A Weak Economy and Disconnect Between People and Finance

WASHINGTON:  There they sat on October 9 interviewing each other, the famous writer who exposed Wall Street’s excesses, and the elegant French woman who leads the international agency set up to is assure financial stability. Big Short author Michael Lewis and International Monetary Fund chief Christine Lagarde agreed  that eight years after the financial crisis progress has been made but more work is required to avert future catastrophe.

Lewis, who worked at Solomon Brothers before an illustrious career in journalism and books, told the audience at IMF headquarters, “the toxic relationship between the financial sector and the public has not been addressed.”  Financial instruments, he said, remain too complex, salaries are still excessive.  The problem began, he continued, when banks became trading entities and downgraded the services they provide to customers.  Likewise, said Lewis, well-intentioned efforts to safeguard the public went astray—regulations became burdensome, complicated and poorly communicated.

The encounter between Lagarde and Lewis culminated six days of discussions by financial policy makers and a separate gathering of several hundred bankers.  The mood was somber.

David Stockton, a former Federal Reserve official who prepares economic forecasts at the Peterson Institute of International Economics, gloomily observed that the U.S. economy is mired at two percent growth in a three percent world economy. He said “we’re a driverless car stuck in the slow lane.” IMF economists also have repeatedly downgraded their forecasts.

What went wrong? Why is the recovery from the great recession of 2008 so slow?

One economist with an answer was Mohamed El-Erian who invented the term “new normal” at the Pimco investment firm in 2009.  El-Erian argued that the magnitude of the financial crisis was so severe that recovery would be slow and of long duration. “The advanced economies,” he said, “had bet the farm on the wrong growth model.”

Carmen Reinhart, now at Harvard’s Kennedy School of Government, argued that because the great recession was triggered by a financial crisis recovery would inevitably be very sluggish. Reinhart said that on average it takes about seven and a half years for the average advanced economy to regain its previous peak of output.  By that standard Reinhart believes the U.S. recovery is on track and further advanced than Japan or Europe.

The really pessimistic group is the bankers. European bankers were particularly gloomy saying it is impossible to make money when interest rates are at zero. There’s too much regulation, they complained, and they don’t like revealing detailed financial data to regulators, fearing it could fall into the hands of rivals.

Andreas Treichl of Erste Bank in Vienna worried about potential disrupters, financial versions of Uber or Airbnb. Uncertainty reigns concerning London’s role as a financial center in the wake of Britain’s vote to leave the European Union. Share prices of European banks languish near historic lows and the continent’s biggest bank, Deutsche, groans beneath the weight of a huge fine from the U.S. Department of Justice.

Banks are on their back foot, laying off thousands of workers as they seek a new business model. The best and brightest university grads no longer flock to New York and London. Finance, as chronicled by Michael Lewis, is no longer the elixir of quick riches.

Larry Summers, the former treasury secretary, observed the somber mood at the Washington meetings. “The specter of secular stagnation and inadequate economic growth,” he said, ”and ascendant populism and global disintegration…led to widespread apprehension.”

El-Erian was even equally pessimistic.  He said central banks have lost their edge in an era of low and negative interest rates and that a low growth economy can’t endure. “The new normal is coming to an end,” he said, “the reason is simple: it has lasted for so long that it is now breeding the causes of its own destruction.”

But to end on a bright note, officials from emerging market economies say they no longer worry about the impact of Federal Reserve moves to normalize interest rates. “The Fed has communicated its intentions very clearly,” said South African ReserveBank chief  Lesetja Kgangyago.  “Our reserves are bigger,” he said, and there is unlikely to be a repeat of the 2013 “temper tantrum” when equity markets temporarily tanked when the Fed indicated that quantitative easing would be scaled back.

 Barry D. Wood has been covering global financial meetings for over three decades.  

Congress Set to Finally Approve IMF Reforms

WASHINGTON: The massive $1.1 trillion omnibus spending bill presented to lawmakers Tuesday night contains provisions for new funding and governance reforms at the International Monetary Fund. The House could vote as early as Thursday on the package, which is expected to pass. Approval is also likely in the Senate and President Obama’s signature is assured. The president pushed hard for the IMF deal, calling it vital to US leadership and security.

The measure doubles to $670 billion the resources available to the IMF to lend to countries in distress like Ukraine or Greece.  The US contribution is put at $300 million.

The legislation gives key developing countries like China, India and Brazil a bigger share of the weighted votes in the IMF while preserving the sole veto power of the United States. The US has 16% of the votes in the 188-member Washington-based IMF. China’s share rises from 4% to 6%.

