the big investment banks converted into bank-holding companies during the crisis to access Fed funding, which then entailed setting up retail banking, or deposit-taking, operations. Under the Volcker Rule, these banks would now be unable to de-link retail and trading operations, even conceptually, thus prohibiting every major bank from engaging in proprietary trading unrelated to traditional brokerage (think boring mutual funds instead of exotic securities). There goes almost ALL the profit-making activities the banks currently have.

But what if banks like Goldman Sachs and Morgan Stanley simply converted into a different legal entity once they no longer relied on easy Fed funding for their trading operations? By ditching the small retail operations they have built, they could theoretically return to the old model once they are self-sustainable, thereby bypassing the Volcker Rule all together. This would put banks with huge depository operations like JPMorgan Chase and Bank of America at a competitive disadvantage. Everyone joked before the crisis that Goldman Sachs was the biggest hedge fund in the world: what prevents them from becoming something like an alternative asset management firm? It's customers would in theory possess a higher risk-tolerance and proprietary trading operations could be justified on serving this investor profile. Without formally resurrecting Glass-Steagall, which doesn't appear to be on the table, I am unclear how the administration can put in place a regulatory apparatus that stays two-steps ahead of financial and legal innovation.

-These reforms are an important step in the right direction, but they are also blatantly political, which makes them vulnerable on a number of levels. The administration is claiming that the proposals have been under serious discussion for months, they just needed to be refined and introduced at the appropriate time. This is plausible, as they were proposed on the very day that health care reform 'died.' The administration may have simply been planning a big financial reform push following health care's conclusion, which they expected this month. And surely the posture of bank execs before Congress last week, not to mention record bonus announcements, didn't do themselves or their industry any favors. 'Keep it cool' Obama seems genuinely furious.

But its timing on the heels of the Massachusetts primary in which a Republican candidate won the seat held by Ted Kennedy for four decades smacks of calculated populism. The FT said as much in its editorial. This leaves it subject to political horse-trading, both within Congress and between legislators and the administration. Could it become a bargaining chip in preserving the controversial consumer financial protection agency, Obama's centerpiece reform? Obama could pick off a few Republican supporters for the banking proposals; John McCain has expressed some similar sentiments recently, and the issue taps right into the anti-Wall Street fervor that shows no signs of abating. But he could also lose votes on his side, like Joe Lieberman or the chairman-in-waiting of the Senate Banking Committee Tim Johnson, who is a 'friend' of the financial services industry, to put it diplomatically. If financial reform gets held up until after the mid-terms (when Chris Dodd, current chairman of the Senate Banking Committee, retires) a Johnson chairmanship could pose real problems for the administration.

-Finally, let's say that the reforms get enacted in some form or another. The big winners are then the hedge fund and private equity industries. A lot of people predicted that they would increasingly fill the risk-taking space vacated by the big banks. But with Goldman trading the daylights out of essentially free loans from the Fed, the current status-quo retains plenty of risk-taking in the big institutions. But if prop desks are truly scaled down at these firms, suddenly hedge funds become the major traders in a range of instruments and markets, providing a goldmine to the industry. This raises a whole host of unresolved problems, including systemic risk considerations (remember Long Term Capital Management?). Reform of the hedge fund industry has proven surprisingly difficult in Europe, and limited reforms have thus far been proposed in the US.

So in conclusion, I am left with two basic questions: will the reforms be precise enough to achieve their objectives in an innovative marketplace, and what are the most effective tools in limiting the systemic risk posed by individual firms? I'm eager to see the details of the proposals.

A defining moment for Ukraine, and a lesson in IPE

Ukraine is awaiting a run-off in its presidential election to be held on February 7th between leader of the opposition Viktor Yanukovych and current Prime Minister Yulia Tymoshenko. The winner will succeed President Viktor Yuschenko, who is leaving office with an approval rating in the low single digits, a dramatic fall from grace for the leader of the Orange Revolution. His successor will inherit a country in crisis: economically, financially and existentially. This election could not be more important for Ukraine's future.

