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  Economics focus: Bad circulation

  Posted: August 26th, 2010, 4:50am MDT

  There is more to America’s stubbornly high unemployment rate than just weak demand

  AMERICANS are used to thinking of their job market as lithe and supple. Employment snaps back quickly after recessions. Workers routinely shuttle between industries and cities to wherever jobs are abundant. But in the past decade, the labour market has resembled an ageing athlete. Each new injury is more painful and takes longer to heal. More than a year into the current economic recovery the unemployment rate remains stuck close to 10%, raising concerns about the kind of sclerosis that continental Europe suffered in the 1980s.

  The slow rehabilitation is in part because the economy suffered a trauma, not a scrape. The fall in GDP during the last recession was easily the largest of the post-war period, and output remains well below its potential. Few had expected a rapid return to full employment, but even modest expectations for jobs growth have not been met. Employment has actually fallen since the end of the recession; and unemployment would be even higher than it is were it not for discouraged would-be jobseekers quitting the workforce. Some economists now fret that other barriers besides weak demand stand between workers and jobs, and that high unemployment is partly “structural” in nature. ...

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  Finance after the crisis: Pactual: The origins of a new species

  Posted: August 26th, 2010, 4:50am MDT

  The latest of our profiles of financial firms after the crisis looks at BTG Pactual, Brazil’s investment-banking powerhouse

  IN RECENT years investment banks were supposedly hijacked by boffins who used their nuclear-physics doctorates to devastating effect. Yet the industry has long been slave to a different tribe of scientists: the bulge-bracket Darwinists. They reckon only giant global firms can survive.

  Until last year, Pactual, a Brazilian outfit, had conformed to their doctrine. In 2006 it sold out to a big foreign firm, UBS, for $3.1 billion, making its partners some of Brazil’s richest men. But then in 2009 the Swiss bank, reeling from losses, unexpectedly sold Pactual back to BTG, a local investment fund co-founded by Andre Esteves, one of the bank’s former top brass, for $2.5 billion. Today the renamed BTG Pactual is owned again by its partners and led by Mr Esteves who has a 25-30% stake. ...

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  Hedge funds: Bigger, safer but duller

  Posted: August 26th, 2010, 4:50am MDT

  A secretive industry opens up to meet the demands of investors and regulators

  FOR much of the past two years hedge-fund managers have tried to convince queasy investors not to give up on them. Now it seems that some of the industry’s biggest names have given up on themselves. Stanley Druckenmiller, a celebrated hedge-fund manager and protege of George Soros, announced on August 18th that he would close his fund, Duquesne Capital Management, because he was “dissatisfied” with its performance. Two days later it emerged that another well-known manager, Paolo Pellegrini, plans to hand back investors their remaining money by the end of September, after making losses.

  Messrs Druckenmiller and Pellegrini are not the only hedge-fund managers to have been humbled. Hedge funds used to boast of their ability to deliver “absolute returns”—to make money regardless of the ups and downs in financial markets. That illusion was shattered in 2008 when the funds’ average returns were -19%, according to data from Hedge Fund Research, which tracks the industry. Funds clawed back some of the losses last year but have struggled to build on that recovery. Returns were -0.2% in the first half of 2010 (although stockmarkets fell by much more). Capital losses and withdrawals by investors have left hedge-fund assets at around $1.6 trillion, down from a 2007 peak of almost $1.9 trillion (see chart). ...

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  Emerging-market debt: A run for your money

  Posted: August 26th, 2010, 4:50am MDT

  Developing countries in Latin America and Asia can borrow for longer

  PERU is not an obvious investment darling. For much of its existence, the country has been in a state of default. As recently as 1990 the inflation rate was 7,500%. Yet in the past few years Peru has persuaded creditors to lend it money for ever-longer periods in its own currency. It issued its first 20-year local-currency bond in 2006; its debut 30-year bonds followed a year later. Earlier this year Peru was able to issue 300m soles ($105.2m) of 32-year local-currency bonds. Investors in these bonds are compensated for the risk of inflation by yields of just 6.9%, a once unthinkable prospect.

  Peru is not alone. Anxious to wean themselves off flighty foreign funding after the crises of the 1990s, many emerging-market governments sought to build up local-currency bond issuance. Extending the maturity of bonds is the next step. In 2007 around 40% of Peru’s local-currency debt was short-term (ie, maturing in less than a year). That had fallen to 30% by 2009, according to the Bank for International Settlements. In Mexico average maturities have gone from 1.5 years in 2000 to seven years a decade later, says Gerardo Rodriguez, who heads the country’s debt office. ...

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  ShoreBank: Small enough to fail

  Posted: August 26th, 2010, 4:50am MDT

  The sorry end to a bold banking experiment

  “LET’S change the world”: ShoreBank’s slogan shouted that the Chicago-based lender saw itself as not just a bank but the leader of a movement. Founded in 1973, it set out to prove that money could be lent profitably to poor people in poor neighbourhoods. For 35 years it thrived but the financial storm that hit in 2008, and the economic downturn that followed, proved its undoing. On August 20th the Federal Deposit Insurance Corporation (FDIC), the bank’s regulator, called time on its experiment in what became known as community-development finance.

  Like many financial institutions, ShoreBank was hit hard by America’s housing bust. Yet in the first few months after the house-price bubble burst, Ron Grzywinski, a founder of the bank, was able to contrast the low default rates on ShoreBank’s mortgages with the higher ones of less responsible subprime lenders, such as Countrywide. The difference, he argued, was that ShoreBank did it the “old-fashioned way”—getting to know the borrower and securing a significant down payment against a realistically-valued property. ...

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  Bank capital: Foundations of jelly

  Posted: August 26th, 2010, 4:50am MDT

  A lawsuit in Germany highlights the flaws of hybrid securities

  “MORE capital, better capital” has been the chant of central bankers and regulators, as they strive to rebuild the banking system on more solid foundations. The debate about how much capital banks should hold against unexpected losses has captured much attention. But a lawsuit in Germany raises equally pressing questions about the sorts of capital banks hold.

  The thinking behind the regulatory push for simplicity and solidity is that over the past few decades banks have been allowed to build complex capital structures made from inferior materials. The best sort of capital to ensure a stable banking system is equity, because it directly absorbs losses and can thus cushion against systemic shocks. It is, however, expensive, so banks have sought to dilute it with cheap fillers, such as the delightfully-named “hybrid capital” and other fancy instruments. One reason for their popularity with the banks that issued them was that they paid fixed interest, which was tax-deductible. Regulators, for their part, took comfort from the fact that hybrids were a bit like equity in that payments could be stopped to preserve capital should a bank run into trouble. ...

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  European banks: A glow from the east

  Posted: August 26th, 2010, 4:50am MDT

  A slow fuse still burns on eastern Europe’s foreign-currency debts

  AFTER firefighters extinguish a blaze they usually look carefully for glowing embers before rolling up their hoses and heading off. With the worst of the banking crisis now receding in most rich countries, it is tempting to send the financial firefighters home. But wafts of smoke from eastern Europe suggest the job of stabilising Europe’s banking system is not yet done.

  In early August a number of banks operating in the region reported sometimes startling rises in loan losses. Among them were UniCredit, Erste Group and OTP. It had been hoped that loan losses would start falling. Instead they have continued to climb—alarmingly in some cases. In Kazakhstan more than a third of outstanding debt is non-performing. In Latvia, almost a fifth of debt is going bad. ...

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  HSBC and Nedbank: Mutual attraction

  Posted: August 26th, 2010, 4:50am MDT

  HSBC learns to play the vuvuzela

  THE closest HSBC traditionally got to sub-Saharan Africa was sending its Hong Kong-bound staff round the Cape of Good Hope before the Suez Canal opened in 1869. It is a sign of the region’s vastly improved prospects and the bank’s evolving strategy that HSBC is now in talks to buy a controlling stake in Nedbank, one of South Africa’s big four banks, with a market value of $9 billion.

  As Africa gets richer and does more trade with Asia, foreign banks are becoming more interested. That was the logic cited in 2007 when China Development Bank bought a stake in Barclays, which owns a big African business, and a few months later when ICBC, China’s biggest bank, bought a 20% stake in Standard Bank, South Africa’s largest, which has operations in some neighbouring countries. Citigroup and Standard Chartered, which along with Barclays have the biggest pan-African networks, now talk more about their prospects there. Portugal’s banks, which dominate in Angola and Mozambique, view their operations there as jewels. ...

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  Chinese banks: Circular logic

  Posted: August 19th, 2010, 5:47am MDT

  Chinese banks are undergoing an odd kind of bail-out

  THE banks of China did their duty by supporting the government’s stimulus efforts last year. Lending soared by a frenetic 32% in 2009; growth has slowed this year, but remains a robust 18%. Now the government is standing by the banks.

  A flurry of reports in the local Chinese press predicts that on August 24th Huijin, a branch of China Investment Corporation (CIC), the country’s sovereign-wealth fund and the holder of big stakes in all of its main banks, will issue the first of a series of bonds. Up to 187.5 billion yuan ($28 billion) should be raised in short order, with much of the demand coming from China’s state-controlled companies. These funds are expected to be used to support rights offerings by the big Chinese banks later in the year, as they seek to maintain capital ratios and protect against an expected wave of dud loans. ...

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  Economics focus: Paper chains

  Posted: August 19th, 2010, 5:47am MDT

  Tight policies in surplus countries helped undo the gold standard, which is a lesson for the euro

  CHRIS ROCK, a comedian, is a big fan of Oprah Winfrey, a television host and philanthropist. He recalls one of Ms Winfrey’s shows during which a woman confessed to her husband that she had frittered away $300,000 and as a consequence their home was about to be repossessed. “By the end of the show, it was all the guy’s fault,” a clearly impressed Mr Rock told David Letterman, another talk-show host. “He was apologising for not loving her enough—it was the greatest ‘Oprah’ of all time.”

  This may seem an odd sort of blame-shifting. Yet reasoning of this kind is increasingly used to explain how spendthrift countries get into trouble. On this view America’s credit boom and bust owed as much to a savings glut in Asia as to laxity at home. A new paper* by Barry Eichengreen of the University of California, Berkeley, and Peter Temin of the Massachusetts Institute of Technology, adds a dash of subtlety and a generous slice of history to this sort of analysis. The authors examine the role of fixed exchange rates in booms and busts and draw parallels between the inter-war gold standard and contemporary schemes, such as the euro and China’s peg with the dollar. ...

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  Finance after the crisis: Survival of the richest

  Posted: August 19th, 2010, 5:47am MDT

  Our continuing series of profiles of financial firms looks at the evolution of Blackstone, the most public private-equity outfit

  BLACKSTONE is used to wowing people with the size of its deals. The firm has taken part in seven of the 25 largest leveraged buy-outs in history. In 2006 it bought Freescale Semiconductor, a chipmaker, for $17.6 billion, and Equity Office Properties for $38.9 billion; it forked out $25.8 billion for Hilton Hotels in 2007. Times have changed. On August 13th Blackstone announced it would buy Dynegy, an energy firm, for nearly $5 billion, the largest buy-out of the year so far but a sum that would scarcely have turned heads in the boom.

  Back then Blackstone’s boss, Steve Schwarzman, was crowned the “new king of Wall Street” and “master of the alternative universe” for his firm’s ability to secure financing and do record-breaking deals. But since debt markets seized up in 2007 buy-out firms have had trouble making acquisitions. The failure to deploy the capital investors had already given them has made it harder for some to raise more. ...

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  Government bonds: A bull market in pessimism

  Posted: August 19th, 2010, 5:47am MDT

  A lot has to go wrong to justify today’s rock-bottom bond yields

  WHEN Japan slid into deflation in the mid-1990s bond investors were caught unawares. As late as 1995 yields on government bonds, a haven in times of deflation, were still approaching 5%. Investors today are not about to repeat that mistake. Inflation may be positive in America, Britain and Germany, but in all three countries government-bond yields have plunged to lows exceeded in recent times only by levels during the 2008 panic.

