A Speech

Proton Bank: Scandal?

Is it a scandal? My view is that it is, for at least three reasons, without going into the nitty-gritty details of the matter. First, because actions taken by the minister of finance were illegal and were noted by the heads of the Treasury, which were dismissed with demeaning comments by the minister of finance(!), second, because of the actions taken by the Greek anti-laundering authorities,  and third, and perhaps more important, because the media in Greece did not play it at all(!), except the newspaper ``Eleutherotypia”, who is the one that made it public (some blogs and some other newspapers did include some comments on the matter but mainly the whole story has passed unnoticed). It is extremely suspicious that none of the main TV channels and major newspapers did find it worth mentioning that 1) the Bank of Greece and the minister of finance urgently decided to subsidize Proton Bank, after/and that 2)  the authorities in Greece for laundering money freezed the private properties and accounts of all the chief executives of the Proton Bank, including the owner and well known business person of the bank, on suspicious transfers of money (laundering, expropriation). I believe that both events are headlines’ events. You do not get every day private properties and accounts of so powerful people to be freezed!

For those who did not read about it and in order to make up your own conclusions, I compile a list of articles that explain the actions of the anti-laundering authorities, the actions by the minister of finance and the surprise of the IMF and the European leaders about the developments on this problem. (All the articles are in Greek)

1. Article 1                                    2. Article 2

3. Article 3                                   4. Article 4

5. Article 5                                   6. Article 6

7. Article 7                                  8. Article 8

9. Article 9                                  10. Article 10

11. Article 11                              12. Article 12

13. Article 13                             14. Article 14

Some Headlines Today

The headlines draw the picture.

1. Pimco’s Bill Gross and BlackRock’s Peter Fisher say U.S. economy is at a tipping point.

2. Unemployment rose in nearly all U.S. cities.

3. Avoid disasters, get out of U.S. assets.

4. If recession hits, investors should prepare for a drop in stocks, says Mauldin.

5. White House: No double-dip recession seen.

Milton Friedman On Government

An educational video providing material for thought. The bright professor Milton Friedman in an interview about taxation, government intervention and many more.

Same Treatment In The Two Sides Of The Atlantic

As expected, a last minute deal could not be a bold deal or one that would “fix” the problem. It just gives a breather, until the problem comes back to us again. The techniques to approach serious problems are extremely identical in the two sides of the Atlantic!: Push the can down the road. It is impossible for the human phycology to do the optimal; to stand above the short term goals and pressures. This is a universal law. Washington did exactly what Brussels did, given the battle they found themselves into. No supremacy of the New World was demonstrated in handling the same problem and this “plan” is not a fix, the same way that the recent deal in Europe is not a fix.

Greek Rescue Increases Its Debt

Yes you read it right! Increases, not decreases the Greek debt. After the dust went away and the parties from the recent summit are over, people started to analyze the so called “deal” about the Greek debt.

Here are three articles that argue that the Greek plan is no solution. Charles Forelle from the WSJ and Hugo Dixon from Reuters explain why the Greek debt will increase and not decrease as a consequence of the “deal”. Also, Wolfgang Munchau of FT argues why the Eurozone crisis is not over and why a 50% reduction on the Greek debt was necessary.

Some Good News: U.S. Plan To Overhaul Its Finances

From the WSJ:

WASHINGTON—A surprise jolt of bipartisan support emerged Tuesday for a $3.7 trillion deficit-reduction plan that had been in development for months, though it was thought to be dead just several weeks ago.

Roughly half of the Senate's 100 members sat through an hour-long briefing on the plan, which was designed by a group of lawmakers known as the "Gang of Six" and would cut spending, overhaul entitlement programs such as Medicare, rework the tax code, and make significant changes to Social Security.

…

The plan does not include an increase in the $14.29 trillion federal borrowing limit. But several senators, including Sens. Susan Collins (R., Maine) and John Kerry (D., Mass.), said they hoped it could be considered as part of a package to raise the debt ceiling before Aug. 2, to avoid a government default.

…

A key question remains whether the plan might receive any support in the House, where Republicans have strongly resisted any new proposal that could bring in new taxes. The gang's plan would bring in $1 trillion in new tax revenue over 10 years by narrowing several tax breaks. But Mr. Conrad said it would also lower tax rates and end the alternative minimum tax. He said the combination of tax changes would be viewed by budget experts as a $1.5 trillion tax cut.

…

The $3.7 trillion deficit-reduction plan would come from roughly 74% spending cuts and 26% new taxes, Mr. Conrad said.

…

Central parts of the plan would:

• Impose immediate spending cuts and caps that reduce the deficit by $500 billion over 10 years.

• Make changes to Social Security to make the program solvent over 75 years.

• Direct key congressional committees to find specific levels of deficit-reduction within their areas of jurisdiction. If the committees fail, then a group of senators—five Democrats and five Republicans—will be able to confer and offer their own a deficit-reduction plan as a replacement.

The full article can be found here.

