The financial crisis of 2008 has turned into the economic crisis of 2009 and the first signs of social unrest are emerging just as the full effects of the downswing and the solution lies in a co-ordinated response on the part of both public authorities and international financial institutions are starting to be felt in eastern Europe.
The region’s problems are deeply interwoven with those of the rest of Europe . Narrow domestic approaches in individual countries would worsen the situation for all.
Most eastern European countries have seen a rapid deterioration of their real economies since last September, when credit flows dried up and their main western trading partners entered into recession. This has had a severe impact on eastern European countries’ all-important exports.
The crisis is threatening to undermine many political and economic achievements following years of consistent effort, high growth and the increasing integration of eastern Europe into the global economy.
The banking sector is crucial to the current crisis and to the region’s recovery. As a practical step, there must be close co-operation in addressing both regulatory concerns and providing financial support for parent banks and is owned their subsidiaries in emerging Europe.
This is at the heart of a recent initiative by a group of European banks, whose proposals for fast, joint action deserve full support as a worsening crisis in emerging Europe will threaten Europe as a whole.
The vast majority of the central and eastern European banking sector by a small group of European Union-based banks. For years, this has been a source of stable capital flows and proven critical to the success of these economies. Now that parent banks are confronted with the global financial crisis it is crucial that they uphold their commitments to emerging Europe.
The governments in eastern Europe lack the means to finance national rescue packages. Meanwhile, measures introduced in the west have to be designed in a way that addresses the needs of subsidiaries in the east. In designing guarantees for domestic lending, depositor protection and capital regulation, the cross-border dimension must be considered fully. Otherwise, a vicious circle could unfold involving the flagging health of banks and enterprises all over Europe.
In our interlinked economy we must realise that only a comprehensive approach can tackle the current crisis. This has been recognised by Jose Manuel Barroso, president of the European Commission, who recently called for “a high level of co-ordination . . . using . . . the common instruments that we have”, and in last December’s EU Council resolution.
The international financial institutions have embarked on joint approaches to tackle the crisis in the most affected countries. The swiftness of the reply so far has been encouraging.
The European Bank for Reconstruction and Development has adopted an action plan designed to support sound banks and enterprises in our region that are suffering from the liquidity shortage and under-capitalisation. We have decided to expand our business volume this year by 20 per cent to EUR7bn ($9bn, pound (s)6.5bn).
We are providing loans and equity to financial institutions so that they can maintain their vital role as financiers of the real economy, especially in the small and medium-sized enterprise sector.
Such projects have already been signed in the past weeks in Georgia, Romania, Ukraine and Russia. We will also dramatically increase our trade financing to maintain regional links.
Similar initiatives are being taken by the European Investment Bank and the World Bank Group. But much more needs to be done and a regional approach is needed. Given the enormity of the crisis, we realise today that every isolated intervention can easily be seen as just a drop in the ocean.
The engagement of the EU and its governments is crucial. We can address the problems properly if the EU, the European Central Bank and the international financial institutions apply their resources in a structured and co-ordinated manner.
Finance And Economics: The nature of wealth; Buttonwood
The Economist, Oct.10, 2009
The world confused financial assets with real ones
AT THE heart of the current crisis is a fundamental confusion about the nature of wealth. Think about it from the perspective of a Martian. Were an extraterrestrial to be shown a room full of gold ingots, a stack of twenty-dollar bills or a row of numbers on a computer screen, he might be puzzled as to their function. Our reverence for these objects might seem as bizarre to him as the behaviour of the male bowerbird (which decorates its nest with shiny objects to attract a mate) seems to us.that give us the ability to produce more such goods and services. Financial assets arise from the desire to postpone consumption so that money can be saved, either for precautionary reasons or to invest so that more goods and services can be consumed in the future.
Looked at in that way, financial assets are not “wealth” but a claim on real wealth. If those claims multiply or rise in price, that does not mean aggregate wealth has increased. If a pizza is cut into eight instead of four slices, there is no more food to eat. If everyone sitting at the table is given shares in the pizza and the share price rises from $1 to $2, the meal will still be no bigger.
The fundamental reason why equity prices rise over time, for example, is that they are linked to the goods and services being produced by companies. As the economy grows so do the revenues of such firms. Assuming margins stay the same over time, profits will also rise and cashflows to shareholders will increase.
This truth is obscured by the business cycle, which causes revenues and margins to fluctuate, and by the vicissitudes of investor sentiment, which cause shares to be derated and rerated (the dividend yield to rise and fall). A rise in share prices that is caused by a rerating does not make us richer in aggregate, unless that rerating represents an accurate prediction about an improvement in an economy’s long-term growth rate.
