Chile and Argentina

There seems to be a war on, but it's largely passed me by. I simply haven't had time to read blogs, watch much news or even read newspapers, so I only have the most cursory knowledge of what is going on with the war, other than that it's not over yet. The reason for all of this is a lot of travel, with my days being crammed with meetings from breakfast till dinner, and even on the weekends my time has been seriously limited. Hence the limited blogging. I should be back in Amsterdam in a week's time, after which normal blogging is likely to resume.

Meanwhile, a canceled meeting has left me with some time to catch up on my work email (866 unread messages), and now I even have a bit of time to write this, sitting in the lobby of my hotel in Buenos Aires. I'll be flying to Sao Paulo later today, so that's where I'll be posting this from if all goes well. My two experiences with Latin America thus far have been fascinating in their contrast. The sheer difference between the drive into town from the airport into Santiago de Chile and Buenos Aires is remarkable. In Santiago, there's a crowded road that passes scrapheaps (sometimes with people living in them) and shiny new office buildings, leading onto jammed winding highway that goes over hills into Santiago. Coming out of Buenos Aires Ezeiza airport the contrast couldn't be bigger: a gleaming six-lane highway, that could have been lifted straight out of Germany. It spills out onto the wide and spacious avenues of Buenos Aires, including the 9. de Julio, the widest avenue in the world (or so the Argentinians claim). Santiago is a town that started small and has been growing into a big town, with all the concomitant problems. They're currently building a highway under the river that flows through town in an effort to fix the traffic problems at least partially. Buenos Aires has the feel of an imperial city, planned to be big, and planned to impress. The rich 19th century architecture fits in perfectly with the idea of wide avenues and luscious parks.

Looks deceive in this case. Santiago is the more dynamic city in the country with an economy that actually works, whereas Buenos Aires is suffused with a wistful yearning for past glory and still hurting from the wounds of the devaluation that was forced on the Argentine economy. After a very promising start in the 1990s with macroeconomic reforms, the government never quite got its act together on the fiscal side as especially the provinces continued to be profligate in their spending. The peg which had kept the peso at 1:1 convertibility with the US dollar had to be let go, and it's amazing that it survived for as long as it had. The peso was horrendously overvalued at $1, and the economy was simply not producing enough economic added value to justify that exchange rate. Meanwhile, the inflexible labor markets and somnolent corporate management never made the adjustments necessary to maintain competitiveness in the face of the strong peso. Put simply, the price level in Argentina was too high, and deflation was the alternative to devaluation. But cutting wages was politically impossible, so in the end it was the devaluation which achieved essentially the same effect, reducing Argentina's labor costs dramatically. It also resulted in a massive impoverishment of the country as suddenly the value of all peso assets was reduced to a quarter of what it had been previously. Then again, the underlying value of assets in Argentina should not have been as high as it had been in dollar terms anyway. The ridiculous price levels still have their repercussions today, although at 3 pesos to the dollar it's becoming affordable for foreigners with hard currency. But restaurant and hotel prices were pre-devaluation on a par with London or Tokyo, and that was completely unreasonable.

It shows the danger of relying on a pegged currency to conjure up macroeconomic stability. It can work, but it requires a flexible and open economy to survive. The exchange rate is the external price of the currency, and as a price it is subject to supply and demand pressures. Changing prices convey economic information, and if you take away the flexibility to convey economic information through the exchange rate, it will find other avenues to assert itself. The underlying economic information is still there and fixing the exchange rate does not make it go away. A currency peg can work if the economy is flexible enough to respond to economic information in other ways, for instance by lowering the domestic price level. But that is painful to the people, who don't like seeing their wages cut and their house prices drop. A weaker currency does the same thing, but it feels very different. Hong Kong, which has its currency pegged to the US dollar too, is experiencing deflation and as a result the price level in Hong Kong is declining. But Hong Kong is able to respond more flexible than Argentina ever could.

