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Dating game

When will China overtake America?

FORGET Monopoly or World of Warcraft. The Economist’s idea of Christmas fun is guessing when China’s economy will leapfrog America’s to become the world’s biggest. The Conference Board, a business-research group, recently predicted that China could become the world’s largest economy as soon as 2012 on a purchasing-power-parity (PPP) basis, which adjusts for the fact that prices are lower in China. But economists disagree on how to measure PPP. And America will only really be eclipsed when China’s GDP outstrips it in plain dollar terms, converted at market exchange rates.

Since by that reckoning China’s GDP is currently only two-fifths the size of America’s, that day may still seem distant. But it is getting closer. When Goldman Sachs made its first forecasts for the BRIC economies (Brazil, Russia, India and China) in 2003, it predicted that China would overtake America in 2041. Now it says 2027. In November Standard Chartered forecast that it will happen by 2020. This partly reflects the impact of the financial crisis. In the third quarter of 2010 America’s real GDP was still below its level in December 2007; China’s GDP grew by 28% over the same period.

If real GDP in China and America continued to grow at the same annual average pace as over the past ten years (10.5% and 1.7% respectively) and nothing else changed, China’s GDP would overtake America’s in 2022. But crude extrapolation of the past is a poor predictor of the future: recall the forecasts in the mid-1980s that Japan was set to become the world’s largest economy. China’s growth rate is bound to slow in coming years as its working-age population starts to shrink and productivity growth declines.

Make your own predictions by adjusting the figures in our interactive chart

Make your own predictions by adjusting the figures in our interactive chart

Then again, the relative paths of dollar GDP in China and America depend not only on real growth rates but also on inflation and the yuan’s exchange rate against the dollar. In an emerging economy with rapid productivity growth the real exchange rate should rise over time, through either higher inflation or a rise in the nominal exchange rate. Over the past decade annual inflation (as measured by the GDP deflator) has averaged 3.8% in China against 2.2% in America. And since China ditched its strict dollar peg in 2005 the yuan has risen by an annual average of 4.2%.

The Economist has created an online chart (www.economist.com/chinavusa) that allows you to plug in your own assumptions about future growth, inflation and the exchange rate. Our best guess is that annual real GDP growth over the next decade averages 7.75% in China and 2.5% in America, inflation rates average 4% and 1.5%, and the yuan appreciates by 3% a year. If so, then China would overtake America in 2019 (see chart). If you disagree and think China’s real growth rate will slow to an annual average of only 5%, then (leaving the other assumptions unchanged) China would have to wait until 2022 to become number one. Americans would still be much richer, of course, with a GDP per head more than four times that in China. But don’t expect that to dampen Chinese celebrations, whenever they come.

Лауринайчуте

The yuan-dollar exchange rate

Nominally cheap or really dear?

China’s exchange rate has risen faster than you think. Really

AMERICAN manufacturers complain that China undervalues its exchange rate. But which one? The nominal exchange rate is now 6.67 yuan to the dollar, having strengthened by almost 2% since September 5th (when Larry Summers, an adviser to President Barack Obama, flew to Beijing to complain about the currency in person) and by 24% since 2005.

But China’s real exchange rate with America has strengthened by almost 50% since 2005, according to calculations by The Economist (see chart). A real exchange rate takes account of price movements in each country. If prices rise faster in China than in America, China’s real exchange rate goes up, even if its nominal exchange rate stays the same. That’s because higher prices at home make China’s firms less competitive abroad, just as if their currency had gone up.

To calculate the real exchange rate, you need a gauge of prices in each country. Many economists use the consumer-price index (CPI). But the CPI contains lots of goods and services (such as housing rents) that cannot be traded across borders. Our measure of the real exchange rate, which we will regularly update, offers a more direct measure of competitiveness by looking instead at unit labour costs: the price of labour per widget. These costs go up when wages rise or productivity (widgets per worker) falls. In American manufacturing, unit labour costs have risen by less than 4% since the first quarter of 2005, according to the Bureau of Labour Statistics. In Chinese industry they have risen by 25% over that period, according to our sums.

Those estimates are rough and ready. There are no official statistics on China’s unit labour costs. Our calculations are based on the value-added in industry (which extends beyond manufacturing) and the wage bill of urban factories, which does not count the town and village enterprises that employ over two-thirds of China’s metal-bashers. But the urban plants probably churn out a big share of the goodies that America buys.

The combination of a 24% rise in the yuan against the dollar and a 21% increase in Chinese unit labour costs, relative to America’s, explains the steep appreciation shown in the chart. The yuan may well still be undervalued but our index suggests American manufacturing should have less to fear from Chinese competition than it did five years ago. Until June 2009 appreciation was largely because of the stronger yuan. Since then it is largely because China’s unit labour costs have grown much faster than America’s. Employers in China’s coastal factories have suffered labour shortages and strikes. America’s factories have reported strong productivity gains as they have wrung more out of the workers that survived the recession (although those gains will be hard to repeat).

Of course, China and America do not trade only with each other. China’s big surpluses and America’s big deficits depend on the real exchange rate between them and all of their trading partners. But calculating that would require timely estimates of unit labour costs for all of China’s trading partners. That is a bit too laborious.

Михайлова

Currencies

Trial of strength

Will today’s currency interventions hurt or help the world economy?

TWENTY-FIVE years ago this week, the finance ministers of America, Japan, Britain, France and West Germany met at a swanky New York hotel and agreed to push the dollar down. The “Plaza Accord” laid out a package of co-ordinated policies. The dollar duly fell, by more than 50% against the D-mark and yen by 1987. The deal is still seen as a high-water mark of international monetary co-operation. The appeal of intervention is now rising once again. But this time the trend is unilateral, unco-ordinated and in one direction.

At its meeting on September 21st the Federal Reserve worried aloud about uncomfortably low inflation and made clear it was prepared to do more to help the flagging recovery. The prospect of even looser monetary policy pushed the dollar down sharply: it dipped to its lowest level since March on a trade-weighted basis.