  Since falling yields raise the value of bond principal, that has delivered bumper returns to investors. Government bonds have returned about 8% this year in local-currency terms in these three countries, according to Barclays Capital, outpacing equity returns. (Investors in weaker sovereign credits, such as Greece, have fared far worse). As go returns, so go investors. American equity mutual funds have seen net outflows this year of $7 billion, according to the Investment Company Institute, a trade group. Bond funds have had inflows of $191 billion. ...

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  Freight derivatives: Boxing clever

  Posted: August 19th, 2010, 5:47am MDT

  Are container derivatives poised for bumper growth?

  FORGET civil rights, sexual liberation and pop music. The swinging sixties also saw the advent of containerisation in shipping. Some 140m containers now carry around half of the world’s exports by value (see chart). And according to the brokers that are starting to offer container-freight derivatives, contracts based on the future price of renting containers, the way these boxes are financed is about to undergo another revolution.

  Clarksons, the world’s biggest shipbroker, which pioneered derivatives for dry-bulk cargoes like iron ore and coal in the early 1990s, made its first container-derivative trade in January this year. Since then two other London-based brokers, ICAP and Freight Investor Services, have also started to offer derivatives settled against the Shanghai Containerised freight index, which is based on per-box rates on the world’s busiest container routes. Alex Gray of Clarksons admits that the market is tiny at the moment. But he reckons that container derivatives may be worth 5-10% of the physical market by the end of 2011. ...

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  Ireland's banking mess: Money pit

  Posted: August 19th, 2010, 5:47am MDT

  Austerity is not enough to avoid scrutiny by the markets

  IRISH businessmen like to say that the country has “first-mover advantage” when it comes to austerity. But that counts for little if the demands on the public purse keep getting bigger. New and direr estimates of losses amassed by the country’s biggest banks, many of which are now being borne by beleaguered taxpayers, have put the bond markets on edge. In an auction of government bonds on August 17th the extra interest, or spread, that Ireland had to pay relative to German bunds widened to its highest level since early May, just before European governments and the International Monetary Fund agreed to set up an emergency fund to help out struggling European economies.

  The jitters were provoked by comments made earlier that day in Beijing by Patrick Honohan, Ireland’s unusually straight-talking central-bank governor, about the rising cost of bailing out Ireland’s banks. The prime culprit is Anglo Irish, a specialist-property-lender-turned-black-hole that now seems likely to have to write off almost half of every euro it loaned. Bailing out the bank will, Mr Honohan reckons, end up costing the government as much as €25 billion ($32 billion). Relative to the size of the country’s economy, that would make Anglo Irish more destructive by far than bigger blow-ups like Royal Bank of Scotland and UBS (see chart). ...

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  China's currency: Wiggle it. Just a little bit

  Posted: August 19th, 2010, 5:47am MDT

  China's exchange-rate reform has so far been a letdown

  “ADOPTING a more flexible exchange-rate regime serves China’s long-term interests as the benefits…far exceed the cost in reorganising industries and removing outdated capacities.” That is the kind of thing Tim Geithner, America’s treasury secretary, might say to his counterparts in Beijing as part of the strategic and economic dialogue between the two countries. But it is in fact a quote from Hu Xiaolian, deputy governor of the People’s Bank of China (PBOC), the country’s central bank.

  In a series of speeches last month, Ms Hu argued that a freer exchange rate liberates China’s monetary policy; spurs innovation in China’s export industries; and channels investment to its service sector, where many of China’s new jobs will be found. China’s decision on June 19th to make its currency more flexible was therefore an “important move”. ...

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  Bank-capital rules: Super model

  Posted: August 19th, 2010, 5:47am MDT

  The Basel club publishes new analysis on the impact of higher capital

  WHEN asked, before the crisis, about the right level of capital they should have, the bankers’ answer was simple: “As little as possible”. Now that the world has changed, their response has morphed to “less than what the regulators want”. Lenders, they say, will have to hammer borrowers to recoup the costs of carrying bigger capital and liquidity buffers. The Institute of International Finance, a lobbying group, reckons the proposed “Basel 3” rules might knock 3% off the absolute level of rich-world GDP by 2015, a scary result. A study by the French Banking Federation concluded that the long-term level of GDP would be 6% lower in the euro area.

  In fact, the bankers, like everyone else, have not had much clue what effect tighter rules would have. Calculating their impact is tricky. Not only is there much argument about the impact of credit on the economy, there is also no reliable theory governing banks’ balance-sheets. They are just too surreal. When banks fail, they devastate the economy. And unlike normal firms, the relationship between banks’ leverage and their cost of borrowing is distorted by their ability to rely on central banks, attract savings from naive depositors and benefit from implicit state backing. ...

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  Currencies: Race to the bottom

  Posted: August 12th, 2010, 5:39am MDT

  A weak economy and an active Federal Reserve have driven the dollar down since June. Will that last?

  THREE months ago, when Europe’s debt crisis had markets panicking about sovereign risk, it seemed that all roads led to the dollar. The greenback was rising against the other big global currencies, the yen, pound and euro. Its role as the world’s reserve currency seemed an inestimable advantage when investors were unsure where they could safely park their cash. Within the rich world, America’s economy looked the best of a bad bunch. The stage seemed set for a dollar rally.

  ...

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  American unemployment: Lower, not hire

  Posted: August 12th, 2010, 5:39am MDT

  How jobless is this recovery?

  THE American economy is in unfamiliar territory. Not since records began has so deep a recession been followed by so shallow a recovery in employment. New jobs figures, released on August 6th, tell the tale. In July the economy added just 12,000 jobs after adjusting for temporary census work—too few to keep up with population growth or to reduce the unemployment rate. Slightly fewer Americans are working now, a full year into recovery, than when the recession ended in the middle of 2009.

  A comparison with previous recoveries is unflattering (see chart). Hiring was weaker in the aftermath of the relatively mild downturns of 1990-91 and 2001, when the unemployment rate topped out at 7.8% and 6.3% respectively. But this recession, in which the unemployment rate hit 10.1%, was much more severe. From peak to trough more than 8m jobs were lost. As many Americans are working now as in November 1999. ...

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  Buttonwood: A special case

  Posted: August 12th, 2010, 5:39am MDT

  The demand for financial assets is not like the demand for iPods

  MARKETS work. A government would never have made a success of an iPod, iPhone or iPad whereas Steve Jobs at Apple was able to anticipate demand for such hand-held devices. Other companies quickly noted Apple’s success and produced rival devices, thereby driving down prices and widening their appeal to consumers.

  Friedrich Hayek argued that markets were the most efficient mechanism for allocating resources because they represented the individual decisions of millions of consumers and thousands of producers—the wisdom of crowds, if you like. Bureaucrats and politicians would never have enough information to allocate resources as efficiently. ...

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  Tax evasion: Dues and don’ts

  Posted: August 12th, 2010, 5:39am MDT

  Southern Europe will have trouble increasing its tax take

  TELL a Greek or an Italian that the only certainties in life are death and taxes and they will laugh—and not because they believe in immortality. Southern European countries have long struggled to collect taxes. By their nature, of course, the data are difficult to collect but Greece, Italy, Portugal and Spain are thought to have some of the largest unofficial economies in the OECD (see chart).

  Now that these countries are trying to get their finances in order, bringing down rates of tax evasion is a high priority. The Italian authorities miss out on an estimated €100 billion ($131 billion) annually in uncollected taxes. European and IMF officials warned Greece this month that curbing tax evasion, which costs the government €15 billion each year, would be vital in unlocking more bail-out money. ...

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  Wheat: Straw man

  Posted: August 12th, 2010, 5:39am MDT

  High wheat prices reflect fires in Russia, not problems in world food markets

  FOR a brief period it looked like “Food Crisis 2.0”, or another “great grain robbery”—the episode in 1973 when a Russian harvest failure sent commodity prices soaring. Spot prices for wheat rose by 24% in July, and by more than 50% between the start of June and August 6th. On August 2nd and 4th futures prices for September contracts on the Chicago Board of Trade rose by more than 5%, the biggest daily increases since the end of the 2007-08 food-price spike. Russia’s prime minister, Vladimir Putin, announced a ban on wheat exports from August 15th. Ukraine this week said it was considering export quotas. Shares in many food-processing firms slumped.

  Yet it is the differences between today’s food-price spike and earlier ones that are striking, not the similarities. In 2007-08 prices rose continuously for months. In contrast, prices recently have been volatile. Weekly wheat-price rises in July were no larger, compared with four weeks previously, than those during May or November 2009. If you look at prices over 12-week periods, they rose more at the end of 2009 (before falling back) than in the past three months. Such volatility is within the normal range, reckons Manuel Hernandez of the International Food Policy Research Institute, a think-tank. True, the increase in futures prices for delivery in three months has been particularly steep. But futures prices for longer-term contracts are a better guide to overall market conditions—and have risen more slowly, suggesting a lack of panic. ...

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  Economics focus: Fiscal fundamentalists

  Posted: August 12th, 2010, 5:39am MDT

  Austerity or stimulus? Some economists have much more extreme views than that

  BY MOST people’s standards, George Osborne, Britain’s 39-year-old chancellor of the exchequer, is a fiscal hawk. In his first budget, announced in June, he promised to raise taxes and cut spending without flinching. As a result, Britain’s net public debt should peak at about 70% of GDP in March 2014. According to the Institute for Fiscal Studies, a think-tank, his spending proposals are even more mortifying than the hair shirt imposed on Britain in 1976 by the IMF.

  But Mr Osborne’s efforts look dainty compared with the rigours some economists think necessary. For example, Christian Hagist and his colleagues at Freiburg University believe Britain’s fiscal condition is far worse than the official figures suggest. In 2005, a time of prosperity and tranquillity, the country’s “fiscal gap” already amounted to 505% of GDP, they calculate, almost 14 times its official net debt for that year. Mr Hagist is an exponent of “generational accounting”, a method pioneered by Larry Kotlikoff of Boston University, among others. Through this lens, the rich world’s public finances look dire indeed. Writing in the Financial Times last month, Mr Kotlikoff declared that America was in worse fiscal shape than Greece. ...

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  Finance after the crisis: Citicorp redux

  Posted: August 12th, 2010, 5:39am MDT

  In the third of our profiles of financial institutions after the crisis, we look at Citigroup, a tarnished American icon

  WALTER WRISTON liked to contend that banks needed little capital as long as they were run well. On several occasions since the legendary Citicorp boss retired in 1984, the bank and its successor, Citigroup—created in a merger in 1998—have been caught embarrassingly short of the stuff. The latest blow-up was the nastiest. Enormous mortgage losses confirmed fears that the group, which grew into a gigantic financial supermarket under Sandy Weill, one of Wriston’s successors, had become too complex to manage—a “frankenbank”, as an insider puts it. Citi almost drowned in the red ink. It ended up needing three bail-outs, the last of which saw the government take a 23% stake.

  Citi must now show that it can thrive on its own. Critics argue that Vikram Pandit, who took over as chief executive in December 2007, has been too slow to pare Citi’s product offering and tighten its risk culture. To some, his survival owes more to obsequiousness—he rushed do the Obama administration’s bidding on mortgage modifications, for instance—than to managerial talent. Mr Pandit counters that he and his team are far along with what could be the largest bank restructuring ever, and that its fruits are already visible. ...

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  High-frequency traders: Spread betting

  Posted: August 12th, 2010, 5:39am MDT

  High-speed traders set their sights on Asia and Latin America

  THE merits of high-frequency trading (HFT) are under scrutiny in America, thanks to the “flash crash” of May 6th when the Dow Jones Industrial Average plunged by nearly 1,000 points in a matter of minutes. But high-speed traders are getting a warm welcome in emerging markets. When BM&FBovespa, Brazil’s main exchange, offered firms “co-location” slots to place their trading machines in the exchange’s data centre in February (giving them an additional edge on speed), they quickly sold out. The exchange plans to double the number of slots to meet demand. On Singapore’s exchange, the share of derivatives trades accounted for by HFT has risen from 10% to 30% in two years.

