Category: Economics

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Economics

[2636] Greek buyback program is not ideal

As part of the bailout agreement between Greece and the Troika, the Greek government has agreed to reduce its debt. This is the context behind the latest Greek buyback program, where the Greek government is looking to reduce EUR20 billion worth of debt. While I typically like debt reduction exercise by the public sector, I am unsure how this particular effort at this particular moment is ideal.

The main issue I have with the program is that Greece has no cash of its own. At least they do not have enough. On top of that, the government suffers from primary deficit and that means the government is unable to finance its operations. So, it is dependent on bailout money, provided by the reluctant Troika which includes European governments, which includes even the more reluctant Germany, the country that is really footing in the afterparty clean-up bill.

So, that is a bailout financed by public money of a different country.

The problem here is that the money will be used to buy back debt from private creditors. As you can see, it is a transfer of wealth from public coffers to private individuals and firms. There is something repulsive in doing so.

The factor that may mitigate that sentiment is that a majority of those private shareholders are Greek banks. In some sense, a large chunk of the bailout money used in the buyback program will help strengthen Greek banks and indirectly, the Greek economy. A majority of holders of Greek sovereign debts, apart from the Greek banks, are European of origin. So I suppose the buyback does help stabilize the European market too.

Anyway, while these private bondholders suffered a large haircut recently, the buyback program will mean that these holders will book in some profits according to the Wall Street Journal.[1]

Another factor is that because the offer is slightly above market price of those debts, the price of Greek sovereign debt has increased and that reduces its yield. In other words, that allows for cheaper financing for Greek government. But I do not think anybody will be crazy enough to buy Greek sovereign debt any time soon.

Regardless the mitigating factors, I prefer one thing more than the buyback: more debt haircut but this time on the public side.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved
[1] — Greece’s debt agency launched a multibillion-euro offer to retire roughly half the debt the country owes to private creditors, part of the latest effort to trim a towering debt burden. Bond markets reacted positively after Greece signaled it would pay a slight premium to buy back that debt, but the higher price and the limited size of the offer raise questions about whether the country will be able to cut its debt as much as its European and international creditors hope. [Alkman Granitsas. Neelabh Chaturvedi. The Wall Street Journal. Greece offers to buy back debt. December 4 2012]

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Economics Society

[2634] Any Malaysian welfare system may encounter some problems 30 to 50 years from now

An ageing population is a major economic problem to a number of developed countries. It is not ageing itself that is the issue or even slower economic growth. An aged society usually has an advanced and rich economy. Further economic growth does not mean much if the society is already extremely rich. The problem comes when there is a social welfare system that depends on the young to support it. With an aged society, the system would have to distribute its resources to the aged majority with the young minority supporting contributing to the system.

Malaysia does not the demographic problem yet because the country has a very young population. The median age is approximately 26 years old. In fact, Malaysia’s baby boomer generation has just entered or just about to enter the Malaysian labor market. With a high proportion of productive population, Malaysia is set to grow in a meaningful way in the long run.

Population growth, specifically labor force growth, is important to the sustainability of a social welfare system, including the Employees Provident Fund. The EPF is a retirement fund for those working in the private sector in Malaysia. It is not a comprehensive welfare system but it is still susceptible to demographic changes nonetheless.

At the moment, words on the streets have it that the EPF has more money than it can invest in Malaysia: there are not enough Malaysian sovereign bonds for EPF to buy (this probably leads to a conclusion that I dislike: the Malaysian government can comfortably raise more debt, especially in this environment of low yield without much economic repercussion). That is a testament of how favorable Malaysian demographics is at the moment.

This is the latest population profile for Malaysia from the Department of Statistics:[1]

You can see the baby boomer generation in the lower part of the chart.

What may be of concern — some far distant future, probably in 30, 40 or even 50 years — is when the Malaysian baby boomers begin transitioning into their golden years. I give the 30 to 50 years range because the current boomers are below the age of 30; remember the population median is 26. Assuming that they will retire at 60 years, you will get an estimate. My guesstimate is somewhere between 30 and 50.

Already the 0-4 years old, 5-9 years old and 10-14 years old cohorts are individually smaller than the 15-19 year old and 20-24 years old cohorts. The profile of a boom is clearer when one compares the population profile in year 2000 against that in year 2010.

There is still possibility that the baby boomers may have more children to produce yet another population boom sometime in the future. Yet, with rising income which tends to lead to smaller families everywhere in the world, I doubt it. And average Malaysian income is set to rise (at least in the next few decades notwithstanding business cycle) — please, not because of Pemandu — it’s the population boom dividend!

I may be wrong still — we will see that within the next 40 years’ time — but I think we are seeing our only population boom. If I am proven right, then the EPF might have trouble servicing the retirees in 40 or 50 years’ time, unless Malaysia suddenly develops a greater appetite for immigration.

The problem of EPF will be the least of our concern if Malaysia institutes the so-called 1Care scheme which aims at creating a more comprehensive healthcare system, which includes universal insurance coverage.

