Tuesday, August 13, 2013

The effects of currency fluctuations on the economy

Currency fluctuations are a natural outcome of the floating exchange rate system that is the norm for most major economies. The exchange rate of one currency versus the other is influenced by numerous fundamental and technical factors. These include relative supply and demand of the two currencies, economic performance, outlook for inflation, interest rate differentials, capital flows, technical support and resistance levels, and so on. As these factors are generally in a state of perpetual flux, currency values fluctuate from one moment to the next. But although a currency’s level is largely supposed to be determined by the underlying economy, the tables are often turned, as huge movements in a currency can dictate the economy’s fortunes. In this situation, a currency becomes the tail that wags the dog, in a manner of speaking. 

Currency Effects are Far-Reaching  
while the impact of a currency’s gyrations on an economy is far-reaching, most people do not pay particularly close attention to exchange rates because most of their business and transactions are conducted in their domestic currency. For the typical consumer, exchange rates only come into focus for occasional activities or transactions such as foreign travel, import payments or overseas remittances.

A common fallacy that most people harbour is that a strong domestic currency is a good thing, because it makes it cheaper to travel to Europe, for example, or to pay for an imported product. In reality, though, an unduly strong currency can exert a significant drag on the underlying economy over the long term, as entire industries are rendered uncompetitive and thousands of jobs are lost. And while consumers may disdain a weaker domestic currency because it makes cross-border shopping and overseas travel more expensive, a weak currency can actually result in more economic benefits.

The value of the domestic currency in the foreign exchange market is an important instrument in a central bank’s toolkit, as well as a key consideration when it sets monetary policy. Directly or indirectly, therefore, currency levels affect a number of key economic variables. They may play a role in the interest rate you pay on your loans, the returns on your investment portfolio, and the price of groceries in your local supermarket, and even your job prospects. 

Currency Impact on the Economy     
A currency’s level has a direct impact on the following aspects of the economy:     

Merchandise trade: This refers to a nation’s international trade, or its exports and imports. In general terms, a weaker currency will stimulate exports and make imports more expensive, thereby decreasing a nation’s trade deficit (or increasing surplus) over time.        

A simple example will illustrate this concept. Assume you are a U.S. exporter who sold a million units  at $10 each to a buyer in Europe two years ago, when the exchange rate was EUR 1=1.25 USD. The cost to your European buyer was therefore EUR 8 per widget. Your buyer is now negotiating a better price for a large order, and because the dollar has declined to 1.35 per euro, you can afford to give the buyer a price break while still clearing at least $10 per widget. Even if your new price is EUR 7.50, which amounts to a 6.25% discount from the previous price, your price in USD would be $10.13 at the current exchange rate. The depreciation in your domestic currency is the primary reason why your export business has remained competitive in international markets.    

Conversely, a significantly stronger currency can reduce export competitiveness and make imports cheaper, which can cause the trade deficit to widen further, eventually weakening the currency in a self-adjusting mechanism. But before this happens, industry sectors that are highly export-oriented can be decimated by an unduly strong currency.      

Economic growth: The basic formula for an economy’s GDP is C + I + G + (X – M) where:
C = Consumption or consumer spending, the biggest component of an economy     
I = Capital investment by businesses and households       
G = Government spending         
(X – M) = Exports minus imports, or net exports. 

From this equation, it is clear that the higher the value of net exports, the higher a nation’s GDP. As discussed earlier, net exports have an inverse correlation with the strength of the domestic currency.

Capital flows: Foreign capital will tend to flow into countries that have strong governments, dynamic economies and stable currencies. A nation needs to have a relatively stable currency to attract investment capital from foreign investors. Otherwise, the prospect of exchange losses inflicted by currency depreciation may deter overseas investors.          

Capital flows can be classified into two main types – foreign direct investment (FDI), in which foreign investors take stakes in existing companies or build new facilities overseas; and foreign portfolio investment, where foreign investors invest in overseas securities. Funding for growing economies such as China and India, whose growth would be constrained if capital was unavailable.

