Sunday, July 25, 2010

Big Mac Index - Rand still undervalued, Euro, Yuan overvalued

The Big Mac index is based on the theory of purchasing-power parity (PPP), according to which exchange rates should adjust to equalize the price of a basket of goods and services around the world. Our index shows that Asia remains the cheapest place to enjoy a burger, while those on the hunt for a value meal should steer clear of Scandinavia. The euro, despite its troubles, continues to be expensive when compared with many other rich-world currencies, though the British pound is trading close to its fair value. China's recent decision to increase the "flexibility" of the yuan has not made much difference yet—the yuan is undervalued on the burger gauge by 48%. For more on the Big Mac index see article.

Sunday, July 18, 2010

Banking Profits: A Mirage, Not a Miracle

The banks contribution to the economy has been overstated

THE huge sums earned by banks and their employees over the past 30 years is a recurring puzzle. How has finance done so well for itself and why haven’t its returns been competed away?

Andrew Haldane, the executive director for financial stability at the Bank of England, has co-authored another incisive contribution to this debate in a chapter of a new book* published by the London School of Economics on July 14th. Analysing the recent performance of the banking industry, he concludes that it has been “as much mirage as miracle”.

Mr Haldane and his colleagues start with a statistical oddity. The fourth quarter of 2008 almost saw the meltdown of the global financial system, with banks’ share prices falling by an average of 50%. Yet according to the British national accounts, the same quarter witnessed the fastest-ever increase in the contribution of the financial sector to the country’s economic growth.

That suggests there is something wrong with the calculations. The standard measure is gross value-added—the output of an industry minus the costs of production. That is a pretty easy sum to calculate when it comes to manufacturing. In finance, however, a lot of the gross value-added comes from making loans. Economists calculate this by measuring the difference between the rate charged on loans and a “reference rate”, which is pretty much the risk-free rate.

The consequence of this approach is that when interest margins rise for corporate borrowers, as they did in late 2008, the gross value-added of the banking sector appears to go up. But without adjusting for risk, this measure of the finance sector’s economic worth is meaningless. What really matters is whether the interest margin properly reflects the risk of default. As Mr Haldane comments: “A banking system that does not accurately assess and price risk is not adding much value to the economy.” That is a particular problem given that it seems clear the banks systematically underpriced risk in the period leading up to 2007.

You can look at the numbers in a different way. Was the finance industry using a larger share of the nation’s resources? In the British case, the industry’s share of labour and capital has been on a declining trend since 1990. Combine the gross value-added figure with the declining share of resources, and you might assume finance has enjoyed a productivity miracle over the past 20 years. This miracle could explain the very high returns on equity achieved by the banks and the very high wages given to bank employees (an international, not just a British, phenomenon).

But if the value-added figure is driven by a mistaken assessment of risk, a quite different picture emerges. Mr Haldane suggests that banks increased risk-taking by pursuing three different strategies: using more leverage, both on and off the balance-sheet; holding more assets on their trading books, where capital charges were lower and rising asset prices boosted profits; and writing “out-of-the-money” options, in other words selling insurance policies that offered steady returns in good times but disastrous losses in especially difficult times.

These greater risks brought little economic benefit. In the same book Adair Turner, the head of the Financial Services Authority (Britain’s soon-to-be-restructured regulator), points out that only a minority of bank activity concerns the channelling of savings to businesses investing in productive assets, what you might call the classic raison d’ĂȘtre of banking.

Instead, lending is dominated by the residential- and commercial-property cycle. These cycles are self-reinforcing: more lending pushes up property prices, which encourages more lending. At the margin, the property cycles might lead to the construction of better buildings, but such modest benefits are outweighed by the accompanying financial and economic instability.

The financial industry has done so well for itself, in short, because it has been given the licence to make a leveraged bet on property. The riskiness of that bet was underestimated because almost everyone from bankers through regulators to politicians missed one simple truth: that property prices cannot keep rising faster than the economy or the ability to service property-related debts. The cost of that lesson is now being borne by the developed world’s taxpayers.

* “The Contribution of the Financial Sector: Miracle or Mirage?” by Andrew Haldane, Simon Brennan and Vasileios Madouros. Taken from “The Future of Finance: The LSE Report”, July 2010

Published in The Economist

Tuesday, July 13, 2010

An Economy of Grinds

If you go to business conferences, you know that at lunch it is definitely better to be seated next to a prince than a grind. Princes, who can be male or female, are senior executives at major corporations.