Note On “Selective Default” and Greece

Given that the category “Selective Default” (SD) exists only in the terminology of Standard and Poors, if Greece defaults in some of its obligations, what are the other rating agencies going to call it?

According to their definitions this event will be called “Default” (D), and it does not matter if it happens in some or all of the sovereign entity’s debt. This is the definition of default we all know and we all teach. If there is a failure to pay an obligation, this is recorded as Default. This is what also every each one of us faces if we miss a payment of our credit card or of any other obligation we have. It is recorded in our credit record as a Default event and we lose points.

I am amazed, for one more time, by the discussion that is taking place in Greece the last few days, regarding the meaning of the term “Selective Default”. As always, in Greece they want to convince us that black is white. Of course we all understand why they do this; they need to calm and confuse the public, by playing with the words, because it is hard to sell the unfair measures they take, when, even though they do take them, they also have to default.

It was always clear, even before 2009, that Greece would need to default, sooner or later, on all or part of its debt. Anyone who was/is objective could call it. For this reason the current soap opera we see in the news every night is not interesting at all.

Selective Default Definition

First, note that the term “Selective Default” (SD) exists only in S&P’s terminology. The other houses have no corresponding term and they only consider “Default” (D). According to the Bankers Almanac, S&P defines Selective Default as:

“An obligor rated 'SD' (Selective Default) or 'D' has failed to pay one or more of its financial obligations (rated or unrated) when it became due. A 'D' rating is assigned when Standard & Poor's believes that the default will be a general default and that the obligor will fail to pay all or substantially all of its obligations as they become due. An 'SD' rating is assigned when Standard & Poor's believes that the obligor has selectively defaulted on a specific issue or class of obligations but it will continue to meet its payment obligations on other issues or classes of obligations in a timely manner. Please see Standard & Poor's issue credit ratings for a more detailed description of the effects of a default on specific issues or classes of obligations.”

Links to the published definitions of credit rating classifications can be found here and here.

Top Greek Bond Holders

Barclays Capital compiled a list of the top holders of Greek debt, revealing who is going potentially to face the biggest problems in the event of default or selective default that is currently under discussion.

To see a description of the top 20 institutions shown in the above list look here.

The conclusions from Barclay’s study are:

“In our previous research on the holders of Greek debt (see for example Euro Themes: Implications of Greece restructuring for banks and CDS, 3 June) we highlighted that these holdings are actually quite concentrated (with the top 30 holders accounting for 70%+ of the total). In this report, we update these numbers and show the details of the biggest holdings on a name-by-name basis. The vast majority of the information comes from disclosures by the companies themselves (for private sector holders, mainly banks and insurance companies), or some official data (for public sector holdings or loans data). In fact, there are only a few holdings that are not up to date as of Q4 10 or Q1 11 or that we have had to estimate (eg, the ECB SMP holdings or some of the central banks holdings, although admittedly, these are probably among the biggest holders). We would also highlight that this data/information has been in the public domain for some time, and so should not be a particular surprise to financial markets, rating agencies and commentators.

The high concentration of holdings, and the type of institutions involved, suggests that some kind of voluntary rollover/Vienna initiative might have more take-up than one might expect at first glance. Having a participation of €25bn in such an initiative (as has been mentioned in the press) over the coming three years seems plausible, in our view.

Certainly, the Greek holders would have a natural incentive to roll over their debt. The Greek pension and social security funds (managed by the Bank of Greece) would clearly be in that case, although it may not have much debt maturing in the coming years. Greek banks are likely to have a mix of maturities in their portfolios, but we would think that probably more than a third of it is maturing in the coming years. One concern on the banks side has been the ECB stance that it would not accept Greek collateral anymore if any private sector involvement was not fully voluntary and/or would trigger a default, and that Greek banks would therefore have to reduce their holdings. We believe one potential way around this would be for the ECB to announce some kind of medium-term ‘addicted banks facility’ that would cover Greek, Irish and some Portuguese banks. This is something the ECB has been mulling for some time, and is linked somewhat to the decision on full allotment in open market operations. Such a facility could provide more security in terms of availability of ECB funding on a medium term to these banks (which will provide or have already provided medium-term liquidity and deleveraging plans to the ECB), and be more flexible in terms of the collateral it accepts than the ‘single list’ that the ECB is using for OMOs (whether or not rolled over debt is considered in default or not seems to vary depending on the rating agency). Such a separate facility would obviously come at a price, in terms of bigger haircuts and potentially a premium interest rate which may be linked to the regular OMOs (which may, or may not, at the same time, revert to variable rate tenders for 3m maturities; the ECB is likely to keep full allotment on the weekly MRO for longer in any case). Over the past few weeks, a number of statements and signs suggest that the ECB might be nearing a decision on this, something which could possibly be announced in September or even earlier (the decision might be precipitated by the downgrade by S&P of Greece and Greek banks to CCC recently). Independently, though, it could be that there would still be the problem of financing of Greek bonds by non Greek holders, if the ECB were to exclude GGBs from its single collateral list (unlikely if there is a simple rollover).