Yuschenko's presidency was an utter failure. Granted, he had little domestic support, as his current prime minister (Tymoshenko) is also his fiercest political rival. But his economic record has been dismal in response to the Ukraine's crisis, sacrificing his early achievements in attracting FDI and cutting unemployment. While he has succeeded in turning Ukraine away from Russia and set the country on a path towards European integration (WTO accession, a promise of future NATO membership and negotiations over an FTA with Brussels), he has also presided over near-annual gas wars with Russia that threaten Europe's supplies, a total economic deterioration (GDP contracted about 15% in 2009) and non-observance of key conditions to Ukraine's $16.4 billion IMF program. This led the IMF to suspend its fourth disbursement or $3.8 billion, leaving Ukraine on the brink of default. Yuschenko also managed to swing public opinion decisively against NATO and EU accession, undermining his key foreign policy successes.

Conventional wisdom therefore interprets the current election as a repudiation of Yuschenko's pro-Western agenda, with the two leading candidates representing a more Russia-oriented foreign policy in the years ahead. But according to Samuel Charap's recent article in Foreign Policy, this assumption overstates the degree to which either Yanukovych or Tymoshenko will turn to Russia. Neither candidate is a 'pro-Russian stooge,' even Yanukovych, who according to Charap did little to endear himself to the Kremlin during his stint as prime minister, even if he was the Kremlin's 'preferred' candidate the last time around. Further, the interests that back Yanukovych are heavily invested in EU trade, so one can expect a lot of pressure on the potential president to deepen Ukraine's economic integration into Europe. This is far more critical to Ukraine's future than the immediate prospects for NATO accession.

Tymoshenko's presidency would hold the most promise, as she is likely to fashion a commanding political majority that would leave her free to enact key economic policy reforms, most importantly the 2010 budget and energy sector reform, that would unlock the remaining IMF funds and set Ukraine on a path to recovery. She would also prioritize Ukraine's relationship with Russia, but in the interest of rapprochement, which is as important to Europe (see: gas) as it is to Russia. Thus, both candidates are likely to conduct a more balanced foreign policy, which would be in the interest of all parties. But economics will determine Ukraine's future, and neither candidate can afford to ignore the pressing challenges at home. Both the EU and Russia have a role to play in stabilizing Ukraine's economy.

One of the fundamental insights of IPE is that domestic politics matter as much in the international arena as they do internally. They either enable or constrain foreign policy decisions, and Ukraine's current situation highlights this perfectly. The EU/Russia dichotomy that Yuschenko spent so much time constructing has clouded our perspective on the current candidates and their impact on Ukraine's future, as Charap's article illustrates. Their presidencies will be dominated by jobs, energy and trade. Rapprochement with Russia is likely and welcome, but there are powerful interest groups in favor of further economic integration with the EU. This will check any drift eastward.

"Wake up Gentlemen:" Paul Volcker has landed

Expect some big financial news out of Washington today: it looks like President Obama is set to publicly support the "Volcker banking plan." Paul Volcker has been pushing this approach for some time (Mervyn King has been doing something similar in the UK), but this is the first time he appears to be getting public support from his boss. Broadly speaking, Volcker's goal is to split the potentially contradictory activities of major banks:

"On the one hand, they are commercial banks, taking deposits, making standard loans and managing the nation’s payment system. On the other hand, they trade securities for their own accounts, a hugely profitable endeavor. This proprietary trading, mainly in risky mortgage-backed securities, precipitated the credit crisis in 2008 and the federal bailout..... Under the new approach, commercial banks would no longer be allowed to engage in proprietary trading, using customers’ deposits and borrowed money to carry out these trades."

Simon Johnson provides some cheerleading; Tyler Cowen provides a list of questions to ask yourself when the new plan emerges. Should be fun.

UPDATE: oh my goodness, oh my goodness, oh my goodness! Press release is here.

Wednesday Readables

- John Kay creates analogy between investors and tailgators; proceeds to beat metaphor to death.

