IMF Urges More Drastic Action in Europe

FT: Lagarde Calls for Bigger Eurozone Firewall
IMF: Lagarde Calls For Urgent Action So 2012 Can Be ‘Year of Healing'
WSJ: Lagarde Says Europe Must Boost Firewall


On Monday, IMF Managing Director Christine Lagarde called for quick action on the part of Eurozone leaders to implement policies designed to promote growth, increase the size of Europe’s bailout fund, and further integrate the Eurozone. The warning comes as the region faces a depression similar to the one that occurred in the United States during the 1930s if the crisis is not contained.

Lagarde stated that, with the Eurozone economy slowing down drastically, there is a risk that growth in the region will fall by 1.6% in 2012. This downturn could make it more burdensome for already distressed European economies to meet their debt obligations. Less economic growth means governments collect less tax revenue (as consumer demand decreases, companies lay off workers leading to less available income to be taxed) which in turn cuts the government revenue necessary to repay debt. For this reason, Lagarde urged the European Central Bank (ECB)—the entity in charge of monetary policy for the Eurozone—to take stronger measures to stimulate economic activity, such as lowering interest rates. Lower interest rates stimulate business investment by making investment projects more profitable to start as the cost of financing such investments is cheaper. With a reduced cost of investment, businesses purchase more goods, build new factories and warehouses, and employ more people. All this new activity creates more income for both businesses and people, which stimulates the economy. Likewise, banks need to establish guidelines aimed at preventing a dramatic worsening of the crisis. For example, implementing better regulatory oversight systems will ensure that banks always have enough capital reserves to be able to sustain themselves when risky investments fail. This change will ensure that banks have enough money to continue to continue lending to consumers and businesses even if they sustain losses. Finally, Lagarde urged countries to tighten their finances quickly by implementing policies directed at reducing government spending and raising taxes.

Additionally, Lagarde stressed the importance of European leaders increasing the bailout fund currently in place—the European Financial Stability Fund (EFSF). Without a larger fund, countries such as Italy and Spain that are currently solvent (capable of repaying their debt) would not be able to continue meeting their financial obligations if the crisis worsens and these countries need a bailout. Lagarde suggested merging the EFSF into the European Stability Mechanism (ESM) as well as doubling the ESM’s resources to approximately €1 trillion. Doing so would help prevent defaults and the negative consequences that may go along with them. Also, by boosting this “firewall” fund, Europe will be able to help banks in the region raise their cash levels without cutting down on lending since the fund can provide financing to banks as well.

Lastly, Lagarde called for greater fiscal integration in the Eurozone. Currently, member countries retain complete control over their fiscal (taxing and spending) policies, while the European Central Bank is in charge of monetary policy for the entire region. However, the current crisis has exposed the ineffectiveness of this system. Although European leaders are currently in talks to implement a “fiscal compact” to limit countries’ budget deficits, Lagarde believes there also needs to be a more cohesive fiscal policy among the countries. To achieve this goal, she calls for the creation of euro bonds---bonds that are backed by all by all the countries in the Eurozone. The euro bonds would make nations’ debt a shared burden while at the same time giving investors more confidence in the region as there is a lower risk on bonds guaranteed by the entire Eurozone.

Drought in South America Impacts Soybean Production

Sources:
The Argentina Independent: Is Argentina’s Economy Overheating?
Bloomberg: South America Soybean Crop to Slide on Drought, Oil World Says
FT: Drought Raises Fears for Brazil Food Crops
IDB: How Will the Food Price Shock Affect Inflation in Latin America and the Caribbean?
IMF: Rising Prices on the Menu
LA Times: Soybeans Now Rule the Range on Argentina Plains
NYT: To Fortify China, Soybean Harvest Grows in Brazil

A drought that began in June in Latin America has impacted agricultural production throughout the region, especially soybean production in South America. Experts estimate that the drought could lead to a decline in total output for Brazil, Argentina, Paraguay, Uruguay, and Bolivia from 136.7 million tons last year to 132.7 million tons this year. South America grows most of the crop for the global market, and Brazil and Argentina produce almost half of the world’s soybeans alone. Experts believe that Brazilian production could decrease from 75.3 million tons last year to 71 million tons this year. Argentine production, however, is expected to rise to 51 million tons this year from 49.4 million tons the year before. This figure is still 1 million tons less than what was expected prior to the drought. Even with rainfall, Brazil’s and Paraguay’s crops cannot be saved because they are almost fully grown, meaning those countries are already facing irreversible losses.

Over the last decade, the global demand for soybeans has increased dramatically, largely fueled by China. China requires soybeans not just to make tofu, a staple of the Chinese diet, but also to feed the livestock consumed by its growing population. China turned to South America as the major source of its soybeans, in particular Brazil, because it lacks the land and water supply necessary to meet its own agricultural needs.

Growing soy has contributed to economic prosperity for many South American countries. For example, it was instrumental in leading Argentina out of its financial crisis following the economic crash in 2001. The Argentine economy has benefitted from a tripling of soybean prices since 2002 because of high global demand. Because of growing global demand and the low risk of loss from this industry, many Argentine cattle farmers have turned in recent years to soybean farming and away from cattle-growing. Soybeans are inexpensive to grow and yield at least two harvests per year. Raising newborn cattle and bringing them to market requires a commitment of three years, carries greater risk, and results in lower profits than cultivating soybeans.