A weaker dollar means stronger currencies elsewhere—the euro hit a five-month high against the dollar on September 22nd. A growing number of countries are determined to stop their currencies from rising. Japan sold about ¥2 trillion ($23.6 billion) on September 15th, its first foray into the currency markets in six years, to stem a surge in the yen that had pushed its nominal rate against the dollar to its highest since 1995. It is not the only rich country to target its exchange rate: in the 15 months to June, Switzerland quadrupled its foreign reserves, to $219 billion, in a bid to stop the franc from rising too fast.

The most active interveners, however, are in the emerging world. China is the extreme case. It has built up $2.45 trillion of reserves thanks to its determination to keep the yuan stable against the dollar. Others have less rigid currencies but still intervene to stem what they regard as excessive upward pressure. Between September 13th and 16th Brazil’s central bank bought dollars at a rate of $1 billion a day.

As the recovery slows, a growing number of people worry about a descent into competitive depreciation, as countries try to grab a bigger share of global demand at others’ expense, a trend that could fuel protectionism. Optimists, however, argue there may be benefits from today’s fad for currency fiddling. One argument is that intervention may be a backdoor route to reflation. If central banks all print money to prevent their currencies appreciating and don’t mop up or “sterilise” that liquidity by issuing bonds, then their exchange rates might end up the same but the world will have had a monetary boost in the interim.

The truth lies in between. Although most of the intervening governments have the same goal—to stop their domestic currency from rising—their circumstances and motivations vary widely. China’s ongoing determination to fix the yuan is the least defensible and most distortive. Unfortunately, it is also the world’s most effective intervener. Thanks to a closed capital account (even if cracks are appearing) and government control over domestic banks, China has been able to buy vast quantities of dollars without fuelling inflation. The central bank issues bills to mop up the liquidity created from buying reserves, which obliging banks hold at low rates.

For most emerging economies, however, intervention is more about coping with volatile capital flows. Thanks in part to rock-bottom interest rates in the rich world, foreign capital is flooding back into emerging economies. By intervening, emerging-market central banks restrain the pace at which their currencies appreciate. But they do so at a price. In countries with freer banking systems than China’s, sterilisation becomes increasingly costly the more reserves are bought. But if the intervention is not sterilised, the added liquidity fuels inflation.

In the rich world, where demand is weak and deflation a risk, the calculus is different. Unsterilised intervention is seen as a route both to counter excessive currency strength and to combat deflation (the prime motive for Swiss intervention). In Japan’s case the first argument does not cut much ice. Thanks to Japanese deflation the yen, in real effective terms, is below its average value since 1990 (see chart). The second rationale has some merit provided the Bank of Japan really does resist the urge to mop up any liquidity. But it could achieve the same reflation, without the political risks of unilateral intervention, in other ways.

Those political risks are the best reason to resist going it alone. Not only is there the danger of a protectionist backlash. But unilateralism will also make it much harder to elicit further action from China, the country whose currency regime distorts the global economy most. The rich world needs reflating but the world economy also needs rebalancing. And that demands a weaker dollar. The finance ministers at the Plaza Accord recognised that reality. It is time their G20 successors did, too.

Музуров

Global rebalancing

The clock ticks

American pressure for China to revalue the yuan is reviving. Others are less fussed

LIKE his leggier boss in the White House, Tim Geithner, America’s treasury secretary, is fond of basketball. In April he called a timeout in America’s long campaign for a stronger Chinese exchange rate, postponing a report that might have accused China of currency manipulation. His objective, he said, was to use his talks with China in May and the G20 gatherings in June to make “material progress” on rebalancing the world economy. The last of those meetings, the G20 summit in Toronto, will take place on June 26th and 27th.

In basketball timeouts provide an opportunity to regroup and substitute players. In politics they give new problems a chance to come into play. The Greek sovereign-debt crisis deflected the world’s attention from China’s currency and sank the euro, which meant the yuan has strengthened overall even as it has remained fixed to the dollar. It also unnerved China’s policymakers, who began to fret again about financial instability and a slowdown in the euro area, their second-biggest export market. This was not the time, they concluded, to fiddle with the yuan.

That sits awkwardly with Mr Geithner’s hopes for global rebalancing. In this vision of the future, American saving would rise as overstretched borrowers repaid their debts. American households have indeed pulled back dramatically if you count their reduced outlays on houses and home improvements, argues Jan Hatzius of Goldman Sachs. The combined spending of American households and businesses now falls short of their income by about 6.8% of GDP. In 2006 spending exceeded income by 3.7% of GDP.

This retrenchment was offset, and made possible, by a dramatic fiscal swing in the opposite direction. But America cannot long maintain a budget deficit of almost 9% of GDP. A sustainable recovery would require America to sell more to foreigners, aided by a cheaper dollar. And surplus countries, living well within their means, would have to buy more.

Things went according to script until the end of last year, but have since reversed. America’s trade deficit has widened notably this year, to a 16-month high of $40 billion in April. Europe’s travails suggest the outlook isn’t much better: it will probably be importing less and exporting more, because of fiscal retrenchment and a lower euro, taking market share from American exporters.

America can take some comfort from a narrowing of China’s current-account surplus, from 11% of GDP at its peak in 2007 to 6.1% last year. China’s imports have ballooned this year, thanks to its prodigious stimulus spending and a rise in commodity prices. It even recorded a trade deficit in March. But in the year to May exports increased by almost half, resulting in a trade surplus of about $20 billion for the month, the biggest since October. The fear is that China’s strong imports of machinery, oil and ores in the early months of this year may simply have gone into one end of a production pipeline, out of which are now emerging excessive volumes of steel and heavy-industrial products that it cannot sell at home. As Janet Zhang of GaveKal Dragonomics points out, China’s steel exports in May were 89% higher than their average over the previous four months.

