lørdag den 22. november 2008

Rethinking Macro Economics ?

As the crisis that started in August with the market for US sub prime loan collapsing now has gathered a momentum that hasn’t been seen for many decades, a lot of observers and experts have expressed a multitude of suggestions and remedies while financial leaders, regulators and politicians have been working around the clock to try to stem the harsh tides. (See: The Fuel that fed the Subprime Meltdown)

And as the traces have now spread to almost all countries and sectors of the economy it is obvious that new approaches, indeed more than a New Deal is needed. As all major European and Western economies are now more or less in recession, the price of oil has dropped to as low as one third of the price during July, the Bloomberg’s Metals Index likewise down to 1/3 of July, prices for food have dropped to 50% of an all-time high. Stock value of most of the Worlds leading companies down to 50% or below, with a threatening overcapacity in industries like transportation, tourism and an automotive industry on the verge of collapsing, it is about time to stop and wonder how this could happen so fast and with an impact of this enormous magnitude.

There are some obvious and some maybe more hidden reasons why this could happen:
Firstly, the Globalization is the direct reason for the rapid spread of the problems; the first wave due to the Financial derivatives being traded on a World Wide basis much alike re-insurance made the sub-prime loans felt in almost all major financial institutions. (See: Gambling on Derivatives)
Secondly, most of the financial regulatory system – especially, but not only the US ‘Greenspan’ system – has been based on a long, steady period of growth, and has not been geared to any kind of massive drop in values and stock prices; this meant for instance that because of rules on Pension Funds protecting their core capital, they had to sell off bonds or stock in the beginning of the downturn, putting additional pressure on the market.
Thirdly the Globalization now means that all major industries spread the value chain across the continents leading to direct and fast reactions in supplier markets.
Add to this the inefficiency of supra national regulatory and supporting systems. We have seen the G7 gather quickly, but before their decisions, some countries were already trying to implement their own strategies, and even if a somewhat concerted effort was indeed agreed upon, it was still implemented in lots of different ways. And then you could argue, that as OECD has pointed out that only 20% of the Global Economic Growth from 2005 to 2009 comes from the advanced economies, G7 should have been enlarged to, well G20 (See declaration on G20 meeting in Nov. 2008), with lots of negotiation power plus obligations put on the BRIC-countries and developing economies, that still has a promise of positive economic growth in the next couple of years. Looking at the IMF, this institution has only once during the last 10 years being called upon by a Western Country – namely Iceland. So IMF and it’s traditional mission, remedies and requirements before putting any substantial credits on the table, it is hardly a toolbox that is fitted to the complicated advanced economies, that are now suffering.
And likewise, the World Bank has other objectives, to help developing countries.

(Figure: IMF: Real Economic Growth by Market Type, 1997-2013 %)

So what is really wrong and why doesn’t the funds but to the disposal of the financial institutions do the trick? Why isn’t the drop of interest rates in most countries helping us?
One of the reasons I expect is imbedded in the psychology of the intervention packages: As Government officers are now being put in charge of banking operations, we are coming from a situation with lots of risky business with lots of willingness in the financial market to finance risk by spreading it around to a situation now where absolutely NO risk is tolerated; it may be that basic international trading business and associated payments are financed, but funding for new start-ups are likely to disappear completely. The next phase of the downturn will be that Government tax revenue will start to drop as income drops and the unemployment starts to rise.

Going back to Economic history the situation looks almost like described in Karl Marx ‘Das Capital’. His prediction that as the competition between the capitalists is bringing down the ‘value add’, the lack of profit will lead to mass bankruptcies, take over and mergers so that the strong will get even stronger – and finally leading to the collapse of the capitalist system. Only this time we put Government officials on top of the Capitalists – but how can they become efficient bankers? Let alone efficient car makers? Is it a take over by the Proletars? Or will it just lead to more bankruptcies?