It is sad to see how a once-great country and economy has fallen so far. At the beginning of the 20th century, Argentina was one of the ten richest nations in the world, and the lavish architecture from those days still reminds the current generation of the former glory. As one Argentinian told me, "all the nice things you see were built by our grandfathers, and we have been destroying them ever since." A sense of despairing, fatalistic hopelessness lurks in the background here, but there is also a worrying sense of entitlement, the sense that Argentina deserves better. It would certainly deserve better, but it won't get there without doing something to get it. Magic solutions are not going to fall out of the sky. Coming to terms with former glory is a hard thing to do, and current-day Argentina still hasn't entirely vanquished the ghosts of its own past.

Chile is doing much better. It's not as flamboyant as Argentina, the people are more conservative and scared as hell about the instability in Argentina and Brazil. The Chilean economy has been plodding along without major mishaps for a long time now, and is slowly moving away from its dependence on copper. It's attracting investment from Australia and Asia as a manufacturing base for shipping exports into the Americas. It has reasonably well-developed capital markets and a fully funded pension system (which will be the topic of a future blog entry). There's also an inflation-protected accounting unit, called the UF. Chilean bonds are quoted in UF, and other prices, such as rents, are also expressed in UF, making it almost a parallel currency (more on this later). One question that many Chileans had as the war was starting was about the relationship with the US. The Chilean president had spoken out against the allied military action in Iraq, and Chileans wondered how that would impact US relations. The people I spoke to were unhappy with their government's stance, but then again, these people were not a representative cross-section of the population. Being there on business, I generally avoided commenting too much on the war other than in generic terms, but some of my interlocutors did express their distaste for France, which I found interesting.

Argentina is the flamboyant and overconfident member of the Latin American family. Its little brother Chile is far less conspicuous, but has plodded along calmly without pretension to build a surprisingly solid economy. The price level in Chile is far more appropriate to an economy that's still not quite fully developed, certainly compared to prices in Argentina. The wines in both Chile and Argentina are pretty good, although I still have to give the edge to the Chileans. A big discovery was also the national drink in Chile, Pisco Sour. It's somewhat like alcoholic lemonade, although that description does not do it justice. I wish they would export it, as I never had the time to buy Pisco Sour while in Chile. As it was, I almost missed my flight to Buenos Aires.

It is time to leave for my final meeting in Argentina; more blogging perhaps over the course of the weekend, which I'll spending in Rio (without too many meetings I hope).

Southern hemisphere

Yes, I am still alive, although business travel is keeping me from blogging much. My days currently begin with breakfast meetings and end with dinner meetings. Not that I'm complaining, because I do get to see new places I've never been before, such as Santiago de Chile, where I am at the moment getting ready for the next breakfast meeting. I hope to have some time to catch up with blogging over the weekend.

The Legacy Quest

It's often been said that those who seek power most are the least suitable for the job. Even in a democracy, it's inevitable that the leaders we elect will have the trait of seeking power. There have been a few exceptions in the kinds of polticians who have attained office more or less through accident without actively seeking power. Václav Havel, the former Czech president, is probably the best-known of this particular breed. Vytautas Landsbergis, the former Lithuanian president is another one. But they're exceedingly rare, and only come to power in exceptional circumstances.

So what do you do once you make it to the highest office in the land, be it President or Prime Minister? The goal of achieving power has been reached, and so the question becomes what to do with it. Having power without wielding it is futile. Aside from running the country day-to-day, politicians often end up dreaming about a Legacy, something that will survive their inevitable demise from power, something that will make others remember them 50 and 100 years from now. The Legacy Quest can become a destructive force if its importance becomes too great. Usually it's just an irritant, but too many grandiose schemes have been dreamed up solely for the purpose of establishing a Legacy. In order to establish a true Legacy, and a positive one at that, requires not just skill and vision, but also historical luck. If you're in power at a time when important decisions must be taken with long-lasting effects, the path to a "natural" legacy (rather than a contrived one) opens up.

