Some countries are very careful about saving for pensions for future generations. Other countries have a "pay-as-you-go" system where nothing is saved and persions are paid by the next generation.
Until now it was fashionable to paint the first type of countries as responsible and the last type as irresponsible. However, the recent fracas about the trade surpluses of China and Germany puts this saving in new light. It looks like the world cannot sustain it if every country would save for their pensions - it will result in too much saving and too little consumption. And with the ageing of the world population this problem is only becoming more acute.
It looks like we will soon have to tell countries that it is irresponsible when they save too much because it harms the rest of the world.
Showing posts with label crisis. Show all posts
Showing posts with label crisis. Show all posts
Friday, March 19, 2010
Sunday, February 21, 2010
To stimulate or not to stimulate
Economists all over the Western world are divided: should we keep stimulating our economies or shouldn't we do so. The fans of the continuing of the easy money claim that when we stop our economies might yet fall into a crisis. They like to point to Roosevelt's effort to end stimulation in 1937 after which the crisis promptly came back. But their adversaries like to point out that the fate of Greece might also happen to the US or the UK. Some day there might be no more money to borrow and then they would face a really big crisis.
I believe it depends on the situation. Some general rules are:
- it is crucial to keep the country from becoming too endebted. So when a country is running trade deficits and has a negative balance of payments - like the US now - it should devalue its currency. Living above your means doesn't work.
- you cannot trust on export alone. China and Japan now are very similar to the US in the 1930s. They are dependent on export for growth. But you can only export so much before the rest of world runs out of money. If that happens your growth model runs into a wall.
- when there is unemployment government may inject extra money in the economy. This is basically a matter of distribution within a country. When the producers have too much money and the consumers too little the goal is to give the consumers more money. In the short term a stimulus is the best way to achieve that.
I think there are three possible situations:
- producers and consumers are rather in balance. In that case a stimulus will get the economy running again. The cost of the stimulus will soon be made up by additional tax receipts and less unemployment benefits.
- there is too much money with the consumers and too little with the producers. This is the 1970s scenario. A stimulus only leads to stagflation. The solution is to direct more money to the producers - as Thatcher and Reagan did with tax cuts.
- there is much too much money with the producers and too little with the consumers. This is the case with export dependent countries like China and Japan and the US in the 1930s. In this case a stimulus has only a temporarily and weak effect. Economists like to say that the government should just stimulate more, but there are both practical and political limits to how much a government can spend. Japan has now spent so much that its government debt is now above 200% of GDP. That is a major distortion. What is needed are more structural reforms that bring more money to the consumers. In the US it was the war economy of the 1940s that finally brought that restructuring. To accomplish a more consumption oriented economy in peace time one might consider the following measures: policies that favor the poor over the rich (the rich tend to save more), policies that aim for full employment (that leads to upwards pressure on the wages of the poor and so to less inequality) and discouraging saving for the old day (it is much better when people build a house that will serve as their old age reserve; a property bubble however will destroy this way out).
My conclusion is that we in the West need to undo what Reagan and Thatcher did. Not because what they did was wrong, but because what they did has gone too far and we need to bring the balance back towards the consumers.
I am rather pessimistic about China despite its foreign currence reserves. Its policies for fighting the crisis have resulted in bubbles. It looks like China is going the way of Japan after the Plaza Accord. The Plaza Acord forced Japan to revalue its currency. China is not yet facing such pressure but it is clear to everyone that China no longer can keep growing by increasing its exports. Its reaction to that is a very similar real estate bubble like Japan created. The one thing ibn favor of China is that its government seems prepared to make unpopular steps to puncture bubbles.
I believe it depends on the situation. Some general rules are:
- it is crucial to keep the country from becoming too endebted. So when a country is running trade deficits and has a negative balance of payments - like the US now - it should devalue its currency. Living above your means doesn't work.
- you cannot trust on export alone. China and Japan now are very similar to the US in the 1930s. They are dependent on export for growth. But you can only export so much before the rest of world runs out of money. If that happens your growth model runs into a wall.
- when there is unemployment government may inject extra money in the economy. This is basically a matter of distribution within a country. When the producers have too much money and the consumers too little the goal is to give the consumers more money. In the short term a stimulus is the best way to achieve that.
I think there are three possible situations:
- producers and consumers are rather in balance. In that case a stimulus will get the economy running again. The cost of the stimulus will soon be made up by additional tax receipts and less unemployment benefits.
- there is too much money with the consumers and too little with the producers. This is the 1970s scenario. A stimulus only leads to stagflation. The solution is to direct more money to the producers - as Thatcher and Reagan did with tax cuts.