  Satisfying the technical needs of these speed merchants is hard. High-frequency traders execute thousands of trades a second. Exchanges are required to process trades in microseconds (millionths of a second). They also need to increase the speed with which traders receive market data to feed into their algorithms. These upgrades are expensive. Singapore Exchange’s plan to build one of the fastest platforms in the world, capable of executing trades in just 90 microseconds, will cost an estimated S$250m ($185m). NASDAQ’s system is currently the fastest with trade times of 177 microseconds (see chart). ...

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  Trading cocoa: Sweet dreams

  Posted: August 5th, 2010, 4:56am MDT

  A hedge fund bets big on chocolate

  SINCE Armajaro, a London-based hedge fund, took delivery of 7% of the world’s annual cocoa-bean production last month, there have been whispers about evil speculators. Sixteen cocoa companies complained to NYSE Liffe on July 2nd that the market had been manipulated and called for more regulation. Armajaro’s retort is that its position should not influence the market’s long-term fundamentals. But that has not stopped prices surging, nor the fund’s boss, Anthony Ward, being dubbed “Chocfinger” by British tabloids.

  Far less attention has been paid to the fund’s thesis. Unusually it took physical control of the 240,100 tonnes it purchased in the cocoa-futures market for just over $1 billion. The beans now lie refrigerated in warehouses in undisclosed locations across Europe. They can stay there for up to 20 years, although Armajaro hopes to have taken profits long before that. ...

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  Financial games: Another roll of the dice

  Posted: August 5th, 2010, 4:56am MDT

  New ways to take your friends and family to the cleaners

  THE most famous board game of them all, “Monopoly”, was launched during the Depression. This crisis may not produce anything quite as successful, but it has also spawned a crop of new financial games.

  “Billionaire Tycoon”, which will go on sale this autumn, is one engaging example. You are an entrepreneur who has been wiped out by the crash; you win when you have GBP1 billion on hand through the strategic acquisition of cash-generating firms, starting with car washes and pet shops and building up to oil rigs and private banks. Along the way, you can bargain, trade, steal, borrow and even engineer military coups to gain businesses and outfox opponents. Its co-creator, Shameek Upadhya, says his entrepreneur friends like to play—as do, apparently, their children. ...

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  European banks: Letting the bottom line talk

  Posted: August 5th, 2010, 4:56am MDT

  Europe’s banks are making money hand over fist. How odd

  A FEW weeks ago Europe’s banks were in real trouble. Many struggled to borrow from their peers or from capital markets amid concern that bad debts could soar or that faltering government finances in Europe could start toppling them like dominoes. Now investment analysts are falling over one another to raise their profit forecasts and slap “buy” recommendations on the stocks.

  That has less to do with the results of the relatively lenient “stress tests” the banks were subjected to in July, although they clearly played a part, than with the revelations that the first half of 2010 was highly profitable. Among the firms that comfortably beat analysts’ forecasts were Deutsche Bank, UBS and BNP Paribas, the biggest banks in Germany, Switzerland and France respectively. ...

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  Economics focus: The Himalayas of hiring

  Posted: August 5th, 2010, 4:56am MDT

  Three out of every ten of the world’s new workers will be Indian. Employing them won’t be easy

  LABOUR is cheap in India: signage is painted by hand; bricks are piled nine-high on the crowns of construction workers; shops are more crowded with attendants than customers. As China’s workforce becomes older, costlier and stroppier, some firms will look to exit the dragon. Only India has the numbers to match it.

  According to the International Labour Organisation, the number of Indians in the workforce will increase by almost 80m over the next decade. But that is an understatement, argues a new paper* by Tushar Poddar of Goldman Sachs and Pragyan Deb, now at the London School of Economics (LSE). Only a third of Indian women currently seek paid work, they point out (other estimates are even lower). If that figure rises to 38% by 2020, then the Indian workforce will swell by 110m, they reckon. Three out of every ten extra workers in the world will be Indian. ...

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  Finance after the crisis: Out of the bush league

  Posted: August 5th, 2010, 4:56am MDT

  Our series of profiles of firms after the crisis continues with Australia’s ANZ

  FOR its new headquarters in Melbourne, ANZ skipped the portraits of yesteryear’s leaders and the money museum that underpinned its lovely old cathedral of finance on Queen Street. Its new lobby is, in effect, an airport lounge, complete with showers and internet connections for travelling staff and clients. The architecture echoes the bank’s strategy: seize a moment when many of the world’s large financial institutions have been hopelessly distracted to carve out a franchise across Asia.

  Australian banks have taken tentative steps in this direction before, with disheartening results. ANZ itself gave up on Grindlays, its Indian business, in 2000. Standard Chartered picked up what soon proved to be a jewel, and ANZ lost access to a market that has yet to be regained. It has set aside such disappointments. Since the end of 2007, just after Michael Smith arrived from HSBC (where he had run its Asian operations) to take charge at ANZ, the number of customers it has outside Australia and New Zealand has grown from 1m to 3m, and the amount of deposits has gone from $13 billion to $37 billion. Net profits from outside its home region have doubled to 13% of the total and the bank wants this to be 20% in 2012. ...

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  The recovery in trade: Defying gravity and history

  Posted: August 5th, 2010, 4:56am MDT

  Despite dire predictions of a repeat of the 1930s, trade is bouncing back

  DURING the Great Depression, America’s protectionist Smoot-Hawley Act of 1930 raised tariffs on more than 900 goods. A series of retaliatory actions by other countries followed. The effect on global commerce was devastating. In the three years to June 1932, the volume of world trade shrank by over a quarter. No wonder, then, that the spectre of the worst recession since the Depression led many to fear another descent into protectionism and a similar decline in trade.

  At first, the recession did hit trade hard. Global GDP fell by 0.6% in 2009 while the volume of world exports dropped by 12.2%. But whereas the Depression saw trade decline for at least four years, this time the rebound has been quick, and sharp. By May this year, emerging-economy members of the G20 were importing and exporting around 10% more than their pre-crisis peaks (see chart). Rich-world trade has recovered from the trough too, though it has not yet made up all the ground lost since the credit crunch began. ...

• 

  Buttonwood: Dodging defaults

  Posted: August 5th, 2010, 4:56am MDT

  The corporate-bond market has proved more resilient than feared

  AS INVESTMENT banks toppled in the autumn of 2008, panic swept the corporate-bond market. With bank finance disappearing, company profits under grave threat and a slump apparently on the way, investors feared that a wide range of firms would be forced to renege on their debts.

  In the spring of 2009, Jim Reid of Deutsche Bank says, the market was pricing in the prospect of more than half of American high-yield bonds defaulting over the next five years, assuming that investors recovered nothing from the bankruptcy process. On a more typical recovery rate (around 40 cents on the dollar), the markets were pricing in a 69% default rate. That compares with a peak five-year default rate of 45% during the 1930s. ...

• 

  Brazil's development bank : Nest egg or serpent's egg?

  Posted: August 5th, 2010, 4:56am MDT

  Ahead of presidential elections, BNDES comes under scrutiny

  EIKE BATISTA, Brazil’s richest man, calls BNDES, the country’s state-owned development bank, “the best bank in the world”. But a former BNDES chairman, Luiz Carlos Mendonca de Barros, says it is a serpent’s egg—a reference to a film about the origins of the Nazi party. And a former central-bank chief, Gustavo Loyola, dubs the bank “Jurassic” and reckons its links with the treasury recall one of the worst periods of military rule. The violence of the rhetoric reflects growing controversy over BNDES and over state interference in the economy.

  BNDES’s rate of new lending now far exceeds that of the World Bank. Its gross disbursements reached 137 billion reais ($69 billion, see chart) in 2009, double the amount in 2007. Its political connections are impressive, too. The finance minister is a former head of the bank and the bank’s current head is favourite to succeed him if Dilma Rousseff, the candidate of the ruling Workers’ Party, becomes president. ...

• 

  Cerberus: Out of the doghouse?

  Posted: July 29th, 2010, 4:55am MDT

  After a few conspicuous flops, a private-equity firm gets back to its roots

  “PEOPLE were prematurely writing the epitaph of our investments and our firm,” says Mark Neporent of Cerberus, a private-equity firm and hedge fund. “Hopefully it’s pretty apparent to people that we’re back.” The firm, named after the three-headed dog in Greek mythology that guards the gates of the underworld, has spent the past two years trying to claw its way out of hell. Two of its largest and best known investments tanked. Chrysler, a carmaker, filed for bankruptcy and GMAC, General Motors’ financing arm, had to be rescued by the American government, which now owns most of it. For Cerberus, an intensely private firm, these were very public embarrassments.

  Some wondered whether the embattled firm would go the way of those two investments. But Cerberus’s flagship private-equity fund rebounded last year, making up for its 25% fall in 2008. (Its main hedge fund was still down by around 4% in 2009.) Its recent sale of Talecris Biotherapeutics, a blood-plasma company it bought in 2005 for $600m, to a Spanish health-care company for $3.4 billion has added to a sense of revival. Nor has the firm given up hope on Chrysler. Cerberus still has control of Chrysler Financial, the company’s finance arm, and there is talk of turning it into a diversified financial firm. Some say Cerberus may be able to recoup its money or even record a profit on its $7.4 billion investment in Chrysler if it plays its card right on Chrysler Financial. ...

• 

  Correction: Big Mac index

  Posted: July 29th, 2010, 4:55am MDT

  Correction: Burger-lovers in Argentina were enjoying a special discount on Big Macs when we collected data for our index (July 24th 2010). At nornal prices the peso is undervalued by 5% not 52%. Sorry for the whopper. This has been corrected online.

  ...

• 

  European banks: Judgment daze

  Posted: July 29th, 2010, 4:55am MDT

  Europe’s stress tests were a mixed affair. Many banks still face an uphill struggle to finance themselves

  “IT’S an analyst’s wet dream,” says one banker of the European stress tests announced on July 23rd. If financial detail is what turns you on, then the exercise delivered in style with hundreds of pages of information on 91 banks’ solvency and their exposures to the bonds of under-siege governments in the euro zone. As a piece of organisation, if not quite a triumph, it was an impressive feat. But whether all that new disclosure or the tests’ conclusion—that seven European banks need a piffling €3.5 billion ($4.5 billion) of new capital—help the banks escape their funding problems remains to be seen.

  The initial signs were modestly encouraging. Credit-default-swap (CDS) spreads, a proxy for banks’ borrowing costs, improved slightly across Europe, according to Markit, a research firm. Banks’ share prices rose too, although that had as much to do with the news on July 27th that the new Basel 3 rules on the sector’s capital and funding would be watered down. Still, wide differences remain. Five of the seven banks to fail were Spanish savings banks (see article): many of the cajas still face CDS spreads many times those of safer firms. On July 26th Bankinter, a midsized Spanish commercial bank that just scraped through the tests, paid a record spread of 240 basis points to issue a mortgage-backed bond. ...

• 

  Spain's cajas: Thinking outside the box

  Posted: July 29th, 2010, 4:55am MDT

  Should the savings banks be embraced by investors, or avoided?

  SPAIN’S savings banks, or cajas, have survived for nearly 200 years without the help of shareholders. But lots of these institutions, which are largely controlled by regional politicians, are now short of capital and on the hunt for private investors. A delegation from the Confederation of Spanish Savings Banks (CECA) toured European cities this week, touting what it called the “lighthouse of a new Spanish equity opportunity”.

  Bad analogy. A lighthouse warns of dangers, and there are plenty of these in the cajas, chiefly political meddling and a high exposure to dud property loans. The state has already pumped €14.4 billion ($18.7 billion) into the sector, most of it from its Fund for Orderly Bank Restructuring (FROB). Five cajas failed the stress tests, and will require another €1.8 billion in capital. Another four came close, and may also need to raise funds. ...