When Tony Blair came to power in 1997, he already had his eyes on not just one, but perhaps several Legacies. One is the remaking of British politics, where his dream was to unite the left-of-center parties (Labour and the LibDems) in order to shut the Conservatives out for a long time. Here he became a victim of his own success, as the majorities he won in 1997 and 2001 were so enormous that he did not need the LibDems for anything, and the Conservatives were imploding of their own accord. But Blair also had his eyes on a much bigger prize, the one that history had thrown into his lap and which he thought would make his an important figure in the annals of Great Britain. And that was Europe, and more specifically, the euro. He believed, or gave the impression he believed, that abolishing the pound and adopting the euro was in Britain's best long-term interest. Moreover, he was determined to use his popularity in order to convince the notoriously skeptical British public of his case. Establishing better relations with Europe would show that Britain did have an important voice in shaping the future of the EU, and Blair put a lot of effort into building relationships with the new wave of leftist politicians who had come to power in the late 1990's. Schröder in Germany and Jospin in France were his allies of the Third Way, the New Middle, or whatever catchy but vacuous moniker they adopted.

September 11th changed all that. Faced with the threat of Evil in Our Time, Blair never blinked and has been a dependable ally of the US in the fight against terrorism. He has been dependable not because of opportunist political calculation, but because he actually did and does believe that the position of the US and her allies is the right one. Not just in pragmatic terms, but more importantly, in moral terms. He actually does really believe this; for a politician who grew up and made his career by following the latest opinion poll and focus group, this is a big change. His belief in the fundamental rightness of our cause, the necessity of defeating the evil of Islamofacsism and its minions, is in stark contrast with his position on the euro. He probably does think that Britain's entry into European Monetary Union is a good idea, but there is no deep abiding conviction there. He never really put his reputation and popularity on the line in order to expound that message. The difference between his campaign for the euro and now for liberty shows where he really thinks Britain's principal interests lie, and it's not the former. For someone like Blair, who's been chained by opinion polls all his life, there must be a sense of liberation in actually leading rather than following.

So ironically Blair is getting his War Legacy, and in its effect it's almost the exact opposite of his hoped-for but stillborn Euro Legacy. Where he thought he'd bring Britain closer to Europe, the old ties of the Anglosphere prove stronger. Where he wanted to be friends with the French and Germans, he now sees their perfidy. Although it's taken him a long time to realize that Britain has more in common with the US than Europe, it's better late than never. Blair is building himself an unexpected (not in the least to himself) but justly deserved Legacy.

Six months of blogging

I'll keep this short. It's now been six months since I started to blog, and it's been a fun ride. the blog is a bigger success than I had thought possible. I'm getting several hundred unique site visits a day now, which puts me slightly ahead of the "total unknown" category. So I'd like to thank my readers for visiting this site and for commenting as well; there have been many good comments here. Also thanks to all those who've linked to me and put me on their blogroll. Which reminds me, I need to update mine as well; right now I am still way behind in reading my favorite blogs, but I hope to be able to catch up soon. On Saturday, I'm off to Miami on a business trip (yes, really. Stop the snickering.)

So here's to the next six months! (My celebration consists of some Pez followed by Jack Daniels. Who says I don't know how to party?)

Strong odors from Denmark

The situation in Denmark has long since passed the early stages of decomposition, as the smells coming from that country are overpowering. A reader forwarded me an email from "a Danish Jew," dated March 5th:

An open letter to Danish MP's, European MP's, the Danish and foreign press and defenders of freedom everywhere:

Gangs of muslim immigrants demostrated openly in the streets of Copenhagen yesterday to kill DANISH JEWS!!

Believe it: An open call to violence and terror in the streets of Copenhagen, confronting Danes with a call to terror against Danish citizens!!! This is not a hoax. It is horribly real.

The question remains if political responsibility and will still exists amongst Parliamentarians and the Courts to stop this here and now!!!

Now Denmark is saddled with a problem of radical, fundamentalist activity by a growing group of young muslims. They are being bred, fed, co-ordinated and inspired by foreign terror and hate cells in the Middle East and in other European cities. With birth rates that far exceed that of the Danish population, and an hostile ideology of world conquest and essentially "religious imperialism" this radical population now open calls for killing Danish Jews - a group they outnumber by 40 to 1.

