Tuesday, February 12, 2013

What Venezuela’s Devaluation Really Means

Hugo Chavez, who is recovering from cancer surgery in Havana, ordered his government to weaken the exchange rate by 32 percent to 6.3 bolivars per dollar, starting Feb. 13, 2013.

The move was motivated to balance the budget deficit and contribute an additional 84.5 billion bolivars ($13.4 billion) in revenue, mostly from government oil sales transacted in dollars, according to Caracas- based research company Ecoanalitica.

There are several ways a government can reduce its budget deficit. It can decrease government spending, increase taxes, print more money or devalue its currency, if a significant part of government income is derived from exports (which in Venezuela's case, is its crude).

The devaluation will also impact domestic consumers, as imported goods (on which Venezuela is largely dependent) will increase significantly, adding to the possibility of an increase in cost-push inflation. Of course the government could have opted to add steam to the bolivar printing press, which also would have been inflationary. However, a devaluation seemed to be the more attractive option and the lesser of the two evils.

Successful monetary devaluations have been successfully orchestrated in the past, especially if an economy is contained in a deflationary environment: the UK and the “Sterling bloc” in 1931, the US in 1933, Sweden in 1992 and Argentina in 2002.

The devaluation opens up growth opportunities for industry that may be focused on exports, as the price of their goods would become competitive. However, as growth in the export market, for goods outside the crude industry are insignificant and government motivation to assist in developing this sector is limited, any expectations need be modestly inclined.

Some companies which are strongly entrenched in the export of goods through contracts, or who hold debt through their transactions as a creditor, could run up significant losses as they may be locked in to transactions or could hold bolivar bills, which are instantly devalued when converted to dollars or other currencies. Although it is surprising that they may not have embarked on action to hedge their positions, through forward currency cover contracts, at times the hedge is too costly, making the cover an inefficient option on a risk-return basis.

Monday, February 11, 2013

Trichet's View on Strength of Euro Puzzles

Former ECB chairman , Jean-Clause Trichet, expressed his opposition to those economists who advocate a weaker euro based on the fact that it would stimulate the European export industry and growth.

The comments come as a surprise, in light of the recent firming of the euro and concern by analysts that a stronger euro will constrain export growth and push the economy deeper into recession.

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Sunday, February 10, 2013

Top 10 Geopolitical Risks for 2013

The World According to Reuters.
Reuters has identified the top 10 global threats facing markets for 2013, in ascending order, starting with the least riskiest:

1. South Africa
The ANC struggle to govern effectively in a country swamped by mining strikes. This is bound to impact growth and investor confidence.
Nigeria remains volatile and in the background, but did not make the top 10 list.

2. India
Corruption continues to impede credible governance.

3. Iran
Relatively low on the radar screen as the risk of a military attack is perceived as low. The red flag is sanctions, which is seen as impacting the economy and prompting the possibility of political upheaval.

4. Asia Geopolitics
China has a more assertive military strategy and some countries will struggle to maintain alliance.

5. Europe
Lower risk in 2013 with stronger banking union. Reuters does not view the possibility of fragmentation as likely.

6. JIBs
Japan, Israel and Britain
There are three main losers in the global geopolitical process.  The challenge for Japan to respond to China's growth from a military perspective. Although Britain is outside EU crisis, it is on the periphery and will consequently be impacted. Israel will be affected by the Arab awakening and a long hot summer.

7. Washington Politics
Washington doesn't work. No prospect of bipartisan agreement, which will bring down growth and what otherwise would have been a relatively successful economic story.

8. Arab Summer 
Political radicalism is growing. Syrian problem will unfold.  Possibility of contagion.

9. China 
The country's challenge, need and inability for it to control information.

10. Emerging Markets
Currently, responsible for two thirds of world growth and at the high end of the risk spectrum.. Indonesia, Egypt and  Iraq do not have political capital to progress. Russia should not be a BRIC. Venezuela and Argentina continue to inspire doubt about their ability to govern effectively.

In a separate category, North Korea, remains the unplayed card. Exactly how politics will unfold in that country remain an enigma.