They are almost always charming, smart and impressive. They’ve read interesting books. They’ve got well-rehearsed takes on the global situation. They can drop impressive names as they tell you about their visits to the White House, Moscow or Beijing. If you’re having lunch or dinner with a prince, you’re going to have a good time.

Grinds, on the other hand, tend to have started their own company or their own hedge fund. They’re often too awkward to work in a large organization and too intense to work for anybody but themselves.

Over lunch, they can be socially inert. You try to draw them out by probing for one or two subjects of interest to them. But as often as not, you find yourself playing conversational ping-pong with a master of the monosyllabic response.

Every once in a while you’ll run into one who can’t help but let you know how much smarter he is than you or anybody else in the room. Sitting at this lunch is about as pleasant for him as watching a cockroach crawl up his arm. He’d much rather be back working in front of his computer screen.

Since the princes are nicer and more impressive, it is easy to be seduced into the belief that they also are more trustworthy. This is false. During the last few years, for example, the princes at Citigroup, Bear Stearns, Goldman Sachs and Lehman Brothers behaved with incredible stupidity while the hedge fund loners often behaved with impressive restraint.

As Sebastian Mallaby shows in his superb book, “More Money Than God,” the smooth operators at the big banks were playing with other people’s money, so they borrowed up to 30 times their investors’ capital. The hedge fund guys usually had their own money in their fund, so they typically borrowed only one or two times their capital.

The social butterflies at the banks got swept up in the popular enthusiasms. The contrarians at the hedge funds made money betting against them. The well-connected bankers knew they’d get bailed out if anything went wrong. The solitary hedge fund guys knew they were on their own and regarded their trades with paranoid anxiety.

In finance, as in other realms of business life, social polish doesn’t always go with capitalist success. Often it is the most narrow, intense, awkward people who start the best companies, employ the most people and create the most value.

Sadly, this recovery has been great for princes and horrible for grinds. The people who work at the big corporations are critical of the Obama administration, but the fact is they are doing very well. The big companies are posting excellent earnings. They’re sitting on mountains of cash.
The aspiring grinds, meanwhile, are dead in the water. Small businesses are not growing. They are not hiring. They are struggling to stay alive.

Princes can thrive in a period of slow, steady growth, but grinds need a certain sort of psychological atmosphere. They need a wide-open economy with plenty of creative destruction. They need an atmosphere of general confidence, so bankers will feel secure enough to lend them money, so big companies will feel brave enough to acquire their start-ups, so they themselves will feel the time is ripe to take on their world and show their brilliance to all of humanity.
The princes can thrive while the government intervenes in the private sector. They’ve got the lobbyists and the connections. The grinds, needless to say, don’t.

Over the past decade, professionals — lawyers, regulators and legislators — have inserted themselves into more and more economic realms. The princes are perfectly at home amid these tax breaks, low-interest loans and public-private partnerships. They went to the same schools as the professionals and speak the same language. The grinds try to stay far away and regard the interlocking network of corporate-government schmoozing with undisguised contempt.
The upshot is that we have an economy that is inching toward recovery but that is not creating much in the way of new innovations and new jobs. It’s not that the overall labor markets are shrinking. It’s just that very few grinds are bringing new ideas to scale and hiring workers to enact their us-against-the-world schemes.

For jobs to recover, the grinds have to recover, but it’s hard to see how that will happen so long as households are still so leveraged, government debt is still so unnerving and the business climate is still so terrible for entrepreneurs.

We’ve been mired in debates over macroeconomic models recently. But maybe the real issue is how we are going to light a fire under the country’s loners, its contrarians and its narrow, ambitious outsiders.

From The New York Times’s David Brooks, writing in his latest opinion column

Monday, July 12, 2010

World Cup 2010: The Legacy

Like a non-stop blast from a nation-sized vuvuzela, South Africa has trumpeted its pride and joy at hosting the world's greatest sporting tournament for the past month.

The excitement of having the World Cup played out on African soil for the first time will never be forgotten, not by South Africa's 50 million citizens, nor Africa's 850 million or the billions in the worldwide television audience.

What a show it was, what a celebration of our shared humanity, what an emotional roller coaster it has been.

From the thrill of the Siphiwe Tshabalala opening goal that sent South African hearts soaring to the crushing cynicism of Luis Suarez's goalline handball cheat that grounded the hopes of Ghana's Black Stars, we have seen it all. The good, the sad and the ugly.