Their overwhelming numbers and a suspended sentence of 3 months in jail for a radical Hizb-ut-Tahrir fundamentalist hate calls to "kill Jews where you find them" on their website, seems to encourage even more activity and calls for violence, terror and death in Denmark!!

Danes have to be able to walk their streets without feeling intimidated. Parents should not have to have their children see this kind of violence, hatred and sociopathy in the streets of Copenhagen. PArents shouldn't have to worry about their children's safety.

Danish politicians have to take upon themselves the responsibility of dealing with this! Without regard to consequences, a foreign population with a hostile ideology is being allowed to create a slow acceptance of violence and change in the Danish society.

The evidence is overwhelming of a growing violence in schools, a lower educational level, hostility and crime on the streets, an explosion of gang rape against Danish girls, economic crime and tax and toll evasion in the kiosk's and vegetable shops muslims have all but taken over, along with open calls of violence toward Jews is the result of a Danish invitation to a new chance, and a new life, in democratic Denmark.

This abuse of freedom must be stopped before lives and liberty are lost. Before Denmark is changed irreparably.

Legislators in Denmark have to do something NOW, before someone is killed and injured.

The reader who forwarded me this email asked me to look into, wondering whether it could be true. Now, I can just enough Danish to get the main point of a newspaper article, but I was not able to find any reports of this demonstration in the Danish press (but my Danish is sufficiently poor that this could very well be my fault.) The English-language press does not contain any references to this demonstration either, so I can neither confirm nor deny that it took place. I would have thought that something like this would have attracted attention in the Israeli press, but I have not been able to find it (my knowledge of Hebrew is negligible, so I only searched the English-language publications in Israel).

However, the email does mention an organization called Hizb-ut-Tahrir, and they're not very hard to find on the web. The blogosphere's favorite expert on Islamofascism Daniel Pipes wrote about Hizb-ut-Tahrir last September:

A Muslim group in Denmark announced last month that a $30,000 bounty would be paid for the murder of several prominent Danish Jews, a threat that garnered wide international notice. [....] Muslim violence threatens Denmark's approximately 6,000 Jews, who increasingly depend on police protection. Jewish parents were told by one school principal that she could not guarantee their children's safety and were advised to attend another institution. Anti-Israel marches have turned into anti-Jewish riots. One organization, Hizb-ut-Tahrir, openly calls on Muslims to "kill all Jews . . . wherever you find them."

The theme of Hizb-ut-Tahrir calling for the murder of Jews in Denmark is not a one-off. An organization linked founded by a defector (who thinks Hizb-ut-Tahrir is too moderate), openly calls for the destruction of democracy in Denmark. The Danish website of Hizb-ut-Tahrir still contains the exhortation to kill Jews: "And kill them, whereever you find them." (The Danish for this is "Og dræb dem, hvorend I finder dem.") There are reports in Belingske Tidende and Politiken in Danish on this. Given this background and the brazen nature of these threats, it would not surprise me in the least that Muslims in Denmark would be willing to go out on the street and chant death threats to the Jews.

The weak response thus far from the Danish authorities to these threats from the Islamofascists is deeply worrying. Something as blatantly despicable as this should show up as a blip even on the radar of the most deranged multiculturalist. But apparently the decades of multiculturalist propaganda have led to the evisceration of any sense of right and wrong, giving a pass to anyone who is the Officially Recognized Victim Groups.

This is a serious threat to our way of life, the values of liberal democracy, and in fact all we hold dear; the things that make life worth living, the foundation of our freedom and prosperity, that which sets our minds free to create, argue and think without fear. Whether it's the Dutch AEL calling for the destruction of Israel, or these calls for the extermination of Jews in Denmark, they're part of the forces that arrayed against us. Not just the US and Britain, as the appeasers delude themselves, but they're arrayed against all of us in Europe. We'd better start dealing with the problem.

The tunnels of Tokyo

Japan is an absolutely fascinating country. Adding the to mystery and the fascination is that I'm never quite sure whether the reports coming out of there are true or not. Some of them are just too bizarre for words, while the use of
Engrish provides an inexhaustible supply of amusement. I saw some cartons of Japanese food at a local store the other day. The only thing I could decipher was the English slogan "Peanut & Me." I shudder to think that the ingredients are.

