Wednesday, March 18, 2009

Roubini on emerging world capital flows

Reversal of Capital Flows in the Emerging World
RGE Lead Analysts | Mar 18, 2009

"The reversal of capital inflows due to deleveraging or losses in financial markets has been one of the most significant effects of the financial crisis on emerging and frontier economies. After a period in 2007 and 2008 when many emerging markets faced the problem of dealing with extensive capital inflows, now capital flows have reversed. Private capital flows in 2009 are expected to be less than half of their 2007 levels, posing pressure on emerging market currencies, asset markets and economies. Countries that relied on readily available capital to finance their current account deficits are particularly vulnerable. Furthermore, capital outflows pose the risk that governments may react with some type of capital controls or barriers to the exit of foreign investments."

Another unsettling analysis from Brad Setser

A bit more to worry about; foreign demand for long-term Treasuries has faded

He states "I wanted to highlight one trend that I glossed over on Monday, namely that foreign demand for long-term Treasuries has disappeared over the last few months." Then he adds this chart:
If the US Treasury is going to sell a lot of long term debt, it is going to have to find some new buyers(other than the US Fed).

Tuesday, March 17, 2009

AIG: unstable reactor at the core of shadow financial system

The following is being quoted all over the place, and with good reason:

"What is equally striking, however, is the all-encompassing list of names which purchased insurance on mortgage instruments from AIG, via credit derivatives. After all, during the past decade, the theory behind modern financial innovation was that it was spreading credit risk round the system instead of just leaving it concentrated on the balance sheets of banks.

But the AIG list shows what the fatal flaw in that rhetoric was. On paper, banks ranging from Deutsche Bank to Société Générale to Merrill Lynch have been shedding credit risks on mortgage loans, and much else. Unfortunately, most of those banks have been shedding risks in almost the same way – namely by dumping large chunks on to AIG. Or, to put it another way, what AIG has essentially been doing in the past decade is writing the same type of insurance contract, over and over again, for almost every other player on the street.

Far from promoting “dispersion” or “diversification”, innovation has ended up producing concentrations of risk, plagued with deadly correlations, too. Hence AIG’s inability to honour its insurance deals to the rest of the financial system, until it was bailed out by US taxpayers."

Setser adds:

"many European banks were growing their dollar balance sheets so quickly that many started to rely heavily on US money market funds for financing. And if an institution is borrowing from US money market funds to buy securitized US mortgage credit, in a lot of ways it is a US bank, or at least a shadow US bank. Consequently I think it is possible to think of AIG as the insurer-of-last resort to the United States’ own shadow financial system. That shadow financial system just operated offshore."

If these flows of capital had been exposed earlier, the shadow financial system would have come apart earlier. US investors in money market funds would have pulled their cash out.

Wednesday, March 11, 2009

US historical oil imports

Frome the US EIA:

Compare that to this chart:

How do you square a spike in imports occurring roughly at the same time as the OPEC embargo?

There is this:
"The rapid increase in crude prices from 1973 to 1981 would have been much less were it not for United States energy policy during the post Embargo period. The US imposed price controls on domestically produced oil in an attempt to lessen the impact of the 1973-74 price increase. The obvious result of the price controls was that U.S. consumers of crude oil paid about 50 percent more for imports than domestic production and U.S producers received less than world market price. In effect, the domestic petroleum industry was subsidizing the U.s. consumer."

That would represent a strong negative incentive to domestic production and exploration. Truly a colossal policy blunder. From the same source:
"In the absence of price controls U.S. exploration and production would certainly have been significantly greater. Higher petroleum prices faced by consumers would have resulted in lower rates of consumption: automobiles would have had higher miles per gallon sooner, homes and commercial buildings would have been better insulated and improvements in industrial energy efficiency would have been greater than they were during this period. As a consequence, the United States would have been less dependent on imports in 1979-1980 and the price increase in response to Iranian and Iraqi supply interruptions would have been significantly less."


US DOE oil projection

In a release today, the EIA states
"In the latest Short-Term Energy Outlook (STEO), just released yesterday, EIA is projecting 2009 global oil demand to be 3 million barrels per day lower than we projected as recently as six months ago, in our September 2008 STEO."

As to why this is the case, the EIA states(bolds mine)
"The downturn in the world economy that became apparent in the second half of 2008 curbed, and ultimately reversed, world oil demand growth, something that rising oil prices between 2004 and 2008 did not achieve. While consumption in the Organization for Economic Cooperation and Development (OECD) began to react to higher oil prices in late 2005, non-OECD consumption continued to rise unabated. Demand growth in large non-OECD oil consumers seemed immune to higher oil prices, because: 1) growth was largely driven by their rapidly expanding economies, and 2) many domestic consumers were shielded from world market prices by domestic price controls and subsidy programs."
The existence of price controls and subsidies was conveniently ignored by many claiming that this demand growth was permanent/secular.

So what does this mean for oil producers? EIA states that
"members of the Organization of the Petroleum Exporting Countries (OPEC) currently hold roughly 4.8 million barrels per day (bbl/d) of surplus production capacity, while they held an average of 1.5 million bbl/d from 2004 to the peak of the market in 2008."
Wait, they had 1.5 million barels a day of excess capacity during the price run-up? They were obviously sitting on that capacity and profiting.

"the lagged impact of high oil prices in recent years will continue to affect oil demand in the short term. During 2007 and 2008, WTI averaged $86 per barrel; these historically-high prices will influence the decisions that individuals and firms make going forward, which will tend to dampen the rise in world oil demand engendered by the return of global economic growth."
I know of individuals who have switched to diesel vehicles and run on waste cooking oil produced in their own mini-refinery. That is permanent demand destruction with respect to crude oil. There have been many improvements in fuel efficiencies such as consumers switching to hybrid vehicles and ditching SUV's, that will suppress demand as well.

Finally, the chart of US gasoline prices shows stabilization at around $2.00 a barrel. I think on an inflation adjusted basis that is a reasonable price and will be a new medium term average.

Tuesday, March 03, 2009

Modern finance and pensions

"The real crime is claiming 7.75% return is achievable over the long term. "

The state of economics as a field of study

The unfortunate uselessness of most ’state of the art’ academic monetary economics

by Willem Buiter

"The Monetary Policy Committee of the Bank of England I was privileged to be a ‘founder’ external member ... contained, like its successor..., quite a strong representation of academic economists and other professional economists with serious technical training and backgrounds. This turned out to be a severe handicap when the central bank had to switch gears and change from being an inflation-targeting central bank under conditions of orderly financial markets to a financial stability-oriented central bank under conditions of widespread market illiquidity and funding illiquidity.; Indeed, it may have set back by decades serious investigations of aggregate economic behaviour and economic policy-relevant understanding .; It was a privately and socially costly waste of time and other resources.

Most mainstream macroeconomic theoretical innovations since the 1970s (the New Classical rational expectations revolution associated with such names as Robert E. Lucas Jr., Edward Prescott, Thomas Sargent, Robert Barro etc, and the New Keynesian theorizing of Michael Woodford and many others) have turned out to be self-referential, inward-looking distractions at best.; Research tended to be motivated by the internal logic, intellectual sunk capital and esthetic puzzles of established research programmes; rather than by a powerful desire to understand how the economy works - let alone how the economy works during times of stress and financial instability.; So the economics profession was caught unprepared when the crisis struck."

I agree...