Saturday, 31 March 2012

The House of Saud

The Good, the Bad and the Ugly
If there is any country in the world which has been laid to waste by rent seeking monopolies then it is Saudi Arabia.

The Desert Kingdom is the sixth largest consumer of Oil, with an economy and population that is not commensurate in size to the 2.8 million barrels it guzzles each day; which increased without unease by 78.2% between 2000 and 2010, shown in the above graph taken from this week's issue of The Economist. For all its vast fields, which represent nearly 18% of global oil reserves, Saudi Arabia is an unequal, politically repressed, and a stagnant society. It follows a highly strict version of Islam descended from the teachings of Muhammad Abd-al-Wahhab, an 18th Century Theologian. Saudi Aramco, the parasitical State Oil Monopoly, inefficiently pumps out more than 95% of the Kingdom's Oil and is controlled on the whims of its political masters; in 2005 it was briefly valued at $800 billion, 20% larger than the current GDP of Saudi Arabia.

The current absolute monarch King Abdullah, the son of the Kingdom's first Ruler, has done little to improve the structural weaknesses of the economy despite having a family wealth that lays to shame the coffers of its neighbours. But its neighbours, like Qatar and the UAE, have striven to diversify their economies unlike the Kingdom's heavy addiction to its one and only sector. The youth, composed mainly of testosterone driven young men as women are heavily marginalised in society, live high octane, idle lives given that the price for a litre of oil is subsidised at 8 pence or 13 cents; part of the delicate social contract between the monarchy and its peoples.

Meritocracy is alien to the Kingdom and labour mobility is based on nepotism and relative distance of lineage from the royal family. Then it is no wonder that the economy is profligate, rent seeking and stray. The weak institutions and monopolies on power and incomes only goes to reinforce this status quo.

Thursday, 29 March 2012

The Great Gatsby

On the Brink
Ben Bernanke, the Fed Chair, finishes off his Financial History Course at GW today. I have been watching his lectures with avid interest. It is an opportunity to observe a current Fed Chair's mindset on Economic History and the role of Finance in our Economy and Society.

Mr Bernanke, in his third lecture, hits upon the dramatic tight jacket Banks around the world confined their assets into. Overnight borrowing between Banks rose to 350 basis on October 10th 2008. That is an annual cost of borrowing of nearly 300,000 percent; unheard of in a major advanced, modern economy. It was a classic symptom of a Diamond-Dybvig model on Banking Panic, as money markets which acted as the linchpin and conduit of capital between non-financial firms and financial markets completely froze on the heels of Lehman's Bankruptcy.

Any sort of Central Bank and/or Government inaction would have proven to be calamitous in the autumn of 2008; the Global Economy would have plummeted if Mr Bernanke had given into the rational expectations classical beliefs in the natural causes of things, still held by a number of economists and professional analysts. Mr Bernanke, and more so the New York Fed President Timothy Geithner and Treasury Secretary Hank Paulson, were indecisive when it came to Lehman which was deeply unfortunate. The Recession would not have been so deep otherwise; which has ultimately led to nearly eight and a half million redundancies in the US, hiccup in Emerging Market Growth, collapse in World Trade and untold [and still counting] losses for Europe and Britain.

Tuesday, 27 March 2012

The Great Stagnation

A bygone age?
Tyler Cowen, of George Mason University, published online an intriguing thesis on Economic Growth last year entitled 'The Great Stagnation'. In a few easy-to-understand 15000 words, Mr Cowen argues the marginal benefits from Technology, Marco-inventions, and Innovations have slowly declined. India and China are growing simply due to the application of previously underutilised capital and labour, and borrowed catch-up technologies from the west; nothing more than that, as otherwise claimed by overpaid analysts. On the other hand, advanced economies are faltering to a growth nadir; the marginal push towards college and university education has already borne fruits in the past half-century.

The previous inventions in Industry, Chemistry, and Electricity from the late 17th to the early 20th century, gave a tremendous boost to Economic Growth. This was helped along in the 20th Century by microinnovations in household technologies such as the radio, refrigerator, television, air conditioning and so forth. Yet Mr Cowen observes the households of today have not significantly changed from those of 40 years back; give or take the odd widescreen plasma tele or a shiny fridge with a centralised distilled water filter system.

The Internet despite its claim to great potential does not create many jobs as were the case with past innovations. Facebook employs a measly 3000 employees, and Google around 30000. In a US labour force of approximately 150 Million and a combined OECD advanced economies' workforce of around 700 Million, the share of employment of technology companies underpinned by the Internet is negligible. In Finance, inventions like credit instruments or 'Sivs' have not exactly been socially and, since the Crisis, privately useful. Arguably Finance's last great innovation was the Automated Teller Machine, commonly known by acronym: ATM; yet there are only a certain number of credit analysts you could employ based on that time-saving and consumption-smoothing 'hole in the wall'.

Mr Cowen is an economist who has a tendency to look at the long term for both good and ill, which he frequently does in dozens of daily posts on his popular and highly recommended blog; for what its worth his thesis is a death knell to the likelihood of any sort of robust recovery in advanced economies from the 2008 Crisis comparable to the healthy recoveries of 1933-37 or 2001-07.

The trouble with Economic History is falling into the logical fallacy that the future is representative of the past. Extrapolating the decreasing marginal use of labour saving devices like the fridge or the ATM ignores the future potentials of cognitive enhancing innovations like the Internet. The Internet is the defining tool of our generation in our drive to endow future generations a Type I Civilisation; where world energy output is commensurate to the entire solar insolation of the Earth, a benchmark measure for Humanity's progress. The Internet has through Wikipedia, Google, and countless other information platforms reduced economic inefficiencies by increasing information symmetry, political accountability, knowledge gathering and pooling, and productivity. Leading to anything but a 'Great Stagnation'.

Monday, 26 March 2012

Causa Latet, Vis est Notissima

One of the great mainstream discussions in the subject are the various attributing causes to the Great Depression; which led the Global Economy to ruin in the 1930s and, arguably, to calamitous Warfare a decade later.

This post is very much inspired by last week's Lectures given by Ben Bernanke, the Fed Chairman, at George Washington University. Mr Bernanke is no stranger to the subject, on the contrary he is a giant. As a student of Economic History, Mr Bernanke was the best man to save the US and the Global Economy at the onset of the 2008 Financial Crisis from a repeat of the policy errors of the 1930s.

The Great Depression was the first global financial crisis; in terms of its scope and scale, it outweighed many of the past confined and local Banking Crises of the early 20th and late 19th Century. The United States, lacking a Central Bank, had always been prone to crises and mania prior to the First World War (WWI). Yet it was also a large insular economy; steadily integrating itself into the global trading and capital networks safeguarded by the British Empire.

By the conclusion of WWI the period ,which now has become known as the 'interwar years', was unstable and asymmetric. The return to the Gold Standard, that bastion of currency and output stability or so it was thought, brought concomitant global imbalances. Britain and Germany had overvalued and uncompetitive parities, whereas the US and France hoarded Gold and kept their exchange rates undervalued. Germany was forced into an inequitable reparation arrangements that it financed through Hyperinflation; sowing the seeds for disillusionment, and later channelled through bigoted fanaticism.