The governance reforms date from 2010 but because 85% of IMF votes are needed for implementation it has been blocked by US inaction. Former treasury secretary Larry Summers blamed US delay for creating space for China to create alternative institutions that challenge the IMF. Despite US opposition, China this year led in the formation of a China-based Asia Infrastructure and Investment Bank. Last year it joined other BRICS countries (Brazil, Russia, India, and South Africa) in forming a new development bank as well as an arrangement for mutual financial support should it be needed.

Despite being the dominant player in the IMF, which was founded in Bretton Woods, New Hampshire in 1944, congressional support for the powerful agency has always been lukewarm. In recent years some lawmakers have accused the IMF of bailing out big banks that made loans that couldn’t be repaid. Others argue that US sovereignty is diluted when US money is pooled into IMF lending.

Randall Henning, a professor at American University and specialist on the IMF, rejects that critique saying, “the IMF reflects US economic policy preferences more faithfully than perhaps any other international organization.” Henning says the IMF promotes free markets and requires borrowers to put in place appropriate, prudent economic policies. The IMF played a central role in resolving the Latin American debt crisis in the 1980s and the Asian crisis in the late 1990s.

Former IMF official and financial analyst Mohamed El Erian has argued that US approval was overdue. He says the recalibration of votes “better reflect the realities of today’s global economy and entail neither new US funding commitments nor any dilution of its power within the institution.” Economic historian Liaquat Ahamed says it is absurd that tiny Belgium has had as many IMF votes as Brazil, or that Belgium and Holland together had more votes than China.

Policy makers including Chinese vice central bank governor Yi Gang and British Chancellor of the Exchequer George Osborne lamented the long delay in US action. Yi called “failure to deliver this reform a threat to IMF legitimacy.” Osborne said recently in New York that “it is a tragedy that an agreement reached across all the members of the IMF was being blocked by the US congress.”#

A Look at Cuba Before Normalization Takes Hold

HAVANA, CUBA: In light of the historic thaw in US Cuban relations announced on December 17^th, three items stand out from a four-day visit to Havana:  1/ Cuba’s economy is a disaster in desperate need of reform. 2/ The communist party retains its tight grip and political change is a long way off. 3/It is likely to be months before normalized bi-lateral relations produce real change.

The Economy

 Havana is a ruin, a surreal time warp, exemplified by ancient cars and trucks from before the 1959 revolution. For 50 years there’s been no imports of cars for private use.  Houses and apartment buildings are run down with their occupants not having cash for needed repairs. 

Amazingly, most Cubans subsist on salaries of $20 per month.  Those with more are communist bureaucrats, workers in tourism with access to hard currency, and those receiving remittances from abroad.

Cuba’s economy is dead in the water with barely any advance in gdp. The country is nearly bankrupt with no access to credit. There are frequent power outages. Unemployment is kept low because jobs are provided in a bloated and inefficient public sector where four out of five Cubans work. Inflation is suppressed. There are chronic shortages. Basic foodstuffs are rationed. Ninety percent of Cubans don’t own a car.

Despite the negatives, reforms unveiled in 2011 by President Raul Castro have allowed a small but growing private sector to take hold. The reforms permit Cubans to buy and sell their apartments, 84% of which are privately owned. But while an incipient real estate market exists, it is stymied by an absence of mortgage credit.

Similarly, Cubans can buy and sell their privately owned vehicles. But contrary to expectations liberalization has boosted car prices. Unbelievably, the asking price on the refurbished 1956 Chevrolet pictured below is well over $100,000. Classic cars can’t be exported, meaning that US-based collectors won’t be able to import these treasures anytime soon.

Restored 1956 Chevrolet on Havana’s Prado

Cuba’s economy is further distorted by there being two currencies, both of which circulate. The government says unifying the exchange rate is a priority but that is unlikely to occur until Cuba obtains access to hard currency. Look for early moves for Havana to rejoin the International Monetary Fund.

A Closed Political System

Cuba remains a one-party communist state with little prospect of liberalization. The media is tightly controlled and state-owned newspapers are mostly propaganda. English language newspapers from abroad are banned.

This past week Cuba released more of the 53 political prisoners it promised to liberate as part of the December accord between presidents Obama and Castro. Thirty-six are now free, a move the White House calls “a tangible sign that Cuba is keeping its word.”

As part of the 2011 reforms Cubans can have cell phones, stay in hotels previously reserved for tourists, use the internet, and travel abroad. But because most people don’t have disposable income, the new freedoms mainly help the better off.

