>Why is the oil price not falling?

The current and expected slowdown in global growth has led to a decline in prices of cyclical commodities (metals), but not in the oil price, which has held up despite the slowdown in global demand for oil. Why is the oil price insensitive to the current global economic cycle? Probably because:

1- A shortage of oil remains the outlook for the medium term, even though it has been deferred;

2- The producer countries (mainly Saudi Arabia) adjust their production according to demand;

3- Geopolitical risks have led to substantial precautionary stock-building.
The fact that the oil price remains very high while growth is weak is obviously pro-cyclical.

To read report in detail: OIL PRICES

RISH TRADER

>Does the world have the economic policy weapons to combat a new global recession?

It is not out of the question that the world is once again entering a global recession, due to:

- the crisis in the euro zone and in the United Kingdom;
- the marked slowdown in the US economy;
- the continuing stagnation in Japan;
- problems with the growth models of large emerging countries;
- the spreading of the crisis to open economies via global trade.

In OECD countries, there is no room for manoeuvre either for fiscal policies or for monetary policies.

As for emerging countries, more expansionary fiscal and monetary policies are possible; but will they help the global economy:

- if emerging countries’ problems are structural;
- if they lead to a sharp depreciation of the exchange rates of emerging countries?

To read report in detail: GLOBAL RECESSION
RISH TRADER

>Do the "fundamentals" really exist? The case of equities

Investors like to refer to the "fundamental value" of a financial asset. We shall take the example of equities. The fundamental value of a share is the discounted sum of the company's future earnings. But can it be calculated?


- There is of course uncertainty regarding future growth and future profitability, but this uncertainty is natural.
- The fundamental value of equities is calculated applying a risk premium; however, the equity risk premium has varied significantly over time. Does it have a standard value, or else does it have a conventional value which
may be different at each period?
- What discount rate should be used for future earnings? The current longterm interest rate could be built on the basis of irrational expectations of future interest rates, or it could be distorted by central bank intervention
and by risk aversion.


Perhaps the concept of fundamental value (in this case of a share) is so vague that it is unusable.



A distinction is generally made between "fundamental" investors and others ("chartists", etc.). Fundamental investors refer to the "fundamental value" of the asset they buy.


In this Flash we shall consider the case of equities.


To read full report: Do the "fundamentals" really exist?

>Towards the end of global imbalances?: The term "global imbalances" is mainly used for the clash between the US structural external deficit and the structural external surplus of emerging and oil-exporting countries, in particular China

The term “global imbalances” is mainly used for the clash between the US structural external deficit and the structural external surplus of emerging and oil-exporting countries, in particular China. We will look at the conventional analyses of this situation of global imbalances.


But we show that there are currently a number of mechanisms that could eventually wipe out these global imbalances:


■ the much faster growth in domestic demand in emerging countries than in the United States;
■ the rise in production costs in emerging countries, relative to OECD countries;
■ the incipient reindustrialisation in the United States;
■ the reduction in the US energy dependence on oil-exporting countries thanks to the increasing role of shale gas.


This will in particular lead to a slowdown in global monetary creation and to a greater stability of asset prices and exchange rates.


To read full report: GLOBAL IMBALANCES
RISH TRADER

>The worst-case scenario for Greece and Portugal: What effects?

Let us assume that the worst-case scenario for Greece and Portugal unfolds: their fiscal solvency does not improve and they decide to default completely on their public debt, for all the holders.


- What would be the effects in that case?

- they would not leave the euro, given the weight of their imports;

- they would have to nationalise and recapitalise their banks;

- if their banks went bankrupt, the European System of Central Banks would incur losses on their holdings of Greek and Portuguese debt, both directly and as collateral for repos to Greek and Portuguese banks;

- the losses for other euro-zone banks (non-Greek or Portuguese) would amount to 0.2% of their total assets, which is very little; those for non-bank investors of all kinds would amount to 5% of their total assets, which is considerable;

- after the default, the fiscal solvency of Greece and Portugal would practically be restored; these two countries’ external solvency would be greatly improved;

- the contagion to other euro-zone government bonds would probably be quite limited, which would not have been the case one year ago.


We imagine that the worst-case scenario in Greece and Portugal unfolds: a total and across-the-board default on their public debt (Charts 1A and B). It may be impossible to avoid this default, given the irreversible deterioration in their fiscal solvency: negative growth (Chart 2), making the restrictive fiscal policies inefficient in terms of reducing the fiscal deficit (Charts 3A and B), which is already the case in Greece; fall in public (Chart 4A) and productive investment (Chart 4B), leading to a loss of potential growth.