In the US, the first decade of the interwar years became known as the 'Roaring Twenties', for its carefree, spendthrift, and lackadaisical attitudes towards rising prosperity and living standards. In parallel, there was rampant speculation and bubbles which were wholly unregulated and uncontrolled by the government. The Economic Philosophy was one of natural causes towards bubbles and manias. Mr Bernanke has called this the 'liquidationist' approach. It would come to haunt inept policymakers when it came to handling falling output, trade, employment and inflation after 1929; I will expand on the fiscal and monetary response towards the Great Depression in a later post this week.

The US by the end of the 1920s was an Economic Superpower. Though the Bank of England and the British Empire still had some clout in determining allocation of global resources and monetary policies; the New York Fed and the deep pool of American equity markets funded German Reparations, Foreign Direct Investment, and Foreign Trade Deficits. Despite this, there was an ambivalent thinking at the New York Fed, the dominant body of the regional branches composing the Fed, over the concerns of a heightening stock market bubble and asset speculation. The New York Fed chose to raise discount rates in the late 1920s, to no avail it seems when the Crash occurred in October1929.

The headstrong Benjamin Strong, Governor of the New York Fed, had a premature death in October 1928. His replacement George Harrison brought little confidence and faith in the Fed's control over the economy; plunging expectations when the Crisis hit.

Sunday, 25 March 2012

Why Nations Fail

Two different Worlds?
This may be an old perspective but it is still relevant today in the ongoing discussions over Economic Convergence, Inequality and Globalisation. Many would point out when looking at the relationship between growth and income per head that it should be negative. In that Growth models and basic intuition would tell us economies at a lower income per head should grow faster than economies with higher income per head. That is not the case in the top graph, where the line of best fit, the regression line, is slightly positive, indicating richer economies grew slightly faster in the period from 1980 to 2000 than their poorer counterparts. Additionally, there is a wide dispersion in the growth stories for poor economies: some growing fast whereas most completely losing out.

Yet that perspective is naive, because if we were to weigh the economies according to population, as is done in the graph below the first, we will see the extraordinary impact growth has had on poorer economies like India and China, who take in the bulk of the developing world's population. In reality the wide dispersion of poor-income economies is due to some falling off the globalisation bandwagon altogether; those some are mainly Sub-Saharan African economies, represented by the yellow dots.

Sub-Saharan Africa has enduring extractive institutions from the Colonial Period upheld by a coterie of parasitic elites. There is seldom any rule of law, secure property rights, or basic social expenditure on health, education and infrastructure in these economies. This is not due to the lack of a state, but in spite of it. Countries like Nigeria and the Congo are unfulfilled nightmarish societies with rife cronyism, failed governance, and rottenness at all levels of the state.

Daron Acemoglu and James Robinson, of MIT and Harvard respectively, co-authored a book on Institutional Economic History recently, provocatively asking "Why Nations Fail"? The answer, however, partly lies on blaming leviathan and oppressive states captured at a point in time. Rather it is primarily due to the historical path dependent evolution of certain regimes, like those of Western Europe and its offshoots in North America and Australia, in gaining inclusive forms of structured governance and institutions; which in turn encouraged private enterprise, capital formation and growth.

There certainly are some peculiar economies which have escaped categorisation and the trend of history altogether, like those of Botswana and Japan. Cecil Rhodes was prevented by the British Government from absorbing Bechuanaland into his marauding private Empire in the 19th-Century 'Scramble for Africa'. Helped by good chance, a tiny population and British encouragement, Independent Botswana developed sound institutional checks restraining any sort of rent seeking over its vast natural resources and diamond deposits; and is hitherto a resounding success in the Dark Continent. Japan, too, through chance, historical accidents and sound economic planning was able to catch-up to its Western Counterparts in half a century after the Gunboat Diplomacy of Commodore Perry in 1854.

Ultimately what Messrs Acemoglu and Robinson are arguing is its difficult to hastily adopt the successes of nations within a generation or so, let alone a few years or decades. The City of London, Britain's largest Industrial Cluster, cannot be replicated in Dubai or Singapore overnight. Neither can the outstanding successes of Silicon Valley and the mass markets created by its shining stars, like Apple, be duplicated in Shanghai or Bangalore.

Saturday, 24 March 2012

Prélude à l'après-midi d'un faune

Waiting for a Leader
The French Presidential election is going to kick off next month with Nicolas Sarkozy seeking a second term in office. Only in January French Bonds were downgraded a notch by Standard and Poor's; the anticipation by investors and speculators was drumming up in 2011 in the form of increasing risk between French and German Bonds, as shown in the graph above.

The dangers of a Hollande presidency, Mr Sarkozy's Socialist Challenger, would likely take a heavy toll on French Borrowing Costs, inter alia. Mr Hollande has declared war on "the world of finance" and has a dislike for German Leadership. Mr Hollande wants to raise the top rate of taxation to 45% and impose an additional 75% tax on incomes above a million euros. The effective tax rates for those earning above a hundred thousand euros are already higher than their counterparts in Britain, Denmark, and Sweden. The French Sarko-State already takes in 42% of GDP in taxation.

The French, never the ones to back away from a fight with les Glouton Riche, should nevertheless re-elect Mr Sarkozy if only to prevent the likes of Mr Hollande from ever appearing as a Socialist Candidate again. The toxic Ms Le Pen, the far-Right politician whose ideas are deeply flawed, is an unfortunate reminder of French disillusion with their changing society, economy, and culture; the recent deeply sad events in Toulouse will only go to reaffirm those misguided beliefs.

Mr Sarkozy has regained French clout in the global community from his stirring actions and words over Libya and Georgia, respectively. The French Economy, hitherto not cracked by the Debt Fiasco, needs all the help it can get for the next holder of the Elysée. The Brits are learning it the hard way, but Globalisation for all its normative reservations is rebalancing the Global Economy in favour of footloose and moody capital; it is ultimately a contest of middling economies, like those of Britain and France, to woo and serenade this femme fatale; otherwise "Hell hath no fury like a woman scorned"!

Time for Kim

Having the time of his life; and over here as well!
Selection for the next head of the World Bank was always a done deal; Christine Lagarde took the IMF, and an American would take the World Bank. With growing resentment of the inequities in the distribution of power at International Institutions disproportional to the increasing global rebalance towards Asia, the Obama administration have chosen Jim Kim as their nominee. America and Europe command 45% of the vote at the Bank, the requirement of a simple majority should be easy enough to cross. His two competitors for the post are from Columbia and Nigeria.

If a candidate were to be selected on merit, Jim Kim would be on that list. Mr Kim, who was born in South Korea, is qualified both on resume[an M.D. and Ph.D. from Harvard] and experience. The World Bank is set for a long due streamlining of its objectives. It has in the last few decades become overstretched and, frankly, useless. Its focus should be on incentive-based Micro projects in eliminating poverty, famine and disease from Sub-Saharan Africa to South East Asia. Mr Kim is an able public health specialist to lead the Bank in that direction. Clearly its time for the economists at the Bank to step aside .

Friday, 23 March 2012

On Tenterhooks

A Stygian Passageway

The map above is the channel of water separating Iran from the Arabian peninsula: the Strait of Hormuz. The dangers of an Iranian Military Blockade of the Strait from retaliation or preemption would be disastrous for the Global Economy. For nearly 17 million Barrels of Oil every day, the Strait is the only access route to global markets. That is around 20% of Global Oil Demand; without which the price of Oil would soar most probably above $200 a barrel. A scenario that would prove to be all too damaging to any chances of an economic recovery in advanced economies and would put to hiatus the strong growth of emerging economies.