- The New York Times to imitate the Financial Times' gated system; Felix Salmon analyzes

- Zimbabwe becomes more mobile, faces dollarization difficulties and even, um, deflation

- Why cable television is bundled. (But just because consumers prefer flat rates, it doesn't necessarily make them a good idea for most people - ditto with gym memberships).

- "If you find yourself in a suddenly resource-rich emerging market and you're interested in knowing whether revenues are being put to the proper uses, just go find the houses of the local government leaders."

- More evidence that Britain is drinking more, binging more, and being less social about it (as if we needed any)

Cheap Money and the Carry Trade, part I: Blowing Bubbles

There are probably very few activities which are shared by both schoolchildren and our fiscal & monetary policymakers, but blowing bubbles is one of them. The difference being that the kids' bubbles usually consist of soap, are far more entertaining, and cannot cause ruin to entire economies when they pop. But it's the metaphorical asset bubbles that I am more interested in.

Metaphorical bubbles and their non-metaphorical problems
Which brings us to the lead story in last week's The Economist. The editorial worries that the loose monetary policies adopted by major economies (printing money; very low interest rates) has created an environment vulnerable to further asset bubbles. In the short term, the side-effect of cheap money on asset prices is being welcomed by many: the profits are helping the market rebound from its earlier downward spiral and firms' balance sheets are being strengthened as a result.

But there are longer-run issues to be concerned about. As the articles explains, "The problem for [investors] is not just that valuations look high by historic standards. It is also that the current combination of high asset prices, low interest rates and massive fiscal deficits is unsustainable." Eventually the cheap money is going to run out when governments scale back their extraordinary measures - this is not a secret. What is not known, however, is whether the process of scaling back is going to be smooth or volatile. History suggests that we cannot assume a smooth transition.

Carry Trade 2009-?
Not all the evidence points to asset bubbles - see The Economist's other article - at least not for the wealthiest economies. Emerging markets, however, are the destination of a lot of this cheap money, which creates its own challenges. To understand why this is so, let's look back to Nouriel Roubini's November editorial about the Mother of All Carry Trades that began in 2009. The "carry trade" is the practice of borrowing in a cheap currency (the USD, with a near-zero - and sometimes negative - interest rate) and investing in risky assets with higher return. Here's Roubini:

"Let's sum up: traders are borrowing at negative 20 per cent rates to invest on a highly leveraged basis on a mass of risky global assets that are rising in price due to excess liquidity and a massive carry trade. Every investor who plays this risky game looks like a genius – even if they are just riding a huge bubble financed by a large negative cost of borrowing – as the total returns have been in the 50-70 per cent range since March [2009]....
Yet, at the same time, the perceived riskiness of individual asset classes is declining as volatility is diminished due to the Fed’s policy of buying everything in sight... By effectively reducing the volatility of individual asset classes, making them behave the same way, there is now little diversification across markets.

Does that bolded sentence sound familiar? It should if you've been following the financial crisis at all. The perception of decreasing risk due to lower volatility can be misleading.

Bear in mind that this carry trade is contingent on cheap borrowing. When (not if) borrowing in USD becomes more expensive, this effect will have to reverse itself or shift to a new currency, like the Yen. If this happens suddenly, Roubini believes there will be a stampede "as closing long leveraged risky asset positions across all asset classes funded by dollar shorts triggers a co-ordinated collapse of all those risky assets – equities, commodities, emerging market asset classes and credit instruments."

So maybe this bubble will pop, as Roubini argues it will. Maybe it will simply deflate. The fact is that nobody can say for certain - but the risk is there. Remember the story of Icelandic people blowing up their Land Rovers to avoid paying them off after the krona tanked? That's a dramatic but useful illustration of what happens when the carry trade reverses itself rapidly.

In the meantime, as I alluded to above, the consequences of cheap money flowing to emerging markets are being felt in a number of areas. I'll look at some of the implications in the next installment.