- there is much too much money with the producers and too little with the consumers. This is the case with export dependent countries like China and Japan and the US in the 1930s. In this case a stimulus has only a temporarily and weak effect. Economists like to say that the government should just stimulate more, but there are both practical and political limits to how much a government can spend. Japan has now spent so much that its government debt is now above 200% of GDP. That is a major distortion. What is needed are more structural reforms that bring more money to the consumers. In the US it was the war economy of the 1940s that finally brought that restructuring. To accomplish a more consumption oriented economy in peace time one might consider the following measures: policies that favor the poor over the rich (the rich tend to save more), policies that aim for full employment (that leads to upwards pressure on the wages of the poor and so to less inequality) and discouraging saving for the old day (it is much better when people build a house that will serve as their old age reserve; a property bubble however will destroy this way out).
My conclusion is that we in the West need to undo what Reagan and Thatcher did. Not because what they did was wrong, but because what they did has gone too far and we need to bring the balance back towards the consumers.
I am rather pessimistic about China despite its foreign currence reserves. Its policies for fighting the crisis have resulted in bubbles. It looks like China is going the way of Japan after the Plaza Accord. The Plaza Acord forced Japan to revalue its currency. China is not yet facing such pressure but it is clear to everyone that China no longer can keep growing by increasing its exports. Its reaction to that is a very similar real estate bubble like Japan created. The one thing ibn favor of China is that its government seems prepared to make unpopular steps to puncture bubbles.
Saturday, January 23, 2010
Greece on the road to an economic meltdown
In 2002 the Argentine economy broke down. For years their coin had been pegged to the dollar, but as the inflation in Argentine was higher than in the US this let to an increasing trade deficit for Argentine. Yet the Argentine government couldn't muster the political courage for the painful reforms that were needed to correct this. And so, finally, in 2002 the country had to let its currency float. As a result the economy shrunk that year with 10%. But in the following years it regained healthy growth.
It looks like Greece is going the same road. But it is doubtful whether it will have such a speedy recovery: the problems look to serious. The budget deficit is 12%, it imports three times as much as it exports (29 vs 93 billion US$) and tourism fills only a small part of that gap.
Yet the Greek government can't be bothered with economic reform. They have promised the EU to reform their budget in 2012. But given their lacking sense of urgency they most probably will resort to new bookkeeping tricks rather than apply real reform. The inevitable conclusion has to be a serious economic meltdown.
When the credit crisis hit the Baltics demanded a speedy entry into the eurozone with the claim that that would save their economy. The example of Greece seems to indicate that it only delays the problems by a few years.
As Greece is a member of the eurozone no one knows what form such a meltdown will take. Will the Greek state go broke and stop payments? Will it exit the eurozone? The eurocrats are afraid and go out of their way to pamper the Greek government in order to delay the inevitable. However, this will only have as effect that the final crisis will be worse.
It may take a few more years before the meltdown happens. But the later it happens the worse it may be. For the Balkan countries such a meltdown will be bad news. Greece is an important investor in many countries and it employs many migrant workers from Albania.
It looks like Greece is going the same road. But it is doubtful whether it will have such a speedy recovery: the problems look to serious. The budget deficit is 12%, it imports three times as much as it exports (29 vs 93 billion US$) and tourism fills only a small part of that gap.
Yet the Greek government can't be bothered with economic reform. They have promised the EU to reform their budget in 2012. But given their lacking sense of urgency they most probably will resort to new bookkeeping tricks rather than apply real reform. The inevitable conclusion has to be a serious economic meltdown.
When the credit crisis hit the Baltics demanded a speedy entry into the eurozone with the claim that that would save their economy. The example of Greece seems to indicate that it only delays the problems by a few years.
As Greece is a member of the eurozone no one knows what form such a meltdown will take. Will the Greek state go broke and stop payments? Will it exit the eurozone? The eurocrats are afraid and go out of their way to pamper the Greek government in order to delay the inevitable. However, this will only have as effect that the final crisis will be worse.
It may take a few more years before the meltdown happens. But the later it happens the worse it may be. For the Balkan countries such a meltdown will be bad news. Greece is an important investor in many countries and it employs many migrant workers from Albania.
Friday, January 15, 2010
The big US mortgage heist
One part of the US crisis concerns the mortgages. Until now the US government has spent $111 billion for the mortgage guarantee that it provided through Fannie Mae and Freddie Mac. But as it recently
raised the cap of $400 billion there is the fear that the final bill may be much higher.
This sounds like the US is just paying for past sins, but I don't believe so. I suspect that much or even most of the money is landing in the pockets of the banks and other mediairies that are between the Fannie Mae and Freddie Mac (the big guarantee holders) and the mortgage holders. These inbetweens tend to give their customesr big fines when they are late with payments. This often results in swamp of fines where customers get another fine for not paying the previous one on time, etc. As a consequence the money that those customers can pay ends up in the pockets of the inbetweens who charge it as a (very generous) reward for their extra work to reclaim the money. The creditors end up getting nothing.
