Sovereign Debt Problems

By yongmed on June 23, 2011

Sovereign debt problems seem to be grabbing the headlines these days. We all know what debt is. But “sovereign debt”? This complicated term simply refers to debt from the issue of bonds to lenders outside your country or money borrowed from other countries. These government bonds are issued in international currency and the money raised will go to improving infrastructure, investment, covering government expenses etc.

The European Union at the moment is in a precarious situation. Countries like Spain, Italy, Greece, Ireland and Portugal are suffering from excessive debt levels. The source of it all? A lack of check and balance in their economies as well as bad luck.

1) There is a lack of regulation of government deficits and poor monitoring of how much debt countries in the EU could accumulate. As a result, “weaker” countries such as Greece have no means of repaying their debts.

2) It was also a case of downright bad luck in the cases of Spain and Italy. While their governments were not as irresponsible, the 2008 crisis worsened the government deficits.

EU members do not have ability to exercise monetary policy and are thus unable to manipulate currencies. Normally, this would stimulate exports and promote growth, countering the effects of rising taxes and austerity measures to reduce government deficits.

What can be done

These countries could be looking at an exit from the EU in the future and regaining the ability to devalue and stimulate exports. In the near-term however, it would be safe to say that the founding members of the EU will not let their “dream” of a single European currency and market go down the drain.

More realistically, there will be increased austerity measures on the part of troubled economies (rein in spending and raising taxes). These are however, deeply unpopular.

There could be bailouts financed by richer members of the EU (i.e. Germany, France). It has been announced that Greece will receive a second bailout this year following a 110 billion Euro bailout in 2010. A bailout works well to keep the problem from escalating into a full-blown crisis, but it brings about the issue on moral hazards. Misbehaving countries accumulating debt will have less incentive to impose checks and balances knowing that it will not bear the full consequence of its actions.

Therefore, there should also be a central watchdog, an authority to “police” these countries’ budgets in return for bailing them out and writing off their debts. While bailouts ought to come with conditions attached to prevent future misbehaviour, countries may not agree to this as it might mean ceding control of the national budget in the future.

We are now back to square one. These countries would be better off leaving the EU and returning to how things were pre-EU. The easy way out would be for these countries to default. However, the repercussions if they were allowed to will be too much for the fragile world economy to handle. This therefore looks improbable.

Further austerity, an external bailout, leave the EU or default. There is no painless exit to this self-inflicted mess by the EU.

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John Cassidy – How Markets fail

By yongmed on June 15, 2011

When we look back on the Great Recession, it is far too easy to begin by blaming a particular person or a financial institution and their actions that contributed to the crisis. However, the root of the problem, as John Cassidy sums up aptly, is the rational pursuit of self-interest. This pursuit forms the basis of free-market ideology that was championed by the US and much of the West prior to the crisis.

I believe that it is now fair to say that those in the West who had the knowledge and authority to make changes presumed that the self-interests of financial institutions and individuals would ultimately lead to a socially desirable outcome. By allowing increasing deregulation in the market, the US was in fact encouraging Wall Street to seek increasingly novel ways to reap larger and larger profit, even if it meant exploiting the sub-prime market (the poor and middle-class).

The ideology of free-market economics, deregulation and believing that the pursuit of self-interest would ultimately lead to a socially desirable outcome is not wrong. What’s surprising is that the people overseeing the economy, the Federal Reserve, state regulators and the president’s economic advisers were content with postponing the inevitable day of reckoning which they hoped would never come. The “exploit and earn as much as possible ASAP” mentality was demonstrated in the years leading up to the crisis.

For the US, it was good while it lasted (believing in human self-interest and championing free-markets). The country is now “reaping the benefits” of its actions in what can at best be described as a painful and embarrassing process.

Telling others what to do (read Asian Financial Crisis 1997) and doing otherwise (read Great Recession bailouts and quantitative easing) is not wise. Inflating the bubble when “Armageddon” was staring regulators in the face is not any wiser. With the world losing confidence in the greenback as a reserve currency, an unbelievable debt pile and no clear way exit without damaging the weak recovery, this is probably one hole too deep, even for the mighty United States of America.

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The Repercussions of Quantitative Easing

By yongmed on November 20, 2010

Quantitative Easing (QE) is a really big term that simply means printing money. The US federal reserve announced on 3 November that it will buy US$600 billion of Treasury bonds from now till June 2011. The long-term (10-year) yields on Treasury bonds have fallen to 0.5% due to the Fed buying up bonds with newly-printed money.

Investors will be driven to seek higher returns elsewhere, causing the US dollar to fall against major currencies like the Yen and the Euro. Ultimately, QE could boost flagging growth in the US through encouraging spending, raising exports and increasing household wealth.