The good ol’ macro economic model for aggregate demand will have to be looked at a mega-economic level, as the best idea in the mid term run will be to stimulate demand:

D = C + I + G + (X-M)

(Demand equals Private Consumption plus Investment plus Government Expenditures + Export minus import). The sinister scenario goes like this:

Consumption: Consumers expect prices to fall and keep their money in the pocket, disposable income may come down due to lay offs, consumer credit is being stopped by risk-adverse banks, and as housing values are coming down, there is no easy way to obtain a mortgage credit to finance major items like cars, washing machines etc.
Investment: Probably only most necessary re-investment programs will survive, capital equipment will begin to be worn down, and banks are not allowed to finance any kind of innovative new start ups or new development, unless the needed capital is generated by the companies themselves.
Government expenditure: If Governments are facing cut in tax revenues and rising unemployment and social costs, this will create a short term deficit, but only major investment programs, new infrastructure projects (Going green? Public Transportation instead of cars?) would help.
Exports are likely to drop, particularly exports to the mature western economies. It does help of course, that Import will most likely drop as well.
If we take all of these factors together, we have the classical remedies for a depression spiral.

So indeed the task that the Governments are facing is enormous, the international institutions not fitted for the magnitude of the problem, the need for collaboration and mutual adjustment is immense, and the risk for potential social unrest is looming.

The dynamics of the model is based on expectation; the more likely it is that prices will fall, the more the aggregate demand will be reduced leading to a very vicious spiral. Only short term remedy could be a marked, temporary and international cut in VAT to kick consumers to go out and buy.
It may only be a short term advantage, but it definitely need to be accepted internationally to avoid problems with the balance of trade in some countries.

So where is the hope for a more long range type of solution?
On the institutional side we need to create a supranational regulatory body with power enough to call for collaborative funding and with benevolence enough not to strangle the countries they are helping.
We also need a ‘Bretton Woods’ type of agreement on common rules and regulations for criteria to have solid banks, with well-defined products, have efficient pension fund regulations, establish a transparent market for dealing with and handling risks and international investments, trying to harmonize mortgage systems around the World - and we need to speed up the Doha round to ensure free trade and break down what may remain of restrictions and local subsidies – to food, cars, anything. We need to have an international agreement beyond Sarbanes-Oxley to ensure public insight into all sorts of major businesses, and we need some sort of international court system for fraud committed by international organisations and companies, much like the Haag International Criminal Court.

But all this require transparency and easy access to information. My point is that the more we speed up the velocity of adequate information related to international trade and finance, the more we will be able to expand commerce and trade. If you remember the old quantitative model:

M x V = P x Q

Saying that is a proportionality between the supply of Money times the velocity of Money circulation and the general Price level P times the aggregate production index, Q.
The theory was in various disguises used by Milton Friedman, suggesting that in case of inflation the volume of Money in circulation should be brought down. But maybe we could reformulate this to:

(M x V(m)) x V(i) = k x (P x Q)

Suggesting that the volume of Money multiplied by the Velocity of Money multiplied by the velocity of information in a transparent economy could be stated to be proportional to P x Q, which again is a pseudonym for the National Product. The idea is that the faster the flow of information needed to exchange info business, transfer financial transactions, exchange freight and customs documents, the more transactions will be performed, and the more transactions can actually be funded by the available amount of money. In other words: Speed AND transparency.
This calls for investment in updating management of value chains, updating flow of information between suppliers, manufacturers, consumers and financial institutions. It also calls for fast introduction of open standards for cross national and cross agency communication (See the EU’s Interoperability Framework!) – and first and foremost it calls for transparent semantics on all aspects of trade and finance. UN EDIFACT was just a beginning.

If we accept this, our supra national regulatory body and it’s steering committee (New role for G20?) should as it’s first task to finance a new global infrastructure look at financing a network, a structure and a set of standards and stewardship rules for ensuring transparency along the ideas described above.

tirsdag den 11. november 2008

Security Outlook for the Middle East – some Comments

A part of our study tour to Dubai with the Danish Press Association described in my former blog, also dealt with security and peace related issues; as we met with the top editors from Gulf News, Emirates Business 24x7, Al Arabya TV and in this respect central observers, Ed O’Sullivan from
MEED – Middle East Business Intelligence and Dr. Mustafa Alani from the Gulf Research Center, we got a very interesting insight into the thinking and current issues in the area.