Venezuela Update: The Hugo Chavez Show continues

Acting on his threats from last week, Venezuelan president Hugo Chavez has begun nationalizing retail stores that would not agree to his enforced "everything 50% off sale:"

President Hugo Chavez ordered Sunday the seizure of a French-owned retail chain on accusations that it raised prices after Venezuela devalued the currency by half....
Almacenes Exito saw some of its stores closed this week by government authorities on accusations that it was increasing prices regardless of Mr. Chavez's orders that retailers were not to adjust prices after he devalued the currency to 4.3 bolivars per dollar from the previous rate of 2.15 bolivars....
Separately, Mr. Chavez also ordered the nationalization of a large shopping-mall recently built in a downtown district in Caracas. The stores controlled by Exito and the shopping mall will be used to build up Comerso, a new government-run retail chain which seeks to sell its products at "socialist" prices, according to the president.

Today it's retail outlets, tomorrow it will be the poisonous video game industry. One can only hope that Chavez will be modeling the new line of government-approved socialist garments on his weekly TV-radio program.

Quick hits and pink picks: emerging markets edition

The FT's profile this weekend of Jim O'Neill, the Goldman Sachs economist who coined the now ubiquitous acronym 'BRICS,' got me thinking about one of my main objectives for IPE Journal: a dedicated focus on the 'rise of the rest.' In looking back over the history of my posts, I realized that the financial crisis, perhaps inevitably, distracted me from this emphasis as my coverage became far more US-centric than I anticipated or desired. That is partly a reflection of the US' role in the crisis and the overwhelming media coverage of the US financial sector over the past year, partly my own engrained anglo-saxon bias in choice of literature and media outlets, and partly a recognition that the majority of our readers are in fact based in North America.

But the pace with which countries like China, Brazil and Indonesia have emerged from the Great Recession has crystalized the importance of the emerging economies to not just my own worldview, but I suspect those of our readers as well. So the following links represent a shift back to the emerging markets and issues that are likely to play a defining role in the years ahead. That is not to say my coverage of US banks or Gordon Brown will cease entirely, but expect a much smaller role for Lord Mandy in the months ahead. This is, after all, a blog on International Political Economy. But I do love Mandelson.

-Via Free Exchange, The Economist looks at a McKinsey study on deleveraging that partly demonstrates why the big emerging markets have emerged far quicker from the crisis than the major economies (Russia aside). If you follow the links to the actual article, I found it interesting that when viewed through the prism of crises, countries like the US and Spain currently look a lot like emerging markets have historically in the aftermath of such episodes.

-China finally takes its foot off the gas by raising reserve requirements on lenders and reimposing a sales tax on certain home sales, fearing that the economy is overheating (asset bubbles and inflation). Conventional wisdom six months ago held that China was likely to allow a gradual depreciation of the renminbi to export its way out of the economic slowdown. Six months later, is a gradual appreciation more likely in 2010?

-A constitutional crisis looms in Nigeria, threatening a recovery in oil output and social/political stability.

-Chile continues the resurgence of the right in the Americas. With Venezuela plunging quite literally into darkness and (hyper)inflation, the 'Bolivarian Revolution' that swept the region looks less-than-promising ten years on.

-Finally, and contrary to the first link, the future may be bright for the emerging economies, but are investors touched by a bit of irrational enthusiasm at the moment?

Efficient Markets Hypothesis: Further Reading

We've seen an uptick in traffic to the site today thanks to Matt Yglesias' reference to the ketchup economics post from a while back. If anyone is interested in exploring this topic further, try reading this discussion of the efficient markets hypothesis.

The challenge for the ketchupal economists is not an abstract one: it affects business execs, government bureaucrats, and huge sections of the financial industry on a regular basis. When attempting to quantify the something as complex as the marketplace, you leave yourself vulnerable to the unquantifiable & the unforseen. For more, see this post about the pretence of knowledge.

(Alternatively, if you're more interested in all things ketchup, I'm sad to say we've got that covered as well: see here and here.)

