Economists' evolving understanding of the zero-rate liquidity trap

MY COLUMN this week sets out three possible scenarios for the American economy in 2016, in the aftermath of the Fed's first rate hike in more than nine years. Each scenario corresponds to an understanding of why it is that near-zero interest rates are so difficult to leave behind; economies eventually managed the trick in the decades after the Depression, but those that have sunk to the zero lower bound in recent years have been unable to escape it for long. 

What strikes me as interesting, and what motivated the column, is that our understanding of the pull of near-zero rates has evolved since late 2008, and continues to evolve, in a very ominous direction.

Back in late 2008 and early 2009, when rates around the rich world fell below 1%, the framework most economists reached...Continue reading

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More hat than cattle

Opening up, ASEAN-style

GRANDIOSE statements from the Association of South-East Asian Nations (ASEAN) are the region’s Christmas crackers: they appear at regular intervals, create a commotion but contain little of substance. In November the leaders of the club’s ten members declared that the ASEAN Economic Community (AEC)—a single market around which goods, services, capital and “skilled labour” are supposed to flow freely—would come into being on December 31st. So will South-East Asia’s 622m people wake up in a new world in 2016, or will the AEC prove another paper crown?

The answer probably lies somewhere in the middle. For one thing, much of the work towards economic integration has been done: by ASEAN’s reckoning, 79.5% of the measures the AEC involves have already been implemented. ASEAN already attracts large amounts of foreign investment, and its leaders have been talking up integration and regionalism since the organisation was founded in 1967. So the AEC represents less a radical change than an attempt to accelerate existing trends.

But anyone hoping that ASEAN is about to turn into an Asian...Continue reading

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One rule to bind them all

LIKE banks, insurers need a cushion of capital to ensure that they can meet customers’ claims in the event of unexpectedly big payouts or poor investment performance. As at banks, these cushions have at times proved woefully thin. In theory, all that changes on January 1st—in the European Union, at least—when a new set of regulations known as Solvency 2 comes into force. After more than ten years of negotiation, all European insurers will have to follow uniform rules on capital that are designed to make the firms more robust and allow investors and customers to assess their strength much more easily.

Not everyone is thrilled at this prospect. Mention “upcoming regulatory changes” to an insurance executive and a tirade inevitably follows about ambiguities and inconsistencies within the new rules, discrepancies in enforcement and the mountains of paperwork involved. Some firms have had to bolster capital in anticipation: Delta Lloyd, a Dutch insurer, announced in November that it would raise €1 billion ($1.1 billion). The rules favour diversified firms, so those that offer just one form of insurance are under pressure to merge. That impetus...Continue reading

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Tales of the unexpected

INVESTORS often start the calendar year in a buoyant mood, only to be caught out by unexpected events. It is almost inevitable that the consensus will be proved wrong in some respects, not least because the views of most investors will already be reflected in market prices.

So this column would like to suggest five potential surprises for 2016. The definition of a surprise is something that the consensus (as judged by betting sites or polls of fund managers) does not expect.

The first surprise may be that the dollar weakens, not strengthens. The consensus view is that the Federal Reserve, having pushed up rates before Christmas, will tighten monetary policy two or three more times in 2016. Higher rates will make investors eager to buy the dollar, especially as both the European Central Bank and the Bank of Japan will keep their rates near zero. However, the dollar has already had a very good run, so higher rates may already be priced into the currency. As it is, investors seem to doubt that the Fed will tighten as much as the central bank currently projects. The actual outcome may be feebler still (see article).

The second surprise may be too familiar to deserve the name. Commentators have been calling an end to the...Continue reading

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Fin-tech

FEW industries involve as much drama and risk as whaling did. The last voyage of the Essex, which inspired Herman Melville’s classic, “Moby Dick”, and is the subject of a new film, “In the Heart of The Sea”, gives a sense of the horrors involved. The ship left Nantucket in 1819 and sailed for over a year before being destroyed by a whale it was hunting. The 20 crew members survived the sinking, but found themselves adrift in the Pacific in three longboats, with little food and no water. Three opted to stay on a desert island, from which they were rescued three months later, on the verge of starvation. The others sailed on, hoping to reach South America but dying one by one. At first the survivors buried the dead at sea; then they resorted to eating the corpses of their crewmates. When they ran out of bodies, they drew lots to decide whom to shoot and eat. Only five of the 17 were eventually rescued. By then, they were so delirious that they did not understand what was happening.

The only reason that anyone could be induced to take part in such a dangerous business was the fabulous profit that could be made. Gideon Allen...Continue reading

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Low for longer

EVER since the financial crisis of 2008, forecasters have scanned the horizon for the next big disruption. There are plenty of candidates for 2016. China’s economy, whose might acted as a counterweight to the slump in the rich world in the years after the crisis, is now itself a worry. Other emerging markets, notably Brazil, remain in a deep funk. The sell-off in the high-yield-debt market in December has prompted fears of a broader re-pricing of corporate credit this year.

Yet one worry is absent: financial markets are priced for continued low inflation or “lowflation”. A synthetic measure, derived from bond prices, puts expected consumer-price inflation in America in five years’ time at around 1.8%. That translates into an inflation rate of around 1.3% on the price index for personal-consumption expenditure (PCE), the measure on which the Federal Reserve bases its 2% inflation target. Ten-year bond yields are just 2.3% in America, and are below 2% in Britain and below 1% in much of the rest of Europe. The price of an ounce of gold, a common hedge against inflation, has fallen to $1,070, far below its peak in 2011 of $1,900. Yet market...Continue reading

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Exit, pursued by bear

IT IS more than two weeks since the Federal Reserve raised interest rates for the first time in over nine years, and the world has not (yet) ended. But it is too soon to celebrate. Several central banks have tried to lift rates in recent years after long spells near zero, only to be forced to reverse course and cut them again (see chart). The outcome of America’s rate rise, whatever it may be, will help economists understand why zero exerts such a powerful gravitational pull.

Recessions strike when too many people wish to save and too few to spend. Central banks try to escape the doldrums by slashing interest rates, encouraging people to loosen their grip on their money. It is hard to lower rates much below zero, however, since people and businesses would begin to swap bank deposits for cash or other assets. So during a really nasty shock, economists agree, rates cannot go low enough to revive demand.

There is significant disagreement, however, on why economies become stuck in this quagmire for long periods. There are three main explanations. The Fed maintains that the problem stems from central-bank paralysis, either...Continue reading

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The scandals of 2016

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Money in the movies

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Bank run

IN PLACES that celebrate Christmas, retailers face the usual year-end scramble to keep their shelves piled high. They will not be the only ones facing a seasonal run on their inventory: banks need to stock up for Christmas, too. 

Just like eggnog, fruitcake and reindeer sweaters, demand for cash peaks in December, as consumers withdraw money to pay for Christmas gifts, tips and holiday travel (see chart). In the weeks leading up to the holiday, banks stash extra cash in their vaults to meet the additional demand. In the weeks that follow, as the beneficiaries of the Christmas rush deposit their takings, the excess cash is sent back to central banks and removed from circulation.

In rich countries, where card payments have become common, cash in circulation tends to jump by less than 5% in December; in America it hardly rises at all. But in emerging economies such as Brazil and Russia, where cards are rarer, it increases by over 10%. The world’s most cash-crazed consumers are in China. Chinese New Year, which typically falls between mid-January and mid-February, boosts demand for cash by over 20%.