Economists fear, however, that the drought will drive prices too high as the supply of soybeans declines and global demand remains high. Rising prices have concerned the global community even before the South American drought, especially emerging and developing economies. The increased costs of importing and buying soybeans will affect developing countries more than developed ones because a larger percentage of the money developing countries spend goes to buying food. Although economists predict that the surge in food prices will eventually stabilize, they warn that an increase in food prices will take time to reverse because the supply of food must catch up with the demand.

The Right to Work in America

Sources:

National Right to Work Legal Defense Foundation

NY Times: Right-to-Work Laws

NY Times: Some Good Economic News, But Will it Last?

Reuters: Europe Searches for Mythical Jobs and Growth Formula

WSJ: Indiana Moves Closer to Right-to-Work Law

For the first time in over half a century there is a heated debate in the United States over right-to-work laws. This issue appears to be a result of the global economic crisis, as similar debates are being waged across Europe regarding the proper scope of labor protections and ways to create new jobs in ailing economies through labor market reform. U.S. right-to-work laws, which currently exist in twenty-two states, prohibit employers and labor unions from requiring—as a condition of employment—workers to join unions or pay union dues without joining the union. The laws are directed at protecting a person’s ability to secure a job without being bound by labor contracts or union membership. Most of the twenty-two states that have right-to-work laws on the books are states with limited labor union involvement, and it has been over a decade since any state enacted such legislation.

Proposed legislation in Indiana stands to change all that. Indiana—a state with significant union membership—is on the verge of enacting right-to-work legislation that would ban contracts requiring all employees to pay union dues, irrespective of membership. The debate in Indiana has developed along party lines, with Republican lawmakers standing firmly behind the bill, while democrats are attempting to delay its likely passage. In light of the economic recession, high unemployment rates, and fierce competition between states to lure employers within their borders, the debate in Indiana has prompted national interest as states look for ways to stem job losses and stimulate economic growth.

Proponents of Indiana’s right-to-work laws base their argument on the idea of employment liberty—the ability of a laborer to independently negotiate the terms of his or her employment. They also argue that the law will provide a greater incentive for businesses to relocate to Indiana, as non-union wages are generally significantly lower than similar union-negotiated positions, thus the cost of doing business in Indiana would be lower than in states with stronger union presences. Employers in favor of the legislation point to the fact that without right-to-work laws, unions drive up wages through collective bargaining and reduce the number of jobs available. Opponents of the legislation claim it would lead to lower wages, sub-standard working conditions, weaker unions, and negatively impact the economy. Lower wages limit consumer purchasing power and drive down demand for goods and services. When demand for goods and services declines, employers cut jobs as a result of reduced manufacturing and service outputs. Opponents further argue that right-to-work laws negate the labor relations laws enacted in the U.S. in the 1930’s, which protect the rights of workers, their ability to form unions, and place laborers on more equal footing with their employers.

While the debate in Indiana continues, the issue of national right-to-work legislation has taken hold and will likely become a topic for debate among presidential candidates as the upcoming election draws closer. Although Europe finds itself grappling with similar labor reform issues, no clear solution has emerged that would assist U.S. policy-makers. Ultimately, the economics of labor relations may matter more than the argument over workers’ rights. With many states facing significant budget deficits and slow economies, right-to-work legislation may offer a much needed economic stimulus.

New Zealand Reserve Bank Holds Interest Rates Steady

Sources:

Bloomberg Businessweek: Bollard Signals Longer N.Z. Rate Pause with Inflation Contained

National Business Review: Bollard Holds OCR at 2.5%, Signals Higher Bank Funding Costs

New Zealand Herald: Bollard’s Arms Stay Folded on OCR

Reserve Bank of New Zealand: What is the Official Cash Rate?

Reserve Bank of New Zealand: Official Cash Rate (OCR) Decisions and Current Rate

On Wednesday, the governor of New Zealand’s Central Bank, Alan Bollard, announced that the Central Bank will hold the Official Cash Rate (New Zealand’s base interest rate) at a record-low of 2.5%, the rate it has been at since March 2011. Mr. Ballard cited weak economic growth due to worsening global economic conditions and lower than expected inflation in the fourth quarter of 2011 as reasons to keep the OCR at 2.5%.

In New Zealand, commercial banks hold accounts at the Central Bank which they use to pay the money they owe to other commercial banks after exchanging assets throughout a business day. The Central Bank pays commercial banks the OCR—currently 2.5% interest—on the amount of money a commercial bank has in its account, and charges the OCR if a commercial bank needs to borrow money to pay other commercial banks it traded with throughout the day. For example, if Bank A sold Bank B $200,000 worth of bonds, Bank B may have to borrow money from the Central Bank to pay back Bank A; the Central Bank would charge the OCR, or 2.5%, on this borrowing.

Although the OCR does not dictate market interest rates in the New Zealand economy, it has a strong influence. As an illustration, commercial banks may find it difficult to lend money at interest rates higher than 2.5% because other banks, which can cheaply borrow money from the Central Bank at a 2.5% interest rate, will quickly undercut an interest rate higher than 2.5%. Alternatively, a commercial bank is not likely to lend money at an interest rate lower than 2.5% because it could receive 2.5% interest by keeping its assets in its account at the Central Bank. Therefore, market rates tend to settle around the OCR.