Such are the dangers of political tensions in affecting each and every one of us. The Right-Wing Israeli government of Benjamin Netanyahu is determined to prevent a Nuclear Iran; thus far placated by the pleas of diplomacy at the behest of President Obama. A crisis, which would come to dwarf any other of this century comparable to the 1962 Cuban Missile Crisis, could very well play out in the coming months in the event of an overt Israeli/US strike on Iran and consequent Iranian retaliation.

Links of the Week

This Week's recommended Economic Writings:

Exchange Traits

A mixed bag of marbles
Since the Financial Crisis struck we have seen a mixed bag of exchange rate levels for advanced economies. With the Euro weakened by its self-induced paralysis, the sterling is relatively stronger since half of British Trade is with the EU. The above graph calculates the exchange rate as a share of an economy's trade with its respective partners; put simply, it is a measure of overall competitiveness for an economy's trading industries in foreign markets and a higher value indicates a higher price for an economy's goods and services.

With the dollar, initially we saw appreciation in the months after Lehman's Collapse as there were strong capital flows into the US from liquidation of US held foreign assets. Since then with several rounds of liquidity support by the Fed and fiscal deficits, the dollar has gradually weakened. By contrast, the Swiss Franc has been stabilised at a ceiling since the summer of last year by the Swiss Central Bank, to prevent a repeat of the drastic appreciation in mid-2011 when hot money fleeing from the then unfolding European Debt Fiasco came into the country.

The Aussie Dollar has become stronger due to two factors in play; firstly, the economy is seen as a safe haven by foreign investors and yields on Australian property, assets, and bonds are quite healthy and robust; secondly, there is an extraordinary demand for Australian commodities from Asian Economies. With world prices for several commodities sky high, Australian terms of trade has drastically improved too.

The Yen is a paradox given the weak health of the Japanese Economy since the Earthquake of March 2011, and its first merchandise trade deficit since 1963 reported last year. The strength of the Yen is most probably due to the unfolding of the Carry Trade. Such arbitrage trade is done with enormous volumes of capital borrowed from low-interest economies, like Japan, and invested in high-yielding currencies, such as the Aussie Dollar. Foreign exchange trading, much of which is conducted here from London, has been wounded by the unravelling of the Financial Crisis.

Thursday, 22 March 2012

Equity Convergence

Taken for a ride

Recently, US equity markets have nearly caught up with their supposedly vibrant Asian counterparts. Emerging markets themselves are very heterogeneous; some economies, like Singapore and Hong Kong, have mature markets with deep pockets. Others tend to be erratic and stagnant, like those of Vietnam and Philippines.

Nevertheless, the above graph, should be indicative that global equity markets are still very much linked to each other in their sentiment over prospective earnings, output, and global growth. Linked to this entry, Ryan Avent talks of the Euro zone over here . Over all I feel pessimistic of short term growth and quite frankly long term growth is not looking good either in advanced economies.

Gentlemen prefer Bonds

The seven month itch 
Advanced Economy Bonds are clearly solidifying their image as risk-free assets. At least in terms of the preference expressed by managers and investors for US Mutual Funds. In the above graph, we can make out an almost symmetric inverse relationship between the capital flows into Bond and Equity Funds. The appetite for equities is still highly cyclical, especially in the last 7 months. But with the European Debt Fiasco contained in the near short term, it is likely flows into equity markets are set to increase in the second quarter of 2012.

Bar the uncertainty on Soverign Defaults, Contagion and the corresponding danger of Credit Default Swap fallouts in the first half of 2011, flows into Bond markets are keeping a swift pace at the start of this year. Nevertheless the above graph is atypical of the relationship between Bonds and Equities, but these are anything but normal times!

Wednesday, 21 March 2012

Faute de Mieux

Counting the years
Occasionally if you ever go to St James Park, London, in the evening you are likely to run into some cabinet minister or, God forbid, an ex-Prime Minister burning of their calorific Westminster Diet. Your Blogger found himself in this predicament when he was rushed by a hoodlum of joggers on Monday evening in the park, which consisted of the British Prime Minister and his portly minders. No doubt training for the Bare-knuckle fights of Budget Day.

Today was the Chancellor's Budget Day. All in all it was a humdrum affair given Her Majesty's Treasury did away with the long held precedence of purdah held before Budget Day. The major pieces of the Budget are threefold. Firstly, the Top rate of Taxation for those earning above £150000 is coming down by 5%, to 45%; far cry from the suffocating 95% common before the 1970s. Secondly, Taxation will start on those earning above £9205, the new personal tax allowance threshold. And Thirdly, Corporation Tax is set to decline to 24%, with the gradual target of 22% before the next general election and, if the government is re-elected, 20% ex post.

The first and third pieces make sense, Britain's comparative advantage and trade lies in financial, legal and glamour [fashion, advertising, management, accountancy and so forth] services; boosting those shall help the economy stutter along. The 50% top rate was the highest for any major economy, and was an act of desperation from the last rueful days of the previous Labour Government. The second piece is a placebo compromise along with the 7% stamp duty on home sales above £2 million, to the Government's Coalition partners: the ever dithering Liberal Democrats.

The Government also has its eyes on balancing the Budget in the long term. In the sense of decreasing the rate of annual net borrowing; the amount which cannot be covered by taxation. In, perhaps, Britain's worst period of stagnation since Napoleonic Times, this may prove all too much for any chances of recovery. In the above graph, the Bank Base Rate has been at its nadir; when in the entire 314 years of the Bank of England's History the rate never went below 2%. Additionally, the Bank has been printing money to make government borrowing cheaper, what PR firms have obtusely called Quantitative Easing. Government borrowing is also at is cheapest; encouraging the Chancellor of the Exchequer to raise longer Bonds of more than 50 years, the nomenclature the FT have given to it are the 'Osborne Bonds'; maybe a lasting legacy of the Current Government for future generations of Brits.

With all this in mind, it strikes me as odd that fiscal conservatism should be the priority of the day. Recession Economics is not normal Macro 101. However the Budget for the faute de mieux, as the opposition have themselves no clear idea on how to stimulate the economy, is a good start to encouraging the expenditure of the £700 billion-odd cashpile British businesses have tucked away under their pillows.

Additionally, Britain stands out amongst advanced economies in its resolve to handle the post-Crisis period. The continental economies have an Albatross around their neck in the form of an ill-thought out currency union. Japan has entered its third lost decade. The United States is far too big to model economic policy on and has its own unique set of problems. Policymakers at Westminster have a long decade ahead in which to shape out the 'Kaleidoscope' Economy they so very much crave for; this Budget marks a good beginning in encouraging private enterprise and investment.


Jumping Ships

The London Interbank Offered Rate (LIBOR) is the short-term benchmark cost of borrowing in international capital markets. The above graph shows the 3-month LIBOR, which underpins some of the deepest markets in global finance; The Eurodollar futures, non-US banks' futures contracts, are based on the 3-month LIBOR and are traded on the Chicago Mercantile Exchange.

