Greek Borrowing Costs and Potential Bailout

According to Reuters Greek borrowing costs hit a record high on Tuesday April 19, 2010. That day Greece sold 1.95 billion Euros worth of 3 month Treasury bills on Tuesday paying a high yield of 3.65 percent. Greece needs to be able to borrow 10 billion Euros in the month of May and may be needing assistance of up to 80 billion Euros in the next few years. This recent treasury auction has fueled speculation that perhaps as early as this week Greece will tap a 40-45 billion Euro aid package from, fellow EU member countries as well as the IMF, in order to finance its debt. This will undoubtedly have a drastic effect on the EU and the Euro. German Chancellor Angela Merkel will be put in a tight spot as she will have to face a public which is opposed to a bailout of Greece, while also making good on her promise to help provide aid to the ailing country. What will likely happen is that during negotiations on the final aid package Germany and other EU member states will try to push Greece off on the IMF hoping for increased IMF funding of the bailout. This approach also has its problems as it will show that the EU is unable to help itself and must rely on an outside body like the IMF that may impose strict austerity measures on Greece and possibly on other EU member states. This news comes as the IMF is proposing new taxes on banks and financial institutions in its member states. This reflects the high levels of borrowing and stimulus spending during the recent recession. Taxes on financial institutions will be put into a fund or simply placed in the IMF to provide for bank bailouts in the future, although the money raised will not necessarily be enough to fund widespread future bailouts. Increasing taxes on these institutions will also make them less competitive in the world market and could increase their chances of failing in the first place. A bailout of Greece will also set a precedent that might encourage other troubled EU states like Portugal and Spain to ask for EU and possibly IMF assistance. An increase in the amount of bailouts for EU member states will take a drastic toll on the Euro and could lead to dynamic and fundamental shifts in the Euro-Zone.

Singapore Currency Revaluation

According to Reuters on Wednesday April 14,2010 Singapore revalued it’s currency sending it’s dollar to a 20-month high. This move was taken after data was revealed showing that Singapore’ economy had expanded an unprecedented 32.1 percent on a seasonally adjusted annualized basis for the first quarter. This jump in GDP was stronger than expected and is the highest rate since records began in 1975. Singapore also raised its inflation expectations for 2010 to 3.5 percent. The expected rise in inflation and the large jump in GDP are what caused Singapore to allow its currency to rise; Singapore uses its currency instead of interest rates to manage its economy. This move is very important because it reflects increasing expectations that China will allow its currency to trade at a higher rate sometime in the near future. Countries like India, Australia, and Malaysia have all raised the value of their currencies as many Asian countries brace for rising global interest rates and a change in the valuation of major currencies like the Yuan. An increasingly valuable currency will put more purchasing power in the hands of Asian consumers possibly setting the stage for a shift in the economies of many of these countries from exported based to focusing more on domestic consumption, possibly improving the standard of living for many on the Asian continent; this will also make Asian exports more expensive as they will be faced with a less advantageous exchange rate, while also requiring higher production costs. If Asian currencies, and in particular the RNB, become more valuable there will be some important implications for the United States. Firstly prices of imports from Asian countries will rise meaning higher prices for traditionally low cost Asian goods. Also, as the Chinese and other countries purchase U.S. treasuries in order to keep their currencies artificially low a rise in the RNB or other Asian currencies could mean a large scale sell-off of U.S. treasuries. This will drive demand for U.S. treasuries and bonds down thus increasing borrowing costs for the U.S. which depends heavily on borrowing to finance its large budget deficit.

imports

According to the New York Times the Commerce Department’s monthly report on trade showed a 1.7 percent increase in imports. Exports barely rose, however they are at a high enough level to have caused the trade deficit to rise to 7.4 percent, despite the increase in imports. Much of the growth in imports came from consumer goods, this is seen by some analysts as a positive thing as it signals a rise in consumer spending. However it is important to note that this consumer spending is not backed by the creation of any goods within the U.S. economy this is why imports are subtracted from GDP numbers. While a rise in consumer spending may signal a rise in economic activity it is only helpful if it is backed by a rise in production, otherwise it becomes a drain on the economy as it subtracts from overall GDP figures; The fact that many analysts ignore this fact and continually focus on spending as the prime indicator of economic growth highlights the shortfalls of demand side economics. What most of these people do not realize is that supply is what creates demand and therefore drives our economy. If an individual wishes to purchase items by acquiring money that individual must first produce something that others will want to buy. If spending is not backed by production it signals a rise in debt levels and no real rise in economic performance.

Financial Regulatory Reform

According to the New York Times the debate continues on the issue of financial regulatory reform. Currently legislators are planning on creating a Consumer Protection Agency to protect consumers against abusive terms on mortgages, credit card debt, and other financial products. This agency will either become a part of the Federal Reserve or will be created as an entirely new agency. While financial regulation is a good idea to keep banks and financial institutions from misrepresenting their assets and debts what is continually misunderstood by lawmakers is the cause of irresponsible lending practices. Government backing and sponsorship of many financial institutions has taken away any accountability or risk in trading and lending. With implicit or explicit government guarantees against failure banks and other financial institutions are able to lend in extraordinarily risky ways without the risk of failure causing them to over leverage and lend to people who have little chance of repaying their loans. Increased regulation is not the answer to making banks resistant to risky lending and trading practices, the re-introduction of risk into these practices is. What the government needs to do is threefold, firstly we must stop bailing out banks and other financial institutions this has caused a dangerous precedent wherein banks can attempt to maximize profits by making risky loan decisions and then when the loans are defaulted on they are bailed out by the taxpayer. If the bank is threatened with closure and the executives threatened with a loss of their livelihoods they will be much more responsible in deciding who to loan to. We need to abolish the FDIC, most people understand the FDIC as an entity that protects consumers from bank failures but what it is really doing is protecting the banks from failure. Bank deposits are essentially loans to the bank and by guaranteeing the repayment of these loans the government is allowing banks to again make risky investment decisions with little risk. If banks were not guaranteed by the government consumers would be encouraged to shop around much more and only deposit their money in banks with sound lending practices. Finally, we need to stop guaranteeing loans via Fanny Mae and Freddie Mac. The reasons for this are explained in more detail in my blog on Fannie and Freddie which can be found further down on this page. To conclude, as with many other things that are wrong with the American economy today, we do not need to introduce new government regulation we need to reintroduce market forces to our economy and hold people accountable for their actions.