In December, analysts expected the Central Bank to raise the OCR in early 2012 to encourage commercial banks to hold money in their accounts with the Central Bank, which would slow inflationary pressures by encouraging banks to save money, thereby decreasing demand which would lower prices and decrease inflation. However, a January 19th report revealed that the consumer price index (a measure of how much money it costs to buy certain goods and, therefore, a measure of inflation) rose only 1.8%, below the midpoint of the 1% to 3% inflation rate that the Central Bank has targeted in accordance with a Parliamentary mandate to set an inflation target. Since inflation was lower than expected and the economy is still growing at a slow rate, the Central Bank decided not to raise the OCR. By keeping the OCR low, the Central Bank hopes to encourage banks and consumers to continue to spend, rather than save, thereby increasing economic growth and inflation (higher demand will push prices up) to the target level of 2%.

According to Mr. Ballard, inflation will naturally settle at the target level of 2% and economic growth will increase due to the ongoing reconstruction effort in the region of Canterbury. Canterbury has been struck by a series of earthquakes since September 2010, including a February 2011 earthquake that killed 181 people. A large-scale reconstruction effort is scheduled to begin in early 2012, and the additional demand for commodities will likely increase inflation to the 2% target and increase economic activity.

The IFC Invests $9.7 Million in Tunisia

Sources:

Canada Newswire: IFC Invests in Candax Energy, Supporting Economic Development in Tunisia
IFC: IFC Organization; Summary of Proposed Investment
NASDAQ: World Bank Group Member, IFC, C$9.8 Million in Candax Energy
Scandinavian Oil & Gas Magazine: Candax Signs Investment Agreement for $11 Million Private Placement

The International Financial Corporation (IFC), a member of the World Bank Group, agreed this week to invest $9.8 million Canadian dollars ($9.7 million U.S. dollars) in Candax Energy to help the country expand its operations in Tunisia. In addition to the IFC investment, certain Candax’s directors and senior management will personally invest approximately two million U.S. dollars into the project. The investment is intended to help Candax increase its oil production in Tunisia while strengthening the local communities and protecting the environment.

The IFC is the largest global development institution focused exclusively on the private sector, with U.S.$68 billion in assets as of 2011. The IFC’s investment in Tunisia is intended to advance Candax’s facilities in the country, especially those in the Robbana oil fields. Candax currently produces 320 barrels of oil per day in Tunisia, but production is projected to increase to 700 per day by the end of 2012 with the proposed investment. The increased production will produce benefits for Tunisian citizens. The oil fields in question are considered marginal, meaning that the amount of easily accessible oil is relatively low and without the proposed investments, extraction at these fields would soon decline significantly, possibly leading to their complete abandonment within the next few years. Candax also hopes the investment will result in the future creation of managerial and oil development positions that will be staffed by Tunisian citizens. However, at the current time, the amount and exact nature of the managerial and development positions are unclear.

Additionally, the IFC will help Candax implement policies and programs intended to minimize the project’s harm to the environment, such as developing methods to safely dispose of water contaminated during oil extraction. Additional IFC funds will be used to create a public consultation and disclosure plan intended to gather input and warn the local community of any potential harms. The investment will also serve to reassure the international community that Tunisia is a safe place to invest, especially considering the instability surrounding the political revolution that started in 2010 and the unknown policies of the recently elected democratic government.

In 2010, the GDP per capita in Tunisia was $9,400 U.S. (as opposed to $47,200 in the United States) and the unemployment rate was 13%. The Candax expansion will hopefully result in both increased economic activity, which will result in increased per capita GDP and reduced unemployment. IFC’s other projects in Tunisia also further these goals by improving the country’s infrastructure and education system, and increasing the availability of credit to start small businesses. The IFC believes the recent investment in Candax, along with its other current projects, will improve the lives of Tunisian citizens.

Eurozone’s Bailout Fund Suffers Credit Downgrade

Sources:
FT: S&P Downgrades Eurozone Bail-out Fund
Reuters: Rescue Fund Downgrade Raises Pressure on Euro Zone
WSJ: S&P Cuts Rating on Europe's Bailout Fund
Telegraph: S&P cuts EFSF bail-out fund rating: statement in full

On Monday, the credit rating agency Standard & Poor’s lowered the credit rating of the Eurozone’s bailout fund, the European Financial Stability Facility’s (EFSF), one notch from its top AAA rating to AA+. The downgrade comes, in part, as a result of S&P’s decision on January 13th to lower the AAA ratings of France and Austria—two of the fund’s guarantors—as well as the Eurozone’s inability to adequately contain the region’s debt crisis. The fund still retains its AAA rating from credit agencies Moody’s and Fitch.

The EFSF’s main function is to safeguard financial stability in Europe by providing financial assistance to Eurozone countries. To do so, the EFSF issues bonds or other debt instruments on capital markets to raise the money necessary to lend to struggling Eurozone governments. The fund is backed by guarantees from Eurozone countries and derives its credit rating from the ratings of those countries. To maintain its AAA rating, the EFSF’s bonds could only be guaranteed by AAA rated countries. However, following the lowering of the ratings on France, Austria, and several other countries, the EFSF bonds are no longer fully supported by the guarantees of only AAA rated countries.