The Obama administration has tried to improve the situation by trying to stimulate the rescheduling of those loans. But this has effectively been sabotated by the inbetweens who formally consider rescheduled loans as new ones and ask the same proves of creditworthyness that they demand for new loans. Given that these customers are in financial trouble it is no surprise that very few loans have been rescheduled. I think the Obama administration has made a mistake by seeing this only as a consumer problem. It encounters the same problem as a guarantor of those mortgages.
The "securization" of mortgages is a recent innovation. In the past banks sometimes outsourced the contact with the customer, but they always kept the final control so that they could push out the intermediary when they found that necessary. In the present situation the economic owners of the mortgages no longer have that possibility. It looks like that has become a serious problem now.
In my opinion there is only one solution: removal of the inbetweens. The US should nationalize Fannie Mae and Freddie Mac and they should take over the handling of any mortgage that is guaranteed by them where the customer is late with payments. Local offices of those organizations should then take care of rescheduling those mortgages when necessary.
Such a solution would be quite similar to the Resolution Trust Corporation that handled the aftermath of the savings & loans crisis.
raised the cap of $400 billion there is the fear that the final bill may be much higher.
This sounds like the US is just paying for past sins, but I don't believe so. I suspect that much or even most of the money is landing in the pockets of the banks and other mediairies that are between the Fannie Mae and Freddie Mac (the big guarantee holders) and the mortgage holders. These inbetweens tend to give their customesr big fines when they are late with payments. This often results in swamp of fines where customers get another fine for not paying the previous one on time, etc. As a consequence the money that those customers can pay ends up in the pockets of the inbetweens who charge it as a (very generous) reward for their extra work to reclaim the money. The creditors end up getting nothing.
The Obama administration has tried to improve the situation by trying to stimulate the rescheduling of those loans. But this has effectively been sabotated by the inbetweens who formally consider rescheduled loans as new ones and ask the same proves of creditworthyness that they demand for new loans. Given that these customers are in financial trouble it is no surprise that very few loans have been rescheduled. I think the Obama administration has made a mistake by seeing this only as a consumer problem. It encounters the same problem as a guarantor of those mortgages.
The "securization" of mortgages is a recent innovation. In the past banks sometimes outsourced the contact with the customer, but they always kept the final control so that they could push out the intermediary when they found that necessary. In the present situation the economic owners of the mortgages no longer have that possibility. It looks like that has become a serious problem now.
In my opinion there is only one solution: removal of the inbetweens. The US should nationalize Fannie Mae and Freddie Mac and they should take over the handling of any mortgage that is guaranteed by them where the customer is late with payments. Local offices of those organizations should then take care of rescheduling those mortgages when necessary.
Such a solution would be quite similar to the Resolution Trust Corporation that handled the aftermath of the savings & loans crisis.
Thursday, December 24, 2009
Why we are heading for the next economic crisis
With a total lack of economic reforms it seems clear that we are going towards the next bubble. The next crisis may make us look back to the present as a picknick.
For reason of its central position in the economy banks have government protection. This is supposed to result in a steady supply of credit to the business sector and private people. This protection and the access to cheap money from the central bank also constitute a hidden subsidy from the government for the banking sector. For this reason this protection has traditionally been reserved for commercial banks while business banks lack this protection.
Many people think that the Glass-Steagall act that regulated this separation was primarily for the protection of the commercial banks of the greater risks of the business banks. I don't agree. Glass-Steagall was introduced at about the same time that the US government introduced guarantees for the commercial banks. Its goal was to make sure the business banks didn't enjoy the same protection. This not only safed the government money. It also prevented ensuing distortions. Risk is a less important factor as it can be huge at commercial banks too: in periods of falling house prices commercial banks tend to suffer heavily.
Of course a separation between business banks and commercial banks has a price. A company need to keep contacts with two banks to get full service and both banks need to do extensive investigations to determine that it is safe to put money into a company. For this reason there is always the pressure from commercial banks to get more leeway to provide business services to companies. From ths 1970s this pressure succeeded and finally in 1999 Glass-Steagall was repealed.
This resulted in an extended financial sector that was de facto subsidized by the government. Of course this subsidy was hidden in guarantees and Central Bank loans but that didn't make it less real. Being subsidized this channel started to attract more and more money - at the expense of other channels. It was one of the factors that contributed to an increasingly endebted business sector.
In reaction to the credit crisis the banking sector was expanding and companies like Goldman Sachs got a status as bank. This certainly helped stabilize the crisis. But for the long term it was exactly the wrong development. Instead of expanding the guaranteed sector it should have been shrinked by forbidding banks to engage in activities outside their core or at least by making such activities unattractive by demanding large reserves. In addition banks should also be equired to have large reserves against any loans they make towards other financial institutions.
Such restrictions would actually help the recovery. Now much of the easy money disappears in all kind of speculation and such restrictions would make that less attractive.
The consequence of the present policies is that the easy money is stimulating bubbles while it contributes not much to permanent recovery. Sooner or later the new bubbles will burst. That time easy money will no longer be an option - many governments are too endebted - and we may face a real crisis.