I would briefly like to comment on the structural breaks of the 3-month LIBOR time series since its inception in 1986. I ran a simple Chow Test on the series to test for the break. Clearly, even without the test, one can see in the graph above after every US recession, 1990-1, 2001 and 2008-9, the rate settles at a new level. The ex post rate succeeding recessions is lower each time; whether that is due to the severity of the respective recessions or the increasing integration of global finance, it is insufficient to conclude. Nevertheless, the 3-month LIBOR offers a great deal of economic and financial information on the respective conditions of markets and the economy.

Tuesday, 20 March 2012

The Beijing Consensus

Long march forward
A discussion paper on China's economic model was released last year from the University of Surrey. It comes to a conclusion that in the short-medium term we are likely to see increasing adoption of China's model of economic development by other developing/emerging economies; which China has so successfully used to become the second [and in due course the] largest economy in the world.

The Washington Consensus, a Decalogue of policy prescriptions coined by John Williamson in 1990, came to describe a one-size-fits-all-model of shock therapy and fiscal/monetary supply-side conservatism. It really was armchair Economics at its worst. The International Monetary Fund throttled the consensus down on its hapless client states in the wake of the number of currency and banking crises faced by developing economies in the 1990 and early 2000s.

The Beijing Consensus, on the other hand, advises a slow, Confucian, and deterministic approach to opening one's economy. It really is based on economic planning, exchange rate control, gradual creation of incentives within industries, and economic targets. Quite similar to the macro-micro mix of economic reforms Deng Xiaoping used to unleash Chinese growth in the 1980s.

The authors of the paper do, however, add a caveat that in the long term we are likely to see a swing towards a more open Chinese economy. One instance, that I had referred to in earlier posts, is the offshore convertibility of the Renminbi. Such an event would boost the Chinese currency globally, but would require a liquid, structured and robust domestic financial system within China itself; supported by an able and sound central bank which the PBOC is currently living up to.

In Search of Lost Time

Les Trente Glorieuses
More than a hundred years ago the World Economy was slowly integrating into a cohesive whole; much like today. During this 'first era of Globalisation' we saw large part of the world coming into the periphery of trading, capital, and economic networks; with the British Empire forming the backbone of this network and London as the alpha-financial command center.

A measure of financial integration is the correlation between Domestic Savings and Investment. If it is high, then clearly the economy is autarkic; in the sense it is reliant on its own pool of savings for its investments. A lower correlation indicates the economy is open to the pool of savings of the entire world. The right hand axis measures this correlation in the above graph. The left hand axis is the difference of bond yields between those of the peripheral [emerging] economies, at that time, and Britain, the Economic Superpower.

The two are very much in sync, a period of financial instability caused by imprudent investments by British Banks in the 1890s cause the two values to go up. However until the outbreak of the First World War, the emerging market risk premium and savings-investment correlations were gradually coming down.

This really was a time of great prosperity and investor freedom granted by the British Royal Navy and the Bank of England. Sadly the period succeeding it was doomed to warfare, depressions, and political instability. Just imagine a counterfactual world in which there were no such genocidal conflicts. After 1913 we would have seen la belle epoque resume its financial, political, and cultural integration of the World Economy. The economies which would have benefited significantly from this counterfactual peace would have been China, Britain, Japan, the Middle East, and [possibly] Russia. The United States was arguably the chief beneficiary of those tumultuous years, 1913-45, in Economic History.

Monday, 19 March 2012

All the World's a Stage

As you Like it

Arvind Subramanian, an Indian Economist, constructed last year an economic power ranking measured by a weighted combination of an economy's share of world output, trade, and capital flows. The results above show the dominant powers of the past, present and future.

Clearly there is some movement for the top berths. Britain's Industrial Revolution, more than a century and a half ago, gave it an impetus to transform her economy, society and culture into modernity. The United States by sheer size and dynamism borrowed and carried forth those ideals into the 20th Century. China, whose transition from Mao's dark days of regressive technological and societal repression into its current industrial behemoth, is destined to become the economic superpower of the 21st Century.

However, acquiring power brings with it certain responsibilities. Britain conducted the International Orchestra, to borrow a Keynesian phrase, through the astuteness of the Bank of England in maintaining the Classical Gold Standard, 1870-1913; a period of unequalled capital and labour openness.

The United States, with a Carte Blanche at the end of WWII, similarly rose to the occasion and organised the International Monetary System (IMS) around its set of preferences. Those preferences were in contrast to Britain's free trade mercantilist system of old. They were defined on the ill experiences of the Great Depression; for US policymakers stability of the IMS came through financial regulation and control. Such was the Bretton Woods system, 1946-73; a continuation of the Gold Standard, albeit, without the lessons learnt from the interwar period. Its collapse in 1973 led to a free for all, where banking and currency crises multiplied and economies became susceptible to investor mood swings. Increased regulatory arbitrage led to leverage and moral hazard. Culminating in the ongoing 2008 Financial Crisis.

The IMS of today is unfit to integrate China, India and Brazil, into the core of the World Economy. Philip Coggan, The Economist's Buttonwood Columnist, recently published a book on the history of the IMS: Paper Promises. In it, Mr Coggan concludes any future IMS will be determined by the preferences of Beijing. Chinese policymakers are averse to capital mobility, risk, and exchange rate volatility. In an IMS maintained by China, we are likely to see some semblance to the Bretton Woods System.

Indeed in the full swath of Economic History, to complete this post's title, "All the World's a stage, and all the men and women merely players; They have their exits and entrances, and one man in his time plays many parts". Transitions between IMS have hitherto been tumultuous periods of global rebalancing: WWI, WWII, Great Depression, 1970s Stagflation. One hopes, this time around, History does not repeat itself.

Financial Culture

Last week I read the resignation piece in the New York Times penned by Greg Smith, a midlevel director at Goldman Sachs in London, entitled "Why I am leaving Goldman Sachs". Though Mr Smith comes across as a moral individual, he does have a self-aggrandising tendency to meander around his Resume: Stanford Scholarship, Table Tennis champion, Rhodes Scholar finalist, inter alia. We learn clients at Goldman are labelled as ''muppets''; and there is a fundamental disconnect between the interests of managers and their muppets. Nothing new hereto.

Indeed corporate management culture has always had its own set of agency problems since time immemorial. But Mr Smith's penmanship may have won him this year's most potent Occupy Wall Street award.

Paul Krugman also noted last night the superficiality of those at the top.

Sunday, 18 March 2012

The Canterbury Tales

The Cook's Tale

I have been carefully studying the above graph. The two indices dance in almost perfect symmetry. That is no coincidence given the Volatility Index (VIX; the red line), traded on the Chicago Board Options Exchange Market, is measured by the price investors are willing to pay themselves against substantial future movements of the S&P 500(the blue line), regardless of whether the movement is up or down.

The S&P is generally believed to be a good bellwether for the health of the US Economy. Many investors are coming to a conclusion there is some light at the end of the tunnel this spring given its recent rise; unlike the two false dawns seen since the depths of the winter of 2008/9.

The VIX and the S&P are appropriate economic and financial measures in most circumstances. Recoveries from recessions, in particular severe financial recessions, are not one of these circumstances. I would place high discounts in any sort of market predictions or modelling based on the movements of the two indices. In the recovery from recessions many indicators which Investors and Policymakers use do not exactly reflect the nuanced rises in durable consumption, capital formation, and other economic factors. If they do, it is with some time lags.

