Category Archives: Economics

OPINION: The cost of the financial crisis – UPDATED

Update: The commentary below from Harvard professor of economics and former IMF chief economist, Kenneth Rogoff, was published before there was any reporting on the “comprehensive plan” that is being announced by Treasury Secretary Paulson this morning. The anticipated cost of that plan according to a report in Politico will indeed be as much as $1 trillion.

America will need a $1,000bn bail-out
By Kenneth Rogoff*, Financial Times, September 17, 2008

One of the most extraordinary features of the past month is the extent to which the dollar has remained immune to a once-in-a-lifetime financial crisis. If the US were an emerging market country, its exchange rate would be plummeting and interest rates on government debt would be soaring. Instead, the dollar has actually strengthened modestly, while interest rates on three- month US Treasury Bills have now reached 54-year lows. It is almost as if the more the US messes up, the more the world loves it.

But can this extraordinary vote of confidence in the dollar last? Perhaps, but as investors step back and look at the deep wounds of America’s flagship financial sector, the public and private sector’s massive borrowing needs, and the looming uncertainty of the November presidential elections, it is hard to believe that the dollar will continue to stand its ground as the crisis continues to deepen and unfold.

It is true that the US government has very deep pockets. Privately held US government debt was under $4,400bn at the end of 2007, representing less than 32 per cent of gross domestic product. This is roughly half the debt burden carried by most European countries, and an even smaller fraction of Japan’s debt levels. It is also true that despite the increasingly tough stance of US regulators, the financial crisis has probably already added at most $200bn-$300bn to net debt, taking into account the likely losses on nationalising the mortgage giants Freddie Mac and Fannie Mae, the costs of the $29bn March bail-out of investment bank Bear Stearns, the potential fallout from the various junk collateral the Federal Reserve has taken on to its balance sheet in the last few months, and finally, yesterday’s $85bn bail-out of the insurance giant AIG.

Were the financial crisis to end today, the costs would be painful but manageable, roughly equivalent to the cost of another year in Iraq. Unfortunately, however, the financial crisis is far from over, and it is hard to imagine how the US government is going to succeed in creating a firewall against further contagion without spending five to 10 times more than it has already, that is, an amount closer to $1,000bn to $2,000bn.

True, the US Treasury and the Federal Reserve have done an admirable job over the past week in forcing the private sector to bear a share of the burden. By forcing the fourth largest investment bank, Lehman Brothers, into bankruptcy and Merrill Lynch into a distressed sale to Bank of America, they helped to facilitate a badly needed consolidation in the financial services sector. However, at this juncture, there is every possibility that the credit crisis will radiate out into corporate, consumer and municipal debt. Regardless of the Fed and Treasury’s most determined efforts, the political pressures for a much larger bail-out, and pressures from the continued volatility in financial markets, are going to be irresistible.

It is hard to predict exactly how and when the mega-bail-out will evolve. At some point, we are likely to see a broadening and deepening of deposit insurance, much as the UK did in the case of Northern Rock. Probably, at some point, the government will aim to have a better established algorithm for making bridge loans and for triggering the effective liquidation of troubled firms and assets, although the task is far more difficult than was the case in the 1980s, when the Resolution Trust Corporation was formed to help clean up the saving and loan mess.

Of course, there also needs to be better regulation. It is incredible that the transparency-challenged credit default swap market was allowed to swell to a notional value of $6,200bn during 2008 even as it became obvious that any collapse of this market could lead to an even bigger mess than the fallout from subprime mortgage debt.

It may prove to be possible to fix the system for far less than $1,000bn- $2,000bn. The tough stance taken by regulators this past weekend with the investment banks Lehman and Merrill Lynch certainly helps.

Yet I fear that the American political system will ultimately drive the cost of saving the financial system well up into that higher territory.

A large expansion in debt will impose enormous fiscal costs on the US, ultimately hitting growth through a combination of higher taxes and lower spending. It will certainly make it harder for the US to maintain its military dominance, which has been one of the linchpins of the dollar.

The shrinking financial system will also undermine another central foundation of the strength of the US economy. And it is hard to see how the central bank will be able to resist a period of allowing elevated levels of inflation, as this offers a convenient way for the US to deflate the mounting cost of its private and public debts.

It is a very good thing that the rest of the world retains such confidence in America’s ability to manage its problems, otherwise the financial crisis would be far worse.