South Africans all found common purpose in wearing yellow and green in solidarity with Bafana Bafana and together dared to dream the impossible that our team, our country, could win against the best in the world.

We revelled in the success of the complex preparations, to the point where our self-congratulation suggested we had doubted our ability and capacity as much as the detractors abroad who willed us to fail.

Perhaps the signs of new confidence and invigorated national spirit could be seen on the eve of the games in an outpouring of patriotism, not seen since 1994.

South Africans took ownership of the flag and waved it, wore it and wrapped themselves, their cars and their homes and offices in it. We felt it. It was here.

But today it is over.

South Africans can sit back and count the costs and the benefits of hosting the event. But it will be a while before the facts emerge from the hype.

The positives

In economic terms, analysts are estimating the event added a half percentage point to gross domestic product (GDP) this year, contributing to the expected 3 percent growth in GDP. Much of the benefit came through in previous years as the country prepared for the event. According to a March research note by Citi, the impact of building new stadiums and upgrading existing ones would have been worth as much as 1 percent to 1.5 percent of GDP - including the spillover effect on other sectors - spread over several years.

South African business confidence rose to the highest level in nine months in June as the World Cup boosted sentiment in Africa's biggest economy, according to the SA Chamber of Commerce and Industry. The business confidence index rose to 84.8, the highest since September 2009, from 82 in May.

"The World Cup has obviously had a positive effect on sentiment both domestically and internationally," said Richard Downing, an economist at the chamber. "The main benefit is that the positive spirit and momentum created by the tournament can be carried forward to realise long-term economic improvement."

A recent update by Grant Thornton Strategic Solutions puts the World Cup's total GDP contribution at R93 billion, with 373 000 foreigners visiting South Africa. Grant Thornton put foreign and domestic tourism and organising spend at R16.1bn, infrastructure and stadium spend at R39.2bn, making a total direct spend of R55.3bn.

The auditing firm has monitored the spending on the event since 2003 when it estimated the stadiums and other infrastructure would cost R2.3bn and 251 000 foreigners would visit.

Tony Twine, the senior economist at Econometrix, noted that there were enduring legacies - including the vastly improved road network and the country's wall-to-wall exposure to billions of television viewers around the world. These benefits will continue to feed into the economy in the months and years ahead.

Iraj Abedian, the chief economist of Pan African Investment and Research, urged the country to harness the "sense of purpose and focus" to deal with pressing issues, such as the needs of municipalities and the health and education sectors.

But no quick fixes

The World Cup was never going to solve South Africa's problems. We must look again at the reality in which many workers who directly took part in hosting the World Cup have no jobs. Many others involved in the preparation of stadiums and other projects have been out of work for months.

We are still the two countries that former president Thabo Mbeki described.

While South Africa may have been united in spirit by the World Cup, the harsh economic reality, where tickets for yesterday's spectacular finale were reportedly changing hands for $10 000 (R75 000), the equivalent of a year's salary for minimum-waged Eskom workers, meant that the festivities were mostly enjoyed by the moneyed classes as the poor majority looked on.

Gestures to include tickets for people from poor communities were certainly part of the R132 million, and counting, spent on tickets by government departments, state-owned enterprises, utilities and agencies, and some of this will have been legitimate marketing.

But most of it will have been public money being used on the "personal indulgences of public officials", to quote the DA.

Fifa will leave South Africa with a reported $3.5bn, tax free.

On balance

While many have railed against Fifa's effective month-long takeover, there is also much for which to thank the world soccer governing body.

The games, of course. But also the peace we have enjoyed. That is not only due to the apparent absence of crime, which could be explained either by the long overdue visible presence of police on the streets or a lack of reporting by football-crazed media or by the police themselves. Special courts for World Cup related crimes heard 170 cases and showed that justice administered quickly and effectively was a deterrent.

The New York Times noted South Africa's criminals had put in a more indifferent showing than the French team.

One of the greatest tests that South Africa passed with flying colours during the World Cup was keeping the lights on.


Brian Sandberg, a Durbanite who blogs for a Facebook group with an international following, wrote on Friday about a British couple who were "sceptical and cautious" as they came to South Africa for the first time to see their seventh World Cup. But waiting to board their flight home last week in a final tweet on Twitter, they said to their followers: "Goodbye SA. We have had the best World Cup ever. Don't care who wins, as SA has already taken the prize."

With contributions by Roy Cokayne, Audrey D'Angelo, Ethel Hazelhurst, Slindile Khanyile, Donwald Pressly and Ingi Salgado.