For reason of its central position in the economy banks have government protection. This is supposed to result in a steady supply of credit to the business sector and private people. This protection and the access to cheap money from the central bank also constitute a hidden subsidy from the government for the banking sector. For this reason this protection has traditionally been reserved for commercial banks while business banks lack this protection.
Many people think that the Glass-Steagall act that regulated this separation was primarily for the protection of the commercial banks of the greater risks of the business banks. I don't agree. Glass-Steagall was introduced at about the same time that the US government introduced guarantees for the commercial banks. Its goal was to make sure the business banks didn't enjoy the same protection. This not only safed the government money. It also prevented ensuing distortions. Risk is a less important factor as it can be huge at commercial banks too: in periods of falling house prices commercial banks tend to suffer heavily.
Of course a separation between business banks and commercial banks has a price. A company need to keep contacts with two banks to get full service and both banks need to do extensive investigations to determine that it is safe to put money into a company. For this reason there is always the pressure from commercial banks to get more leeway to provide business services to companies. From ths 1970s this pressure succeeded and finally in 1999 Glass-Steagall was repealed.
This resulted in an extended financial sector that was de facto subsidized by the government. Of course this subsidy was hidden in guarantees and Central Bank loans but that didn't make it less real. Being subsidized this channel started to attract more and more money - at the expense of other channels. It was one of the factors that contributed to an increasingly endebted business sector.
In reaction to the credit crisis the banking sector was expanding and companies like Goldman Sachs got a status as bank. This certainly helped stabilize the crisis. But for the long term it was exactly the wrong development. Instead of expanding the guaranteed sector it should have been shrinked by forbidding banks to engage in activities outside their core or at least by making such activities unattractive by demanding large reserves. In addition banks should also be equired to have large reserves against any loans they make towards other financial institutions.
Such restrictions would actually help the recovery. Now much of the easy money disappears in all kind of speculation and such restrictions would make that less attractive.
The consequence of the present policies is that the easy money is stimulating bubbles while it contributes not much to permanent recovery. Sooner or later the new bubbles will burst. That time easy money will no longer be an option - many governments are too endebted - and we may face a real crisis.
Friday, December 11, 2009
The appeasement of China
When one studies the runup towards World War II the appeasement of Germany plays an important part. It was not just Munich 1938: on many prior ocassions (like the remilitarisation of the Rhineland) Germany had imposed its will with fait accompli's and military threats. In many cases Germany was just ondoing unfair provisions of the Versailles Treaty. Yet the effect was the same: Germany became used to getting its way unilaterally and became overconfident.
In China we see now a similar pattern. Everybody knows that China will have to do something about its trade surplus and its undervalued renminbi. Yet Obama (just as Bush before him) are too timid to say it openly. Instead they let themselves be lectured again and again by arrogant Chinese leaders. At the end of his last visit to China Obama even signed a common declaration that was widely seen a kowtowing to China's ambitions for regional hegomony.
The price of this indulgence is becoming higher and higher. The world economy is getting seriously out of balance and may end up in a crisis. China's leaders become more and more bold in their demands. Their recent noise about the Dalai Lama's visit to the Tamang region in India was the most striking example. And when one reads posts by Chinese on the internet it becomes clear that the problem is much wider. Many of them are extremely nationalist and quite a few threaten with war if China doesn't get its way.
One can only hope that it doesn't take too long before mr. Obama finally realizes that he can keep giving in to China forever because it will only lead to a steady increase of their demands. And this concerns not only the US: Other countries face the same problem with China.
In China we see now a similar pattern. Everybody knows that China will have to do something about its trade surplus and its undervalued renminbi. Yet Obama (just as Bush before him) are too timid to say it openly. Instead they let themselves be lectured again and again by arrogant Chinese leaders. At the end of his last visit to China Obama even signed a common declaration that was widely seen a kowtowing to China's ambitions for regional hegomony.
The price of this indulgence is becoming higher and higher. The world economy is getting seriously out of balance and may end up in a crisis. China's leaders become more and more bold in their demands. Their recent noise about the Dalai Lama's visit to the Tamang region in India was the most striking example. And when one reads posts by Chinese on the internet it becomes clear that the problem is much wider. Many of them are extremely nationalist and quite a few threaten with war if China doesn't get its way.
One can only hope that it doesn't take too long before mr. Obama finally realizes that he can keep giving in to China forever because it will only lead to a steady increase of their demands. And this concerns not only the US: Other countries face the same problem with China.
Monday, February 16, 2009
Austria wants a bail-out for Eastern Europe
EUobserver brings an article with the title "Austria pleads with Europe for bail-out of east". It appears that "European banks have a financial engagement of some €1.1 trillion in the region" with Austria the most exposed. Other EU countries are less enthusiastic to give the Eastern Europeans a share in the big stimulus and rescue bonanza, but according to Austria there is no alternative because otherwise "eastern Europe will start to collapse.".
