Sunday, May 29, 2011

U.S. Unemployment Rate Falls Amidst High Food and Energy Prices

FT:US Jobless Claims Fall to 409,000; Mixed US Economic Picture as Jobless Claims Fall Back
Economist: America's Labour Market Perking Up
BLS: Commissioner's Statement on the Employment Situation

Earlier this month, the U.S. Bureau of Labor Statistics released its monthly statement explaining the employment situation in the United States. According to the report, the labor market is showing increased recovery and growth. In April, nonfarm payroll employment, which includes the total number of paid U.S. workers of workers of any business excluding government employees, farm employees, and private household employees, increased by 244,000, compared to its average of 104,000 in the previous three months. Likewise, private-sector employment increased by 268,000 jobs, following an average of 250,000 in the previous three months.

The increase in employment was prominent in service-providing industries, manufacturing, and mining. The manufacturing sector has added 141,000 jobs since the beginning of this year alone. Similarly, retail employment grew significantly in April by 57,000, signaling that consumers are not cutting back on their spending despite high oil prices. Such a rise in employment can considerably boost spending, as individuals who were previously unemployed now have a source of income. These individuals will start purchasing more goods and services, thus increasing spending in the economy. The high demand for products will in turn create more jobs as companies will begin employing more workers in order to meet the demand for their products.

Moreover, there are signs that employment will continue to increase in the months to come. For instance, first-time claims for jobless benefits fell by 29,000, to 409,000 in the week ending May 14, compared to 438,000 the week before. Likewise, continuing claims for benefits also decreased by 81,000, to 3.71 million in the week ending May 7. States such as New York, Wisconsin, and Ohio recorded the largest drops in initial claims, while Alabama, California and Puerto Rico had the biggest jumps in claims.

US Dollar Will No Longer Be A Dominant International Currency By 2025

FT: World Bank Sees End to Dollar’s Hegemony;
World Bank: Emerging Market Growth Poles are Redefining Global Economic Structure, Says World Bank Report

According to a recent World Bank report, the US dollar will no longer be a single, dominant international currency by 2025 as the economic power shifts to emerging market economies. Instead, the euro and the renminbi will likely emerge as the international currencies along with the US dollar in a “multi-currency” system. The report, “Global Development Horizons 2011-Multipolarity: The New Global Economy,” expects that by 2025, six emerging market economies (Brazil, China, India, Indonesia, South Korea, and Russia) will account for over half of overall global growth. The report also expects that the average GDP growth rate of emerging market economies will be 4.7 percent between 2011 and 2025 while the average GDP growth rate in advanced countries will be 2.3 percent in the same time frame.

As the power of global growth shifts to the emerging market economies, this will bring several changes. For example, robust economic growth and strong domestic demand in emerging market countries will benefit low income countries through increased foreign investments and trade. There will be much more cross-border merger and acquisition deals and “South-South FDI,” said Mansoor Dailami, lead author of the report and manager of emerging trends at the World Bank. Also, the multipolar world economy will no longer be dominated by “established multinationals,” and emerging market corporations will become more active and influential as well, having better access to global bond and equity markets. Justin Yifu, the World Bank’s chief economist, emphasized that to keep up with these changes, international financial institutions would have to change fast.

The report also pointed out several challenges emerging market economies would face to sustain high growth rate. Emerging market economies need to grow by enhancing productivity and strengthening domestic demand rather than depending on exports and technological transfers. Also, emerging market economies, especially, China, Indonesia, India and Russia, need to reform their domestic institutions while Brazil, India, and Indonesia face challenges of developing human capital and providing quality education.

Lastly, the report emphasizes that multilateral institutions need to provide assistance to developing countries and low income countries as the international monetary system moves to a multi-currency system. Multilateral institutions can provide technological assistance, aid, and policy advice so that those countries can adequately respond to new challenges and opportunities.