To read the full report: WORST-CASE SCENARIO
RISH TRADER

>India’s growth model (and its limitations)

This report explores the idea that India’s economic slowdown is primarily explained by the limitations of its growth model and less by the problems caused by the global situation.


Focusing too much on services in urban areas, India’s economic growth is “creating” the current deficit (since only a small share of services is exported) and inflation (since the rise in agricultural productivity is low and demand for foodstuffs is high) is intensifying income inequalities (absorption of excess labor in rural areas is very slow) and is nurturing public deficits (the State is trying to offset increased income inequality by establishing aid programs).


The domestic financial system also devotes too many resources to finance the public deficit, such that funding for heavy investments (not associated with urban services) is partly limited by the availability of external savings.
India’s growth and enormous economic development potential will clearly continue to draw interest from foreign investors over the coming years.


It is worth noting the presence of macroeconomic imbalances that could increasingly expose the growth path and performance of financial variables to “stop & go” type movements.


To read full report: GROWTH MODEL
RISH TRADER

>Some scenarios that are not worth considering

The financial markets sometimes bring up extremely unlikely scenarios,
which are normally not worth discussing.

We can mention here:
- certain countries leaving the euro (in the short term);
- the acceptance of a sovereign default in the euro zone;
- inflation;
- the collapse of growth in China.

Yet, these scenarios are mentioned every day.

To read the full report: MARKET SCENARIOS

>There will not be any miracle cure

The seriousness of the euro zone’s economic and fiscal situation has led some analysts to believe that "miracle cures" might exist:

− inflation that could make it possible to reduce debt ratios. However, inflation cannot be decreed. Even if monetary creation becomes very rapid, there will be no inflation as long as there is no upturn in credit and global production capacity is saturated; inflation due to a rise in commodity prices does not help reduce debt ratios;

− protectionism, to regain market shares from emerging countries (customs tariffs or equivalent tax measures); but because of the form globalisation has taken, the substitutability between the euro zone’s domestic products and products imported from emerging countries is low, which makes protectionism ineffective;

− depreciation of the euro; it would have a positive effect on activity, but this effect would be weak given the low substitutability between domestic and imported products and the effect on import prices (including commodities);

− return of household confidence and rise in consumption if fiscal deficits are reduced quickly. However, it is unlikely that these "Ricardian neutrality" effects exist.

To read the full report: MIRACLE

>Dollar, official reserves, capital flows, liquidity and exchange rate regime

In the exchange rate regime that prevailed before the crisis, the United States was affected
not only by a high external deficit, but also – and increasingly so - by capital outflows heading to emerging countries.

These countries (as well as oil-exporting countries) wanted to prevent an appreciation of their currencies against the dollar and accumulated huge official reserves, which led to a destabilisation of their domestic monetary policies (excess liquidity and credit, too low interest rates, etc.).

The situation seems to have evolved to a significant extent in the wake of the crisis:
− policies to stimulate domestic demand are being implemented in emerging countries; China in particular now has the will to replace exports - which are weakened by the crisis - with consumption; this is likely to reduce the savings glut in emerging countries;

− in the United States there is a rise in the savings rate due to household deleveraging, albeit only to a limited extent;

− moreover, we can see certain signs that international capital flows are returning to the United States, for different reasons: greater confidence in the US economy (perhaps mistakenly), excessive market valuation in emerging countries, preference for liquidity, crisis in the euro zone. These developments have important consequences if they persist and are confirmed:

− lower liquidity in Asian countries and worldwide, since it is no longer necessary to shore up the dollar;

− greater freedom of action for central banks in emerging countries, since they are less under threat of being flooded with liquidity if they hike their interest rates; accordingly, due to the economic recovery, tightening of monetary policies in emerging countries;

− depreciation of the euro, both against the dollar and emerging currencies.

It is not certain that the spontaneous support for the dollar will become a permanent feature. If that is the case, the winners would be the euro zone as the euro would return towards an exchange rate close to purchasing power parity, and emerging and oil exporting countries due to the regained monetary policy freedom; but there would also be a normalisation of asset prices in these countries due to the return of monetary policies that are suitable for their economic situations. The losers would be the United States, whose economic strategy in the aftermath of the crisis requires a weak dollar.

To read the full report: EXCHANGE RATE REGIME

>To what extent is the financial crisis to blame for the economic problems in the euro zone?

The economic difficulties in the euro zone are most often blamed on the financial crisis, with the following arguments:

− the banking losses led to the credit contraction;
− the financial markets lost all liquidity and closed down;
− global trade came to a halt due to the contraction in trade credit;
− the fiscal deficits stem from the bailout of financial intermediaries.