I don't give them much of a chance for the moment. We will rather see a string of local bail-outs. Crisis management means at the moment a string of ad hoc decisions. A structural approach seems far away.
The Telegraph sounds even more alarmist: "Almost all East bloc debts are owed to West Europe, especially Austrian, Swedish, Greek, Italian, and Belgian banks. En plus, Europeans account for an astonishing 74pc of the entire $4.9 trillion portfolio of loans to emerging markets.
They are five times more exposed to this latest bust than American or Japanese banks, and they are 50pc more leveraged (IMF data).
Spain is up to its neck in Latin America, which has belatedly joined the slump (Mexico's car output fell 51pc in January, and Brazil lost 650,000 jobs in one month). Britain and Switzerland are up to their necks in Asia. "
"Europe's governments are making matters worse. Some are pressuring their banks to pull back, undercutting subsidiaries in East Europe. Athens has ordered Greek banks to pull out of the Balkans."
"If Deutsche Bank is correct, the economy will have shrunk by nearly 9pc before the end of this year. This is the sort of level that stokes popular revolt.
The implications are obvious. Berlin is not going to rescue Ireland, Spain, Greece and Portugal as the collapse of their credit bubbles leads to rising defaults, or rescue Italy by accepting plans for EU "union bonds" should the debt markets take fright at the rocketing trajectory of Italy's public debt (hitting 112pc of GDP next year, just revised up from 101pc – big change), or rescue Austria from its Habsburg adventurism. "
This sounds like a full panic and chaos in the making. The article calls for a stronger role of the European Central Bank to achieve a coordinated response.
Postscript: it seems that a consensus is growing in Europe about how to handle the mess. The price will probably be a weaker euro as a consequence of the high costs of the bailout (good for me as my income is in dollars). More problematic are the weak countries like Greece and Italy. There is some kind of tabu on letting them go from the euro zone as it might weaken the standing of the euro. However, I can't see how they want to accomplish this. The 3 percent limit was already supposed to prevent countries from going bancrupt and it obviously didn't work. I expect that a lot of money will be wasted before the inevitable is accepted: the euro doesn't work with too different economies.
I don't give them much of a chance for the moment. We will rather see a string of local bail-outs. Crisis management means at the moment a string of ad hoc decisions. A structural approach seems far away.
The Telegraph sounds even more alarmist: "Almost all East bloc debts are owed to West Europe, especially Austrian, Swedish, Greek, Italian, and Belgian banks. En plus, Europeans account for an astonishing 74pc of the entire $4.9 trillion portfolio of loans to emerging markets.
They are five times more exposed to this latest bust than American or Japanese banks, and they are 50pc more leveraged (IMF data).
Spain is up to its neck in Latin America, which has belatedly joined the slump (Mexico's car output fell 51pc in January, and Brazil lost 650,000 jobs in one month). Britain and Switzerland are up to their necks in Asia. "
"Europe's governments are making matters worse. Some are pressuring their banks to pull back, undercutting subsidiaries in East Europe. Athens has ordered Greek banks to pull out of the Balkans."
"If Deutsche Bank is correct, the economy will have shrunk by nearly 9pc before the end of this year. This is the sort of level that stokes popular revolt.
The implications are obvious. Berlin is not going to rescue Ireland, Spain, Greece and Portugal as the collapse of their credit bubbles leads to rising defaults, or rescue Italy by accepting plans for EU "union bonds" should the debt markets take fright at the rocketing trajectory of Italy's public debt (hitting 112pc of GDP next year, just revised up from 101pc – big change), or rescue Austria from its Habsburg adventurism. "
This sounds like a full panic and chaos in the making. The article calls for a stronger role of the European Central Bank to achieve a coordinated response.
Postscript: it seems that a consensus is growing in Europe about how to handle the mess. The price will probably be a weaker euro as a consequence of the high costs of the bailout (good for me as my income is in dollars). More problematic are the weak countries like Greece and Italy. There is some kind of tabu on letting them go from the euro zone as it might weaken the standing of the euro. However, I can't see how they want to accomplish this. The 3 percent limit was already supposed to prevent countries from going bancrupt and it obviously didn't work. I expect that a lot of money will be wasted before the inevitable is accepted: the euro doesn't work with too different economies.
Saturday, February 14, 2009
Japanese crisis lessons: honesty or money?
The New York Times has an article about lessons from the Japan for the US about managing the economic crisis. After a real estable bubble in Japan collapsed in 1990 Japan had its "lost decade" of economic stagnation. Much money was spent on stimulating the economy but the economy only started to recover after the Koizumi government in 2003 forced the banks to account for all their losses.
