Japan cuts interest rates

Overnight, the Bank of Japan cut interest rates for the first time in seven years. The bank also cut back on Japan's economic outlook, saying strains in global markets are rising and that severe conditions for the world will stay for some time. Rates there are now at 0.3%, down from 0.5%. Japan already had the lowest interest rates in the developed world before the decrease, but despite this many analysts are disappointed the rate was not reduced even more - a fact borne out by the drop in the Nikkei this morning. A soaring Yen along with the slowdown in Europe and the US have put Japanese exporters under severe strain with Sony, Nissan, Toyota and Fujitsu, this week, all reporting miserable profits for the first half of 2008. The Bank of Japan's move followed a rate cut from the U.S. Federal Reserve earlier in the week and will almost certainly precede 0.5% cuts by the European Central Bank and Bank of England next week.

Russian economy under pressure

An interesting article in this morning's Financial Times examines the current state of play in the Russian economy. As one of the BRIC economies Russia could be excused for having had very positive aspirations for its continued future growth. Before the crisis hit home, Dmitry Medvedev, Russia’s President (pictured above with Prime Minister Putin), boasted in June that Russia was not part of the problem but part of the solution. Its cash-rich companies would invest abroad, Moscow would become a world financial centre, the Rouble would become a reserve currency and so on. On August 8th, their currency reserves peaked at just under $600bn - the third-largest in the world, however by this week they had fallen to $484bn. This week’s fall, $31bn, was the steepest so far. Other factors are also hitting their economy, namely:

• The Russian stock market has lost 70% of its value this year.
• The commodity prices that spearheaded its boom are now falling. Metals, energy, and food account for 80% of Russian exports. Russia is the world's second-largest oil exporter and the government’s spending plans are based on a $70 a barrel oil price, so every $1 decrease in the barrel beneath this price implies $3bn less in export revenues a year.
• Any growth in the non-energy sectors had been fuelled by loans from western banks. However the credit crunch has ensured that this easy money from the west has now fled.
• Russia has failed to diversify its economy and its politics have long made investors nervous.

Full article, Financial Times, 31 October 2008

"New Anxiety Grips Russia's Economy", New York Times, 31 October, 2008

Notice of TV programme, tonight, 7pm

Credit Crash Britain: HBOS - Breaking the Bank
BBC 2 Northern Ireland (Sky ch. 142)
Friday 31st October 2008
Time: 7:00pm to 8:00pm

Just before you go trick or treating for the night, you could catch this, the first part of a special five-part series from the excellent Money Programme examining different aspects of the credit crunch. Tonight, investigating the extraordinary fall of HBOS, they examine the seismic changes that swept through the UK's banking industry. They also examine the role short-selling has played and ask if regulators could have stepped in earlier to protect the bank. If the merger goes ahead, who will be the winners and losers after the creation of this UK mega-bank?

The curse of the footy jersey

No, it's not the title of a cheesy horror movie for hallowe'en. The BBC has a tongue-in-cheek article on its site examining whether sponsoring a football team is a curse which may end up in financial ruin.


"Has the credit crunch produced the best new indicator yet - the tell-tale football shirt sponsorship deal? Just consider the evidence. When Manchester United signed up with AIG two years ago, could the Old Trafford side have foreseen that the US insurance giant would soon be teetering on the edge of financial oblivion? An outcome which can only tarnish the image of the Red Devils, by association. There are uncanny parallels elsewhere. Newcastle United is inexorably linked with the biggest banking failure Britain has seen in 150 years, Northern Rock..."

The full article

First we had 'stagflation'... now we have 'stagdeflation'

'Stagflation' is an economic term which came to prominence in the 1970s. It exists when we have stagnation (little or no economic growth and high and rising unemployment) along with rising inflation. Put basically, stagflation occurs when the economy isn't growing but prices are. One way stagflation could occur would be an increase in the price of oil in an oil-importing country, which tends to raise prices at the same time that it slows the economy by making production less profitable - causing firms to lay off workers. This happened to a great extent during the 1970s, when world oil prices rose dramatically during the the world oil crisis.

