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Economics

Archive | Economics

Could the Global Bond Market cause another Global Financial Crisis in 2013?

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Ben Bernanke, Chairman of the Federal Reserve pictured with Treasury Secretary Timothy Geithner in the background

Ben Bernanke, Chairman of the Federal Reserve pictured with Treasury Secretary Timothy Geithner in the background

With Christmas and New Year cheer and optimism still bubbling away for most of us we now need to turn our attention to the major risk factors that are likely to impact upon the world economy and financial markets during 2013. While the world economy is estimated to have grown by over 3 percent in 2012 overall and has enjoyed such a remarkable escape from the paralysis affecting some of its constituents like Europe, a major issue is whether this stable growth trajectory will continue for the foreseeable future.  At the end of the day the global stock market has been a secular bear market for over a decade and we are now at the juncture of ascertaining whether the bear will have its final growl in 2013 or we will enter a new market phase.

The economic fundamentals are very strong for world economic growth, thanks to a relatively soft landing for China. However, a number of world risk factors prevail that could upset the world’s economic and financial stability. The major risk factor emanates from the global bond market where yields have been driven down to historic lows on both sides of the Atlantic due to Quantitative Easing [QE] or the printing of money. This has had a knock on effect in emerging markets, through the interest rate parity mechanism and emerging economy sovereign debt yields are also historically very low, despite their high level of political risk and this may be why emerging economies outperformed the world’s average GDP growth by around 2 percent because of lower financing costs.

Global risk emanates from the northern hemisphere, in particular the EU and US but these can wreak havoc elsewhere. Europe is still a major issue in terms of world economic fortunes and 2013 will be a make or break year for them in terms of the single currency that necessitates closer banking and political union. Already, the UK is hinting of the need for a tiered system of membership to exist, which although critics describe as a ‘two speed EU’, would allow banking, monetary and political union to move forward at a faster rate. For would-be contenders on the European continent this could boost the viability of the Eurozone, whilst keeping the rationale of a strong Europe intact and expand the free trade area without leaving anybody out. This consensus has been gathering momentum in recent months and would certainly fortify the global institutional framework and contribute to a more stable world economic growth.

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Democracy and Economic Growth: Part Three

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Vladimir Putin at the World Economic Forum in Davos, Switzerland, January 28, 2009.  Photo: Remy Steinegger

Vladimir Putin at the World Economic Forum in Davos, Switzerland, January 28, 2009. Photo: Remy Steinegger

So, economic development precipitates the growth of a middle class, which, in turn, ferments political reform, best manifested through democratization. But does this transition promote further growth? The answer is yes, it does; however, this renewed economic growth is not the same as before. To understand this, it is worth considering the finite nature of economic expansion. Figures of GDP growth such as the annual 8 percent that China has been regularly posting are only sustainable for a limited amount of time.

As has been stated previously in this series, the driving force of national economic growth is competitive advantage. This is achieved, quite simply, by undercutting international competition, and selling goods or services to foreign markets at a lower price. This can only be achieved for so long, because the increasing export sales of national goods bring more money into the country, which leads to a subsequent increase in the value of domestic currency, which accounts for this financial increase.

However when the value of currency rises, domestic wages and costs associated with the construction or delivery of exports rise. This eats into the profits of exporters, who are consequently required to increase the price of the products that they are selling. Thus, the exports lose their original competitive edge, and both sales and profits decrease.

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Democracy and Economic Growth: Part Two

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Saudi King Abdullah speaks with Bahrain's King Hamad bin Isa al-Khalifa during the 26th Janadriya festival on the outskirts of Riyadh

Saudi King Abdullah speaks with Bahrain’s King Hamad bin Isa al-Khalifa during the 26th Janadriya festival on the outskirts of Riyadh

I previously argued that democracy often inhibits the economic growth of developing states. This is because democracy generally results in the diffusion of economic decision making throughout the population, which exposes domestic businesses to larger, more efficient, foreign competitors. Thus, I contended that centrally coordinated control over economic policy allows for greater long term growth, and the political conditions most favourable for this are authoritarian ones.

