We've detected an outdated browser.

You may want to consider updating your browser. International Policy Digest requires a modern browser in order to view the website properly.

Click here for information on how to update your browser.

Continue Anyways
Economics

Archive | Economics

Social Blindspot: Why Risk Models Need to Change

and |
Black swan.  Photo: Sarah Macmillan

Black swan. Photo: Sarah Macmillan

‘Black Swans turn Grey’

The risk landscape is undoubtedly shifting. PricewaterhouseCoopers or PwC, invoking Nassim Nicholas Taleb’s recent book, posit that ‘Black Swans’ are increasingly ‘turning grey’. By this, they mean that previously catalytic and unforeseen events are becoming more regular; betraying an increased level of uncertainty faced by the global community in the face of growing connectivity and dependency.  Their approach is to expand existing ERM (Enterprise Risk Management) frameworks ‘by innovating around them, adding tools and techniques such as scenario modelling, predictive indicators and ‘reverse stress-testing’.

PwC is right to identify a changing terrain, in which political developments play an increasingly important role, however traditional approaches to Political Risk themselves must adjust to remain relevant in the 21st century. So while organisations will benefit from integrating Political developments as a component into their ERM systems, more fundamentally, Political Risk as a discipline needs to be re-calibrated.

Political Risk Today

With the onset of globalization, Political Risk is an increasingly pertinent concern for multinational companies and investors as they attempt to tap into, and harness, the velocity of the global marketplace. New challenges and opportunities are sprouting up, driven by increasingly social and politically aware young populations across the globe who are armed with innovative & enabling forms of technology.

Continue Reading →

Greece on the Brink…Again

|
European Union and Greek flags fly near the Parthenon. Simon Dawson/Bloomberg

European Union and Greek flags fly near the Parthenon. Simon Dawson/Bloomberg

Just one month after the so called “make or break” election, the state coffers in Greece are running low as tax revenues continue to miss targets as the economy slows further. The election outcome, dubbed by European political leaders as a victory for the euro, was supposed to ensure that the bailout programme be implemented in order to move Greece back onto a sustainable economic path.

Since then the emphasis in Greece has shifted towards a renegotiation of the bailout conditions as the austerity measures hit living standards. A recent statistic published by Eurostat claimed that 27.7 percent of Greeks are now living on or below the poverty line. Such rhetoric is falling on deaf ears elsewhere in Europe as leaders in countries such as Germany, Finland and the Netherlands struggle to sell each of the bailouts to their respective electorates further highlighting the North-South divide in the Eurozone.

Recent figures released suggest that Greece is making progress towards reducing its deficit as the figure for the first six months of 2012 came in at 12.3 billion euros well ahead of the Troika target of 14.9 billion euros and down from 13.1 billion euros from the same period in 2011. However, a closer inspection reveals that, whilst spending cuts are being met, the required taxation income was 1 billion euros behind the plan during the first half of 2012. One consequence of this is that Greece will struggle to survive financially until September when the next bailout tranche is due to be made payable.

Continue Reading →

Geithner: Europe Can’t be Left Hanging on the Edge of Abyss

|
Treasury Secretary Timothy Geithner

Treasury Secretary Timothy Geithner

Michael Kinsley once defined a gaffe as “when a politician tells the truth – some obvious truth he isn’t supposed to say.” On that basis, the recent headline that just popped up might well represent a major gaffe of the Kinsley variety by Treasury Secretary Tim Geithner.  Speaking on CNBC’s “Delivering Alpha” conference, the Treasury Secretary argued, “What is very important is that [Eurozone officials] not leave the Continent hanging on the edge of the abyss as a device for getting more leverage for reform, because that leaves the rest of the world much more exposed to financial pressure and slower growth from Europe.”

In essence, Geithner is letting the cat out of the bag. He is implying that Europe is hanging on the edge of the abyss. Only Germany can prevent it from falling in, and at the same time it appears that Berlin has now moved into a position where they cannot or will not prevent that disasterous scenario, either for economic or legal reasons.