However, the economic crisis can also be blamed on problems in the real economy:
− poor productive specialisation (construction) and deindustrialisation;
− excess private sector indebtedness, caused by monetary policies aimed at offsetting deindustrialisation and the weakness of wages.

This weakness is a result of either productive specialisation or distortion of income sharing.
In our view, it is in accordance with the facts to say that the most drastic part of the crisis was due to the financial crisis, but that the permanent, structural part of the crisis was due to the real economy.

To read the full report: FINANCIAL CRISIS

>What are the positive developments in finance since the crisis, and what issues still give ground for concern?

Some developments since the crisis definitely point to greater financial stability:

- reduction in debt leverage among households, companies and banks, which is making them less fragile: weaker link between indebtedness and wealth;

- since end-2009, slowdown in global liquidity growth due to the incipient reduction in "global imbalances";

- investor rejection of overly complex financial assets with overly complicated risk profiles.

But there is reason to worry about:

- the very high demand for return on equity that still persists, which gives an incentive to look for speculative investments (commodities) and which could subsequently lead to a renewed increase in debt leverage;

- the excessive international capital mobility, in particular between emerging and OECD countries, which is destabilising the economies of emerging countries;

- the conflicts of objectives between regulators, who have a huge risk aversion, and economic policy decision-makers, who normally favour the long-term financing of the economy. Regulators may go too far and hurt long-term growth (with Basel III, Solvency) or financial market liquidity (due to the excessive discouragement of trading).

- the excessive and useless liquidity in OECD countries (but not in emerging countries, as we saw above), which persists, especially in the United States.

To read the full report: POSITIVE DEVELOPMENTS IN FINANCE

>Who is next? (NATIXIS)

The help from European countries and the IMF may give Greece time to reduce its fiscal deficit by paying "reasonable" interest rates. But the case of Greece is very particular: Greece’s public finance problems are not the result of economic difficulties, but of bad public management, which must be corrected.

Other European countries are struggling with their public finances because of their economic problems: productive specialisation generating a too low long-run growth to reduce deficits in the wake of the crisis. If the financial markets become aware of the scale of the economic and financial difficulties of these countries (Portugal, Spain and the United Kingdom), the danger is that banks and investors will sell the public debts issued by these countries and that the rise in their interest rates will accelerate their problems.

It has to be pointed out that the risk is far more related to sales due to risk aversion among investors and banks (which now hold huge bond portfolios) than "speculation" by funds.

Are euro-zone countries more threatened than the United Kingdom? On the one hand, the segmentation of sovereign issuers in the euro zone promote crises; we do not know whether the bailout of Greece will persuade investors that other euro-zone countries would also be saved, or that the euro zone has exhausted its capacity for solidarity. On the other hand, the depreciation of the pound sterling is bolstering the British economy, but it may also worry investors.

To read the full report: WHO IS NEXT

>No reason to get too enthusiastic about the US economy

Many investors are becoming very optimistic about the US economy, particularly in view of the consumption figures from early 2010, and are rebalancing their portfolios as a result. We believe that this "enthusiasm" for the US economy is very excessive:
− the pick-up in consumption is due to:
• faster adjustment of employment in the United States than in Europe;
• real dissaving (spending of monetary savings);
− it is also true that, thanks to the geographical structure, US exports are recovering more than those of the euro zone;
− however, fundamentally, the situation with regard to the correction of fiscal deficits, credit, wage incomes, investment and real estate is not better in the United States than in the euro zone; there is not that much asymmetry between the two regions in a medium-term perspective;
− this must be adjusted for the fact that potential growth is higher in the United States.

To read the full report: US ECONOMY

>Is there a risk of new bubbles? (NATIXIS)

Since the 1990s, there has been one speculative bubble after another linked to excess liquidity and indebtedness: equities, real estate, emerging assets, commodities, etc.

Could new bubbles appear today, in the aftermath of the crisis?

Certain developments could indicate that the answer is no:
− the reduction in "global imbalances" that is leading to a smaller increase in global
liquidity;
− the reduction in debt leverage in OECD countries (not seen at all in emerging countries),
which results both from demand effects (excess indebtedness) and supply effects (greater caution among banks and increased capital requirements); this should normally rule out bubbles directly linked to indebtedness;
− the memory of crises (bursting of bubbles in the past);
− the lower proprietary trading activity in banks.