In any event, any additional NPV loss inflicted on Greek banks would require further recapitalisation of these institutions. Under the original EU IMF programme, EUR10bn has been ear-marked for bank recapitalisation. Given the weaker macroeconomic performance and more rapid increase in NPLs than anticipated under the programme, any additional NPV losses associated with public debt rollover at below market rates will require almost a onefor-one capital increase in the context of a new EU/IMF programme.

Rating agencies have been mixed on whether a roll over would constitute a default, a selective default or have limited influence. The bar, though, seems to be quite high for it not to constitute a default on their criteria.

The exact way to involve the private sector and/or do bond rollovers is clearly what the Eurogroup will be focusing on in the coming weeks: this is obviously something that, if done, needs to be done correctly and not rushed through, as a large number of unintended consequences could have a dramatic impact on financial markets. In this regard, we believe different views between Germany and other EU countries on burden sharing by bondholders are likely to be resolved in the coming days, with Germany possibly moving towards the voluntary roll-over proposed by other EU members (and that the ECB appears to support), most likely one based on the principles of the Vienna Initiative.”

Unbelievable Maneuvers

Unbelievable events take place in Greece. As if Greece is hosting a competition on “Amateurship”. This is the softest characterization one can give in the events that took place yesterday, where the prime minister, George Papandreou, first accepted to resign in order to form an Ecumenical Government under the directorship of some person that the two biggest parties would agree upon and then, after pressure from his party, he took it back! Is anybody now either in Greece or elsewhere that sees seriously Mr. Papandreou as the person in charge in Greece? When the prime minister hints on leaving he either leaves or makes elections. There is no other path because now he has no credibility. How can he face the European prime ministers if days before he suggested/accepted to leave the office? How will be credible in negotiations?

The government accuses the opposition for leaking this proposal to the press before it was final and that this damaged the whole deal. Who cares? Who cares who leaked it to the press? What matters is how to save Greece, not the prime minister’s image. What matters is to unite and work as best and fast as possible. After all, now that it is leaked, and also that he did not go ahead with this, which would have made him look better in the eyes of the people since he would have put first the interest of Greece and not egos, does he look better? Unbelievable maneuvers!

Gkikas Hardouvelis Comments On Greece

Economist Gkikas Hardouvelis, Professor of Finance at the University of Peiraius, and Chief Economist at Eurobank, comments on the current situation in Greece.

Professor Morici’s Commentary on Greece’s Debt Problems

A great commentary for the simple reason that it is clear and spelled out completely. One of the best perhaps lines is that “Politicians are like children in a candy story," he says. "They don't worry about the cavities they will receive or the money their parents will have to pay filling those cavities. They just want their candy now."

Two More Videos of Vasileios Markezinis

Βασίλειος Μαρκεζίνης: «Μία Νέα Εξωτερική Πολιτική για την Ελλάδα».

Ο κ. Βασίλης Μαρκεζίνης στις “Ανιχνεύσεις"

Vasileios Markezinis: The Greek Crisis

An important Greek academic and thinker talks about the Greek crisis. He has given a lot of lectures and interviews about economic and political issues that are related to Greece.

Β. Μαρκεζίνης: Η Ελλάδα της κρίσης: Το παρόν και το μέλλον.

Martin Jacques: Understanding China

Important Economists Talk About Greece

Typical Scientific Peer Review

A typical outcome of a referee report.

Video On Greece’s Economic Hardships

Disclaimer: A video is posted to start us thinking about issues, not because the views of the speakers are (necessarily) adopted by me.

Trillion Dollar Bet

This is a very educational documentary about the development of finance as a science – especially what has to do with derivatives pricing – and a very famous application of it, the creation of the LTCM fund and what brought it down. Events that were repeated after 10 years in 2008. The documentary is in Youtube in 5 pieces.

Part 1, Part 2, Part 3, Part 4, Part 5.

The transcript of the movie can be found here.

Change Of View: Greek Economists Find Haircut of 50% Optimal

Leading Greek economists who – rightly so – argued in favor of reform measures back in August 2010, now suggest that a haircut of 50% and restructuring on the remaining debt is the optimal way for the Greek government to go (see here). This is a clear sign on how much unhappy the same academics have been about the way the government has implemented these reforms. The reforms have had no result so far, and this is because no reforms have been implemented. They, therefore realize that we are now are in a much worse point, and our solution now is to cut 50% of the debt and to restructure the rest of it!

At the same time, in Greece, the government and the public do not even want to hear about (just) restructuring. Another example of the many denials of the Greek society of the inevitable? We’ll see. At least now, they will not be able to claim that all the Cassandras  who are coming up with doom scenarios are foreign individuals with private interests in the default of Greece. They should – lets hope they will not find other conspiracy theories – be able to accept that the poor Greek – I emphasize this – academics have no other interest than that of the Greek recovering. Do the politicians have the same interests? This is the question.

Views on Greece’s Reforms

Bellow is a piece of the FT article “Greece: Hard to hold the line”

….