Continuing the note of just plain weird stuff, there's a reporter who claims that there massive secret tunnels under Tokyo. He's been tracking down inconsistencies in published maps, construction records and apparently inexplicable events. For instance, he claims that the new O-Edo Subway Line had been there already long before the official building began. I am in no position to assess the veracity of his claims, but with Japan, few things surprise me anymore these days. It would not surprise me that there are more tunnels in existence than the maps bear out, but that would be true of most cities with an underground transportation system. It's the scale of the undocumented tunneling that's the issue here. It would make sense to have some kind of an underground bunker to keep the government safe in case of a military attack, or perhaps even in the case of a big earthquake. Then again, I'm not sure you'd want to be underground in a case like that. Anyone with seismic imaging equipment in Tokyo?

Not their finest hour

There are reports out of Kuwait that a bunch of Iraqi soldiers tried to surrender to British troops conducting exercises. Apparently they tried to surrender to the 16 Air Assault Brigade, who described the Iraqis as follows:

"The Paras are a tough, battle-hardened lot but were moved by the plight of the Iraqis. There was nothing they could do other than send them back.

"They were a motley bunch and you could barely describe them as soldiers - they were poorly equipped and didn't even have proper boots. Their physical condition was dreadful and they had obviously not had a square meal for ages. No one has ever known a group of so-called soldiers surrender before a shot has been fired in anger."

If this is indeed true (and the British Ministry of Defense denies it), then it's absolutely outrageous. With the publicity that this story has received, those Iraqi soldiers are very likely dead by now, murdered by Saddam's henchmen if they made it back alive in the first place. And their families will have been targeted too. I don't care whether the war has officially started or not, sending these men back was just plain wrong. In fact, it's so wrong that I'm having trouble believing the story in the first place.

Of course, it could also be a propaganda exercise designed to undermine morale further within the Iraqi armed forces.

Financial derivatives

I am still trying to catch up with my backlog of blogging; work as been interfering rather drastically of late, and by the time I got home I seldom had the energy to blog. Hopefully this week will be better. One of the loose ends are comments on financial derivatives, which I referred to recently. I said that I was surprised that we had not seen (publicly) any major blow-ups of equity CDOs. A CDO is a Collateralized Debt Obligation, and comes in many forms, ranging from the harmless to the volatile. The riskier ones are backed by high-yield bonds (more commonly known as "junk bonds," but "high yield" sounds so much better). These are the bonds rated below investment grade, i.e. lower than BBB-. The default risk of these bonds is much higher than for safer bonds with higher ratings. But even high-grade bonds can default. WorldCom's debt was rated AA when it defaulted, for instance.

Let's take a junk bond CDO as an example. What you do is you borrow a chunk of money in the markets and use to buy a portfolio of junk bonds. You want it to be well-diversified so that any one default won't blow your portfolio out of the water while you still profit from the higher yields of these bonds. Now you start redistributing the risk of this portfolio. You create a synthetic AAA-rated bonds for instance, which pays a spread of government bonds of, say 200 basis points. In order to get that AAA rating, you need to overcollateralize it with junk bonds. Essentially the holders of the synthetic AAA bond get first dibs on any cash flows coming from the underlying junk portfolio. Then the buyers of the AA-rated synthetic bond get their share, etc. What's left at the end is the equity portion of the CDO. It concentrates the risk of the junk portfolio in a small part of the capital; the overall aggregate risk of the bits and pieces into which you've sliced the underlying junk remains the same (otherwise you could make risk evaporate), and if some parts have much lower risk than the underlying, some other parts must have much higher risk. And that's the equity portion of the CDOs.