How to help the Haitian people and relief effort

The human and physical damage caused by the 7.0 earthquake in Haiti yesterday looks to be absolutely devastating. By some accounts the entire capital of Port-Au-Prince is leveled. The presidential palace and UN mission headquarters are gone. The prime minister believes the death-toll has already surpassed 100,000, while a leading senator says the final number could be over 500,000. The problem in a country like Haiti, as they both acknowledged, is that we may never really know. The tsunami in 2004 was a level of natural destruction we had never seen in modern times, and judging by the early indications this earthquake could surpass it in a much more concentrated area.

For any of our readers in the United States who are wondering how they can assist the relief effort, I have found two prominent and active organizations moving provide immediate relief to Haiti: the American Red Cross' International Response Fund, which is pledging an immediate effort of at least $200,000, and UNICEF's US page, an organization that focuses on the most vulnerable in a crisis like this, the children.

I encourage everyone to look into how they can help the situation in Haiti, however small or remote that effort might be.

Correction: The American Red Cross has pledged an initial $1 million, far more than the $200,00 figure I found this morning. Also, if you are in the US and want to donate $10 to the Red Cross' Haiti effort, you can text message the word 'Haiti' to 90999. The donation will be reflected as a charge on your cell phone bill.

The Curious Case of Benjamin Bernanke

Bernanke's speech in Atlanta last week spread throughout the blogosphere like wild fire, and the reaction was not positive. The Fed chief defended US monetary policy in the run-up to the financial crisis and claimed that lax regulation, not interest rates, inflated the housing bubble. A chairman of the Fed defending the bank's record and competence against a backdrop of political hostility and regulatory reform is not surprising. Bernanke's position that prolonged low interest rates played no role in the housing bubble is more so.

But after reading the Fed staff working paper that accompanied Bernanke's speech, the folks at Free Exchange believe that, interest rate correlation aside, the Fed's worldview has been quietly transformed. The Fed's analysis featured three names: Shiller, Kindleberger and Minsky. For those unfamiliar with these men, they are three of most prominent advocates of the idea that markets are imperfect, unstable and subject to psychology (hence the title of Kindleberger's book Manias, Panics and Crashes). This is downright antithetical to the Fed's prevailing ideology, and their acceptance could represent an important shift in the Fed's understanding of markets and its role in influencing them. I can assure you that Alan Greenspan would have neither reached nor endorsed their conclusions, and a search of the Fed's website by Free Exchange found only two previous references to Minsky and just one to Kindleberger.

Paul Krugman agrees with Bernanke that there were compelling reasons for 2002-2006 monetary policy. But this doesn't mean that the policy didn't contribute to the housing bubble, or that the Fed failed to act on the warning signs. Krugman faults Bernanke for not acknowledging the inadequacies of the Fed's prevailing wisdom before the crisis and admitting that they all missed the housing bubble. On this measure his speech was disappointing, particularly for those of us who support a second-term. But by digging beneath the headlines, Free Exchange has highlighted an important shift in the Fed's institutional understanding of markets, regulation and monetary policy, one that is hopefully diffused throughout the policy and academic establishment.

Venezuela Update!

Venezuela has taken the "war on inflation" to a new level (via DeLong):

"Hugo Chávez, Venezuela’s president, on Sunday threatened to deploy troops and expropriate businesses that increase their prices following a steep devaluation of the currency on Friday.... Go ahead and speculate if you want, but we will take your business away and give it to the workers, to the people,” he said, stating there was no reason for businesses to raise prices."

Hmm, expropriation by the government for the good of the people.... Maintaining that level of doublespeak must be exhausting. More likely, this money will be used by the government to pay back foreign creditors.

I gather that Venezuela's currency had been overvalued for quite some time, so this is a good news for Venezuela's revenues from oil exports, on which it relies for about 30% of GDP. That very same GDP contracted by about 3% last year.

Unfortunately for regular Venezuelans, this means that their personal savings have been devalued along with the currency, and those lovely imported DVD players are going to be more expensive. But that's okay! because you can't use a DVD player if you don't have any electricity!

Blog Upgrades

We've just added a visitor map widget (over there --->) that plots the IP addresses of visitors to the blog on a map of the world. Cool! Sure beats doing it manually.

