02 July 2011

Global Finance and Economy: a Hot Summer Indeed

Are we seeing ghosts everywhere or is something ugly going on indeed? Take a look to some of the current debates, concerns and questions about Greece, US and China, and imagine how it all could play out.

Greece: Austerity measures and new bailout package

Last week, Greece’s Prime Minister George Papandreou won approval to his 78 billion-euro package of budget cuts and asset sales, key to receive the fifth instalment of 110 billion-euro bailout in 2010. This despite of the boiling public anger and an UN expert’s warning that these austerity measures could violate human rights. Yet the country’s overall debt situation is not likely to improve as a result: a second rescue package for Greece of about the similar magnitude as the initial 110 billion euro bailout is already being considered.

Several questions and concerns arise, e.g.:
* How long this game around Greece can continue? When and how will it end?
* Will or should the second bailout be classified as selective default by rating agencies given that private-sector is in fact forced to participate via a “voluntary” rollover of maturing Greece’s debt by banks?
* What risks the banks are taking when rolling over Greece’s debts? Do they have better alternatives? What are the implications to banks’ lending to private sector?

US: Debt ceiling and QE3

As also pointed out by IMF in its Concluding Statement of the 2011 Article IV Mission to The United States of America (20 June 2011), US public debt is on an unsustainable trajectory. In order to avoid default, the federal debt ceiling has to be raised once again (according to IMF, this has already happened more than 70 times over the past few decades). Meanwhile real economy is picking up very slowly if at all: housing market remains weak, unemployment stays high, credit supply conditions remain tight etc. To somehow (although temporarily) cope with the situation, the Fed is set to buy USD 300bn more Treasuries. Some say, QE3 has already started (see e.g. the post in Zero Hedge, 31 May 2011).

In relation to the above, one could (for example) think about the following:
* The absurdity of the situation where just lifting up the debt ceiling means a top grade credit rating while not doing it would result in default grade
* QE1 and QE2 ended up everywhere else than helping US real economy to recover. Where will go QE3?
* Are there any real possibilities for avoiding high inflation later on? Of course, Fed has at least some technical means for mopping up excess liquidity but can this be done given the likely consequences of reducing money supply?

China: All at the same time

When taking a quick look to the latest news about China, it feels that the blow up is just around the corner. Just consider these headlines and excerpts:

* “The speed at which China's local governments are taking on debt is "terrifying".” (Business Insider, 28 June 2011)

* “After years of housing prices gone wild, China’s property bubble is starting to deflate.” (Wall Street Journal, 9 June 2011)

* “And legendary short seller, Jim Chanos, says China’s local government debt is worse than America’s subprime problem.” (The Christian Science Monitor, 14 June 2011)

* “The official public debt of the central government was only 19% of GDP at the end of 2010. Adding the debts of local governments, the non-performing loans of the banks and other liabilities, such as central-bank bills, the public debt amounts to about 80% of GDP according to Andrew Batson and Janet Zhang of GaveKalDragonomics, a consultancy in Beijing.” (The Economist, 2 June 2011)

* “China: new lending sharply down” (Financial Times, 13 June 2011)

* “The yield on Chinese bonds are inverting at an accelerating rate. This does not portend well for the Chinese economy, and this may have negative implications globally.” (Moneynews.com, 24 June 2011)

Based on facts or just guesses, these expectations may very easily be self-fulfilling. According to the logic of finance, the real risks are extremely high too.

But that’s not all. China’s large forex reserves are not well diversified either. It is estimated that around two-thirds of the total USD 3.04 trillion is invested in US dollar-denominated assets and that US Treasury bills account for half of these assets. In addition, euro-denominated assets accounted for a large share of forex reserves -- up to 25 percent. (Source: Want ChinaTimes, 6 June 2011) What if US rating will be downgraded or Greece will default? Note that if “money game” were fair game, both of these events would have happened already.

Among others the above urges us to ask:
* What are the links between the above and the China’s current monetary policy?
* How China is planning to manage all of these risks and uncertainties at the same time? Which risks are actually manageable and which ones are not?
* What is more likely for China: soft landing and hard landing?
* What is China going to do with its foreign reserves?
* Should we fear a serious conflict between China and US?

The above presents only a fraction of all the current global financial and economic challenges – a bare top of an iceberg. Vote into which topic we should bring the clarity first or add your own: vote, support and win! I feel that no matter how well educated and capable central bankers and policy makers may be, we cannot rely on them only. Our own ability to interpret the news is at least as important.

1 comment:

  1. You are bloody fantastic! I love your blog.