Tuesday, 29 November 2011

Hard Liquor, Loose Women . . . And Interest Rates

You really have to feel for Ali Babacan, the head of the Turkish treasury, you really do. He is very bright and understands extremely well the complexities of the global financial markets and the key role of interest rates in navigating through those markets.  Yet, unfortunately, his job is made extremely difficult by many fellow government ministers, including the prime minister, who are ideologically opposed to interest rates per se and tend to view them along with hard liquor and loose women as spawns of the devil.

Babacan is constantly forced into defensive and somewhat silly explanations of this clash between reality and ideology without seeming to contradict the prime minister who has a notorious dislike of any dissent.  “My prime minister’s will for a zero real interest rate is an ideal target. That is an ideal target which we would really like to see at one point, but that point might not be so close,” the beleaguered Treasury chief said in a recent Wall Street Journal interview. Very careful understatement, that.

The Turkish economy is going through a particularly dangerous period right now, and the prime minister’s zero interest rate goal is starting to resemble the fanciful foreign policy zero problems strategy.  The zero interest goal is morphing into high rates and multiple problems. Babacan’s efforts to resolve the ideological positions of many of his fellow cabinet members and financial reality have led to some odd contortions that strain the credibility of Turkish financial policy. Whether the prime minister likes it or not Turkey’s economic policy is closely bound to Europe, and the same forces creating so much trouble in Europe are rapidly making themselves felt in Turkey. With the currency depreciating rapidly, personal and corporate debt increasing to record levels and inflation headed back to double digits rates in Turkey are set to head north quickly.

And as interest rates head inexorably northward we can expect consumption to slow down, thousands of apartments remaining unsold, government funding becoming more difficult, massive new infrastructure projects remaining on the drawing board, and unemployment rising. Not welcome news to a government that has won the last two elections on the back of strong economic performance.

Growth At A High Price

A little background will help make this clear. For much of the last 9 years the Turkish economy has boomed on the back of a strong currency and low interest rates. Until a few years ago personal and corporate debt were extremely limited, held in check by Turkey’s chronic high inflation and interest rates. Credit card debt was just beginning and mortgages were almost non-existent.  After its own crisis in 2001 Turkey implemented  IMF-approved reforms that had the desired effect of lowering inflation and interest rates. The currency strengthened and the country began a 10-year run of high growth. Credit expanded rapidly, consumers discovered the joy of loading up their credit cards, contractors borrowed heavily to satisfy the incredible building boom all over the country. And why not? Interest rates were low and the relatively strong currency encouraged massive imports to meet demand for industrial material and the latest consumer goods from all over the world. Expensive imported cars were the order of the day.

Kool-Aid, Anyone?

A few notes of caution were raised about the escalating Current Account Deficit (roughly, imports are much more than exports), but they were drowned out in the self-congratulatory celebrations of high growth, low rates and continued currency strength. It was cheap to borrow in foreign currency and repay with a strong, stable currency. And borrow they did. Officials were in no mood to listen to warnings that this rapid ride might end in tears with an equally strong down-turn. It wasn’t just the officials. Bankers and financial market players were all drinking the same Kool-Aid, and they kept telling people that a new day had dawned and Turkey would be able to fund its deficits indefinitely. The Turkish Lira was to become the new, stable model for developing countries. Turkey’s newly assertive foreign policy was supported by this strong economic growth. Listening to the prime minister Turkey was about to assume its rightful place alongside Brazil, India, Russia and China as one of the major winners of the young 21st Century. Or was it? Had the hype gotten ahead of reality?

The first warning bell was sounded by the current account deficit that was on track to reach nearly 10% of Gross National Product – a dangerous level in any country. The problem was how to pay for this huge deficit. As long as global financial institutions were flush with cash they were happy to lend to Turkey. Now that the Euro is close to implosion these same financial institutions have become much more careful where they put their funds. Not good news for Turkey. Then Europe, the major destination for Turkish exports, embarked on aggressive austerity programs with the obvious effect of consumers slowing down their purchases of those nice Turkish – assembled televisions or refrigerators.

Spooked in part by the exploding Current Account deficit investors began to shed the Turkish Lira. It’s 20% decline so far this year makes it one of the worst performing currencies in the world. The Istanbul Stock Exchange has also been in a free fall this year, down more than 30% in US dollar terms.