The decision by Germany’s constitutional court to delay its approval of the German Parliament’s ratification of the ESM and fiscal compact may be a warning. The court could have moved to approve quickly. Instead, it will not rule on emergency appeals for an interim injunction against the parliamentary approvals until the end of this month. If the court rules in favor of an interim injunction, the final decision on the ESM and fiscal compact may not be made for several months.

Continue Reading →

Spain’s Growing Pains

|
Prime Minister Mariano Rajoy in Valencia. Diego Crespo/La Moncloa

Prime Minister Mariano Rajoy in Valencia. Diego Crespo/La Moncloa

Just when you think that things can get no worse in Spain, they do. Yiagos Alexopoulos at Credit Suisse estimates that Spanish capital outflows are currently running at an annualised rate of 50 per cent of GDP. No question, the bank run is clearly accelerating, and one can easily understand why.  The country is turning into a Little House of Economic Horrors. The alleged “rescue” of Madrid’s banks is a non-starter. 100 billion euros won’t begin to cover the scale of the problem on any honest accounting or “stress test” (and that’s before we get to the next phase of announced austerity measures). Chuck Davidson of Wexford Capital has completed a report where he looked at the Spanish banks, extrapolating to all of them from a close look at the big five. He haircutted their assets by 25%, which hardly seems excessive.

Moving from the big 5 to the entire banking system, he came up with 990 billion euros as the capital needed to get Spain’s banks to Basel 3 risk weighted capital standards. Madrid, we have a problem! That’s of course after these very same banks have ripped off thousands of depositors, who were strongly encouraged to buy preferred equity shares and subordinated debt, which were touted to them as higher yielding, low risk fixed income replacements instead of lower yielding deposits

As Ed Harrison of Credit Writedowns has noted: “When the banks tried to get private funding, universally they were unable to get institutional and or foreign investors onboard. Bankia, for example, wrestled with whether to pull its IPO altogether after receiving a tepid response from institutional investors. Instead, Bankia went ahead with the IPO, getting the money from Spain’s retail investor base. Other banks raised money by unethically and potentially illegally pressuring bank depositors into preferred equity and subordinated debt instruments they did not fully understand. Reuters says, for example, that 62% of sub debt holders in Spain are also depositors at the same institutions.”

Continue Reading →

The ECB is Quickly Running out of Options

|
European Central Bank President Mario Draghi. Photo: Pietro Naj-Oleari

European Central Bank President Mario Draghi. Photo: Pietro Naj-Oleari

When policymakers are lacking in credibility and competence, confidence in their ability to govern is likely to be in short supply. This is particularly notable in reference to the Eurozone and its steadily deteriorating economy – most acutely felt by the ’sin states’ of the Mediterranean.

With Europe’s leaders now finally in admission of the debt fuelled malaises, the emphasis has turned to crisis and resolution management, and the markets are feeling uneasy. As the economic data releases worsen by the week investors increasingly look to the European institutions, most commonly the European Central Bank, to provide the financial stimulus to drive an economic recovery. As the crisis shifts to the business end of the cycle it is clear that a solution for the Spanish and Italian sovereigns is barely making progress as borrowing costs teeter at unsustainable levels.

Last week the European Central Bank pitched in with a seemingly last ditch attempt to contain the crisis by cutting its benchmark interest rate to 0.75% and lowering its deposit rate to 0%. With the ECB quickly running out of options, its President Mario Draghi, once again re-iterated that the ultimate remedy must be driven by Eurozone governments in the form of structural reforms and progression towards an economic and political union.

Continue Reading →

Paul De Grauwe is Right: All Roads Lead Back to the ECB

|
Italy's Prime Minister Mario Monti with Ireland's Prime Minister Enda Kenny in Brussels. Source: European Council

Italy’s Prime Minister Mario Monti with Ireland’s Prime Minister Enda Kenny in Brussels. Source: European Council

We’ve always been a fan of Professor Paul De Grauwe from University of Leuven, who has consistently pointed out the structural flaws inherent in the original structures of the EU. Recently, Professor de Grauwe wrote an excellent analysis explaining why the latest “rescue plan” cobbled together by the Eurozone authorities is destined to fail.  The key points: ECB is not currently a ‘lender of last resort’. The ECB was set up with fundamental flaws, where “… one of the ECB’s main concerns is the defense of its balance sheet quality. That is, a concern about avoiding losses and showing positive equity- even if that leads to financial instability.”

