• The purpose of the the Economic Policy Centre (EPC) is to promote high quality research and debate across all areas of economics in a free democratic society.
    The EPC's vision is to close the gap between economic policy and knowledge. Ultimately it brings together economic opinion formers - in academia, business, the media and government - in new and innovative ways.

  • Eastern Europe – the calamitous cost of Foreign Currency Mortgages

    January 10th, 2012

    15 years ago, I went to go and live and work in Luxembourg for what turned out to be a very happy few years in pre-euro euroland. Latterly I was working in the Middle Office of a Corporate Treasury Department where I became familiar with interest rate swaps and how widely debt was priced around the world. I subsequently did a little investigation into taking out a foreign currency mortgage – specifically in Japanese Yen – which back then was paying next to no interest unlike all the other major currencies. Alas, I was politely rebuffed on the grounds of not really being a player !

    Obviously, a lot has changed since then. Today, it seems you don’t have to be a player at all. In fact, anyone can get them – especially if you are working/middle class Eastern European and not remotely interested in hedging for averse currency movements. So what happened?

    This Economist article from a couple of years ago gets it right by calling it Austria’s very own subprime invention. This table below, also old, sums it up quite nicely.

     

    Since then of course, it’s got substantially worse in nations like Hungary – now with a BB+ rating – as the Swiss Franc has superspiked in value, massively increasing the cost of CHF-based mortgages across Eastern and Central Europe – about 1.7 million in total apparently.

    So it’s not just Euroland that is in trouble with the Euro. What Donald Rumsfeld used to call New Europe is in trouble too – but with a quite different kind of currency problem.

    Would that our economic life and times be simple and predictable again, with all our living standards gently rising year after year !

     

    Which way for sterling next against the Euro and Dollar?

    July 16th, 2011

    As this chart shows, sterling has just gone through 18 months of value stability against the dollar and the euro. That’s actually quite a long time. With everything happening now in Euroland and the USA going up against the wire on lifting the debt ceiling, I just wonder if the pound might be due for a long-anticipated recovery?

    Shock Q4 figure have a small silver lining . . .

    January 25th, 2011

    It’s worse than we thought guv !

    Today’s revelation that the UK economy contracted -0.5% in Q4 2010 was a sobering moment. Although not entirely suprising, as I discussed some months ago here and here. Quite apart from further highlighting the ongoing utter uselessness of macroeconomic forecasting which estimated a range of growth of between +0.1 and +0.6, I can see one positive outcome.

    Interest rates are not going to go up any time soon. I never bought into the big Weimar-style inflation threat. If there’s so much cheap money around, why’s my bank offering me an overdraft at 10% when the base rate is 0.5%?

    The rise in our inflation is not to do with QE, but principally stems from a market-driven decline in the value of the pound (thank God we have a floating currency), the additional rising cost of internationally priced, fungible commodities and our Politicians raising VAT – of which only the first we can control with interest rates.

    And once those increases in prices have fed through, where do they think the inflationary wage spiral is going to come from?

    With 2.5 million unemployed and many others underemployed, there are a lot of people looking for work out there, ready to work for much less.

    On balance, I’m still more worried by deflation than inflation. And inflation hawks still have a lot to prove before they win the argument for large interest rate rises.

    Andrew Sentance of the MPC will be feeling a little less confident now.

    Oil price outlook for 2011 – from $90 to . . . ?

    January 5th, 2011

    Oil prices – now at $90 a barrel – rose in 2010 by 15% and by over 8% in December. So as I explained today on Al-Jazeera TV, I’m not surprised that Faith Birol, Chief Economist of the IEA  is worried about the impact of oil prices on the (largely OECD) recovery. That’s because for now, oil is still the indispensable economic input, so you can’t cut it back, just spend more on it and  curtail expenditure and investment in other areas.  Put simply, higher oil prices are a problem in non-producing countries because they manage to dampen agregate economic activity  whilst being simultaneously inflationary.

    OPEC is always walking a tightrope between the higher oil prices demands of its producers and finding a price low enough to suit mostly Western consumers without turning them away. Would that they know where precisely that balance was and even more, reach it !