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Wookienomics

THE latest chapter in the “Star Wars” saga, “The Force Awakens”, was due to open in cinemas worldwide on December 16th, after The Economist went to press. Most fans will queue up to watch nail-biting lightsaber duels and catch up on the lives of beloved characters. Economists, who can render the most exciting of material dull, will be more interested in the state of the galactic economy. Did the destruction of the Death Star at the end of the sixth film in the series trigger a massive financial crisis, as a recent paper* by Zachary Feinstein, a professor of financial engineering at Washington University in St Louis, speculates? What sort of structural reforms might the new galactic government adopt?

While awaiting answers to these and other important questions, The Economist undertook an exhaustive, popcorn-fuelled examination of the first six episodes of the saga, in search of broad economic lessons. The “Star Wars” galaxy is both technologically advanced and economically stagnant, plagued by inequality and ossified political institutions. It is not entirely alien, in other words. Though far, far...Continue reading

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Canary or canard?

THE three investment funds from which BNP suspended redemptions in August 2007 held less than 0.5% of the money the French bank managed at the time. Yet these humble entities turned out to be the proverbial canaries in the coal mine: their spasm was one of the first signs of the impending credit crunch. The question of the moment is whether several similarly obscure funds that recently announced forced liquidations are canaries too. Do their woes reveal financial fault-lines, or did they just take exceptional risks?

The funds in question all invested in low-rated corporate debt. Investors have soured on such “high-yield” or “junk” bonds this year, causing prices to fall sharply and yields to surge (see chart). The best-known of the victims, a mutual fund managed by a firm called Third Avenue, specialised in distressed debt, on which average yields have risen from 8% in 2014 to an astronomical 18% now. The fund had lost 27% of its value this year and had seen big withdrawals, which together had caused its assets to shrink from $3 billion to $790m before Third Avenue suspended redemptions on December 10th. The firm said that the febrile state of the...Continue reading

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Naughty, not nice

CHRISTMAS tends to be the season of goodwill and investor optimism. A poll of fund managers by Bank of America Merrill Lynch (BAML) in December 2014 found that most expected stronger economic growth and low inflation in 2015. Investors were enthusiastic about equities (particularly in Europe) but negative on government bonds.

The consensus is often wrong and this was no exception. Not every bet soured, but most predictions went in the wrong direction. Global economic growth has disappointed once again, although largely thanks to a poor performance by emerging, rather than developed, economies. Forecasts have been steadily revised lower. The OECD’s latest estimate for global growth in 2015 is 2.9%, well below the average rate over the past 30 years, of 3.6%.

When it came to predicting the best-performing asset class of 2015, investors had little doubt. Two-thirds of managers picked equities and just 4% government bonds. Alas, in dollar terms, equity investors have lost money (see chart). As of December 15th the total return from shares in the developed world (in dollar terms) was -1.4%. Government-bond markets have also...Continue reading

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Still on the edge

Self-deluding governments

IN THE late 1980s, Mikhail Gorbachev tried valiantly to revamp the Soviet economy. He had come to realise that his state had fallen far behind the West. But as Robert Service shows in his book "The End of the Cold War: 1985-1991", even Gorbachev struggled to understand quite how badly the economy was doing. Service has had access to records of Politburo meetings. From those it is clear that official figures on defence spending as a proportion of GDP were massively understated. Statistics were generally unreliable. At one point, arms negotiators trying to do a deal with Ronald Reagan were embarrassed to find they did not have an exact figure for the number of nuclear missiles they controlled.

This problem is endemic to command-and-control economies. Governments set targets from the top; bureaucrats and party functionaries know that their jobs (and sometimes their lives) depend on meeting them so the figures are massaged to meet the target. And often the wrong targets are set. By the late 1980s, most western economies had switched away from a manufacturing-led economy to a services-based one; the Soviet Union was still obsessed with...Continue reading

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The Fed awakens

REBOOTING the age-old "Monetary Wars" saga, the Federal Reserve is expected to raise interest rates for the first time since June 2006. What will the impact be for America and beyond?

Europe’s carbon-trading system is better than thought, and could be better still

Failure to address global warming will cost many lives

In December talks in Paris involving more than 200 countries may result in a new agreement aimed at reducing carbon emissions. In the months leading up to the conference, The Economist will be publishing guest columns by experts on the economic issues involved. Here, Damian Tago, of CIRAD Guadeloupe, and Alban Thomas, of the Toulouse School of Economics argue that the human cost of unaddressed climate change means that far more action to halt warming could be cost effective.

CLIMATE change kills. In 2005 the World Health Organisation estimated that climate change caused by human activity claims more than 150,000 lives annually. More recently, the Climate Vulnerability Monitor placed the death toll at around 400,000. Using the Value of Statistical Life proposed by the US Environmental Protection Agency, this represents a cost of more than $3 trillion. Independent of the source, inaction on climate change is expected to increase death and...Continue reading

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On the right track

AS AN asset class, railways have a worrying history. Railway mania in Britain in the 1840s left plenty of unwary investors nursing hefty losses; that episode sits in most lists of history’s biggest speculative bubbles. But the prices of shares and bonds are dauntingly high, which has stoked interest in all manner of outlandish “alternative” assets in recent years. That, along with legal changes making it easier to repossess collateral that goes clickety-clack, may soon have investors funnelling cash into locomotives, carriages and goods wagons again.

Precious little private money is currently invested in rolling stock. That partly reflects the ownership of railways around the world, which are mainly in state hands. Around 87% of the €10.8 billion ($14.4 billion) spent on locomotives and railway cars in Europe in 2011-13, for example, came from governments, according to a new study by Roland Berger, a consulting firm. This reliance on the public purse means that investment comes fitfully, if at all, arriving when it is available rather than when it is needed. Romania’s state railway still operates 60-year-old steam trains.

The scarcity of public funds has hastened deregulation. The European Union’s fourth package of railway reforms, for example, is designed to open all domestic rail markets to full competition by 2019. Operators should be keen....Continue reading

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Raising the dose

THE year started with the belated adoption by the European Central Bank of quantitative easing (QE)—creating money to buy bonds—in the euro area. As the year ends, QE, which loosens monetary policy even when there is little scope to cut interest rates further, is being extended by an extra six months, so that the purchases will last until March 2017. Does this mean that the ECB’s monetary medicine is proving less effective than expected?

Mario Draghi, president of the ECB, argues on the contrary that the adoption of QE has been crucial in fostering the recovery in the euro area. QE has driven down long-term interest rates, the bank reckons, just as it did in America and Britain. Like their counterparts in those countries, ECB staff have analysed the effect of announcements about QE on the markets. Their study found that both the prospect of QE in the autumn of 2014 and the formal embrace of it in 2015—the policy was adopted in January and started in March—was responsible for half of the percentage-point fall in the average yield of ten-year government bonds in the euro zone between the start of September 2014 and the end of March...Continue reading

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In a hole

COMMODITY busts have left more of a mark on the barren mining region of northern Chile than the booms that preceded them. On the road to Sierra Gorda, a ramshackle copper-mining village in the middle of the Atacama Desert, dusty adobe cemeteries hold the remains of hundreds who died in penury after exports of potassium nitrate, or saltpetre, collapsed in the decade after the first world war.