This is a profoundly misconceived idea. As we have noted many times, a private bank needs capital – clearly because there are prudential regulations requiring that – but because it can become insolvent. It has not currency-issuing capacity in its own right. While the ECB has an elaborate formula for determining how capital is from the national member banks at an intrinsic level, it has no need for capital. It could operate forever with a balance sheet that if held by a private bank would signal insolvency. There are no comparable concepts for a currency issuer and a currency user in terms of solvency. The latter is always at risk of insolvency the former never, so the ECB’s focus on profitability is not only misguided, but leading to inadequate policy responses.

The creation of the European Financial Stability Facility (EFSF) and the ESM has been motivated by the overriding concern of the ECB to protect its balance sheet and to avoid engaging in “fiscal policy”. The problem again goes back to the creation of the euro: no supranational fiscal authority to go with a supranational central bank, which means that the only entity that can conceivably carry out “fiscal transfers” of the sort exemplified by a bond buying operation is the ECB.

Continue Reading →

European Debt Crisis: George Soros Exudes Optimism

|
George Soros at the World Economic Forum in Davos, Switzerland, January 27, 2010. Photo: Sebastian Derungs

George Soros at the World Economic Forum in Davos, Switzerland, January 27, 2010. Photo: Sebastian Derungs

George Soros probably understands the nature of the immediate problem facing the Eurozone. Namely, the accelerating bank run which, amongst other things, potentially exposes Germany to trillions of contingent euro liabilities. But even Soros reflects the prevailing – and mistaken – view that Greece might need to become the sacrificial lamb required to save the euro. He said as much in a recent interview in Der Spiegel.

Questioned about his proposal to rescue the European Monetary Union via a Debt Reduction Fund, Soros was asked whether this measure could also save Greece, “Unlikely. Rescuing Greece would require an enormous kind of magnanimity and generosity. The situation there has simply become too poisoned. I think that by standing firm and not compromising on Greece, Angela Merkel would be in a better position to persuade the German public to be more generous toward other nations and distinguish between the good guys and bad guys in Europe.”  Policy makers, market practitioners, indeed anyone like Soros, who keeps saying, “Well, we might have to sacrifice Greece ‘pour decourager les autres” fails to recognize that this type of attitude actually exacerbates the fatal flaw in the euro’s architecture and makes its ultimate demise more likely, not less. The same issues that confront the euro zone today would intensify in the event of a Greek exit.

As Yanis Varoufakis has noted “the lack of a constitutional (or Treaty-enabled) process for exiting the Eurozone has a solid logic behind it. The whole point of creating the common currency was to impress the markets that it is a permanent union that will guarantee huge losses to anyone bold enough to bet against its solidity.”  As Varoufakis argues, a single exit suffices to punch a hole through this perceived solidity. It goes back to the fundamental flaw cited by Peter Garber at the time of the euro’s inception. 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.

Continue Reading →

Angela Merkel’s Nein Problem

|
President Obama with Angela Merkel in Washington. Denzel/Bundesregierung

President Obama with Angela Merkel in Washington. Denzel/Bundesregierung

The pattern is becoming despairingly familiar. The embattled periphery countries, led by Italy and Spain but also endorsed by France, propose more fiscal integration in the form of mutual debt pooling and shared financial liability. Such reforms are met with resounding rejections from Germany who instead point to the long run benefits of austerity in terms of promoting a sustainable economy. Similar responses are also reserved for Greece who is seeking to renegotiate elements of its bailout agreement following a recent general election which resulted in the formation of an awkward coalition government.

