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FT.com / Comment & analysis / Analysis - Rises in the east: Could Asia buckle under the burden of inflation?
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But as the Federal Reserve has slashed US interest rates, the tensions in the trinity have increased. Low US rates raise the attractiveness of capital flows to Asia, putting upward pressure on exchange rates. The result has been that Asian central bankers – often with an eye on not exacerbating currency tensions – have been less than aggressive in dealing with inflation. In effect, they have imported loose monetary conditions from the US.
Quasilinear - Wikipedia, the free encyclopedia
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In economics and consumer theory, quasilinear utility functions are linear in one argument, generally the numeraire.
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Because in standard consumer theory utility functions are ordinal, one may assume without loss of generality that b = 1.
FT.com / In depth - Fears emerge over Russia’s oil output
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Russian oil production has peaked and may never return to current levels, one of the country’s top energy executives has warned, fuelling concerns that the world’s biggest oil producers cannot keep up with rampant Asian demand.
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Russia was until recently considered as the most promising oil region outside the Middle East. Its rapid output growth in the early 2000s helped to meet booming Chinese demand and limited the rise in oil prices.
FT.com / Columnists / John Authers - The Short View: Japanese inflation
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Japanese inflation is back, with consumer inflation now more than 1 per cent for the first time this decade. That should be a cause for rejoicing. Since 1990, the Japanese economy has, after all, been bedevilled by deflation, a symptom of the lack of economic activity.
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This is not visible from the price of the yen, which relies more on global perceptions of risk than on anything endemic to Japan.
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The knock-on effects are nasty. Japan’s stock market is no longer the world’s largest, as it was at the turn of the 1990s, but it accounts for almost 9 per cent of global market value, according to MSCI.
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The Nikkei 225 is acutely sensitive to the yen, thanks to the importance of exports. It has fallen more than 30 per cent as the yen has risen.
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There is no obvious way out. Higher inflation usually aids the case for raising interest rates, which would further strengthen the currency. Weak growth and cost-push inflation argue for a cut in rates.
FT.com / Columnists / Martin Wolf - Why Greenspan does not bear most of the blame
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As Mr Greenspan pointed out in his response to his critics in the Financial Times on Monday, the housing bubble was not unique to the US. On the contrary, as the background chapter on housing in the International Monetary Fund’s latest World Economic Outlook shows, US experience was far from exceptional. On the contrary, the biggest apparent overvaluations occurred in Ireland, the Netherlands and the UK.
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The chart shows the proportionate increase in house prices between 1997 and 2007 that cannot be explained by the fundamental drivers: affordability (the lagged ratio of house prices to disposable incomes); growth in disposable incomes per head; interest rates (short- and long-term); credit growth; changes in equity prices; and changes in working-age population. Thus, the rises reveal the extent to which a country has experienced what seems to be a bubble. The US is in the middle ranks.
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Similarly, the US is in no way exceptional for the level of residential investment.
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US monetary policy cannot be responsible for all these bubbles. This might not be the case if these other countries had followed US policy slavishly. But they did not (see chart). The Bank of England, for example, followed what seems to be a consistently tighter monetary policy than the Fed. Yet house prices in the UK may be even more overvalued.
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Moreover, “the impact of easy monetary conditions on the housing cycle presumably was magnified by the loosening of lending standards and excessive risk-taking by lenders”. Yet the drawback to these US-specific points, plausible though they may seem, is that they do not explain house-price bubbles elsewhere.
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So what might explain these bubbles? I would point to four causes: very low long-term real interest rates, because of the global savings glut; low nominal interest rates, because of both low real rates and the benign inflationary environment; the lengthy experience of economic stability; and, above all, the liberalisation of mortgage finance in many countries. The greater the availability of finance, the easier it was for purchasers to pay higher house prices and the higher those prices, the more willing were people to purchase, in the expectation of still higher prices. The WEO makes clear that house prices tended to rise fastest where finance was most easily available, as one might expect.