A common Central Bank response to rapid consumption growth and depreciating currency is to increase interest rates. Stuck with the government’s rigid zero interest rate philosophy the Central Bank has been unable to take this step. This is where the contortions come in. The official Central Bank interest rate remains at 5.75%. However, there are few, if any, transactions at this price. If a commercial bank needs to borrow from the Central Bank it will pay more than 12%. Commercial banks, under no philosophical constraints, have been quick to ratchet up their loan rates.

None of this is good news for an economy that needs hundreds of millions of dollars in external funding every year just as the sources of that funding are drying up. The sooner government officials acknowledge this trend, the chances the Turkish economy avoiding a major train wreck improve greatly.

Wednesday, 16 November 2011

On Your Mark, Get Ready . . . SHOP!

In all the hype and construction boom surrounding the 2012 Olympic Games in London people are overlooking an event that will generate more participation and viewer interest than any of the hundreds of events on the schedule.

Very few of us can run 100 meters in less than 10 seconds. In fact, very few of us can do that time on a bicycle. Even fewer of us can stagger through 5,000 meters, let alone a marathon. We see film of would-be gold medal winners straining every muscle, training 10 hours a day, eating carefully calibrated meals that most certainly do not include bangers and mash, or spending so much time in a swimming pool that they develop dorsal fins. This is all very uplifting, but it is not really anything the average person can relate to as he sits on his lawn mower chugging a can of beer and working through a pack of Marlboros.

No, what the Olympics really need is an event for Everyman or, in this case Everywoman, an event that captures the imagination of everyone from Beijing to Moscow to Paris to London and to New York. This event requires a certain amount of training, but won’t result in the emaciated long-distance-runner-look or the muscle bound figure of a Bulgarian shot-putter.

This long overdue event is called Shopping, yes Shopping. It is an event that involves millions of people of all ages, genders, and sizes on a daily basis. Sports like football, cricket, baseball or basketball may draw hundreds of thousands of viewers, but how many of us actually get a chance to kick or throw the ball? Shopping, in sharp contrast, is the ultimate participation sport.

It’s not easy picking the right products, the right price or the right place to buy them. It can be even harder fighting through the crowds to get to the treasured pair of shoes or the latest stylish handbag – especially during the sales. If you’re a guy in America it can be tough getting the latest pick-up truck or the newest semi-automatic weapon on sale at your local supermarket – right behind the frozen foods.

Ferragamo on Sloane Street

What I propose is an Olympic Shopping event where each country can enter a team that is given a certain amount of money to buy goods in select cities around the world. The teams will be chosen after tough elimination contests in each country and can be single sex or mixed. The event would start about a month before the Olympics actually begin and would finish in a mad dash during the final week in the Olympic city.

In order not to tilt the event toward girlfriends of your basic Russian oligarch, Arab sheik or South American drug lord, product manufacturers would provide all the cash required in the finals. All the items purchased would be donated to charity.

Competitors in the finals would have to shop in Tokyo, Beijing, Moscow, Milan, Paris, London and New York. They would be given a broad list of items to buy, and would have to search for the best ‘value-for-money’ they can find. Winners must be able to navigate with ease not just the obvious places like Bond Street in London or rue du Faubourg Saint-Honore in Paris or Via Monte Napoleone in Milan but they must be able to find small ateliers in unassuming places like the 19th Arrondisement in Paris near the Canal St. Martin.
Place Vendome

The really tricky part is the judging. Style points are as important as points awarded for best goods purchased with the least amount of cash. That stunning little handbag purchased directly from the manufacturer outside Milan gets bonus points compared to the same bag purchased at the department store Le Bon Marché in Paris. Diamonds from Van Cleef & Arpels in the Place Vendome in Paris also get a few bonus points over sparkly bits from the same shop on 5th Avenue in New York.

Van Cleef & Arpels on Bond Street
Points are generally deducted for anything purchased in department stores like Harrods that have long since surrendered whatever cachet they once had to the camera-toting tourist brigade. Several additional points are deducted for any knock-offs, even the good ones from the Grand Bazaar in Istanbul. Granted, the judging could be even more subjective than the figure skating judging, and efforts would have to be made to exclude home-town judges from influencing the results.