Sierra Gorda itself looks like it is heading toward a similar decrepitude, despite huge copper mines carved into the hills around it. Chile, the world’s biggest copper producer, was a big beneficiary of the China-led commodities boom, yet the only hints of the past decade of high copper prices are newly installed streetlights. The sole open business on a recent afternoon was a woman selling empañadas from a tatty tent by the roadside.

From Chile to China the sense that another once-in-a-generation raw-materials boom has come to a definitive end is haunting global commodities markets. On December 9th shares of mining and oil companies took a fresh battering as iron-ore prices sank below $40 a tonne for the first time in a...Continue reading

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Stumbling blocks

“IT’S time for a group hug,” one of the participants joked at the end. After a long and lively exchange, programmers, who write the software behind bitcoin, and “miners”, whose computers mint the digital currency, had indeed found some common ground. But the rapport between the two camps still seemed tentative. At one point a developer asked whether miners, who now mostly hail from China, would ever collude to steal bitcoin.

Suspicions between developers and miners were not the only ones on display at “Scaling Bitcoin”, a conference in Hong Kong this week. Developers themselves have been feuding, too. The event was intended to end a dispute about how to expand the capacity of the bitcoin system. Currently, it can only handle seven transactions per second—a fraction of what conventional payment systems can manage. The number could be increased by allowing bigger “blocks”—the name given to the batches into which bitcoin transactions are assembled before they are processed.

For years developers have disagreed about how much, if at all, blocks should grow. Fearing that the system would soon hit its limits,...Continue reading

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Two-pronged attack

A pilot, not a plot

TO ESCAPE from penury, poor countries must build schools, roads and power plants. By definition, they do not have the tax revenue to do so. Foreign aid helps, but rich countries do not donate anywhere near the amount needed. That leaves loans as the only way to fund the necessary investment. For countries with limited means, these are in short supply too. The poorest spots on earth, dubbed highly-indebted poor countries (HIPCs) by the IMF, lose access to international debt-relief schemes if they take out loans at commercial rates. Yet concessionary loans are even harder to come by than the usurious sort.

It is this shortage that Bill Gates, whose foundation is the world’s biggest charity, and the Islamic Development Bank (IDB), which finances worthy projects in poor Muslim countries, hope to diminish. They are launching a new scheme to provide poor countries with cheap loans for things that banks rarely fund, such as disease eradication and sanitation. Over the next five years the bank will lend up to $2 billion to projects in health, agriculture and infrastructure, aimed at improving the lot of the poorest...Continue reading

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The secular sulk

THE prospect of interest-rate “lift-off” in America gives investors a reason to take their money there. So it has been odd to see a procession of emerging-market officials call on the Fed to get on with it, the sooner the better. Central bankers from India, Indonesia, Malaysia, Mexico and Peru are among those who have professed a desire for America’s rates to rise.

One explanation is that they are a little like patients waiting to give blood, tired of the excruciating wait and just hoping to be done with it. Things could certainly get painful. As it is, capital is already being diverted away from developing countries and towards America. In 2010-14 non-residents put $22 billion into emerging-market stocks and bonds every month, on average. In November they moved $3.5 billion out, the fourth month of such outflows in the past five, according to the Institute of International Finance, a trade association.

Further outflows in the coming months would put more pressure on the beleaguered currencies of many emerging markets. Depreciation makes their hefty external debts even more daunting. Dollar credit to non-banks...Continue reading

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Buckle up

SINCE interest rates hit rock-bottom in 2009, the Federal Reserve has repeatedly made optimistic forecasts about when they would start rising, only to delay the big day again and again. If the Fed has been a bullish coach, the markets have been trusting fans, continually believing that an increase is imminent, only to have their expectations dashed. At last, however, the moment seems to have arrived. On December 16th, when the Fed’s rate-setting committee meets, it seems all but certain to raise rates.

For that, thank the strength of the labour market. Unemployment, at 5%, is as low as most analysts reckon it can sustainably fall. During the recession, America lost 8.7m jobs. It has since gained 13m. In 2010 there were six unemployed workers for every job opening; today there are 1.5.

Wages, long stagnant, finally appear to be growing again, too. In September, when the Fed toyed with raising rates, average hourly pay had just grown by 2%, on an annualised basis, over the prior three months. Now that has risen to 2.8% (see chart). By one measure, wages grew by fully 4% in the third quarter of the year. Accelerating pay suggests that...Continue reading

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Taking the training wheels off

IF THE Federal Reserve does increase interest rates on December 16th, very few investors will be taken by surprise. It will be the most discussed, most anticipated rate rise in history.

Typically, markets buy on the rumour and sell on the news. So although higher interest rates might be expected to boost the dollar, and be bad for both equities and Treasury bonds, the market may have fully anticipated the impact. The dollar has already risen by 10% against the euro this year.

History suggests that the first rate increase is not a huge market-mover. BCA Research has looked at 17 rate-tightening cycles since 1971. In the three months after the Fed raised rates for the first time, the stockmarket fell on ten occasions, rose on six and was flat in the other instance. Thanks to a couple of very strong rallies during the mid-1980s and mid-1990s, the average movement was a 1.1% gain. On average, the Treasury-bond market marginally underperformed equities in the three months after a first rate hike.

But as Citigroup points out, the Fed is starting to tighten at an unusual time. Normally, the move is made to head off...Continue reading

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The gifts of the moguls

THE month of December began with something to like: a post on Facebook in which its founder, Mark Zuckerberg, and his wife, Priscilla Chan, promised to use the vast majority of their vast fortune to support charitable causes. (More than 1.5m people responded with a thumbs-up.) In celebration of the birth of their first child, the pair announced the creation of the Chan Zuckerberg Initiative, which will eventually receive 99% of the shares they own in Facebook, a pile currently valued at $45 billion.

Mr Zuckerberg has already added to the lives of more than a billion people by creating an extraordinarily popular social network. Now he is compounding that good with an act of generosity that can only be applauded. Nonetheless, the donation—and others like it—raise two thorny questions. The first concerns how such a staggering fortune could ever have been accumulated; the second whether philanthropy can salve the sting of the increasingly unequal distribution of wealth that it exemplifies.

That the rich are getting richer, and the richest are getting richer fastest, is beyond doubt. Research* by Emmanuel Saez and Gabriel Zucman of the...Continue reading

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Cash in a canoe

IMAGINE if, to collect your salary each month, you had to walk to the nearest town, perhaps tens of miles away, to congregate in a school or a football pitch or a church. There, you and your colleagues wait for a man to arrive from the capital, perhaps a thousand miles away, with a suitcase of cash. Most of the time, you do not receive as much money as you should. Sometimes the man does not arrive at all.

Until recently, that is how most government employees in the Democratic Republic of Congo were paid. But over the past three years the government has been urging civil servants to open bank accounts, to which their pay can be transferred directly. In the process, it is accelerating the spread of banking in an economy that, according to Michel Losembe, the bow-tied president of the Congolese Banking Association, is “not very far off barter”.

Few countries are as corrupt as Congo. A persistent national joke concerns a mythical “Article 15” of the constitution, which reads “Débrouillez-vous”—“You’re on your own”. Mobutu Sese Seko, a former strongman, used state funds to charter a Concorde to take him on shopping trips to Paris. By the time of his overthrow in 1997, graft was endemic. Government employees were not paid but rather expected to use their positions to make a living.