1) QE will increase expected inflation, which leads to a fall in the real interest rate (Real Interest Rate = Nominal Interest Rate – Expected Inflation Rate). This gives consumers more incentive to spend and invest as borrowing costs are lowered. When consumption increases, it then boosts employment and increases the economy’s output.

2) A weaker dollar would theoretically boost export sales and reduce imports as US goods are now relatively cheaper compared to foreign goods. e.g. A Japanese consumer would purchase more of a particular US good as it has fallen in price relative to a local Japanese good.

3) The Fed’s QE announcement caused the prices of shares and other financial assets to increase. This will raise household wealth by a significant amount and encourage even more spending.

However, QE could very well have a small impact as the overall outlook for the US economy is rather negative. Consumers could be armed with more cash but choose not to spend. In addition, other countries have not taken particularly well to the Fed’s latest round of QE. For example, the Bank of Japan retaliated with similar QE measures to weaken the Yen to counter upward pressures. South Korea and Brazil have put in place capital controls to stem the inflow of hot money to their economies as investors seek to gain higher returns in fast developing nations.

There is no one size fits all economic policy. The Fed has undertaken QE as a means to combat sustained weak growth levels. While other countries may resent the Fed’s methods, it is beneficial in controlled, measured doses. Having QE is certainly better than having none at a time when the world’s most developed nation is in the doldrums.

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Our New Electric Future

By yongmed on December 9, 2009

Transportation is one of the most pollutive sectors in cities around the world. In order to sustain our thirst for mobility, automobile companies have to constantly develop new means of fuelling our cars, trains, buses and passenger jets. The most viable and exciting development so far has to be the latest generation of electric cars. Electric cars are by no means recent technology. In fact, they have been around since the 19th century, competing with the petrol-powered combustion engine. It is only in the last decade where vast improvements have been made in improving the mileage of electric cars. In other words, it is now economically viable to mass produce electric vehicles, as they are every bit as practical as gasoline powered cars, while being less pollutive or even non-pollutive.

The Electric Future

Ford Motor Coporation, the company that revolutionalised the modern gasoline car, announced on December 8 that it is willing to invest up to US$500 million in Michigan to assemble hybrids, plug-in hybrids and lithium-ion batteries if the state is willing to grant the company tax credits. Closer to home, Singapore is set to begin a 3-year study commencing in September 2010 to test the infrastructure neccessary to keep electric cars running on the roads. This includes collecting data on mileage, frequency and ease of plugging in for battery recharging etc. The government recognises the need for good infrastructure to be available before electric cars can fully take flight. (for example, the building of charging stations in residential areas)

These are but 2 examples of countries pushing forward in promoting the use of less-pollutive transportation means. Toyota Motors has the Prius. Nissan has recently launched the LEAF hatchback. GM is developing the Chevrolet VOLT. Most other automakers are probably looking to expand on the present trend of electric cars. Therefore, the future of transportation is “electric”.

Challenges

1) Inadequate Power Grids

While certain countries generate the majority of their electricity through renewable sources (hydroelectric, geothermal, solar, wind etc), most countries have power stations that combust pollutive fossil fuels. For electric cars to come full circle and be THE technology of the future, our grids have to generate the bulk of electricty cleanly. There is obviously no point in recharging your car’s batteries when the source of that electricity is coal. (or any other fossil fuel for that matter)

2) Government Support

Car owners are not simply going to switch their trustworthy gasoline cars for electric ones, especially when the latter costs so much more initially. As with public goods, the government has to take the initiative to incentivise the electric car industry. Measures to do so could include compulsory fuel-efficiency standards, carbon taxes and even encouraging government agencies to purchase electric cars.

3) Charging Stations

Gasoline cars rely on petrol or gas stations to refuel. Similarly, for the electric car industry to take flight, there has to be convenient charging points. In addition, recharging electric cars is not in the order of minutes. It takes hours to fully recharge the batteries of electric cars. Perhaps mass housing developments like the HDB flats in Singapore could require multiple charging points to cater to residents. On the other hand, those that are able to plug in to the power socket in their garages should not use the charging stations. This is a major hurdle that governments have to solve first before electric cars can take to the roads. The energy grid has to also change in conjunction with this as there has been talk of “smart vehicles”. The electric vehicle is not merely a means to save petrol and reduce carbon emissions. It can store energy as well. When parked, the vehicle can feed power back to the “smart” grid during hours of peak demand. Therefore, the development of the electric car will pave the way for other smart appliances communicating with a smart power grid. This makes for an efficient energy system.

“Electric”

This word can refer to developments that are ”exciting” and “fresh”. Literally, it is the electricity that powers all our appliances. Our “electric” future embraces both meanings. I do hope that this time round, electric cars trump gasoline cars.

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