BROKE COUNTRY WITH LAVISH INTENTIONS

A few hours after a surprising change in power, the World Bank issued a country report in which it warned the incoming Government of the massive gaps in the finances of the country. the theme and the message of the report was that Ghana was broke! This was in contrast to a report barely 3 months ago in which the same institution praised government on its economic management performance and how it had done extremely well in the face difficult external circumstances. But a in a twist that surprises no one but equally abhors everyone

Is monetary policy still a potent weapon against recession?

Is monetary policy still a potent weapon against recession? WRITING in Slate magazine in 1997, Paul Krugman, an American economist, neatly captured the widespread belief in the omnipotence of the then-chairman of the Federal Reserve. “If you want a simple model for predicting the unemployment rate in the United States over the next few years, here it is: it will be what [Alan] Greenspan wants it to be, plus or minus a random error reflecting the fact that he is not quite God.” Faith in the Federal Reserve is not what it used to be. Since September the Fed has cut its policy rate by 1.75 percentage points, to 3.5%. It still has plenty of firepower left—rates are some way above the 1% level reached in 2003—but few seem willing to rely on monetary policy alone to save the day. Politicians and pundits alike were making a case for a fiscal stimulus package even before the Fed's surprise rate cut on January 22nd. That Ben Bernanke, the Fed chairman today, has given his blessing to the plan only adds to the impression that central banks have lost their grip. What lies behind this loss of faith? One cause is the feeling that overly loose monetary policy got the economy into this mess. Repeated cuts in interest rates during the last downturn, in 2001-03, fuelled the housing and credit bubbles that are now bursting to such damaging effect. The legacies of that boom—falling asset prices, high consumer debt and bank losses—may now hamper the ability of central banks to prop up spending. One of the ways that central banks affect the economy is through their influence on the price of assets, like shares or homes. Other things being equal, a reduction in short-term interest rates should bump up asset values, because their stream of future earnings is discounted by a smaller factor. Now that America's housing boom is ending, the worry is that the Fed is less able to stimulate the spending that comes with rising housing wealth. Assets are already dear, it is said; there are no bubbles left to reflate. Falling home prices make for a nation of savers, not shoppers. And firms are not keen to invest when the market value of their assets is shrinking. Falling asset prices hurt the market for credit too, interfering with another policy channel. Monetary policy affects the choice between spending now or spending later and, for the cash-strapped, credit provides the bridge from the present to the future. Interest rates are the cost of using tomorrow's income to pay for today's spending. Lower rates lift spending by more when there is access to borrowing. Firms and homeowners can borrow cheaply with good collateral, but funds are less abundant when asset values are falling. Consumers may in any case have had their fill of borrowing. Household debt in America has vaulted to more than 130% of disposable income from less than 100% in 2000 (see left-hand chart). In Britain the ratio is higher still. And even if credit demand holds up, banks reeling from subprime-related losses are less willing to supply it. Another strain of policy pessimism argues that interest-rate cuts will only fuel inflation, without helping the economy. In fact it seems likely that America's economic slowdown will create enough slack to ease inflationary pressure. That, at any rate, seems to be the judgment of the bond markets. In the months since the Fed's first rate cut in September, ten-year bond yields have dropped steadily, in contrast to the reaction to the rate cuts in early 2001, when bond yields drifted upwards (see right-hand chart). The distant sound of whirring rotors Central banks are not toothless, however. They can still affect spending by altering the returns of existing savers and borrowers. Lower interest rates increase the disposable income of debtors, by cutting their repayments, even as they eat into savers' cashflow. Borrowers are likely to spend more out of each additional dollar, so tilting the scales in their favour by cutting rates should boost demand. In America the household sector's debt has grown faster than its stock of interest-bearing assets, so the cashflow channel is now likely to be more, not less, powerful. The effect is probably stronger still in countries such as Britain and Spain, where most mortgage rates are closely tied to policy rates or fixed for only short periods. Although the asset-price and credit channels are more constricted than in the past, monetary policy can still work through them. Interest-rate cuts are unlikely to lift house prices, but they may at least arrest the size and pace of price falls. The firms and households that are less burdened by debt will be able to take advantage of lower interest rates, even as others are struggling to reduce their borrowing. If the Fed still has some clout, why the clamour for fiscal stimulus? In an election year, politics is one obvious factor, but economic arguments can also be brought to bear. One attraction is that it eases the over-reliance on monetary policy. Alan Blinder, a Princeton professor and former Fed governor, also argues* that fiscal remedies can boost demand more quickly than interest-rate cuts. Tax breaks work well if they bring spending forward, say by targeting help on the poor, who are more likely to spend than save—though this may be hard to arrange in practice. The drawback is that it leaves decisions to politicians, who risk taking too long to agree on the right policies in a slump and are unwilling to raise taxes in a boom. Although monetary policy is normally best placed to help stabilise the economy, there are some circumstances where fiscal policy can help—during long or deep recessions, when demand suddenly slumps, or when interest rates fall to zero. In the latter case, writes Mr Blinder, “a combined monetary-fiscal effort—deficit spending or tax cuts financed by printing money—may be needed”. This is Milton Friedman's “helicopter drop” of money. Only then will the Fed really start to feel impotent.

