Kamis, 02 Juni 2011

The Jamaican Experience - Third World Debt Crises

The history of mankind has been punctuated by an elusive series of booms and slumps. Historians have singled out the experience of the early 1930's as the 'Great Slump' or the more commonly termed 'Great Depression.' This undeniably humbling event, dubbed an 'economic blizzard' by historian Denis Richards, destroyed the then nascent economic stability in Europe and severely dented consumer and investor confidence around the World. Similarly the world debt crisis of the 1970's and 1980's also brought with it its own blizzard effect that engulfed both developing and developed countries. The debt position of developing countries became extremely troubling when as Stambuli (1998) notes it became obvious that there was a growing mismatch of external indebtedness and the ability of nations to service their debt. This serious disparity was ultimately characterized by numerous debt rescheduling arrangements and more importantly countries declaring default. In hindsight there have been many theories that have sought to explain the causes of this crisis, however this paper will explore specifically whether developed or developing countries should be held accountable for causing and by extension alleviating this crisis. Jamaica's debt position will also be comparatively analyzed in a bid to ascertain the extent to which there is an unusual difficulty in servicing debt or in other words a crisis exists.

In order to fully appreciate the concept of accountability we must first understand the general conditions under which third world debt became problematic. Many development economists view the substantial increase in oil prices in 1974, which saw the price of oil increase from $2.70 in 1973 to a daunting $10.00 per barrel, as a major root cause.(1) This price increase immediately elevated the surplus on the current accounts of oil producing countries from $7 billion in 1973 to $68 billion in 1974. These large surpluses created the situation cogently documented by Stambuli (1998) that prompted oil-exporting countries who had more foreign exchange than they needed to invest in western banks. In a bid to offload the subsequent liquidity these banks then sought to recycle the surplus of 'petro-dollars' with developing countries that had experienced deteriorating current accounts. In Jamaica for example Brown (1986) reports that between 1976-1980 the deficit totaled $733 million. This process of recycling was inherently aggressive since as Kenneth Hall notes in the text 'The Caribbean Community Beyond Survival' the real interest rate during the 1970's was actually negative, which implies that borrowers were actually being compensated for taking loans. Developing countries then entered into what has been described as 'an orgy of borrowing' (Hall, 2001 ppxxxiii) that left them severely exposed in 1979 when a second oil price increase occurred. The latter brought the debt service capacities of developing countries to the forefront as countries faced increasing interest rates and shorter maturities on loans that were needed to amortize previous obligations. It is in this general environment that the crisis culminated with Mexico's poignant declaration that it could no longer honor its debt requirements in August of 1982.

Banking is a lot safer than it was

The financial crisis was fought at the weekends. In sweat-stained shirts, fuelled by stale coffee and cold pizza, harried officials worked the phones and held emergency meetings with other bankers to discuss whether to save this bank or to let that one sink—all before markets opened on Monday. The Sunday scrambling reflected the fact that officials had too many fires to put out and too few good options to choose from.

Before the crisis, regulators hoped that the discipline of markets would ensure banks were sensible in the risks they took. That proved to be a vain hope, in part because markets are prone to exuberance and in part because many banks had become so large that they could not be allowed to fail and they knew it. The emphasis now is on drawing up a new rule book for finance. In America, the world’s biggest financial market, the Dodd-Frank act is reversing decades of deregulation. In Britain officials are pondering plans for banks to erect firewalls between the different parts of their businesses. All banks will be required to hold a lot more capital to protect them against unexpected losses. New rules on funding and liquidity will force them to keep more liquid assets that can be easily sold should they need to raise funds urgently. These measures are making banking safer than it was. But the job is still far from complete.

To make banking safer, regulators need to marry two seemingly contradictory aims. The first is to make it less likely that banks will fail in the next crisis. The second is to make it less painful for taxpayers when they do fail. On the first, the biggest gains come from raising liquidity and capital standards—and here there has been plenty of progress. The new Basel 3 rules will have the effect of doubling the amount of core equity that a typical big bank holds as a proportion of its assets. The standards come into full force only in 2019 but the market is making banks plump up their capital cushions far sooner. Had Basel 3 been in force before the crisis most big banks would have been sufficiently stocked up on capital.