As the trip took place in the week of the US election, it was of course of particular interest to discuss which influence the new president was expected to have on the situation in the Middle East.
Ed O’Sullivan had a very straightforward view on this: He stated that in his opinion US had never had any proactive strategy for the Middle East – Neither when the state of Israel was created in 1948, when France and Britain tried to overthrow the Egyptian ruler in 1956, when the war broke out between the Arab states and Israel in 1967, nor in the 1990’s. US always seemed to be reacting to some events, only George W. Bush during his second term seemed to have some sort of strategy, but again, he was forced to it because of earlier events.

During the presidential campaign, Obama had been surprisingly silent about the Middle East, probably backed by Clinto experts and former staff. This also explained, why7 Obama suddenly this summer declared that Jerusalem in his opinion should be the undivided capital for Israel! No other president or Western leader had said this, and is was remarked in the Middle East. As the Palestine/Israeli conflict is very close to the minds of all arabs in the Middle East, it wasn’t really a smart draw to name the new staff manager Emanuel Rahm as his Chief of Staff. Except being described by some of his opponents as aggressive and a ‘Cross between a haemorrhoid and a toothache’, seen in a Middle East context his problem is that his father was an active member of the notorious Israeli group, the Irgun before 1948. Also Emanuel volunteered as a soldier in the Israeli army during the first Gulf war in 1991. So no wonder the Israeli papers were full of praise.
The moderate Arabs hope that Obama’s middle name – Hussein – and his last name – Barack, the blessed one – will balance this out, but the fear is that US as always are heavily influenced by the Jewish lobby.

One of the scenarios we discussed was if the conflict between Israel and Iran could result in a situation where Israel actually tried to bomb the Iranian Nuclear plants in a preventive attack.
Ed O’Sullivan’s remark to this was that even if Netanyahu won the Israeli Election, both he and
Rafsanjani need each other as an external enemy picture to keep internal stability; the more pressure on Rafsanjani from the students, and the more instable political situation in Israel, the less likelihood of a real conflict, but the more the 2 leaders needed to expose each other verbally.
One of the more serious, yet mostly unnoticed events in this respect goes back to 2006. At that time, the Secretary-General of the Gulf Cooperation Council, announced the intention of the six members states to establish a joint nuclear research project. Until then all of these states has been firm opponents of nuclear energy and all are signatories to the IAEA safeguard agreement. This act can only be seen as a warning to the international community that something should be done to prevent Iran from producingnuclear weapons. This si one of the issues inherited by Obama.

Another of the real threats to stability in the area of course is the future of Iraq. As Dr. Mustafa Alani pointed out, the current vacuum between the fighting minorities inside of Iraq – Sunnis, Shias, Kurds – and between the Arab world and the Shia-led Iranians – is in fact a Coalition Army of 100.000 top trained soldiers, mostly US. As US has failed to put an Iraqi army together that could be trusted by6 all parties and first and foremost trained, not even an army of 300.000 could prevent a bloodbath is the US troops withdraw too quickly. The various minorities are intermixed, and an ethical cleansing like in the former Yugoslavia could be terrible. The risk of the Iranian Shias teaming up with the Basra Shias could impact the stability of OPEC and indeed the region as such.

One of the questions we had to the Dubai editors and specialists was related to the suspicion, that the enormous wealth in the UAE and the openness of the Dubai Society might attract all sorts of organized crime that could use the financial facilities for laundering and the free port facilities for smuggling – drugs, weapons.
The response we got from almost all of the specialists was that the border control is strict, the police force equipped with up-to-date IT tools and cooperating with the outside World to prevent this, but of course the possibility still existed that the facilities could be misused. The Secure Trade Lane concept is bei8ng installed in the container areas, and financial investigation into fraud seems to be working. As Dr. Mustafa Asani pointed out, none of the bad guys – Al Quaeda and similar – dared to use the banking system any longer, so couriers would be used travelling with large amounts of cash.