Civil war engulfed Congo in the 1990s and 2000s. As it...Continue reading

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Government cuts have tended to land on the young

MANY suspect governments of protecting increasingly wrinkly electorates over the young within the big austerity packages imposed since the financial crisis and recession. While youths have had a particularly rough ride within labour markets, the overall effects of the response to the crisis are a bit more complicated. A new issue of Fiscal Studies, an economic journal, published today compares the austerity packages implemented in six European countries (Britain, Italy, France, Spain, Ireland and Germany) and would seem to provide fodder for those who think the young have been given a raw deal.

First, look at investment. When there is a hole to be plugged, governments might be tempted to slash investment spending and maintain current spending. This is politically easier; current benefit claimants will squawk more loudly than those who might have used the now-cancelled roads. The papers show that in all countries other than France and Germany investment spending was cut more quickly than current spending--future generations are...Continue reading

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Why low rates mean you need to save more

A LOW interest rate policy is designed, in part, to make people save less and spend more. The problem is that this approach eventually hits a wall. That is because the biggest reason people need to save is to cover their retirement, when they need to convert their savings into an income. And then low rates have a perverse effect.

Say you want a $20,000 private  income (indexed to inflation) in retirement to top up your state pension/social security. The size of the pot you need depends very much on the income you can generate. So look at this simple table

Income rate                 Size of pot ($)

5%                              400,000

4%                              500,000

3%                              666,666

2%                              1,000,000

If 2% seems a low income rate, remember that US TIPS - the only way of guaranteeing an inflation-linked income -...Continue reading

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Are Britons in more debt or less?

IN RECENT weeks there has been lots of talk about how much debt Britons are in. Back in August the former chair of the Financial Services Authority, Adair Turner, said in an interesting documentary on Radio 4 that personal debt in Britain was a big problem. Just today the British Chambers of Commerce has warned about economic growth in 2016, saying that the economy “cannot rely so heavily on consumer spending to fuel our economy, especially when driven by increased borrowing”.

With all this, it is worth bearing one thing in mind. News reports tend to focus heavily on reporting figures in absolute amounts (ie, in pounds) because it sounds scary. ("Britain is sitting on a £173 billion time bomb", etc.) The problem here is that as the economy expands, and as prices rise with inflation, the absolute figure is bound to keep going up. 

What really matters is the stock of debt relative to the incomes of people service it. And when you look at consumer debt relative to Britons’ incomes, things don’t look anywhere near as bad. These figures are taken from the Bank of England and the Office for National Statistics. As you can see, following the...Continue reading

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How to help whistleblowers

WHISTLEBLOWING, responsible for uncovering 42% of exposed corporate fraud, is often met with hostility, penalties and sometimes prosecution. But this may be about to change

How companies massage their profits to beat market forecasts

ALMOST every results season, the markets go through an elaborate ritual, as stylised as Kabuki theatre. The profit forecasts made by analysts, highly optimistic in advance, are reduced. Companies then beat those forecasts by a small margin. Analysts then declare the result season a "success" even though the reported profits are lower than the forecasts they made 6 or 12 months earlier.

This happens at the aggregate level but reflects another pattern at the level of the individual company. Executives have every incentive to match or beat forecasts as the market punishes those that fail to do so. That, in turn, hurts the value of the share options which are the best hope of making the executives rich.

A recent academic paper looks in detail at this process (The Valuation Premium for a String of Positive Earnings Surprises: The Role of Earnings Manipulation by Jenny Chu, Patricia Dechow, Kai Wai Hui and Annika Yu Wang). As the authors point out, it is hard to know whether the ability of the corporate sector to beat forecasts is due to good management, a growing economy or outright manipulation. So they focus on companies that the SEC has identified as indulging in manipulation.

Sure enough they find that 53% of such firms have a record of four straight quarters of beating forecasts, compared...Continue reading

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Democracy's depressing descent into division

BACK in 1935, George Dangerfield wrote a book about the pre-1914 period called "The Strange Death of Liberal England". In this, he pointed out that Edwardian Britain, often portrayed as a Arcadian era before the horrors of the Somme, was in fact marked by violent protests - over women's suffrage (hunger strikes and bombs), workers' rights (frequent strikes) and Irish home rule (the threat of mutiny and civil war). The cracks in the system were already apparent.

The high point for liberal democratic triumphalism is often seen as the fall of the Soviet Union and the publication of "The End of History and the Last Man", Francis Fukuyama's 1992 influential book. A quarter of a century later, and democracy looks a lot less healthy, an argument I have returned to often in this blog (and a book). Voters have become disillusioned with the parties of the centre-left and the centre-right and a good chunk of them have been on the...Continue reading

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Fed policy: all over bar the Yellen?

CENTRAL banker would like to meet economic scenario with obvious policy prescriptions; must have GSOR (good signs of recovery) or CIOR (clear indications of recession). Financial trader would like to meet central banker with predictable policy regime; must be willing to pay for all dates and be supportive in times of distress.

The markets feel a bit like a dating agency at the moment. On Thursday, European traders were waiting for Mario Draghi to turn up with a bottle of champagne and a dozen red roses; all they got was a box of Ferrero Rocher in the form of a 10 basis point cut. The disappointment was clear from the sharp fall in European equity markets. And it stemmed from earlier hints that Mr Draghi would cut by more and expand the quantitative easing (QE) programme (as opposed to merely extending it). Mr Draghi famously promised to do "whatever it takes" to save the euro; this time, the markets felt that he did the minimum necessary.

Over in America, the non-farm payroll increase, at 216,000, was strong enough to guaranteed a Federal Reserve rate increase on December 16, the first since 2006 (before Twitter and the iphone). Expectations are also crucial; the Fed has hinted so strongly that it will tighten that it will need a good reason not to move. Markets were braced for an increase in September; when it didn't happen, that caused some...Continue reading

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As a share of GDP, investment is not in decline

IN OUR cover leader this week, my colleague makes the following point:

Nor are firms investing less. The same system that is accused of myopia has just financed the $500 billion shale-energy revolution, a boom in experimental biotech companies and the electric-car ambitions of Elon Musk, a maverick entrepreneur. Relative to assets, sales and GDP, American firms’ investment has held steady. The mix has shifted from plant and machines to things like software and research and development (R&D), but that is to be expected as equipment costs fall.

This may strike some readers as surprising. Here is the chart behind it. Gross private non-residential investment, though volatile, has fluctuated around 13% of GDP since the 1970s. Today, it is almost exactly at its long-run average. There has been a shift in the composition of investment, towards intellectual property. But, relative to GDP, investment as a whole has held steady.  The IMF made a similar point in its April World Economic Outlook, noting that America’s investment slowdown has been no more severe than expected, given the depth of the...Continue reading

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Keeping it riyal

A currency you can count on

MOST observers expect OPEC to leave production unchanged at its meeting on December 4th. If it does, there will be no end in sight for low oil prices. Saudi Arabia’s strategy of opening the taps to put producers with higher costs out of business is proving painful. Prices are about half what they were a year ago. In 2013 the Gulf countries had a huge combined current-account surplus of 21.6% of GDP. But the IMF expects this to shrink to a deficit of 2.5% of GDP next year, thanks to the plunge in the value of their main export.