Most, but not all. Only a handful of big firms, out of a couple of hundred worldwide, suffered net losses that the new Basel standards would have been unable to deal with. Forcing all banks to hold enough equity to ensure that even the worst outliers think Irish banks are safe is an option from the ivory tower. The amounts needed would harm banks’ capacity to lend, fail to discriminate between well-run outfits and badly run ones, and encourage risks to migrate out of the regulated banks to the shadow-banking system (another area that still needs lots of work). Regulation, even in a business as dangerous as banking, should be restrained and targeted.

A little layer cake in Basel

A bit more equity is sensible for banks that are interconnected and large enough to cause serious economic damage if they collapse. The simplest way of doing this would be to insist on a chunky capital surcharge for systemically important banks. The Basel committee should look at the debate under way in Britain, where an independent commission has proposed an additional equity buffer of 3% for big retail banks.

The other thing that regulators need to do is soften the blow when banks do get into trouble. Most countries are putting in place resolution regimes that allow regulators to shut down smaller banks. But letting a big retail bank close its doors completely is still unthinkable. The real task is finding a way to impose losses on banks’ owners and creditors rather than making calls on taxpayers.

Tools are being developed in the form of convertible-capital instruments and bail-in debt, whereby creditors of struggling banks are turned into shareholders if losses rise high enough. Swiss regulators, for example, want their biggest banks to hold the equivalent of 9% of their risk-weighted assets in convertible capital. The advantage of these instruments is that losses fall where they ought, on those who funded the banks, and that they provide a ready-made pool of capital that is cheaper than equity and large enough to recapitalise all but the most extreme failures. Questions swirl around these new instruments. Is there enough demand for them? Will they stop the problem of creditors running for the hills at the first sign of trouble? But a thick buffer of equity and convertible debt is the best way to make crisis-filled weekends less terrifying.

Rabu, 01 Juni 2011

The Oil Supply and Petroleum Economics

Many have blamed the rapid rise in oil prices in 2007 and the first-half of 2008 on speculators. But if we somehow banned speculators from trading oil futures and options, would the price of oil drop back down to pre-2007 levels? It is not clear that it would.

The link between high oil prices and speculators is understood to work as follows:

1    Oil analysts and traders believe that oil prices will rise in the future due to a combination of increased demand from China and India and due to slowing or even reduced supplies from "peak oil".

2    Seeing the writing on the wall, speculators start buying up oil futures and options today, believing they will be worth more in the future. This buying up of oil futures immediately raises their price, due to basic supply and demand.

3    The price of oil should fall once these futures mature because speculators have no need for a physical delivery of oil - where would they store it?

4    However prices, on average, do not fall - in fact they rise. It could be because someone is buying massive amounts of oil and physically storing it somewhere, but this is highly unlikely. What is more likely is that the price is maintained high because it is being "stored" in the ground rather than making it to market; that is some oil companies are cutting production.

Step 4 in the chain is the crucial one. Unless the oil is being stored by the speculators (or somebody the speculators are selling their futures to), they cannot permanently drive the price up. All else being equal, oil prices must fall as the speculators sell their futures prior to maturity. But since the price of futures are not going down (on average), then all else must not be equal - it must be that production is being cut from what it would have been. We can think of the current situation as being akin to oil companies buying the futures from the speculators and delivering the oil to themselves.

Due to this, it is not clear that getting rid of the speculators would drop oil prices one cent. The high prices appear to be largely supply-side issue. How much of the lower supply is due to oil companies cutting production and how much is due to "natural" factors is open to debate.

Crisis and The Globalization

The IMF has been on the front lines of lending to countries to help boost the global economy as it suffers from a deep crisis not seen since the Great Depression. For most of the first decade of the 21st century, international capital flows fueled a global expansion that enabled many countries to repay money they had borrowed from the IMF and other official creditors and to accumulate foreign exchange reserves.

The global economic crisis that began with the collapse of mortgage lending in the United States in 2007, and spread around the world in 2008 was preceded by large imbalances in global capital flows. Global capital flows fluctuated between 2 and 6 percent of world GDP during 1980-95, but since then they have risen to 15 percent of GDP. In 2006, they totaled $7.2 trillion—more than a tripling since 1995. The most rapid increase has been experienced by advanced economies, but emerging markets and developing countries have also become more financially integrated.