The problem however is beyond the horizon of the current leadership, in both Barisan Nasional and Pakatan Rakyat, judging by the populism of the day.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved
[1] — Population and Housing Cencus, Malaysia 2010. Department of Statistics.

Categories
Economics

[2633] What is the benchmark of failure for austerity?

Has austerity failed?

In the sense of expansionary fiscal contraction, it has. Expansionary fiscal contraction, in short, suggests that government contraction will immediately expand the private sector. That particular interpretation of fiscal austerity has clearly failed to bear out in countries under crisis. It is like the argument that says reducing taxes will increase government revenue, which is untrue if the economy is on the left side of the Laffer curve.

I do not believe in expansionary fiscal contraction. Other parts of the economy have to grow more than the fiscal contraction caused by austerity if the economy is to expand. In times when taxes go up and public spending goes down, especially in an economy dominated by the public sector, an immediate expansion will be impossible.

But the hypothesized result of expansionary fiscal contraction is a narrow benchmark to measure austerity on. Maybe it is a poetic justice to measure harsh policy harshly.

But the success of austerity can be measured against future growth instead of current growth (or rather current contraction). The idea of austerity is to swallow the bitter pill and get well after that. The point of putting government finance in order is to ensure that the government will not go bankrupt or unable to finance its operations.

Swallowing the bitter pill means the same operations that the government would be unable to finance if it had not switched gears would be cut down to a more reasonable level given the condition of public finance. What makes the cut down bearable is that it usually comes with aids: money for government under severe financial pressure. It means instead of cutting down services drastically under no austerity-no aids condition, the austerity scenario with aids prevents the bankruptcy scenario from happening altogether, with less severe cut.

The cut in public spending in times of recession will be painful and that much is clear. Yet, pointing out that austerity is painful is not enough as a benchmark to say that austerity has failed. There has to be a comparison and the comparison is, how more painful austerity is compared to a scenario of bankruptcy?

There is every reason to believe that the latter scenario (the bankruptcy scenario) will be more painful than the former (austerity). If cutting a significant level of services under the austerity program is painful, imagine a complete collapse of services when the government goes bankrupt. Austerity is the bitter pill to avoid a worse fate.

It is worth stating that austerity is the last option. It is required when countries run out of its economic wits. Despite criticism macroeconomics has suffered in the past few years, I think we still know enough that there are wide options of tools (monetary policy anyone?) before we will be left with severe austerity program.

So, how much pain avoided then should be the benchmark of success for any austerity program. The avoidance of government collapse is another benchmark of success because a collapse is exactly what austerity should aim to prevent.

So, has austerity failed?

When somebody pronounces the failure of austerity, I am almost always wanted to raise my hand and ask, “what is the benchmark of failure?” I suspect those who pronounce the failure believe that pain itself is a failure. If that is the benchmark, then I will disagree with it as I have explained earlier: pain alone is not enough; we need to ask if austerity is more painful than no austerity.

This however does not mean austerity should be done in one shot. There is only so much pain anybody can bear before a society collapses or like in the case of Germany, turns to fascist and other extremists for cure. The point of austerity is to prevent that collapse.

That does not mean austerity should be done in one shot. I prefer an austerity program distributed over time, with a combination of aids, debt relief, low interest rate, long repayment and fiscal reform of government under austerity program.

The alternative to austerity is expanded government spending but in many countries under pressure, they do not have the financial resources to do just that. And there are few countries that are willing to throw money into a blackhole called “helping others” without any fiscal reform associated with a typical austerity program.

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Economics Society

[2632] The worthlessness and the vestige of gold

In the olden days when four-legged beasts were the best mode of land transportation, gold was money. Everyday transactions involved gold and other precious metals as the medium of exchange then, just as paper money now dominates transactions in the modern economy. Gold had a very special position in human culture then due to its fundamental functions. It is still special today, but only because of vestigial reasons.

During the European Age of Exploration, Portuguese and Spanish explorers crossed the seas under the guises of God, Gold and Glory. The truth is that it was never really about god and religion. It was about the gold more than anything else. When Hernán Cortés and Francisco Pizarro first set for the heart of Aztec and Inca separately, they were dreaming of the glittering yellow metal for themselves.

As other European powers rose to take their place in history, the search for gold became less explicit. The new explorers, traders and later colonialists did not go out in search of El Dorado but it was still about amassing wealth through commerce. It was less explicitly about gold but yet, wealth was very much denominated in gold still.

Sometime during the industrial era, gold and other precious metals lost their function as the medium of exchange. They were no longer circulated as widely as they were during pre-industrial period. It was all papers and coins by the time motorcars, trains and steamboats were crisscrossing the world. By the 20th century, the dominance of papers was almost absolute.

Nevertheless, all money was still backed by gold and other precious metals.  Papers and coins struck out of cheaper materials were merely claims to those precious metals. All issuers promised to convert those papers and coins to gold upon demand. So, gold may have lost its role as a medium of exchange during industrial times but it was still the ultimate arbiter of the value of money.