Criticism of China’s currency has resurged almost as quickly as its exports. In international basketball, only the coach can call a timeout. But in America, any of the players can interrupt the game. American policymaking is equally chaotic. Unlike Mr Geithner, many congressmen believe China has already run out of time. Charles Schumer, a Democratic senator, has introduced a bill that would authorise America to slap duties on imports deemed to benefit from an artificially low currency. He plans to seek a vote within a few weeks.

With no parallel bill in the House of Representatives, Mr Schumer’s proposal is a long way from becoming law. But Senate passage could press the administration into taking a firmer line. The government could formally label China a currency manipulator in the delayed report, due in early July; or it could rule in favour of several companies—including three papermakers—that have requested duties on Chinese imports because of the cheap yuan.

Would a stronger yuan really save America’s papermakers and other struggling firms? Between mid-2005 and mid-2009, China’s real trade-weighted exchange rate appreciated by about 5.5% a year. If instead it had risen by 10% a year, as many in America would have liked, China’s exports would have been about 30% lower by mid-2009, according to a study by Shaghil Ahmed of the Federal Reserve.

But in China a drop in exports does not translate straightforwardly into a drop in the trade surplus. China re-exports a lot of what it imports, turning hard drives into iPods and iron ore into steel. So when its foreign sales fall, its overseas purchases drop as well. Alicia García-Herrero of BBVA, a Spanish bank, and Tuuli Koivu of the Bank of Finland find that a 10% appreciation of the trade-weighted yuan reduces imports of components by about 6%.

America hoped that other G20 members, particularly in the developing world, would rally to the cause of revaluing the yuan. In April the president of Brazil’s Central Bank described China’s currency as a “distortion”. His counterpart in India made some milder remarks, but India’s government has remained silent. It is the co-chair of the G20’s working group on rebalancing. As a rare example of a big Asian economy with a current-account deficit, it cherishes its role as honest broker.

America’s huge trade deficit with China (see chart) sets it apart from many other G20 members. Japan has a surplus of $45.5 billion with China and South Korea $59.1 billion. Even Brazil can boast more than $14 billion. In the past 12 months China has run a trade deficit with the G20 excluding America (even counting the entire European Union as a member).

Getting global imbalances onto the G20’s agenda took some work. China first resisted the idea, fearing the group would put it under too much pressure. But for champions of yuan reform the hope is less that the G20 sides with America against China, more that China feels comfortable enough to use the forum to unveil a policy shift that is in its own long-run interest.

Петухова

Money from Wall Street

Cheques and imbalances

Financial firms bet on Republicans to fight for their interests

THE recession may have hurt, but re-regulation could hurt almost as much. So in the first quarter of this year the financial services, insurance and property industries spent nearly $125m on lobbying, up more than 11% from last year. The Centre for Public Integrity, a non-partisan research group, reckons the financial-services industries alone hired more than 3,000 lobbyists to influence the financial reform bill now before Congress. On June 14th came news that the Office of Congressional Ethics has launched a probe into the fund-raising activities of eight lawmakers who sit on the House Financial Services or Ways and Means Committees. They are thought to have held fund-raisers days before they voted on financial reform.

The bill has passed both House and Senate, but the two versions still have to be reconciled. Lobbyists hope to water down some of the more contentious provisions, such as a requirement for banks to spin off their derivatives units. They are making their appeals to familiar faces. The senators on the conference committee, which will meld the bills, are some of the biggest recipients of contributions from the financial services, insurance, and property industries, reckons the Centre for Responsive Politics. The 12 senators in question have received over $57m from these sectors during their careers.

If the final bill comes out tough, Wall Street may punish the Democrats. Already, many financial firms have started to spurn Democrats in favour of Republicans. In March 2009 they gave only 37% of their contributions to Republicans. But in March of this year the proportion jumped to 58%. Money-men want to reward Republicans, but they are also betting that Republicans will pick up seats in November’s election, says Jim Thurber, director of the Centre for Congressional and Presidential Studies at American University.

It is not just the reform bill that has prompted financial firms to storm Congress. A provision in the jobs bill, which the House has passed and the Senate is still considering, would hit private-equity shops, property firms and some hedge funds that pay capital-gains rates, rather than income tax, which is higher, on their profits. Congress wants to change this, and has proposed taxing 75% of their profits as income and 25% as capital gains.

On June 8th the Senate Finance Committee threw the industry a bone and proposed that government should tax only 65% of their profits as income. Some cynics note that the third-largest contributor to Max Baucus, the senator who heads the Finance Committee, were, collectively, employees at KKR, a big private-equity firm.

Подлесный

Fiscal tightening and growth

A good squeeze

Bigger budgetary adjustments are not always better

ACROSS much of the rich world an era of budget austerity beckons. Government debt is rising faster than at any time since the second world war. By 2014 the public debt of big rich countries will reach an average of 110% of GDP, up by almost 40 percentage points from 2007, according to the IMF (see chart). On current policies it will continue rising.

How to alter this bleak trajectory will be policymakers’ most difficult task over the next decade. Financial markets are already forcing some into drastic action. Greece plans to cut its deficit from 12.7% of GDP in 2009 to 3% by 2013, using spending cuts, tax hikes and heroic growth projections. Portugal has rushed out plans to cut its deficit from 9.3% last year to 3% by 2013. Britain’s election will be fought over the contours of future austerity.

But so far less than half of the OECD’s member countries have detailed medium-term plans to reduce their deficits. Their choices will have huge implications for the growth and structure of their economies. Worryingly given the stakes, economics offers surprisingly little certainty about either the optimal goal or the best way of getting there.

Begin with the goal. Today’s deficits, which are leading to ever-higher debt burdens, are plainly unsustainable. But what level of public debt should governments aim for? A popular rule of thumb for a “safe” level of government debt in a rich economy is 60% of GDP. That is the limit enshrined in the Maastricht Treaty, which governs membership of the euro. It was the average debt-to-GDP ratio among big rich economies before the financial crisis. And it is the figure to which the IMF reckons rich countries should aspire.