Governments greatly prefer FDI to foreign portfolio investments, since the latter are often akin to “hot money” that can leave the country when the going gets tough. This phenomenon, referred to as “capital flight", can be sparked by any negative event, including an expected or anticipated devaluation of the currency.   

Inflation: A devalued currency can result in “imported” inflation for countries that are substantial importers. A sudden decline of 20% in the domestic currency may result in imported products costing 25% more since a 20% decline means a 25% increase to get back to the original starting point.

Interest rates: As mentioned earlier, the exchange rate level is a key consideration for most central banks when setting monetary policy. For example, former Bank of Canada Governor Mark Carney said in a September 2012 speech that the bank takes the exchange rate of the Canadian dollar into account in setting monetary policy. Carney said that the persistent strength of the Canadian dollar was one of the reasons why Canada’s monetary policy had been “exceptionally accommodative” for so long.           

A strong domestic currency exerts a drag on the economy, achieving the same end result as tighter monetary policy (i.e. higher interest rates). In addition, further tightening of monetary policy at a time when the domestic currency is already unduly strong may exacerbate the problem by attracting more hot money from foreign investors, who are seeking higher yielding investments (which would further push up the domestic currency).      

The Global Influence of Currencies – Examples      
The global Forex market is by far the largest financial market with its daily trading volume of over $5 trillion - far exceeding that of other markets including equities, bonds and commodities. Despite such enormous trading volumes, currencies stay off the front pages most of the time. However, there are times when currencies move in dramatic fashion; during such times, the reverberations of these moves can be literally felt around the world. I list below a few such examples:        

The Asian crisis of 1997-98 – A prime example of the havoc that can be wreaked on an economy by adverse currency moves, the Asian crisis began with the devaluation of the Thai baht in July 1997. The devaluation occurred after the baht came under intense speculative attack, forcing Thailand’s central bank to abandon its peg to the U.S. dollar and float the currency. This triggered a financial collapse that spread like wildfire to the neighbouring economies of Indonesia, Malaysia, South Korea and Hong Kong. The currency contagion led to a severe contraction in these economies as bankruptcies soared and stock markets plunged.
China’s undervalued Yuan: China held its Yuan steady for a decade from 1994 to 2004, enabling its export juggernaut to gather tremendous momentum from an undervalued currency. This prompted a growing chorus of complaints from the U.S. and other nations that China was artificially suppressing the value of its currency to boost exports. China has since allowed the Yuan to appreciate at a modest pace, from over 8 to the dollar in 2005 to just over 6 in 2013.
Japanese yen’s gyrations from 2008 to mid-2013: The Japanese yen has been one of the most volatile currencies in the five years to mid-2013. As the global credit intensified from August 2008, the yen – which had been a favoured currency for carry trades because of Japan’s near-zero interest rate policy – began appreciating sharply as panicked investors bought the currency in droves to repay yen-denominated loans. As a result, the yen appreciated by more than 25% against the U.S. dollar in the five months to January 2009. In 2013, Prime Minister Abe’s monetary stimulus and fiscal stimulus plans – nicknamed “Abenomics” – led to a 16% plunge in the yen within the first five months of the year.
Euro fears (2010-12): Concerns that the deeply indebted nations of Greece, Portugal, Spain and Italy would be eventually forced out of the European Union, causing it to disintegrate, led the euro to plunge 20% in seven months, from a level of 1.51 in December 2009 to about 1.19 in June 2010. A respite that led the currency retracing all its losses over the next year proved to be temporary, as a resurgence of EU break-up fears again led to a 19% slump in the euro from May 2011 to July 2012.