Top Financial Risks in 2012 Revisited

The top financial risks, as perceived by analysts (polled by Reuters) for the fourth quarter of 2012 were:
  • The fiscal cliff
  • Low growth and unemployment
  • The possibility of a Greek exit from the EU
  • The Euro Zone debt crisis
Going forward in 2013, nothing much seems to have changed. These factors are still very much in contention for potential blow-ups, although they are currently being managed (or pushed out) by politicians. In order to eliminate the risks significantly, more meaningful action will be required.

The only variable, which is a little more of an enigma than the other risks, is the possibility of Greece exiting the EU. Exactly the extent of this risk escapes quantification. An exit from the EU by Greece may in fact improve the position of that country and prospects for Europe in general. Uncertainty may prevail for a short period, as  politicians come to grips with the fact that the world will not end.

Saturday, February 9, 2013

The Next Financial Crisis

A brief review of the documentary "Overdose: The Next Financial Crisis" by Devell Borgs under the auspices of journeymanpictures (available on YouTube).

This is an excellent production with superb editing, imagery, commentary and archival clips. The idea of an overheated economy with too much government influence (which this production explores) is a common theme however, which is often oversimplified. This documentary is no exception.

Testimony by Ben Benanke, indicating that there does not appear to be any evidence suggesting a housing bubble, is captured. In defense of the Fed chief, the existence of the bubble was often questioned, but rarely predicted. The market reflected that perception, that housing prices were not over inflated. Hindsight is always 20/20, so many wonder, "How could everyone have been caught left-footed?"

Peter Schiff is frequently featured and captured, indicating that the government had to provide housing loans, because the private sector would not have invested in mortgages, with the risk that such investment required. This is not totally accurate. The private sector in fact lost billions, as a result of its exposure to the sub-prime market.

The documentary indicates that the stimulus lacks definition and that public spending on projects which are unproductive, will not help the economy in the long term. Although there is substance to this argument and may well be the reason why the fiscal spending initiative has not succeeded in lifting the economy out the recession, there is a school of thought which suggests that any form of government spending (irrespective of its perceived merit) will help the economy from sinking deeper into negative growth.

In the U.S. the move out of recession has been lackluster, while the economy has until now, avoided an increase in unemployment and further recession. The producer, Devell Borgs, suggests that because of the increase, artificially, in government spending  and the monetary policy of the Fed which has been "excessively loose", worse is yet to come.

This supposition ignores the Keynesian approach to recession, which advocates increased government spending (with a loose monetary policy). Conversely, in the times of high economic growth, Keynesian economics would dictate decreased government spending (with a tighter monetary policy), with intent to flatten activity curves and decrease volatility in the economy.

By current accounts, even when the government does participate in the economy to reduce the impact of a recession, lower overall government involvement is an objective which is ultimately sought. This is the approach which Greenspan and Bernanke have adopted, although their management of the economy has been limited to driving the reins of monetary policy, rather than fiscal policy.

Many, like Borgs, argue against any government participation, as this only creates an illusion, hiding the real challenges within an economy, suggesting that the approach is ill-conceived and that it will ultimately come to haunt its manhandlers.

Devell Borgs' documentary is highly recommended, if not just for its consideration of an economic approach which I do not agree with, but which has gained some support.

Wednesday, February 6, 2013

Do Natural Gas Vehicles Have legs?

  • Technology for natural gas powered vehicles (NGV) is making new strides in lowering costs and reducing emissions.
  • Fueling costs of natural gas vehicles are one third of traditional unleaded gasoline fueled vehicles.
  • However, the challenge of fueling availability, remains an obstacle.
  • Consequently, the gas industry needs to build infrastructure, like a network of fueling stations, to meet the needs of motorists.
  • In light of the potential for NGVs, manufactures such as Ford, General Motors, Dodge, and Honda are already producing models of natural gas powered vehicles.
  • As expected, mechanics and auto shops will also need to make some changes. But they won’t need to become familiar with a whole new engine.
  • The potential for the growth of the NGV industry remains significant.

Top 5 Geopolitical Risks Facing Commodities in 2013

5 Major Geopolitical Risks Facing Commodity Markets In 2013:

"On January 14, Deutsche Bank published their 2013 market outlook in which they identified several geopolitical hot spots to worry investors and businesses.