It will start updating shortly, so tell your friends.

A Reminder, Revisited

(Our look back at 2009 is stretching out into January a little, but I'm not quite finished with the stock-taking exercise. Our soap box, our rules)

Around this time last year, I pointed out that, if nothing else, 2008 drove home a fundamental lesson of IPE: the economy drives politics. Many of the best laid plans of early 2008 were sucked down the toilet along with the global economy, leading to some surprising outcomes.

My question for 2009 was therefore: how hard would politics push back? Because push back it did: countries that once championed free market principles quickly turned inward in order to protect their interests and respond to popular outrage. Let's have a look back:

Protectionism

As discussed below, the spectre of protectionism was haunting us early in 2009. In Britain, we suddenly saw shades of populist xenophobia from Gordon Brown (pray tell us, Gord, what exactly constitutes a British worker? shall we ask the BNP?). In the USA there was the noxious "Buy American" clause, the auto-bailout, and some other hilarious examples. India banned Chinese toys for six months. But the most gregarious example of all comes from China itself: the undervaluation of the yuan, and its consequences for everyone else, is probably the biggest protectionist story of the year.

Tobin Tax
While not exactly a crackpot policy proposal, the Tobin Tax (explained here) is still a bad idea. Unfortunately, because it was re-introduced by Lord Turner of the FSA in a widely-publicized report, it got a lot of media play. Thankfully, the US made it clear that they weren't interested so the idea was stillborn (er, maybe not).

[Don't get me wrong - sometimes capital controls are a good idea, especially for emerging markets facing massive inflows of capital, but more on that later.]

Pay czars! Wait, Pay czars?

Somehow the use of the term "czar" here just doesn't inspire confidence. Here we have liberal, democratic, relatively free and competitive societies appointing pay czars to set limits on the compensation of a particular subset of society. I get that skewed pay incentives led to excessive risk-taking, but there were much bigger factors at play.

However, as one astute observer pointed out, the job description of the pay czar is not to curb bankers' pay but rather to curb public anger at bankers' pay. I hope it worked, since I'll bet there were some Frenchmen dusting off their guillotines... just in case.

SuperTax 2009

Further caving to popular anger, the UK and France introduced the SuperTax 2009. I feel no sympathy for the uber-rich bankers traveling in their Mercedes to the Human Rights Tribunal to plead their case. But why stop at bankers? You should at least be consistent.

We Still Like Capitalism, Though, Right?

Taking the long view, capitalism has been a resounding success for humanity. It is the single biggest poverty-killer in history. But as we have seen, the free market is a fragile thing, and prone to excesses. These excesses produce backlash, and the backlash can be severe.

We need only ask John Maynard Keynes, a first-hand observer of how bad the backlash can be. An astute observer of history and human psychology, Keynes had the following to say about pre-WWI Europe:

The power to become habituated to his surroundings is a marked characteristic of mankind. Very few of us realize with conviction the intensely unusual, unstable, complicated, unreliable, temporary nature of the economic organization by which Western Europe has lived for the last half century. We assume some of the most peculiar and temporary of our late advantages as natural, permanent, and to be depended on, and we lay our plans accordingly.

Those advantages collapsed spectacularly in 1914. We spent the next seven decades sorting out the mess. Now, I'm not suggesting that pay czars and supertaxes are the first steps towards a return to communism or fascism or whatever - not by a long shot. But try to remember how unlikely those things would have seemed a couple of years ago. Things change in a hurry.

The lesson that I take from all of this is as follows: the liberal market economy is a fragile social experiment - it is not a naturally occurring phenomenon. We need to keep this message in the back of our minds as we take stock of recent events. This little project of ours requires safeguarding, not hysterics. So let's tone down the ideology and tone down the populism and instead focus on pragmatic ways to keep it going a little longer.

Thursday Readables

- Britons decidedly skeptical of global warming. Children are thrilled; Arsenal fans less so.

