CHINA'S CURRENCY POLICY AND YUAN REVALUATION

The Economist published a thorough discussion (link) of China's currency policy and reasons why yuan is unlikely to revaluate any soon.

U.S DOLLAR AND RESERVE CURRENCIES

The Economist published an excellent analysis on the future of reserve currencies in the world (link).

BUBBLES AND MACRO RISK

Frederic Mishkin says not all bubbles are a threat to the economy (link):

"Nonetheless, if a bubble poses a sufficient danger to the economy as credit boom bubbles do, there might be a case for monetary policy to step in. However, there are also strong arguments against doing so, which is why there are active debates in academia and central banks about whether monetary policy should be used to restrain asset-price bubbles.

But if bubbles are a possibility now, does it look like they are of the dangerous, credit boom variety? At least in the US and Europe, the answer is clearly no. Our problem is not a credit boom, but that the deleveraging process has not fully ended. Credit markets are still tight and are presenting a serious drag on the economy..."

ECONOMIC THEORY AND THE FINANCIAL CRISIS

Eric Maskin offers a comprehensive insight into financial crisis from the perspective of the economic theory (link)

SWISS BANKS AND FINANCIAL PRIVACY

Pierre Bessard of the Liberales Institut in Switzerland, makes the case in NY Times (link) why financial privacy shouldn't be infringed and why Dept. of Justice and the European Union should not exert pressures on Swiss banks regarding financial privacy and client information disclosure to foreign governments:

"Switzerland, which is home to an impressive number of global corporations, has also come under fire from the European Union for offering too-favorable tax rules, including exemptions for income earned abroad. But what critics forget is that these practices also benefit other countries. Swiss firms alone employ hundreds of thousands of people in the United States and Germany, for example. Subsidiaries of multinational corporations usually pay income taxes where they operate, so having their headquarters in Switzerland can help companies avoid multiple taxation in high-tax countries, thereby safeguarding productive capital for investment."

ICELAND SOVEREIGN CREDIT REPORT

Moody has maintained Iceland's negative outlook on economic and financial crisis (link).

ARGENTINA'S STATIST SEIZURE OF PRIVATE PENSION FUNDS

Bloomberg reports that Argentina's president has announced a seizure of $29 billion of private pension funds (link).

ICELAND'S RESCUE PACKAGE

Icelandic government announced $6 bn rescue package to stabilize the economy (link) after an increase in government debt which is expected to reach as much as 100 percent of the GDP. Here is some interesting insights into financial crisis in Iceland (link). Meanwhile, Fitch downgraded Iceland's long-term foreign currency rating to BBB- and long term IDR (issuer default rating) to A- (link). Here is also a brief factsheet of Iceland's economic indicators in this year's September (link). IMF's official inflation and output estimate for Iceland suggest output decline and inflation surge in 2009 (link).

THE MYTH OF SOVEREIGN WEALTH FUNDS

Edwin M. Truman highlighted the revealed preferences of sovereign wealth fund establishment. The article can be read here.

CDS IN ICELAND

In Forbes, there is a brief article (link) on credit default swap in Iceland in the wake of credit crunch and external shocks that affect macroeconomic stability.

FISCAL FEDERALISM AND TAX COMPETITION: THE CASE OF SWITZERLAND

Financial Times recently published an article (link) describing how fiscal federalism works in Switzerland. Contrary to conventional belief, Swiss constitution gives a significant degree of decision-making and fiscal responsibilities to cantons and municipalities. In economic perspective, one of the key advantages of fiscal federalism is tax competition among jurisdictions within Switzerland. Cities such as Zurich and Lucerne charge notably higher taxes while a growing number of cantons and municipalities use low-tax policies to attract entrepreneurship, savings and investment and stimulate economic growth. Empirically, the sources of productive behavior are favorable to seeking low-tax shelters, generating greater efficiency and welfare.