They include a wide range of developed and less developed economies, many of which are key producers of commodities and/or a key link in product supply chains. If something goes awry in any of these hot spots what will be the impact on commodities?"

1. The US/Middle East

The shift in the U.S.’s strategic priority from the Middle East to Asia has pros and cons for stability in the Middle East and by implication oil prices. Whereas previously the U.S. might have intervened sooner in Syria sooner not so long ago; the on-going conflict in the country as well as tension elsewhere (Israel/Egypt) has the potential to spiral out of control and drag other countries in the mix – potentially disrupting oil production. Unintended consequences.

 Meanwhile, the likely appointment of Kerry and Hagel as US Secretary of State and Defence Secretary could see renewed diplomatic efforts with Iran, which could reduce the risk premium (estimated at somewhere between $10 per barrel and $20 per barrel) that exists currently based on fears that the Strait of Hormuz will be blocked. The probability of an attack on Iran by the US/Israel by the end of 2013 has dropped from around 50 percent in October to 25 percent currently.

2. Venezuela 

 As the health of the country’s President Hugo Chavez worsens, attention has centred on what this will mean for oil output from Venezuela and its affect on oil prices. Oil production has suffered under Chavez’s rule through breaking contracts with private companies, firing workers that did not support Chavez and a lack of investment. In the short-term uncertainty over whether there will be a smooth transition of power and social unrest may underpin oil prices.

For a decline in oil prices to be seen, there would need to be clear signs of increased drilling activity. However analysts at WTRG say there is little chance of any downside risk to prices as there would need to be a 50 percent increase in drilling activity and a reversal of many of the social projects Chavez set up.

 3. Mali/Nigeria 

 On the face of it, the onslaught of radical Islamic fighters against the Mali government would not appear to have a big impact on commodity markets. Mali’s main commodity export is gold – the country being the third biggest gold producer in Africa after South Africa and Ghana. Mali’s gold mines are centred on the south and south west of the country far away from where the civil war is taking place in the north. Even so the unrest has already led to mining delays, as travel bans have made harder to secure technicians and suppliers.

 The recent terrorist attack to a gas facility in Algeria may be symptomatic of events that could occur more often in the region. Algeria is a major exporter of gas to Europe. Although there is no sign that the current unrest has led to lower gas supplies to Europe there could well be supply shortfalls and increased energy price volatility in Europe. However, even if Algeria were to suffer a serious disruption it would not be too bad. The real risk is that countries like Nigeria (the eight largest exporter of oil) suffer similar unrest leading to disruption to their energy and commodity output.

4. South Africa 

Unrest at platinum mines in South Africa last year served to illustrate some of the endemic problems in the country including high unemployment, poor conditions and poor pay. Weak demand for platinum from the car industry led to lower platinum prices in 2012. In mid-January,

Amplats announced that it would be closing 7 percent of annual platinum output in response to low prices and weak demand, increasing the likelihood that strike action will take place undermining and boosting prices. Furthermore mine workers will be looking forward to the election later in 2013 for signs that conditions will be improved.

 5. China/Japan

 In contrast to East Asia the potential for conflict between China and Japan is barely mentioned elsewhere. Since Japan announced last September that it would nationalise the Senkaku Islands (three privately owned islands which China has long contested Japan’s sovereignty over) relations between the two economies has deteriorated while both sides have undertaken tit for tat military exercises. Any escalation in tensions may also bring in other countries like India, Vietnam and the Philippines, which also have territorial disputes with China.

Appropriating Risk to Sovereign Debt

By Grant de Graf

Sovereign debt can be defined as Bonds issued by a national government in a foreign currency, in order to finance the issuing country's growth.