People nevertheless use the stockmarket as a barometer of economic health. So a rise in equity markets can be (and has been) seen by governments and central bankers as evidence that the economy is headed in the right direction. That can lead to policy mistakes, such as a lax monetary stance, and further irrational exuberance.
Housing is more complicated than the stockmarket since people get utility from their homes (shelter, relaxation) while simultaneously treating them as assets. Even so, a rise in house prices that outpaces GDP growth does not make a society richer. Instead, all that is achieved is a transfer of wealth from first-time buyers to retirees exiting the property market.
In theory house prices can rise faster than GDP for a while if citizens decide to devote more of their incomes to housing services (for example, they may prefer a bigger flat to a bigger car). In practice it is hard to disentangle such structural shifts from the speculation that is prominent in all property booms.
It is the link between speculation and asset prices that explains this crisis. The ability to borrow money to buy assets fuelled the rise in asset prices. And the wealth effect of higher prices persuaded those in English-speaking countries to borrow money to sustain consumption.
Not long ago the BBC transmitted a programme about credit-card use. One man said he felt “wealthier” because he was given a credit-card limit of Pounds 5,000 ($8,000). Of course, once he used the card he was poorer. Not only did he have to repay the Pounds 5,000, but he had to service a double-digit interest rate as well. Similarly those who buy an overvalued asset with borrowed money have not made themselves richer but poorer.
Thinking about wealth in this way is also useful when assessing rescue packages for the economy. Will these policies boost the amount of goods and services the economy produces in the long run, or will they have consequences that actually restrict economic activity? Does quantitative easing really boost wealth or simply create more claims on the same underlying pool of assets?
Central banks have repeatedly intervened to rescue financial markets, or paper wealth, over the past 20 years. But have they propped up prices at levels that simply do not reflect the long-term fundamentals? The ingenious schemes of John Law, an 18th-century financier, to hold up the share price of the Mississippi trading company broke down in the end because the delta was not the El Dorado he promised investors, but a fetid swamp.
Britain: On the Brink; Postal Services
The Economist Oct.17, 2009 Royal Mail’s managers and workers play chicken
SPORADIC strikes by postmen over the past 16 weeks will turn into crippling nationwide action from October 22nd, if the two sides in a bitter dispute over working conditions and pay cannot get closer. The Royal Mail, the state-owned postal group, and the Communications Workers Union (CWU) which represents 121,000 of its 162,000 postal workers are at loggerheads. On October 15th the CWU gave notice that 42,000 of its Royal Mail members would strike on October 22nd, and a further 78,000 the day after.
The argument centres on a deal struck in 2007 to modernise the company. Postal services in many countries are being transformed by greater competition and new technology. Royal Mail says it is losing traffic at a rate of some 10% a year. E-mails are consigning letters to history, and, though Royal Mail is delivering more parcels than before, online and mail-order firms have a widening choice of services to use.
Despite these negative trends, the Royal Mail group showed a pre-tax profit of Pounds 321m ($515m, at current rates) for the financial year ending in March. Of its closest European counterparts, TNT of the Netherlands made EUR 802m ($1.3 billion) in 2008, and Deutsche Post of Germany earned EUR 136m in the first six months of 2009 (it lost money the year before). But relations between Royal Mail’s managers and workers have become unbearably strained.
Royal Mail says it is halfway through a Pounds 2 billion programme of investment in new machines and processes, and that things are going well. Automation has not, in fact, proceeded at a heady pace. The company is only now testing walk-sequencing equipment, which sorts mail into the right order for street delivery, with a view to rolling it out in January.
The CWU, for its part, says it welcomes automation and is not resistant in principle to change in working practices. But it claims its members have been bullied by managers and kept in the dark about greater demands on their time and workload. Unite CMA, the union that represents the managers, says it is not aware of such complaints. In short, each accuses the other of breaking the spirit of the agreement.
On October 8th the CWU announced the results of a national ballot of its Royal Mail members: 76%, it said, had voted to strike. The company points out that (because not all posties belong to the CWU and participation among those who do was not universal) almost 60% of all postal workers did not express that view. Meanwhile, local strikes have caused disruption: London was hit on October 14th.
The stakes in this dispute are high. For all the challenges, Royal Mail still has a reputation for reliability. It also has a near-monopoly over the last mile to the front door, and often completes deliveries for other services. But in the current uncertainty, corporate customers are falling by the wayside. Amazon, an online retailer, and John Lewis, a physical one, are among those that have made other arrangements. Small businesses which rely on postal delivery and payment by cheque are particularly vulnerable if postmen hang up their bags; many are looking at alternatives.