A NEW THINKING IS REQUIRED

If emerging economies diverge from America's, monetary policy also needs to break free POLICYMAKERS in Washington and London have been losing sleep over the risks of financial meltdown and recession. In sharp contrast, the biggest worry in Beijing, Moscow and other emerging-market capitals is rising inflation. China's inflation rate has jumped to 8.3% from 2.2% in early 2007; Russia's is running at 13.3% (see left-hand chart). HSBC forecasts that the average inflation rate in emerging economies will rise to 6.6% this year, its highest in ten years. One reason is the surge in food and energy prices. Food accounts for a bigger slice of spending in poor countries than in rich ones, so rising grain and meat prices have a bigger impact on inflation. But this is only part of the story: core inflation rates are also creeping up, and lax monetary policies are to blame. As America stumbles, growth in emerging economies seems to be holding up well. HSBC forecasts average GDP growth of 6.5% this year, more than four times as fast as in developed countries. The problem is that although economies may have decoupled, their monetary policies have not. Whereas the greater resilience of the emerging world is a source of stability for the global economy, the monetary linkages between rich and poor economies complicate matters. Emerging economies were partly to blame for America's housing and credit bubble. As China and Gulf oil exporters purchased American Treasury bonds in order to hold down their currencies, this pushed down bond yields and helped to fuel the housing boom. Low yields also encouraged investors to seek higher returns in riskier assets, such as mortgage-backed securities. That bubble has burst, prompting the Federal Reserve to slash interest rates. Now, those same exchange-rate policies that helped to cause America's financial crisis are leading emerging economies to run overly loose monetary policies. Apart from the Gulf states, few countries still peg their currencies to the dollar, but most try to limit the amount of appreciation. This means that as the Fed cuts rates there is pressure on emerging economies to do the same, to prevent capital inflows pushing up their exchange rates. Saudi Arabia, the United Arab Emirates, Qatar and Bahrain have all followed the Fed's April 30th rate cut. In the face of rising inflation, emerging economies should be lifting interest rates, not cutting them, but their rigid currency policies make this hard. In turn, continued surging demand in emerging economies boosts commodity prices, which reduces Americans' spending power and so encourages the Fed to cut rates further. The more the Fed cuts, the bigger the risk of inflation in emerging markets. The right-hand chart shows just how loose monetary policy is. Joachim Fels and Manoj Pradhan, of Morgan Stanley, have made a stab at estimating neutral interest rates, ie, the short-term rates that would keep GDP growing at its trend pace and inflation on a stable path. The results are startling. In China and Russia, actual real rates are negative, against estimates of neutral real rates of 8% and 5% respectively. In India, real rates are close to zero—still far below the estimated neutral rate of 6%. Only in Brazil are real rates positive and above the neutral rate. Admittedly this ignores other tightening measures that central banks use, such as banks' reserve requirements (both India and China have been steadily increasing them). Nevertheless, it is no coincidence that Brazil has the lowest inflation rate of the four countries. Russia, with the lowest real interest rates, has the highest inflation. Not so easy The usual advice given to overheating emerging economies is that they must let their currencies rise. This would help to curb inflation by reducing import prices, and a flexible exchange rate would create more room for an independent monetary policy. Currency appreciation thus seems the obvious solution. However, Stephen King and Stuart Green, economists at HSBC, argue in a recent report that it raises many awkward questions. How far should currencies rise in order to keep inflation in check? China has allowed the yuan to rise by 18% against the dollar since 2005. Brazil's currency has appreciated by more than 100% since 2003, yet even this has not stopped inflation from picking up. At 4.7%, the rate may be lower than other big developing countries, but it is still up from less than 3% a year ago, partly because of excessive growth in domestic demand. In the past two years real interest rates have fallen sharply (although they are still the highest in the world) and public spending has surged. In April the central bank raised interest rates for the first time in three years, but this is likely to lure in foreign capital. Should Brazil let its exchange rate rise further—when its current account has already moved back into deficit? The danger of allowing these currencies to float is that they could overshoot as foreign capital floods in, eroding competitiveness and leaving economies vulnerable to a future reversal in capital flows. Another concern is whether it is wise to allow exchange rates to rise sharply when emerging-market exports are being hurt by an American recession. There are no easy solutions. One alternative to a free float is a one-off appreciation. The danger is that this could encourage the expectation of further appreciation, attract even bigger capital inflows and so exacerbate inflation. To work, the revaluation would need to be so big that speculators no longer expected a further rise. But a big increase might not be politically feasible. Another solution is to tighten fiscal policy. This would cool domestic demand without the need for a big rise in interest rates. The snag is that it would boost domestic saving and hence lead to larger current-account surpluses—the opposite of what America requires. The third option, and the one most likely to be pursued, is to do nothing apart from slapping on some temporary price controls, and hope that inflation pressures will soon ease. The risk is that if inflation continues to rise, policymakers will eventually have to slam on the monetary brakes. IF GILBERT AND SULLIVAN were looking for the very model of a modern intellectual, they would surely pick Jeffrey Sachs. He is so “right on” that when Time magazine featured him in its global list of people who influence the world, his profile was written by Bono, a rock singer. His job titles—director of the Earth Institute and special adviser to the United Nations Secretary-General on the Millennium Development Goals—seem almost tailor-made to get up the noses of conservatives. Nor is Mr Sachs lacking in ambition. His previous book was called “The End of Poverty”. Now he has moved on to tackle a wide range of other challenges facing the planet, from climate change through to disease eradication. His goals include stabilisation of the world's population, a move to sustainable energy use and “a new approach to global problem solving”. If the above makes Mr Sachs sound like an impractical dreamer, that would be rather unfair. This densely written book is packed with statistics and carefully worded arguments. Nor is the author a left-wing ideologue. He recognises that the private sector and market-based solutions have a vital role to play. He cites, for example, the success achieved by public-private sector initiatives in tackling acid rain and chlorofluorocarbon emissions. On population control, he makes the good (if counter-intuitive) point that improvements in infant mortality are an important part of the solution. When families know that more of their children will survive into adulthood, they have fewer kids. Reduced fertility in turn leads to improved living standards and, eventually, by cutting the numbers of idle and impoverished young men, reduces the potential for conflict and terrorism. As he remarks, this makes the Bush administration's negative attitude towards family planning even more difficult to understand. Courageously, Mr Sachs does not ignore costs. He reckons the bill for tackling the issues he raises will come to a total of 2.4% of rich-world economic output (about one year's growth). That seems a reasonable price to pay, provided of course that you are not paying it. Indeed, the book's rather jaunty tone plays down some of the hard choices that will need to be made if the world's problems are to be tackled. On climate change, Mr Sachs is very enthusiastic about carbon capture and sequestration, a technology that is unproven on a large scale and will be difficult to adapt to existing power plants. One must also doubt whether all the world's cars could really be converted into gas-electric hybrids by 2026, as he suggests. This brings us to the main problem with the book: it is unremittingly worthy and expects other people to be so too. When the author writes that a post-Kyoto agreement on climate change “should include all actors, not just the rich ones, and not just the rich ones who are willing to reduce emissions”, one wonders how many real people would vote for that. Similarly, he says blithely that “in order to combat poverty and inequality, it is also essential to combat racism and intolerance.” If everyone in the world were as reasonable as Mr Sachs, his solutions would be easy to implement. However, if everyone were that reasonable, there would not be so many problems in the first place.