Dr. Asani got the question why Dubai didn’t arrest Osama Bin Laden in 1996 when he was thrown out of Sudan and in transit to Pakistan/Afghanistan. He answered that Al Quaeda as such was not really on the top of the list at that time. Although – like CIA – Bin Laden was ‘being followed’. Former events was a partly successful bombing in Aden, Yemen in 1991, but it wasn’t until the bombings of the US Embassies in Kenya and Tanzania in 1998 that Bin Laden was put on the WANTED-list. And in 1996 CIA agents weren’t allowed to kill anybody abroad. That restriction was only lifted after the 9.11 events.

The final major possible threat we discussed was whether or not the Saudi rulers could be counted on to stay in power. Dr. Asani stressed that no real opposition exists in Saudi, and that an internal fight between members of the ruling class is highly unlikely, as everybody in this class has an extraordinary wealth at his disposal. So in his eyes, there is no threat to the Saudi throne. The last person to suggest otherwise, Fred Halliday in his 1971-book ‘Arabia without Sultans’ tried to peddle some Yemenite Marxist visions, but it seems to be extremely far out

The specific Danish issue on the reactions in the Arab World on the printing of the so-called ‘Danish Cartoons’ was a point of discussion with all the editors and specialists, we met.
The issue of course is that it may be hard for a man on the street in an Arabic country to understand why not our Prime Minister could have stepped in, forbidden the printing – or at least have made an excuse. As the Danish press by law is COMPLETELY outside the control of any Government, we sort of expected that this would be the hard thing to bring across. But the editors in Al Arabya seemed to be extremely well informed of the legal situation in Denmark and stated that the reactions had to be seen as a very natural reaction from a lot of Arabs that had felt they were all being accused on being terrorists after 9.11, and that the whole World was against them. These drawings then made the fuse go off. Also the Gulf News team said that they understood the freedom of the press principle, but simply could not understand why these drawings were being produced in a paper, that should have as it’s primary objective to get people of all sorts to work together and not to fight each other. And all editors were likewise puzzled by the necessity to re-print the drawings a second time. There is no reason to doubt, that for most Arabs, Denmark’s reputation have suffered. But for most educated and balanced news people, this is now a past story, and the security level for Danes in the Middle East and in the UAE is unshaken. We are still allowed to enter UAE without Visa.

mandag den 10. november 2008

Revisiting Dubai - The Eye of the Financial Tempest

Last week I visited Dubai for the first time since 2003 as part of a study tour arranged by the Danish Press Association. I was excited to see the developments since then, as I participated as an e-Government Advisor in several IBM bids to the Dubai government, at that time Crowne Prince Mohammed Al Mahktoum, since 2003 now the ruler of Dubai.
The largest projects were the proposal for an internet based strategy for the government in 1999, followed by projects to fill the Dubai Internet City and later the IT infrastructure of the Dubai Marina Project. Both of these projects were nothing but a large mock up, a lot of desert sand, and for the Marina the diggings of the Marina to-be – a 2 x 4 kilometer swimming pool-like hole in the desert to be covered with white tiles.
It is said that ¼ of all building cranes are active in Dubai, and I think this explains why the growth of tall buildings, and entire cities have broken all known records (with the possible exception of Shanghai in China); The World’s tallest building (at least for some time), the Burj Dubai, will soon reach the 187 floors originally decided upon – but it may not stop there. Workers are adding 1 floor every second day.

The Dubai story began shortly before 1900 when Sheik Mohammeds grandfather decided on 2 key things: He lifted any customs on imported goods and he dug out the Creek. This gave rise to a lot of transit trade, and Dubai soon became one of the most active ports in Gulf, also working as a practical transit station for the British ships en route to India and back to Europe and UK.
When his son in turn decided to build modern harbour and began designing a whole new city with hospitals, schools, facilities to help trade, the modern Dubai began to take form.
Dubai found oil – but only a limited volume compared to Abu Dhabi, so it was clear from the outset of the oil boom, that Dubai had to rely on other income sources than oil, and trade seemed to be promising.
When the current sheik Mohammed as a crown prince began to make his name known in the region one of his first priorities was to secure Dubai as a leading nation in deploying and using IT and in particularly the new internet. Sheik Mohammed’s vision was to attract and create a complete new ’third industry’ based on modern technology – and by now, some 8 years after his first formulated strategy, he seems to have succeeded.
Tourism was likewise one of the key areas for development, and as one of the first attractions for wealthy tourists from Europe, US, Russia seemed to be the beautiful beaches, the coast line was too short, so the development advisor suggested to build a complete series of islands in the arabic Gulf; already now the coast line has almost doubled, and more Islands, the latest project ’The World’ is being build 4 kilometres from the cost line with sufficient capacity to host another half million residents and visitors.