Tough to pick favorites in this event, but the Italians would seem to have the early edge given that so many of the products come from there. But never underestimate the sharp-elbowed, high-heeled Russian oligarchs’ girlfriends. Their bodyguards can at least make sure they get to the front of the queue. The Spaniards and the newly-rich Turks can also provide serious competition. A Turkish couple on holiday in Athens recently spent more than €40,000 in a single day in that beleaguered city. The Athenians should have awarded them the Order of Pericles with Oak Leaves for their single handed effort to salvage the Greek economy. There should also be good effort from the Chinese, the Americans always on the look-out for decent bargains for anything from countries to handbags, and the Brazilians eager to demonstrate that their country offers more than Ipanema Beach or football.

All in all it promises to be a spirited contest, one that will draw the attention of millions around the globe.

Monday, 14 November 2011

The Easy Part Is Over

Getting appointed interim Greek prime minister may prove to be the easiest part of the job for the academic central banker Lucas Papademos. Widely acknowledged as the prototypical bright technocrat required to lead Greece out of the economic swamp he will be sorely tested when his brief honeymoon ends. But the new coalition government has one thing its hapless predecessor never secured – wide public support. Recent polls show more than 70% support for the new government, while the two main parties are languishing with sharply lower numbers.

The formula for the beginning of Greece’s recovery has been well known for months, if not years. Reducing the state sector, reforming the ridiculous pension system, opening closed professions, selling state assets, starting to collect taxes, cleaning up the scandalous health care sector, and reforming the stagnant legal sector are just some of the steps required to stop the haemorrhaging from the state budget and get the country moving. The problem has been finding anyone with the political courage to implement these changes because their implementation spells the end of the corrupt patronage system that has dominated Greek politics for decades. In effect it is like asking Greek politicians to write their own political and, in some cases, financial obituaries.

For months the politicians have wasted time promising everything and delivering very little as the downward spiral of the Greek economy rotated faster and faster. The little social consensus existing in Greece was getting pulled apart in almost daily protests and strikes. The politicians were caught in the headlights unable to move as Germany, France, the International Monetary Fund, the European Commission and a host of others told them what they must do to secure additional assistance. The country was rapidly heading toward a disorderly default on its sovereign debt.

Terms of Debate Changed

In the middle of all this Prime Minister George Papandreou threw up his hands saying he could no longer cope with the conflicting demands and called for a referendum on the latest bailout package. However ill-timed, capricious, or irresponsible it was, this call served one very important function. It changed the terms of the debate within Greece. Suddenly the debate was no longer about this cut or that cut, this reform or that reform. It became simply “Do we want to stay in Euro and, ultimately, the European Union or revert to being a political and economic afterthought stuck onto the southeast corner of Europe?”

That set the stage for a few fevered days of politics when the main parties were pushed kicking and screaming into coalition discussions. The main opposition party demanded Papandreou’s resignation, and he dutifully – probably delightedly – complied. After much pushing and shoving they finally divided cabinet seats and settled on the only serious candidate for interim prime minister – Lucas Papademos, the former governor of the Bank of Greece and a vice chairman of the European Central Bank. The only mark against him is that he, like too many people in the EU and ECB, accepted at face value statistics prepared by the Greek government alleging that the country met the requirements to join the Euro in the first place.

The Communist party and another leftist party stayed out of coalition talks and refused to agree to any of the austerity program demanded by Greece’s creditors. This move is essentially irrelevant, and the joke going around Athens is that the Greek communists are the sole remaining distributor of a company that’s been out of business for years.

Papademos is supposed to remain as prime minister until elections are held sometime next year. Up until that time he is supposed to oversee the wholesale changes required to keep Greece in the Euro zone. No date has been set for the elections although the main opposition party New Democracy wants to hold them as soon as February. This date may well get pushed back if the country is in the middle of serious reform. Few people would be willing to sacrifice those gains for a return to petty politics. New Democracy has been stalwart in its opposition to anything since the crisis began, and its leader had resisted all calls for a coalition government of national unity. There are signs that the people are tired of this juvenile gamesmanship. If elections were held as early as February it is doubtful that any party would gain a majority, and the country would be forced right back into a coalition.