OUR MACRO OBSESSION

Our central Bank has taken its eye off the essential Ball of growth and is fixated with fighting inflation...and returning impressive macro economic data Headline Inflation Headline consumer price inflation which rose steadily to 18.4 percent in June, eased back to 17.9 percent in September, showing three (3) consecutive months of decline in the third quarter of the year. Price developments within the quarter saw monthly growth rates especially for the non-food category slow down relative to trends observed for the same period in 2007. Food prices also decelerated during the quarter mainly on account of improved food supply situation during the quarter. As a result, the average price increases of food in the third quarter improved relative to trends a year ago. Non-food prices also turned in better than a year earlier. Cumulatively for the year as a whole, inflation, by the end of the third quarter had registered an increase of 5.1 percentage points, moving from 12.8 percent at the beginning of the year to 17.9 percent at the end of September 2008. The increase in the year so far has been driven by both food and non-food prices. Food inflation which stood at 10.5 percent at the end of December 2007 increased to 17.9 percent by the end of September 2008. Non-food prices, on the other hand, also increased from 14.4 percent at the end of December 2007 to 18.5 percent by the end of September 2008. Details of the annual inflation rates within the various sectors of the economy for the periods September 2007 and September 2008 are reported in Table 2. Inflation rate varied across sectors. Some key sectors experienced sharp increases were the food sub-group, alcoholic beverages and tobacco, clothing and footwear, housing, and utilities, imported household goods and equipment, transportation costs, and educational costs. Inflation has turned in better than expected during the third quarter of the year with prospects of continued easing. At the last policy meeting, the Central Bank raised its key policy rate by 1 percentage point in an effort to dampen inflationary pressures and expectations. The response to the rate rise has been elastic with economy wide rates moving by more than a percentage point. Credit conditions tightened and crude oil prices have since retreated significantly and crude oil is trading at around US$60 per barrel (in the early weeks of November). The significant drop has occurred in the midst of the financial turmoil in the world economy with concerns about the depth and duration of recession in the global economy. At the July 2008 MPC meeting, the expectation was that crude oil prices would continue to rise and stabilize at around US$150 per barrel for 2008. That assumption combined with initial conditions at the time, including spiralling food and energy prices and a relatively faster pace in the depreciation of the