Contrary to what many outsiders want to believe, Fidel, his brother Raul and the revolution remain popular, although independent surveys don’t exist. Cubans are proud of their country’s achievements in education and health care, which is free to all.

Change from Normalization May be Slow

 Every Cuban of the two-dozen or so I spoke with favors normalization. Some were deeply emotional, saying they can’t wait for Americans to arrive in significant numbers. The lives of ordinary people are bound to improve with the lifting of the embargo.

But while Cubans and Americans are eager for visits, important restrictions remain. Despite President Obama’s announcement, it is still not possible to use US-issued credit cards in Cuba. Likewise getting email on dial up internet servers can be difficult.  I was unable to access my Google and Yahoo email accounts, getting instead a prompt saying, “access is denied in the country you’re in.” There is disagreement whether these measures can be lifted by executive order or must await congressional action.

Bob Corker, the new chairman of the Senate Foreign Relations Committee, said last week that the embargo has been ineffective, a clear sign that he may favor its repeal. Both the Chamber of Commerce and leading agricultural organizations favor normalization. Congressional hearings are already planned and a top state department official is visiting Havana this month to advance the normalization process.

A Cuban businessman, who declines being identified, told me that Cuba urgently requires reform.  “We’ve created a system,” he said, “that we can’t control.”  The only way for us to have any prospect of economic improvement, he continued, is to open up and build a market economy.

Last May Washington’s Peterson Institute for International Economics released a study on the Cuban economy.  In it researcher Gary Hufbauer concluded “that once the tectonic plates shift” there will clear benefits for both Cuba and the United States.  The tectonic plates have shifted and from my perspective Hufbauer is spot on.#

Barry D. Wood writes often about economic transitions. He last visited Cuba 11 years ago. This piece appeared first on market watch.com.

Poland's Extraordinary Transformation

WASHINGTON:  Twenty-five years ago this autumn two remarkable events took place in Washington.

On September 27^th, 1989 in the musty embassy ballroom of the Polish People’s Republic on upper 16^th Street, Leszek Balcerowicz, finance minister in the new non-communist government, outlined a plan to transform Poland’s economy from communism to capitalism. Shock therapy would be launched in three months.

Balcerowicz’s message was breathtaking.  Prices would be decontrolled, individuals allowed to start businesses, the survival of state enterprises determined by the market. There was more-- the printing press would be shut down—halting hyperinflation, the worthless Polish currency redeemed.

Financial journalists in Washington for the annual meeting of the International Monetary Fund were astonished.  Some sprang from their seats to file stories after the modest man in the ill-fitting East European suit stopped talking. For those of us remaining the room was electric. One reporter said, “there are lots of books about transforming capitalism to communism, none for going the opposite direction.”

This was six weeks before the Berlin Wall came down.

On October 19th, 34-year-old Jeffrey Sachs, the Harvard economist advising the Polish government, made an emotional plea to Washington insiders. At a Willard Hotel dinner arranged by the Institute for International Economics, Sachs said Poland required a cash injection to “leap across the chasm” from disintegrating communism to capitalism. “The next six months,” he said, “are critical in determining whether Eastern Europe’s first non-communist government since World War II succeeds.”

Sachs had made his name by helping to end hyperinflation in Bolivia. He essentially shamed his Washington audience into action, excoriating the US government, the IMF and World Bank for dragging their feet.  It was imperative, he said, that the Polish experiment succeed.

The debate over big bang and shock therapy essentially began that night.

Sachs had offered his services to Poland only weeks earlier and was just off the plane from Warsaw where there was chaos and anger over shortages of basic commodities, including food. Few outsiders thought the planned reforms-- that in the short-term would further depress living standards—had any chance of working. Sachs said later, "It was a terrifying and unpredictable period."

The rest, of course, is history. Not only did the Balcerowicz reforms stabilize and activate the economy, they won critical public and government backing. They became a model for similar plans in Czechoslovakia and the Baltics (where they worked) and in Russia (where they failed).

What could not be foreseen in the autumn of 1989 was that Poland would become the star performer of all the economies that emerged from the wreckage of the Soviet empire. Poland’s return to growth and fiscal discipline were powerful factors in the European Union agreeing to admit eight former communist countries in 2004.

Balcerowicz, now 67, served as finance minister and then central bank chief until 2007. Currently he teaches at the economics university and runs his own research institute.