The credit downgrade of the EFSF could potentially lead to higher lending costs for countries borrowing from the EFSF. This is because the fund’s lending capacity would now have to be reduced (as there are fewer AAA guarantors) or the remaining AAA countries (such as Germany) would have to agree to increase the amount of their guarantees. However, Germany has already rejected raising its contribution to the fund, leaving the EFSF to attract investors by promising to pay higher premiums (return for the investor, but additional cost for the borrower). Nonetheless, last Tuesday, the EFSF managed to successfully sell its full target amount of €1.5 billion ($1.9 billion) of six-month bills at a yield of 0.2664% compared to a yield of 0.222% when it was rated AAA, signaling that robust demand still exists for ESFS debt.

Lastly, in an effort to increase the bailout fund’s lending capacity and effectively deal with the debt crisis, Eurozone leaders have accelerated the implementation of the European Stability Mechanism (ESM) (which will replace the EFSF as a bailout fund) to July 2012. The ESM differs from the current EFSF fund in that it is funded through paid-in capital provided by Eurozone countries, instead of just guarantees as with the EFSF. Also, the ESM would have a lending capacity of 500 billion euros—much larger than that of the EFSF. Thus, the ESM should offer lower lending costs since investors should be more willing to purchase bonds that are backed by capital rather than guarantees. In any event, the downgrade of the EFSF will make it more costly for troubled economies in the Eurozone to get financial aid and harder for the region to contain the debt crisis.

Haiti Works to Rebuild Its Economy Two Years After Earthquake and Cholera Outbreak

Sources:
CFI: Investment in Haiti
FT: Haiti Struggles to Rebuild
The Guardian: Haiti Earthquake: Where has the Aid Money Gone?
The Guardian: Haiti Embarks on Economic Recovery Plan with Help from Private Sector
NYT: Haiti: Cholera Epidemic’s First Victim Identified as River Bather Who Forsook Clean Water
PBS Newshour: Two Years After Quake, Most Haitians Still Living in Disaster Zone

Two years ago, an earthquake in Haiti caused the deaths of 316,000 Haitians. An additional 1.5 million people were left homeless, and over 300,000 buildings were destroyed or badly damaged. Currently, 500,000 Haitians still live in settlement camps that were originally intended as temporary housing. A cholera epidemic also broke out two years ago, sickening 500,000 Haitians and resulting in the deaths of 7,000 more. Under the direction of the newly appointed prime minister, Garry Conille, the Haitian government has announced that foreign aid alone may not be sufficient to develop the country into a modern, industrial state. Therefore, it aims to attract private and public sector investments to help stimulate the economy through job creation, combating cholera, permanently housing displaced people, and improving the country’s infrastructure.

Experts agree that reconstruction efforts thus far have been too slow. International aid has proven insufficient to cover the costs of rebuilding. Although $4.5 billion were pledged by world leaders for the first two years of reconstruction in March 2010, only 53% of this amount has been delivered. Only 77% of the United States’ pledge of $180 million to aid Haiti during the cholera crisis has been delivered. Experts attribute dwindling donor support to concern over the stability of Haiti’s government in the last two years, especially since a disputed election in 2010 left the then newly elected Haitian president, Michel Martelly, without an effective government for several months. Experts suggest that donors seemed unwilling to contribute to recovery efforts because they feared that an ineffective government could lead to inefficient distribution of resources and aid.

By contrast, Haiti’s current government’s efforts to attract foreign investors seem successful. The government held a forum in December, inviting 1,000 potential investors to invest in Haiti, and Marriott Hotels and Digicel (a mobile phone network provider active in the Caribbean) have already agreed to collaborate in building a $45 million hotel in Port-au-Prince, which will hopefully create 175 jobs and provide a boost to the tourism industry. The government is promising initiatives to investors such as a fifteen-year tax holiday and other generous subsidies, such as a zero tax rate for up to fifteen years with a partial tax exemption that gradually decreases over an additional five years and an exemption on most import taxes.

The Haitian government is also working with the Inter-American Development Bank and USAID to develop Haiti’s manufacturing industry. For example, last November, construction began on the Caracol Industrial Park (CIP) which will house much of this industry. Sae-A, a South Korean textile company that supplies US retailers like Walmart, is looking to benefit from Haiti’s guaranteed duty-free access to US clothing markets by investing $78 million in the CIP, and plans to hire about 20,000 workers. The government anticipates that the CIP will provide many opportunities for local entrepreneurs and include a residential development with 5,000 homes.

The government is also looking to public and private investment to help improve the country’s sanitation infrastructure. It plans to implement a $700,000 health and sanitation program to help contain the spread of cholera that will include a latrine and potable water system in the south-western Grand’Anse region that will benefit about 80,000 families. In the Cite Soleil district of Port-au-Prince, it is working with USAID and the Caribbean trade group Caricom to improve access to medical supplies, toilet facilities, and hand-washing stations. Although experts have expressed optimism about the government’s projects and the international community’s support, they emphasize that the government needs to prioritize the needs of Haitians and not foreign investors to ensure the maximum development benefit for the country.

Indonesia Earns Investment-Grade Bond Rating

Sources:

FT: Indonesia Makes Investment Grade at Moody’s

Jakarta Post: New Rating Upgrade Shows Faith in RI

WSJ: Indonesia Gets Ratings Boost from Moody’s

Moody’s Investor Service—one of the “big three” credit-rating agencies—raised Indonesia’s credit rating to “investment grade” with a stable outlook for the first time since 1997. The decision by Moody’s comes on the heels of a similar decision by Fitch Ratings in December, and analysts expect Standard & Poor’s will also upgrade Indonesia’s bond rating in the coming months.