Although fiscal federalism is perceived as an expensive experiment that does not yield required incentive to maximise efficiency, personal income tax rates are modest compared to continental Europe and Nordic countries. Switzerland might offer a lessons to high-tax jurisdictions in the rest of Europe. Politicians and (surprisingly) even some economists often state that low tax rates on personal income lead to the loss of tax revenue. Contrary to static assumptions, low tax rates on personal income, given favorable conditions such as low and upward limited public spending, generate higher tax revenue. In fact, expatriates in Switzerland contribute SFr 390 million to federal, cantonal and local tax budgets.

GERMANY'S REGULATION AGENDA

As a response to subprime mortgage crisis, German government suggested further unilateral tightening of bank regulation as a step to prevent future risk volatility caused by external shocks such as recent subprime mortgage crisis (link).

AFTER YEARS OF TREMENDOUS GROWTH, THE ECONOMY OF ICELAND FEELS THE HEAT

Financial Times just recently posted an article about the macroeconomic and financial prospects of Iceland regarding recent turmoil in financial markets.

Throughout 1990s, Iceland's economy recovered signficantly subject to economic and structural reforms. As a result, fishing, which still remain the dominant source of export revenue decline from 16 percent in 1980 to 6 percent last year, being replaced by finance, insurance and real estate. Moreover, Iceland's three largest banks, Glintir, Landsbanki in Kaupthing have asset capitalization of more than 110 billion EUR, which is more than eight times Iceland's GDP.

So how have the prime movements in credit markets affected risks associated with financial turbulence? A report from F. Mishkin and T. Herbertsson has shown that Iceland's economy is stronger than ever, concluding that fears of rough landing and possible recession were overblown. In a broader sense, Iceland's banking sector was not intensively exposed to credit market turmoil as banks increased their operating capacity by switching to retail deposits as a pattern of funding.

In addition, total assets of Icelandic banks remain solid and there has been almost no sign of a liquidity loss, default loans, exposure to subprime mess and credit blowing. But, loan to deposit ratio is still around 300 percent, reflecting the dependence on gross markets. The question is how the sovereign risk may be managed. Explosive growth of financial sector has certainly benefited Iceland's economy but the problem is the long-term sustainability of risk management due to immediate or sudden fluctuations in business cycle and exchange rate. In fact, krona, Iceland's currency, has been one of the weakest performers recently. Agreeably, the information asymmetry plays an important role in this case. It is important how banks perceive macroeconomic risk and respond to imbalances. As a result, market premium shows how the investors absorbed and perceived the information about Iceland's economy accountably.

SOVEREIGN FUNDS IN EMERGING MARKETS

Standard Chartered predicts the great controversy may be bubbled by the most secretive sovereign funds in emerging markets. The reports suggests more transparency such as establishing a code against protectionist pressures from western markets.

Source:
Financial Times, Sovereign funds warning, October 14 2007 (link)

U.S. HOUSEHOLD RETAIL SPENDING FALLS AS HOUSING SECTOR SLUMPS

The Financial Times reports about the decline in periodic retail sales in the U.S. presumably to the impacts of the housing market turmoil.

As prices weakened, the lending practice has become far more restrictive, reflecting the experience of sub-prime mortgages. In fact, this particular shock outbursted the sell-off in the capital markets which heated the situation close to panic, leading to price corrections respectively. Despite the recent news about the possible interest rate cuts by the FED, borrowing conditions have become tighter. In turn, immediate market sell-offs sprang out a highlighted price reductions and a downslide of stocks and bonds.

In effective terms, the indicators in the U.S. financial market envisage a high degree of uncertainty in the future, especially due to the aggresive assertions of the interest rate cutting and due to housing and sub-prime mortgage slid. I believe the confidence index will play the major role in regaining the positive outlook of financial markets which crucially determines the dynamics of household spending particularly on retail consumption.