Reducing debt burdens to pre-crisis levels may make some sense. It would ensure the costs of the crisis were not passed on to future generations. It would leave governments with more fiscal room to deal with recessions to come. And it would ensure that higher government debt did not crowd out private investment, which could lower future growth. The fund reckons that the 35-percentage-point increase in rich countries’ debt could raise borrowing costs by two percentage points.

Unfortunately, there is little rigorous evidence in support of a target of 60%, let alone for reaching it quickly. In the past some countries’ public-debt ratios have been higher than they are today and they have often fallen slowly. Andrew Scott of the London Business School points out that Britain’s debt burden rose from 121% of GNP in 1918 to 191% in 1932 and did not return to its 1918 level until 1960. In a recent study Carmen Reinhart and Ken Rogoff find that public-debt burdens of less than 90% of GDP have scant impact on growth, but they do see a significant effect at higher ratios. That argues against a single number for all. With the world’s biggest sovereign-bond market and trusted institutions, America will be able to carry a higher public-debt burden than Greece.

In principle, countries can cut their debts in several ways. They can default, either outright or, if they have their own currencies, through inflation. For most countries, these paths are unappealing (see article). They can try to boost growth, which reduces the burden of public debt and makes it easier to cut deficits by bringing in more tax revenue. But the size of today’s deficits—on top of the future cost of existing pension and health-care promises—means growth alone will not be enough. Budgets also have to be tightened.

By how much depends on governments’ debt goals. The IMF’s calculations, for instance, suggest that to reduce their ratios of public debt to GDP to 60% by 2030, the rich world’s governments need to improve their budget balances by an average of 8% of GDP by 2020. The average structural deficit (ie, before interest payments) must swing from 4.3% of GDP in 2010 to a surplus of 3.7%. They must then maintain that surplus. A fifth of the rich world’s economies (including America and Britain) would need adjustments of around 10% of GDP or more. Stabilising debt ratios at 2012 levels would demand, on average, an adjustment only half as big.

The appropriate debt-to-GDP goal will depend on the means used to get there. Balancing a budget by raising taxes, for instance, may harm growth more than living with a higher debt ratio. Here, the academic evidence is clearer. Fiscal adjustments that rely on spending cuts are more sustainable and friendlier to growth than those that rely on tax hikes. Studies show that cutting public-sector wages and transfers is better than cutting public investment. Many cuts, from raising pension ages to slashing farm subsidies, have a double benefit: they boost growth both by improving public finances and by encouraging people to work harder or promoting more efficient allocation of resources.

Austerity can even be expansionary. A number of budget adjustments based on spending cuts in the 1980s and 1990s were accompanied by faster growth, presumably because the effect on confidence and interest rates outweighed the loss of government demand. That may not happen again, not least because consumers are weighed down with debt and interest rates are already so low. But the superiority of spending cuts still holds. The problem, however, is that the scale of adjustment may be too big to achieve by cuts alone. The IMF’s analysts, for instance, reckon that three percentage points of the 8% of GDP fiscal swing they deem necessary will have to come from higher tax revenue.

The taxes that do least harm to growth are those on consumption or on immobile assets such as property. Given the pressures of global warming, green taxes also make sense. European governments already rely more on consumption taxes than other rich countries do, and some are raising their rates of value-added tax. But politics often points elsewhere, towards making rich people pay to clean up the fiscal mess: the highest marginal rates of income tax are set to rise in America and Britain. That may please populists but it will not boost growth.

Половинкина

Buttonwood

Race to the bottom

Countries compete to weaken their currencies

ONCE upon a time, nations took pride in their strong currencies, seeing them as symbols of economic and political power. Nowadays it seems as if the foreign-exchange markets are home to a bunch of Charles Atlas’s 97-pound weaklings, all of them eager to have sand kicked in their faces.

First the dollar took a battering in 2009 when the return of risk appetite, and the ability to borrow the currency at very low rates, sent money flowing out of America for use in speculative “carry trade” transactions. Then the euro got pummelled because of concerns about the euro zone’s exposure to sovereign-debt problems in southern Europe. Finally sterling hit the canvas this week because of concerns about the British government’s deficit and the policy gridlock that may result from a hung parliament after a general election expected in May.

Is there any sign that politicians and central bankers are upset by these depreciations? None at all. Mervyn King, governor of the Bank of England, seems to welcome sterling’s weakness as a boost to exporters. European politicians, such as Christine Lagarde, the French finance minister, have revealed their pleasure at the euro’s recent decline for similar reasons. The American authorities, while parroting their belief in a strong dollar, have done nothing to shore it up, neither raising interest rates nor cutting the fiscal deficit nor intervening in the markets.

Nor has there been much sign of rejoicing in those countries whose currencies have tended to strengthen. The Swiss have intervened to hold down the franc. And Japan’s latest finance minister, Naoto Kan, has called for a weaker yen (although he received a rebuke from the prime minister for doing so).

The one country that most economists agree should let its currency rise is China (in theory, faster-growing countries should enjoy real appreciation over the long term). But the People’s Republic also resists the temptation, intervening to stop the yuan from rising against the dollar.

Why are weak currencies so much in favour these days? The answer seems to be that the interests of exporters are paramount, given the desperate scramble for growth that has followed the credit crunch and the global recession.

Of course, because currencies cannot depreciate all at once, there seems to be a kind of “Buggins’ turn” to be the land of the rising exchange rate. The starring role tends to be brief, either because the government takes action to weaken the currency, or because economic news prompts the markets to drive it down.

At the same time weaker currencies have not been punished in the traditional way—by higher inflation. Consider sterling. Using the currency’s 2007 peaks as a guide, the pound has fallen more sharply against the dollar and euro (around 25-30%) than it did after the exit from the Exchange Rate Mechanism in 1992.

In the 1970s that kind of depreciation was accompanied by double-digit inflation. But the year-on-year increase in the British retail-price index was just 3.5% in January and even that number was pushed up by higher rates of value-added tax, a home-grown factor. Nor is Britain paying any great price for losing its European and American creditors more than a quarter of their money in three years. Short-term rates are just 0.5% and ten-year government bonds yield a lowish 4%.