Let us hope the US political and regulatory response continues to inspire this optimism. Otherwise, sharply rising interest rates and a rapidly declining dollar could put the US in a bind that many emerging markets are all too familiar with.

*The writer is professor of economics at Harvard University and former chief economist of the International Monetary Fund

http://www.ft.com/cms/s/0/dd9aa390-84d6-11dd-b148-0000779fd18c.html

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NEWS, OPINION & ANALYSIS: Global food crisis

A ‘revolutionary’ moment in Egypt?
By Tony Karon, Rootless Cosmopolitan, April 9, 2008

The idea of the starving masses driven onto the streets to demand bread, and then being forced by the violent response of the state to seek its overthrow, had seemed impossibly quaint for decades — the stuff of a distant epoch, kept alive in Broadway musicals and Warren Beatty vehicles in a world where the masses were acquiring cell phones. Bread? Who needs bread? Let them eat arugula at globalization’s ever-expanding buffet table.

But a cursory look at the headlines of the past month — a general strike and mass protests in Egypt, the storming of the presidential palace in Haiti, violent protests in Cote D’Ivoire and Cameroon, demonstrations in Uzbekistan, Yemen and Indonesia, among others, suggests that the proverbial “wretched of the Earth” are arising, all over again, this time in response to skyrocketing food prices.

Turns out the Malthusians, and even — gasp! — their Marxist progeny, were not entirely wrong, after all: Spread capitalism to every corner of the globe (a planet already blighted by a century of industrialism with its attendant sometimes catastrophic climate) and the rich do, indeed, get richer, while the poor do get poorer, although not necessarily more numerous. The patterns are uneven, but basic laws of scarcity still prevail. Global food prices have risen 80% over the past three years, and the primary reason may be the success of capitalism in China and India over the past two decades: Their industrialization has spurred demand for energy beyond the capacity of supply, which has pushed oil prices to levels five times what they were in the mid 1990s. That, in turn, has raised pressure on food prices by making agricultural inputs more expensive, and by prompting the substitution of biofuel crops for edible ones on scarce farmland. And, of course, capitalism has indeed raised the living standards of hundreds of millions of people in those countries — they’re eating more, and better, particularly more meat. The fact that it takes some eight calories of grain to produce a single calorie of beef means that the expansion of meat protein in the diet of previously poor Chinese workers also creates a massive increase in global demand for grains. Throw in climate disasters such as the Australian drought, and you have food inflation spiraling so fast that even the U.N. agency created to feed people in emergencies is unable to keep pace. [complete article]

Food price rises threaten global security – UN
By David Adam, The Guardian, April 9, 2008

Rising food prices could spark worldwide unrest and threaten political stability, the UN’s top humanitarian official warned yesterday after two days of rioting in Egypt over the doubling of prices of basic foods in a year and protests in other parts of the world.

Sir John Holmes, undersecretary general for humanitarian affairs and the UN’s emergency relief coordinator, told a conference in Dubai that escalating prices would trigger protests and riots in vulnerable nations. He said food scarcity and soaring fuel prices would compound the damaging effects of global warming. Prices have risen 40% on average globally since last summer.

“The security implications [of the food crisis] should also not be underestimated as food riots are already being reported across the globe,” Holmes said. “Current food price trends are likely to increase sharply both the incidence and depth of food insecurity.” [complete article]

Food riots grip Haiti
By Orla Ryan, The Guardian, April 9, 2008

United Nations peacekeepers fired rubber bullets and used tear gas to control mobs rioting over rising food prices in Haiti yesterday.

Angry protesters tried to break into the presidential palace in the capital, Port au Prince, and demanded that President Rene Preval step down.

Preval was inside the palace at the time, aides said. The president has made no public statements since riots broke out on the island last week. Five people have died in a week of protests, Reuters reported. [complete article]

Map of food riots
Where food riots have taken place around the world since January 2007. Map compiled by Allegra Stratton, The Guardian. Click on blue pointers for information on locality. Click on “minus” button for wider view.


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FEATURE: The economic drive to turn to Islam

Stifled, Egypt’s young turn to Islamic fervor
By Michale Slackman, New York Times, February 17, 2008

The concrete steps leading from Ahmed Muhammad Sayyid’s first-floor apartment sag in the middle, worn down over time, like Mr. Sayyid himself. Once, Mr. Sayyid had a decent job and a chance to marry. But his fiancée’s family canceled the engagement because after two years, he could not raise enough money to buy an apartment and furniture.