    And for all that, it’s not like they even agree amongst themselves – at the last OPEC meeting in December, the Saudi Oil Minister, Al Naimi, said he favoured an oil price of “$70 and $80 a barrel” whilst his neighbouring Kuwaiti confrere, Sheikh Ahmad al-Abdullah al-Sabah, today said he considered oil at $80 to $100 a barrel to be fair price. Is that just because it’s gone up in the meantime?

    Anyone who asserts they know what the oil price is going to do is foolish in the extreme. But we can sketch out scenarios of what might happen. The first point is that OPEC are not scheduled to meet again to discuss quotas until June 2011. That may well change. The second is that some analysts believe that the US Summer driving season just might lift the price of oil to $120. And the third influence that outweighs everything else are extreme events like;

    i) A Mideast War – involving Iran trying to close down the Straits of Hormuz in response to a US and/or Israeli attack

    ii) A trade dispute between the USA and China – forcing China to revalue its currency upwards and thus effecitvely make oil cheaper (because it’s priced in dollars) and massively increase Chinese demand for the black stuff

    iii) Tensions going hot between the 2 Koreas

    iv) Some sort of collapse of the Euro – leading to mass selling of Euros and a retreat to quality – commodities like oil and gold

    Hopefully, none of these will happen. But the risk is there and higher oil prices will come with them or even some inkling of their possibility.

    One way or another, we do seem to have reached a new trading range – where $80 is the new $70 – as a recent note from Lombard Street Research made clear. Maybe next year OPEC leaders will be saying a fair price is more like $110 a barrel . . . Plus ca change !

    The unwelcome consequences of a US-forced Chinese Yuan revaluation

    October 12th, 2010

    Over the summer, I really savoured reading Tom Bower’s book, OIL – Money, Politics, and Power in the 21st Century which – covering 1990-2009 – has become the unofficial sequel to Daniel Yergin’s The Prize: The Epic Quest for Oil, Money, and Power – covering the 1850s to 1990.

    So if you’ll forgive the pun, I’d like to crudely summarize some of the best points from Bower’s book thus;

    1. There’s actually plenty of oil – it’s just in the wrong place, too many restrictions on its extraction, limited finance and bottlenecks in refineries
    2. The immensely diverse oil industry – downstream, upstream, traders, engineers, accountants, politicians, economists, refinery workers etc. all work in silos and don’t interact, less still understand each other
    3. So no one apart from the occasional brilliant or lucky trader has any lasting insight on the price of oil which has a massive impact on the investment horizon
    4. As for the IOCs (Independent Oil Companies)
    5. BP under Lord Browne was very go-ahead trying to boost reserves and sloppy on safety and outsourcing engineering (this before Deepwater Horizon)
    6. Shell prospered but was often beset by Anglo-Dutch internal squabbles and having rings run round it by  Oligarchs, Greenpeace etc.
    7. Exxon is a stultifyingly dull bureaucracy, obssessed with safety, has absolute faith in itself and is usually right
    8. As for the NOCs (National Oil Companies)
    9. They may have the oil, but they don’t have the technology or the finances and tend to overstate their reserves
    10. And they constantly strive to renegotiate settled deals with scant regard to reputation or the balance sheets of their partners
    11. Oil producers are ultimately far more dependent on consumers than the opposite
    12. It’s all about achieving an elusive balance between governments, regulators, markets and nature

    For all that, compared to preceeding years, oil prices have now gone through a year of relatively high stability, largely in the $65-$80 range which makes me think it won’t last.

    So I keep wondering about this piece in the Wall Street Journal a few days ago, The Trade and Tax Doomsday Clocks. Whilst being critical of the Currency Reform for Fair Trade Act which would mandate the US Department of Commerce to take a foreign country’s currency interventions into account in determining whether its trading practices are unfair (crazy in my view – see my earlier post) it makes a fascinating point about the impact such a policy would have on the price of oil;

    …an unintended consequence is that it will make China an even more voracious competitor for oil. That’s because oil is priced in dollars, so a revaluation would make it cheaper in yuan terms. Remember, during the period from 2005 to 2008 when the yuan was revalued under similar political pressures from the U.S., the price of oil rose, not coincidentally, to $147 per barrel from $60. That could happen again—and it would be another inflationary tax on U.S. consumers.