Junk bonds have not done well in the last five years. The spreads over government bonds have widened dramatically, far more than nominal yields on government bonds have fallen. Coupled with increasing default rates, this has meant that junk bond portfolios have had negative returns for several years now. Credit spreads have started to tighten again in the fourth quarter of 2002, so the worst may be over now. But institutions who bought equity CDOs have seen those investments get marked to zero. Individual investors will not have been affected, since you typically need tens of millions of dollars to buy into such a structure. In some cases, the issuing investment bank will keep the equity CDO on its own books to show its commitment and confidence in the deal. In many cases, equity CDOs have been sold on to third parties. Big buyers in Europe have been primarily insurers and some banks. I've talked to some people who've been involved with CDOs over the last years, and they say that it has hurt the equity CDO buyers, but that they were generally well diversified and did not invest too much of their portfolios in these things. But it's hard to tell; these deals are very private, and nobody likes to talk about them in the first place, let alone when they go sour. So we're unlikely to see these deals reflected explicitly in the investment results unless some institution really blows up in a big way. The losses are there, but CDOs have not been big enough (yet?) to cause a blow-up. I sincerely hope it stays that way.

Schröder's next gamble

With yet another election defeat to haunt him and the economy disintegrating around him, Chancellor Schröder is on his way to announce a major economic package in a few days' time. In his first four years in office he invented a forum called the Bündnis für Arbeit, the Job Alliance. It was a get-together of labor unions, employers and the government, and never really amounted to very much. Last week he tried to revive the Alliance, but the attempt ended in failure. The curious thing is that his reaction was to drop heavy hints that he would be introducing a reform package. It's not new to be hearing reformist rhetoric from Schröder, but this time the labor unions seem to be laden with a sense of foreboding. There's little chance Schröder will turn into a raving free-marketeer overnight, but many of the reforms that he might be considering (and which the unions have been training their guns on) would be at least pointing in the right direction. It's quite a gamble, because he risks alienating the members of parliament of his SPD party, three-quarters of whom are union members. And with a very precarious majority in the Bundestag, it would not take many defectors to bring down his plans, and possibly his government. While the opposition of CDU/CSU and FDP might in principle agree with more market-oriented reforms, they would not hesitate to vote against such proposals if they saw a chance to topple Schröder as a result.

Perhaps he's realized that he won't be able to survive without reforms to resuscitate the German economy. With his party potentially turning against him on the issue, he's taking a gamble. What are the odds that the SPD parliamentarians would risk a new election right now? They would suffer massive defeats at the polls, so they may just go along with the plans. The position of the unions has come under unprecedented attack in Germany, with both the FDP and now also the CDU taking aim at the strangehold the unions have over the German economy. The CDU does not speak with a single voice on this issue though.

It could be the last desperate gamble of a man who has little to lose anyway.

The AEL opens up shop

it comes as no surprise, but now it's official: the AEL has opened its Dutch subsidiary. The AEL is the Arab-European League, an organization which had its roots in Belgium and claims to represent (and probably does) the muslim immigrants in the Netherlands. It claims to be a democratic and Islamic party. There is little doubt that it is Islamic, but the democratic bit seems to be more difficult to find. At the inaugural meeting, the interim leader Jamil Jawad immediately called for the destruction of Israel, claiming that it has no right to exist. The quote is for "the State of Israel to be dismantled." That's great way to start a new democratic party, by calling for the desctruction of the only democratic state in the Middle East.

But what of the citizens of Israel? Do they only want the state destroyed, or the people as well? The press officer of the Dutch AEL, Naima Elmaslouhi, is quoted in the Dutch daily NRC Handelsblad as saying that she did not disapprove of Moroccan youths chanting "Hamas, Hamas, gas the Jews" during a protest march last year in Amsterdam. Of course, she now denies making the remark. Speaking of democratic credentials, the interim leader Jawad also said he understoof why Moroccan youths are keen to see body bags with US soldiers to be sent back to the US. He said, "Those kids see war against Iraq as a war against Islam." Keep this up and it'll become one.

Light blogging

Work is interfering again with my blogging I am sorry to say, so before I can return to expound on fixed income derivatives, you can read up on the wider topic of financial derivatives in general in Warren Buffet's latest comments. He calls derivatives "financial weapons of mass destruction." I wouldn't go that far, but then again, I'm no Warren Buffet.

I wish I were.