In simple financial theory, equity markets should indicate the expected discounted value of future earnings and output. Yet they are clearly ill-measures for recessionary economies, one-dimensional and due to the atomistic behaviour of 'naive', optimistic noise traders inherently bent towards short-termism.

So what measures should we use to discover and extrapolate the growth trend for the US Economy. I have two graphs below that should give us a clearer, historical, and long-term picture. Nevertheless, one should still take the recommended graphs with a pinch of salt, for what matters in economic growth are the productivity of workers, soundness of institutions and practices, efficient capital, correct allocation of scarce resources and so forth; all of which are difficult to quantify and wolf up into graphs and tables.

Firstly, the cyclically adjusted Price/Earnings (P/E) Ratio gives a clear indication of Market Exuberance than just the naked P/E. In fact the latter has the tendency to make the market look cheap, and is ahistorical in its scope as it measures next year's profits. The Cyclical P/E is calculated with the Business Cycle taken into account by: a)taking the 10 year moving average of earnings, and b)deflating using a Consumer Price Index. The Cyclical P/E has the record of highlighting the four great market peaks of the 20th Century:
The Monk's Tale
The Cyclical P/E is currently close to its peak of the 1960s, which gave way to a long bear market in the 1970s. It is therefore a bad omen that is oft-ignored by investors and policymakers in the context of current market recoveries. Yet with the rising emerging economies and competitive nature of most monopolistic markets, equities for some businesses and industries are due for a cut. Secondly, if you believe in financial markets and their respective measures as rent-seeking boondoggles, then I recommend you use non-traded economic indicators such as real house prices, which are still due for a ride down:
The Squire's Tale

Economics of Space Exploration

An Historical Aberration
On July 21st 1969, two men walked on the face of an extraterrestrial body; at a total cost of approximately $200 Billion, over the course of two and a half years ten others followed. Yet it all petered out to a slow end, there was never a scientific, social, prestigious or let alone economic need to repeat the feat at a comparable cost. The 1960s was the height of the Cold War; for the first time in Economic History two civilisations had the means and ability to destroy all civilisations. Playing out their Detente through proxy wars and recognitions of being first was the ultimate aim of those space missions.

The Apollo Space Program lasted for 11 years, and cost approximately 2% of US GDP over that concomitant period; when the US produced more than a third of World Output, the highest share of any economy in modern Economic History. Currently NASA's space budget is a paltry 0.1% of annual GDP. To an economist, the gains of Space Exploration are uncertain and unquantifiable. More so if there are any perceivable side benefits they would be spaced over many generations. Inherently, like defence expenditure, street lighting, and welfare benefits, space exploration is a public good. In that its supply cannot be excluded to the beneficiaries of any one country and, if left to the initiative of private agents, would be considerably under-supplied. The Great Age of Discovery was similarly laden with these characteristics, but the accidental sighting of the New World brought untold possibilities of plunder and power for European states within a matter of years. And that is the Heart of the Matter.

Like all Public Goods, only governments are able to supply them. Space Exploration [let alone possible Colonisation], with the current set of technology, takes time. Longer than the lifespans of political regimes and our current generation. A manned mission to Mars would cost around the same as the Apollo program; the International Space Station (ISS), a zero-gravity Lab, is nothing more than a $150 Billion White Elephant due to the opportunity cost of its construction and maintanence; Cost of Future Moon bases for purposes of heavy metal extraction or energy generation would be measured in Trillions, with perceivable benefits not obtainable through current level of Technology.

Much of the ongoing empirical and theoretical advancements in Physics and Astronomy have been made not through the ISS, Martian Space Probes, or Manned Shuttle/Soyuz Missions, but through orbital telescopes [Hubble, Planck and Chandra], Particle Labs like CERN and the Fermilab, and the innumerable scientific research institutes around the world. Given the reluctance of Governments to spend their kitties on intergenerational public goods, the Final Frontier lies in achieving a thorough understanding of the Cosmos whilst still on Earth.

Beijing already has its eyes set on achieving, like the USSR of old, its honours as a World Power through costly manned missions; and unlike India's space program, China's is bent with an entirely political agenda. However, Space Exploration and eventual habitation of Second Earths would require more than superpower rivalries. Only through the sense and sensibility of a benevolent World Government, Cost-effective Engineering and Technological solutions, and an advanced knowledge of Man's self-defined purpose, will their be consensual movement towards Space Exploration. All three which are sadly amiss in our times.

Gene Roddenberry, inventor of Star Trek, conquered the vast distances of Space through a science fiction device called the 'Warp Drive'; in which one could traverse those mileages without going into the nitty gritty of Time Dilation and other mathematical foibles that come with interstellar travel. Such science fiction tales are just tales. In reality and on hindsight, the Apollo program was an historical blur, that in the full span of Economic History and path dependent evolution of Civilisations, would have possibly occurred in a generation from now; when it could be economically, socially and technologically feasible. Our current generation's duty is to ensure the sustainability of our planet for the welfare of future generations.

Indeed without eliminating poverty, famine and warfare at home, it is unlikely any nation or world government will ever find it wise to boldly go where no man has gone before.

Saturday, 17 March 2012

Friday, 16 March 2012

Monetary Woes

Bumpy Expectations

The FOMC, US Federal Reserve's monetary policy committee, met last week to discuss the possibility of an additional stimulus to the US Economy. Looking over the last five years, in the graph above, when ever we saw Inflation dipping the Fed was at the scene with a Fire Hydrant. Firstly we saw Quantitative Easing I (QE) in early 2009; followed by another measure in late 2010, aptly named QEII. There was the possibility of using a third round of monetary intervention in late 2011 as the European Sovereign Debt Fiasco was reaching its climax, but the ECB did the job for the Fed.

In the last three months the European Central Bank has pumped in more than $1 trillion into the European Banking System. A more direct method than buying bonds; and I would think it would prove to be equally potent in the coming months.

Greg Ip, The Economist's US Economy editor, had a post last night on Okun's law: the inverse relationship between unemployment and GDP Growth. The law has been unseen in the current crisis, the current dip in US unemployment has in the past been recorded with 5% GDP growth. Yet we are seeing a paltry 2-2.5% in the current recovery; additionally, 2% of the US labour force is still offline compared to pre-crisis levels of labour force participation rates.

Ryan Avent also does a parallel post on current monetary and growth targets. Mr Avent has always been a fan of using monetary instruments towards targeting nominal GDP rather than using pre-crisis inflationary measures. Targeting Nominal GDP exposes the danger of higher inflation expectations setting in; bringing back economic woes of the 1970s, a period of high inflation and unemployment, and low growth. It would setback years of monetary credibility built over the Great Moderation.

Amongst economists in general over the blogosphere and journals there is currently a level of ambiguity as to whether the US economy should be able to reach its pre-crisis trend  level of GDP, of which it is currently off by more than 10%; or, whether post-crisis there has been a structural break in potential GDP due to hysteresis, lost output and investment, and low business and consumer confidence.

Thursday, 15 March 2012

Things Fall Apart

It is a sultry faux-summer's afternoon here in London, with that I wish to end my death knell on the World Trade Organisation's (WTO) torrid affair with bringing together in the last two decades two disparate and motley bunch of economies, in the hope of reaching a utopian global free trade arrangement.

The Doha round, initiated in November of 2001, has fallen apart many times due to acrimony primarily over the concessions offered for liberalisation of agricultural trade in poorer parts of the world, that are still reliant on farming as a single source of growth, employment, and subsistence. A group of developing economies, led by the emerging coterie of Brazil, India and China, have done more than their share in obstructing liberalisation.