In October alone, Saudi Arabia’s central bank spent $7 billion of foreign reserves financing the kingdom’s deficit. If it ran short, it would have no choice but to abandon the riyal’s long-standing peg to the dollar. Sure enough, jitters about the peg are discernible in the futures market. On November 24th the price of buying a riyal in a year’s time fell to its lowest level since 2002. Futures for other Gulf currencies have also sagged.

There is little reason for Gulf countries to devalue if they can avoid it. Their main export is priced in dollars,...Continue reading

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Love and war

STARTUPS in the world of financial technology, or “fintech”, think of banks as hulking mediocrities ripe for disruption. Banks in turn look down on fintech outfits as little more than gadflies swarming over chicken feed. As any fan of romantic comedies would know, such apparent incompatibility is often the precursor to a close relationship. On December 1st JPMorgan Chase (JPM), America’s biggest bank, announced it would make small-business loans through OnDeck Capital, a “marketplace lender” of the sort that usually claims to be on the verge of putting financial-services behemoths out of business.

The deal may seem odd at first: after all, banks like JPM have customers wanting to borrow and the money to lend to them. The catch is that their desire to make smallish loans—the pilot will focus on credits of $250,000 or less—is limited by the cost and hassle of originating them. It is “the kind of stuff we don’t want to do or can’t do,” said Jamie Dimon, JPM’s boss.

OnDeck, whose share price spiked on the news, is one of hundreds of lending platforms active in America. Most of them started life by matching individuals or firms needing money with those with too much of it, dubbing themselves “peer-to-peer” lenders. But the relatively high returns on offer attracted banks and other financial institutions, which began to buy up the...Continue reading

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Fit as fiddles

THE past few years have been tumultuous for American health insurers. Barack Obama’s landmark health-care reform spawned a bevy of co-operatives to compete with them, among other measures intended to cut the cost of insurance. More than half of these have already gone bust—most recently Health Republic of New York. It had received $265m in federal loans but closed on December 1st, leaving 200,000 people in search of a new insurer. That is partly because the exchanges on which co-operatives and private insurers alike were supposed to sell lots of new policies have proved a disappointment: last month UnitedHealthcare, America’s biggest health insurer, announced that it may stop selling policies on them.

Meanwhile, presidential candidates are demanding tougher government scrutiny of pending industry mergers. The public is hostile too: a survey published in August by the Kaiser Family Foundation, a think-tank, found health insurers were even more disliked than other corporate punchbags, such as banks and airlines.

Yet the share prices of America’s five biggest health insurers—UnitedHealthcare, Aetna, Humana, Cigna and...Continue reading

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I’ll give it my way

Like!

MANY people take to social media to share news of big events. On December 1st Facebook’s boss, Mark Zuckerberg, followed in the tradition he helped create, when he and his wife, Priscilla Chan, announced the birth of their daughter on the social-networking site, along with news that they will give away the majority of their fortune during their lifetimes. Around 99% of the shares they own in Facebook, which today are worth around $45 billion, will go into the Chan Zuckerberg Initiative (CZI). Their aim, they wrote, is to improve the world for their daughter and future generations.

For now, the move allows Mr Zuckerberg to relinquish wealth, but not control, as he will retain the votes associated with any shares transferred to CZI. He anticipates remaining the controlling stakeholder of Facebook “for the foreseeable future”, and plans to sell, or give away, no more than $1 billion of Facebook stock each year for the next three years.

Mr Zuckerberg is far from the first tech titan to pledge billions to philanthropic activities, but he is following a slightly different path to Bill Gates, Microsoft’s...Continue reading

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The best is the enemy of the green

ECONOMISTS have long championed a price on carbon as the ideal way to limit the greenhouse-gas emissions that cause global warming. So has this newspaper: it first embraced the idea in 1989. Yet the bitter truth is that the world is nowhere near the sort of carbon-pricing regime that would keep greenhouse gases at tolerable levels. The negotiations under way in Paris this week will not yield one. Economists are used to being ignored, yet the contrast between academics’ enthusiasm for a carbon price and the rest of the world’s disinterest is striking.

Carbon prices tackle the problem of emissions head on. When people engage in a carbon-intensive activity, such as driving a car, they impose a cost on others, often without even realising it: the emissions produced when petrol is burned contribute to global warming. Because that cost is not built into the price of petrol, people buy more of it than they otherwise would, atmospheric carbon goes up, and the world bakes. A carbon price that added the missing cost to the price of petrol (and coal and every other carbon-generating activity) would give people an incentive to emit less. To impose a price, a...Continue reading

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Stressful times

IN FINANCE, things that grow very fast have an irksome tendency to blow up. American subprime mortgages prior to 2008, southern European sovereign debt in the run-up to 2010 and Japanese banks in the 1980s are but recent examples. So it is worrying that bank lending in emerging markets has ballooned in recent years, from about 77% of GDP in 2007 to 128% at the beginning of this year, according to JPMorgan Chase, a rich-world bank (see chart). That 51-percentage-point jump dwarfs the mere 20-point rise in credit in the rich world in 2002-07.

Now that the economic prospects of emerging markets have dimmed, banks from Shanghai to São Paulo are in the spotlight. Trouble in such places would once barely have registered in global financial circles. In 1990 only three of the world’s 100 biggest lenders by assets were in developing countries. Now the world’s four biggest banks are in China, and the fifth-biggest, HSBC, does much of its business from Hong Kong. More than a third of the world’s biggest banks have their headquarters in emerging markets, and plenty of rich-country firms (such as Standard Chartered, based in London, or BBVA, a Spanish bank)...Continue reading

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Weatherproof

FEW people place great store in the ability of negotiators to reach a meaningful deal during the conference on climate change that began in Paris this week. One problem is that some politicians refuse to admit the problem is real. But those who work in the financial markets have to take the issue seriously: ever since being hit by losses from Hurricane Andrew in 1992, insurance companies have been modelling climate risks. Bank of America Merrill Lynch (BAML) just weighed in with a 332-page report on their economic and financial impact.

A changing climate, and the eventual efforts of governments (however reluctant) to deal with it, could have a big impact on investors’ returns. Companies that produce or use large amounts of fossil fuels will face higher taxes and regulatory burdens. Some energy producers may find it impossible to exploit their known reserves, and be left with “stranded assets”—deposits of oil and coal that have to be left in the ground. Other industries could be affected by the economic damage caused by more extreme weather—storms, floods, heatwaves and droughts. “Investors have to worry about a material and...Continue reading

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Live longer, work longer

The state-pension age is no longer set in stone at 65 (or lower). Already 66 in America, it will rise to 67 by 2027. By the end of the 2020s it will also reach 67 in Britain and Germany.

But the age at which workers can get full pension benefits and the age at which they retire are not necessarily the same. The effective retirement age is often much younger than the official one. Some older workers are unemployed; others receive disability benefits, private pensions or reduced state pensions under early retirement schemes. Though some money can be saved by raising the pensionable age, public finances will benefit much more if older people stay in work longer, boosting GDP and taxes. Improving health and promoting more flexible ways to work can help make this happen.

Current employment rates among those in their late 60s are typically very low, at 20% on average among the 34 members of the OECD. In many countries simply ensuring that people work until 65 will be an achievement in itself. Although the employment rate of 55-64-year-olds has generally risen in the past decade (Greece and Portugal are exceptions), the rate...Continue reading

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Maiden voyage

PASSING through the Suez Canal became easier earlier this year, thanks to an expansion completed in August. Now it is about to become a little bit more complicated. Transit fees for the canal are denominated in Special Drawing Rights, a basket of currencies used by the International Monetary Fund (IMF) as its unit of account. This week the IMF decided to include the yuan in the basket from next year, joining the dollar, the euro, the pound and the yen.