A martyr for the cause

The Man who may say defined the art of Central Banking admits "he didnt understand the financial Markets"! People say the former Federal Reserve chair is just trying to save his own skin – I think he's trying to save ours First they came for the short-sellers, and I did not speak up because I wasn't a short-seller. Then they came for the bankers, and I did not speak up because I wasn't a banker. Then they came for Alan Greenspan, and he rolled over, said sorry and provided some much needed confidence in a crisis-laden market. Yesterday, Greenspan told the House oversight committee that he took some of the responsibility for the current turmoil by admitting his prior lack of elucidation on the subject of regulation. Today, the press has mostly been deciding not only whether he was right or wrong but whether he actually admitted he was right or wrong. The thing with the economy is that because it involves money, it is seen as a science – a thing to be right or wrong about. Yet the variables in the economy – indicators such as consumer confidence or unemployment – are just extrapolations of theories that give a general idea of the state of the economy, not a definitive answer to its problems. Obviously much of the press attention has been devoted to the dichotomy of blaming Greenspan for the current turmoil, having previously worshipped him as the god of all things shiny and bling. Yet very little has been devoted to why he has made this confession – why a retired official, two years out of office, would return to take some of the current deadweight on his shoulders. It is interesting to look at Greenspan's reputation. He is almost universally seen as the man who led the way through the stock market crash of 1987 and the dot.com boom/bust crisis of 2000. However, according to the New York Times, he says he refuses to accept blame for the crisis. Is it not strange for a man so universally revered for the biggest period of growth in capitalism's history to suddenly step up and take responsibility? At 82 years old, with an almost religious following, would you take responsibility for an international financial crisis the likes of which we haven't seen for 80 years? I hope so. At this stage in the meltdown, people like Greenspan know better than anyone else the options available to US, European and UK banks and treasuries. The options are limited. They can ban short-sellers, but to what end? It quickly became clear that the short-selling ban was merely an attempt to prove that something was being done. So what else is there to do? The injection of billions of dollars into banks might allow some further liquidity to allow business to continue but it does little to allay panic. Greenspan has martyred himself for the cause. He has presented himself to congress as a part of the problem. By suggesting he has made mistakes he is allowing for the recognition that his absence from the Federal Reserve might precipitate some positive changes to the economic system. Greenspan's most important role at the Federal Reserve was to inspire confidence through bad times: a job that he continues, unpaid, today. Many people say he's just trying to save his own skin; I think he's trying to save ours. Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient.” — Alan Greenspan in 2004

The high priests of the bubble economy

The high priests of the bubble economy If Barack Obama really wants things to change, he shouldn't be seeking economic advice from Clinton-era officials Those following the meeting of Barack Obama's economic advisory committee could not have been very reassured by the presence of Robert Rubin and Larry Summers, both former Treasury secretaries in the Clinton administration. Along with former Federal Reserve Board chairman Alan Greenspan, Rubin and Summers compose the high priesthood of the bubble economy. Their policy of one-sided financial deregulation is responsible for the current economic catastrophe. It is important to separate Clinton-era mythology from the real economic record. In the mythology, Clinton's decision to raise taxes and cut spending led to an investment boom. This boom led to a surge in productivity growth. Soaring productivity growth led to the low unemployment of the late 1990s and wage gains for workers at all points along the wage distribution. At the end of the administration, there was a huge surplus, and we set target dates for paying off the national debt. The moral of the myth is that all good things came from deficit reduction. The reality was quite different. There was nothing resembling an investment boom until the dot-com bubble at the end of the decade funnelled vast sums of capital into crazy internet schemes. There was a surge in productivity growth beginning in 1995, but this preceded any substantial upturn in investment. Clinton had the good fortune to be sitting in the White House at the point where the economy finally enjoyed the long-predicted dividend from the information technology revolution. Rather than investment driving growth during the Clinton boom, the main source of demand growth was consumption. Consumption soared during the Clinton years because the stock market bubble created $10tn of wealth. Stockholders consumed based on their bubble wealth, pushing the saving rate to record lows, and the consumption share of GDP to a record high. The other key part of the story is the high dollar policy initiated by Rubin when he took over as Treasury secretary. In the first years of the Clinton administration, the dollar actually fell in value against other currencies. This is the predicted result of the deficit reduction. Lower deficits are supposed to lead to lower interest rates, which will in turn lower the value of the dollar. A lowered dollar value will reduce the trade deficit, by making US exports cheaper to foreigners and imports more expensive for people living in the US. The falling dollar and lower trade deficit is supposed to be one of the main dividends of deficit reduction. In fact, the lower dollar and lower trade deficit were often touted by economists as the primary benefit of deficit reduction until they decided to change their story to fit the Clinton mythology. The high dollar of the late 1990s reversed this logic. The dollar was pushed upward by a combination of Treasury cheerleading, worldwide financial instability beginning with the East Asian financial crisis and the irrational exuberance propelling the stock bubble, which also infected foreign investors. In the short-run, the over-valued dollar led to cheap imports and lower inflation. It incidentally all also led to the loss of millions of manufacturing jobs, putting downward pressure on the wages of non-college educated workers. Like the stock bubble, the high dollar is also unsustainable as a long-run policy. It led to a large and growing trade deficit. This deficit eventually forced a decline in the value of the dollar, although the process has been temporarily reversed by the current financial crisis. Rather than handing George Bush a booming economy, Clinton handed over an economy that was propelled by an unsustainable stock bubble and distorted by a hugely over-valued dollar. The 2001 recession was relatively short, but the economy continued to shed jobs for almost two years after the recession ended. Because President Bush refused to abandon the high dollar policy, the only tool available to boost the economy was the housing bubble. In addition to the growth created directly by the housing sector, the wealth created by this bubble led to an even sharper decline in saving than the stock bubble. Of course, the housing bubble is now in the process of deflating. The resulting tidal wave of bad debt has created the greatest financial crisis since the second world war. With the loss of $8tn in housing wealth, consumption has seized up, throwing the economy into a severe recession. While the Bush administration must take responsibility for the current crisis (they have been in power the last eight years), the stage was set during the Clinton years. The Clinton team set the economy on the path of one-sided financial deregulation and bubble driven growth that brought us where we are today. (The deregulation was one-sided, because they did not take away the "too big to fail" security blanket of the Wall Street big boys.) For this reason, it was very discouraging to see top Clinton administration officials standing centre stage at Obama's meeting on the economy. This is not change, and certainly not policies that we can believe in.

