The Great Debate UK

from Anooja Debnath:

When it comes to recessions, 40 is the new 50

If it were about age, 40-somethings would cringe. But it seems a dead certainty that 40 now means 50 -- or even higher -- when it comes to predicting the chances of a recession taking place.

Going by past Reuters polls of economists, every time the probability hits 40 percent, the recession's already started or is perilously close to doing so.

After the brief recovery period from the Great Recession, Reuters once again started surveying economists several months ago on the chances of developed economies stumbling back into the muck.

As the data get nastier and euro zone politicians wrangle over the sovereign debt mess, the probability goes higher. Just not high enough or fast enough.

The probability that Britain slides back into recession hit 40 percent in the Reuters poll this week, up from one in three last month.

The last time that happened was in July 2008, a few months before U.S. investment bank Lehman Brothers collapsed. The British economy contracted by 2 percent that quarter, its second contraction of 2008. And we all know what happened next. If 40 is the new 50, we're in it.

"It is a very big thing to say we are going into recession ... it is one of those things people are cautious sticking their necks out about," said Alan Clarke, who said there’s a 75 percent chance of that happening.

from The Great Debate:

Five ways to correct the Greek debt crisis

By Mohamed El-Erian This piece is the English version of the one that appeared in Handelsblatt. The opinions expressed are his own.

Not a day goes by without a flood of comments on Greece and its debt problems. They seem to come from everywhere. Some are later denied while others are left to stand, accompanied by a continuous string of worrisome data. In the process, even greater disorder is gaining hold of the country’s debt markets, with credit spreads exploding in an ever more alarming fashion.

There is a risk that all this could serve to confuse rather than illuminate the key issues that should be on the radar screen of many, whether they are policymakers or normal citizens. I can think of five such issues.

First, there is a good reason why Europe’s current approach to Greece's problems has not worked well. Indeed, many, including me, believe it will not work any better going forward. Meanwhile, the costs and risks are growing exponentially.

Despite a year of large sacrifices on the part of Greek society and exceptional financial support from neighbors, Greece is still very far from regaining economic and financial stability. Output continues to collapse, unemployment is rising, the budget deficit remains alarming, and the already excessive debt burden is increasing further.

As a result, the country is no closer to re-establishing normal access to the global financial markets. New investors prefer to wait on the sideline, thereby starving the country of fresh capital. Meanwhile, doubtful liabilities are increasingly being transferred from creditors, who knew they were taking risks in lending to Greece (rather, for example, than buy German debt at a lower interest rates), to Greek and European tax payers as well as to the balance sheets of public organizations.

Second, the time has come to urgently recalibrate the EU/ECB/IMF approach to solving Greek’s debt crisis. This must start with an open recognition that an insufficient number of the original key objectives of the Greek adjustment program have been realized and, going forward, even fewer stand any realistic chance of being realized under the current approach. As a result, the country will not be able to harvest gains from the courageous steps taken to improve the efficiency and functioning of the public sector. Indeed, it could be forced to reverse them.

from MacroScope:

Central banks should hedge: Gary Smith

Gary Smith, head of central banks, supranational institutions and sovereign wealth funds at BNP Paribas Investment Partners, has written a special guest blog for Macroscope in which he argues that central banks should consider ways to hedge their FX reserves against the crisis.

"After the 2008 crisis, a mathematical approach to measure the adequate level of foreign exchange reserves – import cover or an equation relating to short-term debt – no longer has much credibility. In the absence of sensible guidelines on adequacy of reserves there is now a general desire to have plenty of reserves.

What is lacking from the reserves debate, however, is whether National Wealth Managers in general (and central bank reserves managers in particular) should invest in assets that might increase in value during a crisis.

The traditional approach of investing in short dated, high grade government bonds is based on the desire to be in safe and liquid assets, which is logical enough. However during a crisis, it is not the stable value of the assets in which reserves are invested which is of interest to the currency speculators, but the pace at which reserves are being spent to defend the value of the domestic currency. Foreign exchange reserve managers do not invest in assets which might appreciate during a crisis for two probable reasons, firstly these investments would be based on the use of derivatives, and secondly such a strategy, as with any insurance policy, would require the payment of premiums. But perhaps using a small proportion of the many monthly increases in the value of foreign exchange reserves to help insure against the intense pain that can be created during a crisis might make some sense?

This chart shows the monthly change in Asian foreign exchange reserves in each month during a 15 year period 1995-2010. In most months (73%) foreign exchange reserves increased, usually by a small increment. What is also clear is that although months in which reserves fall are considerably less frequent, a fat-tail decline can be debilitating for the NWMs, and indeed for the nation.

Imagine the power of being able to announce during a currency crisis that foreign exchange reserves had received a positive impulse from the successful crisis management strategy of owning call options on gold, or put options on the S&P500. When all the news is bleak, the desire to announce any type of good news is immense. Why doesn’t this prompt a more detailed exploration of strategies that might have a positive pay-off during a crisis? My many conversations with NWMs around the world suggest that the principal reason is that local politicians are unlikely to fully understand, and hence sanction such a strategy (a strategy that would not be without costs, i.e. in the 73% of months of rising reserves, some of the upside would have to be used in order to pay for the insurance protection). For many, the use of derivatives is associated with speculative attempts to capture asset price appreciation, rather than insurance against the downside."