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First, it is unclear how far house prices are going to fall elsewhere. If the US fall turns out to be exceptionally severe, the bubble there will be relatively bigger than now appears the case. Second, the consequences of the bursting of the bubble may turn out to be worse in the US, because a higher proportion of lenders was persuaded to take on mortgages they could not afford. I will wait for several years of falling house prices in the UK and elsewhere before deciding on that. Finally, the US is the most influential country in the world. It may be held responsible for the movement towards liberalisation. But US influence on other high-income countries can be exaggerated. For better or worse, the latter made up their own minds.
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Why, then, are so many Americans determined to blame Mr Greenspan for the mess? I can see three reasons. One is that it is far more painful to admit that the US was, in large measure, the victim of circumstances beyond its control. Another is that it is far easier to complain that the Fed made us do things we now bitterly regret than take responsibility for one’s own mistakes. Last, the more one can blame the Fed, the more reasonable become demands for bail- outs now flooding into Washington.
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Yet I still disagree with Mr Greenspan on two points.
First, I do believe it should have been possible for regulators to be tougher. In the FT’s economists’ forum, Mr Greenspan argues that “even with full authority to intervene, it is not credible that regulators would have been able to prevent the subprime debacle”. Mr Greenspan is saying that there is nothing to be done, even by attacking grotesque abuses, such as undocumented loans and ridiculous “teaser” rates.
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Second, I still do not see why, at a time of soaring asset prices, monetary policy should not be tighter than it would otherwise be. This is what I mean by “leaning against the wind”. I do not believe that this is likely to stop a bubble forming. A rise in interest rates from, say, 4 per cent to 5 per cent is not going to stop people borrowing to buy an asset they expect to appreciate by 10 per cent this year. But such a policy would push inflation below the normal target. That would give the central bank room for manoeuvre when the bubble burst, since it is far less likely that its credibility would come into question.
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Yet the biggest question raised by Mr Greenspan’s views lies elsewhere. Essentially, he is arguing that there is no middle way between repressed financial markets, on the one hand, and almost completely free ones, on the other. This is a counsel of despair. I greatly fear that if the people of the world are given this choice, after what I expect to be an expensive crisis, they will choose the former.
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I also do not find it a logical choice. If we accept that we are going to bail out the financial system when it gets into trouble, regulation is inevitable. The trick is to find simple, robust, rules-governed forms of regulation. The view that this is entirely impossible plays into the hands of those who wish to see the end of free financial markets altogether. Regulation cannot be perfect. But the worse the outcomes now become, the more difficult it will be to defend free financial markets at all. Without a credible design for regulatory improvement, it will prove impossible.
FT.com / World - Banks take blame for credit crisis
Tags: economics, banking on 2008-04-09 and saved by2 people -All Annotations (0) -About
more fromwww.ft.com
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“We think it would be completely wrong to jump to some premature regulatory measures,” Josef Ackermann, chief executive of Deutsche Bank and chairman of the IIF board said, adding, “we want to demonstrate we can do a better job within the industry”.
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The IIF report detailed banks’ failings in managing risks, conflicts of interest over bankers’ pay, over-reliance on models, and inadequate protection against liquidity shortages. It also pointed to failures in credit ratings agencies and the dangers of mark-to-market accounting at times of illiquidity in creating a vicious circle of forced asset sales, lower prices, further writedowns and more asset sales.
Credit crisis | Fixing finance | Economist.com
Tags: economics on 2008-04-08 and saved by2 people -All Annotations (0) -About
more fromwww.economist.com
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It would be convenient to blame the regulators for all that, but the system is stacked against them. They are paid less than those they oversee. They know less, they may be less able, they think like the financial herd, and they are shackled by politics. In an open economy, business can escape a regulatory squeeze in one country by skipping offshore. Once a bubble is inflating many factors conspire to discourage a regulator from pricking it.
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And even if you could put all that right, regulators would still fail, because of the nature of finance itself. Financial progress is about learning to deal with strangers in more complex ways. The village moneylender, limited by his need to know those he did business with, was gradually superseded by ever-broader impersonal markets that can cheaply mobilise colossal sums and sell more complex products. The remarkable thing is not that finance suffers from booms and busts, but that it works at all. People who would not dream of lending £1,000 to that nice family three doors down routinely hand over their life savings to strangers in a South Korean chaebol or an Atlantan start-up. It all depends on trust.