In 1997, Indonesia’s bonds were downgraded to “junk” status due to the ongoing negative economic effects of the Asian financial crisis, unstable leadership, and a mounting public debt. Since then, the economy and political environment have improved drastically. Under the leadership of President Susilo Bambang, Indonesia’s economy has expanded by at least 5% in seven of the last eight years. Some of this economic growth is due to increased domestic demand from the growing middle class, but much of it is due to Indonesia being the world’s largest exporter of coal and palm oil. The country has also improved its fiscal situation. In 2000, the public debt accounted for 90% of Indonesia’s annual gross domestic product, but now that figure has been trimmed to 25%.

Despite strong economic growth, stable leadership, and less public debt, Indonesia requires infrastructure improvements if its economy is to keep pace with recent growth rates. Companies are increasingly citing congestion on roads, and at ports and airports as burdens to Indonesia’s business climate. In response, Indonesia has stated that it needs more than $400 billion over the next thirteen years to upgrade its infrastructure.

Fortunately, borrowing to fund infrastructure improvements will be less costly if Indonesia can retain its “investment grade” credit rating. Last week, 30-year Indonesian bonds reached a record-low yield of 5.375% due to investors being willing to pay higher prices (yields drop as bond prices rise). Shortly after Moody’s recent announcement, 10-year Indonesian bonds fell to a record-low yield of 5.83%–another encouraging sign. The ability to issue bonds at low yields is important because it has the effect of lowering Indonesia’s borrowing costs: rather than paying 7% annual interest on new 30-year bonds that it issues, as Italy currently does, Indonesia only has to pay 5.375% interest. Put another way, an upgrade in bond rating from credit-rating agencies signals to investors that Indonesian-government bonds are at less risk of default, and could increase much needed investment in the growing economy.

If Indonesia is able to upgrade its infrastructure, it will continue to attract foreign investment, which creates jobs and raises wages for the country’s citizens. Indonesia’s net foreign investment (foreign investment coming into the country less Indonesian investment in foreign countries) has tripled to more than $15 billion in the last three years, and improved infrastructure—funded with lower borrowing costs—will increase foreign investment. Furthermore, both Moody’s and Fitch have stated that if Indonesia is successful in improving its infrastructure, the country may see another credit-rating upgrade, which would lower borrowing costs once again. For a country that “became a poster child for emerging economies run amok” in the 1990s, these trends are encouraging developments.

Democracy and Financial Crisis Management

Sources:

ABC News: Detroit Can Avoid Emergency Manager

Michigan Public Radio: 7 Things to Know About Michigan’s Emergency Manager Law

NY Times: Looking Up Detroit Faces New Crisis

State Bar of Michigan: Michigan Supreme Court Orders Briefs Filed in December on Emergency Manager Law

State of Michigan: Emergency Manager Law

WSJ: Humbled Flint Forced to Take State’s Orders

While many states in the U.S. have laws that provide for emergency management of local finances in crisis situations, Michigan is setting a controversial new standard. Michigan law allows an emergency manager to assume the responsibilities of locally elected officials when a city or school district runs out of money or experiences a financial crisis. Like many states, Michigan’s legislation was modeled after New York City’s Municipal Assistance Corporation (MAC), which was established in 1975 in response to the city’s debt crisis. In the event of a financial crisis, MAC provided for the establishment of an oversight board to control of municipal finances. What makes Michigan’s law so controversial is that, rather than an oversight board or committee consisting of several members, emergency management powers are given to a single individual. As states across the U.S. face economic difficulties, Michigan’s approach may have far reaching implications.

The State of Michigan has been hit particularly hard by the Great Recession, industrial job losses, and a declining tax base. Major employers have either slashed operations and jobs or left the state entirely. As a result, Michigan has experienced a decade of job losses and increasing unemployment rates. Currently, four Michigan cities are under emergency management: Benton Harbor, Ecorse, Flint, and Pontiac. The City of Detroit is also on the verge of financial crisis with a $196 million deficit.

In response to growing financial concerns, Michigan’s legislature expanded the emergency management system in 2011. The new legislation broadens the scope of emergency powers and allows the emergency manager to take over responsibilities normally reserved for elected officials. Voters, local officials, unions, and civil libertarians have taken issue with Michigan’s approach to emergency management, claiming it is unconstitutional and contrary to the democratic process. In addition to budgetary control, emergency managers are empowered to void or revise contracts, modify pensions and payrolls, renegotiate loans, and hire or fire local government officials. The argument in favor of a single emergency manager is based on efficiency, accountability, and responsiveness. A single manager can respond to problems quickly as meetings and board approvals are unnecessary, the manager is fully accountable for his or her decisions and cannot hide behind the guise of committee or board majority votes. In a state where multiple emergency managers are appointed, budgetary constraints can be a consideration. Emergency managers are paid officials and they also have the ability to hire a support staff. Thus, unless other jobs are cut, the emergency management team can be an additional payroll expense for the financially distressed city.

While the debate continues, Michigan’s governor has asked the Michigan Supreme Court to render an expedited opinion on the constitutionality of the emergency manager law. In the face of this financial crisis, a tug-of-war between efficient, centralized powers and the constitutional protections of democracy is being played out at the local, national, and international levels. The crisis-driven centralization of economic power and limitation of democratic process presents an issue without a clear resolution. Perhaps the Michigan Supreme Court will provide some guidance.