Yet despite its accurate analysis the article draws the wrong lessons. It concludes that "more money fast" is the lesson from Japan. I think the lesson should be: make the banks (and the economy) honest again. Banking is based on trust. And that trust has been totally destroyed in the US both by the Enrons and the Madoffs, but also by those bankers who sold mortgage packages to their collegues that they knew would never be repaid. If a bank now writes off a huge sum it means that until now it lied about that sum. Worse, it suggests that this or other banks might have more hidden losses. It is this blanket of lies that has to be lifted. That may very well cost a few trillion to the US. But money is not the core of the problem.
Yet despite its accurate analysis the article draws the wrong lessons. It concludes that "more money fast" is the lesson from Japan. I think the lesson should be: make the banks (and the economy) honest again. Banking is based on trust. And that trust has been totally destroyed in the US both by the Enrons and the Madoffs, but also by those bankers who sold mortgage packages to their collegues that they knew would never be repaid. If a bank now writes off a huge sum it means that until now it lied about that sum. Worse, it suggests that this or other banks might have more hidden losses. It is this blanket of lies that has to be lifted. That may very well cost a few trillion to the US. But money is not the core of the problem.
Thursday, February 05, 2009
The pros and cons of devaluation
I have plead before for letting the markets have their way with the currencies of Serbia and other countries. This time I want to explore the arguments for it.
The British pound fell 30% against the euro in 2008 and the fall is continuing. Yet the British Central Bank lets it go. It has learned its lesson from 1992 when Soros made US$ 1.1 billion speculating against the pound. Yet surprisingly countries that are new to free markets don't show this reluctance. Russia has spent $200 bln supporting the ruble until now - and has little to show for it. Serbia and other countries keep supporting their currencies too.
Their are basically two supporters for this monetary support: the IMF and the EU:
- the IMF operates defends the interests of foreign creditors. As local companies will need more local money to pay their foreign bills after a devaluation some will get in trouble and go broke. This means that the foreign creditor won't see its money. IMF doesn't like that.
- the EU aims for extending the euro zone. Countries who want to enter this zone need to keep their currencies in line with the euro for some time.
However, one can wonder whether the euro is really such a success as the EU paints it. I love being able to travel without having to change money. But the business case for the euro is weaker: The EU likes to stress how many billions are saved by not having to change money and not having any currency risk. Yet it doesn't show in the rather weak economic growth figures of the euro zone. Given the poor performance of the Euro zone until now in the economic crisis (we do worse than the US) this crisis may well mean the end of the Euro as we know it.
Very threatening is that nowadays people start openly talking that some country in the euro zone might go broke (the favorite examples are Greece and Italy). Italy used to have a high inflation economy and it regularly adapted the exchange rate to keep its currency competitive. This worked very well and Italy had a vibrant economy. Nowadays Italy is in the low inflation euro zone and it seems to have difficulty adapting to it. Being to able to devalue it currency was seen as a blessing by the Italians - not as a curse. This brings me to Slovakia that is very happy that it doesn't have to support its currency as it has entered the euro zone. I wonder whether they still will be happy in a year or two - or that they will broke as it proved to difficult to adapt their economy to the new reality without a devaluation. They are lucky that they didn't have a very skewed trade balance. But the crash of the car market may destabilize their economy.
An often heard objection against devaluation is that people will become poorer as they can buy less for their money. But that ignores that the country is living above its means and that it needs to reduce its trade deficit. Doing so with a devaluation spreads the pain equally over all citizens. The alternative (that the IMF favors) is firing thousands of government employees and stopping most government investment. That means spreading the pain less fair and usually with more damage to the economy.
One has also to consider the price one pays for an overvalued currency. It not only leads to an ever-increasing foreign debt, it also harms the national industry that cannot compete against the foreign imports. Supporting the currency subsidizes foreign imports at the expense of the local industry. All the Asian fast growth economies had an undervalued currency. The only country that used to have a sound economy combined with a strong currency was Germany with the Mark. But Germany compensated it with a very conservative fiscal policy, leading to trade surpluses.
At the moment one can see both models existing next to each other. While Ukraine has - on advice of the IMF - floated its currency that since has halved in value the Baltic states have kept their currency locked to the Euro - and they are paying a heavy price for that. It will be interesting to see which countries come out the best in the long term. In the mean time the Baltics lobby for a fast entry to the Euro zone.
The British pound fell 30% against the euro in 2008 and the fall is continuing. Yet the British Central Bank lets it go. It has learned its lesson from 1992 when Soros made US$ 1.1 billion speculating against the pound. Yet surprisingly countries that are new to free markets don't show this reluctance. Russia has spent $200 bln supporting the ruble until now - and has little to show for it. Serbia and other countries keep supporting their currencies too.
Their are basically two supporters for this monetary support: the IMF and the EU:
- the IMF operates defends the interests of foreign creditors. As local companies will need more local money to pay their foreign bills after a devaluation some will get in trouble and go broke. This means that the foreign creditor won't see its money. IMF doesn't like that.
- the EU aims for extending the euro zone. Countries who want to enter this zone need to keep their currencies in line with the euro for some time.