To some, the lesson of all this is clear. If all the issuers of paper money want to see their currencies depreciate, then the only answer is to own an asset that central banks cannot debase—namely, gold. Part of bullion’s rise to more than $1,100 an ounce this year must be attributed to the conviction that governments will inflate away their debts.

But it is hard to see how sustained rises in inflation will be generated in the next couple of years, given the amount of spare capacity in the global economy. It is also far from certain that governments could get away with a deliberate strategy of higher inflation, given the generally short maturity of their debts (less than five years, in America’s case). The markets would see them coming and increase bond yields accordingly.

Indeed the current sovereign-debt jitters may be a sign that creditors are starting to assert themselves again, and demanding higher yields from less prudent governments. Where countries depend on foreigners to fund their deficits, they may find that the “easy” option of depreciation carries a much higher cost than in recent years. In time, having a strong currency may once again come to be seen as an advantage, not a handicap.

Попыкина

Dealing with budget deficits Who pays the bill?

Throughout the rich world battle lines are being drawn in the coming fight over deficit reduction

WHEN friends go out to dinner, the convivial atmosphere can be shattered once the waiter brings the bill. A pleasant evening can descend into a dispute about who had a starter and who ordered the lobster. Running a public-sector deficit is similar: the arguments start when the tab has to be paid.

The battles will be all the more fierce this time around because the deficits are so large and likely in the short term to stay that way. With developed economies still weak, many governments are (often rightly) keen to run large deficits for a while longer. But the bond markets are getting impatient, especially with weaker European countries. Greece was forced to announce a third austerity package this week, after its initial efforts failed to reassure either the markets or its neighbours (see article). Although Britain has a lower debt-to-GDP ratio than Greece and its debt has an average maturity of 14 years, sterling also wobbled this week, with investors spooked by the prospect of a hung parliament. True, the three biggest rich-world economies, the United States, Germany and Japan, are under less pressure. But Japan has high debt levels and America has the government-bankrupting cost of ageing baby-boomers.

If the world were run by economists, deficit reduction would be a very complicated balancing act. For politicians one question may well dominate all others: who is going to pay? The candidates differ from country to country, but the list usually includes taxpayers, public-sector workers, entitlement recipients (such as state pensioners or public-health users), foreign investors and future generations. Already battle lines are being drawn: witness the strikes by Greece’s public-sector unions and the tea parties thrown by America’s tax protesters.

Two immediate answers appear, which should be easier for politicians to embrace than all those spending cuts and tax rises. The first is to be honest about the size of the problem. Public-sector accounting is Enronesque. Creditors will punish governments with dodgy numbers, as the Greeks have discovered. And voters can hardly make judgments about what to scale back if they do not know what promises have been made. Talk in continental Europe of an “Anglo-Saxon” conspiracy of greedy speculators is also dishonest. The speculators did not invent the deficits. As one bank analyst has tartly remarked: “You can’t blame the mirror for your ugly face.”

The second is to focus on economic growth. Higher growth reassures markets, increases tax revenues and reduces spending on unemployment benefits and other welfare payments. So politicians should eschew policies that reduce the long-term growth rate, such as protectionism or higher taxes, and focus instead on measures that boost the growth potential, such as more flexible labour markets and other productivity-enhancing reforms. No matter what taxes it raises, Japan will not solve its fiscal woes without faster growth. Many European governments are walking into the same trap.

Even assuming that most governments tell the truth a bit more and their economies grow a bit faster, there will still be hard choices. The main fault-line is often intergenerational. Some promises, particularly on public-sector pensions and health care, may impose too great a burden on the next generation. Middle-aged Americans have written cheques on the accounts of their children. Scaling back those promises, for example by raising the pension age, is a prerequisite for getting public finances in order just about everywhere, even if it will not do much to reduce the deficit in the short term.

The more immediate fight, which is already starting to break out in many European countries, is between taxpayers and public-sector workers, and between raising taxes and cutting public spending. Politically, the contest is evenly matched, pitting powerful unions against the biggest taxpayers—corporations and high-earners—who often have the ear of politicians. In terms of economics, though, the bulk of the adjustment should come in the form of spending cuts.

There is no alternative

The state had to step in during the credit crunch, given the scale of the banking crisis, but this expansion of its scope should be temporary. This is not just ideological bias on our part; economic studies suggest that fiscal adjustments that rely on spending cuts do better than those based on tax rises. Yes, some tax rises may be necessary, if only out of the political necessity of persuading the electorate that the burden is being shared. But tax rises, like Japan’s in 1997, can kill a recovery.

In the past some governments have dealt with debts by walking away from them. Iceland is voting on a milder form of that solution this weekend (see article). The graver threat this time is that countries are tempted to diminish their debts through higher inflation. But that would be a dangerous option to adopt and may not even be possible, given that markets can see such policies coming and demand higher bond yields.

Whichever path governments choose will be hard. As a period of loose credit gives way to an era of austerity, the social cohesion of many nations will be put to the test. Not all countries will pass. Over the next few years the careers of many politicians will be made and broken in the bond market. 4550

Кошелева

Economics focus

From bail-out to bail-in

WHAT should policymakers do when faced with the potential failure of a large bank? In 2008 officials had to choose between taxpayer bail-outs (bad) or systemic financial collapse (probably worse). Various ideas to make finance safer, like contingent capital and living wills, are circulating today. But the central issue of bank resolution, perhaps the most vexing aspect of the financial crisis, has not been clearly addressed.

A “bail-in” process for bank resolution is a potentially powerful “third option” that confronts this problem head-on. It would give officials the authority to force banks to recapitalise from within, using private capital, not public money. The concept builds on time-tested procedures that have been used to keep airlines flying and industrial firms going even as their capital structures were being reorganised. It accelerates those procedures to address the unique circumstances of financial firms operating in today’s fast-moving markets. If done correctly it should strengthen market discipline on banks and reduce the potential for systemic risk.

