Tuesday, 28 April 2009

The UK budget: What is really going on…?

by Juan Pablo Painceira

The debate on the nature of the UK budget has been hot over the last week in all media. The main issues addressed are the taxation on the wealthy, Darling’s economic forecasts and the huge climb in public debt since October 2008. The rise to 50% taxation on the top income earners (over £150,000) has been called a revival of class war, a return to Old Labour policy or even a populist measure targeting the next election.

The UK growth forecasts of a fall of 3.5% and rise of 1.2%, respectively, for 2009 and 2010 have been ridiculed by many analysts. It does seem a bit unrealistic given that the IMF and consensus forecasts are a drop of 4% in 2009 and growth of only 0.3% in 2010. Besides, it is well known that governmental forecasts are always more optimistic than the market’s: if a finance minister forecasts less than the market for sure they should be fired! It’s all about information and expectations my dear! Surely we can all agree that growth forecast of 3.5% to 2011 is somewhat exaggerated. According to the debate in the media the other areas to focus on included a rise in the annual limit for tax-free ISAs to more than £10,000 - to come in from October 2009 for the over 50s; the stamp duty holiday for homes up to £175,000 is to be extended to the end of the year; and there will be more job help for the long term young unemployed.

The rise of public sector borrowing and, consequently in public sector debt have raised concerns about the sustainability of the UK’s finances over the coming years which is affecting the pound and is reflected in a possible downgrade by a rating agency from AAA. Since last Wednesday there has also been capital outflow from the Gilts with the benchmark yield Gilt-10 rising more than 20bp.

Basically, the economic debate on budget which has played out in the media has been whether the UK government has to cut more on public expenditure or to increase taxation in the coming years. It sounds familiar, doesn’t it? This is the same old debate re-heated.

What we haven’t heard so much about is the huge public exposure to the bank bail-outs which is around £1,000 bn. since the Northern Rock rescue. It’s off the agenda already?!?!

Or even the cuts in planned public spending, where the public sector, in particular the NHS is expected to generate savings, but which are being labelled efficiency savings.
It is a strange world where via a cut in spending, the system suddenly becomes more efficient and generates cash! We can only imagine how this will work at the micro level…

The Economist's reaction to the budget is at least harsh. They are calling for a more realistic budget where the government should say explicitly to the British nation that the costs for getting the UK out of the financial crisis and recession should be shared (or paid) by everyone, including you!

In the same rhythm, the IMF is just as concerned by the extension of fiscal stimulus in Spain, talking of the need for institutional reforms (mainly in the labour markets) in order to keep the sustainability of the Spanish long-term economic growth. There is no free lunch.

Yet for all the criticism, slowly events are potentially generating a situation and political environment where the fiscal adjustment could be implemented, the cost borne by the tax payer, perhaps with some neo-liberal reforms thrown in to convince us it won’t happen again. That way the fiscal expansion could be calibrated according to the needs of banking system and we can get back to business as usual…

For the time being…as we have addressed in past posts, it seems ‘plus ca change’… let’s see how the GDP predictions turn out and if they really have enough in the tank to plough on through…

Monday, 20 April 2009

Plus ca change… Finance Capitalists (still) rool ok?

by Duncan Lindo

A month or so ago the world seemed about to change: bankers were bad, Sir Fred was in hiding, AIG was being punished and a rethink of financialised capitalism seemed possible. Today the bad banker headlines are fading, banks’ results are improving and there’s talk of repaying TARP funds. In fact finance capitalists seem to be winning the struggle by some margin. Three news stories of recent weeks show that so far there has been no fundamental questioning whatsoever of financialised capitalism; indeed is anything the crisis is being used to usher in ever more market-friendly measures.

A review of fair value accounting led to a relaxation of the rules, resulting in less mark-to-market, but no fundamental questioning of the idea that market prices in financial markets are efficient and result in correct allocation of resources – despite the crisis. In a previous blog we explored how expansion of mark to market expands the “everything-for-sale” attitude with it’s short-termist outcomes and ever more power to the financial elites.

The so-called CDS big bang cedes some power from banks to other investment firms such as PIMCO. But let’s be clear here, PIMCO or any other investment firm are just as much interested in trading revenues as the banks. This is not a big bang it’s only a small shift. Are these really the hedgers / investors that the literature makes so central to the ability of derivatives to spread risks? I don’t think so. The contract changes all work in the direction of further standardisation in preparation for central clearing. This flies in the face of returning CDS to be a hedging tool. Credit transfer products such as CDS have become steadily more standardised over the last 20 years inviting ever increasing trading volumes for those who spend the day buying and selling. But a true hedger requires the opposite - a bespoke contract which they will hold until maturity. As explored previously “counterparty risk” is a red herring being used to usher in ever more trading / market friendly conditions.

These two stories trends are manifesting themselves in a slight upturn in the latest banks’ results. Banks have taken advantage of the relaxation of fair value accounting to report better numbers and are also reporting better trading revenues on wider bid-ask spreads. Strange world where large spreads are due to the low level of liquidity that is caused by the financial crunch which was caused by…..banks!

When the vast majority of economists are trained to believe markets work we shouldn’t be surprised that when markets fail (again) the response is to look past the facts and attempt to implement markets yet harder and faster. How long will it take for the realisation to sink in that something more fundamental needs to change? Well don’t hold your breath! It takes a long time to turn a tanker even as it hits a storm, what’s more there are powerful forces trying to ensure the route through the storm is to keep in the same direction but go even faster!

PS: Should we be surprised that the finance capitalists are winning the day when two of their number are holding the most relevant posts in the White House? As Stiglitz puts it: “America has had a revolving door. People go from Wall Street to Treasury and back to Wall Street. Even if there is no quid pro quo, that is not the issue. The issue is the mindset.”