A NEW WORLD ORDER?

More than a new capitalism, the world needs a new multilateralism JUST under ten years ago, during the emerging-market financial crises, Time magazine ran a cover headlined “The committee to save the world”. It showed Alan Greenspan, then chairman of the Federal Reserve; Robert Rubin, the treasury secretary; and Larry Summers, his deputy. Inside was a breathless account of how this trio of Americans had saved the world economy from calamity by masterminding IMF rescue packages for cash-strapped Asian countries through weekend meetings and late-night conference calls. Today the threats facing the global economy are graver than they were a decade ago, yet it would be hard to know whom to put on such a cover. Wall Street is at the centre of the mess, so America’s stature and intellectual authority has plunged. Rather than staving off defaults in Asia, Mr Paulson, today’s treasury secretary, and Ben Bernanke, chairman of the Federal Reserve, are battling to prevent the implosion of their own financial system. Instead of dictating tough terms to Asian governments, they have been begging Congress for public money to deal with Wall Street’s most toxic securities. But even as the crisis spreads far beyond America, few others have so far shown much sign of leadership. Europe is rife with Schadenfreude at America’s travails but its politicians have been slow to recognise the scale of their own problems. China, the biggest, most resilient emerging economy and the one with the deepest pockets, has stood quietly on the sidelines. The IMF provides useful analysis but has no political clout. The only institutions that have co-operated, and creatively so, are the rich world’s central banks. Even as many politicians have grandstanded and pointed fingers, the ECB, the Fed, the Bank of England and others have tried to stem panic by flooding financial markets with liquidity, lending eye-popping sums of money against all manner of collateral. Unfortunately, central bankers—however creative—cannot sort out this mess with injections of liquidity alone. That is because it is a crisis of solvency as well as liquidity. The bursting of the biggest housing and credit bubble in history has caused a banking bust that will probably turn out to be the biggest since the Depression, affecting many countries simultaneously. Across the rich world banks are short of capital; many are insolvent. As they deleverage, they will force down asset prices and weaken economies that are already stumbling, so the mess will only worsen. Uncertainty and panic have already amplified the problem as banks hoard cash. The urgent task is to prevent a grave multi-country banking crisis from becoming a global economic catastrophe. That ought not to be too hard. Thanks to the growing importance of emerging markets, the world economy has become more resilient to trouble in its richer corners. Capital is plentiful outside Western finance. Now that commodity prices have tumbled, the rich world’s central banks have plenty of room to cushion their weakened economies with lower interest rates. And although public-debt burdens are already heavy, notably in Italy, Europe’s governments, like America’s, have enough public funds to prevent a capital-starved banking system dragging their economies down. This has already started to happen, most strikingly with the American government’s $700 billion plan to take over mortgage-backed securities. But other governments too are stepping in. Five European banks were nationalised or bailed out with public funds in the last week of September. Several European governments have guaranteed the deposits and in some cases the debts of their banks. Yet these disparate rescues are likely to be more expensive and less effective than a more co-ordinated policy that reaches beyond the financial system alone. The panic in the markets would be stemmed if the rich world’s governments agreed on a common approach for stabilising and recapitalising banks. Equally, a co-ordinated interest-rate cut would boost confidence and make economic sense: the inflation threat is receding simultaneously across the rich world. Any such policy co-ordination must include the big emerging markets as well. By boosting domestic spending and allowing its currency to appreciate faster, China could counter deflationary pressures in the rest of the world economy and help support growth in Europe and America just when this is needed most. There are precedents for high-profile international economic co-operation, notably the Plaza and Louvre Accords in the 1980s. Designed, respectively, to push the dollar down and to prop it up, these agreements met with mixed success. Today’s problems are deeper, and the number of parties is larger. But if there were ever a time for a new multilateralism, this, the biggest financial crisis since the 1930s, is surely it. Learning the right lessons A successful multilateral strategy to staunch the crisis would also make it more likely that the world will rise to the second challenge: learning the right lessons. Too many people ascribe today’s mess solely to the excesses of American finance. Putting the blame on speculators and greed has a powerful appeal but, as this special report has argued, it is too simplistic. The bubble—and the bust—had many causes, including cheap money, outdated regulation, government distortions and poor supervision. Many of these failures were as evident outside America as within it. New-fangled finance has its flaws, from the procyclicality of its leverage to its fiendish complexity. But the crisis is as much the result of policy mistakes in a fast-changing and unbalanced world economy as of Wall Street’s greedy innovations. The rapid build-up of reserves in the emerging world fuelled the asset and credit bubbles, and rich-world central bankers failed to counter it. Misguided monetary rigidity caused financial instability. Much though people now blame deregulation, flawed regulation was more of a problem. Banks set up their off-balance sheet vehicles in response to capital rules. It is the same story with the spike in food and fuel prices over the past year. To be sure, commodities markets can overshoot—but rather than pointing the finger at speculators, governments should look in the mirror. Rich countries’ biofuel policies pushed up the cost of food. Poor countries’ food-export bans and fuel subsidies compounded the problems. In many ways today’s mess is a consequence of policymakers’ misguided reactions to globalisation and the increasing economic heft of the emerging world. If markets are not always dangerous and governments not always wise, what policy lessons follow? In the aftermath of the crisis the battle will be to ensure that finance is reformed—and in the right way. The pitfalls are numerous. Banning the short-selling of stocks, for instance, makes for a good headline; but it deprives markets of liquidity and information, the very things that they have lacked in this crisis. Even if the easy mistakes are avoided, improving supervision and regulation is hard. Financial regulators must look beyond the leverage within individual institutions to the stability of complex financial systems as a whole. Wherever the state has extended its guarantee, as it did with money-market funds, it will now have to extend its oversight too. As a rule, though, governments would do better to harness the power of markets to boost stability, by demanding transparency, promoting standardisation and exchange-based trading. Over-reaction is a bigger risk than inaction. Even if economic catastrophe is avoided, the financial crisis will impose great costs on consumers, workers and businesses. Anger and resentment directed at modern finance is sure to grow. The danger is that policymakers will add to the damage, not only by over-regulating finance but by attacking markets right across the economy. That would be a bitter reverse after a generation in which markets have been freed, economies have opened up—and prospered. Hundreds of millions have escaped poverty and hundreds of millions more have joined the middle class. As the world reconsiders the balance between markets and government, it would be tragic if the ingredients of that prosperity were lost along the way.