Following the aid money with Linda Polman

As political leaders wrangle over how best to deal with warring factions in hot spots around the world, enclaves of humanitarian aid workers grapple with how best to help innocent victims of violence.

Author and journalist Linda Polman proposes in “War Games: The Story of Aid and War in Modern Times” that since the end of the Cold War, there is much more at stake than the simple distribution of billions of dollars in aid money each year to fix crisis situations. Aid agencies relegated in the past to the peripheries of war zones and refugee camps now play a very different role.

An estimated 37,000 international non-governmental organisations follow the flow of aid money and compete with each other for billions of dollars, Polman writes, reporting that Organisation of Economic Cooperation & Development (OECD) donor countries contribute $120 billion (84 billion pounds) a year for developmental cooperation and an estimated $11.2 billion for emergency humanitarian relief. Some $6 billion a year is channeled into humanitarian aid out of the combined tax revenues of the world’s richest countries, she says.

Warring factions use money and supplies intended for humanitarian purposes for their own gain.

“In some wars aid capital is decisive,” Polman writes. “Under certain circumstances trading in aid supplies may be the most important economic activity around, and money and goods from NGOs are weapons in military strategies, including those of our own armies.”

Between 2001 and 2008, more than 60 governments allocated more than $15 billion to aid for Afghanistan but “where the money ended up is unclear. Neither the donors nor their INGOs dare to visit the projects they finance. The result is an unfathomable channelling of aid billions that is highly susceptible to fraud.”

“The majority of western INGOs never venture outside Kabul,” says Polman. “Instead they subcontract local and other international NGOs to implement their projects, who in turn engage further subcontractors.”

Crisis, what crisis?

– The author is a Reuters Breakingviews columnist. The opinions expressed are his own. –

 Crisis, what crisis? That could be motto for the election manifestos published by Britain’s main political parties this week. Neither Labour nor the Conservatives addressed the country’s fiscal crisis head-on.

Instead, they have sought to bribe the electorate with promises.

There are some good ideas in the manifestos. But there are too many promises to cut taxes and not to touch spending – as well as a general lack of urgency. Once one puts the pledges into categories of good, bad and ugly, there are too few in the former bucket.

OVERALL DEFICIT

The two parties are promising roughly the same fiscal squeeze over the course of the parliament. Labour says it would halve the deficit, which is standing at 167 billion pounds or 12 percent of GDP, over four years. The opposition Tories say they would reduce the bulk of the deficit over five years. But such cuts aren’t deep enough. What’s more, neither party has been prepared to say how they will achieve them.

from Global News Journal:

If Greece’s debt dam breaks, who gets wet?

The 16 countries that share the euro single currency have agreed they will help Greece out if it needs. So far so good. But only now is the nitty-gritty of how member states will go about paying for their contributions being hammered out. And suddenly things are getting a little complicated.

Italy announced on Tuesday it would have to issue government bonds -- known as BTPs --  to raise funds for its part in any Greek assistance. 

Under the agreement finalised by euro zone members on Sunday -- by which they will provide about 30 billion euros to Greece if needed, and the IMF a further 15 billion euros -- Italy may be called upon to disburse about 5 billion, a figure proportional to its economic weight in the euro zone. Germany, the European Union's biggest economy, would have to provide a little over 8 billion euros. 

If Italy, which already has national debts in excess of 100 percent of GDP, issues more debt to raise money to help Greece get over its debt problems (Greece has a debt-to-GDP ratio of 120 percent),  then, in theory, the yield on Italian bonds is likely to rise as investors factor in the increased risk. And since almost all members of the euro zone have severe budget deficits (and therefore little free cash), potentially all of them are going to have to issue more debt to raise the funds to pay Greece to overcome its even more serious deficit problems. It's spreading the risk around.

By the same token, if Greece asks for and gets the help it needs, its bond yields can be expected to fall if investors (or speculators) believe that the worst of the crisis is over and that the risk of a Greek default has now passed.

Multiply that scenario across the 16 members of the euro zone and what you get -- again, in theory -- is the risk profile of 15 member states increasing slightly in order to allow the 16th member, Greece, to lower its profile. It's like the water in a vast dam being released to save the one village next to the lake, with the result that all the villages in the valley get flooded equally.