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Regulators cannot know how trust will ebb and flow as new markets develop the experience and practice they need to work better. They therefore cannot predict the peril of new ideas. They have to let new markets develop, or stifle them. The system learns—dangerous junk bonds are reborn as respectable high-yield debt; bankers will now be scared of extreme leverage—but it is delicate, as the world learned last summer. The regulator is condemned to muddle through.
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The notion that the world can just regulate its way out of crises is thus an illusion. Rather, crisis is the price of innovation, so governments face a choice. They can embrace new financial ideas by keeping markets open. Regulation will be light, but there will be busts. The state will sometimes have to clear up and regulation must be about cure as well as prevention. Or governments can aim for safety and opt for dumbed-down financial systems that hobble their economies and deprive their people of the benefits of faster growth. And even then a crisis may strike.
Heathrow airport | Hemmed in at Heathrow | Economist.com
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That aviation is important to the economy is not in question. But the case for expansion is not quite as strong as OEF's conclusions suggest. Central to the firm's estimation of air travel's contribution to the economy is the value of a business journey compared with a leisure one: £400 for business, £120 for leisure. However, OEF acknowledges that business travel is only about a third of the total from Heathrow. If some leisure travellers were to fly from other airports, capacity would be freed for additional, more valuable business flights. On the assumption that business travellers are less sensitive to price than holiday-makers, one way to bring this about would be to increase the price differential between Heathrow and other London airports.
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Perhaps the chief defect of OEF's report is that although it puts a price on climate-change emissions, it makes no attempt to do the same for local air pollution or noise, the negative externalities that affect people most directly. Yet whereas greenhouse-gas emissions will be much the same whether or not Heathrow expands (because most of the traffic would go elsewhere), the effects of local air pollution and noise vary greatly depending on where extra capacity is built.
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A good start would be to recognise that, even at the prices just set by the CAA, Heathrow will still be far too cheap. The CAA is obliged by law to act in the interests of passengers and airlines by restraining BAA from extracting monopoly rents. It must also give BAA an incentive to run its airports efficiently and invest in improved facilities. Striking that balance has proved difficult. Shabby facilities are evidence of under-investment, while, as the CAA privately admits, BAA has been encouraged by charges linked to passenger numbers and the “single till” policy, which allows its profits from retailing to subsidise airside operations, to stuff as many passengers into its airports as it can. The CAA has no duty to promote competition.
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That raises the question of whether BAA should be allowed the full benefit of higher prices at Heathrow. A case could be made for the CAA eventually getting out of price regulation if BAA no longer owned Gatwick, the only existing British airport with the potential (given a second runway), to compete with Heathrow. Gatwick is reasonably near London, has good transport links and its main flight path is over the Channel and farmland. It is already the world's seventh-busiest international airport and the busiest with one runway. With another, it could support more traffic than Heathrow does now.
A new owner of Gatwick would have a strong incentive to run it as an alternative hub to Heathrow—something that seemingly has not appealed to BAA. Mr Griffins thinks an expanded Gatwick might well be able to lure a big airline alliance with lower prices and the promise of its own terminal away from the long shadow BA casts at Heathrow. Such is the importance of the economy of London and the south-east—it contributes 40% of GDP—that it could well support a second hub airport.
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That a bigger Heathrow and a continuation of the flawed regulatory system serve the interests of both BA and BAA is obvious. But it is far less clear why the government still behaves as if it thinks two private-sector companies should be the chief influences on such an important area of public policy. In a saner aviation market, airports would be free to compete against each other and eventually to set their own prices. Over to Mr Brown.
Bankruptcies in America | Waiting for Armageddon | Economist.com
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If the debt markets are to be believed, companies could be in at least as much trouble as they were in the previous two downturns, in the early 1990s and at the start of this decade, after the dotcom bubble burst. A leading indicator is the spread between yields on speculative “junk” bonds and American Treasury bonds. A year ago, the spread was only about 280 basis points; the long-term average is around 500 points. This month the spread exceeded 800 points for the first time since March 2003, reaching 862 on March 17th.