- Dispatches from countries that do not exist. "I had my leg propped up on a dark wooden desk and was wincing at the sting of a vigorous alcohol-swabbing by the health minister himself. I was not accustomed to such personalized government service. Fake countries have to try harder, I thought." Outstanding.

- Remember Calvinball? Meet something similar, but more sinister: Terrorball. This game has only two rules: (1) the game continues until there are no terrorists left, and (2) if the terrorists manage to kill, injure or seriously frighten anyone, they win.

- Finally, the chart of the day: the accuracy of economic forecasts from the past decade (or not). Unfortunately, this little graph doesn't tell you who'se forecasts are being plotted, what the forecast time-periods were, or even what the Y-axis represents (GDP, presumably) - so its credibility is suspect. Nevertheless, it vizualizes an important point about market forecasters (or forecasters of almost any kind): they're usually wrong. Forecasts huddle around the median, reality does not.

So the next time a professional economist, government official or IPE blogger offers you a specific forecast - do yourself a favour and ignore them. (...then go read this book!)

Quick hits and pink picks: Shooting yourself in the foot edition

-A leadership challenge to Gordon Brown has once again thrown Labour into disarray, just as the party managed to reverse the Tory poll momentum. Who knew British politics could be so fun! (Update: he has survived, again...)

-The president of Iceland, a country on a fast-track to EU accession, has refused to sign off on legislation that would have repaid the UK and Netherlands some $5.5 bn lost in failed 'Icesave' accounts. He has instead decided to put the matter to a referendum. The move seriously jeopardizes Iceland's EU prospects and threatens to further isolate the tiny nation. The economy minister says the referendum decision has effectively put on hold both the country's IMF program and any decision to lift capital controls. Ouch.

-Argentina's president has fired the president of the central bank over his refusal to back a government plan to tap the country's $48 billion reserves to pay off $6.6 bn in debt this year. One problem: Martin Redrado says he won't go! He says the power to fire the central bank chief rests with Congress and he has no plans on going. Further, the man tapped by Fernandez de Kirchner to replace Redrado, former central bank president Mario Blejer, has declined the offer. Blejer resigned in 2002 due to government interference in the bank's independence. Argentina has finally been making progress in negotiations with defaulted creditors who refused the previous government's offer to renegotiate their portion of the $95 bn 2001 debt default, and was aiming to return to international markets this year for the first time in nearly a decade. The president's intervention does little to bolster the confidence Argentina has taken so long to recover.

Chart of the day: World Trade in 2009

In our year in review of economics, I deliberately left out any discussion of trends in world trade for 2009. This was because, frankly, I couldn't find any information to use. Luckily, there is Mike Mandel to the rescue (via Felix Salmon):




So the IMF figures we're back to where we were in 2003. Great.

That Was The Year That Was: Economia

"The best that can be said for 2009 is that it could have been worse" - Joseph Stiglitz, in China Daily

That pretty much sums it up right there. I have been looking through some of our posts from late '08 and early '09 and things looked pretty grim on a number of fronts. But the year did not turn out quite as badly as it could have. Let's have a look back at some notable items from the world of economics in 2009, shall we?

Some Statistics from 2009
# of US banks shuttered by the FDIC: 136; the current yield on a 1-year US Treasury bond: 0.00%; China's government stimulus package: 4 trillion yuan ($586 billion); inflation of the gold bubble this year: 27%; IIF's projected decline in foreign direct investment to emerging market economies in 2009: 82%; Actual decline as of October 2009: about 30%; IIF's prediction for 2010: probably worth ignoring entirely; The Economist's global public debt clock as of today: $32,052,820,000 (or thereabouts).

Protectionism
When we started our year, the threat of protectionism loomed large in many different countries. We've seen some bad examples throughout 2009 - government-sponsored stimulus packages being probably the worst offenders - but I suspect the above quote from Stiglitz applies here. We can find a number of protectionist anecdotes that make us shake our heads, but it doesn't appear to be systemic. Encouragingly, the G20 at least got the right language in their public statements, even if they haven't followed it to the letter.