Yet the picture is surely more nuanced than that. These three leading emerging economies will form the core of the Global Economy and world trade networks in the coming decades. The failure of the Doha round is more then the lost opportunity to free trade; it is a fatal blow to the concept of future multilateral co-operation. The WTO is perhaps the only International Institution which reflects the post-Financial Crisis global political and economic Balance. A future system will be determined by the growing clout of these three economies; in particular China, who has been a chief beneficiary of the GATT/WTO in realising its economic development, will prefer a free trade mercantilist system; playing a role similar to that of Britain in the pre-WWI Classical Gold Standard period.

Unlike the protectionist backlash following the Great Depression in the 1930s, most economies rose to maintain the liberal trading order in the onset of the Financial Crisis. The WTO has played a helpful part in gradually reducing the ceilings on de jure tariff protections; thus preventing a recourse to tariff hikes as trade collapsed due to output and demand loss in late 2008.

More importantly once we accept agriculture is an unnegotiable and politically charged item for developing economies in future trade rounds, the WTO could possibly move forth in encouraging complete liberalisation of manufacturing and services. Indeed it can also play a bigger role in tackling efforts on Climate Change mitigation, through incentivising 'greener' trade.

Wednesday, 14 March 2012

Incidit in Scyllam Cupiens Vitare Charybdim

A Brave New World

In Greek Mythology, two sea monsters menaced the straits of Messina, the channel of water separating Sicily from Mainland Italy. Like the victims of Scylla and Charybdis, since the World Trade Organisation (WTO) was founded in 1995 as a successor of the GATT, World Trade has succumbed to grievous and prolonged trade disputes between its major members.

India, Brazil and [to an extent] China have been very reluctant to chop down their trade barriers in order to protect their agricultural and light manufacturing industries. Advanced Economies in turn have been trying to placate their own protectionist minority lobbies, protect their special interests and political constituencies, and standby their previous trade agreements with their respective allies.

As a consequence we have seen a proliferation of bilateral Regional Trade Agreements [RTAs], pictured in the map above by frequency of individual country participation. They are what Jagdish Bhagwati has labelled the 'termites' in the International trading system. Indeed they are second-best solutions but against a possibility of no trade at all, something we saw as a response to the Great Depression in the 1930s, they seem to be what is feasibly possible given the Realpolitik of political constraints.

Trade has always been a normative issue; if we were to think of the goose's nest that is International Economics, not much of what is thought up in the much vaunted corridors of MIT or LSE goes into the actual processes of negotiating a multilateral trade agreement. The Doha round which has been the ongoing legacy of the WTO, of which I will expand in a later post, has had an abysmal record in liberalising world trade; not helped by the steepest decline in World Trade in modern economic history in the onset of the Financial Crisis (Eichengreen and O'Rourke, 2010).

Ultimately, we are seeing enormous bodies of RTAs enveloping the arteries of the global supply chains. China and the ASEAN RTA consists of nearly 40% of the world's population. Whilst the nascent Trans-Pacific Trade Agreement  will overtake the EU as the single largest economic free trade zone. Indeed with a growing network of RTAs overlapping with the motley of South-East Asian economies which form the ASEAN grouping, we are likely to see what is essentially a core group of economies belonging in the most potent RTAs. Slowly leading to a quasi-global Multilateral trading system. This is not however without its omens. Much of the world is still developing. Parts of South Asia, the Middle East, Sub-Saharan Africa, and parts of Latin America, will be horribly excluded from the RTAs of large emerging and advanced economies.

The title of this post can be translated into aptly describing the status quo of Trade Liberalisation: "He runs on Scylla, wishing to avoid Charybidis", Incidit in Scyllam Cupiens Vitare Charybdim. One hopes given the dire state of the WTO, like Odysseus, trade liberalisation through RTAs passes Scylla inflicting only minor losses; thus avoiding the loss of the entire ship at the hands of Charybdis.

Tuesday, 13 March 2012

Global Cities II

A measure of urban might

Some time ago I made a back of the hand ranking of the most important global cities measured by social, economic and cultural indicators; well, The Economist's Intelligent unit has published a ranking of 120 global cities, pictured above, which does more justice to the changing global dynamics. I have some comments in regards to what they have produced.

Firstly, They have three separate rankings for economic weight: 'economic strength' measures the annual city PPP GDP, 'physical and human capital' is a proxy for labour productivity and urban infrastructure, and 'financial and institutional' measures city wealth, financial strength, political stability and rule of law. They have respective weightings of 30%, 25%, and 25%.

London does not do well in the first three, combined weightings, but makes up in the last measure to come an overall second. The last measure is an overall social, living standards and cultural indicator with a smaller weighting of 20%. I would divvy up this indicator. Indeed, if the last indicator was weighted heavier, London would take the alpha spot from New York. Dear Readers, I am clearly a Londoner! 

Secondly, we see upcomers in the form of Singapore(3), Hong Kong(4), [and maybe] Seoul(20); clearly a shift to Asian cities reflects the continent's contemporary economic and social strengths.

Thirdly, in the bottom graph we see a correlation between cost-of-living and the respective 'competitive' rankings. North American cities carry the value of the dollar further than other global cities given their rankings; this maybe due to the deterministic and planned nature of their urban development, better regulated and contestable urban markets, and lax planning restrictions.

A Peking Opera

I want to show a graph and a map this morning, which I have taken from yesterday's FT and this week's The Economist, respectively.

Firstly, The Economist has an excellent piece in its business section highlighting the growing problem of rising labour costs in China and the consequences thereof. In particular, we have in the coastal provinces of China the manufacturing workshop of the world. By Exports they dominate their interior counterparts:
East is Best
With the exception of the Beijing Municipality, from top to down, the Chinese Provinces which exported more than $50 billion last year are all coastal: Liaoning, Shandong, Jiangsu, Shanghai, Zhejiang, Fujian, and Guangdong. Global supply chains are embedded into these provinces; the cost of rerouting the chain to another part of the world offsets any perceivable profit margin gained through lower relative wages compared to that of coastal China's. We are also seeing in the form of Chinese Technology Firms such as Lenovo and Hauwei, global upstarts who are adding value and productivity to Coastal China.

Let us imagine a scenario in which we do see advanced levels of productivity, incomes, and better overall living standards in Coastal China, all three assumptions are questionable; nevertheless, we would see mass geographical and income inequalities within China itself. The Economist mentions the Gini co-efficient to be presently around 0.5 in China, the highest for any large economy except Brazil. In such an eventuality we would require massive restrictions to labour mobility and large fiscal transfers from the federal government in Beijing to rural, interior provinces, to placate any social unrest. Chinese economic development could turn out to be one of the most inequitable and stark models of growth in Economic History.

Secondly very briefly, this graph shows the two way correlation between Copper Prices and the ratio of emerging/world Equity Markets:
Shifting Scales
Another source of fear is a Chinese slowdown in the coming years indicated by the uncertainty surrounding the future direction of Copper Prices. Chinese demand for copper was insatiable even during the Financial Crisis, however since September of 2011 we have seen a 20% drop in prices. Without going into any identification problems, copper prices closely follows the ratio of the emerging/world FTSE index; the causality may be due to both sharing a common [instrumental] variable: Chinese Growth.