How can an investor benefit?           
Here are some suggestions to benefit from currency moves:        

Invest overseas: If you are a U.S-based investor and believe the USD is in a secular decline, invest in strong overseas markets, because your returns will be boosted by the appreciation in the foreign currency/s. Consider the example of the Canadian benchmark index – the TSX Composite – in the first decade of this millennium. While the S&P 500 was virtually flat over this period, the TSX generated total returns of about 72% (in Canadian $ terms) during this decade. But the steep appreciation of the Canadian dollar versus the U.S. dollar over these 10 years would have almost doubled returns for a U.S. investor to about 137% in total or 9% per annum.
Invest in U.S. multinationals: The U.S. has the largest number of multinational companies, many of which derive a substantial part of their revenues and earnings from foreign countries. Earnings of U.S. multinationals are boosted by the weaker dollar, which should translate into higher stock prices when the greenback is weak.
Refrain from borrowing in low-interest foreign currencies: This is admittedly not a pressing issue from 2008 onward, since U.S. interest rates have been at record lows for years. But at some point U.S. interest rates will revert to historically higher levels. At such times, investors who are tempted to borrow in foreign currencies with lower interest rates would be well served to remember the plight of those who had to repay borrowed yen in 2008. The moral of the story – never borrow in a foreign currency if it is liable to appreciate and you do not understand or cannot hedge the exchange risk.
Hedge currency risk: Adverse currency moves can significantly impact your finances, especially if you have substantial Forex exposure. But plenty of choices are available to hedge currency risk, from currency futures and forwards, to currency options and exchange-traded funds such as the Euro Currency Trust (FXE) and Currency Shares Japanese Yen Trust (FXY). If your currency risk is large enough to keep you awake at nights, consider hedging this risk.


Conclusion 
Currency moves can have a wide-ranging impact not just on a domestic economy, but also on the global one. Investors can use such moves to their advantage by investing overseas or in U.S. multinationals when the greenback is weak. Because currency moves can be a potent risk when one has a large Forex exposure, it may be best to hedge this risk through the many hedging instruments available.

Saturday, April 27, 2013

The Ins and Outs of Bank fees


Banks love to provide services that make our lives easier. Perhaps, the only thing they love more is charging us all sorts of fees for these services. Want to put money into your account? The bank will charge you. Take it out? The bank will charge you. Send money to a relative's account? Oh, you better believe the bank will charge you.

Banks do provide an important service, but it's crucial to remember they don't do it for free. Many of us don't notice what our banks charge for their services, but if we're not careful these fees can add up. To that end, below is a list detailing some of the more common fees levied by domestic banks.

Overdraft Protection Fees
Many people assume that when they hand a bank teller a cheque along with a deposit slip, the money they are depositing will be available immediately. Often they are wrong. It's common for out-of-town or out-of-country checks to take seven days or more to "clear". That is, for the money to officially be placed in the account, and therefore ready for your use.

This leads to a huge problem when you then try to write a cheque from this account while under the false impression that the money you deposited earlier has cleared. The new cheque you write will bounce if your previous deposit doesn't clear in time.

To eliminate these rubber cheques, some individuals obtain overdraft protection. This means that the bank will simply advance the money that your account is short and allow the check to be cashed. Of course, the bank doesn't do this for free (usually). Depending upon the lending institution, and the terms of the agreement signed when the account was opened, a fee is charged for this overdraft protection. In addition, interest may be charged on any outstanding balance (that is the money the bank had to advance) until those funds are repaid. Naturally, overdraft charges can be very expensive, particularly if you aren't aware of your account balance at all times, or are careless with the cheques you issue.

Wire Transfer Fees
Suppose you owe someone money, money that must be paid by tomorrow, yet the person you have to pay lives 2,000
km away on the other side of the country. There's no way to put a cheque in the mail and have it arrive in time; however there is another option - a wire transfer.

A wire transfer is a way to instantaneously send money electronically from one account to another.

Not surprisingly, there is a fee for this service. Be wary, while this service can be a tremendous convenience, the costs can add up fast.

Fortunately, with the advent of internet banking, you may be able to transfer money for free between members of the same bank. Make sure you ask your bank about any of these transfer features to save you from spending excess money on transfer fees.

Monthly Account Fees/Minimum Balance Fees
Many banks charge a monthly fee simply for maintaining an account at the branch. This fee can be as low as nothing to K10,000 per month, or be as much as K45,000 per month. The fees vary widely, so it's good to shop around.