Hungary on Brink of Default

Sources:
ISRIA: Hungary - Fellegi Started Negotiations with IMF
MarketWatch: Hungary Won't be Last to Make Bondholders Pay
WSJ: Hungary, IMF meet on Loan Conditions
WSJ: Hungarian Forint Strengthens; Euro Falls Below HUF309
Trading Economics: Government Bond Yields - 10 Year Notes - List by Country

Hungary, a country with a total population of 10 million and a GDP of less than $200 million, is not normally the focus of international investors due to its relatively small size. However, Hungary is running out of money and may, within the next few weeks, be the first country in Europe to default as a result of the sovereign debt crisis. A Hungarian default by itself would not likely be catastrophic, due to the country’s relatively small economy, but it could be a precursor to additional European defaults.

Hungary is currently facing default due to a number of factors. Before the recent financial collapse, Hungary’s government and citizens used the availability of cheap credit to grow the economy at unsustainable levels, but after the recent credit crunch the country was unable to obtain the credit necessary to continue fueling that growth. Additionally, many Hungarian citizens incurred significant amounts of debt, most notably on personal mortgages, that many can no longer afford and are unable to refinance. When the Hungarian economy slowed, the country’s debt became a large burden. For example, Hungary’s personal and corporate incomes fell, which lowered government tax revenues and decreased Hungary’s ability to pay its debts. Also, with lower personal incomes, Hungarians had to spend a larger portion of their income on mortgage payments, leaving less income for other purchases, thus lowering consumption and economic growth further. In response to these economic issues, rating agencies have reduced the country’s bond rating to junk status (as a result, the country’s ten-year bond yields are around 10%—as compared to 1.85% in Germany, 3.37% in France, and 1.96% in the United States) and the Hungarian stock market has suffered greatly.

International financial markets want the IMF to step in with a loan of approximately €20 billion, which is enough for Hungary to meet its current debt obligations while the country’s economy recovers. Without IMF assistance Hungary will likely default on its loans, resulting in losses for Hungarian debt holders. The IMF loan would prevent a default, which would assure international investors recover their investments. However, recent talks have broken down based on disagreements about the independence of the Hungarian Central Bank from the Hungarian government and the implementation of austerity measures.

Based on these disagreements, the prime minister of Hungary may decide that a deal with the IMF is not the best option and the country could instead default on its financial obligations. This belief is based, in part, on a comparison of Greece and Iceland. Greece accepted IMF assistance and saw its economy shrink by 5% in one year. Iceland entered a financial crisis in 2008, did not accept IMF assistance, and instead defaulted on certain obligations. While this resulted in a shrinking economy from 2008-2010, the economy is now growing. While defaulting may be a good decision for Hungary, investors are worried that Hungary’s example will lead other countries to reach the same conclusion. Investors fear this outcome because when a country decides to default it will result in debt holders receiving less than the full value of their original investment. Investor confidence in the region would decline, which would negatively affect the amount of money invested and increase countries’ borrowing costs, both of which would harm the European economy. Even though a Hungarian default is possible, most believe Hungary and IMF will reach an agreement.

Oil Strikes in Nigeria

Sources:
CNN: Nigeria’s Oil Economics Fuel Deadly Protests
MarketWatch: Nigeria Oil Union Says Not Shutting Production Yet
NYT: Nigerians Protest Rise in Oil Prices
Reuters: Update 6- Nigerian Fuel Protests Grow, 13 Killed in Attacks

Nigeria has recently experienced a sharp increase in oil prices. The increase is the result of a government decision to discontinue funding an oil subsidy. Although Nigeria is one of the largest producers of oil in the world, its refineries are dysfunctional, forcing the government to import gasoline for its population at higher prices than what Nigeria receive from its own oil sales. The government started the subsidy to help its large poor population afford gasoline.

The government’s decision to end the oil subsidy comes after two decades worth of attempts that failed due to public resistance. President Goodluck Jonathan stated that the decision would save the government around $7 billion that it could allocate to other uses. The government’s goal is to use the money saved from the subsidies to develop roads, electricity, education, and healthcare. These areas have long been neglected, and are now substantial hindrances to economic development in Nigeria.

However, many Nigerians are angry with the government for taking away what they believe is the only help the government has ever given them. Riots and strikes have erupted as many doubt the historically corrupt government will follow its stated goal of using the saved money for the benefit of all. The riots are escalating daily and the strikes have shut down most of the country’s oil production and other economic activity.

Ongoing riots and striking and the lack of government compromise on the subsidy issue will likely make Nigeria’s economic situation worse. The escalating violence from the riots has already begun to dissuade foreign investment, which is important for encouraging economic growth. The strikes have also lowered oil production, which decreases the amount of money the government has available to spend for the benefit of the citizens. Nigeria may face a period of prolonged economic decline if the government fails to quell the escalating riots and strikes.

Germany Could Face Trouble in 2012

Sources:
FT: German Economic Recovery Stalls
Spiegel: Germany Could Face Recession in 2012
WSJ: German Economy Heads Downward

On Wednesday, the German Federal Statistical Office reported that despite the country’s strong economic growth during much of 2011, Germany’s gross domestic product (GDP) contracted by 0.25 percent in the final quarter of the year. This contraction increases the chances of Germany falling into a recession—defined as two consecutive quarters of negative economic growth measured by a country’s GDP—which would make it more difficult for Eurozone leaders to contain the region’s debt crisis.