For example, all of the so called ‘Asian Tigers’ achieved economic growth through the implementation of protectionist economic policies, which were coordinated via a centralised authority. Moreover, almost all of these countries democratised only after their economies had become developed.  Nonetheless, they did democratise, which brings us to another question: Is economic growth good for democracy. And the answer is, initially, no

As stated in the first article, only three of the world’s top twenty richest countries are not democratic. Of these three, both Saudi Arabia and Russia derive their wealth from the primary economic sector, resource extraction, in the form of non-renewable energy reserves. The former, in particular, generates massive revenue from its abundant crude oil reserves, which constitute 95 percent of exports. Coupled with a relatively small population, of which around a third are foreign expatriates, the kingdom is blessed with a very high per capita GDP.

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Democracy and Economic Growth: Part One

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Voters in Portland, Maine.  Joel Page/BDN

Voters in Portland, Maine. Joel Page/BDN

As the world becomes increasingly fearful of the economic crisis which has emerged within the Eurozone, it seems poignant to contrast the fate of Greece, the home of democracy, and the centre of Europe’s economic malaise, with that of China, the poster boy for authoritarian governance. Whilst there are, of course, vast differences between these two countries, the economic rise of China under an authoritarian regime suggests that it is worth posing the question; is democracy good for the economy?

To begin, it is worth stating that democracy is a complex concept, so for the purpose of this article, we shall consider democracy in its most basic terms: A political system based upon the right of citizens to participate in political decision making through representation; whereby only laws essential to maintaining democratic procedures are necessary criteria to terming a state democratic.

Out of the world’s twenty richest countries, measured by nominal GDP, only three are governed by non-democratic systems: Russia, China, and Saudi Arabia. Moreover, this striking correlation of strong markets and democratic political systems is, theoretically speaking, logical. This correlation is underpinned, not by democracy per se, but by liberalism, most commonly manifested politically as liberal democracy.

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Mark Carney to head the Bank of England

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Mark Carney, Governor of the Bank of Canada, speaking at the World Economic Forum in Davos, Switzerland, January 27, 2011. Photo: Jolanda Flubacher

Mark Carney, Governor of the Bank of Canada, speaking at the World Economic Forum in Davos, Switzerland, January 27, 2011. Photo: Jolanda Flubacher

As a Canadian, perhaps I should feel a surge of patriotic pride now that Mark Carney has been designated the new head of the Bank of England – quite a step up for the current governor of the Bank of Canada. There is no question that Mr. Carney is a market-savvy guy (he did, after all, work for the vampire squid), and his experiences as Chairman on the Financial Stability Board (FSB) suggests that he is sensitive to the ongoing systemic risks present in our increasingly complex global banking system.

That said, his recent attack on the Bank of England’s Andy Haldane in a Euromoney interview last month, does give one some cause for concern, particularly as it evinces the usual complacency that most Canadians seem to feel about the basic soundness of their own banking system, which essentially upholds the universal banking model as a viable one. By contrast, in his famous “dog and frisbee speech” delivered last August at Jackson Hole, Wyoming, Haldane suggested that, “Regulation of modern finance is almost certainly too complex. That configuration spells trouble…Because complexity generates uncertainty, it requires a regulatory response grounded in simplicity, not complexity.”

In contrast to Andy Haldane, Governor Carney is comfortable with the “universal banking” model, so long as they have sufficient capital buffers and do not put taxpayers at risk. Well, there’s a number of things to be said in response to that. For one, even though Canada’s banks are large within the context of the Canadian economy, their asset size is still relatively paltry in relation to, say, JP Morgan/Chase.

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The Fiscal Cliff and the American Economy

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President Obama with Congressional Leaders at the White House.  Pete Souza/White House

President Obama with Congressional Leaders at the White House. Pete Souza/White House

Looking at the latest US data, business sentiment and capital spending have been eroding, and given the lagged impact of capex, that trend looks set to continue for the next few months. Against that, a number of consumer sentiment indicators remain upbeat and housing looks like it is in a firmly established uptrend, after a 5 year bear market. In fact, the existing home inventory to sales ratio is as low as it ever gets, and that is with still very depressed sales. If sales pick up further, given low inventories and with new housing starts still below the replacement rate, home prices could lurch forward.

That said, the markets have been fairly upbeat given the rising perception of a deal to avert the US falling off the ‘fiscal cliff’. But even a deal that drains, say, 1-1.5% of GDP will have negative consequences for the US economy. Bear in mind that the U.S. still has a very high ratio of private debt to GDP. Therefore any such fiscal restriction as contemplated by the two parties may result in a significantly lower economic growth rate than the average 3% rate of the last five quarters (which is what the revised economic data of the past few quarters will eventually show).