• 

  Finance after the crisis: Vigilante on the move

  Posted: July 29th, 2010, 4:55am MDT

  In the first in a series of profiles of financial institutions after the crisis we look at PIMCO, a giant fund manager

  BILL GROSS has a dual passion for philately and philanthropy. In 2007 he gave to Doctors Without Borders the $9.1m he earned from an auction of his collection of British stamps. He has said he is happy to part with “old friends” for a good cause. But the 66-year-old shows no sign of parting ways with the company he co-founded in 1971, Pacific Investment Management Co (PIMCO), one of the world’s largest bond-fund managers and, since 2000, a unit of Allianz, a German insurer. As co-chief investment officer, he manages PIMCO Total Return, the world’s largest mutual fund with $234 billion of assets. It is as successful as it is big, returning an average 7.5% over the past five years—better than 98% of its peers, according to Bloomberg.

  PIMCO itself, however, is changing. Having long marketed itself as “the global authority on bonds”, it recently switched to “your global investment authority”. It is too early to claim that crown. But the asset-management industry is sure to feel the effects of any effort by its most respected—and, by many, most feared—member to diversify its portfolio of offerings into equities, exchange-traded funds, risk hedging, valuation services and more. ...

• 

  SKS comes to market: Microfight

  Posted: July 29th, 2010, 4:55am MDT

  Can microlenders serve shareholders and the poor?

  THE loans that microfinance companies make may be tiny but their ambitions can be vaulting. Take SKS Microfinance. Already India’s biggest microlender, with 6.8m clients and 5.8m active borrowers in the year ending on March 31st (see chart), it intends to become the world’s largest by 2012, with 15m clients. To fund this growth, it hopes to raise nearly $350m by selling a 21.6% stake in an initial public offering (IPO) which got under way this week.

  According to the Consultative Group to Assist the Poor (CGAP), a think-tank housed at the World Bank, the IPO is only the second by a pure microfinance institution, after the offer by Mexico’s Compartamos Bank in 2007. More may follow. CGAP reckons that SKS’s move “should set the stage for future IPOs in the sector.” The omens are good. On July 27th SKS announced that it had raised $64m from anchor investors, including JPMorgan Chase, Morgan Stanley, and India’s ICICI Prudential and Reliance Mutual Fund, at the top end of the expected price range. ...

• 

  Buttonwood: Paying the price

  Posted: July 29th, 2010, 4:55am MDT

  Time to reassess how fund managers are rewarded

  FUND managers have been some of the biggest beneficiaries of the financial sector’s growth over the past 30 years. Bankers may routinely earn million-pound bonuses but some hedge-fund and private-equity managers have become billionaires. Seldom has so much been earned by so few.

  These riches have been generated despite the ability of investors to take advantage of low-cost exchange-traded funds and index-trackers. Investors have surged off-piste in search of higher returns. In aggregate, however, they will merely end up paying higher fees (typically, a 2% annual fee plus 20% on performance), a phenomenon this column has described as “catch two-and-twenty”. ...

• 

  Economics focus: A wealth of data

  Posted: July 29th, 2010, 4:55am MDT

  A useful new way to capture the many aspects of poverty

  WHAT IS poverty and when is a person poor? Most would agree that poverty involves not having enough of certain things, or doing without others that richer people take for granted. But what is “enough”, which goods and services really matter, and who should decide these questions—researchers, governments or international agencies—are less tractable issues. Perhaps the poor themselves should have the final word. But this presents its own problems. Tabitha, a 44-year-old woman from a slum outside Nairobi, told researchers from Oxford University that going without meals was “normal for us”. Diminished expectations are only one of the effects of dire poverty.

  In the world of international development, most have rallied around the “dollar-a-day” poverty line (or more precisely, the $1.25-a-day measure) and its less acute cousin, $2-a-day poverty. These World Bank measures judge a person to be poor if his income falls short of a given level, adjusted for differences in purchasing power. In principle poverty rates based on these measures count the fraction of people in a country who lack the resources to buy a notional, basic basket of goods. ...

• 

  Fannie Mae and Freddie Mac: Unfinished business

  Posted: July 22nd, 2010, 5:21am MDT

  Can the American mortgage market survive without taxpayer support?

  THE hefty financial overhaul that Barack Obama signed into law on July 21st (pictured) left behind one big piece of unfinished business. In 2008 Fannie Mae and Freddie Mac, mortally wounded from losses on loans acquired during the bubble, were placed in “conservatorship”, a halfway house between bankruptcy and outright nationalisation. There they remain, their losses duly covered with new injections of capital by the Treasury—$145 billion so far. Tim Geithner, the treasury secretary, has promised to address the matter of Fannie and Freddie by early next year but so far he has no answers, only questions (literally so: in April he asked the public to comment on seven of them).

  The hesitancy is understandable. Millstones though they are, the two firms remain critical to the economy. In the first quarter they and Ginnie Mae (which unlike Fannie and Freddie has always enjoyed the explicit backing of the state) guaranteed 96.5% of all newly originated mortgages, according to Inside Mortgage Finance, a newsletter. ...

• 

  Buttonwood: Losing confidence

  Posted: July 22nd, 2010, 5:21am MDT

  Looking at the dollar in the old-fashioned way

  WHEN the Bretton Woods system was cracking in the early 1970s the price of a troy ounce of gold, in dollar terms, was raised in two steps from $35 to $42.22. This was, in effect, a devaluation of the dollar.

  The authorities then still thought it worth expressing the shift in terms of bullion, rather than against another currency like the Japanese yen or French franc. In the 1930s Franklin Roosevelt had a specific policy of devaluing the dollar against gold, pushing the price from $20.67 to $35 in the belief this would push commodity prices (and thus farm incomes) higher and reduce the burden of debt service. ...

• 

  Burgernomics: When the chips are down

  Posted: July 22nd, 2010, 5:21am MDT

  The latest Big Mac index suggests the euro is still overvalued

  Correction to this article

  ASK Western policymakers how they intend to squeeze growth from their sluggish economies and most pin their hopes on higher exports. That makes exchange rates an especially sensitive topic. A weaker currency improves the competitiveness of a country by making exports cheaper. It also encourages domestic consumers to switch from expensive imports to domestic goods. The Economist’s exchange-rate scorecard, the Big Mac index, shows that currencies continue to be cheap in the developing world but overvalued in Europe. ...

• 

  Infrastructure finance in India: Infra red

  Posted: July 8th, 2010, 5:50am MDT

  India’s ambitious development plans hinge on attracting private capital

  MOVING through a drab terminal with overcrowded halls and jostling passengers, many international travellers are left wondering if this really is the gateway to one of the world’s largest economies. Heathrow’s answer to the problem was Terminal 5. Now Delhi’s airport also has a new terminal that matches India’s aspirations. Terminal 3, part of a $2.7 billion upgrade of the airport, opens later this month. Along with Delhi’s new subway system it is one in a series of projects that the city is racing to complete before the Commonwealth games in October.

  Construction activity is not limited to the capital. For many years India’s lack of infrastructure has been identified as one of the major constraints on sustaining a high growth rate. In 2007 the government set a target of increasing total investment in infrastructure from around 5% of GDP to 8.4% by 2012. This translates to over $500 billion in five years, with one-third coming from the private sector. But three years on, and despite plenty of outward signs of activity, the country faces a financing shortfall of at least $150 billion. ...

• 

  Global house prices: Froth and stagnation

  Posted: July 8th, 2010, 5:50am MDT

  House prices in parts of Asia continue to soar, despite efforts to slow them

  IN RECENT months several countries have experimented with measures to cool bubbly property markets. Yet since The Economist’s global round-up of housing markets was last published in April, house-price inflation has accelerated in some of the very countries where the authorities have intervened to slow its rise.

  Asia has been at the forefront of such interventions. In February Singapore’s government raised down-payment requirements and imposed stamp duties on all residential properties sold within a year of purchase in a bid to curb speculation. Despite these steps prices in the island nation rose by nearly 40% in the year to the end of the second quarter, after a rise of just over 25% in the year to the end of the first quarter. Singapore has overtaken Hong Kong to become the frothiest housing market among those we monitor. ...

• 

  The inventory cycle : Stocking filler

  Posted: July 8th, 2010, 5:50am MDT

  The economic slowdown does not herald a double dip. Yet

  IF THE foreclosure signs that sprouted on front lawns across America symbolised the mortgage crisis and the queues outside Northern Rock, a British bank, epitomised the credit crunch, the best symbols of the manufacturing meltdown were the thousands of new Toyotas stowed on-board a vessel in Sweden with nowhere to go.

  To clear such stockpiles, carmakers and other firms had to cut their production dramatically—even more dramatically than their sales. This destocking added to the world economy’s woes in the worst months of the crisis in early 2009 (see chart). But just as the downswing of the inventory cycle deepened the recession, the upswing has boosted the recovery. Output grew faster than sales, as firms refilled their warehouses as well as meeting customers’ orders. This swing in inventories accounted for over two-thirds of America’s growth in the first quarter. And it added over two percentage points to Asia’s growth (outside Japan and China), according to HSBC. The surge in industrial production helped lift the IMF’s latest forecast for global growth this year to 4.6% from 4.2% in April. ...

• 

  KKR's New York listing: Start spreading the news

  Posted: July 8th, 2010, 5:50am MDT

  KKR will at last list on the New York Stock Exchange. Will others follow?

  KOHLBERG KRAVIS ROBERTS (KKR), a large private-equity firm, became famous after its fierce campaign to take over RJR Nabisco was documented in the book “Barbarians at the Gate”. For the past three years KKR has been banging on another set of doors: those of the New York Stock Exchange (NYSE). After filing with the Securities and Exchange Commission (SEC) this week, KKR is expected to transfer its current listing in Amsterdam and finally float on the NYSE on July 15th.

  The timing is puzzling to many. The equity markets are turbulent. The stock price of Blackstone, a rival private-equity firm that went public in 2007, has tumbled to less than a third of its listing price. Many are wondering why KKR, which has around $55 billion under management, wants to take its New York bow now. ...

• 

  Italian motor insurance: Claim and misfortune

  Posted: July 8th, 2010, 5:50am MDT

  Italian drivers count the cost of driving badly

  AS A business model, insuring Italian drivers is right up there with betting on English World Cup victories. Hope can get the better of experience. About one Italian car in 12 is involved in a claim each year, compared with one in 23 in France, which has similar numbers of people and cars. Whereas fewer than 200,000 Frenchmen claim injury in accidents every year, some 1m Italians do.

  The result is sky-high premiums. At an average of €407 ($515), Italians pay well over twice as much for their annual car insurance as French drivers. Premiums increased by 18% in Italy between 2002 and 2009, against an average of 7% in Europe. Even so the business lost money last year. Italy’s car insurers lost almost €8 on every €100 of third-party insurance sold; claims settlement absorbed €14.9 billion. ...

• 

  Buttonwood: Carry that weight

  Posted: July 8th, 2010, 5:50am MDT

  A new approach to bond indices

  THINK of all your old classmates from school. Which of them would you lend to? There were probably a few you would not trust to return a pencil. So the idea of lending to all of them, in proportion to the size of their accumulated debts, sounds like a stupid proposition.

  But that is what bond indices do. Just as equity indices are weighted by the market value of the constituent companies, fixed-income benchmarks are weighted by the value of the debt. In the case of government-bond indices, the more a country borrows, the bigger its weighting. ...

• 

  Agricultural Bank's IPO: Agricultural revolution

  Posted: July 8th, 2010, 5:50am MDT

  China has now transformed the appearance of its big banks, leaving the vexing issue of substance

  THE $19.2 billion raised by Agricultural Bank of China’s initial public offering (IPO), which was priced on July 6th and 7th, does not simply mark one of the world’s largest-ever stockmarket listings (the biggest, if the bank fully exercises a right to issue additional shares). It also ends a decade-long process to transform China’s huge financial institutions from wards of the state to banks that resemble publicly listed firms in the rich world.

  The deal attracted more than the usual amount of attention—in part because of ongoing palpitations in global markets, in part because Chinese share prices in particular have collapsed in recent months, and in part because the listing coincides with fierce debate about the health of China’s banking system. Agricultural Bank itself is notable for both its gargantuan size (320m customers) and its giant past loan losses. Optimists see it as a superb macro play on China, pessimists as a Chinese version of Fannie Mae and Freddie Mac, America’s nominally private, and deeply flawed, housing-finance firms. ...