Mr Papaconstantinou, the finance minister, argues against underestimating “the willingness of the government to push forward”, pointing out that it still enjoys broad public support. But behind the scenes, Greek business leaders and eurozone policymakers worry that he is not in control of events. “Nobody is managing the government,” says one business executive. “The troika sets constraints and ministers try to get around the constraints. It is 100 per cent a leadership issue.” Another jokes: “The best thing that could happen would be to put the administration of Greece in the hands of Brussels or Berlin.”

There are some bright spots. The Greek tourist industry expects a good season, with the country benefiting from unrest in north Africa and the Middle East. Goods exports, largely of agricultural products, have staged a recovery although they still account for less than 8 per cent of GDP.

Evidence is scant, however, of an economic turnround that would turn international sentiment in Greece’s favour. For every example of progress, there is at least one tale of setbacks.

An early step forward was the opening up of the road freight industry – in the face of protests by militant truckers, who blocked roads and suspended food and fuel deliveries. But the government yielded to the pharmacists’ lobby, which has kept its guaranteed 35 per cent profit margin on prescription drugs. In tourism, cruise tour operators hoped for deregulation measures that would encourage holidays starting and ending in Greek ports, thus boosting local hotel and restaurant revenues. Instead, they have faced increased bureaucracy – including a requirement that they sign annual contracts with the state on the frequency and duration of calls at Greek ports – an obstacle not faced elsewhere in the Mediterranean. “Greece is losing income and the law needs to be amended,” says Michael Nomikos, Greek representative of Royal Caribbean International, the world’s second largest cruise operator.

Athens has failed noticeably to liberalise its energy sector – adding to costs faced by industry and leaving one of Europe’s sunniest countries behind in solar technology. Investors complain that gaps remain in a new framework investment law. “The only way out is to encourage private investment, foreign direct investment and export-oriented growth,” says Nikolaos Karamouzis, deputy chief executive of EFG Eurobank.

. . .

The risk is of a vicious circle. Until economic uncertainty over Greece’s future abates, there is little incentive for the investment needed to boost long-term growth. Dangers are rising rapidly.

The longer Greece is unable to tap global financial markets, the more the country’s banks will have to rein back their domestic lending – adding to a credit crunch that is already crippling the economy. “We are the victims of a state that has lost international credibility,” says Mr Karamouzis. Greek banks are dependent on the ECB for liquidity – currently borrowing about €90bn in short-term loans. But the ECB wants to exert maximum leverage on Athens to speed up reforms and could cut its liquidity lifelines if not satisfied.

Athens had hoped to return to financial markets next year, when according to current plans it will need to raise €25bn-€30bn. With yields on its two-year bonds recently at record highs of 25 per cent, that timetable is almost certainly unsustainable. But a fresh bail-out would be hard to stomach especially for taxpayers in fiscally prudent northern European countries such as Germany and Finland.

Unsurprisingly, financial markets have started to believe a debt restructuring is inevitable. It is a scenario that the IMF and European authorities remain determined to resist. The ECB has warned of possible apocalyptic consequences on the country’s banking system and beyond. Jürgen Stark, an ECB executive board member, has said the 2008 collapse of Lehman Brothers on Wall Street could be put “in the shade” by a Greek default. Last month the finance ministry asked Athens prosecutors to investigate rumours of a restructuring – a move that strengthened the impression of a government under siege.

…

When – or if – Athens says public finances are back under control, will anyone believe it?

The country’s crisis erupted in late 2009 after the newly elected Socialist government of George Papandreou revealed the public sector deficit that year would be three times higher than previously forecast. But Athens was already a serial statistical offender. Based on revised budget deficit data, Greece would not have met the criterion of 3 per cent of gross domestic product set for membership of the eurozone, which it joined in 2001.

Since August last year Andreas Georgiou, head of the Hellenic Statistical Authority, has been in charge of sorting out the mess. For 21 years, he worked at the International Monetary Fund in Washington. His return to Greece meant a hefty salary cut but he “wanted to provide help at a difficult time for Greece”, he says in a rare interview.

One solution – throwing money at the problem – was not an option. With public spending being slashed, Mr Georgiou faced a hiring freeze. His staff, based mostly in an office block in a rundown suburb of Athens with views of concrete roadways rather than the Aegean, have faced pay cuts.

Instead, Mr Georgiou has focused staff on areas such as statistics on government finances. Backed by experts from other European Union countries, another priority has been to change Greek-style informal working practices. Mr Georgiou has strengthened, for instance, the crucial process of validating data – going back to original sources to check their reliability and cross-checking with other information. “All these things are new, they did not exist before,” he says.

However, he says, “the most fundamental change that moved everything forward” was the granting of his unit’s independence – bringing the country into line with standard European practice. Previously, it was a secretariat within the finance ministry.

“Of course, there has been pressure ... but my approach has been to continue to do my work according to the rules. My aim is to keep our work independent and produce credible data according to the appropriate standards.” Greece, he adds, “cannot afford any grey areas”.