Tuesday, 14 April 2009

Financial Literacy - important points to think about

by Christina Laskaridis

Provision of services to enable consumers to handle money, debt and their overall finances better has expanded considerably in recent years. In the UK the FSA are leading initiatives in financial capability and literacy e.g. spending £90m on it’s National Financial Capability Strategy, in conjunction with government, the financial sector and a multitude of non-profit organisations. This follows the discovery that the UK’s population has a low level of financial literacy, manifested as money and debt mismanagement, little planning, limited shopping around for alternative financial products and low product awareness. In 2006 an estimated 10.5 million people around the UK were experiencing difficulties in at least one of these areas, a figure which has probably risen since. The campaigns aim to improve personal financial administration through better budgeting and debt prioritisation and improved maths’ skills.

Despite the belated effort to address a serious problem by introducing such support, the strategy raises a few points of contention. Firstly, it focuses on debt prioritisation but leaves unaddressed the choice this will leave for the most vulnerable between rent and food. The National Strategy does not encompass food support for those in such a position, as has been proposed for example in Canada’s financial capability raising programmes.

Secondly, if the National Financial Capability Strategy is taking the form of a larger scale social welfare programme should the responsibility of leading it lie with the FSA – the financial services ‘regulator’, a body that is not subject to the public’s scrutiny, or should it lie with the government – through the Departments with the capability in providing social and education services? Given the experience and access to provision channels would it make more sense for this to be publicly provided?

Thirdly such a strategy implicitly accepts without argument that households have and should accept these responsibilities. Arguments focusing on the recklessness of consumers and home-buyers evade the discussion about the structures that cause oppression through finance. Households are now burdened with a much greater individual responsibility of financial risk management as finance has expanded into ever more areas of everyday life, e.g. the decline in public welfare policies and wide-spread privatisations, which means a precarious balance of risks are transferred and borne by the household.

The debate on raising financial literacy and capability – the crux of this financial education approach - does not ask what the institutional factors that have led people to find themselves in the situation they do and, as corollary why others do not. Without addressing the inequality within the financial system, the whole debate on financial capability resigns those deemed financially incapable to being seen as irresponsible and out of date – quite ironic as concurrently masses of analysts highly specialised in finance are also defamed for irresponsibility. Should we all be learning the theories which have guided us into the current crisis?! The focus of the National Financial Capability Strategy is in educating the innumerate, financially incapable segments of the population, rather than identifying let alone re-arranging the provision of financial services as a cause of the problem to start with. It orientates itself around educating the public about becoming better consumers, evading altogether the content of economic and financial relations that people are in.

Lastly, an entirely different model of education about finance and economics could be put in place, in which adult education is not used as a disciplinary mechanism to assist conforming and adapting to society. Community-wide education in economics and finance can be work by looking at one's own position and linking it to others; by connecting knowledge and action, education can lead to a critical assessment of one’s situation. Education fostering critical thought in the sphere of economics and finance can lead to comprehending a historical specific situation which is susceptible to change. Financial capability need not be only about better budgeting support but a wider and deeper awareness raising programme to assist people in demanding more equal treatment in the sphere of finance.

Tuesday, 7 April 2009

The SDR by IMF: could it become a new World Money?

by Juan Pablo Painceira

The size and spread of present financial crisis has shown to analysts and public alike how important the dynamic of world money is to the global economy. Surely this crisis would not have the same magnitude if the heart of crisis was not the US economy, the issuer of world money. The importance of international money in the unfolding of financial crisis was addresses by this author in an earlier RMF discussion paper (http://www.soas.ac.uk/rmf/papers/).

It is well know that the Federal Reserve has taken conventional and extraordinary measures to tackle the 2007-08 financial crisis in order to rescue/recover the financial system’s ability to perform their normal functions, and in particular banks,. Among the FED’s measures, the swap currency lines, initially offered to the major central banks and extended to the key developing countries after September 2008, are directly related to the role of dollar as world money. Basically, the Federal Reserve has offered credit lines in dollars around the global economy.

The spread of those swap lines and the monetisation of US public debt have raised questions about the functionality and stability of international money, ie the US dollar. Recently, the China’s central bank chief and the Russian government have proposed a bigger role for the IMF’s SDR in global financial operations in order to achieve a supra-national reserve currency to replace the dollar as world money. The Special Drawing Rights (SDR) created by IMF in the 1970s is a basket of major currencies traded in the international financial and commercial operations. The value of SDRs daily is determined by summing, in US dollars, the values of a weighted basket of currencies and used as monetary reference to the IMF’s operations. So, the SDR are reserve assets.

The emergence of new world money and the reform of international financial system has been widely discussed in the last weeks e.g. G. Soros addressed the need for the IMF to take care of some developing countries external financing immediately in order to avoid a Great Depression; the increase of issuance of SDR would be the instrument to use. Some analysts are arguing that a new global reserve currency would lead also to changes in the process of reserve accumulation and exchange rate regimes among the major countries. A UN commission lead by J. Stiglitz advocates that to deal properly with the consequences of global imbalances it is necessary to have a new global reserve system based on the expansion of the SDR.
It seems that this new world money would lead a more stable and equitable global financial system.

However, some questions are still remained…Would China be really interested in walking away from dollar denomination, considering that its foreign exchange portfolio is highly concentrated in dollar? The same question could be asked for Japan. If the IMF becomes the global lender of last resort, who would be the Treasury of last resort? Who will control the political decisions to lend or not lend? I recognise that those questions are hard but we know from the economic history that a change in the global monetary standard can be painful and that effects can last many years as did the change from the gold standard to the dollar-gold standard. Lastly, a currency has a political force behind it, even when it is a supra-national currency, are the conditions ripe for the IMF / World Bank to take on such a role?