The focal point of this resistance is Germany’s Chancellor Angela Merkel who, supported by its Central Bank’s President Jens Wiedmann, is adamant that the focus for the Eurozone should be implementing the necessary fiscal reforms rather than loosening conditions. This position, generally supported by the ‘northern core’ countries, highlights the almost daily division between the creditor and debtor nations in the single currency bloc. The current official line from Germany is that ‘More Europe’ is the solution to the crisis however without a clear prescription as to that definition uncertainty will remain.

As the crisis intensifies, hopes are low that a two-day summit starting Thursday will produce agreement on the best course forward. Since the election in Greece, investors have dumped Spanish bonds leading to higher funding costs, which in turn have led to a bailout request from Spain to deal with the funding problems being experienced by its banks.

Continue Reading →

The Eurozone Still Faces Several Challenges

|
Greece's Prime Minister Antonis Samaras with French President François Hollande in Paris

Greece’s Prime Minister Antonis Samaras with French President François Hollande in Paris

European financial officials are preparing their policy package to deal with the current crisis for the meeting scheduled next week. It is not clear whether any of the proposals will be able to stop the ongoing bank run. Here are some of the rumored proposals. Euro members jointly issue short term bills – in effect, short term euro bonds, a debt redemption fund as proposed by economic advisors to Merkel, new procedures for euro area banking supervision and using the ESM to purchase peripheral nations’ bonds in order to reduce their sovereign interest rates.

French President Hollande is advocating the ESM purchase program. He is also advocating that the ESM be given a banking licence linked to the European Central Bank’s balance sheet. This makes sense as it addresses the solvency issue.

In the Eurozone we have a solvency problem and a crisis of deficient aggregate demand. Unfortunately, within the European Monetary Union these twin crises ultimately fall entirely in the realm of the issuer of the currency- the ECB, and not the users of the currency- the euro member nations. So without the ECB, directly or indirectly, underwriting the currency union, solvency is always an issue, whether that be Greece, Portugal, Spain, Italy or, indeed, Germany. Likewise deficient spending power has been exacerbated via the austerity imposed as a condition of the ECB’s help.

Continue Reading →

Future of Greece and the Eurozone Remains Uncertain

|
Greece's Prime Minister Antonis Samaras. alex@faraway/Flickr

Greece’s Prime Minister Antonis Samaras. alex@faraway/Flickr

So for the short term, it appears we won’t have a “Grexit”, which has led many commentators to suggest (laughably) that a crisis has been averted. Typical of this sentiment is a headline in Bloomberg today “Greece avoids chaos; Big Hurdles Loom”. To paraphrase Pete Townsend, meet the new chaos, same as the old chaos. It is worth pondering how acceptance of the Troika’s program (even if cosmetic adjustments are made) will help hospitals get access to essential medical supplies, whilst the government persists in enforcing a program which is killing its private sector by cutting spending and not paying legitimate bills, and an unemployment rate creeps towards 25 per cent and 50 per cent for youth.

Prior to the June 17th vote, Greek voters were intimidated with a massive number of threats of what would happen if they didn’t vote “the right way” (i.e. anybody but the “radical leftists” in Syriza). Even then, the conservatives just led the vote count against their main anti-austerity rival. Amazingly, New Democracy leader Antonis Samaris suggested in his victory speech last night that the results reflected a vote for “growth.”

There is more than a touch of Orwell at work when one can redefine the kinds of programs which the Greeks will be forced to swallow as conducive to “growth” and “prosperity”. So the Greek government will continue to plug away at austerity and the Troika will continue to pretend that such policies will ultimately lead to a Greek economic recovery. There will be some fake advertising about Europe making it easier on the Greeks, but it will be something without substance. Then things will get worse to the point where Samaras might have to take a helicopter to flee the crowds.

Continue Reading →

Not so Super Mario Brothers

|
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

This week Italy was carted into the spotlight of the Eurozone crisis as its benchmark 10 year borrowing costs moved above 6 per cent for the first time since January and with Italy now beginning to suffer as contagion spreads from the currency block’s other problem areas it is clear that tensions are rising in the Euro area.  In a further sign of disunity between the Eurozone’s Latin bloc and other EMU member states on Tuesday, Italian Prime Minister, Mario Monti, was forced to reject claims from the Austrian Finance Minster that Italy would require financial assistance. Italy is now seen as the final battleground of the euro project with any bailout for Italy likely to be the final nail in the coffin of the Eurozone.