The bankruptcy rate (in the previous 12 months) for high-yielding bonds has so far edged only modestly higher, to 1.28% from a record low of 0.87% in November. But most forecasters expect it to rise sharply over the coming months. For instance, Moody's, a ratings agency, predicts that the default rate will rise to 5.4% by the end of this year, mostly due to problems in America. (Moody's also expects a rise in European bankruptcies this year, but only to 3.4%, thanks to lower levels of borrowing and less exposure to economic weakness.)
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A big concern for company bosses will be the role of speculative investors, especially hedge funds. They can use derivatives to pursue complex strategies that may not be in the best interests of the firm that has issued the underlying debt, says Henry Hu, a law professor at the University of Texas, Austin. In a bankruptcy, a hedge fund could use the voting rights attached to different securities to maximise the overall value of its holdings in the firm at the expense of other investors.
Imagine, for instance, a hedge fund that owns debt secured against a company asset. It may prefer to force the firm into liquidation in order to win that asset rather than engage in a restructuring negotiation that will keep the firm alive. Meanwhile, it can boost its returns by short selling its unsecured debt and its equity. Or suppose that a hedge fund owns credit-default swaps as well as a firm's debt. If the fund makes enough money from the pay-out of the credit-default swaps, it may prefer to use the voting rights on its debt to ensure that the firm goes bust rather than negotiate a way to avoid bankruptcy.
FT.com / Columnists / Lunch with the FT - Lunch with the FT: Nassim Nicholas Taleb
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In The Black Swan, he returns to the idea that we all, including Wall Street traders, tend to underestimate the risk and impact of rare events. It came out last year, a few months before it became clear that Wall Street had underestimated the risk of an unprecedented downturn in US house prices – with disastrous consequences.
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After working on Wall Street for 20 years, Taleb is scathing about its risk management and forecasting models which are more “therapy” than anything useful. This is because they rely on past experience, like the Europeans who thought all swans were white until they discovered black swans in Australia.
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Although most attention tends to focus on “bad” Black Swans, there are also good Black Swans, he says, for instance in scientific research and drug discovery. “There is a lot more randomness in biotechnology and any form of medical discovery. The role of design is overestimated. Every time we plan on trying to find a drug we don’t because it closes our mind. How are we discovering drugs? From the side-effects of other drugs.” Researchers very often “change their story” when they discover something by accident to give the impression it was by design. “The biggest discovery in cancer came from a mustard gas accident in Italy, not from the 130,000 compounds systematically tested by the National Cancer Institute. They were not looking to improve the lives of older men when they discovered Viagra.”
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He became convinced that the financial markets systematically underestimated the risk of big improbable events and says he made a fortune for his then employer – First Boston – when the stock market crashed in October 1987.
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This triggered a very simple idea that he has been thinking about all his life. “That is that things in the real world are far messier that in recorded history or in memory.” But we find it hard to live with such messiness so we tend to look for causes and patterns that do not exist, what he terms the “narrative fallacy”.
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The real villains are those whose refusal to admit the limits of their knowledge can cause serious damage. These include economists “predicting 30 years of social security deficits when we don’t know what we are going to have for lunch tomorrow” and the doctors who thought they knew more than they did and killed their patients. “Until the 20th century, the risk of dying was increased by going to a doctor, particularly in a hospital.”
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Some of his critics have claimed that, taken to its logical conclusion, Taleb’s scepticism would lead to a kind of passive nihilism. Not so, he says. He is not arguing that all forecasting is pointless, for example. “I am saying that we should first know the error rate and then make the prediction. Because the error rate is far more relevant that the prediction.”
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Taleb is conducting experiments to test his theory that we can only cope with so much scepticism and that people who are sceptical about religion are gullible in other ways. “Most people are sceptical about the wrong things and gullible about the wrong things.” He admits his extreme scepticism can lead to extreme conservatism. “I believe it is dangerous to mess with complex systems and traditional things, such as religion or the environment.”
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