However, one can wonder whether the euro is really such a success as the EU paints it. I love being able to travel without having to change money. But the business case for the euro is weaker: The EU likes to stress how many billions are saved by not having to change money and not having any currency risk. Yet it doesn't show in the rather weak economic growth figures of the euro zone. Given the poor performance of the Euro zone until now in the economic crisis (we do worse than the US) this crisis may well mean the end of the Euro as we know it.
Very threatening is that nowadays people start openly talking that some country in the euro zone might go broke (the favorite examples are Greece and Italy). Italy used to have a high inflation economy and it regularly adapted the exchange rate to keep its currency competitive. This worked very well and Italy had a vibrant economy. Nowadays Italy is in the low inflation euro zone and it seems to have difficulty adapting to it. Being to able to devalue it currency was seen as a blessing by the Italians - not as a curse. This brings me to Slovakia that is very happy that it doesn't have to support its currency as it has entered the euro zone. I wonder whether they still will be happy in a year or two - or that they will broke as it proved to difficult to adapt their economy to the new reality without a devaluation. They are lucky that they didn't have a very skewed trade balance. But the crash of the car market may destabilize their economy.
An often heard objection against devaluation is that people will become poorer as they can buy less for their money. But that ignores that the country is living above its means and that it needs to reduce its trade deficit. Doing so with a devaluation spreads the pain equally over all citizens. The alternative (that the IMF favors) is firing thousands of government employees and stopping most government investment. That means spreading the pain less fair and usually with more damage to the economy.
One has also to consider the price one pays for an overvalued currency. It not only leads to an ever-increasing foreign debt, it also harms the national industry that cannot compete against the foreign imports. Supporting the currency subsidizes foreign imports at the expense of the local industry. All the Asian fast growth economies had an undervalued currency. The only country that used to have a sound economy combined with a strong currency was Germany with the Mark. But Germany compensated it with a very conservative fiscal policy, leading to trade surpluses.
At the moment one can see both models existing next to each other. While Ukraine has - on advice of the IMF - floated its currency that since has halved in value the Baltic states have kept their currency locked to the Euro - and they are paying a heavy price for that. It will be interesting to see which countries come out the best in the long term. In the mean time the Baltics lobby for a fast entry to the Euro zone.
Tuesday, January 13, 2009
Stagflation
The international reaction to the financial crisis leaves me more and more puzzled. Everyone seems to be a Keynesian now. This reminds me of the reason Keynes got out of favor.
The 1973 oil crisis (that greatly increased the oil price) led to an international economic crisis. This became even worse when the Iranian revolution led to the second oil crisis that again doubled the oil price. Western governments generously spent money in order to stimulate the economy, but it didn't lead to growth, only to inflation. This became known as stagflation. In the end it was the Reagan-Thatcher doctrine of "economic reform" that got the world out of the crisis with its emphasis on less government.
Now it seems that the Reagan-Thatcher doctrine has had its time. The present crisis had to do with not enough government and there is demand for a stronger government role. But I wonder whether the financial stimuli will really help.
The 1960s and 1970s were the time of the rise of Japan. Much manufacturing jobs had gone there. Much of the compensation had been in the government related area. The financial drain of oil crisis exposed this as untenable. It looks like we have now a similar situation: the productive jobs have gone to China. Now the financial sector was the main creator of new jobs, but they were just as unproductive.
My expectation is that the financial stimuli won't work and that instead we will have to reform the financial sector.
The 1973 oil crisis (that greatly increased the oil price) led to an international economic crisis. This became even worse when the Iranian revolution led to the second oil crisis that again doubled the oil price. Western governments generously spent money in order to stimulate the economy, but it didn't lead to growth, only to inflation. This became known as stagflation. In the end it was the Reagan-Thatcher doctrine of "economic reform" that got the world out of the crisis with its emphasis on less government.
Now it seems that the Reagan-Thatcher doctrine has had its time. The present crisis had to do with not enough government and there is demand for a stronger government role. But I wonder whether the financial stimuli will really help.
The 1960s and 1970s were the time of the rise of Japan. Much manufacturing jobs had gone there. Much of the compensation had been in the government related area. The financial drain of oil crisis exposed this as untenable. It looks like we have now a similar situation: the productive jobs have gone to China. Now the financial sector was the main creator of new jobs, but they were just as unproductive.
My expectation is that the financial stimuli won't work and that instead we will have to reform the financial sector.
Monday, January 12, 2009
Serbian dinar is falling fast
Due to the Ukrainian gas crisis and the ongoing economic crisis the dinar is falling fast - despite the central bank spending $40 mln in one day to support it.
I have already repeated pled for a more sensible currency policy. The dinar is going to fall much more as Serbia's current account, trade and government deficits are simply not sustainable in the present economic climate. The Serbian central bank can react in two ways:
- it can fight the decline because it doesn't like the effect that the Serb companies that have lent in foreign currencies will have to pay back more and may get in financial trouble. This strategy amounts to subsidizing currency speculators. In the end the currency will still end low, but Serbia will be out of money.