• 

  Economics focus: Hoard instinct

  Posted: July 8th, 2010, 5:50am MDT

  The nature of the recession, not government schemes, may explain why some countries lost so few jobs

  GERMANY’S gross domestic product fell by 4% in the two years to the end of 2009, twice as much as in America. Yet its employment rose by 0.7% while America’s plunged by 5.5% (see left-hand chart). When German politicians contemplate why a gruelling recession produced almost no increase in unemployment, they usually have a one-word answer: Kurzarbeit. “It is only thanks to Kurzarbeit that more jobs were not lost,” Angela Merkel, the chancellor, told Germany’s parliament in November.

  Kurzarbeit is Germany’s practice of providing a federal subsidy to companies that voluntarily reduce the hours of their employees while keeping them on the payroll. It is perhaps the best known of many short-time work programmes implemented or expanded during the recession by countries trying to defray the social and economic costs of unemployment. But such schemes only partly explain why employment in many countries, Germany included, diverged so greatly from output. Other reasons can be found in the OECD’s annual “Employment Outlook”, published on July 7th. (But only after a lot of digging: the 308-page report is a dense mass of impenetrable jargon, a frustrating way to treat a subject so vital to the average citizen.) ...

• 

  Joe Cassano at the FCIC: No ordinary Joe

  Posted: July 1st, 2010, 5:08am MDT

  A credit-crunch legend has his say

  FINANCIAL hearings can be dull, but they spring to life when shadowy moneymen are dragged into the spotlight. This week it was the turn of Joseph Cassano, one of the most elusive protagonists of the crisis, who broke his silence before America’s Financial Crisis Inquiry Commission.

  The financial-products (FP) division that Mr Cassano ran was the epicentre of the earthquake at AIG. After insuring $70 billion of dodgy mortgage debt, the firm was caught in an almighty liquidity squeeze when the debt’s market value fell. Outrage over the resulting government rescue was compounded by news that Mr Cassano had earned $315m on his watch and secured a $1m-a-month consultancy with the firm after being pushed out. ...

• 

  China and Taiwan: Branching in

  Posted: July 1st, 2010, 5:08am MDT

  After 61 years of forced separation, a slow restoration of financial ties

  THE Economic Co-operation Framework Agreement signed by Taiwan and China on June 29th encompasses hundreds of categories in goods and services (see article). Negotiations were particularly wrenching for agriculture and financial services because each, in its own way, raises security concerns.

  The risks that come from the loss of control over food supplies are obvious. The link between financial services and security is more subtle. China’s banks, insurers and brokerages are all, to at least some extent, state-controlled. No surprise then that Taiwan, if it hopes to remain politically independent, fears having its companies nourished by credit that is run by Beijing. Anyone doubting the intensity of these concerns need look only at the American government’s efforts to sell AIG’s Taiwanese life-insurance operations to a Hong Kong partnership that is suspected of being backed by mainland money. The deal, announced last year, is still stuck in regulatory purgatory in Taipei. ...

• 

  Klaus Regling: Chief bail-out officer

  Posted: July 1st, 2010, 5:08am MDT

  The new head of the euro-zone SPV

  IT IS registered in Luxembourg, the “offshore” domicile of many hedge funds. It has hundreds of billions of euros with which to place macroeconomic bets. And from July 1st the newly formed European Financial Stability Facility, the special-purpose vehicle (SPV) set up to support ailing euro-zone countries, is even being run by a former hedgie. But this is one fund that will never short its investments.

  Klaus Regling owes his appointment as the SPV’s chief executive to his nationality as well as his expertise. The fund will be able to borrow as much as €440 billion ($537 billion) to lend to struggling countries. Its borrowing will be guaranteed by euro-zone countries, and Mr Regling’s native Germany could be on the hook for €148 billion of those guarantees. ...

• 

  Buttonwood: What goes up

  Posted: July 1st, 2010, 5:08am MDT

  Equities are still suffering from a valuation hangover

  THE best bet for the long term is to buy shares and hold on to them. That was the lesson hammered into the heads of investors in the 1990s when the “cult of the equity” was at its peak. Unfortunately, they absorbed the message at precisely the wrong time.

  The past decade has been disastrous for equities. Over the ten years to June 18th 2010 investors in developed-market equities earned a cumulative total return of minus 7.9%. By contrast medium-dated Treasury bonds returned 95.3% and high-yield American bonds 102.2%. Richard Cookson, the chief investment officer at Citi Private Bank (and a former journalist at The Economist), points out that the cumulative outperformance of high-yield bonds over equities dates back to 1995. ...

• 

  Iron-ore derivatives: Fixed ore floating

  Posted: July 1st, 2010, 5:08am MDT

  Steelmakers hold the key to a fast-growing market

  FOR decades the system for setting the price of the iron ore that feeds the world’s steel mills was as inflexible as the girders it was turned into. Annual negotiations between the world’s three biggest miners—Rio Tinto, BHP Billiton and Vale—and steelmakers set a benchmark price for ore delivered under long-term contracts. But the emergence of China as a big buyer, which felt it should have more control over prices, helped precipitate that system’s demise earlier this year.

  That was a blow to steelmakers accustomed to predictable prices for their most important ingredient. Others are happier, however. Miners now sell their wares on the spot market or on three-month contracts linked to spot prices, avoiding fractious negotiations and enabling them to take speedier advantage of fast-rising prices. And the shift has also been a boon to traders in the rapidly growing market for iron-ore derivatives. ...

• 

  Economics focus: The click and the dead

  Posted: July 1st, 2010, 5:08am MDT

  E-commerce favours large companies but only because that is what people want

  FOR as long as anyone can recall, chess enthusiasts in Cambridge, Massachusetts, have played on large streetside chessboards in the shadows of the stately buildings of Harvard Yard. But even in a place that seems impervious to the passage of time, there is change. One example is an empty space where a much-loved local institution, an independent bookshop called WordsWorth, stood for 30 years. Like small-business owners in other industries, its proprietors held the internet, of which the student-heavy populace of Cambridge were early adopters, responsible for having to shut up shop in 2004.

  Everywhere people bemoan the replacement of the local and the quaint by outposts of big, homogeneous chains. But how true is the notion that the internet in particular has hastened the demise of some retailers, and that those it hurt were overwhelmingly small? A new study* on this subject by four economists at the University of Chicago looks at three industries—bookshops, travel agencies and new-car dealerships—for answers. They find much truth in the conventional wisdom, but also some solace for those who believe small is beautiful. ...

• 

  Clarification: The euro zone’s special purpose vehicle

  Posted: July 1st, 2010, 5:08am MDT

  In “Spivvy” (June 12th) we said that the euro zone’s special purpose vehicle was “backed by the credit of its 16 members, plus Poland and Sweden, which said they would join in.” If the SPV does lend money, Sweden and Poland will decide on a case-by-case basis whether to make bilateral loans of their own.

  ...

• 

  Companies' cash piles: Show us the money

  Posted: July 1st, 2010, 5:08am MDT

  For the recovery to proceed smoothly, firms must stop hoarding cash

  IF THE private sector continues to save hard even as governments try to borrow less, the risks of a double-dip recession rise. A long period of high household saving seems assured in rich countries whose consumers lived off credit and have heavy debt burdens to show for it. But much of the recent increase in private-sector savings comes not from consumers but from businesses. Profits have been more than enough to cover corporate spending in many parts of the rich world, leaving an excess of funds for firms to squirrel away. A lot depends on whether this continues.

  If cautious firms pile up more savings, the prospects for recovery are poor. Economies will be stuck in the current—and odd—configuration where corporate surpluses fund government deficits. If firms loosen their purse-strings to hire workers and to invest, that will allow governments to scale back their borrowing. ...

• 

  Economics focus: The price of entry

  Posted: June 24th, 2010, 5:19am MDT

  A new proposal from Gary Becker to make a market in immigration

  NORTH AFRICANS risk their lives to try to cross the Mediterranean to southern Europe. Mexicans pay “mules” to get them across the border with the United States. Afghans camp outside Calais in filthy surroundings, waiting to cross into Britain. Everywhere, it seems, there are people trying to get into another country. Even those who seek to move legally in order to work face huge barriers to entry in certain countries. People on work visas account for 70% of legal migrants to Germany, for instance, but only 5.6% of those entering America, the original land of opportunity. Most of the rest get in because a member of their family is already in the country. America’s annual quota of visas for the highly skilled can run out in a matter of weeks. More people want to move to rich countries than are able to.

  In a lecture delivered on June 17th at the Institute of Economic Affairs, a think-tank in London, Gary Becker proposed a “radical solution” to this messy problem. Fittingly for a Nobel laureate who pioneered the application of economics to areas such as discrimination, crime and the family, his answers involved market mechanisms. Mr Becker argued that immigration was out of kilter because of the absence of a price that would match supply and demand. Governments, he suggested, could use economic principles to allocate visas, either by selling the right to migrate at a price that called forth a desired number of migrants, or by auctioning immigrant visas. ...

• 

  Buttonwood: Clearing the usual suspects

  Posted: June 24th, 2010, 5:19am MDT

  Investors may not have caused commodity price rises

  NO ONE likes paying more to fuel their car. The fluctuations in the oil price caused by political turmoil in the Middle East are hard enough to bear. But the idea that speculators are driving commodity prices beyond their “true” level seems particularly galling.

  To many, that oil went from $65 a barrel in June 2007 to $145 in July 2008, and back down to $31 in December of the same year, is proof the price was not being set by supply and demand. Academics who have proclaimed on the issue come down on both sides of the argument. A recent report* from the OECD analyses the literature, applies its own statistical tests and finds investors not guilty. ...

• 

  Art sales: Stooping, not conquering

  Posted: June 24th, 2010, 5:19am MDT

  Auctions at Christie’s and Sotheby’s were not as successful as they claim

  THEY were expected to be the biggest art auctions ever: 113 carefully chosen lots that would shatter records and prove, once and for all, that the market had returned to the boom years of 2006 and 2007. When it came to it, though, evening sales at Christie’s and Sotheby’s of Impressionist and Modern art in London on June 22nd and 23rd were patchy at best.

  Sotheby’s came first, and had the worst time of it. The Bond Street auctioneer drew a stellar crowd that included Laurence Graff, a British jeweller specialising in huge diamonds, and Larry Gagosian, an influential New York art dealer who rarely appears in person at auctions. Sixteen of the 51 lots failed to find a buyer, however, including works that should have been popular: two Edgar Degas pastels, a late Picasso of a woman seated in an armchair with a cat, and a circus scene by Marc Chagall. ...

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  Exchange-traded funds: Explosive

  Posted: June 24th, 2010, 5:19am MDT

  A fast-growing industry is attracting more regulatory attention

  EVEN the best financial innovations have a nasty habit of spinning out of control. No surprise, then, that regulatory antennae are twitching at the rapid growth of exchange-traded funds (ETFs), investment pools that are listed on stockmarkets. ETFs have plenty of attractions, giving retail investors a relatively cheap way to diversify their holdings. But their dangers are also becoming more apparent.

  The sheer size of the industry is one cause of concern. At the end of May ETFs in America held around $792.6 billion in assets, according to Morningstar, a research firm. The worldwide total passed $1 trillion at the end of 2009. Morgan Stanley predicts the industry will grow by 20-30% in 2010. The market has rapidly evolved to meet demand for more exotic products, particularly in commodities, where many worry about the impact of the appetite for ETFs on prices (see Buttonwood). ...

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  Glenn Beck and Friedrich Hayek: Essential reading

  Posted: June 24th, 2010, 5:19am MDT

  What would Hayek have made of his new cheerleader?

  THE credit crisis was kind to the reputation of John Maynard Keynes, whose scribblings from over 70 years ago inspired practical men of action to fight the recession with uninhibited stimulus. Now that a backlash against expansive government is taking hold, one of Keynes’s old antagonists is getting his turn in the sun.