new posts

Hello everyone,
I have been travelling in Europe for the past week or so but I will be back in the States by tomorrow and I will be writing plenty of new posts once i have returned. I have had a lot of thoughts brewing in my head while over here and I will hopefully have some interesting things for you all to read come Tuesday or Wednesday until then cheers.

The End of the Federal Housing Credit

On April 30 the eight thousand dollar federal home buyer credit will expire. This has prompted a brief spike in home sales as people lower the prices of their homes in order to try and sell before the credit expires. Despite a recent increase in the number of pending sales and contracts the housing market has continuously underperformed during the current recessionary period. After the housing market collapsed in 2008 home prices have refused to rebound in any significant way. Housing prices hit all time lows even after the introduction of state and federal subsidies for new homebuyers which were enacted to stimulate demand. Speculators worry that repealing the federal home buyer credit will result in a further decrease of the value of homes since any demand created by the credit will be removed. Some lawmakers advocate extending the credit although there are no figures on whether the plan had any significant effect on demand for new homes. Even if the credit is not extended there are plenty of states that also offer home buyer credits. Despite an impending debt crisis California voted to extend a 10,000 dollar home buyer credit last week, New Jersey and South Carolina have similar plans.

What the government can’t seem to understand is that artificially creating demand will do very little to stimulate the economy in the long run. And unless you keep the programs in place forever, which they very well might try and do, the demand will evaporate as soon as the artificial stimulation is repealed. Housing prices need to be allowed to fall to their real market value, the whole reason we got in this mess in the first place is because prices have been artificially inflated creating rampant consumer spending not backed by any real production. Price deflation in the housing market is a result of market forces at work trying to bring housing prices back to reality so that more people will be able to afford homes and capital can be allocated in a more efficient manner. The recent spike in housing sales highlights this, more homes are being bought and sold because sellers have lowered prices in anticipation of the end of the credit, if the credit stays in place there will be no incentive to lower prices instead the opposite will happen as artificial demand will produce artificially high prices. Sure this will benefit the few sellers who are able to close on their homes but it will also allow people to take out loans based on artificially high prices and spend and speculate their way into the next recession while also denying people access to affordable housing.

Japan

After the financial crisis in 2008 many countries throughout the world have engaged in stimulus spending in order to prop up sagging demand and reinvigorate many of the world’s largest economies including, of course, the United States. Therefore I think it will be prudent to examine other countries that have utilized stimulus spending in the past and see how the measures have affected their economy and whether they were an appropriate tool in bringing an economy back to vitality. Japan in the 1990’s is an interesting case because it provides us with a financial situation not very different from what many countries face today. Japan can also give us keen insight on the effects government stimulus, regulation, and access to easy money have on an economy and whether these are effective measures to combat a recession.

After World War 2 ended Japan was brought back onto the world stage with the help of the United States. With special trade privileges and access to American technology and consumer markets Japan was able to claw its way towards being the world’s second largest economy. Japans economy was controlled by the central government, large parts of the banking and corporate sectors were controlled by relatively few powerful families or organizations called keiretsu. The Ministry of Finance used tax revenues and access to the large savings of many Japanese as a direct outlet to fund industrialization and infrastructure projects. Also the closely intertwined banking and corporate sectors enabled access to virtually unlimited sources of credit. The economy was assumed to continue growing as housing and stock prices skyrocketed, this had the effect of fueling the economic fire as a viscous cycle of investment and inflating asset prices continued. What is interesting is that this economic collapse occurred under a very centrally controlled system, even with the power to lend and spend consolidated in the hands of a few, low interest rates and access to easy sources of credit led to a collapse in the Japanese economy. Japan’s problem was not a lack of regulation or oversight, as the government was intricately connected with industry, access to easy credit and the proliferation of rampant speculation fed the economic bubble in Japan much as it did in the United States during the 2000’s. We see the use of these same methods throughout the world today as countries attempt to solve a problem by continuing with the very policies that caused the problem in the first place.

After the bubble popped in 1990 real estate and stock prices began to collapse. Deflation began to take hold as credit dried up and the Japanese began to spend less. This deflation is seemed by many to be a horrible economic phenomenon that occurs when an economy enters a recession and resources are not being utilized to their fullest. To many economists deflation is to be avoided at all costs. What many, including the Japanese, do not understand is that deflation is a necessary part of the economic cycle that occurs after an economy that has been spending and speculating too much and must come to terms with its loose monetary policy and large number of malinvestments. In effect the economy is trying to right itself; consumers are saving more so that eventually their savings can be loaned out again into projects that are hopefully more efficient and useful. This period is necessary and is a result of market forces trying to balance out the distortions caused by loose money. The Japanese and apparently the United States did not and do not understand this concept as both economies sought to re-inflate their economies by keeping access to credit artificially easy. This of course causes bad and inefficient investments to be made all over again as consumer savings now and in the future are squandered on centrally directed projects. For Japan this has meant over a decade of stagnation as the economy keeps on falling back into recession after repeated attempts at stimulation, for the United States whose debt dwarfs that of Japan the consequences could be dire.