Neither Royal Mail nor its workforce stands to benefit from such attrition. And falling revenues could add to another burden: the deficit in the pension scheme, which has increased during the financial crisis to an estimated Pounds 9 billion-10 billion. Even planned payments into the fund of around Pounds 290m a year hardly seem enough to guarantee that it meets its obligations.
The government is keen to shake up Royal Mail by selling a minority stake to a private buyer, promising to assume its pension liabilities in the process. But politics has intervened. The proposed partial privatisation encountered fierce opposition, not only from unions but also from left-wing MPs. It has gone precisely nowhere—but the opposition Conservatives, favourites to win a general election next spring, are unlikely to leave matters there.
Countdown to the next crisis is already under way
Wolfgang Munchau Financial Times Oct.19, 2009
We did not need to wait until the Dow Jones Industrial Average hit 10,000. It has been clear for some time that global equity markets are bubbling again. On the surface, this looks like 2003 and 2004 when the previous housing, credit, commodity and equity bubbles started to inflate, helped by low nominal interest rates and a lack of inflation. There is one big difference, though. This bubble will burst sooner.
So how do we know this is a bubble? My two favourite metrics of stock market valuation are Cape, which stands for the cyclically adjusted price/earnings ratio, and Q. Cape was invented by Robert Shiller, professor of economics and finance at Yale University. It measures the 10-year moving average of the inflation-adjusted p/e ratio. Q is a metric of market capitalisation divided by net worth. Andrew Smithers has collected the data on Q, a concept invented by the economist James Tobin.
Cape and Q measure different things. Yet they both tend to agree on relative market mispricing most of the time. In mid-September both measures concluded that the US stock market was overvalued by some 35 to 40 per cent. The markets have since gone up a lot more than the moving average of earnings. You can do the maths.
The single reason for this renewed bubble is the extremely low level of nominal interest rates, which has induced people to move into all kinds of risky assets. Even house prices are rising again. They never fell to the levels consistent with long-term price-to-rent and price-to-income ratios, which are reliable metrics of the property markets' relative under- or over-valuation.
But unlike five years ago, central banks now have the dual role of targeting monetary and financial stability. As has been pointed out time and again, those two objectives can easily come into conflict. In Europe, for example, the European Central Bank would under normal circumstances already have started to raise interest rates. The reason it sits tight is to prevent damage to Europe's chronically under-capitalised banking system, which still depends on the ECB for life support. The same is true, more or less, elsewhere.
Now, I agree there is no prospect of a significant rise in inflation over the next 12 months, but the chances rise significantly after 2010.
Once perceptions of rising inflation return, central banks might be forced to switch towards a much more aggressive monetary policy relatively quickly - much quicker than during the previous cycle. A short inflationary boom could be followed by another recession, another banking crisis, and perhaps deflation. We should not see inflation and deflation as opposite scenarios, but as sequential ones. We could be in for a period of extreme price instability, in both directions, as central banks lose control.
This is exactly what the economist Hyman Minsky predicted in his financial instability hypothesis.** He postulated that a world with a large financial sector and an excessive emphasis on the production of investment goods creates instability both in terms of output and prices.
While, according to Minsky, these are the deep causes of instability, the mechanism through which instability comes about is the way governments and central banks respond to crises. The state has potent means to end a recession, but the policies it uses give rise to the next phase of instability. Minsky made that observation on the basis of data mostly from the 1970s and early 1980s, but his theory describes very well what has been happening to the global economy ever since, especially in the past decade. The world has witnessed a proliferation of financial bubbles and extreme economic instability that cannot be explained by any of the established macroeconomic models. Minsky is about all we have.
His policy conclusions are disturbing, especially if contrasted with what is actually happening. In their crisis response, world leaders have focused on bonuses and other irrelevant side-issues. But they have failed to address the financial sector's overall size. So if Minsky is right, instability should continue and get worse.
Our present situation can give rise to two scenarios - or some combination of the two. The first is that central banks start exiting at some point in 2010, triggering another fall in the prices of risky assets. In the UK, for example, any return to a normal monetary policy will almost inevitably imply another fall in the housing market, which is currently propped up by ultra-cheap mortgages.
Alternatively, central banks might prioritise financial stability over price stability and keep the monetary floodgates open for as long as possible. This, I believe, would cause the mother of all financial market crises - a bond market crash - to be followed by depression and deflation.
In other words, there is danger no matter how the central banks react. Successful monetary policy could be like walking along a perilous ridge, on either side of which lies a precipice of instability.
For all we know, there may not be a safe way down.