His efforts have already brought results. In October last year, Eurostat, the European Union’s statistical office, dropped its warnings about the reliability of Greek data on public sector finances.

“For anyone to say there will never be any revisions would be very suspect,” Mr Georgiou says. “But I expect that any future revisions to our data will be within the normal margins you would see in other European countries.”

Greece’s Deficit At 10.5%, Wider Than Expected

From the WSJ:

Greece's budget deficit in 2010 was 10.5% of gross domestic product, significantly higher than forecast by either the Greek government or European Union authorities, the EU's official statistics agency, Eurostat, said.

The new deficit figure will add further pressure on Greece to cut its deficit this year to meet targets set under a rescue program overseen by the EU and the International Monetary Fund. The European Commission, the EU's executive arm, said in February that it expected Greece's deficit to be 9.6% of GDP in 2010 and 7.6% by the end of this year.

Eurostat also revised Greece's 2008 budget deficit to 9.8% of GDP from 9.4%. Greece's total government debt was 142.8% of GDP at the end of 2010, the highest level in the EU, the agency said.

Read the whole article here.

A Must-See Interview: Ex Minister Of Economy Alekos Papadopoulos On Greece’s Dire Outlook

The video, bellow, also includes an interview of the German Economist Hans-Werner Sinn on the Greece's situation.

Γνώμες: Τι Γίνεται Στην Ελλάδα;

“Inside Job” Documentary

The Stock Rally

Evidence that the stock rally is losing steam. Time for the big institutions to unwind their positions. When small investors pick up, we reach the last phase of an up market. This though could take a lot of time, depending on how many small investors are willing to come in.

New Reserve Currency In The Making (?)

After the World Bank made the case for a new reserve currency, more than a month ago, these voices were repeated from the IMF’s managing director Dominique Strauss-Kahn who on February 10, 2011, also called for a new world currency, because he is worried about volatility in the foreign exchange markets – see here . The same thoughts were again repeated by Mr. Strauss-Kahn on February 26, 2011 (see here). He envisions an asset the could be similar but distinct from the IMF’s SDRs. He said that having other alternatives to the dollar “would limit the extent to which the international monetary system as a whole depends on the policies and conditions of a single, albeit dominant, country.” Countries that have called for an alternative to the dollar as a reserve currency include Russia and China, and other European countries have voiced concerns about the role of dollar, like France’s president, Sarkozy.

Enhancing the role of alternative to dollar currency assets is not a new discussion but it goes back to the creation of the SDRs as a substitute of the dollar-gold exchange rate in 1969. The current discussion though has been active the last few years, especially after the global debt crisis and the monetary policies of key player countries which arguably cause debasing of global currencies, bring new inflation fears and volatility in the currency markets. In an attempt to stabilize currency markets the IMF issued new international money worth of $250 billion, in 2009 (see here).

All these bring us to renewed concerns about the difficulty to maintain reserve currency status for the dollar by Prof. Michael Kuczynski from Cambridge University, as it is expressed in his comment in FT today, and also on the G20 meeting in Paris where IMF’s Strauss-Khan wants the Renminbi in SDR.

What Are Special Drawing Rights (SDRs)?

“The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves. Its value is based on a basket of four key international currencies, and SDRs can be exchanged for freely usable currencies. With a general SDR allocation that took effect on August 28 and a special allocation on September 9, 2009, the amount of SDRs increased from SDR 21.4 billion to SDR 204 billion (equivalent to about $308 billion, converted using the rate of August 31, 2010).”

Here is the official factsheet of SDRs at the IMF’s website.

Reserve Currencies

Even though dethroning the dollar from its current status as the primary reserve currency is not something that can happen in the current setup, there is discussion about what being a reserve currency means and what are the alternatives to a dollar reserve currency.

FT published an article on the subject and can be found here. It considers a few alternatives like (a) the renminbi, (b) the euro, (c) SDRs (Special Drawing Rights), (d) pegging to gold price. A lot of research has been done on these issues and some thoughts are presented in this article about the pros and cons of being a reserve currency or having one of the alternatives as reserve currency. Bellow are some passages taken from the article together with some of my own thoughts on the matters. The parts taken from the article are in quotation marks.

One reserve currency?

“In truth, the benefits to the US, in terms of support for its currency and its financial assets, are uncertain. Also unproved is the wider case that having just one reserve currency is inherently unstable, contributing to the global current account imbalances that are widening again as the world economy recovers from recession.”

Is one reserve currency an unstable structure because it leads to the currency’s devaluation according to the Triffin’s dilemma?

“On the face of it, a modern version of the Triffin critique explains recent persistent American current account deficits; they have been funded largely by foreign governments buying dollar bonds. But the causation is not straightforward. Under a floating exchange rate system, as long as countries accumulate only moderate amounts of currency reserves allowing them to intervene in any future crisis, the demand for dollar-denominated assets should be limited.”

Are SDRs a good alternative to one reserve currency?

“The SDR is closer to an accounting unit than a currency.”