The best way to understand the idea is to look at how a bail-in could have changed the outcome for Lehman Brothers over that fateful weekend in September 2008. Despite intensive efforts to find a better alternative, the bankruptcy of Lehman became unavoidable by the end of the weekend. When the two of us left the New York Federal Reserve on Sunday night, we knew that the financial landscape was in for a seismic shock.

Sunday, bloody Sunday

So it proved. According to market estimates at the time, Lehman’s balance-sheet was under pressure from perhaps $25 billion of unrealised losses on illiquid assets. But bankruptcy expanded that shortfall to roughly $150 billion of shareholder and creditor losses, based on recent market prices. In effect, the company’s bankruptcy acted as a loss amplifier, multiplying the scale of the problem by a factor of six. This escalated the impact elsewhere in the financial system. For example, the Reserve Primary Fund, a large money-market fund, “broke the buck” the next day, leading to severe pressure on other funds. A bail-in during the course of that weekend could have allowed Lehman to continue operating and forestalled much of the investor panic that froze markets and deepened the recession.

How would it have worked? Regulators would be given the legal authority to dictate the terms of a recapitalisation, subject to an agreed framework. The details will vary from case to case, but for Lehman, officials could have proceeded as follows. First, the concerns over valuation could have been addressed by writing assets down by $25 billion, roughly wiping out existing shareholders. Second, to recapitalise the bank, preferred-stock and subordinated-debt investors would have converted their approximately $25 billion of existing holdings in return for 50% of the equity in the new Lehman. Holders of Lehman’s $120 billion of senior unsecured debt would have converted 15% of their positions, and received the other 50% of the new equity.

The remaining 85% of senior unsecured debt would have been unaffected, as would the bank’s secured creditors and its customers and counterparties. The bank’s previous shareholders would have received warrants that would have value only if the new company rebounded. Existing management would have been replaced after a brief transition period.

The equity of this reinforced Lehman would have been $43 billion, roughly double the size of its old capital base. To shore up liquidity and confidence further, a consortium of big banks would have been asked to provide a voluntary, multi-billion-dollar funding facility for Lehman, ranking ahead of existing senior debt. The capital and liquidity ratios of the new Lehman would have been rock-solid. A bail-in like this would have allowed Lehman to open for business on Monday.

Many investors would no doubt complain about the rough justice of a regulator-imposed reorganisation. To preserve value, officials would have to move very, very quickly, leaving little time to fine-tune various claims or observe normal procedures. The new structure would be based on bankruptcy reorganisation principles, allocating value in accordance with investors’ seniority and ensuring that each class of investors would be better off than in liquidation. The process would not be pretty but overall, investors should be relieved by the result. In this example the bail-in would have saved them over $100 billion in aggregate, and everybody—other than short-sellers in Lehman—would have been better off than today.

Why can’t the bankruptcy code do this today? To an insolvency professional, this restructuring looks somewhat like a “prepackaged” bankruptcy, in which creditors agree to a new, less leveraged capital structure negotiated over a period of months. But a lengthy, voluntary process is impractical in the panic surrounding the failure of a very large, complex financial institution. Even the recent “fast-track” reorganisation of CIT, a small-business lender, took 38 days. Lehman had only 48 hours before its liquidity and customer franchise would have been irrevocably damaged. A resolution framework for a large financial organisation must allow a recapitalisation to be implemented much faster than today’s bankruptcy rules allow.

I do like Mondays

Would shareholders and creditors invest in a big bank given the risk of a forced recapitalisation? We think so. After all, investors buy securities that carry the risk of a similar restructuring today. Any extra cost of capital should be quite limited because the losses from a bail-in resolution are so much smaller than the losses at risk in a liquidation. A well-designed bail-in process would also be more predictable for creditors than the wide range of resolution outcomes seen in the crisis.

There are, no doubt, numerous legal and regulatory issues to be overcome for a bail-in to work. Sceptical customers and counterparties would still need to be convinced to deal with the new company. The process would need to be flexible so it could handle a variety of possible situations. But this proposal offers a powerful new way to recapitalise financial institutions using a bank’s own money, rather than that of taxpayers. It would help design resilience and discipline directly into the banking system and prevent individual problems from turning into systemic shocks. Wouldn’t that be a Monday morning worth fighting for?

Лауринайчуте

Multilateral development banks

Cap in hand

A difficult time for a fund-raising spree

A SENIOR World Bank official describes its efforts to secure an additional $3 billion-5 billion in paid-in capital as a “once-in-a-generation increase to deal with the effects of a once-in-a-generation crisis”. The bank agreed to lend $32.9 billion to poor countries in the year to June 2009, two-and-a-half times the previous year’s outlay of $13 billion. If it carried on at this rate, Robert Zoellick, the bank’s president, warned in October, its lending would face constraints by the middle of this year.

But its search for funds is being complicated by two factors. Some of its rich-country backers have overstretched budgets of their own, to put it mildly. And other large multilateral development banks (MDBs) are also seeking cash.

Some are further along than others. The board of the Asian Development Bank (ADB) approved tripling its capital base to $165 billion last April, though only 4% of the increase would be paid-in capital. The shareholders of the European Bank for Reconstruction and Development (EBRD) have reached a general consensus on augmenting its €20 billion ($27 billion) capital base by 50%, including €9 billion in callable capital (which countries commit but do not immediately pay)*. The African members of the African Development Bank want to triple its capital to $99 billion (94% of which would be callable). The Inter-American Development Bank (IDB) and the World Bank are finalising their capital-increase plans ahead of their annual meetings in March and April respectively.

The begging competition is affecting how much money the MDBs feel they can ask for, and how they plan to raise it. The World Bank, for instance, is only seeking enough money to allow its lending to return to pre-crisis levels. It wants to raise over half of its new capital from developing countries, partly in return for giving them greater say in its running. The dominance of callable capital in the other MDBs’ proposals also reflects the unfriendly climate for fund-raising.