If lots of things were priced in SDRs, the IMF’s decision would have forced companies around the world to buy yuan-denominated assets as soon as possible, to hedge their exposure. That would have prompted China’s currency to strengthen dramatically. But few goods or services are priced in SDRs. Instead, admission to the currency club is significant mainly for its symbolism: the IMF is lending its imprimatur to the yuan as a reserve currency—a safe, liquid asset in which governments can park their wealth. Indeed, far from setting off a groundswell of demand for the yuan, the IMF’s decision may pave the way for its depreciation.

The reason is that the People’s Bank of China (PBOC)...Continue reading

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Ukraine threatens to wreck two years of economic reform

THE ECONOMIST is at a conference in Kiev, organised by the Kiev Post, a newspaper. Most delegates speak in glowing terms about how Ukraine’s economy, currently moribund, will in time be one of Europe’s most prosperous. (Jaded observers at the conference say they have heard it all before.) But few are talking about something much more pressing. Politicians are fighting over Ukraine’s proposed budget for next year; if things don’t go to plan, 2016 could look very tricky.

There are two competing proposals for the budget. One, which is being pushed by the Ministry of Finance, is a fairly sensible plan. It will eliminate a range of tax loopholes and would also cut some spending. With that budget, Ukraine would probably run a budget deficit of about 4% of GDP next year. The IMF, which has arranged a bail-out with Ukraine, is happy with it.

But the IMF is not so happy with the competing proposal, which has come from a member of the party of Petro Poroshenko, the president. This plan envisages hefty tax cuts, but also keeps plenty of loopholes. For that reason it is politically far more palatable. But that...Continue reading

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People's beliefs and motives influence the effectiveness of green policies

Should we tax sugar?

GOVERNMENTS around the world are taxing sugary drinks to help curb obesity, but do so-called 'sin taxes' on the likes of sugar or cigarettes work or has the nanny state gone rogue?

Without carbon pricing, subsidies to renewables can be counterproductive

THE world's economies have not been idle in the face of climate change. Companies and consumers are endeavouring to reduce their carbon footprint by investing in energy efficiency and changing their travel plans. Financial institutions are pressed to disinvest shares in fossil fuel industries by the “Keep it in the ground” campaign launched by NGOs and the media. In the last decade many countries, particularly EU Member States, have invested heavily in renewable energy sources such as wind and solar power, through generous feed-in tariffs, public tenders and mandatory renewable portfolio standards. China installed about 23 terawatts of new wind power capacity in 2014, almost half of the 53 terawatts installed worldwide. Rich countries have pledged to contribute up to $10 billion a year to the UN Green Climate Fund, with the aim to eventually reach $100 billion. This money is to be used to assist developing countries in adaptation and mitigation practices.

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Latin American economies should show leadership on climate negotiations

In December talks in Paris involving more than 200 countries may result in a new agreement aimed at reducing carbon emissions. In the months leading up to the conference, The Economist will be publishing guest columns by experts on the economic issues involved. Here, Felipe Calderon, former President of Mexico and Chair of the Global Commission on the Economy and Climate, and Ricardo Lagos, former President of Chile and a member of the Global Commission argue there are many opportunities to improve economic performance while reducing growth in emissions.

LEADING countries in Latin America and around the world are showing how ambitious climate action is the right choice for both their citizens and their economies. The evidence is building that the global economy is reaching a key turning point away from its fossil fuel past.

We already know that climate change presents immense risks from rising global temperatures, melting of ice-sheets, more frequent and extreme heat waves and storms, and less predictable growing seasons. These are hurting subsistence communities already, and with greater warming, will affect us...Continue reading

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Bankers v mattresses

IN JUNE of last year the European Central Bank reduced its benchmark interest rate, at which it lends to commercial banks, to 0.15% and its deposit rate, which it pays to banks on their reserves, to -0.1%. For a central bank that was once cautious about unconventional measures, setting a negative interest rate was a bold move. The ECB was in effect charging commercial banks to hold their excess deposits at the central bank, in the hope that this would drive down borrowing costs more generally.

Three months later, the ECB cut the deposit rate again, to -0.2%. When the ECB’s rate-setting council next meets, on December 3rd, it is widely expected to trim the deposit rate even further, as well as to approve more “quantitative easing” or QE (the creation of money to buy bonds). In a recent speech Mr Draghi claimed that the ECB’s unconventional policies over the past 18 months had been the “dominant force” in spurring the euro-zone economy and staving off deflation. Lending by banks is slowly reviving. Even so, he suggested, deficient inflation and lingering concerns about the strength of recovery justify further action.   ...Continue reading

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Big hunk of junk

Just 25 years ago less than a quarter of corporate-bond issuers were ranked speculative, or junk. Now, according to Standard & Poor’s, a rating agency, it is nearly a half. Growth in the market is due to a number of factors. Investors are more willing to buy high-yield debt, thanks to low interest rates; banks are retreating from corporate lending, particularly in Europe; companies are keen to borrow, given the tax benefits. The shift means the average corporate bond is riskier than it used to be. The default rate is rising, but is still low by historic standards: just 2.5% of issuers defaulted in the year to September.

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Stopping slurping

It comes at a cost

AROUND the world, governments and beverage makers are locked in battle over taxes on sugary drinks. Hungary has been taxing them since 2011. In 2012 the French government introduced a tax on all drinks with added sugar or artificial sweetener, now €0.075 ($0.08) a litre. The Mexican government followed suit last year, with a tax of 1 peso ($0.06) a litre on all sugary drinks. Chile and the city of Berkeley, California introduced similar measures in January; Barbados followed suit in June and Dominica in September.

The drinks industry has won some victories too, seeing off proposals for taxes on sugar in several American states and persuading the Slovenian government to backtrack on plans to impose a 10% tax on sweetened drinks last year. In 2013 Denmark repealed its tax on soft drinks and ditched plans for a broader sugar tax.

Governments are adopting the taxes in the hope of trimming bulging waistlines and slowing the rise in diabetes, which cost taxpayers vast sums in spending on health care. Mexicans, for instance, are the fourth-biggest guzzlers of sugary drinks in the world, according to...Continue reading

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Burden-sharing

BANKS in Italy fared better during the financial crisis than many of their peers, sparing Italian taxpayers the bail-outs their counterparts in other countries had to shoulder. But although they stuck to their cautious business models and avoided fuelling a big housing boom and bust, Italy’s protracted recession has enfeebled them. It has caused bad loans to soar, which in turn has prevented them from supporting a still weak recovery with new lending.

The burden of non-performing loans (NPLs) in Italy is now immense: they amount to €350 billion ($370 billion), the equivalent of 21% of GDP. With these unproductive assets tying up their capital, Italian banks are unable to extend new credit to businesses. In fact, they are lending out less in an effort to shore up their balance-sheets (see chart).

The government would like to fix all this by setting up a “bad bank”—an asset-management company that would strip bad loans off the banks’ books and thus enable them to resume normal service to businesses. Schemes of this sort recently helped Ireland and Spain overcome big banking crises. BCG, a consultancy that has worked...Continue reading

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Not so smart

IN 2008, as the financial system was collapsing, Alan Greenspan, the former chairman of the Federal Reserve and champion of free markets, admitted he had been wrong. “I made a mistake in presuming that the self-interests of organisations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms,” he said. In other words: why would bankers destroy their own livelihoods?