But other developments may on the contrary indicate that bubbles will return:
− excessively high demand for return on equity, which persists;
− while global liquidity growth is lower, its level remains extraordinarily high, and monetary policies in OECD countries will remain expansionary;
− renewed expansion in hedge funds;

− very high international capital mobility, precisely seeking high returns (on emerging
country equities and commodities) and which, moreover, is preventing emerging countries from conducting more restrictive monetary policies;
− decorrelation between commodity prices and the spot market situation of these commodities, which already shows the presence of "bubbles".

What would be needed to prevent bubbles in the future? Probably:
− the return of "normal" guidelines of monetary policies and a reduction in excess liquidity;
− increased capital requirements for "non-banks"; a more specific monetary policy
management (for example via statutory reserve ratios);
− obstacles to international mobility of purely financial capital, enabling a return to
"normal" monetary policies in emerging countries;
− extending the horizon for investors in terms of holding assets, to reduce the number of
investors seeking short-term capital gains.

To read the full report: NEW BUBBLES

>China: inflation, economic growth and exchange policy (NATIXIS)

Following successive statements by China’s authorities (the USD/RMB peg is a “non-conventional” measure linked to the global economic crisis, RMB exchange policy must depend solely on the country’s economic situation...), we know that sooner or later the PBoC will replace the current peg with another exchange rate regime and that stable economic recovery would be a necessary condition.

Today, the 11.9% growth rate in the first quarter 2010, in conjunction with rising prices, are leading some to believe that it is time to revalue the RMB and/or make it more flexible. However, we show that finding a solution that offers both greater flexibility and monetary policy autonomy (controlling inflationary risk) is no easy feat and that a distinction should be made between flexibility and managed RMB appreciation.

We also believe that investment will slacken off (having already reached too high a level at almost 50% of GDP and some restraining measures have been already put in place) and that consumption will be unable to sustain the same dynamic level. China must thus rely on exports in order to achieve sufficiently high growth.

In view of the complexity of this exercise and the macroeconomic instability of China's economy, we do not believe that a shift in the exchange rate regime will come as promptly as the markets anticipate (+1.4% in 3 months being the consensus).

To read the full report: CHINA

>What questions should be asked about fiscal deficits and sovereign debts? (NATIXIS)

We suggest the following interpretation grid for countries posting high fiscal deficits and public debt ratios:

1. Was it justified to run up these fiscal deficits?
That is the case if the economic situation will be better in the future, which justifies transferring
income from the future to the present via fiscal deficits;

2. Are the fiscal deficits squeezing out private investment, or are there sufficient savings to prevent this?

3. If fiscal deficits are very large in the short term, is fiscal credibility maintained? If it is ensured, even if the fiscal deficit is very high in the short term, investors expect fiscal solvency to be restored and long-term interest rates not to rise.

4. If a country is in a budget crisis, is this a liquidity crisis or a solvency crisis? In the first case, the remedy is loans from other countries (or from the IMF) that enable countries to continue to finance themselves. In the second case, these loans are useless and solvency must be restored.

To read the full report: SOVEREIGN DEBTS

>Which countries benefit from a weak euro? (NATIXIS)

It is likely that the euro will continue to depreciate against the dollar, not so much because of the euro zone’s institutional problems as above all because of the weakness of its economy and the fact that the dollar is being shored up by the central banks of emerging and oil-exporting countries. Which countries would benefit from a persistently weak euro? Most analysts reply that it will be Germany because of the heavy weight of its industry but is this certain?

• Germany has above all gained market share within the euro zone, imports a great deal from emerging countries due to outsourcing and manufactures high-end products for which demand is relatively insensitive to price; this implies that the euro has little effect on Germany;

• countries which have a weak export capability and significant trade deficits (Spain) are normally the losers if the euro depreciates, since the predominant effect of the euro’s depreciation on these countries is to increase the prices of imports;

• countries that continue to have a substantial industrial sector but which is oriented more to the mid-range or which is in direct competition with companies in the dollar zone (France, Italy) are normally those which gain the most from the euro’s depreciation.
  

Contrary to accepted wisdom, neither Germany nor Spain would benefit from a weak euro.

To read the full report: WEAK EURO

>False and real risks for the Chinese economy (NATIXIS)

We often see completely mistaken analyses concerning China:
− inflationary risk: despite rapid monetary creation, this can be ruled out given the situation of excess production capacity and the savings glut;

− risk of a banking crisis as a result of massive lending in 2009: granted, the levels of non-performing loans have increased, but it would be very easy for the Chinese government to recapitalise the banks (something they are doing for the time being in the markets);

− risk of speculative bubbles as a result of the excessively expansionary monetary policy being conducted, which is due to the exchange-rate regime: the central bank is controlling these bubbles by using instruments other than interest rates: credit caps, statutory reserve ratios;

− risk of a slowdown in growth resulting from monetary policy tightening: this risk is nonexistent, first due to the political will to create jobs, and second because private companies and households receive hardly any of the bank loans granted (which above all are used to finance state-owned companies and local authorities).