  For the past few weeks Friedrich Hayek’s 1944 classic “The Road to Serfdom” has battled Swedish thrillers and vampire novellas atop Amazon’s charts. The Viennese apostle of the free market owes much of his success to Glenn Beck, a TV host on Fox News, who believes the book carries an urgent message for today’s Americans. ...

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  Capital controls in South Korea: The won that got away

  Posted: June 17th, 2010, 5:20am MDT

  A surgical strike in a volatile market

  WHENEVER South Korea’s currency, the won, has fluctuated against the dollar in recent months, the authorities in Seoul have had a deep sense of deja vu. They remember the dark days of 2008 when finance officials jetted around the world trying to convince people that their export-dependent country was not the next Iceland. It was a tough sell.

  Back then local and foreign banks in Seoul had amassed huge short-term dollar debts. That was partly a result of foreign-exchange hedging in South Korea’s large shipbuilding industry and partly thanks to a “carry trade” in which investors swapped cheaply borrowed dollars for won on the expectation that the local currency would rise. After the collapse of Lehman Brothers, there was rapid deleveraging. As South Korea’s capital account plunged into the red at the end of 2008, the won tumbled (see chart). In 2008 it was the second-worst-performing currency in the OECD—after the Icelandic krona. ...

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  Sovereign-wealth funds: Cash in hand

  Posted: June 17th, 2010, 5:20am MDT

  State-backed investors are coming back into the spotlight

  WHEN markets are jumpy and cash is needed, sovereign-wealth funds have some very fetching characteristics. As well as having lots of money, they tend to make decisions quickly. During the financial crisis they pumped money, often ill-advisedly, into imploding banks. Now they have a fresh set of suitors. The Greek government has been wooing sovereign-wealth funds in the Gulf and Libya; this week it played host to a Chinese delegation. Agricultural Bank of China is thought to have lined up state-owned funds from Kuwait, Qatar and Singapore as cornerstone investors in its imminent listing. Sovereign funds may invest directly in the Asian insurance arm of AIG following Prudential’s failed bid.

  Where sovereign-wealth funds invest, however, political concerns often follow. Funds have made some changes to the way they operate since they ploughed money into the banks. In October 2008, 26 sovereign-wealth funds, with support from the IMF, agreed to a set of accounting standards and investment practices called the Santiago Principles. The most significant of the 24 guidelines is the principle that the funds should comply with all the disclosure rules of host countries. Over the past year many funds have started publishing annual reports and disclosing their asset allocation, a significant step for a secretive sector. ...

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  Retail banking in America: A new dominion

  Posted: June 17th, 2010, 5:20am MDT

  Cracking the American market has proved beyond many foreign banks. Is Canada’s TD different?

  AT MOST banks, tellers who have been particularly helpful to a customer are content with a pat on the back from their manager. Star workers in the American branches of TD (for Toronto-Dominion) can expect a lot more. The bank’s WOW! Department (yes, really), a jazzed-up version of internal communications, sends costume-clad teams from Alpha WOW! Omega, its “fraternity”, to “surprise and delight” high performers in front of colleagues and (presumably bemused) customers, dishing out tokens that can be redeemed for TD-branded goodies.

  Cringeworthy, perhaps. But TD, which touts itself as “America’s Most Convenient Bank”, takes service seriously. Its branches are open 50% longer than a typical rival’s, including Sundays. It provides water bowls for clients’ dogs, colouring books for their kids. Its ATMs offer stamps as well as cash. It eschews ropes for customer queues. “We don’t want them to feel like sheep,” says Mike Carbone, head of TD’s branches in Philadelphia, whose staff, like everyone at the bank, are trained at its “university” in New Jersey. TD calls 800 customers a night to gauge their experience. All of this seems to work. JD Power, a research firm, ranks it top for customer service among large banks in America’s mid-Atlantic region. ...

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  Economics focus: Rights and wrongs

  Posted: June 17th, 2010, 5:20am MDT

  Why price competition between investment banks is so feeble

  WITH governments seeking soft targets for tax revenues and regulators looking to curb their activities, investment banks have plenty to contend with. Now they face a new battle. The Office of Fair Trading (OFT), a British competition agency, said on June 10th that it would conduct an inquiry into equity underwriting, following complaints from issuing firms.

  What might the OFT be looking for? One concern is that the industry may have too few firms to ensure vigorous price competition. One bank may have so big a share of the market that it can charge high fees without worrying how its rivals will respond. But it is rare for trustbusters to find a single firm that dominates in this way with a market share below 40%. No investment bank comes close to that threshold. Rights issues by already-listed firms accounted for the bulk of equity-raising in Britain last year; the leading bank’s share of revenues was 20% (see chart). ...

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  Global rebalancing: The clock ticks

  Posted: June 17th, 2010, 5:20am MDT

  American pressure for China to revalue the yuan is reviving. Others are less fussed

  LIKE his leggier boss in the White House, Tim Geithner, America’s treasury secretary, is fond of basketball. In April he called a timeout in America’s long campaign for a stronger Chinese exchange rate, postponing a report that might have accused China of currency manipulation. His objective, he said, was to use his talks with China in May and the G20 gatherings in June to make “material progress” on rebalancing the world economy. The last of those meetings, the G20 summit in Toronto, will take place on June 26th and 27th.

  In basketball timeouts provide an opportunity to regroup and substitute players. In politics they give new problems a chance to come into play. The Greek sovereign-debt crisis deflected the world’s attention from China’s currency and sank the euro, which meant the yuan has strengthened overall even as it has remained fixed to the dollar. It also unnerved China’s policymakers, who began to fret again about financial instability and a slowdown in the euro area, their second-biggest export market. This was not the time, they concluded, to fiddle with the yuan. ...

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  Buttonwood: Something doesn't fit

  Posted: June 17th, 2010, 5:20am MDT

  Why are both Treasury bonds and gold performing so well?

  “ALICE laughed: ‘There’s no use trying,’ she said; ‘one can’t believe impossible things.’ ‘I daresay you haven’t had much practice,’ said the Queen. ‘When I was your age, I always did it for half an hour a day. Why, sometimes I’ve believed as many as six impossible things before breakfast.’”

  Occasionally investors can believe impossible things, as they did when dotcom stocks with no profits were valued at more than flourishing multinationals. But they can also believe in incompatible things, which is even more striking. ...

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  Buttonwood: When markets go wrong

  Posted: June 10th, 2010, 4:39am MDT

  The problem is not the shorts, but the longs

  IF YOU accept that markets are inefficient, that implies they are occasionally unfair. Just as dotcom stocks were driven to ridiculously high levels, currencies can get out of line with economic fundamentals. By implication government-bond yields can be forced to extreme levels, too, imposing an excessive funding cost on the countries concerned.

  Governments may also respond to market signals by pursuing inappropriate economic policies. Some would argue that this is happening in Europe now, as politicians take fright at the Greek crisis and pursue austerity policies which may result in a further economic slowdown (though that danger can be exaggerated). ...

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  Budget cuts in the euro area: Nip and tuck

  Posted: June 10th, 2010, 4:39am MDT

  Europe’s plans for fiscal austerity are not quite the threat to recovery they seem

  INVESTORS who may once have doubted that euro-zone countries could right their public finances seem now to fear that crisis has spurred too much austerity. A handful of countries, notably Greece but also Spain, Portugal and Ireland, have been forced to take drastic action by nervy bond markets. To avoid a similar fate, Italy pledged in May to cut its budget deficit by €24 billion ($30 billion) by 2012.

  Now even the most creditworthy are joining in. On June 8th Germany’s government announced a package of measures that will save it around €80 billion by 2014. Its chancellor, Angela Merkel, said Germany should set an example of budgetary discipline to other euro-zone countries. France has also said it will act to trim its deficit by abolishing tax exemptions and freezing most spending programmes from next year. This rush to don the hair-shirt raises a fresh concern: if budget cuts are too severe, might they push the economy back into recession, defeating their purpose? ...

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  The euro's safety net: Spivvy

  Posted: June 10th, 2010, 4:39am MDT

  The rescue fund has at last been set up but bond markets are still nervy

  IN THE early hours of May 10th, after a rocky few days in the bond markets and a tense weekend, European Union finance ministers agreed on a €500 billion ($600 billion) “stabilisation fund” for euro-zone countries that have trouble financing their debts. The EU itself, by pushing its existing credit lines to the limit, could raise only €60 billion of that total, and even that needed the backing of countries outside the euro, such as Britain. To fund the other €440 billion, euro-zone countries decided to create a new entity: a special-purpose vehicle (SPV) backed by the credit of its 16 members, plus Sweden and Poland, which said they would join in.

  Four weeks later, on June 7th, euro-zone finance ministers announced that the SPV had at last come into being, even if it is not yet open for business. It has only one shareholder so far—Luxembourg, where the fund is registered—but other countries will soon back it in proportion to their economy’s muscle. Once nine-tenths of the shareholders have approval from their parliaments to guarantee the SPV’s debts (a hurdle that Germany and France have already cleared), it will be ready to issue securities. In a ruse to attract a AAA rating for the SPV’s bonds, each member will have to provide a guarantee for 120% of its pro rata share in the scheme. That way even if small countries’ pledges look flaky, the rest should be able to compensate. ...

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  Hungary's wobbles: Careless talk

  Posted: June 10th, 2010, 4:39am MDT

  A government scares markets, then tries to repair the damage

  GLOOMY talk and stern warnings can help assure markets that a government is taking its fiscal duties seriously. But Hungary’s new government blundered badly on June 4th by casually comparing the country’s economic woes to Greece’s, and saying that it was “no exaggeration” to talk of a default on its debts. Hungary’s cost of borrowing shot up and the forint plunged. International markets shuddered at the prospect of another European crisis.

  Whether by accident or design, that helped concentrate minds. On June 8th the government presented a 29-point economic programme that included a promise of deep tax reform—such as a big business-tax cut and a 16% flat tax on incomes to be brought in next year. It promised to try to meet the deficit target agreed upon with the IMF, of 3.8% of GDP (it is now more than 7%). It says it plans to cut public spending by 0.6-0.8% of GDP and to impose a hefty temporary levy on banks. Foreign-currency mortgages (taken out by two households in every three) are to be banned. ...

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  Accounting standards: To FASB or not to FASB?

  Posted: June 10th, 2010, 4:39am MDT

  A transatlantic divide over the treatment of financial instruments

  HEARD the joke about a businessman who asks his accountant what two plus two is? The accountant draws the blinds, leans over the desk and whispers: “What would you like it to be?” The crafting of accounting rules is more art than science, thanks to the need to balance the interests of companies, their investors and—especially in banking—their regulators. No great surprise, then, that the world’s two big standard-setting bodies—America’s Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), which covers most other countries—are on very different tracks in their treatment of financial instruments.

  Investors are still digesting the 214 pages of proposals released by FASB on May 26th. But if adopted, these would shake up banking by greatly expanding the impact of fair-value (or mark-to-market) accounting, in which assets are valued at market prices rather than on an historic-cost basis that reflects the price banks paid for them. ...

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  Agricultural Bank of China: Listing or capsizing?

  Posted: June 10th, 2010, 4:39am MDT

  A huge public offering tests global sentiment about China

  THE long-planned public offering of Agricultural Bank of China (ABC) is being launched in a market storm. For devout believers in China, ABC’s 320m customers, in a sector largely shielded from competition, are reason enough to go ahead regardless of turbulent conditions. Others think that it is madness for a company with a sketchy record and no desperate need for capital to come forward now, and they whisper that the deal cannot possibly get done.

  The bank’s listing process will be a prolonged test of sentiment on China. On June 9th the bank was approved for listing in Shanghai. It was due to be approved by the Hong Kong stock exchange the next day. On June 14th underwriters will begin pitching to clients. A number of sovereign-wealth funds are said to be lined up as investors, along with as many state-affiliated Chinese institutions as may be necessary. Pricing will be on July 6th—long enough for enthusiasm, or panic, to take hold. ...