In Europe, government debt has escalated significantly over the past few years, ostensibly causing what is known as the Euro debt crisis. The reality is that the European Debt Crisis is complex and a consequence of a number of factors, including:
  • off-balance sheet and surprise debt discovery (Greece)
  • a failure of the Euro zone economic model,
  • potential debt burden realized (real estate in Spain, banks in Ireland)
  • the inability of monetary policy to function in step with fiscal policy, 
  • the Euro currency and the constraints it imposes on member nations to automatically adjust to economic imbalances through  market mechansim, 
  • contagion from the U.S. recession,
  • exposure to the sub-prime crisis, 
  • a dilution of confidence in nations to service and repay debt, 
  • austerity being haphazardly imposed by European central government on its weaker members 
  • cyclical economic factors in growth trends
  • Inflation (current Zimbabwe and Latin America in the 1980s)

What many pundits argue is the result of the Euro debt crisis, in some cases is in fact the cause, which means that although a dip in the economic cycle was inevitable, the extent of the swing has been exaggerated through harmful government policy and initiative.

Although the debt ratio of PIIGS (as a percentage of GDP) has escalated since the advent of the Euro debt crisis, many developed countries continue to exhibit high levels of GDP. For example Greece (as of 2010) had a percentage debt to GDP of 165, Italy 120, Portugal 109, and Ireland 108, relative to Japan's 208. (See source: List of Countries by Public Debt)

* Source: Wikipedia, Sovereign Debt Crisis

At risk globally, are countries who are exposed to significant debt, but who are unable to function with a successful economic model, which provide investors with a level of certainty that debt can be serviced or repaid in the long term.

In many instances the servicing of debt is effected by other factors extraneous to debt. For example in South Africa, political tension and the instability of the labor force, has more recently affected investors' perceptions of the mining industry, placing the country's key strategic resource in jeopardy.

In some South American countries, drug violence continues to limit the development of industry, as the risk of new investment constrains growth and development.

The extent of a nation's sovereign debt and the risk factor that is appropriated to it, will ultimately depend on the country's economic viability and its ability to meet short-term and long-term obligations.

  • Interest rates of bonds specific to a country increase
  • Capital values of existing bond issues fall
  • Cost of capital for future bond issues increased
  • Possibilty of default in debt repayment
  • Central banking institutions (like ECB or IMF) need to buy bonds or take up new issues to keep interest rate in check and take up slack in demand
  • Governments need to increase taxes to meet shortfall in servicing of bonds 
  • Decrease in investor and business confidence
  • Deflation as economies shrink
  • Austerity as governments cut expenditure in anticipation of growing budget deficit   

  • Countries can buyback debt at lower, discounted capital values
  • Potential to renegotiate terms of debt repayment with creditors
  • Traders may buy debt (if they anticipate interest rates will fall in the future, and if possibility of debt default is low, or if there is anticipation that currency will strengthen as with South African rand in early 2000s)

Groups at Risk
  • Investors 
  • Traders
  • Stocks and forex
  • Central banks
  • Investment banks
  • Government
  • Importers and exporters
  • Shipping and industry
  • Tourism
  • General business
  • Bond holders and traders
  • Politicians
  • Rating agencies
  • Civil servants
  • Labor unions

Monday, February 4, 2013

Why the Big Mac Index is an Inefficient Predictor of Forex Valuations

By Grant de Graf

The Economist has once again posted its Big Mac Index, a measure of the strength of foreign exchange rates, based on the purchasing-power parity (PPP) of a McDonald burger. The Big Mac uses a single point of reference (the Mac) to calculate the over or under valuation of a currency , the theory being that prices and exchange rates should adjust over the long run, so that identical baskets of tradable goods cost the same across countries.

Using the PPP of the Mac for measuring the strength of a currency as opposed to a basket of goods does have distinct advantages, in that the noise and deflections which may exist in selecting a broad spectrum of goods, is removed. However, there is another factor which will intrinsically effect PPP.

The PPP of a currency, will always reflect the fundamental political and economic attributes of a region, which serve to skew it's value. For example in Switzerland, the Swiss franc is used by investors as a safe haven. Consequently, it is priced in at a premium. Conversely, South Africa is considered an economically and politically high risk region, hence the discount at which the rand trades.

Similarly, currencies of other emerging markets or volatile regions also tend to trade at a discount, with the exception of Brazil 's real. Brazil's price enigma can be attributed to the capital controls which the country maintains and to the fact that many traders use the Brazilian real, as a point of reference and security to price in other currencies in the region.