Thursday, May 26, 2011

New Derivatives Rules Would Hurt Competitiveness of US Banks

FT: Derivatives Reform Will Not Prevent Next AIG ; Lawmakers Warning on Derivatives Rules; Banks Anxious Over Fed Regulations

A group of New York lawmakers recently sent a letter to US financial regulators including the Federal Reserve and the Commodity Futures Trading Commission, warning that a newly proposed rule on derivatives under the Dodd-Frank Act would hurt the competitiveness of the US financial institutions. The lawmakers also wrote in a letter that the rule would be “inconsistent with Congressional intent.” It is a margin rule that the lawmakers make an issue of, which applies to US banks as well as their foreign subsidiaries located outside the US. Specifically, the rule requires parties to some derivatives transactions to post cash or securities as collateral or “margin” in order to assure their obligations. Under this rule, foreign subsidiaries also have to collect collateral from their foreign clients.

Unless foreign regulators do not adopt a similar approach, the rule would put foreign subsidiaries of US banks in a disadvantageous position, said the lawmakers. While the lawmakers acknowledged that the new rule would provide important safeguards and make the US financial system more resilient to another financial crisis, they argued that it should not harm the competitiveness of non-US subsidiaries of US banks. Those who oppose express their concerns that under the new rule, more clients will opt to transact with non-US financial institutions in Europe such as Deutsche Bank and Barclays Capital which are not subject to the same rule. Opponents also worry that the rule would tie up capital that could be used for investments and prevent investors from making rational risk management decisions.

On the other hand, those who support the rule emphasize that the margin rule is essential as a measure to prevent future financial crises. Proponents also argue that since exempting foreign subsidiaries of US banks from the margin requirement would put US banks in a disadvantageous position, the same rule should apply both to US banks and their foreign subsidiaries. The US financial regulators defend the extraterritorial application of the rule by saying that it is necessary “because the US parent company’s ownership of the subsidiary is likely to expose the US parent company, as a result of legal, contractual or reputational factors, to the risks of the foreign subsidiary’s derivatives activities”.

Responding to the critics of the rule, US financial regulators have said that the margin rule has not been finalized yet and the problem of regulatory arbitrage could be resolved if regulators in foreign jurisdictions also adopt a similar rule.

Sunday, May 22, 2011

Cuba Attempts to Depart From Its Centralized Economy Through Major Economic Changes

The Miami Herald: Cuba Publishes List of Proposed Economic Changes
Guardian Media: Raul Castro has Launched a Campaign of Genuine Renewal and Redirection
Guardian Media: Cuba's Theater of the Absurd
BBC: Cuba's Economic Changes

Last week, the Cuban government announced various broad goals in a 313-point economic plan. The plan details Cuba’s effort to revive and shift its economy from a state-controlled Communist system, in which the government controls every aspect of the economy, to a more market-based economy where citizens will be allowed to participate in private enterprise and sell their products and services in the market. The economic plan was unanimously approved at the Communist Party Congress, but remains for the Cuban National Assembly to work out the specifics and translate the guidelines into law. The plan purports to allow Cubans to purchase and sell homes, a practice which currently only takes place in the black market. Today, the only way for Cubans to acquire new property is through an exchange of their homes, in which multiple families must coordinate the transactions and money is often exchanged under the table. However, the details of how the purchase and sale system will work and the restrictions or taxes to be applied have not yet been revealed.

Another important feature of the plan is the establishment of private cooperatives. The new guidelines will allow Cubans to form cooperatives that would function as mid-size companies, capable of hiring private employees. The cooperatives would also be allowed to determine the salary of each worker according to their productivity. Currently, such entities have only been allowed in the agricultural sector. Additionally, for the first time, Cubans will be allowed to hire employees that are not family members.

The guidelines will also permit the sale of cars between citizens. Under current law, Cubans can only obtain cars by purchasing them from the government and with special permission. Cubans often circumvent such restrictions by illegally selling their cars in the black market, while claiming to government authorities that the transaction is simply a lending of the vehicle. Still, the change will be welcomes by Cuban citizens who hope to upgrade their cars to more efficient ones without fear of breaking the law. Other guidelines included in the plan are a reduction of travel restrictions for Cuban residents, an elimination of the dual currency system, the legalization of the sale of construction materials at unsubsidized prices, the promotion of the fishing industry, and the connection of sugar prices paid to Cuban producers to those prices paid on international markets.

Moreover, despite the government’s official announcement, there are various conflicting views about what these purported changes will actually mean to the Cuban people. On the one side, many welcome the changes as a genuine renewal and redirection of the economy. On the other side, some Cubans are wary as to how these changes will actually be implemented and whether they will truly lift the Cuban economy out of its crisis.