Of course, if there is no compromise, the impact could be calamitous. The IMF projects as much as a 4% decline in GDP if there is a full fiscal cliff. In 1936-37 there was a fiscal cliff of almost 6% of GDP. It was followed by a 36% non annualized decline in industrial production in a mere eight months in late 1937/early 1938. More recently, all of the European countries fiscal restriction has had a more negative impact on GDP than had initially been forecast.

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Weariness Foretold: The EU Budget Summit

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Prime Minister David Cameron during a news conference in Brussels on the negotiations over the EU budget.  Philippe Wojazer/Reuters

Prime Minister David Cameron during a news conference in Brussels on the negotiations over the EU budget. Philippe Wojazer/Reuters

There were always going to be disagreements about next year’s EU budget, which started in the evening instead of a sensible morning hour, and occupied officials into the early morning. Various MEPs pitched for an increase in spending for this year (some 7.3 billion pounds) and the next. The European Parliament has been considering restoring some 6.5 billion pounds worth of funding slashed by governments from next years’ budget. The austerity battles continue to remain running affairs. Eight hours of negotiations only ended out in walkouts, suggesting that the summit to agree to the EU’s funding plans for 2014-2020 might be stalled.

The EU Commission’s claim is that an increased amount is necessary to pay the bills. New Dutch finance minister Jeroen Dijsselbloem found that claim barely believable. “I’d question that very much. The Commission has to re-prioritise, that’s just the way it is. Budgetary discipline is not just for the member states.”

The British are being characteristically cantankerous. When in doubt, cut, slash and burn. To be fair, the system of funding in the EU is such that increased contributions will be required from contributor economies if the desired amounts are to be met. Each state has its own domestic program to implement, austere or otherwise. That, at the end of the day, is a problem the EU has yet to resolve.

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China’s Investments in Africa

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Chinese and Chadian oil workers worked side by side at the exploration site in southern Chad. Ruth Fremson/The New York Times

Chinese and Chadian oil workers worked side by side at the exploration site in southern Chad. Ruth Fremson/The New York Times

There is agreement among those who follow China-Africa relations that state-owned and private Chinese companies have become major investors in Africa over the past 10 years. Even Chinese individuals are investing small amounts in enterprises ranging from restaurants to acupuncture clinics. It is possible that in the past several years, China was the single largest bilateral source of annual foreign direct investment (FDI) in Africa’s 54 countries.

There is, however, considerable confusion as to what constitutes Chinese investment in Africa. Many analyses, especially journalistic accounts, conflate investment with multi-billion dollar loans from China to African governments that often use the loans to build infrastructure by Chinese construction companies. These loans tend to go to resource rich countries such as Angola, Democratic Republic of the Congo and Ghana and are usually repaid by shipping natural resources to China. These loans are not FDI; they are commercial deals, albeit often with a concessionary loan component. It is important to keep them separate from investment.

So how much have Chinese companies and individuals invested in Africa? I have concluded that no one, including no one in China, knows the answer to this question. For that matter, it is not even clear how China defines FDI. China’s Minister of Commerce, Chen Deming, stated in mid-2012 that as of the end of 2011 China’s cumulative FDI in Africa “exceeded $14.7 billion, up 60 percent from 2009.”

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Has Mario Draghi Saved the Euro?

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Mario Draghi, President, European Central Bank. Monika Flueckiger/World Economic Forum

Mario Draghi, President, European Central Bank. Monika Flueckiger/World Economic Forum

Germany’s Constitutional Court gave a green light on Wednesday for the country to ratify Europe’s new bailout fund, boosting hopes that the single currency bloc is finally putting in place the tools to resolve its three-year old debt crisis.

In an eagerly anticipated ruling that has had investors on tenterhooks for months, the court in the southern city of Karlsruhe insisted the German parliament be given veto rights over any increase in Berlin’s contribution to the 700 billion euro European Stability Mechanism (ESM). There were strings attached to its endorsement of the ESM and a separate European pact on budget rules, and a relief rally has occurred as another apparent impediment to a euro “solution” appears to have been eliminated.

That said, in rejecting several applications for injunctions to block the ESM and a parallel “fiscal compact”, the constitutional court warned that it would only issue a final judgment later. Officials said that could be before the end of the year or in early 2013. Although the final judgment is unlikely to differ in substance from Wednesday’s ruling, the judges warned that they may also then investigate the legality of the European Central Bank’s move last week to resume buying periphery government sovereign bonds to reduce the excessive cost of borrowing. So, is all not clear for the euro? Certainly, the ECB’s involvement in an “unlimited” form (to use Mr. Draghi’s own words) appears to ensure that the euro fat tail risk of “vaporising” has been reduced, but at what cost?