- it can also let the fall happen and spend the money that it saves on supporting the companies that get in trouble because of it.
Until now Serbia chooses the first option. Rather foolish in my opinion.
I have already repeated pled for a more sensible currency policy. The dinar is going to fall much more as Serbia's current account, trade and government deficits are simply not sustainable in the present economic climate. The Serbian central bank can react in two ways:
- it can fight the decline because it doesn't like the effect that the Serb companies that have lent in foreign currencies will have to pay back more and may get in financial trouble. This strategy amounts to subsidizing currency speculators. In the end the currency will still end low, but Serbia will be out of money.
- it can also let the fall happen and spend the money that it saves on supporting the companies that get in trouble because of it.
Until now Serbia chooses the first option. Rather foolish in my opinion.
Friday, December 19, 2008
The mysteries of the financial 40 pct profit share in the economy
One of the aspects of the financial crisis that still gets little attention is how big the financial sector has become. According to this lecture (See the pdf for graphs)from Kemal Dervis:
If you see the graph (page 9 in the pdf) you will see that historically that share of the profits has been about 15% and that it has been growing for decades, but in a very irregular way. The big question is:
how can a sector that is not really productive produce 40% of the profits?
Some ideas:
My expectation is that the present crisis will not enough bleed the financials to stop them. After things get back to normal they just will go on to create the next bubble. Until we have finally a crisis that is too big...
In the early 1980s the share of the financial sector in both, corporate value-added and profits in the American economy, was about 5 to 6 percent. The share of financials in value added has steadily increased and has reached about 8 percent in 2006-2007. The share of profits, however, climbed to reach an extraordinary 40 percent and more!
If you see the graph (page 9 in the pdf) you will see that historically that share of the profits has been about 15% and that it has been growing for decades, but in a very irregular way. The big question is:
how can a sector that is not really productive produce 40% of the profits?
Some ideas:
- The financial boom started with the Reagan-Thatcher financial deregulation. In a time when it was difficult to find venture capital it seemed like an obvious solution. The same argument is still repeated nowadays allthough the problem is no longer there. Easy credit helps also good ideas.
- The financial sector is protected. Financial loses are often covered by government. See LCTM in 1998 and the present bailouts. See also the way in which the IMF pressures countries to extreme savings when they default on loans.
- Bubbles have created a casino mentality with investors. They may have lost with the Dot-Com bust but that they know that many others who stepped out in time make a lot of money. Just like gamblers investors tend to think that they are able to beat the average.
- More and more sectors of the industry become target of the financial "wizards". Two of their tactics are the Leveraged Buy Out and the deregulation of traditional sectors of the economy, like energy. As these sectors are usually too important too fail they have considerable leeway to extort money from other parties (labor consessions, higher tarifs, government support, etc). The high leverage of these investments makes it possible to score enormous profits when things goes well. For the investors it is no problem to take irresponsible risks: what counts for them is only the chance for big gains.
- The consumer is the victim. Easy credit may sound very attractive. But in the end the effect was that the prices rose and it was nearly impossible to buy a house without taking a huge mortgage.
- The money gives the financial sector power as a presure group. We see ever more pressure for the creation of new "investment opportunities". One of the targets at the moment is financial deregulation in developping countries. In this demand in the context of the GATS free trade negotiations the Western countries ask for deregulation of the financial sectors over there. They wouldn't even be allowed to ask that foreign banks keep local reserves.
My expectation is that the present crisis will not enough bleed the financials to stop them. After things get back to normal they just will go on to create the next bubble. Until we have finally a crisis that is too big...
Monday, October 20, 2008
The economic crisis in developing economies
The financial crisis is not restricted to the US and the EU. Developing economies suffer even more as they are often dependent on foreign finance. The NY Times notes that the Ukraine has asked the IMF for 14 billion US$ while Hungary just got 5 billion euro from the European central bank.
The Balkan will not be spared either. Business Week this week published a list of 10 countries in the danger zone. Among them are Serbia and Romania.
Reuters has some economic facts about the Serbian economy. The current account deficit is 18 percent (IMF advice: les than 10%). Foreign investment is artificially keeping the exchange rate high so that there is much more import than export. But of course this is borrowed money that one must be paid back. The Ukraine is already suffering from the hangover of foreign-investment led growth. Serbia may well follow if it doesn't take measures to decrease its trade deficit.
The Balkan will not be spared either. Business Week this week published a list of 10 countries in the danger zone. Among them are Serbia and Romania.
Reuters has some economic facts about the Serbian economy. The current account deficit is 18 percent (IMF advice: les than 10%). Foreign investment is artificially keeping the exchange rate high so that there is much more import than export. But of course this is borrowed money that one must be paid back. The Ukraine is already suffering from the hangover of foreign-investment led growth. Serbia may well follow if it doesn't take measures to decrease its trade deficit.
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