SEC's New Rules on Credit Rating Agencies

WSJ: SEC Aims to Tighten the Rules on Raters
Bloomberg: SEC Credit-Rating Rules, 401(k) Bill, WTO’s Airbus Aid Ruling: Compliance
SEC: SEC Proposes Rules to Increase Transparency and Improve Integrity of Credit Ratings

On Wednesday, the Securities and Exchange Commission (SEC) proposed more restrictive rules on credit rating agencies (CRAs). CRAs rate the “creditworthiness” of debts as well as financial institutions holding debts. During the financial crisis, CRAs were criticized for contributing to the housing bubble by providing inaccurate and inflated ratings for mortgage-backed securities. Congress, in passing the Dodd-Frank Wall Street Reform and Consumer Protection Act, intended to correct such problems, and the SEC’s new rules would implement relevant provisions of the Act. The SEC’s proposed rules aim to “strengthen the integrity and improve the transparency of credit ratings,” said SEC Chairman Mary L. Schapiro.

Specifically, new rules would require CRAs to disclose more background information explaining their ratings. In the case of ratings on asset-backed securities, CRAs would have to submit any information provided by a third-party firms which conduct a review of the underlying assets. Also, the new rules require CRAs to file an internal control report with the SEC every year. Additionally, the new rules propose measures to prevent conflicts of interest problems. CRAs and issuers of debts have close relationships as most CRAs get fees from issuers and CRAs provide advice for issuers regarding how to receive high ratings. Under the new rules, for example, CRAs are not allowed to issue a rating if their employee who is involved in the sales of a debt also plays a part in assigning a credit rating for the debt. If a CRA violates such rules, the SEC can suspend or revoke the CRA’s registration with the SEC.

Critics say that the new rules still do not require CRAs to provide sufficient information about the ratings. In addition, some point out that the rules would not solve the fundamental problems of an “inherent conflict” that arise from close relationships between CRAs and issuers. As for the internal control report requirement, Kathleen Casey, one of the SEC commissioners, said that small-sized CRAs might find the requirement onerous and the requirement could discourage such CRAs from registering with the SEC, reducing competition.

The new rules will be finalized after the 60-day comment period. Upon a final approval by the SEC commissioners, the rules will apply to the CRAs registered with the SEC. Currently, 10 CRAs including Moody’s Corp. and Standard & Poor’s are registered with the SEC.

Monday, May 16, 2011

IMF Warns Europe’s Sovereign Debt Crisis Could Spread to Other Parts of Europe

Guardian: Fix Banks to Avoid Eurozone Meltdown, IMF Warns
IMF: IMF Calls for Strengthened Policy Response, Stronger Financial Integration to Bolster Europe’s Recovery
WSJ: IMF Weighs Extending Greek Repayments

Last week, the International Monetary Fund (IMF) published the latest Regional Economic Outlook for Europe. The IMF expects that economic growth in Europe will not be fast “but still solid and sustainable.” It estimates that economic growth for Europe will be 2.4 percent and 2.6 percent in 2011 and 2012, respectively. In the case of emerging market economies, they are expected to grow at 4.3 percent both in 2011 and 2012. However, the IMF also warns that sovereign debt problems in Greece, Ireland and Portugal could spread to “the core euro area, and then onwards to emerging Europe,” calling for comprehensive and strong policy actions to restore confidence and fix vulnerabilities in the financial sector and accelerate reform efforts.

As banks in other countries in Europe hold substantial amounts of bonds of the governments with sovereign debt problems, “a shock to confidence” could spread to other European countries, said the IMF. According to Morgan Stanley, BNP Paribas in France holding around €5billion of such bonds would be hit the hardest. In order to contain contagion risk, the IMF emphasized a need to strengthen the banking system in Europe and it also said that the 2011 EU-wide bank stress test will be a great opportunity to identify and fix weaknesses in the banking sector. Antonio Borges, Director of the European Department said that while systemic risk in the European banking sector had been reduced, banks in Europe would have to raise additional capital and accelerate their efforts to consolidate. Also, the IMF called for more financial integration, arguing that the incomplete financial integration as well as the lack of effective institutions to handle cross-border problems at the regional level had contributed to the worsening of the financial crisis in Europe.