Even as the Eurozone debt crisis has escalated, Europe’s largest economy saw only a modest economic slowdown last year after 3.7 percent growth in 2010. In 2011, the German economy grew three percent and the national deficit decreased to about one percent of GDP from 3.3 percent in 2010. This growth was partly due to an increase in consumer spending, which was up by 1.6 percent from 2010 and the highest seen in the last five years.

Despite last year’s growth, many economists expect Germany’s economy to grow very little or not at all this year mainly due to the continuing Eurozone debt crisis. The Bundesbank (Germany’s central bank) is forecasting that growth will slow to 0.6 percent in the first half of 2012 before starting to recover in the second half of 2012 and reaching 1.8 percent by 2013. The slowdown in global growth and trade along with increasing doubts about the austerity measures in many Eurozone countries are the main reasons behind the possible contraction. Lower global trade negatively affects German exporters, while the Eurozone debt crisis has caused German businesses to put investment plans on hold due to economic uncertainty. Similarly, doubts about the austerity measures in other countries can affect Germany significantly. Foreign austerity measures tend to decrease the disposable income of individuals in those countries as taxes increase and wages fall. As a result of the lower income, citizens stop buying many goods and consumption declines. A downturn in the debt crisis is likely to lead to serious problems for Germany’s economy, as about 40 percent of its exports go to other European Union countries.

A recession in Germany would have negative consequences for all of Europe. In the face of a recession at home, German lawmakers and voters may refuse to support additional funding for bailouts for struggling Eurozone countries. Without a contribution from Germany, those bailout funds may disappear entirely, the consequences of which could be disastrous.

Iran’s President Ahmadinejad Travels to Latin America to Strengthen Economic Ties

Sources:
ABC News: Iran’s Leader Looks to Latin America for Support
Aljazeera: Iran’s Bear Hugs and Business in S. America
Christian Science Monitor: What’s Ahmadinejad Getting Out of His Latin American Tour?
FT: Iranian President Starts Latin American Tour
Washington Post: Ahmadinejad Travels to Nicaragua After Defending Iran’s Nuclear Program in Venezuela
Yahoo!NEWS: As Sanctions Bite, Iran Feels the Pain

Iran’s president Mahmoud Ahmadinejad visited Venezuela and Nicaragua this week and plans to visit Cuba and Ecuador, as well. Experts suggest that President Ahmadinejad’s visit is motivated by the lack of economic growth in Iran that increasingly concerns Iranians who fear that the economic situation will grow worse as a result of recent U.S. sanctions imposed on the country. Experts believe that, as upcoming elections in Iran draw near, President Ahmadinejad is trying to assure Iranian constituents that Iran has friends in Latin America that also oppose U.S. policy. They argue that President Ahmadinejad will attempt to convince Iranians that economic ties to Latin American countries can help Iran face the difficult financial challenges ahead. As the United States attempts to convince other countries to seize trade with Iran (like China, which is a major importer of Iran’s oil), Iran may be looking for new markets and to strengthen economic relationships with allies.

Experts warn that Iran’s economic circumstances may grow increasingly worse because of the sanctions. Prior to the United States’ recent announcement that it would enforce tougher sanctions against Iran because of its growing concern over Iran’s nuclear program, Iran was already experiencing low growth. It had a projected economic growth rate of 2.5 percent for 2011, the lowest of any major oil producer in the region. The sanctions specifically target Iran’s banking and oil sectors to cut off funding sources for the nuclear program. Critics are concerned that these measures will continue to devastate Iran’s domestic market. For example, Iranian businessmen have already expressed concern that U.S. sanctions on the banking sector will mean that they will have to rely on cash to do business since credit will become more difficult to obtain. Iran’s economy will also suffer if it cannot benefit from the petroleum industry on which it depends.

Critics are skeptical that President Ahmadinejad’s visit to Latin America or Iran’s commercial deals with Latin America will affect Iran’s economic position since, excluding Venezuela, Iran’s Latin American allies are mostly poor countries. Iran and Venezuela share longstanding economic interests since they both rank among the leading world producers of oil and are founding members of the Organization of Petroleum Exporting Countries (OPEC). More recently, the two countries have cooperated to build low-income housing throughout Venezuela, and Iranian-designed tractors can be found throughout the Venezuelan countryside. However, Iran has not followed through with promises it has made to help with over 100 development projects in Latin America. For example, Iran promised to build a $350 million port in Nicaragua and an oil refinery in Ecuador, neither of which it has done. Critics note that President Ahmadinejad is not visiting Latin America’s strongest economies, including Brazil, and lacks their political and financial support. Although Brazil’s former president Luiz Inacio Lula da Silva invited Ahmadinejad to visit Brazil in 2009, Brazil’s current president Dilma Rousseff did not make a similar invitation and spoke out against the Iranian regime’s violation of human rights.

Will Cheap Natural Gas Alter U.S. Energy Consumption?