FRANCE'S EXCESSIVE REGULATION PROPOSAL WOULD DISTORT FINANCIAL MARKETS

"Capitalism without failure is like a religion without sin."

Allan Meltzer

France responded to recent turmoils and frictions in credit markets by calling for tougher and tighter regulation of global financial markets. Clearly, recent dynamics of credit markets and ECB's strongest intervention yet, reflect the turbulence and heating of risk over debt securities in avoiding speculation and credit default swamps which notably increase the probability of financial crisis (Mishkin, Herbertsson 2006).

The question is whether regulative pressures to disclose more of particular data and information about traded financial products could ease the credit flows and ensure more transparency. Since information is the most valuable tool in picking-up financial products to invest in particular assets with sufficient return predictions, adding trickier code laws would simply burden the ability of financial markets to catch growth momentum and enforce risk management rules to respond to the volatility of the level markets properly. Risk management is of course an important aspect of decision-making in globally competitive markets. In addition, pressures for more information disclosure would enforce control over credit and broadly financial markets.

Financial markets are faced by risks and shocks every day and failures which occur frequently could hardly be a reasons for imposing more regulation on decision-makers. One of the ways to confront risk-taking and risk-minimization measures is to ensure a broader access to particular funds, thus to provide sound sources of liquidity.

Recently, France's finance minister stressed (link):
"We have been proven right. We need more transparency and better governance in financial markets and we need it on a G-7 basis."

The evaluation of risk which investors and creditors face in the course of financial market, crucially depends on the ability to reduce the risk of biased information regarding decision-making in particular activity, say hedge fund industry or private equity investment. Transferring the liabilites of governance and transparency to a global body would fail already in the short-run because the amount of information needed to be absorbed and the lack of acceptance of risk in terms of responding to the outcome of the excessive regulation, are the prime reasons why globally enforced regulation would punish and penalize financial markets which could face significant distortions and risk aversion leading to lower returns and discounted ability to target particular markets with particular financial products respectively.

Recently published in Wall Street Journal, Allan Meltzer wrote a simple fact which politicians obviously can't understand:
"But whatever the perceived problem, more regulation is not the answer. It is far better to change some incentives for excessive risk-taking."

Because the regulation of credit and financial markets does not achieve stated objectives, information-sharing pressure reversingly forces equity investors, traders and market actors in particular financial industry to disclose the information required and this, in turn, leads to more complexity and government's control over the financial markets to go for an intervention which is perceived as a negative affection of stock market performance. For instance, could the regulation of carried risk in hedge fund industry really ensure more transparency if trading is conducted on the basis of contract deals where the treatment of information is regarded as contract stakers negotiate.

If the assessment of risk is perceived as low and underestimated, than the portfolio and price reassessment boosted by spontaneous market behavior would give bankers, traders and investors a far better incentive to re-evaluate the risk involving repackaged debt securities. A regulation such as proposed by France's policymakers rather induce external risk pressures to hit hedge fund industry, stock market and private equity firms, causing more harm than good.

The cinism of France's minister of finance is well seen:
"It's not a question of forbidding trading or barring market activity, it's making sure that the sophistication of financial products does not get so complicated that even investors dealing in those products are lost as to what they actually are."

So according to this statement, government officials know better how and where to allocate market resources to maximize the return from financial markets by purchasing traded products at agreeable conditions to traders and investors/purchasers. Market fluctuations are a daily reaction to innumerable decisions and contracts in the financial markets. The assessment of product sophistication could hardly be attached to government's responsibility. The proper degree and size of regulation is much better managed trhough contract deals at which both sides agree on terms and conditions involving particular products to take action in financial markets. In sum, transparency of particular financial products is the matter of the contractual enforcement and the reflection of dealing preferences and the overall efficiency of trading and financial markets always gets worse when government decides to intervene the market with excessive regulation whereas the cost adjustment is high; both for the cost of government and the private trading sector's ability to akin compliance burden.