The founders of the Bretton Woods system had taken it for granted that private capital flows would never again resume the prominent role they had in the nineteenth and early twentieth centuries, and the IMF had traditionally lent to members facing current account difficulties. The latest global crisis uncovered a fragility in the advanced financial markets that soon led to the worst global downturn since the Great Depression. Suddenly, the IMF was inundated with requests for stand-by arrangements and other forms of financial and policy support.

The international community recognized that the IMF’s financial resources were as important as ever and were likely to be stretched thin before the crisis was over. With broad support from creditor countries, the Fund’s lending capacity was tripled to around $750 billion. To use those funds effectively, the IMF overhauled its lending policies, including by creating a flexible credit line for countries with strong economic fundamentals and a track record of successful policy implementation. Other reforms, including ones tailored to help low-income countries, enabled the IMF to disburse very large sums quickly, based on the needs of borrowing countries and not tightly constrained by quotas, as in the past.

Egypt's revolution

In The four months since the fall of Hosni Mubarak, Egyptian politics have rocked along in a see-saw fashion. The Supreme Council of the Armed Forces, which has assumed interim powers in advance of elections scheduled for the autumn, tilts in favour of the status quo. Its members 18 ageing generals seem instinctively shy of risk and bewildered by the noisy civilian world into which they have stumbled. Their reluctance to move rouses suspicions among the wider public. Pressure for prompt, tangible evidence of revolutionary change builds, culminating in threats to reignite the massive protests that toppled Mr Mubarak. The military men buckle, and cast a few concessions to the crowd. Equilibrium is briefly restored until the next surge of public passion.

Such was the background to the decision, on May 24th, to refer the former president, his two sons and a fugitive billionaire associate to trial on criminal charges which may include murder. Last month Mr Mubarak and his sons, who spent the first weeks after their ouster in a secluded resort, were arrested in response to massive protests in Cairo's Tahrir Square. As their incarceration dragged on (the 83-year-old Mr Mubarak has been held in a hospital rather than prison), doubts arose as to the government's will to prosecute them.

Not only did the generals, all of whom served most of their careers under the command of Mr Mubarak, himself a former general, show little sign of sharing the public's outrage over growing evidence of the former first family's gross abuses of power. The army's imposition of swift, draconian military justice on civilian activists, and its deployment of thuggish military police to quell protests, contrasted jarringly with the relatively mild treatment enjoyed by hated strongmen of Mr Mubarak’s regime. Although dozens of these men are in custody or under investigation, few have been sentenced and only one, a low-level police officer tried in absentia, has been convicted for his part in the killing of more than 800 people during January's unrest.

With much of the disparate movement that organised the revolution calling for another huge gathering in Tahrir Square on May 27th, Egypt's hesitant rulers again budged. Not only are the Mubaraks now certain to face trial, a development that is unprecedented in any Arab country. The government's apparent bid to stem public anger in advance of Friday's protest included the sacking of several top police officials and the amnestying of many civilians held in military prisons.

Such efforts to show good will are effective, up to a point. Many Egyptians have tired of the turbulence that has dogged the country since the fall of Mr Mubarak and would be content to let the soldiers rule in peace. Parts of the political spectrum, most glaringly Islamist groups, led by the powerful Muslim Brotherhood, have sought to score tactical gains by praising the military and condemning its detractors. Yet the protests will go ahead, nevertheless, if only because a broad spectrum of Egyptians has concluded that they are the only thing the generals listen to. This strange dialogue looks set to continue through a long, hot Egyptian summer.

Minggu, 29 Mei 2011

Economy and The Presidential Elections

It seems that during every presidential election year we hear that jobs and the economy will be pivotal issues. It's commonly assumed that an incumbent president has little to worry about if the economy is good and there are lots of jobs. However, if the opposite holds true, he should prepare for life on the rubber chicken circuit.