Finance And Economics: Two sides to every story; Economics focus
The Economist Oct.10, 2009
Capping credit-card levies on retailers and other merchants could hurt consumers
WHEN finance is not being blamed for wrecking the economy, it is being attacked for profiteering. Earlier this month the 7-Eleven chain of convenience stores in America presented a petition with more than 1.6m signatures to Congress, calling for a reduction of the fees levied by payment-card firms and their member banks each time a purchase is made using plastic. The House of Representatives is mulling a bill that would cap these "swipe fees", known in the industry as merchant-interchange fees. In America these are 1.5-2% of the price of an average purchase, which is high by rich-world standards. Retailers grumble that the charges inflate their costs, which they are forced to pass on to consumers--even those who choose to pay by cash.
Similar complaints have already prompted regulatory action elsewhere. Visa and MasterCard, the payment-card giants, are fighting an attempt by the European Union to limit swipe fees to 0.3% of a transaction's value whenever a credit card issued in one EU country is used in another. (Until two years ago the EU's competition authorities had been pacified by Visa's pledge to bring average interchange fees down to 0.7%.) In Australia, where regulators set charges in relation to the payment system's running costs, the average swipe fee has fallen to around 0.4%.
The case for tight regulation seems strong, at first glance. In rich countries, where paying by plastic is now commonplace, the firms that run card-payment systems look like other utilities, which have long been subject to price caps. Visa and MasterCard are associations run on behalf of their member banks. Competition officials are usually wary of such shared ventures but accept that it is more efficient for rival banks to band together in one network in order to process payments and settle accounts. A common fee structure stops members from abusing the rule that retailers must take all cards issued with the association's brand. It also obviates the need for countless bilateral deals between thousands of banks. Even so, regulators still fret that banks might use their combined heft to overcharge.
They need to tread carefully. Judging how much credit-card firms ought to charge for their services is trickier even than setting the right price for water or energy supplies. That is because the payment-card system is a "two-sided" market. What sets this type of enterprise apart is that it caters to two distinct groups of customers and each sort benefits the more custom there is from the other sort. Consumers will sign up for a credit-card brand if it is widely accepted as a means of payment. Merchants will more willingly accept a card if lots of consumers use it.
Building up a two-sided market, and balancing the needs of each side, require pricing strategies that would make little sense in more traditional, one-sided industries. Charges may have little relation to costs and often lean to one side of the market. For instance, outfits that act as matchmakers for lonely hearts (dating clubs, singles bars, and so on) often levy higher charges on men than on women. They judge that single men will be keener to join clubs that are visited by lots of women. Computer operating systems make more money from users than from software developers. Most media outfits rely on a mix of charges to both sides of the market that is tilted towards advertisers. Broadcast networks and some local newspapers provide their wares free and charge advertisers for access to consumers. Others are now opting for a one-sided business model, without advertisers, where consumers pay directly for news and programmes.
Skewed pricing is one solution to the central challenge of two-sided industries: how to lure one set of clients with the promise of custom from the other. In its early days, the Diners Club card took a hefty 7% cut of the tab from restaurants that accepted it. They did so because the eateries were given privileged access to the wealthy New Yorkers who had been given the card free. With one side on board, Diners Club found it easier to charge the other. As a rule, the side that bears more of the cost of bringing both sides together is the one that is least reluctant to pay--the side that Jean-Charles Rochet of Toulouse University, an expert in two-sided markets, describes as "caught". But because finding the right mix of charges is so crucial to a successful two-sided business, regulating prices could upset a delicate balance. It is hard for firms to know what the "right" prices are in two-sided markets. Cut charges on one side and it will raise them on the other, chasing customers away and making the business shrink. Not going Dutch
Trustbusters are nevertheless suspicious of a credit-card business model, where one side covers all of the running costs. That looks sinister on two counts. First, in mature markets merchants may have little choice but to take the main credit cards. If so, it may allow the big brands to overcharge, pushing merchants' profits down and consumer prices up. Second, to the extent that card issuers use some of their excess profits from interchange fees to compete for cardholders--through lower fees, loyalty schemes and other benefits--a hefty swipe fee could distort the payments markets by favouring credit cards over other forms of settlement, such as debit cards, cheques or cash.
Even so, that does not add up to a compelling case for regulation, since it is hard to see how consumers could be made better off. The tentative evidence from Australia is that caps on interchange fees for retailers have not been offset by any gain in the form of lower consumer prices. If interchange fees merely shift economic rents from merchants to card firms, then that is not a concern for competition policy (especially if some of the rents end up washing back to cardholders). It is true that interchange fees facilitate credit-card usage, which can encourage indebtedness with all its attendant problems. That makes them a tempting target for crisis-burned regulators. But if consumer debt is the problem, tinkering with swipe fees is the wrong way to tackle it.