All the banks are keen to highlight improved efficiency. The IDB says that administrative costs per $1m in loans approved have declined by 57% between 2006 and 2009, to $26,833. Its costs per $1m lent in 2009 were $15,314, lower than the World Bank's $20,600. The latter also raised charges on its loans last year, partly to assuage rich countries who want it to generate more income internally.

Fine-tuning their demands and pushing further on institutional reform will probably ensure that no MDB is denied cash, even if the politics are likely to be messy all around. But Nancy Birdsall, a former senior official at both the IDB and the World Bank, thinks a more fundamental reorientation is needed. Although these institutions have begun to place greater emphasis on measurable results, she argues, their focus is on pushing money out. The percentage of the IDB’s projects whose impact was rigorously evaluated doubled between 2005 and 2009, but only to 14%. Changing that would be an excellent use of a once-in-a-generation crisis.

Correction: We originally said that the EBRD's shareholders had agreed to augment its capital. In fact, the proposal has not yet been voted on. A vote is scheduled for bank's annual meeting in Zagreb in May. This was corrected on March 5th 2010.

Михайлова

Sovereign-debt ratings

The grim rater

Countries don’t like bad news about their creditworthiness

WHEN the subprime crisis broke in 2007, credit-rating agencies were among the first groups to take the blame. Critics argued that investors had drawn false comfort from the AAA ratings that the agencies handed out on complex packages of mortgage-related debt. Furthermore, the raters were hamstrung by the conflicts of interest inherent in being paid by issuers to assess their bonds. Never again, it was solemnly proclaimed, should the markets rely on the word of the agencies.

Now that investor attention has shifted to sovereign risk, the three big agencies (Fitch, Moody’s and Standard & Poor’s) once more find themselves at the centre of the action. Upgrades of sovereign debt exceeded downgrades in every year between 1999 and 2007. That has changed as a result of the financial crisis.

The rules of the financial system make ratings impossible to ignore. If Moody’s joins its peers and downgrades Greece below A-, the country’s bonds risk becoming ineligible for use as collateral by the European Central Bank when the ECB tightens its rules at the end of this year. Politicians fetishise ratings, too. Tim Geithner, the treasury secretary, claims that America will “never” lose its AAA mark. Britain’s opposition Conservatives have promised to defend its AAA rating.

Over the long term the ratings of most developed nations have been remarkably stable. No country rated AAA, AA or A by S&P has gone on to default within a subsequent 15-year period. Indeed, nearly 98% of countries ranked AAA were either at that rating, or the AA level, 15 years later. (Ratings are based on the probability of default so they are absolute, not relative; in theory, all countries could default on their debts.)

That stable record may not persist. Investors have been buying government debt for years in the belief it is “risk-free”, almost regardless of the economic fundamentals. But if they lose faith in a government’s policies, the situation can change very quickly. “Countries can go bust in a matter of weeks if the markets close to them,” says one rating-agency executive.

Governments and investors may well be attaching too much importance to the totemic AAA grade, however. “People’s perception is that a downgrade from AAA to AA means minutes later you default,” says David Beers of S&P. “In fact it means only a slight increase in long-term default risk.” Canada lost its AAA rating in the 1990s but regained it during the past decade. And Japan has managed to keep borrowing at a cheap rate, despite losing the highest level of approbation.

The agencies are well aware that ratings changes are highly sensitive. Decisions are made by committee, rather than by an individual, to reduce the scope for outside pressure. Consensus is generally sought before a downgrade is made. The agencies also seek to protect themselves from criticism by being as transparent as possible.

A number of factors helps determine whether a country’s AAA status can be maintained, including economic and institutional strength, the government’s financial strength and susceptibility to “event risk”, or specific shocks. In the eyes of Pierre Cailleteau, Moody’s chief economist, the key ratio is not debt-to-GDP but interest payments as a proportion of government revenues. Once that gets beyond 10%, a government may face difficulties.

That does not mean a downgrade is inevitable, however. If the government is implementing a credible plan to cut its deficit, then it may maintain its AAA status. Of course, what seems a credible plan to a government may appear less plausible to an agency. Agencies also have to make qualitative judgments about a range of other factors such as, for example, the willingness of euro-zone governments to bail out the likes of Greece (which unveiled another austerity plan on March 3rd, in part to head off a further downgrade).

Trickiest of all perhaps is the question of contingent liabilities such as bank-insurance schemes, public-sector pension schemes and the like. Even when the agencies are aware of such commitments, the scale of the problem may not be clear. “The state of public-finance accounting is extremely rudimentary relative to private-sector accounting,” says Mr Cailleteau. As more of those contingent liabilities become due, the agencies will be forced to make further decisions that could raise the cost of government debt and make budget-balancing even harder. The agencies will be in the limelight for a while yet.

Музуров

What is Customer Relationship Management (CRM)?

Customer Relationship Management (CRM) is a phenomenon that is becoming a major discipline within business. CRM can be traced back to the airlines attempt to gather information about their customer flying habits in order to stop their high-fare airliners choosing low-fare carriers, however, the concept was invented even further back, when the shop owner knew all his customers by first name and they knew his name. In 1998 The Economist Intelligence Unit (EIU) in conjunction with Andersen Consulting published the result of a CRM survey of different companies around the world. The survey revealed a new heightened focus on CRM as a discipline, where companies increased their customer focus and using a process approach to customer relationship management. This was a market shift from the traditional transaction-based and functionally managed approach where the relationship with customer was divided up and dealt with by different departments. The EIU report also showed that between 1994 and 1997 the spending on customer relationship management software and services grew from $200 million to $1.1 billion in the USA. The EIU report is one of many investigations that indicate a growing interest in CRM and some literature concerning CRM even postulate that companies will have to adapt it to survive.

Several researchers define CRM differently. Couldwell defines CRM as:

Customer relationship management is a combination of business process and technology that seeks to understand a companys customer from the perspective of who they are, what they do, and what they like

and Hobby, defines CRM as:

A management approach that enables organisations to identify, attract and increase retention of profitable customers by managing relationships with them".

