Tuesday, 18 November 2008

Impact on Emerging Markets

One of the biggest stories to emerge from the G-20 Summit was the seating arrangement: Lula da Silva of Brazil was on George Bush's right and Hu Jintao of China was on his left. This has repeatedly been said to signal the new international economic order. Immanuel Wallerstein, for example, argues that American political and economic power peaked between 1945 and 1970 and has been declining since. He contends that George Bush's eight years in office hastened that decline, and Brazil's insistence over the weekend on being partners with the US, not mere junior parters, evidences a new multipolar world system.

Yet, assertions of the new multipolarity does not mean emerging economies will be resistant to financial or economic contagion. How will countries be affected? First, stock market spillovers are quite clear. We've seen the MSCI emerging market index (which includes stock markets in Brazil, South Africa, India and China) drop precipitously by 23%. Just as important now it seems is the growing global economic downturn. RGE monitor reports that growth in nine of the largest emerging Asian economies was revised downward. According to the Asian Development Bank, India's growth will fall sharply.

Developing countries are impacted in a number of different ways. Trade, especially in natural resources will slow following drops in demand. Remittances, the second largest financial inflow to many developing countries (exceeding foreign aid) will decline as both economic migration to developed countries declines with job losses and the quantity per remittance drops. Foreign aid, which is pro-cyclical, will suffer along with bad economic news, though development aid has been in secular decline already for two decades. While falling capital flows into developing countries may adversely affect some, for others it may ease pressure on climbing exchange rates and allow for greater internal capital mobilization.

Countries strongly affected will be those with substantial exports to the US and EU, especially those countries selling commodities that are highly income elastic--that is commodities particularly sensitive to changes in income--including, for example, Caribbean and African countries with big tourism sectors. Countries with substantial current account deficits (a macroeconomic account which includes a country's balance of trade, or their exports minus imports, plus their net on interest, dividends and foreign aid) may be in trouble. RGE monitor notes that South Africa's current account deficit (at 7.3% of GDP) has been widening and the country will be less able to finance it with foreign investment, making possible sudden and large capital outflows.

However, despite these turbulent times for the developing world, this crisis is unusual in that it is a crisis in the core. Merrill Lynch's Emerging Markets Macro Weekly from November 10th did an old school country by country risk analysis, which seems to strongly support this view. They crunched about 5000 economic indicators and built a risk ranking for the world (based on current account financing gaps, foreign exchange reserves, exports to GDP ratios, private credit to GDP ratios, private credit growth, loans to deposits ratios, and bank capital to assets ratios). Their results are pretty interesting, and if anything may support Wallerstein's faith in the new multipolarity. They conclude:
The world’s ten most vulnerable economies are: Australia, Switzerland, Korea, Romania, Hungary, Sweden, Bulgaria, Euro area, UK and US. The world’s ten least vulnerable economies are Nigeria, Mexico, Philipinnes, Colombia, Egypt, Oman, Indonesia, Peru, China and Russia.

Wednesday, 12 November 2008

Waking up to the crisis

The price of oil

Oil prices continue to fall amid persistent fears of a sustained global recession. Until last August the price of oil and the price of oil futures (claims on future oil production that can be originated, bought and sold) consistently fluctuated in a counter-cyclical fashion in relation to the values of major stock indices. The fact that oil tended to go up in price when stocks went down while oil tended to down if stocks went up indicated a shuffling of funds between the two markets. The causality was case by case but there was certainly a strong negative correlation between the two classes of investment. Since late September, equity and oil have been continued to exhibit strong correlation. This correlation, however, is now positive. Both stocks and oil have been plummeting in step with one another.
How should this change in the relationship between oil and equity be interpreted? This is one point where virtually all schools of economic thought can probably agree. The downward movement is a reflection of the economic crisis deepening and becoming universal. In order for investors to move money from sinking stocks into the oil market they would have to believe that global demand for petrol was buoyant. This would imply that the global slowdown was such that the worlds appetite for fossil fuels would continue through what would have to be a relatively mild period of global gloom. Investors are coming to understand the gravity of the situation. This is far from news. The shift in the relationship between equity and petrol began in August--before the collapse of Lehman Bros. What is note worthy is that the price of oil seems to have no floor. It has continued to sink in step with equity far below where many thought it possibly could.