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Public Sector Jobs Are Real Jobs

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President Barack Obama in the White House press briefing room

President Barack Obama in the White House press briefing room

In 1976 at a time when economists thought more about unemployment, the US economist Charles C. Killingsworth wrote a paper entitled “Should full employment be a major national goal”. He was a long-time advocate of public employment programs and understood how deficient the economics profession was when it came to caring about people.

I thought about this paper recently upon reading an article in the Daily Beast by the always insightful Michael Tomasky, “The Real Obama Needs to Fight Five GOP Myths About the Imaginary Obama” . Tomasky discusses the myths that Obama needs to dispel during his party’s upcoming convention. One in particular caught my attention: the idea that the President needed to confront the myth that he allegedly believes that jobs come from government.

What’s wrong about that? In one sense, it is a myth: to the extent that jobs are an outgrowth of sales, which are a function of aggregate demand, it is wrong to say that the public sector per se creates jobs. But demand (and, by extension, sales) is more robust when employment rates are higher and, in that sense, it matters not to the restaurant owner, or the engineering firm, whether the source of that demand comes from a private or public sector job. The teacher’s cash is just as good at the cash register as the accountant’s.  So why does the president even need to disparage the notion that good jobs and vocations cannot come from public employment in order to prove to American voters that he’s not some kind of radical Marxist?

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War By Other Means: Chinese Economic Espionage in the Automobile Sector

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Automobile assembly line in Ningbo, Zhejiang province. Source: Business Week

Automobile assembly line in Ningbo, Zhejiang province. Source: Business Week

China’s continued development and geopolitical rise, though impressive and seemingly globally-minded, serve as a reminder that its dual economic and security-focused interests remain a threat undermining both competitors and trading partners.

In May of this year, the US Department of Defense released its annual report on China’s military capabilities, entitled, “Military and Security Developments Involving the People’s Republic of China 2012.” The report outlines a growing and emerging Chinese military focused on obtaining Western dual-use and military technologies by any means. The report asserts, “Chinese actors are the world’s most active and persistent perpetrators of economic espionage.” Adding, “Chinese attempts to collect U.S. technological and economic information will continue at a high level and will represent a growing and persistent threat to U.S. economic security.”

Unsurprisingly, China vociferously objected to the report’s contents and being labeled a “growing and persistent” threat. Nevertheless, a more accurate depiction is not that China is a threat to the US but it is also a threat to any foreign nation state possessing technology China lacks.

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Products with a Purpose

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Fair trade coffee beans being sold in West Bridgewater, Mass. uusc4all/Flickr

Fair trade coffee beans being sold in West Bridgewater, Mass. uusc4all/Flickr

In Eli Marmar’s life story, water is a recurring theme. “I was raised in the Bay Area as a competitive swimmer and spent my formative years in the ocean surfing. It rained on my wedding day. My son was born in a birthing tub.” No surprise then that he launched his company Freewaters with one mission: provide clean drinking water, one pair of sandals at a time. That’s right, sandals. San Francisco-based shoemaker Freewaters represents a new breed of social enterprises that have philanthropic agendas built explicitly into their corporate DNA.

Beyond the traditional selling points of price and presentation, companies like Freewaters are offering products that directly support a humanitarian purpose—and the concept is catching on fast.  But while the entrepreneurs behind these socially conscious start-ups have tapped into consumer demands to play donor, they also raise questions about whether applying the profit motive can achieve positive and sustainable developmental ends. Advocacy as part of the business model is nothing new.

The iconic Vermont-based ice cream manufacturer Ben and Jerry’s has promoted social activism since it was founded in 1978. The company has paid a “livable wage” to its employees nearly twice the national minimum wage, sourced Fair Trade-certified ingredients for its products and utilized environmentally friendlier hydrocarbon freezers. From 1985 until the company was acquired by Unilever in 2000, Ben and Jerry’s committed 7.5 percent of the company’s pretax profits to philanthropy.