However, I have found the following definition of CRM, to be the most adequately:

"CRM is a business strategy - an attitude to employees and customers - that is supported by certain processes and systems. The goal is to build long-term relationships by understanding individual needs and preferences - and in this way add value to the enterprise and the customer".

This definition places the strategy of adding value to the customer in the focus, whereas the first mentioned definition gives technology and processor first priority. As the chosen definition explains, the systems and processes are vital support elements in creating value for the customer. The second-mentioned definition is found to be somewhat thin and practical useless but it notice an important aspect of CRM, that the organisation has to learn how to listening to customers. In the definition, CRM is defined as a business strategy. This is an important aspect, as CRM is not to be seen as a concept or a project but as a business strategy, which affects all parts of the company.

CRM is about identifying, retaining, and maximising the value of a companys customers. CRM is a sales- and service business strategy where the organisation wraps itself around the customer, so that whenever there is an interaction, the information exchanged is relevant for that customer. This means knowing all about that customer and what the profitability of that customer is going to be. CRM is an effort to create the whole picture of a given customer, bringing together consistent, comprehensive and credible information on all aspects of the existing relationship, such as profitability information, risk profiles and cross-sell potential.

To keep customers satisfied and make them return, CRM, as a strategy, is not a new phenomenon. Every company wants profitable and loyal customers. The new aspect is that companies start to measure this profitability and loyalty and use this information to segment customers and develop strategies for approaching these customers.

However, before implementing CRM, companies need to have some basic foundations settled. First of all, the basic quality of the products has to be in order, i.e. if the product does not live up to the expectations of the customer, he will not be satisfied, hence loyal for long. The typical strategies prior to CRM are quality control systems such as Total Quality Management (TQM). Secondly, companies also have to know more about their customers before implementing CRM. I.e. they have to evaluate, which customers are most valuable in terms of profitability, loyalty and future expectations. Thirdly, the companies have to have the necessary technology to enable the employees to access information about customers in order to offer customers the best service. Finally, CRM needs full support from the management of the company to stand a chance of success.

Петухова

A Perfect Partnership for Business

Too often we small business owners get caught up in our day-to-day bottom line, and miss the needs of the community outside our door. By doing this, we miss an opportunity to include socially responsible marketing -or sponsorship- in our yearly promotional plan. Sponsorship is a perfect collaboration, considering the similarities that entrepreneurs and non-profit organizations have in common. We are value-driven, highly motivated and creative risk takers, results-oriented and close to our clients. With this in mind, consider exploring sponsorship as a humanitarian duty, first and foremost, as well as an investment. This is a business investment or partnership between two parties, who work together for mutual benefit

Sponsorship can open cost-effective doors to target markets, and media that you or they may not be able to access on their own. It also creates an incredible opportunity for your business to boost an awareness of social issues that match your values and goals as an organization.

This leads to a valuable and exciting exercise for your company. Make a list of the values of your organization, as well as a list of the things that your organization does better than anyone else. Studying these two lists will lead you to the best organization with which you partner.

Refer to these lists when you approach or are approached by an organization which may fit your values criteria. This partnership needs to be based on an honest and clear commonality of goals and values. It is much bigger than just writing a cheque. Ask questions, lots of questions. Go and see what the organization does. Try to think of as many options for sponsorship as possible. Be creative when looking for events or campaigns that match you as an organization.

You can donate money, of course. But you can also donate products or services. This is usually known as a donation in kind. Can you involve clients, suppliers or staff? Are there resources, staff or office equipment that can be shared or given? Think of opportunities that will bring people through your doors. Or where people will be able to try your product or service. Is there a special promotional item that you can use in connection with the event/campaign? Where can you put your corporate image or phone number? Are there opportunities for potential business? Remember that you already have something in common: You are both supporters of the same organization. What a terrific way to begin a client relationship.

Once you have confidently selected a partner, throw yourself into it. Be passionate, be proud and, most importantly, be very clear. Outline in writing the details of promotion, money, image, description and responsibilities, all with time lines attached. Evaluation is an important thing which could be included here.

Above all else, you want to create a positive experience that eventually will lead to other partnerships. These first steps are the beginning of a community relations or fundraising policy as your company grows.

There are many examples of excellent sponsorships. Take a look around you and see if anything catches your eye. Entrepreneurs and small business people are resourceful and always looking for opportunities for additional profile and revenue. Sharing a mailing, donating goodies to be handed out, giving children a small toy, promoting a food bank or a free meal program, buying an ad in a theatre programall are useful to the community in which we entrepreneurs do business.

Lastly, remember that sponsorship acts as a lubricant to the goals, values and promotion plan that you have in place. It is meant to compliment, not replace, the promotion that your company already has planned. People will not necessarily buy your product or service because they saw your name/logo as a sponsor on a T-shirt. But they may buy something from you if they saw your name/logo on a number of different promotional items.

Philanthropy is the love of those around us. This in mind, you are invited to attempt to embrace this principle through sponsorship of events or campaigns that affect you and the people around you. But be prepared, and be clear of your values and goals. A partnership is a serious commitment and is not for the lighthearted. Walt Whitman said it well: When I give, I give myself.

Sponsorship then might be a perfect partnership for small business. It can be one of the most valuable tools available to create revenue, profile, goodwill and relationship buildingand it may be far more meaningful than just a charity money exchange.

Подлесный

Marketing Planning Made Simple - Another Small Business Power Tool

Marketing planning must be really difficult and complex, otherwise why would there be so many books written on the subject right?

Well, Im just enough of a skeptic to believe that many of these books were designed more to make money for their publishers and authors than to make marketing planning simple and understandable.

I spent more than 30 years working with very successful small business people who never wrote a single marketing plan. Why didnt they need complex, 100-page marketing plans chock full of statistics, charts and graphs like the experts recommend? Its because they knew exactly where they wanted to take their companies and how

Дата добавления: 2015-11-14