That last real function of gold ended in the 1970s. The United States government ended the direct convertibility of the US dollar to gold as a reaction to an economic crisis. Soon after, the world followed in ditching the convertibility and thus, gold stopped being special.

Many continued to believe that money, even in Malaysia, is backed by gold but the truth is that all economies in the world today run on fiat currency. That is, money today has value only because its issuers say so and the market believes the words of the issuers.

To put it in clearer terms, gold has no importance to modern central banking.

Of value instead to the modern central banking system — and the wider economic system — as far as money is concerned is trust. Indeed, at the heart of capitalism, is trust but not gold. Capitalism can survive without gold—it is running affirmatively better without gold—but it cannot survive without trust.

So, gold has no fundamental economic function to play anymore in our modern world. Gold is neither a medium of exchange nor does it back any money. Because of this, gold really does not deserve the reputation it enjoys now.

The reputation of gold lives on only because of humanity’s vestigial attitude towards gold.

The phenomenon is much like in the case of Pavlov’s dog. The dog learned that a ringing bell meant food. The dog then began salivating at the sound of the ringing bell instead of at the food per se. It did so even when food was not present. At the end of the day, the dog had been conditioned to salivate to something else entirely. In some ways, the dog had been tricked.

In the same way the dog had been conditioned, humanity has been conditioned to think favorably of gold. Gold has seeped into our consciousness regardless of the fact that gold now has no fundamental economic function anymore. So persistent in fact the favorable predisposition towards gold that too many laypersons still believe that money today is backed by gold, despite the abolition of such a system more than four decades ago.

The momentum of history is huge and it takes time for humanity as a whole to adapt to the new reality of fiat currency.

The failure to adapt can exert cost especially on the gullible. The case of Genneva is one example where individuals were cheated out of their vestigial sentiment for gold.

Believing that gold had a special place in the modern world, they too eagerly bought the metal from Genneva while not realizing that they were being manipulated. It is only too bad that reality had to set in and the scam had to end. Actions by the authority in both Malaysia and Singapore only hastened the inevitable collapse of Genneva, just as any large-scale scam eventually will under of its own weight.

Of course, financial scams come in so many other ways and gold is not an exclusive tool for scams. Old-styled Ponzi scheme relies on just money, plain old greed and some doses of gullibility. Still, the obsession with gold is unhealthy. The sooner we all realize that there is nothing special about gold anymore, better we all will be.

After the learning is complete then perhaps we may start to put our money into something more productive than the vestige of gold.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved
First published in Selangor Times on November 23 2012.

Categories
Economics

[2630] Pegging debt forgiveness to the pace of Greek reform would be better

The Economist supports further debt forgiveness for Greece to get Greece out of the economic disaster it is in now.[1] I support such move. It is essentially a default, but making it consensual between the creditors and the debtors will be important in maintaining some kind of stability in the market.

The forgiveness will definitely free up resources for the Greek government. Even right now, just as The Economist wrote, Greece is increasingly unlikely to repay whatever it owe without resorting to the debt market. Besides, as The Economist pointed out in the same article, more than 70% of Greek debts are owned by European governments and the ECB. Given that these governments as well as the ECB are in it together with Greece if they want to maintain the integrity of the Eurozone, they should take further haircut. The ECB has been adamant about not suffering a haircut, but I think that is an unfair uncompromising position given how private bondholders had agreed to a haircut themselves. Why should the other sector be any different?

Right now, Greece is utterly dependent on bailout money from the Troika to run its government. The bailout money has been the carrot for various necessary reforms in Greece. The Troika wants Greece to execute those reforms before releasing the bailout money. With the Greek tight on money, bankruptcy looms.

If it was not for all the European complications, an outright default would have been the best way forward. It is clear that Greece cannot pay whatever it borrowed and the world might as well accept it and more on. Greece will undergo severe pain (it is already there anyway) but at least, it would have smaller or no debt at all after that. Greece can start afresh.

I think, the best is for the Troika, the government creditors as well as the ECB especially to peg debt forgiveness with the pace of reform, just as The Economist proposed. That would be better than pegging the bailout money to reform. Bailout money only increases the burden of debt for Greece and I am unsure how that would help in the long run. Considerable amount of government revenue would continue to go into servicing those old and new debts and only limited residual resources would be available for Greece to invest in itself. A debt relief program may enable Greece to invest in itself and carry itself out of the hole sooner than the ongoing bailout program can.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved
[1] — A GENERAL strike; protesters on the streets; parliamentary battles over austerity measures needed to unlock rescue funds; and a sinking economy with an ever bigger debt burden. The situation in Athens this week is grimly familiar—and not just because Greece has had so many similar weeks over the past couple of years. There are also eerie echoes of the developing-country debt crises of the 1980s and 1990s. [The Economist. How to end the agony. November 10 2012]