Now, while a few thousand Kwacha per month might not seem like much, the fees can have a material impact on accounts with small balances. With that in mind, banks will encourage you to deposit larger sums of money by waiving the monthly fees if you maintain a minimum daily account balance - usually around K1,000,000 to K5,000,000.

While this might sound good, keep in mind that if the balance dips below that threshold, even by K1 the bank will levy a fee.

There is another downside as well. By leaving that much money on deposit, you are essentially giving the bank an interest-free loan. You can't touch the money or you'll risk incurring the fee. At the same time, the bank is making money off of it by lending a certain percentage (18% to 28%) of it out to other customers in the form of loans or mortgages - loans and mortgages that the bank earns interest payments on. You're loaning your money to the bank and saying, "Here, borrow my money - interest free - and use it to make yourself rich."

Debit Card Transaction Fees
Don't like the idea of lugging around your cheque book or paying cash for groceries? No big deal, simply hand the cashier your debit card and the funds will automatically be deducted from your checking account.

It sounds easy and it is. And just like monthly account fees, these fees can add up quite quickly, particularly if the consumer uses his or her debit card for multiple transactions throughout the month.

ATM Fees
The good old automated teller machine (ATM) - if you've ever been short on cash on a Saturday night with your friends, there's nothing like the convenience of an ATM. The trouble is these machines often cost you a lot of money.

Many banks don't charge a fee if you use the machine in the bank's lobby, but walk a couple blocks to the corner ATM and you'll find it's a different story.But pick a location where you could suddenly need cash very badly and it's possible to see fees of even close to K10,000 per transaction.

Additional Cheques
Some banks will give their customers a free book of cheques upon opening an account. It's nice to get a "gift", but once you run through your initial stash, additional cheques are going to cost you.

Miscellaneous Fees
Banks are becoming more creative every day, cooking up new ways to bill their customers. Some charge fees for depositing large amounts of cash; they levy online-banking fees, annual account-maintenance fees (on top of a monthly fee), excessive-transaction fees or even charge fees for using a teller.

How To Limit The Fees You Pay
The best thing you can do to limit the fees you pay is shop around. Look at several banks in your area, get a schedule of the fees they charge and spend a few minutes figuring out which one offers the best deal. In addition, keep good records and analyze your monthly account statement to see what you are being charged. That way, if an unexpected fee shows up, you'll be aware of it, and you won't get hit with it the following month.

"No Monthly Fee" Accounts
These accounts can be a great deal. However, often when banks offer "no monthly fee" accounts (or something else for "nothing"), they make up for it by charging extra for cheques, or ATM withdrawals. Make sure you read the fine print.

Bottom Line
Banks provide a tremendous service, and our economy probably couldn't function without them. However, these services aren't free. The best protection is to be aware of the fees you are paying and not blindly accept them. Remember your bank is a business; if you don't like the fees you are paying, you can always take your money to the competition.

Trust me, I'm a banker

Thursday, January 3, 2013

What is sovereign debt?


What is sovereign debt?

It's debt guaranteed by a particular government, often called external debt.

What happens is this: In order to raise money, a government will issue bonds in a currency that is not the government's—and sells those bonds to foreign investors.

This is what makes the debt external, as purchasers are from outside the country.

The currency chosen for the sovereign debt is usually a strong one, in that its value is higher than other currencies.

Bonds, of course, are instruments of debt to be paid back at a certain time—that can be as long as ten years or as short as one year—with the original investment plus interest. Bonds issued by a government in a foreign currency are called sovereign bonds.

The money collected by the sale of the bonds can be used in any manner the issuing government wants. For instance, the funds can be used to spur job growth with spending on infrastructure projects. A government could also give the money to private companies or banks.

It's important to note, sovereign debt is technically owed by a government and not the citizens of the country issuing the sovereign bonds. It's not the national debt .

However, in order to pay the sovereign debts, the government has to come up with the money in the foreign currency in which it sold the bonds. To get that money, the country could divert funds from internal spending, increase taxes, and/or induce cutbacks in social programs such as pensions.

What happens if a country defaults on its sovereign debt?