I decided to examine this common wisdom to see if it holds true, and to see what it can tell us about the upcoming election between George W. Bush and John Kerry. Since 1948 there have been eight presidential elections that have pitted an encumbent versus a challenger. Out of those eight, I chose to examine six elections. I decided to disregard two elections where the challenger was considered too extreme to be elected: Barry Goldwater in 1964, and George S. McGovern in 1972. Out of the six remaining presidential elections, incumbents won three and challengers won three.

To see what impact jobs and the economy had on the economy, we'll consider two important economic indicators: the growth rate of real GNP (the economy) and the unemployment rate (jobs). We'll compare the two-year vs. the four-year and previous four-year performance of those variables in order to compare how "Jobs & The Economy" performed during the incumbents presidency, and how it performed relative to the previous administration. First we'll look at the performance of "Jobs & The Economy" in the three cases where the incumbent won.

Out of our six presidential elections, we had three where the incumbent won. We'll look at those three, starting with the percentage of the electoral vote each candidate collected.

    1956: Eisenhower 57.4%, Stevenson 42.0%

    Real GNP growth (Economy):
    Two Year: 4.54%
    Four Year: 3.25%
    Previous Administration: 4.95%

    Unemployment Rate (Jobs):
    Two Year: 4.25%
    Four Year: 4.25%
    Previous Administration: 4.36%

    Although Eisenhower won in a landslide, the Economy had actually performed better under the Truman administration than it did during Eisenhower's first term. Real GNP, however, grew at an amazing 7.14% per year in 1955, which certainly helped Eisenhower get reelected.

    1984: Reagan 58.8%, Mondale 40.6%

    Real GNP growth (Economy):
    Two Year: 5.85%
    Four Year: 3.07%
    Previous Administration: 3.28%

    Unemployment Rate (Jobs):
    Two Year: 8.55%
    Four Year: 8.58%
    Previous Administration: 6.56%

    Reagan won in a landslide, which certainly had nothing to do with the unemployment statistics. The economy came out of recession just in time for Reagan's reelection bid, as real GNP grew a robust 7.19% in Reagan's final year of his first term.

    1996: Clinton 49.2%, Dole 40.7%

    Real GNP growth (Economy):
    Two Year: 3.10%
    Four Year: 3.22%
    Previous Administration: 2.14%

    Unemployment Rate (Jobs):
    Two Year: 5.99%
    Four Year: 6.32%
    Previous Administration: 5.60%

    Not quite a landslide, we see quite a different pattern than the other two incumbent victories. Here we see fairly consistent economic growth during Clinton's first term as President, but a consistently improving unemployment rate. It would appear that the economy grew first, then the rate of unemployment decreased, which we would expect since the unemployment rate is a lagging indicator.

If we average out the three incumbent victories, we see the following pattern:

    Incumbent 55.1%, Challenger 41.1%

    Real GNP growth (Economy):
    Two Year: 4.50%
    Four Year: 3.18%
    Previous Administration: 3.46%

    Unemployment Rate (Jobs):
    Two Year: 6.26%
    Four Year: 6.39%
    Previous Administration: 5.51%

It would appear then from this very limited sample that voters are more interested in how the economy has improved during the tenure of the presidency than they are in comparing the performance of the current administration with past administrations.

We'll see if this pattern holds true for the three elections where the incumbent lost.

Real GNP Growth
Clinton's 2nd Term: 4.20%
2001: 0.5%
2002: 2.2%
2003: 3.1%
2004: 4.2% (First quarter) 37 Months Under Bush: 2.10%
Last 15 Months: 3.32%

and secondly, the average unemployment rate:

The Unemployment Rate
Clinton's 2nd Term: 4.40%
2001: 4.76%
2002: 5.78%
2003: 6.00%
2004: 5.63% (First quarter) 37 Months Under Bush: 5.51%
Last 15 Months: 5.92%

We see that both real GNP growth and the unemployment rate have been worse under the Bush administration than they were under Clinton in his second term as President. As we can see from our real GNP growth statistics, the growth rate of real GNP has been rising steadily since the recession at the beginning of decade, whereas the unemployment rate is continuing to get worse. By looking at these trends, we can compare this administration's performance on jobs and the economy to the six we have already seen:

  1. Lower Economic Growth than the Previous Administration: This occured in two cases where the incumbent won (Eisenhower, Reagan) and two cases where the incumbent lost (Ford, Bush)
  2. Economy Improved In the Last Two Years: This occured in two of the cases where the incumbent won (Eisenhower, Reagan) and none of the cases where the incumbent lost.
  3. Higher Unemployment Rate than the Previous Administration: This occured in two of the cases where the incumbent won (Reagan, Clinton) and one case where the incumbent lost (Ford)
  4. Higher Unemployment Rate in the Last Two Years: This occured in none of the cases where the incumbent won. In the case of the Eisenhower and Reagan first term administrations, there was almost no difference in the two-year and full-term unemployment rates, so we must be careful not to read too much into this. This did, however, occur in one case where the incumbent lost (Ford).

While it may be popular in some circles to compare the performance of the economy under Bush Sr. to that of Bush Jr., judging by our chart they have little in common. The biggest difference is that Dubya was fortunate enough to have his recession right at the beginning of his presidency, while the senior Bush was not so lucky. The performance of the economy seems to fall somewhere in between the Gerald Ford administration and the first Reagan administration. That, coupled with all the non economic issues such as the war in Iraq, makes it difficult to tell if George W. Bush will end up in the "Incumbents Who Won" or the "Incumbents who Lost" column. As of May 7, 2004, Internet trading site Tradesports.com gives George W. Bush a 60% chance of winning the upcoming election, showing that the betting public is split on the President's chances as well.

Banks in Central Europe

Herbert Stepic could qualify as the grand old man of central European banking, and not just because of his avuncular beard: at Austria’s Raiffeisen Bank (now RBI) he has been the face of its foreign business since the 1970s. RBI’s subsidiaries now range over 16 former communist countries including Russia and last year yielded around €930m ($1.3 billion) in pre-tax profits. He is bullish about the potential for banking in the region, having just bought Polbank, a Polish retail bank, which he says fills “the last gap” in his diversified portfolio.

Only UniCredit of Italy has a comparable spread, if its banks in the Baltic states and Turkey are included. UniCredit calculates that, by assets, it is the biggest regional player. Erste Bank, which is Austrian like RBI, has more concentrated market power. Through its subsidiaries it has around a quarter of the retail markets in the Czech Republic, Slovakia and Romania.

The region is undoubtedly promising. For 2011, RBI predicts GDP growth of 3.9%, more than double the euro area’s 1.8%. Each group insists it is well placed to profit from the upswing. UniCredit points to its exposure to Russia, Turkey and Poland, which it says combine size with low banking-sector volatility. The trio accounts for 57% of the Italian bank’s regional revenues.

A handful of other foreign banks have a presence in one or two central European countries, but they lack a grand regional strategy. Intesa San Paolo of Italy, for example, owns the biggest bank in Serbia and the second-biggest in Croatia and Slovakia. KBC, a Belgian banking and insurance group, owns the biggest bank in the Czech Republic and the second-biggest in Hungary. It is expected to hang on to those but is planning to sell its banking interests in Russia, Serbia and Slovenia.

Two decades after the fall of the Berlin Wall, Erste, RBI and UniCredit are benefiting from their early commitment. Each has been led by a man with a zest for the place. In Austria, Andreas Treichl, still head of Erste, and Mr Stepic at RBI acquired banks early on in neighbouring countries and never looked back. Alessandro Profumo, then head of UniCredit, was early into Poland and later bought Germany’s HypoVereinsbank, which owned Bank Austria Creditanstalt, the market leader.

These men had the foresight, during the global banking crisis, to keep their banks engaged in the region, with a little help from their home governments, the European Commission and the European Bank for Reconstruction and Development. Together they developed a voluntary pact known as the Vienna Initiative, to keep money flowing in the European Union’s eastern states. It is paying dividends today.

There are some clouds. The recoveries in Hungary and Romania may falter and the Polish economy could overheat. Mr Stepic reckons the biggest irritant is bank windfall taxes imposed by Austria and Hungary, based on balance-sheet size. Other countries will follow, perhaps with performance-based levies. But old hands like Mr Stepic seem to relish an obstacle race.