However, an economist has now coined a new phrase 'stagdeflation' for us to concern ourselves with. It comes from Nouriel Roubini (or 'Dr. Doom', as he has become known), pictured above, a professor of economics at New York University. He believes stagdeflation will, in six months, become the main worry for economic policymakers worldwide. Stagdeflation exists when we have low growth or recession along with falling inflation rates.

Why should we heed what Roubini says? Well, his predictions about the current global crisis have been uncannily correct. For example, he said in August 2006, "A housing hard landing will lead to a sharp and severe recession. It may also lead to a banking and financial crisis that may be more acute – and cause a more severe credit crunch – than the Savings and Loan crisis of the 1980s and early 1990s that led to the 1990-1991 recession". We will examine his forecasts further at a later date. He believes stagdeflation is happening already. The US recession is leading to deflation in areas where supply vastly exceeds demand (housing, consumer durables, motor vehicles, etc.). The unemployment rate is up sharply and commodity prices are down sharply - about 30% (from their July peak) in the last three months and, he believes, they are likely to fall much more in the next few months as the advanced economies' recession goes global. It will be interesting to see how his predictions pan out in 2009.

New York Times profile of Roubini, 17 August 2008
Roubini on the financial crisis, 15 July 2008, Bloomberg TV

Bank of Ireland forecasts loss of full employment

The Bank of Ireland published its Quarterly Economic Outlook today. Its outlook for the economy falls into line with other recent forecasts. The main points are:

• The falloff in house construction, high oil prices in the first half of 2008 and the global credit crunch will lead to a decline in our GDP of 1.6% this year, the first decline in national income in 25 years. They said they cannot forecast the fall in GDP in 2009.
  

• Exports will provide the only substantial support to economic activity.

• There are two positives that may restore some confidence - dropping oil prices and lower interest rates.

• Unemployment will go over 7% next year, moving the Irish economy away from full employment (160,000 or fewer unemployed) for the first time in a decade.

US lowers interest rates but does it matter?

Following the Fed's reduction of US interest rates to 1% yesterday, Time magazine analyses whether lowering rates will have any effect - even a reduction to zero, like what happened in Japan in 1999.

"The U.S. Federal Reserve cut its benchmark interest rate by 50 basis points to 1% on Wednesday, continuing an aggressive effort to fend off a deep recession. The rate now stands at the lowest level since 2004 — and central bankers signaled they may resort to more cuts in the months ahead. The hope is that further rate cuts will stabilize volatile financial markets and accelerate the slowing economy. But as the rate heads toward zero, the Fed is rapidly running out of room for reductions. Not only that, economists and analysts are questioning whether rate cuts produce any bang for the buck under the current extraordinary circumstances.

In a normal cyclical slowdown, lowering interest rates encourages fresh business activity by reducing the cost of borrowing from banks. With more borrowing comes more investment, more jobs and more growth. But these are far from ordinary times. Banks, already burdened with bad consumer and commercial debts, are desperate to clean up their balance sheets and avoid risk — they are not eager to take on more risk by issuing new loans against the backdrop of a deteriorating business climate. American consumers, too, are trying to reduce household debt, so borrowing more money for a new car or to remodel the kitchen is not a high priority. And without greater consumer spending, most companies have little need for new loans to expand operations".

Full article

Housing slump affects paint company

Here is a good example of how changes in demand in one industry can have an effect on both sales and profits in another.

Dutch company, Azko Nobel, the world’s largest paint maker and owner of the Dulux brand, today announced a 23% fall in profits to €367m. They plan to make 3,500 of their 43,000 workers redundant worldwide. Business is being affected by the end of the international boom in residential and commercial property construction which has led to a fall in market demand for decorative paints. So a slump in the building industry - with many housing projects being shelved - is impacting on paint sales. Furthermore, profits are also being squeezed by a rise in the costs of raw materials used in manufacturing paint.