Can China help power the global economy out of a crisis?

Can China help power the global economy out of a crisis? The usual economic powers are still struggling and help is sorely needed. so will China prove that help. from all indications they are doing just that. They are currently providing almost all the funding for the US government's $700bn bail-out plan. After five years of double-digit expansion, the world’s fastest-growing economy has succumbed to the economic chill wind sweeping across the globe. China’s economy slowed to an annual growth clip of 9 per cent in the third quarter from 10.1 per cent in the previous quarter ¬– well below the consensus forecast of 9.7 per cent. With the credit crisis buffeting global economic growth, China’s industrial production and construction declined due to weaker export orders, factory closures for the Beijing Olympics and the sagging property market. However, retail sales growth remained strong, while inflation eased amid falling commodity prices. Nevertheless, Dominic Barton, Asia Pacific chairman of consultancy firm McKinsey & Company, is “very bullish about where China is going to be over the next two to three years.” Speaking at the World Knowledge Forum in Seoul, Barton says that while consensus economic forecasts point to a likely two-percentage point drop in China’s economic growth in 2009, its underlying growth drivers remain formidable ¬¬– due to its large consumer base, significant infrastructure expenditure and the Chinese government’s strong fiscal position. For its part, the government, which has currency reserves of US$1.9 trillion, has announced a raft of measures to address the darkening economic outlook. The government will increase infrastructure spending, raise export tax rebates, reduce property transaction fees, encourage banks to lend more money to small- and medium-sized companies, and introduce new programmes to support farmers. Furthermore, economists expect the central bank to cut interest rates for the third time this year. “We think growth will continue in China in almost every sector; there are some sectors where it will be zero,” says Barton, adding that some sectors and companies are growing at a rate of 40-45 per cent. For instance, steel manufacturers supplying construction companies in Shanghai, Shenzhen and Guangzhou are being hit hard by the property market slump, but companies in the software and pharmaceutical sectors are growing rapidly. Notably, the International Monetary Fund estimates China’s economic growth in 2009 at 9.3 per cent, compared with virtually zero growth in the US, euro area and Japan. To be sure, the forecast growth rate of 9.3 per cent is “still a very strong number,” says Steven Xu, chief representative of the Economist Group in China, who adds that inflation in China is “not a threat”. Xu, who was also speaking at the World Knowledge Forum in Seoul, cites three key cyclical reasons for his belief. Firstly, there are severe excess capacities in many of China’s business sectors – so businesses would have to lower prices in the domestic market at a time when China’s exports to the US, which accounts for 21-23 per cent of China’s goods and services, are slowing down. Secondly, the Chinese currency, which is loosely pegged to the US dollar, has been rising in tandem with the greenback, which has been counter-intuitively boosted by the credit crisis. This is due to fears that the financial crisis in Europe is even worse than in the US. The strengthening of the renminbi against most currencies is therefore deflationary for China, Xu says. Lastly, in terms of China’s equity markets, the A-share market has fallen from its peak of 6,300 points to a recent low of 2,000 points. “So the equity market has done certain things the central bank wanted to do but was not able to do as far as inflation-fighting,” explains Xu. In any case, China has accounted for a significant portion of global economic growth for many years. From this perspective, China’s economic ascent in the past two decades is a “re-rise”, says Barton, who has lived in Korea and China in the last eight years. Far from reaching a plateau, China’s economy will continue to soar, as 350 million Chinese will migrate from the rural areas to the urban areas in the next twenty years. Consequently, China will reach a “critical inflection point” as an estimated 270 million people will enter the middle-class bracket (per capita GDP of US$5,000), which will drive an exponential growth in demand for goods and services. This seismic macroeconomic shift is, in turn, fuelling a massive infrastructure boom: China is building 24 new airports by 2010; Beijing Airport’s new third terminal, which has a floor space of 986,000 square meters, is alone larger than