    I looked at this chart (CNY:USD 5 years)  and this seems to be true. The roughly 16% gain in the Yuan over the last 5 years against the dollar is quite well correlated to the jump in oil prices that we had over that period. So maybe we now have a clearer idea with recent history in mind of what can cause oil prices to go up again?

    The bottom line is that the USA has had all the benefits of having the global currency – cheap credit, low transaction costs and enormous diplomatic leverage for too long to now turn round and demand China revalues their own which will cost the Chinese and the USA dearly if not managed gradually. And should such a dispute kick off, all sorts of unintended consequences like higher oil prices will hurt the rest of us. I really hope America’s politicians pull back from the brink on this one. Because as I wrote back in Spring 2007 for World Finance magazine, The nightmare of a Chinese economic collapse, the consequences could be very ugly.

    China – Currency Manipulating Protectionists or President Obama’s scapegoat?

    March 20th, 2010

    An excellent, absolutely must-read piece in this weekend’s Wall Street Journal – The Yuan Scapegoat – and a timely rejoinder to calls for China to orchestrate a revaluation of the Yuan so that all will be well with global imbalances, US trade deficit etc.

    And before we get started, those of you not familiar with the deep interdependence of the America and Chinese economies could have it summed up as what the excellent Niall Ferguson calls Chimerica;

    To put it very simply, one half did the saving and the other half did the spending. Comparing net national savings as a proportion of gross national income, American savings declined from above 5 per cent in the mid 1990s to virtually zero by 2005, while Chinese savings surged from below 30 per cent to nearly 45 per cent. This divergence in saving allowed a tremendous explosion of debt in the United States because one effect of what Ben Bernanke, chairman of the US Federal Reserve, called the Asian “savings glut” was to make it very much cheaper for households to borrow money – and to a lesser extent for the government to borrow money – than would otherwise have been the case.

    Back to the WSJ piece. Ok, so China pegs its Yuan to the dollar at about 6.83 and if it was floating, it would be worth a lot more because of the US recession and continued growth in China. However, the point is that currency pegs are not just about mercantilism – far from it. They are also about exchange rate stability and stable monetary policy.  Those were after all the two main reasons for the creation of the Euro (thank God we never joined it!) and all the legion currency pegs that have existed in the past and continue to exist today.

    The WSJ leader adds that “China is right to resist calls for devaluation, not least because a large revaluation could damage growth. China has learned from the experience of Japan, which bowed to similar US currency pressure in the 1980s and 1990s” which as we all know was followed by a prolonged bout of deflation and near zero growth.  Less observed though is that Japan continued to run a trade surplus, as imports fell with slower internal growth and cross-border prices adjusted.  Whilst conceding that the current situation is not ideal, a far better solution to the revaluation says the WSJ would be to address the shortcomings of the yuan’s development as a tradable currency and disintermediate China’s central bank who keeps buying US T-Bills or Fannie Mae Securities which it calls a huge misallocation of global resources.  What the Chinese could do would be to make the yuan convertible (+ a small one-time revaluation to 6.5), and let capital and trade flows adjust through private markets rather than the Chinese Central Bank. All of which sounds pretty sensible to me.

    Unlike a spectacularly worse solution that is now being proposed by none other than Paul Krugman, who is actually advocating a 25% surcharge on Chinese goods.  As Jeremy Warner cogently observes;

    Let us briefly consider what would happen if Professor Krugman got his way and there was either a 25 per cent devaluation of the dollar against the renminbi or 25 per cent import duties. Almost overnight China would sink into a deep recession as exporters already operating on wafer-thin margins were plunged into insolvency“.

    A Chinese recession  really matters a lot because as I wrote in Spring 2007 (the May 2008 date shown is incorrect) for World Finance Magazine – The Nightmare of a Chinese Economic Collapse – the country could quite literally implode into a morass of ethnic tensions and profound rural unrest and may even try to maintain unity by lashing out at Taiwan, which America is pledged to defend.

    When you start a trade war, you just don’t know where it’s going to end. No doubt, some genius at the European Commission is already thinking about how to implement a 30% import tariff on US goods because the Euro is seriouly over-valued against the US Dollar.

    Now back to the real world. Can I just say that I for one, have been very impressed with my Chinese printers – who are cheaper, better, keener and almost as fast thanks to air freight as my local ones.  No wonder the price of paper pulp has shot up since last year because of Chinese demand . . .