Global trade is expected to contract, in global terms, for the first time in 26 years. This news is coming at a time in the history of the global economy when trade constitutes a more important role in growth than at any other time. Throughout the global expansion of the last decade and a half, increases in trade have out paced global growth by a large and consistent margin. The world bank has announced that it will be releasing $100 bn in funds to deal with the slowdown in trade and some of the devastating effects it is expected to have on poor and middle income countries.

Fiscal policy

One of the only issues that the nations participating in the G20 meeting in Washington this weekend can agree on is the need for major fiscal stimuli. This comes after the realization that even the most aggressive monetary policy (rate cuts to stimulate lending and increase the money supply) would have little effect on the willingness of financial institutions to begin lending again. Money markets (the markets in which firms raise money for short and medium term debt usually related to raw materials and pay-role; the overhead costs that bring firms through one production cycle to the next) are still hemorrhaging funds as investors pull back from market exposure.
A major fiscal response by China has just been announced ($586 bn) while preliminary responses by the worlds richest countries have been made public (USA $170 bn, Japan $168 bn, Germany $15.7 bn). The spending packages announced will most likely be spent on everything from consumer stimulus (tax rebates to increase demand), transport investment, and possibly investment in utilities such as water and electricity. The nature of the distribution of the fiscal package will depend largely on the ideological leanings of the government implementing it. In the free-market spirit of minimized state intervention the US is more likely to concentrate on stimulating consumption. Other nations, such as China, can be expected to concentrate on long term investment like infrastructure--this creates jobs in the short term while creating long term capacity increases. European and North American nations will do the same albeit in a smaller scale.
Can this sort of massive public expenditure benefit normal people? If so how? And, if the answer is yes, how can we ensure that aside from bettering our lot economically it also deepens democracy? Can there be democratic accountability of public revenue of the sort that could empower normal people? These are questions to think about.

Other economic news...

Bush has rejected continued calls for a rescue for Detroit's big 3 auto makers. Economists predict that allowing the companies to collapse would cause more than 2.5 million job losses. The effect of that would be devastating for the American economy and would certainly pull the rest of the world down with it.

Between now and the end of 2011, approximately $2,100 bn of European corporate debt will be due to be payed back, $800 bn of which will be due next year. These massive paybacks come at a time when it will be harder to refinance (take out new loans to pay back old ones) debt than at any other time since the great depression. With the world economy in free fall, the default of more major companies would surely only accelerate the decline.

The IMF, in its World Economic Outlook Update, predicted that the advanced economies, taken as a whole, would experience a contraction of output for the first time in the post-war period.

If you cannot feel the effects of the economic crisis yet, expect to soon.

Sunday, 9 November 2008

On interest and the Nov. 6 rate cuts

Among the non-Obama related news is a massive Bank of England cut in the cost of borrowing by 1.5 per cent and the European Central Bank's cut of .5 per cent. The cuts came alongside a gloomy International Monetary Fund report forecasting 2009 to be the first contraction of industrialized countries since WWII. Meanwhile, the Financial Times has continued to report that inflation is set to fall along with declining commodity prices.

The aim of the interest rate cut is both to loosen credit to allow for the continued daily functions of capital and hopefully to increase investment, which would then combat falling prices. But how should we understand the determinants of the rate of interest? Academic economists theorize the longer term tendencies of the interest rate more than day to day shifts. Neoclassical economists assume that the average rate of interest and the average (or general) rate of profit equate in equilibrium. Here, the sheer mobility of money capitalists and productive capitalists will tend to generate an equalization of returns. Marx however, disagreed.

Marx's thoughts on the rate of interest are somewhat scattered and fragmented. He did not however seem to believe that the rate of interest was determined by the same laws of motion which determined the general rate of profit, ie, the technical conditions of production. He says in volume III of Capital: "The prevailing average rate of interest in a country, as distinct from the constantly fluctuating market rate, cannot be determined by any law. There is no natural rate of interest, therefore in the sense that economists speak of a natural rate of profit and a natural rate of wages."

While there is no general theory of the average rate of interest, he does say a few things about it's determinants. He indicates that the average rate of interest will fall below the general rate of profit and above zero. For if the average rate of interest and the general rate of profit were equal, where would be the incentive on the part of any individual capitalist to go through the difficult and uncertain process of production; much easier would be to simply lend and collect. Thus there must be rewards to "profit of enterprise." Marx also notes that the average rate of interest depends to some extent on the supply and demand of money capital.