The G20's extraordinary economic intervention
Surpassing my wildest expectations, the G20 has proven itself to be something other than a complete waste of time. The members of the G20 have shown themselves to be genuinely interested in making a crack at international cooperation on economic affairs - albeit with the usual cases of counter-productive grandstanding by leaders for their domestic political purposes. Granted, the "trillion dollars" of stimulus money pledged by the G20 in April may have been fudged a little, but the perception that governments were willing to step up and do something probably helped counter the deep-seated uncertainty felt by markets and citizens across the globe.

In all likelihood, the G20's accomplishments will be less about the big numbers and rhetorical posturing of the summits, and more about the incremental changes made by sub-bodies. Take the Financial Stability Board which, despite sharing an acronym with Russia's domestic security services, may prove to be quite useful. The FSB, like the IMF, has been tasked with some of the heavy lifting for the G20: strengthening regulatory standards, developing principles for compensation practices, and monitoring "exit strategies." They will also likely play a role, alongside the IMF, in the G20's efforts to conduct peer-review evaluations of each other's financial policies starting in 2010. Something to watch for.

Return of growth or govt life support?
Many of the economies of the world officially exited recessions my mid- to late-2009. These stats are always subject to later revision, but the overall point - that things did not get profoundly worse for economic growth - is the take home message. Of course, what's unclear is whether this growth will sustain itself when governments begin to ease off the stimulus measures. Moreover, the focus on overall GDP growth ignores the fact that unemployment rates have skyrocketed in many countries.

Macroimbalances
A running theme throughout the year was the dynamic between the US's efforts to re-balance their chronic deficits with China's efforts to continue export-led growth with an under-valued currency. Pressure on China has been growing throughout the year and will continue into the next.

Public Debt
Really piled up.

Some Losers
American auto-makers (esp. GMAC and Chrysler); traditional newspapers; global trade & Mother Nature (casualties of shifting priorities); Gordon Brown (policies as finance minister came home to roost); the US dollar (losing relative clout to China, maybe); frozen waffles & the Icelandic BigMac.

Some Winners
Gold, Goldman Sachs (God's work is apparently quite lucrative); Gordon Brown (crisis has temporarily breathed new life into premiership); IMF (relevant & better resourced); Ben Bernanke; and crackpot populist economic measures

That Was the Decade That Was: the long view

In looking back at the past decade, most commentators have forfeited any meaningful narrative in favor of the proverbial 'better luck next time.' But if the following trends are taken in toto, the past decade in the markets looks downright revolutionary:

-The S&P500 fell 24%, its worst performance since the 1930s, FTSE down 7.3%, DJIA down 9.3%, Nikkei down a massive 44% over the past ten years. Contrast that with the major emerging markets: Russia's Micex index hit the moon with an astounding 802% rise, Brazil's Bovespa jumped 301%, India's Sensex rose 249% and the Shanghai Composite closed 140% higher.

-The benchmark Nymex crude oil contract ended the decade up 210%, but the story in between is among the most volatile in memory. Oil closed out 1999 at $25.60 a barrel, hit $147.27 in July 2008 and ended 2009 at $79.36.

-Spot gold closed the decade up 281%, while copper ended 290% higher.

-Two major stories in the currency markets: the dollar's long decline and the euro's rise to viability. The dollar ended the decade down 23.5% on a trade weighted basis, while the euro gained 43% on the dollar.

So what can we extrapolate from the data above? The 'rise of the rest' is the defining trend of the past decade; loose monetary policy contributed to a great capital flight from developed market equities; the dollar's long relative decline has eroded the US' influence internationally and will shape the coming decade as much as any other trend (politically, financially and economically); emerging market industrialization made commodities a really, really good bet; and precious metals retained their mystical aura in uncertain times.

If you ask people in China, India and Brazil for their impressions of the past decade, I suspect you'll get a more positive consensus than 'good riddance.'

Progress

As usual, The Economist's year-end issue is sweeping and engaging. Its lead article, 'Onwards and Upwards: Why is the modern view of progress so impoverished?' is the paper at its absolute best.

Happy new year.