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  Banking on mobile phones: Out of thin air

  Posted: June 10th, 2010, 4:39am MDT

  The behind-the-scenes logistics of Kenya’s mobile-money miracle

  IT IS like magic. By clicking a few keys on a mobile phone, money can be zapped from one part of Kenya to another in seconds. For urban migrants sending money home to their villages, and for people used to queuing at banks for hours to pay bills or school fees, the M-PESA money-transfer service, operated by Safaricom, Kenya’s largest mobile operator, is a godsend. No wonder it is used by 9.5m people, or 23% of the population, and transfers the equivalent of 11% of Kenya’s GDP each year; or that it has inspired more than 60 similar schemes across the world.

  But despite the apparently frictionless transfer of money through the air, making a money-transfer system work smoothly requires a great deal of backstage effort. Jake Kendall and Ignacio Mas of the Bill & Melinda Gates Foundation, and Frederik Eijkman of PEP Intermedius, a financial-services firm, explain how it all works in a paper presented in late May. ...

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  Economics focus: Socialist workers

  Posted: June 10th, 2010, 4:39am MDT

  Is China’s labour market at a turning-point?

  ON JUNE 7th strikers at a rubber factory near Shanghai clashed with Chinese police. “The smell from the rubber is unbearable,” a migrant worker told the South China Morning Post, “but we don’t even get a toxic fumes subsidy.” On the same day Honda suffered a strike in a factory that makes its mufflers and exhaust parts, less than a week after it settled an earlier dispute by offering a 24% pay rise. On June 6th the owner of Foxconn, an electronics-maker, said that workers at its Shenzhen complex could earn 2,000 yuan ($293) a month from October if their work was up to scratch, about double the basic pay it previously offered, following a string of widely publicised suicides.

  China is known for its plentiful, pliable workers. But these incidents have cast doubt on that caricature. In March Arthur Kroeber of GaveKal Dragonomics, a consultancy, declared the “end of surplus labour” in China. Three years earlier, Cai Fang of the Chinese Academy of Social Sciences argued that China, a country of 1.3 billion people, would soon run short of workers. ...

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  European banks: Waiting for the big one

  Posted: June 3rd, 2010, 5:10am MDT

  Where do Europe’s money-market jitters sit on the financial Richter scale?

  IF YOU live in San Francisco you get used to the tremors. In banking, however, every shake and jerk still feels like it might herald another devastating earthquake. Investors are nervous and regulators are too. Monitoring risk in the financial system was once a job for officials thought to be too dull for monetary policy. Now financial seismology is where it’s all at.

  When all three of the most-watched gauges of stability in banking deteriorate, as they did in Europe in the last week of May, there is naturally a rush to sound the alarm. Nerves had already been frayed by the Bank of Spain’s seizure of CajaSur, a savings bank, on May 22nd (despite the central bank’s efforts to telegraph this for months). Ratings downgrades of assets guaranteed by Spain’s central bank didn’t help either. ...

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  Insurance: Too far, too fast

  Posted: June 3rd, 2010, 5:10am MDT

  Prudential’s plans for Asian domination hit a brick wall

  WHEN it was unveiled in March, the agreement by Britain’s Prudential to buy AIG’s Asian life-insurance unit, AIA, for $35.5 billion was widely hailed as the deal that would help transform the stodgy insurance industry, radically reshaping both buyer and seller. Prudential would become the dominant insurer in the world’s most exciting markets; AIG would get cash to repay a big slug of the bail-out it was forced to accept in 2008.

  With the transaction’s collapse on June 2nd, it is Prudential’s top brass, rather than the industry, that can expect a shake-up. Faced with little hope of getting the 75% approval needed in a shareholder vote on June 7th, Prudential’s chief executive of just eight months, Tidjane Thiam, had tried to negotiate a 14% price cut. But AIG was having none of it. ...

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  Buttonwood: Time for a rent cut

  Posted: June 3rd, 2010, 5:10am MDT

  Controlling the finance sector’s excess returns

  WHY do people who work in finance earn more than most other people? It is a question that concerns politicians, as they debate reform of the industry. It ought also to worry those millions who, as savers and borrowers, are consumers of the industry’s products.

  Something has clearly changed within the past 40 years. Banking and asset management used to be perceived as fairly dull jobs, which did not attract a significant wage premium. But after 1980, financial wages started to climb much more quickly than those of engineers, another profession that ought to have benefited from technological complexity. ...

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  Private equity: Money can't buy love

  Posted: June 3rd, 2010, 5:10am MDT

  Private-equity firms battle to keep their tax perks

  “PRETTY much everybody hates us,” admits one private-equity executive. The industry once wore its unpopularity as a badge of honour. Now it is a liability as Congress considers removing some of the tax perks that helped inflate the private-equity bubble. “There’s no senator or congressman who represents the interest of private equity,” says the executive. Not even the charms of the industry’s big hitters seemed to have worked. Stephen Schwarzman (pictured), the boss of Blackstone, one of the largest buy-out firms, travelled to Washington, DC, to lobby against the proposals. To no avail, it seems. The House of Representatives has already passed them and the Senate is due to consider them this month.

  The legislation in question is the “American Jobs and Closing Tax Loopholes Act of 2010”. This would change the tax treatment of “carried interest”, or the profits that private-equity firms and other investment partnerships make when the funds they run perform well. Currently, carried interest is taxed at the lower rate of capital gains (15%), as opposed to income (35%). The bill suggests changing this and taxing 75% of carried interest as income and 25% as capital gains, starting in 2013. That might sound fiddly, but the sums involved are big. The tax change would help raise around $18 billion over ten years and affect mostly buy-out shops, venture-capital firms, real-estate partnerships and some hedge funds. ...

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  Asian currencies: Chips off the block

  Posted: June 3rd, 2010, 5:10am MDT

  Currencies around Asia are more flexible than you think

  AMID all the diplomatic ding-dong over China’s yuan, it is easy to lose sight of emerging Asia’s other currencies. There is not much din over the dong, for example. While China has kept the yuan pegged to the dollar since July 2008, ignoring complaints that it is artificially cheap, Vietnam’s currency, the dong, has depreciated by 13% against the greenback over the same period, unremarked and unprotested. South Korea and Taiwan, the only countries besides China ever to be labelled currency manipulators by America’s Treasury, have seen their currencies cheapen by 17% and 6% respectively.

  China’s critics justify their preoccupation by invoking a “yuan block”. China’s neighbours and rivals are reluctant to allow their currencies to rise too far against the yuan, for fear of losing China as a customer, or losing out to it as a competitor. Thus although China accounts for only 19% of America’s imports, its peg, it is argued, frustrates a broader realignment of currencies in the region. ...

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  Monetary policy in Japan: Deep hibernation

  Posted: June 3rd, 2010, 5:10am MDT

  Another attempt to boost the economy

  CENTRAL bankers in Western countries are getting used to the idea that part of their job is to try to raise animal spirits after a slump. In Japan, after two decades of stagnation—nominal GDP is at the same level as 1992—Japanese politicians are leaning on the Bank of Japan (BOJ) to stir the beasts in ever more inventive ways. Already, interest rates have hovered around zero for a decade, and quantitative easing has flooded the system with funds, to little avail.

  This month the BOJ will unveil a radical measure for “strengthening the foundations for economic growth” that borders on fiscal policy. It plans to lend to private banks at the policy rate of 0.1% for one year (which is extendable), provided that the funds are used for loans or investments in certain growth sectors. The rate is considerably lower than the 12-month interbank rate. Although the loan size and industries have yet to be specified, the areas are meant to dovetail with the government’s growth strategy which will be announced later this month, and is expected to include energy, the environment, space and robotics. ...

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  Economics focus: A winding path to inflation

  Posted: June 3rd, 2010, 5:10am MDT

  Even if governments could create inflation, they may not want to

  IN THE short run inflation is an economic phenomenon. In the long run it is a political one. This week The Economist asked a group of leading economists whether they reckoned inflation or deflation was the greater threat; this was our inaugural question in “Economics by invitation”, an online forum of more than 50 eminent economists. The rough consensus was that in the near term, as Western economies struggle to recover, the bigger worry there is deflation. But as the time horizon lengthened, more experts cited inflation, because it seems the most plausible exit strategy for governments trying to deal with crushing debts. “Deflation is not a lasting threat,” wrote Arminio Fraga, a former president of Brazil’s central bank. “The more interesting question is whether they can manage to keep inflation down over time under the regime of fiscal irresponsibility now prevailing almost everywhere.”

  Creating more inflation is harder than it sounds—even if rich-world governments were tempted to try, as a solution to their fiscal problems. It requires aggregate demand to return to, and exceed, potential output. Measuring the output gap (the shortfall of actual demand compared with potential GDP) is notoriously tricky. The OECD reckons for its members it will be about 4% this year, down from about 5% last year. It has revised that estimate down since November in recognition of better-than-expected growth, especially in America. Still, the revised gap is larger than at any time since at least 1970. America’s gap was larger in 1982, but inflation today is much lower. Indeed, the OECD estimates that in each of the G7 countries, inflation will be less than 2% through to the end of next year. The process could be hurried up if inflation expectations rise. But with underlying inflation below central banks’ targets in many countries, and dropping, expectations could move down instead. ...

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  Buttonwood: Who's the patsy?

  Posted: May 27th, 2010, 5:06am MDT

  Even sophisticated investors have just been chasing returns

  SMALL investors are often portrayed as the “dumb money” in markets, doomed to buy just before a crash and fatally drawn into buying fashionable sectors like technology funds in the late 1990s. But are wealthy and institutional investors really any better?

  A new study* by researchers at the European School of Management and Technology examines how investors allocated money to hedge funds from 1994 to 2004. This process ought to be highly sophisticated. After all, hedge-fund investors tend to fall into three categories: rich individuals, who usually take advice from private banks; institutions, such as pension funds and endowments, which often employ investment consultants; and funds of funds, which market themselves on their expertise. ...

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  Basel 3: The banks battle back

  Posted: May 27th, 2010, 5:06am MDT

  A behind-the-scenes brawl over new capital and liquidity rules

  THE world is now knee-deep in proposals to reform finance. From industry lobbies to global regulators, everyone is brimming with ideas. On May 26th the European Commission became the latest to propose a new bank levy, joining the IMF and governments in Europe and America. On the same day America’s Financial Accounting Standards Board unveiled proposals requiring banks to report the fair value of loans on their books.

  As the proposals pile up, so does the estimated cost to the banks. In America analysts at Barclays Capital calculate that the hit from domestic legislation alone could amount to 16% of banks’ profits in 2013. Analysts at Credit Suisse reckon European banks’ profits in 2012 could fall by 37% because of proposed regulation. ...

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  America's reform bill: Give us a huddle

  Posted: May 27th, 2010, 5:06am MDT

  America’s reform debate moves from the chamber to the conference room, where some big issues still need resolving

  BANKERS usually look forward to conferences as an opportunity to get out of the office, network with colleagues and whoop it up in the hotel bar. But this time they are full of trepidation, not margaritas. Now that America’s Senate has passed a set of financial reforms, after three weeks of testy debate, its bill must be reconciled with a version passed earlier by the House of Representatives. This will be done in a horse-trading exercise known as “conference”. Though the broad outlines of the final product are already clear, its precise shape is yet to be determined.

  The job of ironing out the differences between the bills will fall to a group of 15 Democrats and ten Republicans, with roughly half coming from each chamber. They will be steered by Barney Frank, head of the House Financial Services Committee and a fierce critic of Wall Street, and Chris Dodd, his counterpart in the Senate. The Treasury will also, in practice, have a say. The participants’ staffers are already at work, hoping to resolve many issues quietly over the next fortnight. Those that prove sticky will be tackled by the formal conference, which will begin in mid-June. Once its work is done, both chambers must vote again on the package. Mr Frank wants to have the final version ready for the presidential signature by July 4th. ...