The program for the study tour was really exciting – visiting the Danish Consulate to get the general information seen from a Danish Perspective – including experiences from a Danish developer and real estate broker. Then a meeting withEd O’Sullivan Middle East Business Intelligence a famous Middle East expert, briefing with the editorial staff of an up coming media star, Chief editor of Emirates Business 24x7 Riyad MickDady, Meeting with Gulf News chief Editor Abdul Hamid, Ahmed, with Al-Arabya TV, chief editor Nabil Khatib and finishing off with a in-debth discussion of Middle East security issues by Dr. Mustafa Alani and his staff from Gulf Research Center.

Starting with the property market, Lars Silberg Hansen from Larsen & Hansen, Dubai, explained the back ground and development going on 9in the real estate sector. It all came back to the so-called free-hold act 7 years ago allowing foreigners to own land and property in Dubai. As the tax rate is guaranteed 0 for the next 50 years, this led to an enormous boom, which is still accelerating:
229.000 new persons per year in 2007, 60.000 new companies registered in 2006 and 112.000 new companies registered in 2007! This has put a pressure on the real estate market, and it is quite normal that a flat or house is sold 3-5 times before the first inhabitant moves in – giving the investors a nice return. Rental is a good business for the developers as well with a yield of 8-12% pr. Year. The building boom is not directed towards the temporary workers, though. They can’t afford a flat at 200.000 Dirhams (50.000 Dollars) pr. Year, so they live in labour camps. 6-8 persons share a room, and as half of them work night shift, it is not crowded. Salary, security, dwelling conditions are in any case much better than in Pakistan or India, and since 6 years ago the developers acting as sponsors for the workforce, has been forced to offer them free transportation in nice busses and better working conditions, so the number of incoming labours seems to be secured.

The projects in Dubai seem never to stop; at the same time as ‘The World’ and the new Palms are being created, Dubai is finishing a sports city with the aim of hosting the Olympics plus a formula 1 track, and the World’s largest entertainment Park, Dubai Land, will be some 60-70 times the Disneyland parks in Orlando. Plus of course some 150 new hotels and an entire theme park to mirror the different cultures of the World. Also a brand new airport, 4 times the size of the current major international airport, is under construction. Plan is to attract 60 Million tourists pr. Year and keep them happy! The value of the on going building projects in Dubai is 1500 Billions US Dollars. And rising.

The general economic situation in UAE is excellent, only topped within the GCC by Quatar, the emirates average income pr. Person is 41K Dollars/year. Inflation has been running quite high, 10-12% in Dubai, mainly due to the housing boom, and as the oil in UAE is expected to last at least 30 years, the outlook is bright. You would expect that the recent drop in oil price from 150 $ pr. Barrel to a mere 65 $ took it’s toll, but as the dollar value have risen as a consequence of the crisis, the emirates are backing the dollar which is the basis for the Dirham anyway.
If UAE’s income from the oil is projected to 2020, the revenue will be between 3 to 5 trillions of dollars pr. Year. Variation based on an oil price between 30 and 50 dollars pr, barrel. This means that because the oil is so easily accessible in UAE, the costs are low. And the plans are to have UAE build refineries, plastic plants instead of shipping crude oil outside the region.

We learned that the general business climate as such seems to be at best not really stirred by the current crisis – the abundance of free funds in the UAE and in the Gulf Council Countries, and we also witnessed Gordon Brown on a courtesy visit to Sheik Mohammed and the Abu Dhabi government to ensure fuelling the British banks in the crises.
You could argue that as Dubai’s real estate and government funds may have a deficit of 40+ Billions of Dollars, it could be ‘high risc’. But nobody knows what the Maktoum Family’s wealth really is, and when all comes to all, the Abu Dhabi’s have at least an equal interest in Dubai’s prosperity, so this is where the trillions of dollars pr. Year from oil revenue come in very handy.