“In order for the SDR to work as a proper global currency, Prof Eichengreen says, some organisation – probably the IMF – would need systematically to control its issuance beyond the current system of ad hoc one-off distributions. Any such proposal to globalise monetary policy would provoke explosions of disbelief in legislatures worldwide. As Prof Eichengreen concludes: “No global government, which means no global central bank, means no global currency. Full stop.”

Linking currencies to the price of gold?

“An even less likely option is linking currencies to the price of gold, recreating one of the models of international gold standard used in the past few centuries. Following the rapid rise of the gold price in recent years, a phenomenon some investors claim is driven by fears about fiat currencies (those not backed by a physical commodity) being debased by inflation, interest in the subject was revived last year by Robert Zoellick. The World Bank president raised the eyebrows of economic policymakers – before rushing to clarify that he was not in favour of a strict gold standard – by arguing that the metal had become an “alternative monetary asset” and that governments should consider using its price as an “international reference point of market expectations” for inflation and currency values.”

“However, economists have long argued that linking currencies and price levels to the value of a fixed or nearly fixed stock of precious metal means forcing real variables such as growth and employment to bear the brunt of economic shocks – a socially and politically unacceptable outcome. Prof Eichengreen, in response to Mr Zoellick’s speech, pointed out that targeting the domestic price of gold would have caused the Federal Reserve, the European Central Bank, the Bank of Japan and the Bank of England to have tightened monetary policy sharply in recent years. “It is lunacy to suggest that in circumstances of weak growth and deflation risk, key central banks should simultaneously tighten [policy],”

How about the Euro or the Renminbi?

For these two currencies to be used as reserve currencies they need to strengthen. By that is meant, to strengthen their institutions. For the Euro, Europe has to overcome its current debt crisis, and to emerge from it stronger. In this case Euro may gain some power as a reserve currency.

As far as the Renminbi is concerned, this is a more remote possibility. Perhaps in 30 or more years Renminbi could play a role as one of the reserve currencies. Until then, the Chinese institutions should have to strengthen and be accepted from the rest of the world. It is not just the size of the market that matters but also the stability of its institutions and the trust of the rest of world on them. This is by far the most important determinant of a currency in order to gain its reserve status. 

A Changing Attitude

I do not like to bring up politics but this is an exception for a lot of reasons. First, because I am concerned about the path Greece is on and second, because I want to bring to your attention opinions of foreign officials as they are described by Mr. Michalis Ignatiou, an – according to the Greek media – informed and objective Greek journalist in the U.S. capital.

Mr. Michalis Ignatiou,  the permanent correspondent of several Greek media in Washington and a person with a lot of connections in the US capital, writes an article on the recent reactions in Greece after the announcement by Troika of the 50 Billion Euros privatization plan the government agreed with its foreign lenders. It is important when a person like Mr. Ignatiou, who spends all his time in Washington, describes how the Greek ministers and prime minister are perceived by their foreign counterparts, after 10 months of common life with Troika. The article is in Greek and can be found here, however, I attempt to translate a few key observations of Mr. Ignatiou.

Mr. Ignatiou states, that a source of his reassures him, that the decision to announce the privatization plan of 50 billion Euros was taken at the highest level, i.e. between Mr. Strauss Kahn the head of the IMF  and Mr. Papandreou, the Greek prime minister.  This point is coming together with the opinions of foreign officials about the deterioration of the economic conditions in Greece since Greece entered into the IMF program. Mr. Ignatiou again states that according to foreign officials – his sources – prime minister Papandreou is now seen as the reason of this deterioration. He says that the same person that in the beginning of the IMF involvement in Greece, was considered as the person who can push Greece forward, now is seen as the source of the problem. After a year of interacting with him, they realize that his objectives have changed, and he has become more concerned about prolonging his political career in Greece, rather than pushing forward hard reforms. On the other hand, they view the minister of economy, Mr. Papaconstantinou, as the one who strongly believes that without this program Greece will not survive, and as the only one in the Greek government who firmly pushes for the necessary actions.

Mr. Ignatiou, towards the end of his article, in an attempt to decipher the changed attitude of the prime minister, reminds the Greek people and the prime minister, that if Greece does not pay back the debts it has created with the IMF-EE-ECB consortium, its lenders have rights over the public property. A note that a lot seem to forget in Greece and which can bring Greece in a much more difficult position than the one it was before the IMF involvement.

Why Does The Economy Fall To Pieces After A Financial Crisis?

Here is Robert Hall’s paper published in the Journal of Economic Perspectives.

Inflation and TIPS 101

I am very concerned about inflation and this is a theme that I plan to be coming back to it regularly. Here, I want to first give, for those who are not familiar with, some definitions of inflation and then to introduce a class of assets that provide (perhaps) a hedge against inflation, the Treasury Inflation-Protected Securities (TIPS). The reason is to clarify some differences among different inflation measures and where perhaps each of them is used and also to dispel the misunderstanding that exists with respect to which measure of inflation do TIPS use and more specifically whether food and energy prices are included in it.