Additionally, it must be noted that the interest of money capitalists does not reflect any contribution to the production of value. Instead it is a deduction on "profit of enterprise" or industrial capital. That is, surplus value is divided between what productive capital keeps and what must be paid out to money capital in interest. This might be why he refers to them as "parasites" and "bandits". Again, Marx notes: "It is indeed only the separation of capitalists into money-capitalists and industrial capitalists that transforms a portion of the profit into interest, that generally creates the category of interest; and it is only the competition between these two kinds of capitalists which creates the rate of interest."

Regarding day to day fluctuations of interest and central bank policy, Marx seems to deny that monetary authorities take the role of prime mover: "An ignorant and mistaken legislation ... may intensify a money crisis. But no manner of bank legislation can abolish a crisis." This, in a post gold-standard era, is because of the central bank's perpetual struggle to both avoid the devaluation of commodities and maintain money as the reflection of social labor (on this point see David Harvey, Limits to Capital, 2006, p. 294). In a crisis, the contradiction of a central bank may be between devaluing money on the one hand via inflation that is caused by lowering interest rates (low interest rates prompt investment and an increase in the money supply hopefully generating more production and higher prices, which is why unions have backed the move), and allowing commodities to devalue in a recession or depression. Put more generally, the problem for Marx is the simultaneous management of "capital in its money form and capital in its commodity form." Currently we are seeing the inflation/devaluation strategy. In a period of falling inflation, especially in Europe, central banks are hoping the drastic rate cuts will both to loosen credit and prop up prices of goods so to better reflect their value. Savers on the other hand are rightly worried about the value of their currency.

Monday, 3 November 2008

Global Outlook...

With tomorrow's election looming and continuing signs of an immanent global recession, the world's leaders are moving forward on their plans to rearrange the worlds financial infrastructure. The meeting of 20 industrialized and developing nations outside of Washington DC on Nov. 15 will be the beginning of a process, known as Bretton Woods II, that will determine the future international finance law and regulation. While participating nations agree on the need to forge a united response to the crisis, tensions exist regarding the nature of said response. Some participating countries, led by France, would like to see an effective convergence of regulatory law to prevent competition between financial centers. This proposal is likely to be contested. The reason this proposal is likely to meet resistance is that it would limit the ability of states and municipalities to enact policies that minimize regulation thus attracting oversight-averse financial institutions. The theory behind demanding a unified regulatory system that would eliminate the ability for financial centers to develop exceptional policy structures is that the lack of universal legal norms would lead to financial centers being forced to out-do each other in the race to deregulate and attract financial businesses. In other words, if left the option, national and regional governments will, following their self interest, undermine any progress made in the way of new regulatory norms. (Here we can see yet another example of how entities, guided by self interest can undermine the collective good.)

In IMF (International Monetary Fund, a Bretton Woods I institution) news, the UK is pressuring Saudi Arabia to contribute more to the fund's coffers in order deal with threats to sovereign financial stability. Saudi Arabia accumulated over $500 bn in foreign assets during the boom in oil prices. It is unlikely the Saudis will give into the pressure without an agreement that would redefine Saudi Arabia's role in new financial order (in this case, their role within the decision making structure of the IMF).

Strikes are expected in Europe's largest economy, Germany. Over 130,000 trade unionists have voted to strike over the rejection of a wage increase that was proposed in August. IG Metall is the trade union leading the strike. It is an important union in Germany because many other unions look to IG Metall as benchmark for wages.
Portugal is set to nationalize a small bank that has become insolvent. The Socialist Party government rejected pleas from the bank for a bail-out (capital injection). Instead the government determined that it was in the interest of the people of Portugal that the bank be nationalized.

This is what Bloomberg columnist, Mark Gilbert has to say about the macroeconomic outlook:

"The Shipping News Suggests World Economy Is Toast:

In the third quarter of 2007, Volvo AB booked 41,970 European orders for new trucks. Guess how many prospective purchases Volvo, the world's second-biggest maker of heavy rigs, received in the third quarter of this year?

Here's a clue. Picture a highway gridlocked by 41,815 abandoned trucks -- because Volvo's order book got destroyed to the tune of 99.63 percent, with customers signing up for just 155 vehicles in the three-month period, the Gothenburg, Sweden-based company said last week.