While Poland has not yet joined the euro currency zone, Balcerowicz subscribes to the fiscal austerity doctrines championed by Germany. He faults Greece and other southern periphery countries for not moving fast enough or hard enough to restructure their uncompetitive economies.

The Polish miracle continues.  Alone among European Union economies it did not experience a downturn following the 2008 financial crisis. In most recent years Poland has been the fastest growing economy in the EU. Its gross domestic product has doubled since 1989 and is today Europe’s sixth largest economy.

More significantly, per capita g.d.p. has more than doubled since 1989.  This in a country of nearly 40 million, by far the largest in Eastern Europe.

Poland and Germany—with a long history of conflict—have become partners, demonstrated most recently by Chancellor Angela Merkel championing the selection of conservative Polish  Prime Minister Donald Tusk as the new president of the EU council. 

Reflecting on the 25^th anniversary of his reforms, Balcerowicz credits Sachs with playing a vital role in persuading the Solidarity-led government that shock therapy was the best way forward. For his part, Sachs says he is "thrilled that the Poles acquitted themselves so beautifully in the pages of history."

  

Greece..Economy Stabilizing

Thessaloniki: In the short-term more protests are coming. On November 6th, about the time the troika of Greece’s creditors arrives, a 24-hour general strike is planned. There will be more complaints that citizens have endured too much austerity and can’t take more. They’re wrong; much more needs to be done.

Greeks desperately need the structural reforms that will boost competition and bring down the high prices that daily afflict consumers who have seen their wages fall while supermarket prices are mostly steady. Analyst Miranda Xafa in Athens writes of, “an urgent need to improve the business environment by reducing red tape, regulatory obstacles and barriers to competition.” Examples, she says, are government-mandated rules prescribing who can sell what, dictating shop-opening hours, and setting unnecessary standards to limit competition from imports.

Economist Megan Greene, an astute observer of the Greek economy, relates a personal encounter with the over-regulated small business sector. Visiting a new bookstore cafe in downtown Athens, she ordered coffee and was surprised to see the waitress dart across the street to fetch the coffee. The owner explained that she couldn’t obtain a license to sell coffee. Wanting to buy a book, Megan was told she couldn’t because it was after 6 p.m. and books couldn’t be sold after six.

Prime Minister Samaras pledged in a recent speech at Washington’s Peterson Institute for International Economics “to replace red tape with a red carpet for foreign investors.” That’s a tall order as nearly half the members of parliament come from protected, privileged professions.

Greece’s leading economics think tank, IBOE, says the economy “is very near the stabilization point.” While a further 4% fall in gdp is likely this year, that projection is mildly improved from six months ago. There is improvement in public finance as both the trade and budget deficits have narrowed.

The biggest plus is the turnaround in tourism, a main driver of the Greek economy. Reassured by relative social peace this year and bargain hotel prices, tourists have been flocking into the country. 2013 is set to be a record year for both tourist arrivals and revenue. The tourist association says arrivals are up 15% and that 2014 should be even better. Tourism, it says, is likely to account for 35% of anticipated gdp and job growth over the next decade.

                                              Beans on sale at Thessaloniki outdoor market

Here in Thessaloniki, a commercial center rather than tourist destination, hotel prices are down at least 20%, a pattern replicated throughout the country. Unemployment approaches 25% while wage reductions have not been matched by price cuts, severely squeezing household budgets. With the economy in its 6th year of recession, a recent survey shows that many households will cut back on home heating this winter because they can’t afford heating oil. Statistics suggest that household incomes are down 40% from 2006 while house prices are down 35%.

This kind of internal devaluation, say troika economists, is the only way an economy can regain competitiveness when it is locked in a common currency zone. While doomsayers at the depth of the crisis predicted Greece would abandon the euro, such a drastic response was opposed by government and the public. A May 2012 survey showed that while Greeks opposed austerity, 88% wanted to remain with the euro.

An engineer I met on a Thessaloniki bus commented, “there is no question we lived far beyond our means after joining the euro in 2001.” His remark matches the assessment of Harvard economist Carmen Reinhart who observed that household debt in Greece exploded from 6% of gdp in 2001 to 50% in 2009. Low interest rates in a traditionally high inflation economy arrived in Greece with the euro. Not surprisingly, a borrowing binge was the result.

Reinhart also observes that Greece has been so profligate in public finance that it has been in default for half the 180 years since independence. Some time ago, a participant in the Greek financial rescue told me, “they have to become poorer.” Well, that happened. They are poorer. But contrary to expectations the government is taking the reform medicine. Greece has made considerable progress. But more hard work is required. #