A similar pattern can be observed with the pricing of options. When implied volatility of specific equities experience a spike, relative to their historical volatility, thus reflecting an apparent overvaluation, some traders view this as an opportunity to sell the option and profit from the anomaly. Invariably, the incongruousness is a function of weakness within the equity or the underlying company. Without the appropriate hedge, many a trader has been wrong-footed.

The Mac Index is a good exercise to measure currency valuations, but to trade on the apparent anomaly, can be dangerous.    

Top 15 Factors Governing Financial Risk in 2013

The following variables will play a critical role in governing financial risk in 2013:

  1. Sovereign debt
  2. Political instability
  3. Regulation
  4. Environment
  5. Social
  6. Technology
  7. Infrastructure
  8. Economics
  9. Environment
  10. Energy
  11. Global workforce
  12. Natural resources
  13. Currencies
  14. Market volatility
  15. Austerity
Other variables that should also be on the radar screen:
  • Litigation
  • Health
  • Natural disasters (event risk)
  • Climate
  • Education
  • Copyright protection

Reality of Euro Crisis Comes to Light

Uri Dadush, senior associate and director of the International Economics Program of the Carnegie Endowment for International Peace,in an opinion for the Wall Street Journal, expresses disbelief with the suggestion the Euro Crisis is over, in his article, "Who Says the Euro Crisis Is Over?"

His points are well foundered and can be summarized as follows:
  1. 18 million people still remain unemployed in the euro zone.
  2. Markets incorrectly believe that European Central Bank President Mario Draghi's emphatic promise that the ECB will buy the bonds of troubled countries has all but eliminated the risk of a collapse.
  3. The risk of relapses triggered by domestic rifts or an external economic shocks will remain high.
  4. The euro zone can fail even if the single currency survives.
  5. Application of "boiling frog" allegory: If you put a frog in scalding water, he said, it will jump out. But if you place it in cold water and slowly raise the heat, it will stay put, eventually being boiled to death.
  6. Instead of a region of shared and uniform prosperity, the euro zone has become a study in internal divergence.
  7. Unemployment is at 26.8% in Greece, 26.6% in Spain, 16.3% in Portugal, 14.6% in Ireland, 11.1% in Italy—and joblessness is still rising in all of these countries. Meanwhile, the unemployment rate is 5.4% in Germany and 7.8% in the U.S.
  8. Italy's gross domestic product has fallen by 6% since the pre-crisis peak in 2007, whereas Germany's is up 8%. In the U.S., where the world financial crisis began, GDP has surpassed its pre-crisis peak by 7%. By comparison, Europe's GDP is only 2% above its pre-crisis level.
  9. The fiscal stance in Europe remains contractionary, reflecting the inexistence of a large central government, the inability of the periphery countries to borrow, and a fiscally conservative government in Germany, where the effect of the crisis has been felt much less.
  10. The limited monetary-policy response, which is now changing belatedly, was also the result of a conservative approach by the core, especially Germany.
  11. Falling interest-rate spreads and improving financial markets are not enough to reignite growth and competitiveness.
  12. In Brussels, plans for a banking union are advancing, but at a snail's pace. Proposals for forgiving official-sector debt holdings are dead on arrival. Fiscal union is not on the table.

Creativity vs. Execution

Merissa Meyer, Yahoo's new CEO makes an interesting observation in conversation, with Bloomberg's Erik Schatzker, at the World Economic Forum in Davos. (See video below for shortened version, key points of the discussion.)

Meyer depicts creativity within a company, in a novel and interesting light.  

"One would think that the opposite of creativity is stagnation," she argues. "But there is a school of thought, which suggests that on the opposite side of creativity is execution." In other words, if a company is focused on creativity, many aspects of execution (in respect to growth, may be compromised) or visa versa. 

Ostensibly, Yahoo is in execution mode, which means that the company will focus on taking the platform (spawned from creativity) to optimizing the experience and making functionality more accessible to users.

Jan. 25 (Bloomberg) -- Highlights from Yahoo CEO Marissa Mayer's conversation with Bloomberg's Erik Schatzker at the World Economic Forum in Davos.