The pathogen that has fatally infected swathes of the banking industry is now contaminating non-financial companies. ``We're heading toward the sharpest downturn I've ever seen in Europe,'' said Chief Executive Officer Leif Johansson.

Volvo has company. Daimler AG, the world's biggest truckmaker, said earlier this month that its U.S. deliveries slumped by a third in the first half of the year.

After months of money-market madness, slumping stock markets, collapsing currencies and bank bailouts, the headlines from the broader economy are starting to roll in -- and the news is all bad and getting worse, fast.

Let's begin with the shipping news. If nobody is buying your trucks, you don't need to rent a vessel to carry that shiny new 18-wheeler to its new owner. Hence the Baltic Dry Index, which tracks the cost of shipping goods and commodities, fell below 1,000 this week for the first time in six years.

Slow Boats From China

Put another way, it is now almost 90 percent cheaper to ship goods over the oceans than it was at the beginning of the year. And because the huge vessels known as capesize ships can't currently charge much more than their daily operating cost of about $6,000 per day, their captains have slowed down to economize on fuel and save money, to about 8.68 knots from 10.33 knots in July, according to data compiled by Bloomberg.

It isn't just the oceans that are emptying. Air freight traffic dropped 7.7 percent in September, according to the latest figures from the International Air Transport Association. That's the steepest decline since the trade group began compiling the data in January 2003.

Figures this week showed U.S. consumer confidence collapsed to a record low in October; retail therapy probably isn't the cure. With Christmas looking like it might be canceled, why bother fighting with your bankers for the letters of credit you need to export the stocking-stuffers you make in the factory?

`Growing Anxiety'

``The October reading signals the deepening concern about the marked deterioration in the overall economy as well as the growing anxiety arising from the continued travails in the financial markets,'' David Resler, chief economist at Nomura Securities in New York, wrote in a research report. ``Confidence declined across all regions, all age groups and all income categories.''

One way in which the current recession/depression/meltdown (take your pick) will differ from previous economic collapses is the granularity of information now available. The world is awash with more data than ever before, generating a plethora of ways to scare yourself silly.

The Bank of England, for example, produces what it calls a Financial Market Liquidity Index, a global measure of stress that gauges how far a basket of nine indicators strays from its historical mean. The index gets updated twice a year; this week's bulletin, which recalculates the level up to Oct. 17, showed liquidity at its lowest level in at least 17 years.

Default Danger

The next wave of headlines to scare shoppers out of the mall is likely to come when companies find they can't pay their debts. Credit-rating company Moody's Investors Service predicts that the default rate among sub-investment grade borrowers will surge to 7.9 percent in a year, from 2.8 percent at the end of the second quarter of 2008 and from just 1.3 percent 12 months ago.

``With the global credit crisis intensifying and credit spreads widening, it is increasingly likely that corporate default rates will spike sharply in the next 12 months,'' Kenneth Emery, the director of default research at Moody's, said in a research report published earlier this month.

The Markit iTraxx Crossover index of credit-default swaps on mostly speculative-grade companies traded as high as 920 basis points this week. That level suggests investors and traders are anticipating more than half of the companies in the index will default, based on bondholders recouping 40 percent of their money from companies that fail to keep up their debt payments.

Going Bust

At a recovery rate of 20 percent, the implied default level is about 45 percent. At a salvage percentage of just 10 percent, the index is still suggesting about 40 percent of its members will renege on their commitments. It is hard to see how consumer confidence will recover when companies start going bust.

``Worries about defaults are mounting as liquidity is strained,'' Guy Stear and Claudia Panseri, analysts at Societe Generale SA, wrote in a research note this week. ``Earnings expectations still look optimistic, with analysts projecting 2009 earnings for the S&P 500 rising by 19 percent.''

There's a great scene in the film version of Annie Proulx's Pulitzer Prize-winning novel ``The Shipping News.'' A grizzled journalist explains to rookie hack Kevin Spacey how dark clouds on the horizon justify the hyperbolic headline ``Imminent Storm Threatens Village.''

``But what if no storm comes?'' Spacey asks. The veteran replies with a second-day headline: ``Village Spared From Deadly Storm.'' Unfortunately, the global village we live in is unlikely to survive unscathed"