Some clues to Mr Greenspan’s conundrum can be found in a new book* on Lehman Brothers, the American investment bank whose failure precipitated the worst of the crisis, and a recent report** on the collapse of HBOS, a British retail bank, that imploded soon after. Although the two banks had different histories, they made similar mistakes.

For a start, both strayed from their core expertise. HBOS was created through the combination of Halifax, a retail mortgage lender, and Bank of Scotland, one of Scotland’s two biggest banks. The merged entity wanted to gain market share in England and compete with the likes of HSBC and Barclays. The easiest way to increase business was to focus on smaller,...Continue reading

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For richer, for poorer

IN DECEMBER, as a winter chill descends on the continental United States, temperatures in Puerto Rico often reach 30°C. Palm trees sway alongside the Spanish colonial buildings in Old San Juan; the blue Atlantic stretches to the horizon. Yet the economic outlook for America’s Caribbean dependency is anything but sunny. Its government owes $72 billion in debt, which it says it cannot repay. On December 1st the territory is supposed to make—and is almost certain to miss—a $354m debt payment. And that is just the first of a series of repayments that add up to $1.4 billion (or nearly 1.5% of GDP) due in December and January.

Politicians in Washington are scrambling for a solution. The island’s fiscal woes are in part the result of chronically bad budgeting. But they also stem from structural economic weakness. Bailing out Puerto Rico, which is self-governing but not a state, is not a popular option. Yet when any corner of America faces a deterioration in its long-run economic fortunes, the costs will end up being shared, one way or another.

For decades Puerto Rico, which is poorer than the mainland, enjoyed a special tax status designed...Continue reading

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Pricing risk

CHINA’S domestic bond market has never been riskier. It was only last year that it suffered its first default. This year at least six companies have defaulted. The miscreants are a diverse lot, including a beverage bottler, a solar-panel maker and a cement company. As economic growth grinds lower, defaults will inevitably rise.

A gloomy outlook of this kind would normally lead investors to demand a premium before buying bonds. Instead, they have lapped them up, making it cheaper for China’s companies to borrow. Bond issuance has boomed this year, reaching almost 12 trillion yuan ($1.9 trillion) so far, up from the record 7.7 trillion sold in all of 2014, according to Wind Information, a data provider. This has prompted warnings that, much like the stockmarket earlier this year, China’s bond market is swelling into a bubble.

Banks accounted for almost all lending in China until a decade ago. Today, for every five yuan of loans companies take out, they also finance themselves with one yuan of bonds. That has made China the world’s third-biggest bond market, behind America and Japan—a development that should...Continue reading

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The perils of planning on the basis of economic forecasts

THE joke is not new but it is a good one. How do we know that economists have a sense of humour? They put decimal points in their forecasts. Yesterday, Britain's Office for Budget Responsibility published its analysis of the government's spending package. The big news was that the OBR revised up its assumption on the tax revenues the government could raise, giving chancellor George Osborne the leeway to retreat from some (but not all) unpopular spending cuts. But for this blog let us focus on its economic assumptions.

The OBR revised up its forecast for 2016 and 2017 growth by a tenth of a percentage point in each year, from 2.4% to 2.5%. That is amazingly precise. The average error in estimating UK GDP growth in the official statistics, after the year has actually ended, is half a percentage point. The OBR's forecasts for GDP growth in successive years are 2015 (2.4%), 2016 (2.4%), 2017 (2.5%), 2018 (2.4%), 2019 (2.3%), 2020 (2.3%). 

That is an amazingly smooth pattern. Here are the annual numbers for GDP growth since 1948. There has never been a five-year run of steady growth in...Continue reading

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Deep impact

Trying times for Esteves

AS THE founder and boss of BTG Pactual, a Brazilian investment bank, André Esteves has been a shrewd and hyperactive dealmaker. But on November 25th some of those deals appeared to sour, when he was arrested in Rio de Janeiro as part of a vast bribery investigation centred on Petrobras, Brazil’s state-controlled oil-and-gas giant.

Prosecutors allege that Mr Esteves and Delcídio do Amaral, a prominent lawmaker from the party of Dilma Rousseff, the president, tried to help Nestor Cerveró, a former Petrobras director who has since been convicted of corruption, to escape trial. According to the police, Mr Esteves was willing to stump up 4m reais ($1.1m) to spirit him out of the country. Messrs Esteves and Amaral protest their innocence.

What interest, if any, Mr Esteves might have had in putting Mr Cerveró beyond the reach of the law is unknown. Mr Esteves has always insisted that BTG’s investment in Petrobras assets in Africa is spotless. So, he has said, was its involvement with Sete Brasil, a troubled firm that built oil rigs for Petrobras.

Mr Esteves’s predicament nevertheless puts pressure on the...Continue reading

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Small changes in diet can make a big difference to greenhouse gas emissions

High pay motivates bankers, but bonuses often do not

JOHN CRYAN, the new(ish) co-chief executive of Deutsche Bank, caused a stir earlier this week when he said that bonuses do not encourage bankers to work any harder. The German lender's boss was reported to have said that he had "no idea" why his contract included a bonus scheme. 

Financiers like to claim that their bonuses are necessary to attract and motivate the highly talented. Many financial jobs are stressful, demand long hours and involve a great deal of unrewarding grunt work. Those who fill them have many outside options. With junior bankers literally working themselves to death high pay is necessary to attract people to the sector. Goldman Sachs hiked their juniors’ salaries by 20% this August.  

Whether paying large bonuses—as opposed to higher base salaries—is the best way to motivate employees is a separate issue. Europe's regulators imposed a bonus cap in the aftermath of the crisis. That was strongly resisted by some banks. The practise of paying bonuses made it easier for them to...Continue reading

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Douglass North, a pioneer in institutional economics, has died

Terrorism and the economy

ANALYSING the effects of terrorist acts on lost GDP or lower stockmarket indices may seem to be missing the point. But terrorists aim to wreak havoc, including with our economy

Does the size of the state hold back the economy?

LATER this week, the British government will announce its latest spending review. Its aim will be to balance the budget by 2020. In part, this is because the Conservative party genuinely believes a smaller state is good for economic growth in the long run. But is there a hard-and-fast relationship?

This is the kind of issue economists spend years researching. But your blogger pursued a simple approach; comparing the GDP per capita of OECD countries with government spending as a proportion of GDP. (Statistical purists should note; the latest figures on the fomer are from 2014 but the latter only go up to 2013.)

The OECD has data covering both measures for 26 countries. So step 1 was to rank the countries by government spending and then divide them into quartiles (six countries in the 1st and 4th quartiles, 7 countries in the 2nd and 3rd). The results were as follows

Quartile                                        GDP per capita ($)

Highest spenders                         40,285

2nd highest              ...Continue reading

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The euro crisis was not a government-debt crisis

THE euro-zone crisis has transitioned from an acute phase to a chronic one. At just this moment the fear that market panic might force one or several economies out of the single currency is low. Yet few analysts believe the euro zone has solved its fundamental problems. In a piece published at Vox EU last week, a cadre of prominent economists made the very sensible point that unless euro-area leaders can agree on the fundamental causes of the crisis, they will struggle to craft long-run fixes. The authors set out their view of the crisis, in hopes that it will prove a foundation for consensus building.