Monday, 12 March 2012

The Empire Strikes Back

Oily Correlations
In Russia: The Wild East, Martin Sixsmith takes a sweeping overview of Russian History since the setup of the subservient Muscovy Duchy to the Mongol Hordes, from the 12-14th Century, to the turbulent years of Stalinist rule. To describe the ebbs and flows of the Russian Narrative over the 900 years, Mr Sixsmith concludes: "In Russia things change only to remain the same".

Russia's dual Scythian nature, straddling in time and space between European Liberalism and Asiatic Strong-handedness, allows it to shift respectively from enlightened exuberance into Svengalian repression with uncanny ease. In light of Vladimir Vladimirovich Putin's de jure return to power on March the fourth, Russia is conforming to this Faustian Pact; which has been unfortunately a permanent feature of its tumultuous history.

The Russian State has significantly benefited from the buoyancy of the global economy up to the onset of the Financial Crisis. In the above graph, there is an overlapping correlation between the depth of Russian equity markets and the benchmark price of Crude Oil. In a previous post, I said the Oil price is unlikely to return to its pre-2007 levels given the supply constraints and rising global demand.

In the last year or so, Russian Markets have lost the trend of following rising oil prices. This maybe the beginning of an increasing foreign discount attached to investing into Russia. Given its institutional frailties, predominance of unsound frameworks, weak rule of law and a regressive society which stems from cronyism at the very top, one would be an optimist to hope for Russia becoming an advanced economy in the coming decades let alone years.

Like the slow, sad and melodious Largo of Shostakovich's fifth symphony, Russia is ultimately a sorrowful indictment of itself; its size and abundant wealth of natural resources have stymied it from fitting into the 21st century model of economic development and places itself neatly into the Middle Income Curse.

Sunday, 11 March 2012

Il Professore

At the right place, at the right time

In less than four months of his tenure as Prime Minister and Minister of Finance, Mario Monti has rescued Italy, from what seemed to be in the dying embers of Silvio's government a prolonged kamikaze path to self-destruction. Mr Monti, who has always been a steadfast Europhile, was invited by the President of Italy, Giorgio Napolitano, to form a 'technocratic' and non-partisan government. His services to the European Commission and Economics placed him in a strong position to reduce spending, increase taxation, and liberalise what is still a stagnant and dysfunctional economy.

Mr Monti is just the latest of new leaders that have been the product of the mishap of the Financial Crisis and the European Sovereign Debt Fiasco. It is expected Mr Monti would step down by next year, but given his popularity and strong standing with fellow European Leaders it would not be far-fetched to suggest his government is likely to be around for a while.

An interesting question remains in the broad swathe of Economic History whether the Crises of the last four years heralds a new bread of technocratic, economic-savvy Politicians. Given the separation of political governance and economic management, prior to the financial crisis, in a number of advanced economies, are we going to see the reverse in the coming years?

Saturday, 10 March 2012

Slavish Dependence

A Window to the World?

I remember a time, less than eleven years ago, I got my first computer which had a measly one gigabyte memory, 250 megahertz processor and took 5 minutes to boot up; additionally it had an ever-addictive demo version of roller-coaster tycoon, a moneymaking video game which had been quite popular in 2001. Nowadays my real work is spread across four platforms: my desktop, netbook, LSE network computers, and smartphone. On top of this some of my friends have Ipads, Kindles and assortment of other nouveau portable devices.

The point of Virtual Reality inundating our daily lives is brought up by The Economist's Schumpeter Column in this week's issue. Using all four platforms I gather information, learn, communicate, and process whatsoever may be relevant to the former three. In other words I have become my own search engine. Yet through various ways the interaction with the internet does become overwhelming and tiresome; to an extent where it dilutes originality, independence, and productivity. None has been worse than the ever constancy of the Smartphone; the ability to study and work whilst procrastinating or falling asleep is taken to new ambivalent levels.

I however do not feel its possible to quarantine our beloved devices as Schumpeter recommends. In order to contain their ever encroachment into our personal, social and working spheres, it requires a certain amount of discipline which is habitually acquired over time. Now where is my worn copy of the Nicomachean Ethics when I need it!

Friday, 9 March 2012

Lord Tom Bingham: Crusader

No one drove the importance of individual freedoms more than the late Lord Thomas Bingham of Cornhill. His son-in-law does him a great justice in a moving and personal biographical piece on Tom.

As an afterthought, I strongly believe Lord Bingham advanced many of the rights that we in Britain take for granted, ensuring our economic and social freedom which gives any society an upperhand in the race to Utopia.

Simple Advise

Leaning against complexity

Ray Dalio established Bridgewater in 1975. Since then his Hedge Fund has gathered total profits of $35.8 Billion. Last year this figure was a chunky $13.8 Billion, due to his prudent investment into Gold and Bonds, easily eclipsing his competitors by a fair margin. How does Mr Dalio do it, when we are seeing a large number of Hedge Funds, or Alternative Asset Managers [as some of them now like to be called], closing down in recent years.

For one he believes the economy is a machine albeit difficult to graspin his quite frankly simple to understand manifesto, Template for Understanding, Mr Dalio focuses on the individual transactions that are essentially the machine's cogs, to extend the metaphor.

Mr Dalio has in the last forty years used a series of nontrivial decision rules to determine the viability of different asset classes. Paul Volcker, the ex-Fed Chairman, has been an outspoken admirer of Mr Dalio's methods. The assortment and collection of reams of data to establish economic models is a key priority at Bridgewater. The vast majority of his staff work on gathering data on credit and equity of individuals, firms, and the wider economy; mimicking the function of research departments at Central Banks, perhaps even better given Bridgewater's early warning signals on the European Sovereign Debt Crisis .

An intriguing part of Mr Dalio's Economic Philosophy is his belief in short run Business cycles, which are easily correctable, and long term debt cycles lasting fifty years or so, that require in their downturn a concerted combined effort of debt restructuring, write-offs, austerity, wealth transfers, and money-printing, according to Mr Dalio.

Given the long term success of his fund, Mr Dalio may be worth listening to.

Meades on France

The phonie Empire

Jonathan Meades does a wry and amusing job of exposing the underbelly of French Culture, Politics, and Society in his BBC series A Biased Anthology of Parisian Peripheries. 

Mr Meades midway through episode two discusses the mission of the Francophonie, France's Commonwealth equivalent, as a relic for the enlightened nostalgia of its second empire. Through the Francophonie, France has been able to extend its global reach, parcel out arrondissements to kleptocratic West African Autocrats and in return has been able to maintain its illusion as a World Power, so argues Mr Meades.

Mr Meades digs into its motto of égalité, complémentarité, solidarité with dry irony, as he sees France's series of De Gaullian Presidents of the fifth republic as stooges for the underground realpolitik of statesmanship and concealed diplomacy. All in all it leaves one with a nuanced, but benighted, view of the French State. 

Thursday, 8 March 2012

Gold Illusions

Just a special Commodity
Recently I have been mulling over a report produced by the star studded Gold Taskforce team at Chatham House. The report lays out the arguments quite objectively and comprehensively for whether their should be a future role of Gold in the International Monetary System (IMS); as was the case prior to 1971.