Risk that a country may not be able to pay the foreign investors who bought sovereign bonds is an issue — because it has happened. Recent examples are Russia, which defaulted on its sovereign debt in 1998, and Argentina in 2002.

This usually happens when a new government takes power and refuses to pay the sovereign debt, or simply when the country does not have the money to pay when the debt is due.

In most cases, the only recourse for the lender is to renegotiate the terms of the loan — it cannot seize the government's assets. When a country is unable to pay its sovereign debt, the loans are rescheduled for later payment or restructured at better interest rates for the country owing the debt.

Nevertheless, a default would hurt a country's chances of obtaining a loan in the future. Its credit rating would also be hurt, making it more expensive for the country to sell sovereign debt bonds in the future.

Also, investors might not want to invest in a country that's not able to pay its sovereign debt, leaving the country with fewer funds for economic growth.

Sovereign debt defaults can send stock and bond markets around the world into a frenzy. Confidence in the markets can suffer when a country defaults, depending on the size of the default. Investors don't get their money back or have to take reduced rates on their investments. Often, the countries that own the debt might pledge funds to help the debt-ridden country survive any type of economic collapse.

The question thus is, are we ready and able to pay back the Eurobond and Municipal Bond issued?

Tuesday, December 18, 2012

Can LIBOR regain credibility?

The very existence of the London Interbank Offered Rate (Libor) has been threatened by the escalating scandal involving banks allegedly manipulating the rate during the credit crisis.
 
The credibility of the benchmark, which has been in place for nearly three decades, and affects everything from the survival of the world’s biggest banks to interest rates for ordinary savers, has been dented. Ben Bernanke, US Federal Reserve chairman, told Congress Tuesday that it is “structurally flawed.” International efforts to reform the benchmark rate are underway.
The revelations about artificial lowering of the rate, which helped mislead markets about banks’ willingness to lend to each other, have already claimed the job of ex-Barclays Chief Executive Bob Diamond. More scalps are likely to follow as the investigation continues.
So, will Libor itself be killed off? Or can it survive in a different form

Totally eliminating the rate, which is used to set rates for an estimated $800 trillion of derivatives and debt, sends shivers down spines in London and Wall Street.
“The size of the markets which reference Libor is so large that to abandon or radically alter it would cause unpredictable consequences,” Laurence Mutkin, European interest rate strategist at Morgan Stanley, pointed out.

A new futures contract known as the GCF (“General Collateral Financing) Repo Index Futures, launched on Monday and traded on NYSE Euronext, has been touted as a possible alternative, but pessimists believe that it is too short-term to reflect the overall tone of the market.
The British Bankers’ Association was already considering changing the way Libor was set before the scandal erupted – and this consultation has been made more urgent by recent events.
How to Fix Libor
What exactly can be done to fix the Libor system or is it worth fixing at all? Catherine Boyle has more.
 
At the moment, Libor is set at around 11am London time, when the banks involved in the panel which set it send the rate at which they are lending money to other banks to Thomson Reuters, via a secure network. The highest and lowest quartile rates are removed and the average of the remaining rates becomes Libor.

This basic model is followed by other inter-bank lending rate-setting panels around the world, who will doubtless be watching London closely. Several banks have quit these panels in recent days as the Libor fallout grew. Royal Bank of Scotland , for example, has left the panel which sets the Libor equivalent in Tokyo, Hong Kong and Singapore. If banks continue to drop out of setting the rate, this could itself cause its demise.

One point in Libor’s favor is that it does, with notable exceptions such as during the US sub-prime crisis, generally reflects what is in the market, as Mutkin points out. Another is that it is useful for market stability to have a benchmark rate based on three-month rather than less stable day-to-day lending.

Mutkin believes that part of the problem is that the Libor panel is just not asked the right question to reflect market realities.

“The Libor panel question as it now stands could well be re-phrased as: ‘At what rate would you do a transaction which you haven’t used much for funding during the past 20 years, and which Basel regulations discourage you from doing?’” he wrote.

The key message from London sources is that for Libor to regain credibility, it will have to become the basis for real transactions. Roughly speaking, it has to be real rather than conceptual.