Ed Sullivan’s vision for the area is an intense growth from currently 38 million inhabitants in the GCC countries to over 100 Mio and Dubai-like cities along the cost from Ra’s al Khaima to Kuwait. Not only UAE, but also Quatar, Bahrain, Kuwait are booming.
He compared Dubai in the 1970’es with San Francisco in 1846, just before Gold Rush started.
Like San Franscisco, Dubai is now to 98% depending on anything but natural resources – it is a World class center for free trade with a booming building industry, a booming tourist industry and hosts a number of Hi-Tech companies and media companies. Plus the similar problem as San Francisco has with the density of cars and the traffic jams. Dubai is building it’s metro – and in one year from now the brand new metro will open it’s first part.

The open policy towards foreigners is not limited to tax exempts, free ports and increased efficiency in handling visas and work permits; also democracy as such is slowly spreading. In UAE a new council of 40 has been put in place – 20 of those are elected and the other 20 named by the Government of UAE. The interesting thing is that the government actually appointed several women, as the turn out by the elected persons where discouragingly low.

It was interesting to learn how the press and the media navigated in a political environment where they in theory could be closed any moment by the rulers in the various Gulf states. In spite of this – or maybe more correctly – because of this, they have been given a lot of what we will call freedom of the press. The new 24x7 Business paper expressed it this way, that even if their ambition was to get advertising money and their largest customers where from Saudi, they still pursued an open and fair analysis of business situations in the Middle East.

Similar views were expressed by the Al Arabya editor, Dr. Nabil.
30% of their advertising revenue came out of Iraq, their primary objective was free and accurate journalism. This had meant that 11 of the staff had been killed by various groups in Iraq since the war in 2003. Their editorial line is to be bold, and hence they weren’t that popular in Syria, Libanon and Palestine. This line is of course difficult in a basically conservative area, but nevertheless this is what Al Arabya is looking for – a balanced, objective line.

During our visit, the Global Economic Forum opened in Jumeira, Dubai. More than 700 international specialists, spokesmen and experts from academia, Government and Industry met to discuss the World Crisis. It was opened by Sheik Mohammed Al Maktoum, who called for a new World Order with much more responsible Governments and with a higher level of collaboration across the borders. This was not just because he just had to listen to Gordon Browns plea for assistance, but also because the true story behind what looks like and extreme liberal economy in Dubai (And UAE – where he is the Prime Minister) is in fact an attempt to control and balance supply and demand from the Government side – whether we are talking about public assessment of the value of properties and the regulation of the banks to a inquisitive attitude towards fraud in private companies. In fact, the UAE/Dubai balance between government and liberalism might be the cure we need right now?
So the Sheik is a benevolent ruler in the sense that there is room for everybody, but under regulated forms. It was interesting to note that some of our recommendations from the projects 5 years ago are now being finalized – for instance the issuance of smart cards and digital identities to all citizens in Dubai. By the 1. of January every resident inhabitant will have to have this, bringing UAE and Dubai to the top of the most advanced countries to have digital identities.

The only vague signs of the World crisis we observed during our stay were some of the top shops autumn sale with 75% off. But then again when a new Mall, the Mall Dubai opened on Friday afternoon, the roads were blocked by cars for several hours. Consumer confidence seem at a peak.

The week was completed in an excellent way by a private lunch at the Burj Arab, a seven-star hotel, overlooking the Palm, the Marina and the Jumeira Beach – with just a faint view of The World in the horizon. When you are sitting on the top of this extraordinary building you realize that there is no place like Dubai. A truly international melting pot with almost no crime, no problems with immigrants, a high standard of health care – but obviously also with access to ready cash at a magnitude nobody can really imagine – so even if the UAE shares fell 6% on Sunday Nov. 9, it didn’t have any real impact on the traffic in and out of Dubai airport this morning.
What could turn this place a part could be a serious security threat.
We will investigate this in another blog.