Additionally, it sets aside the arguments, usually put forth by Gold Standard Advocates like the current Republican Presidential runner Ron Paul, on the supposed stability and nominal anchor value that would come with the adoption of Gold in the IMS. In fact, as the report highlights, Gold is believed to be empirically volatile and not counter-cyclical. Nevertheless, in its inclusion in portfolios of private agents, it can control for valuation risk and provide a hedge against short term idiosyncratic risk.

Even though Gold is not a liability unlike the ever shifting credibility of fiat currencies and their denominated risk-free assets; Gold does not have an inherent yield. Its value is determined rather by the peculiarities of the occasion; between 1996-2001 Gold lost a third of its value even though we concomitantly saw a Boom and later collapse of the Dotcom Bubble. By contrast, Gold rose by 400% between 2005-2011, over a similar section of the business cycle as seen few years prior.

I am of the firm belief that aside from Gold's unusually inactive metallic chemical properties, and sentimental values attached to its shininess and malleability into an adornment form, it has a very little role to play in any sort of control mechanism of the future IMS. A return to any form of the Classical Gold Standard, 1880-1913, would be highly impractical, resulting in an enormous liquidity crunch and global output loss. Rather, when we first see the full offshore convertibility of the Chinese Yuan then the future of the IMS shall be decided.

Oil Woes

Expensive Tastes
The above graph is from the FT today highlighting once again the frailties of western and eastern economies of their dependence on Oil. Currently Brent Crude as measured in Euros is the highest its ever been, which is partly due to the weak Euro and Iranian sanctions. Further to this, the highest Oil imports as a share of total Oil consumption for European economies are unfortunately for those economies currently in the fray: Greece, Ireland, Portugal, Spain and Italy.

The possibility of an overt Iranian attack by US or Israel would compound these problems. A repeat of the 1979 Oil crisis, when the Shah of Iran was overthrown, could very well be realised. This is an omen to the Global Economy, as four of the five permanent members of the UN Security Council face political elections/transitions this year. 2012 could perhaps be even more newsworthy than 2011, but all for the worse.

Wednesday, 7 March 2012

GATT or a GATTing

It's a Wonderful Life

On a day when Apple's value touched the $500 Billion mark and with the sight of a trillion dollar company in the imminent future, I would briefly like to carry on from where I left off with my last post on Trade.

World exports since 1948 have increased from a miserly $70 Billion to above $20 trillion by 2007; before the downturn brought it below that figure. This increase has been the consequence of the tenure of arguably the most successful post-WWII International Institution: The General Agreement on Tariffs and Trade (GATT).

Trade was always an issue liable to be politicised in democratic, advanced economies by strong protectionist lobbies, declining industries, and special interests; Plummeting trade was the stand out feature of the Great Depression of the 1930s where beggar-thy-neighbour policies and retaliatory trade barriers were the pitiful norms.

In a series of eight GATT trade rounds from 1948 to 1994, of which the first and last three were the most potent, trade barriers in the advanced economies, which formed the core and periphery of the global economy prior to the 1990s, collapsed.

The success of the GATT was largely due to it dealing exclusively with similar economies; many of the developing economies, prior to the 1990s, were completely disengaged from the Global economy. Their free-riding behaviour at the GATT rounds were palatable due to their measly contribution to any form of industrial and services trade.

This goes back to the story of Apple, without the leadership of the Quad Policymakers [US, EC, Canada and Japan] in liberalising the world economy through the GATT, in the fifty years following WWII, many of the innovations and technological gadgets we take for granted would not have been born. Trade nurtures a dynamic and innovative economy. The fallacy of a limited pool of work, output, and trade is beset by unsound judgements and normative observations.

Even the East Asian economies, who essentially free-rode on the liberalising efforts of the Quad in the early stages of their development, embraced Trade towards ensuring their export-oriented Industrialisation. Ultimately those autarkic developing economies that suppurated in misguided state-led import-substituting industrialisation also renounced it in favour of embracing foreign technology, sound and open institutions, global cut-throat competition, rule of law, education and trade. Allowing for some of them, like India, to enter the periphery of the global economy in recent years.

When it comes down to it, the GATT, compared to its ill-fated successor: the WTO [of whom I will comment in a later post], was definitely a resounding success unlike the fate which befell English Cricketer Mike GATTing on an overcast 'summer' day at Old Trafford some years ago.

Links of the Week

This Week's recommended Economic Writings:

Tuesday, 6 March 2012

Back to the Future

A tale of two Halfs

Between the mid-80s to 2007, we in the advanced economies have seen moderate output volatility [variance] and low inflation volatility. Many economists have in recent times including Ben Bernanke, the current Fed Chairman, attributed this to a combination and interaction of various factors: Good luck, lack of exogenous shocks, Monetary targeting and independence, East Asian Savings, low real world interest rates, financial innovations, and so on.

I would just like to briefly focus at the moment on one factor: the fluctuating levels of the oil price. Recently it was argued in a paper demand inelasticity for Oil varies after a certain threshold; additionally it also varies depending on whether it comes as a shock or not. Stable and cheap Oil prices for most of the 'Great Moderation' allowed for stable current and future investment and consumption, negating any volatility.

Oil is an important input into the real economy. With an oil shock, trade-off between Output Volatility and Inflation Volatility (Bernanke 2004) worsens. Policy response to this can be ambiguous. We are in some ways fortunate to have had an oil shock on the foot of the downturn; cost push inflation is easier to handle with lower GDP growth. However I use the term loosely, with rising demand, as many parts of the world integrate into the global economy and oil supply constrained at 90 million barrels per day, it is likely resumption to normal service of which we were used to will not be the case. With Brent crude currently trading around $120; the sight of £1.35/litre or $4/gallon at the pump could turn out to be a permanent shock.

Dragonomics: 2012

Reverse Manipulation

There are two graphs I wish to show this afternoon, the above graph shows the gradual revaluation [appreciation] of the Chinese Yuan since 2005, when it was at 8.28 for a dollar. The second graph is from the FT yesterday showing the period from the beginning of 2010 when Beijing still maintained a solid post-crisis exchange rate peg:
Sticking to the Path
This graph shows the somewhat bumpy but preordained revaluation of the Yuan, as sections of the politburo have given way to suggestions by the reformist PBOC, the Chinese Central Bank, to gradually liberalise the economy.

Ultimately if China is to become a core component of the global economy, it is necessary for it to have sound financial institutions and independent bodies free from government control. This follows on from the World Bank report on China calling for significant reforms if China is to avoid the Middle Income Trap, the fate of many a historical rising economy; Li Keqiang, Beijing's prime ministerial successor for this decade, recently expressed enthusiasm for the report. Yesterday, I saw there was a front-piece cover analysis on the report in China Daily, the party's flagship English language newspaper. Despite this, as The Economist comments "China remains a big deal for the [World] bank, but the bank is not a big deal for China".

In light of the recent downgrade of [minimal] target GDP growth to 7.5% and PBOC's monetary worries of rising inflation, it is unlikely we will see further revaluations. The Yuan is going to settle at the 6.3-4 mark for the coming months. Especially in light of this year's political change at the top, any economic woes would be squashed to enable a smooth transition period. Governing China towards high-income status will resume from 2013 onwards.

Nevertheless as China liberalises its economy, capital controls it has had in place for decades would have to be loosened. In International Economics it is impossible to maintain monetary discretion, capital mobility and fixed exchange rate, even if you are set to become the world's largest economy.