One suggestion is the bank which submits the lowest rate to the panel should then be obliged to lend a set amount of money at that rate to other banks. The amount should be substantial but not enough to materially affect the bank.

The BBA could also use more up-to-date technology than the current secure network to take the Libor sample. If all Libor transactions were monitored by a single mechanism which then took an average, this argument goes, banks wouldn’t be able to fix the rates at an artificially low or high rate.
Broadening the sample beyond the 15 banks currently used to set the euro rate (the sterling panel has 16 banks and the dollar 18) is another option. Or the rate could be set by a new body rather than the BBA.

Whatever the eventual solution, the message coming from trading desks around the financial sector is that change is inevitable

Thursday, December 6, 2012

Internal Polical Risk

Banks regularly take active measures to manage and minimize risks that are inherent in our industry. These include credit risks, interest rate risks, operational risks, compliance risks, legal risks and even reputational risks. 

However, I believe there is one key risk that is the most neglected risk of all from a performance management standpoint: internal political risk.

What is internal political risk? It's a very weak operating culture, and it results from ongoing and unsettled disputes among different departments and individuals within the bank. Poor communication and weak leadership are to blame, as it nurtures the constant quarreling, disgruntled relationships and failure to fulfill organizational goals.

I have noted in my years of experience that few banks have a truly effective culture, while the rest are inhibited by selfish attitudes and organizational ineffectiveness. Banks must take a stand against this shattered culture syndrome or suffer the repercussions of a fractured chain of command, low employee morale, reduced productivity, high employee turnover, weak customer service and poor work quality.

Establishing a solid operating culture starts at the very top of the organization. The board of directors and senior management must come together to define the values and characteristics the bank intends to operate under and grow with long term. More specifically, values need to be integrated with shared beliefs and a powerful business mission into an energizing narrative that uniquely positions the bank for growth and profitability. Without this integration, real change is unlikely to occur, leaving the bank to continue floundering in a toxic culture that will undoubtedly preclude it from reaching its full potential.

Once a cultural framework is established and corporate values are identified, a detailed plan can be constructed to fully immerse all relevant parties in the new culture.  Coordinated, purposeful and comprehensive internal communication must be established to signal to the staff that a meaningful cultural change is underway.  A key element of this plan may be a companywide employee engagement event focused on getting staff to also serve as brand advocates. This will instill a strong sense of employee pride in the organization and build a deeper emotional connection between the employee and the bank.

Additionally, efforts to reward sound values and behaviors, in the form of an established employee recognition program, can contribute to strengthening your culture. In my opinion, these steps counteract the most widespread banking industry weakness:  a lack of accountability for results
.
I urge you to actively and thoughtfully design the culture you want, one that promotes your values, teamwork, customer satisfaction, innovation, change, accountability, employee achievement and effective communication. Build it into your branding and marketing efforts. Feel and see the difference. Make the message of your strong culture resonate profoundly with your customers.  Keep it vibrant, trendy, topical and fresh.  Make it fun.  Renovating your bank's culture will elevate your bank's performance.  And in the process, you will have one less risk to worry about.         

Monday, October 15, 2012

Economics Today

There is an old story from the heyday of the Soviet Union. As part of their May Day celebrations they were parading their latest weapon systems down the street in front of the Kremlin. There was a long column of their newest tanks, followed by a row of tractors pulling missiles. Behind these weapons were four pick-up trucks carrying older men in business suits waving to the crowds.

Seeing this display, the Communist party boss turned to his defence secretary. He praised the tanks and missiles and then said that he didn't understand the men in business suits. The defence secretary explained that these men were economists and "their destructive capacity is incredible".

People across the world now understand what the defence secretary meant. The amount of damage being inflicted on countries around the world by bad economic policy is astounding. As a result of unemployment or underemployment, millions of people are seeing their lives ruined. The current policies have led to trillions of dollars of lost output.