How did Volkswagen become the biggest company in the world yesterday - for just one day?

Short-sellers of VW shares got very badly burned yesterday. Not that too many will be shedding a tear for any losses incurred by short-sellers. They have been called vultures, rumour-mongers, cheats and even criminals in recent months. Short-selling is where you borrow shares from someone for, a set period of time, let's say a week. You expect them to drop in value, so you sell them immediately with the intention of buying them back at the end of the week at a cheaper price. You pocket the profit and return the shares you borrowed. It is basically gambling on a company's share price falling and is a surefire way of making money from falling stock values. In September, the Financial Regulator banned the short-selling of shares in Irish banks, as it was felt it was accelerating the drop in their share values.

The problem with short-selling VW shares this week was that Porsche bought VW shares at the weekend, leaving few others available and the news of the takeover rose the share price. On Sunday, Porsche announced that it owned, or had options to buy, more than 74% of Volkswagen's shares. VW's home state of Lower Saxony controls 20% of the shares, leaving just over 5% available on the market.

The traders who had short sold now had to buy back the shares at any price to cover their investment - but as there were only 5% of the shares available, the huge demand for them (along with the positive news of the takeover) increased the share price massively. Yesterday, the carmaker's shares peaked at €1,005 (an increase of 348%), which valued the company at €296bn, which is well above the €265bn value of Exxon Mobil, the world's largest company. As an indication of how overvalued the VW market valuation on Tuesday was, Exxon, last year, made profits of $41bn on sales of $390bn whereas Volkswagen managed profits of about $8bn on sales of $136bn.

It is estimated that €18bn was lost in two days by short-sellers! However, VW shares fell 37% in trading this morning as Porsche said it would help to solve the short-sellers' problems. "In order to avoid further market distortions and the resulting consequences for those involved, Porsche SE intends - depending on the state of the market - to settle hedging transactions to the amount of up to 5% of the Volkswagen ordinary shares," Porsche said in a statement.

Americans no longer the big spenders

US consumer confidence plunged to a record low in October as consumers felt the bite of the credit crisis. The US consumer confidence index plummeted to 38.0, its lowest reading since the index was launched in 1967 - down from 61.4 in September, and down from 95.2 twelve months ago! The figure has shocked analysts but is it really that surprising with more than 460,000 a week losing their jobs in America and about 6.1% of the workforce now unemployed? Americans have all but stopped spending on discretionary items (non-essential items) such as cars because they are scared of losing their jobs and anxious about the declining value of their homes. The figures do not bode well for American retailers either as they enter into what is meant to be their busy holiday period.

The news increases expectations that the US Central Bank will reduce interest rates this evening to 1% or maybe even 0.75%. Japan and Britain will then probably follow suit before the end of the week. They hope lower interest rates will boost the economy as people will be more likely to borrow and then increase their spending.

Enough oil to go around?

The Financial Times reports this morning that output from the world's oilfields is declining faster than previously thought. According to the report by the International Energy Agency, the world will struggle to produce enough oil to make up for steep declines in existing fields, such as those in the North Sea, Russia and Alaska, and meet long-term demand. It states that the demand, not just the supply, will move away from the US, Europe and Japan, towards emerging nations.

Here is the article in full.

Poles returning home

The ESRI quarterly economic commentary published earlier in October forecasts net outward emigration of 30,000 in 2009 - compared to the net inflow of 72,000 in 2006. The number of people leaving Ireland next year will outstrip those moving here for the first time in 14 years, according to the ESRI. The biggest exodus will be among the 170,000 workers who arrived the past four years from Poland and other East European states. The government's decision in 2004 to open our labour market to all EU workers resulted in a massive influx of eastern and central Europeans into Ireland, but the tide is turning. In the first half of 2008, the number of people from the "EU12" (the states that joined since May 2004) who registered to work or access public services here fell by 40% compared to the same period in 2007.