the combined size of London Heathrow Airport’s five terminals. And according to Barton, China is building power generators with capacity thirty times that of New York City. “The power sector, just the energy it needs to fuel that growth … you’ve got to have the water systems, the energy, the electricity, all of that to go with it,” “We’re talking roads, bridges, 50,000 skyscrapers, over 200 cities with a million people. That all has to be built, so you’re going to see in many sectors – over half the world’s consumption of those products being there – that’s why commodities prices long term, I don’t see the pressure coming off. They may not be as spiky high as they are now, but that demand will continue.” Attracted by China’s explosive growth, foreign investment is still flooding in. “We are seeing a very substantial increase in the number of European and North American companies that are saying: ‘How are we getting our footprint right here? How do we participate in the growth?’” Barton says. Even so, foreign direct investment (FDI) has not been a major factor in China’s growth, which has been driven more by its domestic investments and consumption, says Barton. Indeed, China does not need FDI because of its huge domestic savings (of individuals, corporations and the government). But FDI has nonetheless aided China’s growth by bringing in advanced technological capabilities. Chinese companies are also starting to come of age. “These companies are getting the scale where they can actually buy other companies,” says Barton. “We’re seeing M&A activity. We’re seeing geographic expansion within China like we haven’t seen before, and encouragement from the government.” By his reckoning, probably 70 or 80 firms are “on deck and ready to go global” for a myriad of reasons – to access and compete in new markets, find new sources and enhance supply chains. “They’ve got the ambition, they kind of know where they want to go. The challenge is how do you do it because there are not a lot of role models in terms of how to do that. Probably more in India, than there are in China, but they are there. They are just getting to the scale now where they can do it.” But for all the hype over China’s role as an emerging driver of the global economy, it bears remembering that while China’s economy is larger than that of the UK, it is still smaller than the economies of the US, Japan and Germany. As such, China, by itself, would not be able to offset the global economic downturn caused by the US credit crisis. “It’s difficult to expect that China’s going to power us out. I think they can play a role definitely and I think they will,” says Barton. “And I think they can play a role in Asia because they can help the Koreans, they can help the Japanese, they can help the Southeast Asians in terms of the growth as well, so I think they definitely can be helpful but I don’t think we should look at them as the pillar that’s going to pull us out. They’re just not big enough yet.”

Rethinking global financial systems

Rethinking global financial systems

The consensus is loud and clear: in the wake of the worst global financial crisis since the Great Depression, a fundamental rethink of the structure of the global financial markets and greater cooperation of the major regulatory bodies are paramount, said the heads of major financial institutions at the World Knowledge Forum in Seoul.

And ahead of a meeting of the G20 nations in mid-November to discuss financial reforms, leaders from the 45 member nations of the Asia Europe Meeting (ASEM) have pledged to cooperate in overhauling the world’s financial systems and called on the International Monetary Fund (IMF) to ‘play a critical role’ in assisting countries most in need of aid.

At least five countries have reportedly sought the help of the IMF in injecting capital into their economies. The IMF, which has agreed to lend Ukraine $16.5 billion to ease the impact of the financial crisis, is also lending $2 billion to Iceland. Meanwhile, Hungary is reportedly close to securing a ‘substantial financial package’ from the IMF and the European Union.

Speaking at the World Knowledge Forum, Douglas Feagin, head of Goldman Sachs’

financial institutions group for Asia, believes that reforms of the financial services sector

are crucial in restarting economic growth in the US, Europe and the rest of the world.

Pointing to the bubbles in key asset classes, “unclearly unsustainable” leveraging in the financial systems, and poorly understood and managed derivative securities, Feagin says: “We are going to have to have a change across all these areas – the asset price bubbles, deleveraging and reform of the fundamental securities markets – in order to have a basis to restart economic growth.”