Mr. Sayyid spun into depression and lost nearly 40 pounds. For months, he sat at home and focused on one thing: reading the Koran. Now, at 28, with a diploma in tourism, he is living with his mother and working as a driver for less than $100 a month. With each of life’s disappointments and indignities, Mr. Sayyid has drawn religion closer.

Here in Egypt and across the Middle East, many young people are being forced to put off marriage, the gateway to independence, sexual activity and societal respect. Stymied by the government’s failure to provide adequate schooling and thwarted by an economy without jobs to match their abilities or aspirations, they are stuck in limbo between youth and adulthood.

“I can’t get a job, I have no money, I can’t get married, what can I say?” Mr. Sayyid said one day after becoming so overwhelmed that he refused to go to work, or to go home, and spent the day hiding at a friend’s apartment.

In their frustration, the young are turning to religion for solace and purpose, pulling their parents and their governments along with them.

With 60 percent of the region’s population under the age of 25, this youthful religious fervor has enormous implications for the Middle East. More than ever, Islam has become the cornerstone of identity, replacing other, failed ideologies: Arabism, socialism, nationalism.

The wave of religious identification has forced governments that are increasingly seen as corrupt or inept to seek their own public redemption through religion. In Egypt, Jordan, Syria, Morocco and Algeria, leaders who once headed secular states or played down religion have struggled to reposition themselves as the guardians of Islamic values. More and more parents are sending their children to religious schools, and some countries have infused more religious content into their state educational systems. [complete article]

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FEATURE: Barreling into recession

How oil burst the American bubble
By Michael T. Klare, TomDispatch, January 31, 2008

The economic bubble that lifted the stock market to dizzying heights was sustained as much by cheap oil as by cheap (often fraudulent) mortgages. Likewise, the collapse of the bubble was caused as much by costly (often imported) oil as by record defaults on those improvident mortgages. Oil, in fact, has played a critical, if little commented upon, role in America’s current economic enfeeblement — and it will continue to drain the economy of wealth and vigor for years to come. [complete article]

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OPINION: How to sink America

Capitalism’s enemies within
By Robert J. Samuelson, Washington Post, January 23, 2008

Amid the mayhem on world financial markets, it is becoming clear that capitalism’s most dangerous enemies are capitalists. No one can have watched the “subprime mortgage” debacle without noticing the absurd contrast between the magnitude of the failure and the lavish rewards heaped on those who presided over it. At Merrill Lynch and Citigroup, large losses on subprime securities cost chief executives their jobs — and they left with multimillion-dollar pay packages. Stanley O’Neal, the ex-head of Merrill, received an estimated $161 million. [complete article]

Why the debt crisis is now the greatest threat to the American republic
By Chalmers Johnson, TomDispatch, January 22, 2008

There are three broad aspects to our debt crisis. First, in the current fiscal year (2008) we are spending insane amounts of money on “defense” projects that bear no relationship to the national security of the United States. Simultaneously, we are keeping the income tax burdens on the richest segments of the American population at strikingly low levels.

Second, we continue to believe that we can compensate for the accelerating erosion of our manufacturing base and our loss of jobs to foreign countries through massive military expenditures — so-called “military Keynesianism,” which I discuss in detail in my book Nemesis: The Last Days of the American Republic. By military Keynesianism, I mean the mistaken belief that public policies focused on frequent wars, huge expenditures on weapons and munitions, and large standing armies can indefinitely sustain a wealthy capitalist economy. The opposite is actually true.

Third, in our devotion to militarism (despite our limited resources), we are failing to invest in our social infrastructure and other requirements for the long-term health of our country. These are what economists call “opportunity costs,” things not done because we spent our money on something else. Our public education system has deteriorated alarmingly. We have failed to provide health care to all our citizens and neglected our responsibilities as the world’s number one polluter. Most important, we have lost our competitiveness as a manufacturer for civilian needs — an infinitely more efficient use of scarce resources than arms manufacturing. Let me discuss each of these. [complete article]

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FEATURE: Economic recovery from Bush will take a generation

The economic consequences of Mr. Bush
By Joseph Stiglitz, Vankity Fair, December, 2007

When we look back someday at the catastrophe that was the Bush administration, we will think of many things: the tragedy of the Iraq war, the shame of Guantánamo and Abu Ghraib, the erosion of civil liberties. The damage done to the American economy does not make front-page headlines every day, but the repercussions will be felt beyond the lifetime of anyone reading this page.