Sometime fairly soon the government has to come up with ways to get Greece moving again. You can accomplish only so much with cuts, then you have to start growing. It may well be true that Greece is unable to become competitive and grow within the Euro and may have to – someday – revert to the drachma. If the country has shown signs of stabilizing and the European banks are largely out of their Greek debt it may just be possible to arrange an orderly, well planned departure from the Euro. Once the panic and hysterical rhetoric have died down officials will have a chance to do the hard, honest analysis they should have done before Greece joined the Euro.

Wednesday, 2 November 2011

A Risky Outbreak of Democracy

I would not like to be anywhere near French President Sarkozy or German Chancellor Angela Merkel as they discuss (?) the latest desperate move by their counterpart in Greece to call for a referendum on the deal that was forged with great acclaim just a few days ago.

Merkel could be forgiven for bemoaning the lack of a few good panzer divisions and Sarkozy must be thinking that George Papandreou’s balding head would look quite nice at the bottom of a guillotine. The cumbersome deal they patched together to bail out Greece and save the Euro – not to mention leading French and German banks – looks set to unravel if Greece goes ahead with the referendum announced late Monday evening.

But months of mounting tension, demonstrations and protests in Greece against the high cost of solving their self-inflicted debt burden have taken their toll. Political and social consensus, never very strong in Greece in the first place, has disappeared completely with the sharp decline in living standards and the imposition of austerity measures -- like paying taxes. No one, least of all the two main political parties, is in a mood to accept any responsibility for the mess. People are furious at what they see as the injustice of the so-called ‘austerity’ measures being forced on them for ‘someone else’s´ sins. “Why are they doing this to me? I had nothing to do with this crisis,” is a common moan. The fact that the entire Greek economic structure rested on an unsustainable, rotting foundation is irrelevant to most people. All they see is that their pensions and jobs have been cut. They overlook or simply don’t care that other measures are slowly forcing the economy to open previously closed professions or to generate revenue by selling some state companies.

You Deal With It!

In effect, Papandreou is throwing up his hands as if to say “I can’t deal with this anymore. I’m tired of trying to lead. You, the people, decide.” While this all-too-rare practice of real democracy in the European Union should be considered a good thing, the thought of about five million furious Greeks of voting age having the right to vote in a referendum that could endanger the entire Euro project is sending chills through the capitals of northern Europe. Leaders of those countries must be urging their Greek colleague to have a re-think. “Steady on, George. We know you Greeks think you invented democracy, but let’s not get carried away here.”

Also, there are serious questions as to whether the referendum will actually take place. As Kerin Hope points out in today’s Financial Times the Greek government faces a very difficult vote of confidence on Friday the 4th. Second, it is by no means clear that the Greek president will endorse the proposal. And third, the main opposition party says it will do everything in its power to block the referendum. This would be more convincing if the New Democracy party had itself demonstrated any better, realistic ways of dealing with the crisis. It is insisting on new general elections that could well bring it power. Then it will be interesting to see if it a) acknowledges its role in creating the Greek economic catastrophe, and b) is able to get better terms from its European partners. We would be unwise to hold our breath waiting for either of these to happen.

Time Has Run Out

But the biggest hurdle may be time, or the lack of it. Essentially Greece has no time left. If the referendum proceeds it is doubtful that next tranche of aid to Greece will be released until the referendum is decided sometime in January 2012. If the tranche is delayed then Greece runs of out money sometime this month and is effectively bankrupt. Europe is then faced with a default on Greek sovereign debt, and that has unknown—all bad -- consequences for Europe and the rest of the world. If Greece defaults on its sovereign debt it is likely that the country would be forced out of the Euro zone and plunged into an even deeper economic crisis. Argentina, with its strong commodity exports and deeper economy than Greece could get away with such a default and freeing its currency from the peg to the U.S. dollar. Greece is in a much more difficult situation with extremely limited exports of any kind and almost complete reliance on imported raw materials to keep what industry it has working.

A referendum would at least have the virtue of confronting the Greek people with some simple, stark choices. The Greek political class has thrived for decades on inflated promises paid for with borrowed money that has shielded people from some of the harsher economic realities that would be thrown into sharp relief by such a vote.

Do you want to stay in the Euro with all its rigid rules and requirements leading to declining (temporarily, one hopes) living standards OR do you want to be thrown out of the Euro zone and be relegated to the second division with unknown, but mostly unfavorable, economic consequences? The only pity is that such a referendum was not held years ago.