Unfortunately, there are many inflation measures and they differ on the composition of the asset basket for which prices are used in order to find the level of the Price Index, which then will result to the corresponding inflation measure. Inflation is the rate of change of the Price Index of each corresponding basket. Usually inflation is measured in a monthly frequency, as it is not feasible and perhaps it is not necessary to measure at a higher frequency.

The two inflation measures that matter for us are the Core Inflation and the Headline Inflation (CPI-U). What matters for us, as consumers, is the Headline Inflation because it incorporates the prices of more consumption goods – and goods that are broadly used – than the Core Inflation. Notably, the Core Inflation does not include food and energy prices. This is done because their prices are more volatile and they are more susceptible to short term supply shocks that can make a measure that includes them deviate substantially in the short term from a long term trend. Economists, and especially FED macro-economists, who want to gauge inflation dynamics in order to form monetary policy, need to base their policies on stable price trends and not on transitory effects, filter out these deviations – or “noise” around the trend – by focusing on the Core Inflation measure.

Why does the FED focus on Core CPI?

Different websites and even popular press takes this wrong hinting on negligence or conspiracy. The truth is far from that. The answer is that transitory deviations from the true CPI trend would give a lot of false signals to the monetary authorities and this would result to a huge distraction of value in the economy. This can be understood better with the help of the following example that I borrow from an anonymous source.

Suppose that the Federal Reserve had a mandate to stabilize the full Consumer Price Index, and that food prices suddenly doubled. To keep the CPI at a stable level, other prices would need to decrease. The problem, however, is that many prices are sticky, meaning that they do not instantaneously respond to changes in monetary and macroeconomic conditions. This is especially true in the service industry (which comprises the bulk of both GDP and the CPI).

To create these compensating price changes within a relatively short timespan, the Fed would have to impose extremely tight monetary policy, with sky-high nominal interest rates. And as we saw in the early 1980s, a large increase in nominal interest rates is extremely destructive to the real economy, leading to a massive increase in unemployment. Given our already weak economic conditions, such a policy would be even more damaging today.

Core CPI is a way to prevent this kind of needless suffering and unemployment. By targeting a more stable set of prices, the Fed avoids the wild swings in monetary policy that would inevitably arise from targeting an index that includes commodity prices. In other words, the demagogues who assail core CPI have it all wrong: the average American would be much, much worse off if the Fed targeted a volatile measure like headline CPI.

For more on CPI’s and their performance see here, here, here and here.

What are TIPS?

TIPS are Treasury Inflation-Protected Securities. They are bonds that have a fixed interest rate (coupon rate) which is determined at their auction, but they differ from Treasury bonds, in that their face value fluctuates positively one-to-one with the CPI. What I want to clarify here that is confusing to a lot of people is what is the CPI measure that is used for the face value. Several people spread around that this is the core CPI which is not correct. It is the CPI-U or Headline CPI that is used – that includes food and energy – in order to compute the TIPS face value. This is stated explicitly on the Treasury’s website. A question one may have is how does the Treasury come up with the future face values since they announce ahead of time the Daily Index Ratio for the next month. The answer to that is that they do a three month rolling average, extrapolating for the next one month period. The interesting remaining question is, how do they come up with daily CPI-U? I will respond to that when I find the answer.

To conclude, there is no cheating in the way TIPS have been constructed, as the belief that TIPSs face values do not reflect real inflation is not correct.

Roubini On Risks

Euro Under Attack

A video about the crisis in the Eurozone. The inside story of important events during the Eurozone crisis. Appear, Jean-Claude Trichet, George Papaconstantinou, Jean-Claude Juncker, George Soros, Christine Lagarde, Olli Rehn, and others. It is in French, with Greek subtitles.

Oil Prices And Recessions. Double Dip?

I take some facts, about the role of oil prices in the economy, from the article of Roubini on FT found here.

“About two-thirds of the world’s proven oil reserves and almost half of its gas reserves are in the Middle East.”

“Three out of the past five global recessions have followed a Middle East geopolitical shock that led to a spike in oil prices. In the other two global recessions, oil prices also played a role.  The Yom Kippur war of 1973 triggered a sharp increase that led to the global stagflation – recession cum inflation – of 1974-75. The Iranian revolution in 1979 led to a similar stagflationary rise in oil prices that triggered the 1980 recession (a double-dip recession for the US in 1980 and 1982). The Iraqi invasion of Kuwait in August 1990 led to a spike in oil prices at the time when the savings and loan crisis was already tipping the US into a recession; the US and most advanced economies then entered a short recession that lasted until the spring of 1991, when the war against Iraq was won. Even in the 2001 global recession – triggered by the bursting of the technology bubble – oil played a modest role as the second Palestinian intifada and broader Middle East tensions led to a modest but significant increase in prices.”