Having been widely praised for his reform agenda, including the modernisation of antiquated labour laws as well as unprecedented public pension cuts, it appears that the wheels are starting to fall off. Two unconvincing auctions of short and long term debt this week underscored Italy’s need to go further to ensure the confidence of the markets. Battling with public debt levels of 120 percent of GDP, a contracting economy and resentment to reform, a sense of urgency is increasing as Monti’s government tries to distance itself from the other weak periphery countries.

With the honeymoon period well and truly over, Mario Monti is facing an on-going backlash against his reform agenda- perhaps made more poignant due to the fact that he is not a directly elected head of state – but an appointed technocrat. Struggling to push through reforms, Monti has increased the rhetoric against the Eurozone creditor nations and the European Central Bank addressing the increased need for a collaborative growth agenda.

Continue Reading →

Spain’s Economy faces many Years of Pain

|

Spain’s Prime Minister Mariano Rajoy with Herman Van Rompuy, President of the European Council. Source: European Council

Nobel Laureate economist Joseph Stiglitz characterizes the Spanish bank bailout as “voodoo economics” that is certain “to fail.” New York Times economic analyst Andrew Ross Sorkin agrees, “By now it should be apparent that the bailout has failed—or at least on its way to failing.” And columnist and Nobel Prize-winning economist Paul Krugman bemoans that Europe (and the U.S.) “are repeating ancient mistakes” and asks, “why does no one learn from them?”  Indeed, at first glance, the European Union’s response to the economic chaos gripping the continent does seem a combination of profound delusion, and what a British reporter called “sado-monetarism”—endless cutbacks, savage austerity, and widespread layoffs.

But whether something “works” or not depends on what you do for a living. If you work at a regular job, you are in deep trouble. Spanish unemployment is at 25 percent—much higher in the country’s southern regions—and 50 percent among young people. In one way or another, those figures—albeit not quite as high—are replicated across the Euro Zone, particularly in those countries that have sipped from Circe’s bailout cup: Ireland, Portugal, and Greece.

But if you are Josef Ackermann, who heads Deutsche Bank, you earned an 8 million Euro bonus in 2012, because you successfully manipulated the past four years of economic meltdown to make the bank bigger and more powerful than it was before the 2008 crash. In 2009, when people were losing their jobs, their homes, and their pensions, Deutsche Bank’s profits soared 67 percent, eventually raking in almost 8 billion Euros for 2011. The bank took a hit in 2012, but the Spanish bailout will help recoup Deutsche Bank’s losses from its gambling spree in Spain’s real estate market.

Continue Reading →

Germany’s Constitutional Conundrum

|
French President Nicolas Sarkozy with German Chancellor Angela Merkel during the G20 Summit in Cannes, France. F. de la Mure / MAEE

French President Nicolas Sarkozy with German Chancellor Angela Merkel during the G20 Summit in Cannes, France. F. de la Mure / MAEE

Hans-Werner Sinn, President of Germany’s Ifo Institute and the Director of the Center for Economic Studies at the University of Munich, has taken to the pages of the New York Times to explain why Berlin is balking on a further bailout for Europe. Amongst the points that Sinn makes against German sharing in the debt of the euro zone’s southern nations is a legal one: “For one thing, such a bailout is illegal under the Maastricht Treaty, which governs the euro zone. Because the treaty is law in each member state, a bailout would be rejected by Germany’s Constitutional Court.”

Sinn also argues that Germany’s counterparty credit exposure already exposes the country to immense credit risk: “Should Greece, Ireland, Italy, Portugal and Spain go bankrupt and repay nothing, while the euro survives, Germany would lose $899 billion. Should the euro fail, Germany would lose over $1.35 trillion, more than 40 percent of its G.D.P.”