Bad policy
From an economic standpoint this loss is every bit as devastating as if it building had been destroyed by tanks or bombs. And people have lost their lives, due to inadequate healthcare, food and shelter, or as a result of the depression associated with their grim economic fate. 

If an enemy had inflicted this much damage on the United States, the countries of the European Union, or the countries elsewhere in the world that have been caught up in this downturn, millions of people would be lining up to enlist in the military, anxious to avenge this outrage. But, there is no external enemy to blame. The villains are the economists, still mostly men, in business suits.     

 The New York Times reported last month that formerly middle class workers in Spain are now picking through dumpsters looking for food. There are similar accounts from Greece. Both countries have unemployment rates hovering near 25 per cent, with youth unemployment rates that are nearly twice as high. 
And, the expectation is that things will only get worse. The latest projections from the IMF show the economies of both countries continuing to shrink through the rest of 2012 and for the whole of 2013. It is also important to remember that the IMF's growth projections have consistently been overly optimistic.

There are similar stories across the euro zone and now also in the United Kingdom as that nation's leaders have pursued economic policies that have thrown it back into recession. And of course the US is also losing close to $1 trillion in output each year, with close to 23 million unemployed, underemployed or out of the workforce altogether because of poor job prospects.

The economists in policy positions are doing their best to convince the public that the economic catastrophe that they are living through is a natural disaster that is beyond human control. But that is what Vice-President Biden would call "malarkey". This is a disaster that is 100 per cent human caused and is being perpetuated by bad policy.

 Social wreckage
The original collapse was the result of central bankers who were at best asleep at the wheel, or at worst complicit in the financial sectors' wheeling and dealing, ignoring the risks that massive housing bubbles obviously posed to the economy. However, the response to the downturn has made a bad situation far worse than necessary.

 As the evidence keeps telling us, the basic story is about as simple as it gets. The housing bubbles were driving demand prior to the collapse both directly through building booms and indirectly from the consumption generated by bubble generated housing equity. When the bubbles burst the construction booms went bust. And when the bubble generated housing equity vanished so did the consumption for which it provided a basis.

The basic economic problem in this context was finding a way to replace the lost demand. The right-wing politicians and their allied economists can repeat all the nonsense the like about promoting business confidence and tax breaks for job creators, but there is no remotely plausible story in which it would be possible to generate enough demand from investment to make up for the demand lost from the collapse of the bubbles.

 This means that in the short-term the only way to make up the demand is from the government budget deficits. This is not even economic theory, it is simply accounting.

In the longer term, the shortfalls in demand will have to be made up from a rebalancing across countries. Countries with large trade deficits, like the United States, Greece and Spain will have to move toward more balanced trade.

 In the case of the US this can only plausibly be done with a decline in the value of the dollar. In the case of the euro zone, there is no plausible alternative than to have the surplus countries, most importantly Germany, have more rapidly rising wages and prices in order to allow the deficit countries to regain competitiveness.
All of this is pretty straightforward, but the economists are instead steering the world toward more years of stagnation and rising unemployment and poverty. The human and social wreckage they have caused puts our enemies to shame. 

Friday, October 12, 2012

Bonds

What are Bonds?

A bond is simply a long-term loan. Most people have at some stage applied for a loan at a bank and had to pay interest on the amount of the loan. The bond market operates in exactly the same way. A bond is a financial instrument that promises that the borrower (a company or a government) will pay the holder (investor) interest over a period of time and repay the full amount of the loan on a predetermined maturity date. Just as people need money, so too do companies and governments.

Why invest in Bonds?

Bonds provide investors with a regular and steady income in the form of interest while preserving their initial investment amount (principal). They can help investors spread assets across different asset classes of the financial market, thereby minimising the risk of concentration in any one asset class. Bondholders usually have priority over stockholders when a company is liquidated and more likely to receive payment. Bonds are usually evaluated and rated based on credit history and ability to pay interest and repay obligations on time.

How to invest in Bonds

Investors can buy and sell bonds through a broker, just like shares. If you are not already a client of a broker, you will be assisted by your broker to set up an account and transact with a minimum delay. Your broker will be able to offer you advice and trade on your behalf.