“Oil prices were also significant in the most recent global recession. The US entered a recession in December 2007 following the subprime bust, but this became global only in the autumn of 2008. This global recession was not triggered only by the collateral damage of Lehman’s bankruptcy. By the summer of 2008, oil prices had doubled in about 12 months, reaching a peak of $148 a barrel. That was a massive negative terms of trade and real income shock not just for the US, most of Europe and Japan but also for China and all the other net oil/energy-importing emerging markets. An already fragile global economy was tipped into an outright global recession.”

“This rise – and the related increase in other commodity prices, especially food – pushes up inflation in already overheating emerging market economies where oil and food prices represent up to two-thirds of the consumption basket.”

“But if oil prices were to rise much further, these economies would slow down sharply and some might even experience a double-dip recession. Finally, rising commodity prices increase investors’ risk aversion and may lead to a reduction in consumer and business confidence that is both negative for financial markets and the real economy.”

Credit Crisis Explained

Those At The Nucleus May Not Have The Best View

A really great article, full of truths about different things. The article is here, written by John Kay of FT. Here are some quotes from the article that I find worth mentioning .

“I was disappointed to find that the most distinguished of my lecturers, the economist Sir John Hicks, had never mastered how to hold the attention of a class. But clarity of thought and clarity of expression tend to go together. The best textbooks are often written by the best researchers: Richard Feynman could not only do physics brilliantly but also brought it alive with words.”

“… few people are as irritating as those whose combination of ignorance and arrogance is so profound that they claim to understand things they do not even know they do not know. The world of business and finance, which values confidence and certainty, is full of such people. “It isn’t really like that,” they will say; and when you ask what it is really like, they will tell you it is too complicated for you to apprehend. What they really mean, but do not recognize, is that it is too complicated for them to apprehend.

The bad financier, or businessman, like the bad scientist, pursues complexity almost willfully because he believes such complexity demonstrates his knowledge and sophistication. So the blind lead the blind through the mysteries of structured financial products and the jargon-ridden thickets of corporate strategy. People sell securities whose properties they only dimly appreciate to people who do not understand them at all. Consultants describe the business world in language – and, of course, PowerPoint presentations – whose elaboration disguises the banality of the thought.”

“Perhaps Henry Ford and Bill Gates were the men who really understood the automobile and computer industries, or perhaps they were just the people whose opinions turned out to be right, which is not the same at all.”

EU Commission Authorities Protecting The Greeks

We should thank the European Commission competition authorities for doing the obvious, something that the Greek authorities did not do, for the usual reasons of collusion and corruption. I am of course talking about the proposed merger between two of Greece’s largest airlines, Aegean and Olympic Air. The competition authorities declined the proposition on the grounds that it would create a monopoly. They state,

“This would have led to higher fares for 4 out of 6 million Greek and European consumers traveling on routes to and from Athens each year.”

It is interesting that the commission rarely uses its veto on mergers. You may read the article here.

Burton Malkiel’s Interview About Efficient Markets

The Stock Market Is Here

It has been a great come back! Motivated by today’s crossing of DJIA of the 12,000 level, which with certainty is going to be heralded in the media, I wanted to remind a few facts. First, where were we before we get into this mess? We (DJIA) hit a level of 14,093 on October 8, 2007. Then we landed at 6,626 on March 2, 2009, and since then we have been going up and up until today we crossed the 12,000 mark. If you ask me where it is going to go, I will have to say that “I do not know”. However, it is more likely that will go higher than lower. Apart from the ongoing slow worldwide economic recovery, an important factor that can affect significantly the “near” future market returns is the positive feedback by the media. The index is climbing higher with no big hiccups and quite low volatility, VIX is at  16.71, a level we crossed, moving upwards, in July 2007 and we revisited in October 2007, as well as a few other times since then, which was the market’s high. For all these reasons, I see an upward movement in the overall market as being more probable than otherwise, even though the fact that we have not seen any serious disruptions in the up-trend makes me cautious. The market is back, good news come from a lot of directions, the news will be heralded, the hype may catch on again, the market probably will continue higher, but be cautious about when a correction, or a turn may come. The turn is not very probable. For it to happen, the bad news will have to be quite significant.

Sheer Regulators’ Incompetence

The failures of SEC in identifying Ponzi schemes or even following up after people pointed them out to the authorities are known and monumental. So, perhaps one more failure would not be of surprise or worthy to be mentioned. However, here I report the latest one, the failure to uncover a 500 million Ponzi scheme run by Westridge Capital Management that lasted more than a decade, in Los Angeles.

Other notable failures of SEC officials to uncover such practices include the Madoff scandal. Here are some older articles on the subject. Article 1, article 2.

With all this new regulation in place, the question that we still have to answer is who is going to do the job. It is not merely a matter of less regulation, but of sheer incompetence of people to perform their tasks, that brought us, to a big extent, where we are today.

A Paper on Greece’s Woes

My appointment at NYU has taken a toll on my time devoted on this blog. However, here is a paper I meant to include in the information about Greece’s economic problems. The article, written by well known academics Meghir, Vayanos and Vettas, not only identifies the causes of the Greek crisis but also proposes measures in order to get out of it as fast as possible. Hope you enjoy it.