As for Greece, the IMF showed optimism, saying that there would be no possibility of a default and that any type of debt restructuring would be necessary at this point. Mr. Borges said, he did not think that restructuring would provide a “miraculous” solution. Instead, Mr. Borges pointed out that the Greek government “has an extraordinary portfolio of assets” and it can raise additional cash through privatizing such assets. Currently, the Greek government is in the process of privatizing its assets amounting to €50 billion. Also, the IMF said that Greece will likely meet it deficit target of 6.2 percent of gross domestic product in 2012.

Saturday, May 14, 2011

Brazil’s Economic Success leads to Inflation

FT: Brazil resolute on rate rises to calm inflation
WSJ: Price of Success in Brazil: $15 Movies
IMF: Watching Out for Overheating in Latin America
CIA: World Fact Book, GDP Real Growth Rate

Over the past few years, Brazil’s Gross Domestic Product (GDP) has steadily increased, going from 3.70% in 2006, to 5.10% in 2008, and reaching 7.50% in 2010, making Brazil’s economy one of the most stable, and the country itself one of the wealthiest in South America and the western hemisphere. However, this success has not come without a price, as Brazil’s cities have become some of the most expensive in the world. The Wall Street Journal reported that Brazilians pay the equivalent of $15 for a movie, which is more than New Yorkers pay. Likewise, the jump in the price of food, transportation, and land has resulted in the inability of millions of poor Brazilians to maintain their standard of living as their income remains unchanged but the price of items continue to rise.

One reason for these rising prices is Brazil’s increasing inflation rate, which currently stands at 6.4%. In a statement issued earlier this month, President of Banco Central de Brazil, Alexandre Tombini, stated that Brazil will continue to increase interest rates for as long as necessary in order to drive inflation down to the target rate of 4.5% by 2012. The government continues to use conventional monetary policy in its effort to reach this goal. Such policy includes increasing taxes on lending and financial transactions in order to dissuade the flow of “hot money,” or speculative investments,into Brazil from abroad. “Hot money” occurs when investors attempt to ensure high short-term interest rates by taking their money from low interest rate yielding countries into higher interest rates countries as a way to obtain higher returns. Also, it can lead to lower savings rates and cause rapid overvaluation of the currency. These type of investments are particularly troublesome because as investors pull their money out of one country, in an attempt to profit off the exchange rate, it can shock the economic system and cause instability in that country. Likewise, speculative investments can lead to bubbles in certain economic markets such as real estate.

Two weeks ago, Brazil’s central bank increased interest rates by twenty-five basis points, to 12%. The increased interest rates will help to reduce the growth of demand in the economy, which in turn will slow growth and reduce inflation. Higher interest rates will reduce consumer spending by increasing the cost of borrowing and making it more attractive for citizens to save money. Although it is expected that such measures will decrease the month-on-month inflation starting as early as this month, the annual inflation rate might still continue to rise in comparison to the lower inflation rate of the corresponding period in the previous year. Nonetheless, for the time being, there is no indication that the Brazilian government will implement harsher capital controls such as the imposition of “quarantine on foreign investment” which, if implemented, would force investors to deposit a portion of their money with the central bank for a period of time.

Brazil is not the only country facing inflation and the risk of an overheating economy. In a report issued earlier this month, the head of the International Monetary Fund’s (IMF) Western Hemisphere Department, Nicolas Eyzaguirre, warned about the overheating risks facing many countries in Latin America.Rapid economic growth leading to an increase in demand and high levels of inflation are the main causes of an overheating economy. The problem is that if these overheating risks are not addressed, they can eventually lead to a recession. There are early signs of overheating problems in Latin American where countries that are facing rapid economic growth coupled with an expanding domestic demand, which has already led to inflation in much of the region. Although many central banks are increasing interest rates in order to deal with this problem, it is likely that more rate increases will be necessary in the future to contain much of the demand pressures.