Meanwhile, fears of a global recession continue to weigh heavily on financial markets around the world, even as many individual countries – such as Australia, Japan, South Korea, Singapore, Kuwait and Saudi Arabia – have announced new financial and regulatory measures to shore up their financial systems and currencies, and boost confidence.

Governments around the world have so far reportedly pledged about $4 trillion to bolster banks and restart money markets. China, South Korea, Japan and ten Southeast Asian countries have also pledged to create an $80 billion fund to combat currency speculation.

“I think we are going to see for the first time a private-public sector partnership and a

globally coordinated attack on some of the underlying weaknesses in our global economy,” says Steve Ellis, worldwide managing director of consultancy Bain & Company.

“If we continue to act as the really globalised economy we are today, and if we maintain that tight linkage between public and private sector in ways that can reinforce the flow of capital, that can hopefully reinforce economic growth and address some of the very pressing issues facing our planet, I think we could look back on this as a real catalyst.”

While there appeared to be consensus among the speakers at the Forum that comprehensive reforms of the global financial systems are needed, opinion was split between some calling for a universal financial regulatory body and those supporting closer and greater cooperation between the major regulatory bodies around the world.

Sir Leon Brittan, vice chairman of UBS Investment Bank, expressed scepticism about

former Irish prime minister Bertie Ahern’s suggestion about the creation of such a universal regulatory body. Brittan, a former vice president of the European Commission, says he doubts this would be a “correct solution” given the presence of the IMF and the World Bank, as well as the protracted length of time needed and the significant challenges in creating such a regulatory body.

Brittan says a ‘more promising avenue’ would be a “college of regulators – and not a new super regulator – which would work closely together, with detailed regulations being applied in each individual country.”

“Cooperation between international regulators on a greater scale – even though it is already taking place and one shouldn’t underestimate the extent to which it is already happening – is something that is going to be important.”

Agreeing with Brittan, Jeffrey Shafer, vice chairman of global banking at Citigroup, criticised calls for “a universal global body with no direct democratic accountability” as an “ivory tower fantasy” and “a diversion of energy”.

Shafer, a former Under Secretary of the US Treasury, favours a focus in the US on regulatory functions rather than just on individual institutions. Regulatory bodies, he says, are needed to look into systemic risks and the activities of individual financial institutions.

“You need to give that systemic institution the power to intervene and actually make individual institutions do things when they see large imbalances emerging in the world, and that will be a tough thing to get into the regulation at the end of the day,” says Shafer.

To be sure, overhauling the financial regulatory frameworks around the world is a dicey proposition because while bad regulations can create crises, it’s not certain that good regulations can prevent them, cautions Paul Tregidgo, a vice chairman of the investment banking division of Credit Suisse.

The fundamental issue “right at the centre of the (financial) storm” lies in how risks are created, assessed, distributed and regulated, which are regulatory questions that must be addressed, says Tregidgo.

“Do we actually know when we create risk what we are creating? … When we assess risk, are we actually assessing risk in a world of global connectivity? Do we understand the cost and price of risk as it should relate to other instruments?”

“Do we understand that when it is subject to stresses which we have not experienced before, and lastly when we distribute risk, are we really distributing it?”

Tregidgo adds there is a need for closer regulatory oversight of how major financial intermediaries approach, assess and price risks.

“It’s time for a new regulatory contract but that regulatory contract, broadly speaking, must balance the complexity and connectivity of which I spoke earlier,”

“I would suggest minimal regulation but forceful in letter and spirit because innovation … is not going to go away and must be encouraged to flourish. But innovation cannot be allowed to game the system.“

Certainly, there are mixed views about how best to balance regulatory oversight and allowing room for financial innovation to spur economic growth. But for the next few years, ‘de-structuring’ or structural changes to banks and financial institutions will be a theme, says Michael Gordon, global head of institutional investments at fund manager Fidelity International.

“Regulation is going to have a goal of trying to get us to a more simple financial world,” says Gordon. “We may look forward to a world where banks are more like banks as we used to know them, brokers more like brokers, corporate finance returns as a function of itself, asset managers being pure asset managers and the like,”

“I think we will see a trend back to simplicity away from complexity. I think financial modelling will be less trusted.”

For now, the concerted efforts of central banks and major financial institutions around the world to inject liquidity to resolve the global credit seizure are working, says Goldman Sach’s Feagin.

“We are now seeing people starting to be comfortable opening up the markets again,”

“I think we have seen some pretty dramatic steps and some pretty positive steps but a huge uncertainty remains, and this is going to take many years to get fully resolved.”

IS THE CENTARAL BANK'S SHINE DIMMING?

As Recent Actions Leaves the Market in Uncertainty The recent upward review of the prime rate by the monetary policy committee by the bank of Ghana has thrown up some major doubt about the direction and the monetary policy posture. Apparently the aggressive inflation targeting policies of the Bank at the expense of growth has failed to arrest the inflation to rate below the double digit. the bank has been so obsessed with a single digit inflation over the last decade that it was prepared to sacrifice all other policies to achieve it. buoyed on by the Bretton Woods institutions and a government obsessed with achieving "macro-economic stability".