Sources:

Americans for Energy Leadership: How Cheap and Abundant Natural Gas Affects Renewables

NPR: Solar Panels Compete with Cheap Natural Gas

Rice University The Baker Institute Energy Forum: Impact of Shale Gas Development on Global Gas Markets

WSJ: Glut Hits Natural Gas Prices

Prices for natural gas in the U.S. have fallen to their lowest levels in over two years and are expected to drop further. The dramatic decline in gas prices is attributed to several factors, including technological advances in drilling capabilities as well as climate forecasts for mild winter temperatures throughout the U.S that have driven natural gas supplies to all time highs. The decline of natural gas prices spells relief for businesses and homeowners who use gas for heat, and has spawned revived interest in natural gas as an alternative to coal and a compliment to clean energy initiatives. The surplus of natural gas has greatly impacted the energy market in the U.S. and abroad in the past decade. Compared to natural gas, the cost of wind, solar, nuclear, and even coal generated power appears much less attractive, and exportation of excess U.S. natural gas production could impact global markets as well.

Advances in drilling technology in the last decade have played a large role in creating the current surplus. The introduction of hydraulic fracturing of shale formations, known as “fracking,” and the seemingly endless supply of shale formations across the U.S. loaded with natural gas have kept reservoirs full and suppliers looking to export excess gas. Current excess reserves are so high that some companies are simply burning off the natural gas produced as a byproduct of oil and ethane extraction.

For several reasons, experts do not expect the excess natural gas supply to decline anytime soon. In addition to the extraction of natural gas through fracking, natural gas is a byproduct of oil drilling which has expanded greatly in recent years thanks to high oil prices. Most wells in the U.S. contain a mixture of oil, gas and other petroleum products, such as valuable ethanes. Since oil and ethanes are profit-makers for exploration companies, drilling will continue as long as oil prices are high. Another factor contributing to the increased supply is the fact that most energy companies have land leases that will expire unless the company performs a certain amount of drilling.

In less than a decade, the U.S has become a major source of natural gas with unforeseen surpluses. Due largely to fracking technology and an extensive pipeline infrastructure, the U.S. is exploring the possibility of replacing some nuclear and coal burning electricity generating facilities with natural gas facilities. Export opportunities are also increasing as global demand for liquefied natural gas grows. Wind and solar energy initiatives are also seeking to partner with natural gas facilities to bridge supply gaps when the sun is not shining or the wind is not blowing. Natural gas production in the past decade has altered the economics of energy consumption in North America with the potential for a global impact.

North Korea Addresses Food Assistance and Nuclear Weapons

Sources:
NYT: North Korea Open to Talks on Nuclear Program
USA Today: North Korea Keeps Door Open for Food-Nuke Deal with U.S.
WSJ: North Korea Accuses U.S. of Politicizing Food Aid

In its first statement addressed to the United States since Kim Jong-il’s death on December 17th, North Korea—now headed by Jong Il’s son, Kim Jong-un—accused the US of “politicizing” the issue of food assistance. The statement condemned the United States’ insistence on North Korea halting its uranium-enrichment program as a condition to food assistance. It did, however, indicate that North Korea may be willing to engage the U.S. in future negotiations.

The U.S. first agreed to deliver food assistance to North Korea in 2008 when it promised to provide 500,000 tons of grain. The U.S. delivered 170,000 tons to North Korea in 2008, but the food-assistance program ended in 2009. Nuclear testing in North Korea was the main reason U.S. ended its aid disbursement, but the U.S. was also concerned that the government was distributing the food to the relatively well-fed military rather than North Korea’s impoverished citizens.

During the last year, North Korea and the United States have held negotiations for an aid-for-nuclear-disarmament agreement. The countries were on the verge of a deal prior to Jong-il’s December death which would have, according the U.S., provided “nutritional assistance” (vitamin supplements, nutrition bars, and snacks) to children in exchange for North Korea’s agreement to suspend its uranium-enrichment program. However, the negotiations stalled in December as North Korea began an official mourning period for Jong-il.

Currently, it is unclear whether any deal is imminent. In its statement, North Korea accused the U.S. of “drastically” changing the type of food assistance from the initially-promised grain to what the U.S. now calls “nutritional assistance.” Oddly, however, the statement also suggested that North Korea has not requested food at all, saying the “hostile forces are spreading unsavory slander” in reporting that North Korea had requested food assistance from the United States. Apparently, the “unsavory slander” is reference to recent reports in South Korean and Japanese newspapers which stated that North Korea had requested aid from the US.

Despite these mixed messages, North Korea has acknowledged that the food crisis is a “burning issue.” The United Nations (UN) World Food Program conducted an extensive survey in 2011 in North Korea that revealed that one-fourth of the country’s twenty-four million people are in need of food assistance. North Korea has gone through decades of economic mismanagement and it has very little arable land to support the nutritional needs of its people.

Given the lack of transparency in North Korea’s government, it is difficult to know what this all means for North Korea’s future. Some analysts speculate that the North Korea’s new leader, Kim Jong-un, has stepped back from his father’s deal for strategic reasons. If there are any threats to his leadership, he must gain the support of North Korea’s powerful military leaders who are resistant to limiting, much less ending, its nuclear program.

It is unclear whether North Korea’s retreat from the proposed December deal signals the continuation of a prolonged relationship of disagreement and distrust with the United States, or rather was a political maneuver meant to ensure Jong-un does not lose the support of North Korea’s military. However, if the move reflects North Korea’s long-term policy toward the United States, it is likely that North Korea will remain underdeveloped and impoverished.