The two most serious dangers are in reality:
− the Chinese authorities’ inability to reduce the household savings rate and under-consumption;
− the shortfall in certain natural resources, in particular water.

To read the full report: RISKS

>Do Asian countries still have a risky debt structure? (NATIXIS)

We propose in this study to analyze the debt structure trends of the institutional sectors of six emerging economies in Asia and the risks related to them.

The large proportion of contracted external debt (regardless of the institutional sector) had in fact been identified as one of the main sources of external vulnerability of these economies at the time of the Asian crisis in 1997.

We shall show that in the 2000s the debt structure balanced gradually towards more stable and less risky domestic debt due primarily to the reduced exposure to foreign exchange risk. However, there are still persistent signs of financial vulnerability. First for certain countries, the balance has not been restored in all institutional sectors (public sector and non financial private sector in the Philippines; non financial private sector in Indonesia), second, new financial vulnerabilities have appeared as attested by the high debt levels (particularly concerning the non financial private sector in South Korea), which raises the issue of their medium term sustainability.

We propose in the context of this study to analyze the debt structure of six emerging economies in Asia (South Korea, India, Indonesia, Malaysia, Philippines and Thailand) by adopting both a time-factor and transversal viewpoint.

We were particularly interested in the debt of three institutional sectors: the government sector, the banking sector and the non financial private sector (households and corporate) over a period starting from the middle of the 1990s (pre-Asian crisis) to today.

The findings of this study can be summarized in three main points:

- Public sector:
• On the domestic level, India seems to show relative vulnerability linked to the long-term sustainability of public debt. This sustainability could be reassessed if the budget deficit were to worsen,

• On the external level, only the Filipino public sector seems to be relatively vulnerable due to the volatility of capital flows and the foreign exchange rate, caused by the non negligible proportion of external liabilities contracted with foreign private creditors. The other economies present no particular vulnerability linked to the public debt structure.

- Banking sector:
• On one hand, this sector’s proportion of external liabilities fell for all countries over the study period and on the other hand, the economies of the zone no longer have since the beginning of the 2000s, external currency mismatches on the balance sheet of these sectors. As a result, the economies of the sample present no specific vulnerability linked to the external debt structure of the banking sector.

- Non-financial private sector:
• On the domestic level, South Korea presents relative vulnerability with respect to the heavy debt burden of households and corporate which exposes them in the short-term to a greater sensibility of their net worth to an interest rate or income shock. Against a background of relatively limp global recovery, the high debt level strains also the potential of economic recovery given the limited possibilities of using debt to leverage growth. In the long term, there is also the issue of the sustainability of corporate debt and the solvency of this sector for which an adjustment would entail reduced investment.

• On the external level, Indonesia and the Philippines seem to be the economies that require watching due first to the non negligible proportion of externally-contracted liabilities, although these have been on a downward trend since 2001 (especially in Indonesia). A depreciation of the national currency would threaten the solvency of these sectors by increasing the burden of the liabilities owed.

To read the full report: DEBT STRUCTURE

>Why are financial markets not worried about the US fiscal deficit?

The financial markets are not penalising the United States, whose public finances are in a very poor state, while they are penalising many European countries. Can this asymmetry in the way they are treated be explained?

− Are the financial markets confident about the capacity of the United States to quickly regain vigorous growth capable of reducing the fiscal deficits? This is unlikely, due to deleveraging and accelerated deindustrialisation. Moreover, the low level of asset prices is eliminating the tax revenues generated by capital gains.

− Are the financial markets confident about the US administration’s commitment to reducing the fiscal deficits? But the Obama administration’s plans do not suggest this is the case, and the drastic reductions in fiscal deficits in the past in the United States (under Clinton) were due to exceptional circumstances (military spending cuts, taxation of capital gains, etc.).

− Are the financial markets confident that it will remain easy to finance the US fiscal deficits? Admittedly, the household savings rate is rising, central banks in emerging and oil-exporting countries are investing massively in dollars and the dollar plays a safe-haven role when risk aversion increases. This explanation is probably the right one, but it cannot be valid in the medium term. We therefore believe that there is an anomaly in the way US public debt is valued in the financial markets.

To read the full report: FINANCIAL MARKETS