Let’s leave aside Sinn’s broader rhetorical points (“Has the United States ever incurred a similar risk for helping other countries?” Umm, yes, it did – there was that little matter of World War II). Levity aside, professor Sinn does raise a huge potential conundrum as far as Germany and its broader relationship to the Eurozone’s institutions go. In fact, recent German Constitutional Court rulings on bailouts could well blow apart the European Monetary Union. This is because the potential unlimited liabilities to which Germany is exposed under Target 2, the ELA, and various other lender of last resort facilities adopted by the European Central Bank do on the face of it run afoul of the court’s ruling, which argued that any future bailouts had to be limited and subject to the democratic consent of Germany’s Parliament. What happens, for example, if someone in Germany were to challenge the very legality of Target 2 on those grounds?

Continue Reading →

From Russia with Love? Cyprus seeks another Bailout

|
Russian President Dmitry Medvedev with Cyprus President Dimitris Christofias during an official visit.  Source: Kremlin Press Office

Russian President Dmitry Medvedev with Cyprus President Dimitris Christofias during an official visit. Source: Kremlin Press Office

Cyprus today hinted that it was seeking a €5 billion loan from the Russian authorities to bolster its bank’s capital levels before a key regulatory deadline at the end of June.  This assistance would follow a €2.5 billion loan in 2011 from the Kremlin which the island nation has been fully dependent on having been effectively shutout of capital markets. There had been signs over the past couple of days that Cyprus would formally request financial aid from the current Eurozone bailout fund, the EFSF, but this has yet to materialize, although it has not entirely been ruled out by the Cypriot authorities who claim to be “considering all available options”.

Cyprus is under pressure to recapitalise its banking sector, particularly Popular Bank, which requires a capital injection of €1.8 billion this month in order to satisfy the conditions of European regulators. A rights issue underwritten by the Cypriot government is planned to start this Friday and will place further stress on Cyprus’s finances if, as expected, private participation is low.

A bailout, which looks likely, poses an interesting conundrum for the Cypriot authorities. Accepting an EFSF package from its European partners would likely tie the small Mediterranean nation in to austerity conditions akin to those imposed on the other peripheral Eurozone economies. Furthermore, it is presumed that any Russian assistance would be free of fiscal conditions, which would be favourable but may subject Cyprus to other agreements likely to arouse suspicion in Europe and beyond.  For Russia, a country flushed with Euro denominated reserves, this could be a targeted investment with potentially lucrative returns. It has been reported that Russia has an interest in developing a deep-water naval capability in this strategic location as well as tapping into the reported sizeable natural gas reserves in the waters surrounding Cyprus.

Continue Reading →

Another One Bites the Dust: The ECB Pours Cold Water on Bankia Bailout Solution

|
Bankia ATM in Madrid. Source: Global Post

Bankia ATM in Madrid. Source: Global Post

It might seem strange to invoke Freddie Mercury and Queen in the context of the eurozone, but it’s the first thought that springs to mind, as Brussels and the increasingly hapless ECB, continue to mismanage their way to financial and economic catastrophe. Yesterday, there were signs that the Spanish plan to recapitalise Bankia (which came with the implied backing of the ECB’s balance sheet) introduced a potential way out of the eurozone’s metastisizing banking crisis.

Sadly, it’s another idea which will never get off the bulletin board, as the ECB bluntly rejected any proposal to use its balance sheet to indirectly fund Bankia, the troubled Spanish lender. So we’re back to floundering and the markets are reacting accordingly. What most investors, experts, and policy makers fail to realize is that this bank run is not simply a Greek problem, which will cease if and when Greece is thrown out of the euro zone.

If one looks at the Target 2 balances, the ELA, and the ECB’s lender of last resort facilities, it’s clear that this has extended into all of the periphery countries, including Spain and Italy. It may well end with Germany’s banks effectively serving as the deposit base for all of Europe. Perversely, the ECB and the European authorities acknowledge none of this and seem to be doing nothing about it. At least not publicly. They are like ostriches with their collective heads in the sand. If anything, “tough talk” from some of them may be escalating the bank run, rather than restoring confidence.

Continue Reading →