Their explanation, which strikes me as the right one, is that the euro-area crisis was not a sovereign-debt crisis. If it had been, one would have expected Belgium and Italy, which entered the crisis with extraordinarily high debts, to have landed in serious trouble. As it turned out, they made it through without troika programmes, while Ireland and Spain, which entered the crisis with low levels of sovereign debt, needed bail-outs. The problem, instead, was one of massive capital flows across borders, which encouraged high levels of private borrowing in the economies that eventually got into trouble. When the global financial crisis generated a reversal in those flows, private borrowers and banks...Continue reading

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To get a climate agreement, first set out principles for fair cost-sharing

In December talks in Paris involving more than 200 countries may result in a new agreement aimed at reducing carbon emissions. In the months leading up to the conference, The Economist will be publishing guest columns by experts on the economic issues involved. Here, Lucas Bretschger of ETH Zurich argues that an initial focus on setting clear principles for fair cost-sharing will clear the way to a broader climate deal.

BOTH climate change and climate policies have a major impact on world income distribution. If nothing is done to address climate change, less developed and vulnerable countries will suffer disproportionately: climate shocks destroy part of their capital stock, making successful economic development even more difficult than it was in the past. Conversely, the adoption of stringent climate policies will mean that carbon-intensive countries will have to carry a substantial policy burden. Yet, the concerns of high climate-policy costs are not fully warranted, as I show in the book “Greening Economy, Graying Society”. Positive growth effects of climate...Continue reading

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Many unhappy returns

“KEEP your eyes on the stars,” said Teddy Roosevelt, “and your feet on the ground.” America’s can-do spirit keeps its economy moving forward, but over-optimism can be harmful, especially if it leads people to make promises they cannot meet. If investment returns are lower in coming decades than they have been in recent ones, that is the position pension funds and college endowments will be in.

When final-salary pension schemes, which are still prevalent among America’s public-sector employees, decide how much to put aside to pay pensions, they have to make an assumption about what returns they will earn. The higher their estimate, the less employers have to contribute today. Similarly, endowments have to estimate their future returns to determine how much to spend each year: pay out too much and their funds will dwindle away.

The average American state or local-government pension fund assumes it will earn a nominal (ie, not accounting for inflation) annual return of 7.69% in future, according to the National Association of State Retirement Administrators (NASRA). Based on past performance, that seems reasonable. Over the past five...Continue reading

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Celtic phoenix

In the pink

WHILE the euro zone limps along, growing in the third quarter by a disappointing 0.3% (an annualised rate of 1.2%), one small member of the 19-strong currency club is racing ahead. Less than two years since Ireland exited its humiliating bail-out, its economy is resurgent. Following growth of 5.2% in 2014, GDP rose by 7.0% in the first half of 2015 compared with the same period a year earlier.

Welcome as it may be, the vigour of the upswing highlights the troublesome volatility of the small and ultra-open Irish economy. It is bouncing back, after all, from a deep slump that followed an earlier spell of vaulting growth. The notion that the Irish economy might rebound so strongly would have been dismissed as fantasy only a couple of years ago. Irish banks went spectacularly bust during the financial crisis and required a bail-out of €64 billion ($89 billion), close to two-fifths of GDP. Their woes meant that the Irish state had itself to be bailed out by the EU and the IMF in late 2010. Between its pre-crisis peak in late 2007 and its nadir at the end of 2009, the economy contracted by 11.2% (see chart). A...Continue reading

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Takeover bid

FOR ordinary Chinese investors, painful memories of the summer’s stockmarket meltdown are fading away, soothed by a fresh rally in share prices. But for the government, the fallout is just getting started. In recent weeks it has launched investigations into officials, bankers and hedge-fund managers suspected of illegal trading. It has tightened rules about using debt to buy shares. Now it is planning the biggest overhaul of Chinese financial regulation in more than a decade.

The idea is to create a “super-regulator”, combining three separate agencies and, possibly, the central bank into a single, powerful entity responsible for monitoring all financial firms: banks, insurers, brokerages, asset managers and so on. Consolidation has been mooted before, only for the system to remain unchanged. But according to people familiar with government discussions, big changes are virtually certain this time because of the stockmarket debacle.

China assembled its regulatory framework in piecemeal fashion in the 1990s and early 2000s as the financial system took shape. Different agencies look after banks, brokerages and insurers, whereas the central...Continue reading

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Prizes

Prizes: Patrick Foulis, our New York bureau chief, has won State Street’s 2015 UK Institutional Press Award for best editorial comment; Sacha Nauta, our finance correspondent, won the award for best newcomer.

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Class divides

 

THE University of Missouri, which opened in 1840 and admitted its first female students in 1867, began accepting blacks in 1950. Racial tensions are still all too evident, however. Student protests at the poor handling of a series of racist incidents led to the resignation earlier this month of the university’s president, Timothy Wolfe.

The row unfolded against a backdrop of black frustration: with police violence, such as the shooting last year of Michael Brown, an unarmed black 18-year-old, in Ferguson, Missouri, but also with the persistence of black economic underperformance. The unemployment rate for blacks is twice that for whites. A larger share of whites than blacks work in skilled jobs; even within well-paid professions whites earn more per hour than black workers. The typical white household has more than ten times the wealth of the typical black household.

Blacks do worse than whites on every rung of America’s educational ladder (see chart). A smaller share of black students completes high school, a smaller share attends university and a smaller share graduates. Black students are heavily...Continue reading

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What a carry on

NEXT month will probably see the first great divergence in monetary policy since the financial crisis of 2008. The Federal Reserve is widely expected to push through a rate increase—its first since 2006. But the European Central Bank is expected to cut its deposit rate, already in negative territory, or to expand its programme of asset purchases. The Bank of Japan is also expected to maintain or amplify its expansionary monetary policy.

For the currency markets, the shift will herald a new era. Before 2008 one of the most popular strategies was the “carry trade”—borrowing in a low-yielding currency and investing in a higher-yielding one. But with interest rates in most of the rich world at or close to zero since 2008, there has been little carry to trade.

After December traders can probably look forward to a prolonged divergence between interest rates in America and the euro zone. Back in 2010 the markets thought the first interest-rate increase by the Fed and the ECB would occur at roughly the same time. (In fact, the ECB fleetingly began raising rates in 2011, before cutting them again.) But now there is an expected...Continue reading

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A funny form of conservation

TEMPORARY solutions have a way of becoming permanent. The fate of Fannie Mae and Freddie Mac, the two “government-sponsored enterprises” (GSEs) that stand behind much of America’s housing market, is a case in point. The GSEs, which buy American mortgages from banks and other originators, bundle them into securities and resell them to investors with a guarantee, are stuck in a technocratic no-man’s land. Their status has not yet been normalised after their first bail-out, but they may soon require a second. If they do, the administration of Barack Obama, which has been running them since 2009, will be largely responsible.

Fannie and Freddie were tethered to America’s housing market when it fell off a cliff in 2008. The GSEs faced a double impact: they had to cough up to honour their guarantees, while also suffering losses on their own big portfolios of mortgage-backed securities. The firms had an odd ownership structure, with a public charter, and thus an implicit government guarantee, but private shareholders. To stop them collapsing, which would have further hurt both the housing market and the financial system, the government...Continue reading

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