Extending the metaphor, Germany, which doesn't get flooded very often and has taken sensible precautions against such an outcome, clearly doesn't like the idea of getting wet at all and has promised to keep its villagers dry. Italy doesn't mind getting a bit wet because it's been flooded a few times before and it might need the help of the other villages in the future. France, which likes to be seen as the driving force of inter-village cooperation, thinks it's the responsibility of everyone in the valley to take on a bit of a water to help out the village by the dam -- Greece. And meanwhile Greece, which was responsible for putting most of the water behind the dam in the first place, just wants to make sure it doesn't end up completely inundated, even if that means its neighbours taking a bit of a dousing in the process.

from The Great Debate:

Watch banks for clues on Greece

-- James Saft is a Reuters columnist. The opinions expressed are his own. --

As odd as it sounds, concerns about the effects of a euro zone sovereign crisis on Europe's still poorly capitalized banks may prove to be the tipping point that leads to a swifter bailout of Greece.

While discussion of contagion may seem very 2008, the problems with Greece, which faces a huge fiscal deficit, are becoming tougher for euro zone authorities to leave uninsured.

That's not just because worries about Greece spread markedly in the past week to Portugal, Ireland, and Spain, all of which saw their financing costs rise.

While Greece is, in the scheme of things, pretty small beer, though crucial as test of the euro project, the combined size of all four countries is large enough to pose a substantial threat to banks across Europe.

According to Bank for International Settlements data compiled by BNP Paribas, foreign bank exposure to Greece is just about 300 billion euros - a big, ugly number surely, but not the end of the world.

Lump in Portugal and Spain and you quickly get up to 1.75 trillion euros. That figure may not include all of the 400 billion euros of Spanish structured financings, most of which are tied to the ailing real estate sector.

2010: Another year, another crisis

- Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own. -

If the financial crisis were a theatre production of Hamlet, we would now be at the end of Act III.

But look . . . the audience is already standing up, applauding wildly and putting on their coats. They obviously think it’s all over. Little do they know how much blood remains to be spilled . . . Look at the facts.

The FTSE is up by nearly 50 percent since March, so that it is now more or less back to where it started 2006.  The same is true of gilts, corporate debt, and more or less every other financial asset on both sides of the Atlantic and across the globe. Even the housing market, where it all began, seems to be reviving.

So the crisis must be over, right?

But the jubilation may be premature, because, since Lehman Brothers collapsed in September 2008, policymakers have used every conceivable tool of monetary and fiscal policy so as to restore the status quo ante. Indeed, the success or failure of these policies has largely been judged by the criterion of how far the numbers look normal – where the norm has been redefined to mean “similar to the levels of 2005 and 2006”.

In these terms, the policies, especially quantitative easing, have been extremely successful. In many respects (not just bankers’ bonuses), the clock has indeed been turned back to 2005.

from MacroScope:

Crisis? What Crisis?

The title of this post is taken from two sources. One was a headline in British tabloid, The Sun, in January 1979, when then-prime minister James Callaghan denied that strike-torn Britain was in chaos. The second was the title of a 1975 album by prog rock band Supertramp that famously showed someone sunbathing amidst the grey awfulness of the declining industrial landscape.

Are we now getting blasé about the latest crisis? Not so long ago, perfectly respectable economists and financial analysts were talking about a new Great Depression. The world was on the brink, it was said. Now, though, consensus appears to be that it is all over bar the shouting. The world is safe.

Wealth managers at Barclays have gone as far as telling their clients to get over it.

Move past the crisis .... The past year's events were deeply traumatic for most investors, but now is the time to move on, and take a more "business as usual" approach ...."

Such bullishness may not be comforting to the record numbers of jobless in parts of the world, but it is bordering on consensus. It is left to the likes of perma-bears such as  Nouriel Roubini to try to burst the bubble of optimism on which many are floating. The economist began one of his latest articles bluntly:

Think the worst is over? Wrong.

Roubini's main point is that unemployment is likely to get worse rather than better and that many U.S. jobs that have been lost will not come back.

Is a bubble burbling in financial markets?

-Jane Foley is research director at Forex.com. The opinions expressed are her own.-

The discrediting of the efficient markets theory in the aftermath of the financial crisis appears to have been accompanied with growing support for the view that rather than efficient in nature, financial markets are predisposed towards the formation of bubbles.

A bubble can simply be defined as an occurrence that begins when the price of an asset has been driven significantly above it “fair” value. According to the efficient markets theory this would not happen.

If bubbles are a natural outcome of financial market activity it is relevant to ask whether the very loose fiscal and monetary policies of many central banks and governments are presently sowing the seeds of the next bubble.

Even though the real economies of the U.S., UK, Eurozone and Japan continue to be defined by expectations of rising unemployment and falling real wages, access to cheap money has already helped restore the profitability of many investment banks.

In turn, this has fed risk appetite which is evident in the rally in stocks since the spring, increased demand for “risky” currencies and a recovery in commodities prices. Brent oil has rallied by 128 percent from its 2009 low. The ability of oil to rally despite the existence of oil supplies well above the seasonal average suggests there is already speculative element in this market which could be in danger of driving prices above their fair value.

This week’s meetings of the Federal Reserve, the Bank of England and the European Central Bank have focussed attention not so much on rates, but on the extraordinary policy decisions taken by these central banks in the wake of the financial crisis and whether conditions are ripening in favour of a gradual withdrawal of some of these policies.