Thursday, May 12, 2011

Many Banks in Europe Face Funding Difficulties

Economist: Cutting It Fine
Bloomberg: European Bank Funding Threatened as Basel III Meets Solvency II
FT: Banks Endorse Option of Creditor ‘Bail-in’; Brussels to Target Bondholders on Bail-outs

In many European countries, the maturities of bank debt have shortened dramatically in 2011 compared to 2006, according to data provided by Dealogic. In particular, in countries having sovereign-debt problems such as Greece and Portugal, the maturities of bank debt have fallen more sharply. In other countries such as Spain and Italy, banks also face funding difficulties and have been issuing more short-term bonds or paying higher yields. In the case of Italy, banks pay higher yields on their bonds by 1-1.5 percentage points than banks in France and Germany. Having more short-term funding is worrying because it makes banks vulnerable to a sudden liquidity dry-up in short-term funding markets as it happened during the recent global financial crisis.

On the other hand, banks in some countries including France and Germany have been able to improve their funding situations, issuing more long-term bonds during the same time period. In France, for instance, banks’ weighted-average debt maturity in 2011 increased over eight years from around six years in 2006.

However, most banks in euro-zone countries will likely continue to suffer from funding difficulties in the near future as new regulations pose additional challenges. The new Basel III rules require banks to hold more capital. McKinsey & Co. estimates that banks in euro-zone countries will have to raise additional €2.3 trillion ($3.4 trillion) in long-term funding. However, other two regulations imposed by European regulators may make it even harder for banks to sell long-term bonds. First, under the Solvency II rules, insurance companies are required to hold more capital against corporate bonds when they purchase longer-term bonds. Insurance companies are the biggest purchasers of bank bonds in Europe, holding about 60 percent of banks’ debt. The Solvency II rules may discourage them to hold longer-term bonds. Second, European regulators have proposed a regulation which requires bondholders to share the losses of failing banks. Under the proposed rules, bondholders will be first asked to reduce the value of their bonds before taxpayers bail them out.

Saturday, May 07, 2011

Diverging Views on Greek Debts

Economist: A Question of Maturity; Latin Lessons
FT: Jump in Greek Yields Spurs Restructure Talk
WSJ: Greek Debt Talks Widen Divisions in the Euro Zone

In May 2005, the euro-zone governments and the International Monetary Fund (IMF) provided a bailout program of €110 billion ($162.9 billion) for Greece, hoping that Greece will be able to reduce its budget deficit and repay its public debts in full. Recently, however, yields on the Greek bonds, which are inversely related to bond prices, sharply rose to over 20 percent, reflecting investors’ fear that restructuring Greek debts is inevitable. Also, Greece’s budget deficit remained still high (10.5 percent) in 2010. While the German government is now open to a restructuring of Greek debts, other European policymakers including the European Commission and France still firmly oppose any type of restructuring, arguing that it will lead to the belief that Ireland and Portugal will follow the same path.

What German officials suggest is a voluntary debt restructuring by extending the maturity dates without a “haircut,” a debt reduction. In that case, Greece will have more time to repay its debts and avoid borrowing more loans from the euro-zone governments and the IMF. However, there is a concern that the extension of the maturity dates alone will not fundamentally solve the Greece’s insolvency problem. The German approach does not aim to restore Greece's solvency, but it is politically motivated to reduce the taxpayers’ burden to provide additional loans to Greece. If no measures of a debt restructuring or a haircut are introduced, taxpayers in euro-zone countries will have to pay about €142 billion by the end of 2013, according to David Mackie, an economist at J.P. Morgan. However, if the maturity dates of Greek bonds that come due in 2012 and 2013 are extended, taxpayers’ burden can be reduced to 77 billion.

Countries in Latin America offer examples of how to solve sovereign debt problems in Greece. In 2003, Uruguay negotiated its debts with its creditors and extended the maturity dates by five years without reducing the size of its debts. Such option was successful in that Uruguay was able to avoid default on its debts and minimize losses on creditors. However, the problem Greece faces is worse. Greece holds debts (145 percent of GDP at the end of 2010) twice the size of the Uruguay’s and its economic growth prospect is not as strong as Uruguay’s. According to the Economist, Greece will ultimately need to reduce its debts as Mexico did during the debt crisis in the 1980s. In the case of Mexico, a debt restructuring was the first measure taken in 1982, which only provided additional time without solving the problem. In 1989, another measure to reduce the size of the debts eventually had to be introduced.

Economists also believe that reducing the size of Greece debts is ultimately inevitable and any further delay will likely contribute to a worsening of the problem. However, whether policymakers in Europe will achieve political consensus remains to be seen.