I can hear an irritated counterthrust already. The president has not driven the United States into a recession during his almost seven years in office. Unemployment stands at a respectable 4.6 percent. Well, fine. But the other side of the ledger groans with distress: a tax code that has become hideously biased in favor of the rich; a national debt that will probably have grown 70 percent by the time this president leaves Washington; a swelling cascade of mortgage defaults; a record near-$850 billion trade deficit; oil prices that are higher than they have ever been; and a dollar so weak that for an American to buy a cup of coffee in London or Paris—or even the Yukon—becomes a venture in high finance.

And it gets worse. After almost seven years of this president, the United States is less prepared than ever to face the future. We have not been educating enough engineers and scientists, people with the skills we will need to compete with China and India. We have not been investing in the kinds of basic research that made us the technological powerhouse of the late 20th century. And although the president now understands—or so he says—that we must begin to wean ourselves from oil and coal, we have on his watch become more deeply dependent on both. [complete article]

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INTERVIEW: Oil price rises driven by investor speculation

The price of fear
Fadel Gheit interviewed by Foreign Policy, November, 2007

Foreign Policy: The price of oil has come close to reaching $100 recently. What does that $100 figure mean?

Fadel Gheith: It’s a psychological number. I mean, what’s the difference between $100 oil and $99 oil? There are a lot of futures contracts tied to hitting this number of 100, but it’s only another number; it really doesn’t mean much.

FP: The International Energy Agency is now saying that it’s really growing demand from China and India, not tight supply, that is driving these high oil prices. What do you make of that argument?

FG: Well, that is also true, but does it change the equation so much that we see oil prices up 60 percent in less than six months? Obviously not. I’ve been in this business for 30 years, and I can tell you, I try to justify $60 oil and I can’t find any plausible reason to think that oil prices should be a dollar above $60, let alone above $90 or $100.

FP: So what about derivatives trading—

FG: That’s exactly what I’m focusing on. I truly believe that major investment banks and a large number of very high-risk-taking financial players have seized control of the oil markets, especially in the last six months. During that time, oil prices moved in one direction and market fundamentals really moved sideways or even lowered. Demand has slowed down significantly. We have seen all kinds of indications that we are reaching a breaking point here. We’ve seen what happened to gasoline margins on the West Coast; they’ve dropped to an almost 18-year low. All this is an indication that something is wrong with the system, that supply and demand fundamentals do not justify the current price. But if the current price is based on speculation, there is no limit to how high oil prices can go. Basically, as long as there is somebody willing to bid higher, the price of the commodity will move higher. [complete article]

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NEWS: Iran, Russia and Venezuela feel benefits of rising oil price

Oil price rise causes global shift in wealth
By Steven Mufson, Washington Post, November 10, 2007

High oil prices are fueling one of the biggest transfers of wealth in history. Oil consumers are paying $4 billion to $5 billion more for crude oil every day than they did just five years ago, pumping more than $2 trillion into the coffers of oil companies and oil-producing nations this year alone.

The consequences are evident in minds and mortar: anger at Chinese motor-fuel pumps and inflated confidence in the Kremlin; new weapons in Chad and new petrochemical plants in Saudi Arabia; no-driving campaigns in South Korea and bigger sales for Toyota hybrid cars; a fiscal burden in Senegal and a bonanza in Brazil. In Burma, recent demonstrations were triggered by a government decision to raise fuel prices.

In the United States, the rising bill for imported petroleum lowers already anemic consumer savings rates, adds to inflation, worsens the trade deficit, undermines the dollar and makes it more difficult for the Federal Reserve to balance its competing goals of fighting inflation and sustaining growth. [complete article]

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NEWS: Will the dollar collapse?

Fears of dollar collapse as Saudis take fright
By Ambrose Evans-Pritchard, The Telegraph, September 21, 2007

Saudi Arabia has refused to cut interest rates in lockstep with the US Federal Reserve for the first time, signalling that the oil-rich Gulf kingdom is preparing to break the dollar currency peg in a move that risks setting off a stampede out of the dollar across the Middle East.

“This is a very dangerous situation for the dollar,” said Hans Redeker, currency chief at BNP Paribas.

“Saudi Arabia has $800bn (£400bn) in their future generation fund, and the entire region has $3,500bn under management. They face an inflationary threat and do not want to import an interest rate policy set for the recessionary conditions in the United States,” he said. [complete article]

See also, Has the repudiation of the dollar begun? (Naked Capitalism).

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