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  Spain's cajas: Unholy mess

  Posted: May 27th, 2010, 5:06am MDT

  Spain’s troubled savings banks edge towards their day of reckoning

  IN THE end CajaSur trusted in God. On May 22nd the small savings bank (or caja), which is controlled by the Roman Catholic church in Cordoba, was seized by the Bank of Spain after failing to agree on a merger with Unicaja, a larger Andalusian rival. The move shocked investors and prompted other savings banks to hasten consolidation. But mergers between wobblier cajas, which are unlisted and make up close to half of Spain’s financial system by assets, are merely a first step in a longer process.

  CajaSur is tiny, holding just 0.6% of Spain’s financial assets. Yet its seizure unsettled investors for two reasons. First, it was a reminder that politics often trumps rationality. CajaSur’s refusal to do a deal is a mystery. The bank blamed Unicaja’s failure to provide assurances on wages and jobs, but this seems absurd. It could now be liquidated, broken up or sold. ...

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  Shorting China: Sino cure

  Posted: May 27th, 2010, 5:06am MDT

  Betting against China is not easy but plenty are trying

  BEING bearish on China may not turn out to be wise, but it does require some ingenuity. Shorting domestic stocks is illegal. Futures and options markets for equities either do not exist locally or barely trade. It is possible to buy credit-default swaps (CDSs), a form of insurance against default, on China’s sovereign debt, but few think that would really go belly-up anyway. A pair of widely circulated reports on how to hedge a downturn, written in April by Goldman Sachs (stamped “highly confidential”) and Morgan Stanley respectively, spell out some of the alternatives for investors. In each, the underlying idea is similar: if shorting China is impossible, find things tied to China.

  In Morgan Stanley’s view, that means starting with various financial assets—shares, credit instruments, and currencies—in South Korea and Australia (see chart), the two countries with the strongest connections to China after adjusting for re-exports. Both places offer numerous financial products, such as exchange-traded funds linked to indices, that can be shorted. The report also cites three commodities that are particularly tied to China’s growth: copper, above all; then soyabeans; and oil. ...

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  China's property market: Home truths

  Posted: May 27th, 2010, 5:06am MDT

  China’s economic boom can survive a property bust

  A DISCARDED toilet bowl lies on a pile of rubble in Tongzhou, a Beijing suburb which is busily remodelling itself as a “modern” and “international” city. On one side of the railway, a string of single-storey dwellings, built of brick and tile, have yet to be demolished. Their occupants make the most of the surrounding debris, loading bent window frames onto the back of bicycles to be sold as scrap. On the other side of the tracks tower new blocks of flats, more than 20 storeys high, waiting for their first residents.

  Tongzhou’s new flats are one example of the property boom in China, where 1.87 billion square metres of living space were under construction in the first quarter of this year, 36% more than a year earlier. The boom has resonated widely. Banks have expanded their mortgage-books briskly; local governments are filling their coffers by selling land to developers or to the “urban investment vehicles” they sponsor. Property and construction represent about 10% of China’s GDP, not counting the consumer goods that homebuying inspires, such as the quilts and curtain rails on sale in Tongzhou’s market. ...

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  Economics focus: You've been framed

  Posted: May 27th, 2010, 5:06am MDT

  Consumers are suckers for “special” deals that are costlier than they first appear

  THE lyrics of “Step Right Up”, a 1976 recording by Tom Waits, a gravel-voiced American singer, are a lexicon for hawkers and street traders. In the course of the song’s six minutes, the singer-pedlar makes ever-bolder claims for his wares. A wise consumer might not shell out for the wonder-product that “mows your lawn” and “picks up the kids from school” as easily as it “entertains visiting relatives” and “gets rid of your gambling debts”. But he might still be tempted by a “year-end clearance” that promised “50% off original retail price”.

  A new study* for the Office of Fair Trading, Britain’s main competition-policy watchdog, seems to confirm that the way prices are presented, or “framed”, can tempt consumers into error. Its authors, Steffen Huck and Brian Wallace of University College London (UCL), and Charlotte Duke of London Economics, a consultancy, base that finding on a controlled experiment. They tested responses to five different price frames: “drip pricing”, where only part of the price is revealed at first and extra charges are levied as the sale progresses (think of buying an airline ticket online); “sales”, where the price is contrasted with a higher price (was $2, now $1); “complex pricing”, such as three-for-two offers, where the unit price has to be worked out; “baiting”, where a cheap deal is advertised but restricted to a few lucky shoppers; and “time-limited offers” that are available for a short period. ...

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  Chinese economic data: Reading China's palm

  Posted: May 20th, 2010, 7:25am MDT

  A new leading indicator for China’s economy

  IN THE back lanes of old Beijing, a fortune-teller inspects his customer’s palm under a magnifying glass, consults his I Ching tables, then scribbles the formulae of fate with a blunt pencil. His customers include many businessmen, he says, anxious to know more about their economic prospects.

  China’s fortune-tellers now have fresh competition. On May 17th, after four years of research, the Conference Board, a research group, unveiled a new monthly index of leading indicators, which aims to foretell China’s immediate economic future. After sifting through the country’s notoriously patchy statistics, the Board compiled its index from six: the expectations of consumers; lending by banks; the supply of raw materials to industry, as measured by a central-bank survey of firms; the amount of floorspace developers have started to build; and the export orders received and supplies delivered to manufacturers, as measured by a survey of purchasing managers. ...

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  Central banks under scrutiny: Prometheus bound

  Posted: May 20th, 2010, 7:25am MDT

  Financial reform will make the Fed more powerful and less independent

  THE decision of the European Central Bank to start buying government bonds follows a path trodden by the Federal Reserve in 2008 and 2009. Both entered politically charged territory to save the financial system at great risk to their reputations. For the Fed, one consequence is that the big financial-reform bill making its way through the Senate—a vote was expected after The Economist went to press—will leave it more powerful but more beholden to Washington, DC.

  The Fed has fought for, and kept, its supervision of banks. It acquires important new powers to regulate big non-bank financial companies and even to break up firms deemed a threat to the financial system. Its only significant loss of turf is direct oversight of consumer protection. The Fed keeps its emergency-lending powers, though it needs the Treasury’s approval to use them (it has usually sought such approval anyway). It cannot lend to failing firms because that job now sits with the Federal Deposit Insurance Corporation under the bill’s new resolution authority. ...

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  Economics focus: Satchel, uniform, bonus

  Posted: May 20th, 2010, 7:25am MDT

  Pay-for-performance for school students is no silver bullet

  POLITICIANS around the world love to promise better education systems. Proposals for reform come in many flavours. Some tout the benefits of more competition among schools; others aim to train more teachers and reduce class sizes. Still others plump for elaborate after-school programmes or for linking teachers’ pay to how well pupils do.

  A relatively recent addition to this menu is the idea of paying students directly for performance. Boosters argue that pupils may fail to invest enough time and effort into education because the gains—better jobs and higher incomes—are nebulous and distant. Cash payments, on the other hand, reward good performance immediately. Link payments to test results or graduation rates, the argument goes, and test scores should increase and drop-out rates decline. Two new papers* describe the effect of such schemes in Israel and America. Their results will disappoint those who hope for a silver bullet. But they also suggest that cash payments may have their uses in some situations. ...

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  Hedge funds: Man to Goliath

  Posted: May 20th, 2010, 7:25am MDT

  Man Group acquires GLG

  FOR Man Group, which started doing business in London in 1783 as a sugar broker, life just got a bit sweeter. On May 17th the world’s largest publicly traded hedge fund said it would buy another big hedge fund, GLG Partners, for $1.6 billion. Combined, they will oversee $63 billion in assets, making Man one of the largest hedge funds in the world.

  The deal brings two big-name hedge funds under one roof and restores Man’s assets under management to pre-crisis levels. It also at long last provides Man with a more diverse investment offering. Man’s flagship fund, AHL, is a “black box” fund that uses computer algorithms to make investment decisions. Having performed successfully for years, AHL suffered a disappointing end to 2009. In contrast GLG has over 40 funds and a more varied bag of tricks, including long-only, macro and emerging-market funds. ...

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  Central banks under scrutiny: After the fall

  Posted: May 20th, 2010, 7:25am MDT

  The ECB’s dented reputation is in part a result of hubris about the euro

  IT IS meant to be an example of European unity, but in response to the euro zone’s fiscal crisis the European Central Bank (ECB) is having a fight on several national fronts. Even as the bank’s dealers were pushing cash into the bond markets of selected euro-zone countries, its president, Jean-Claude Trichet, was trying to reassure Germans that the ECB had not lost its inflation-fighting zeal or its independence. He told Der Spiegel that it was “ridiculous” to believe that the decision to buy bonds, in the early hours of May 10th, was in response to political pressures. In a separate interview, he insisted that the bank’s monetary policy was unchanged and that its actions would not spur inflation.

  To back up that claim, the central bank conducted a special auction of one-week deposits on May 18th to “sterilise”, or soak up, the €16.5 billion ($20.4 billion) of cash it had created by buying bonds. Banks offered almost ten times what was required, which meant the ECB had to pay an interest rate of just 0.28%. The exercise was largely cosmetic given how much liquidity the ECB supplies to banks. But appearances count. “It’s as if the ECB has sinned and has to do penance,” says Julian Callow at Barclays Capital. ...

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  Prudential and AIA: Judgment day

  Posted: May 20th, 2010, 7:25am MDT

  A giant insurance deal goes to the wire

  BY THE standards of the wider stockmarket it is odd that Prudential’s $35 billion bid for AIA, the Asian arm of American International Group (AIG), has become quite so controversial. Shareholders are due to vote on the deal on June 7th and it is expected to be a knife-edge affair. If at least 75% of them approve, the Pru will conduct a $21 billion rights issue that month, with the deal closing later this year.

  True, that is a lot of new shares to swallow. But far from being the next Royal Bank of Scotland-ABN AMRO, or even Time Warner-AOL, the deal looks reasonable in many respects. It is less about striking out in a new geography or product area, and more about uniting competitors in Hong Kong and Singapore, which comprise about half of the activities in Asia of both AIA and Prudential. “In-market” deals have a fair record, especially if, like Pru-AIA, they create businesses with big market shares. ...

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  Private equity: Crazy little thing called leverage

  Posted: May 20th, 2010, 7:25am MDT

  Back in business but not back to normal

  THE credit crunch took such a toll on private-equity firms that some commentators were “writing our industry’s obituary”, said Henry Kravis, the boss of Kohlberg, Kravis & Roberts (KKR), a big buy-out firm, last year. Financing was hard to scare up, and deals were smaller and rarer. Things look healthier now.

  On May 7th HCA, a health-care operator owned by Bain Capital and KKR, filed for an initial public offering (IPO) with plans to sell $4 billion of shares. If it happens, it will be the largest IPO of a private-equity-backed company in history, according to Dealogic, a research group. Other private-equity-backed companies are posting strong numbers. Alliance Boots, a British pharmaceutical company backed by KKR, this week announced an annual profit of over GBP1 billion ($1.4 billion). ...

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  The Alternative Investment Fund Managers Directive: The wrong targets

  Posted: May 20th, 2010, 7:25am MDT

  A pointless tussle over regulating hedge funds and private equity

  A WEEK after the virtual closure of Europe’s government-bond markets and a dramatic bail-out for countries on the periphery of the euro, you might have thought the European Parliament’s Economic and Monetary Affairs Committee would have urgent things to discuss. It could have debated ways of restoring investors’ trust in the region’s bond markets, perhaps, or tried to understand why European money markets are freezing up. The same might be said of a committee of European finance ministers, which also met this week.

  Curiously, both committees thought their time would be well spent agreeing on tough new rules for an industry that has had remarkably little to do with the financial crisis. On May 17th and 18th the two committees agreed to proposals that are intended to govern “alternative investment funds”, a long-winded name for hedge funds and private-equity funds, two sectors that in the eyes of many exemplify the ugly face of free-market capitalism. Confusingly the drafts contradict each other in some important respects; both differ, too, from a draft law proposed by the European Commission, Europe’s executive branch. ...