These immigrants had fed our manufacturing and building booms that helped double the size of our economy during the past ten years and made it the most dynamic in Western Europe. Now the slowdown in our construction industry along with the credit crunch has plunged us into our first recession in two decades, pushing unemployment to an 11-year high. However, economic growth remains above 5% in Poland, boosted by EU investment in roads, higher consumer spending and the building of new offices and apartment blocks. The unemployment rate over there has halved to around 9% over the last two years. The ones leaving now are simply responding to changes in our economy and theirs. In a small country like ours, where immigrants have made such a major contribution, it's far more visible than in a bigger economy such as in the U.K.

Here is an article from the Irish Times where a Polish immigrant gives her reasons for going back home.

Poor GDP Forecasts

The growth in Ireland's Gross Domestic Product (the market value of all the output produced here) will turn negative in 2008 for the first time in 25 years with only modest growth forecast in 2009, according to a new report from PricewaterhouseCoopers (PWC).

According to PWC, the rate of Irish growth will fall to -1% this year and recover only slightly next year to 0.5%. "Low consumer confidence, higher unemployment and weakening demand from Ireland's main trading partners will continue to have adverse effects on prospects for growth in the Irish economy with the recent reduction in interest rates only a small step towards aiding recovery," said Yael Selfin, head of macro consulting at PWC.

Keynes to the Rescue?

John Maynard Keynes (pron. 'Caines') was an English economist in the early 20th Century. His ideas influenced the policies of various governments and his views changed how people studied economics. At the moment, there seems to be a revival in his way of thinking in how to deal with the recession. You see, he wrote a lot about the Great Depression of the 1930s and did not believe in laissez faire economics where the government intervenes little or not at all in the economy. In fact, he believed government fiscal policy was the best way to regulate the economy. He argued, that if the government increased borrowing and spent the money on public spending projects during a recession, that would stimulate demand and increase employment. This was down to what he termed 'The Multiplier Effect', i.e. any injection of money into the economy will create income greater than the actual size of the injection.

E.g. Let's say, the government invested in the roads network, the money would be used to employ workers who would in turn buy tools, a newspaper, a packet of cigarettes etc. The toolmakers, newspaper publishers and cigarette makers would respond to increased demand by upping production and taking on extra workers themselves. They would then spend their wage packets on goods and services and the whole circle would carry on.

Here are four recent articles about him and how his ideas may be still relevant today:

• We now face Keynesian conditions and need truly Keynesian solutions.
• How to kickstart a faltering economy the Keynesian way.
  
• The big question: Who was J.M. Keynes and does he offer solutions to the economic crisis?
• It's Keynesian, Captain, but not as we know it.

Chinese Toymakers Feeling the Crunch.

The 4c students may recall on Thursday, while we were looking at factors which can shift a supply curve, I mentioned how Chinese toy exporters were being put under so much strain that half of them have gone bust in 2008. The reasons behind the failures are weaker demand from the US, a stronger Chinese currency and tougher safety standards.

Here's the BBC news report on it.
If you'd prefer to read the report, it's here.

What's Happening with Oil?

In London, today, Brent crude oil was trading at $60.55 a barrel. That's down $87 from July! The fall in fuel demand, along with a decline in market confidence has outweighed a decision by OPEC, a cartel of oil producing nations, to cut production by 1.5 million barrels a day.

OPEC has expressed concern that the record high prices in July, and the economic downturn, may have permanently damaged demand for oil. "I think they needed to do something", said Tom Orr, head of research for trading firm, Weeden & Co., in Connecticut. "If prices fall near $50 a barrel, I think they will cut more ... they have to," he added.

This article from the BBC analyses why the price of oil is sinking so fast.

Poundshops and Inflation

Here's a good article about poundshops in Britain and how they are affected by inflation.

1. What type of goods do such shops deal in
(a) normal goods?
(b) inferior goods?
(c) veblen goods?
(d) giffen goods?

2. What kind of income elasticity of demand figure would you expect them to have?

The answers tomorrow.