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Greece is being kept alive by the ECB’s Emergency Lending Authority

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From left to right: Mario Monti, Prime Minister of Italy; Mario Draghi, President of the European Central Bank; Angela Merkel, Federal Chancellor of Germany

From left to right: Mario Monti, Prime Minister of Italy; Mario Draghi, President of the European Central Bank; Angela Merkel, Federal Chancellor of Germany

Greece has moved off center stage, as Spain has become the preoccupation de jour for Europe’s increasingly embattled authorities. But one has to wonder how the Greek banking system has managed to sustain itself over the past several months, given widespread deposit flight and the country’s ongoing solvency challenges. Well, we now have a better idea, courtesy of a leak to the German weekly news magazine Der Spiegel, which has published information about ECB plans to keep Greece on its feet until the next tranche of European Union-International Monetary Fund aid is paid out.

According to Der Spiegel, the ECB has chosen a detour via the Greek central bank under its so-called “Emergency Liquidity Assistance” (ELA) program: “Now, information has leaked regarding how the ECB plans to keep Greece on its feet until the next tranche of European Union-International Monetary Fund aid is paid out. The ECB has chosen a detour via the Greek central bank. It will allow it to issue additional emergency loans to the country’s banks. These in turn are supposed to use the money to buy up Greek bonds with short maturities. This will scrape together €4 billion, according to the plan.”  Although the context of the Der Spiegel article suggests that the ELA has been activated here for Greece as a short-term bridging measure, it is almost certain that the program has already been used extensively by the ECB to keep Greece alive. Perhaps this is what Mr. Draghi meant when he suggested that he would do “whatever it takes” to keep the euro alive?

We have long speculated that the main source of funding for Greece over the last several has been the European Central Bank’s ELA program, given that it has become virtually cut off from Target 2. To reiterate: Under Article 66 of the EU treaty there is complete capital mobility within the Eurozone. A citizen in any country can hold deposits in the common euro currency in banks domiciled in other countries. To meet this opportunity the banks in Europe’s northern core improved the banking facilities they offer to prospective deposit and loan clients on Europe’s periphery.

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Resource Nationalism: Old Threat, New Opportunities

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Shuttered shops selling Coca-Cola in Bolivia. Photo: Agustina Triquell

Shuttered shops selling Coca-Cola in Bolivia. Photo: Agustina Triquell

Resource Nationalism: Can a Leopard Change its Spots?

Resource nationalism, like other components of economic protectionism, has receded since the institutionalization of the Washington consensus and the gradual - if unsteady - democratisation of the developing world. The days of aggressive expropriation, the seizing of private assets by governments, are empirically in decline. Governments, as The Economist point out, are increasingly open to foreign involvement in heavy extraction industries as they seek to exploit the technical, infrastructural, employment and foreign currency advantages of foreign ownership.

But rather than a wholesale liberalization, governments are exerting a competitive impulse into contracts: to drive up prices as a means of maximizing revenue while simultaneously assuaging popular nationalism from below. Companies in turn, sensing an opportunity to achieve scale, are turning to Corporate Social Responsibility projects to heighten their attractiveness to prospective countries – and specifically, the people within.

There are exceptions: Zimbabwe’s indigenization policy serves to remind us of the close correlation between authoritarianism (competitive or complete) and state sponsored, often economically destructive, nationalism. It is with this example in mind that Ernst & Young ranked resource nationalism as the number one global risk facing mining and metal companies. Resource nationalism then has not disappeared, but it has been accompanied by pragmatism on the part of governments in developing economies.

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How Far is the ECB Prepared to Go to Save the Euro?

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European Central Bank's Mario Draghi with Ramon Tremosa. Source: European Council

European Central Bank’s Mario Draghi with Ramon Tremosa. Source: European Council

Re-reading Mr Draghi’s market-moving remarks last Thursday, one gains a sense that the European Central Bank chief recognizes that the ECB has a banking run on its hand. Most market participants have understandably focused on Mr. Draghi’s pledge that the ECB was “ready to do whatever it takes” to preserve the single currency. “Believe me, it will be enough,” he told a conference in London. We prefer to focus on other aspects of the speech.

It is particularly salient that Mr. Draghi highlights the fatal flaw of the euro zone noted by Professor Peter Garber some 14 years ago: As long as there was no perceived probability of euro exit by any euro nation, the established transfer system coupling private markets with European system of Central Bank support (Target 2, ELA, ECB repos) would function like any other monetary system in a single nation state.

However, Garber recognized that if there arose the prospect of a euro exit and, therefore, a devaluation risk for holders of deposits in the banks domiciled in the country slated for exit (e.g. Greece or Spain), the European monetary system would be exposed to a bank run. Under the EU treaty capital mobility was guaranteed.

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