The power of television

Before I delve futher into fixed income derivatives, I'd like to take a bit of time and focus on the positive aspects of television. Deriding TV is very common, and I won't deny there's a lot of crap out there. But some people will go even further and agitate actively against TV as a medium, saying that it only makes people stupid and nothing worthwhile ever came of it. Well, they're wrong. Here's a first-hand account why. Yesterday morning I stacked the dishwasher full of plates, glasses and silverware. I closed the dishwasher. It popped open. I closed it again. It popped open again. I could not figure it out. Nothing was sticking out, the latch seemed OK, but it would released as soon as it caught. After half an hour's of futile tinkering, I started to panic. What if I can't get it work? What will happen with the dishes? With the lag times involved in getting an service engineer out here, it could be weeks before I could have clean dishes again. I'd have to buy more dishes in the interim. Disposable dishes? Good heavens! This was serious. And the current set of dishes would sit here until they could be washed again. I needed my dishwasher badly.

How does this relate to television? TV brought me the answer. I knew all those hours of TV watching in my youth would pay off someday, and this was the day. I used to watch MacGyver, and the one central lesson that he brought to America's (and the world's) TV watchers is that you can't have too much duct tape. All problems can be solved with duct tape, including my dishwasher problem. I just taped the door shut and let it run. Clean dishes! Thanks to duct tape, MacGyver and TV.

So there.

Flying the tricolor

Fearful of the anti-French sentiment that is brewing the the US, the French hotel group Accor has decided to stop flying the French flag at its American hotels. I guess they'll replace those empty flagstaffs with the France's other national flag, the one that is all white. (They've already hoisted that one at the hotels they run in the Middle East.)

Japan follow-up

There have been many good comments in response to yesterday's blog entry on the Japanese economy, deserving of a more thorough response than a long comment. Besides, it's easier for me to write this way, so this is not an entirely selfless exercise.

Jakub Rehor commented on the yield curve:

Sorry, the yield curve is already squashed. The 1 year JGBs are yielding 0.0184%, the 30 years 1.4577%. Monetization of debt and reversal of deflation may not move nominal rates much, but the real rates would drop and stimulate the economy.

I'd add that the 10-year bond is now trading at around 70 basis points, so the yield curve is indeed pretty flat already. Squashing the yield curve down even further will indeed reduce interest rates, but I wonder how much stimulus this will actually bring to the economy. Suppose the yield curve goes effectively to zero all the way out to the maturities of 30 years. Initially this will produce a nice (but one-off) price gain for holders of the bonds, but once the curve is stuck at nominal zero, it will cause additional problems for financial institutions who won't be able to ride the yield curve anymore. This means they lose their last instrument for generating relatively low-risk investment income. Of course, with 10-year bonds at 70 bps right now, the situation is already serious, but flatlining at zero could make things worse for the financial sector. And the BoJ would have to keep buying JGBs in order to keep the yield curve pinned down. Once yields reach zero, there's little point in buying any additional bonds. Then again, the state of the financial sector is already so grim that a public bailout and de facto nationalization of the banks may already be inevitable. Whether it's a direct takeover or one that goes through the balance sheet of the BoJ does not matter too much in the end.

As for structural reform, there is indeed an additional deflationary danger in that. But the current situation of endlessly propping up zombie companies can't go on forever either. Corporate Japan has long had a problem with generating a good return on capital, as the fixation has always been on market share rather than economic value added. While the P/E ratio of the Japanese stock market has been very high compared to the US and Europe, its P/BV has been very low; in other words, the amount of earnings generated per unit of capital has been miserable. Eradicating excess capacity will be necessary, as is fixing the NPL problem. You can cure the NPL problem to an extent by inflating your way out of it, but thus far the money supply has proved hard to budge, even with huge increases in the monetary base. It's going to take both structural and monetary measures in order to get the economy going again, and that would require a level of cooperation between the government and the BoJ that we're unlikely to see anytme soon. Politics is a problem in itself, as Thomas Grover pointed out.

Tictoc commented on the demographic problems facing Japan, asking whether it's a big factor in Japan. The population pyramid for Japan is not looking good at all and is showing signs of inversion. According to the Aging Vulnerability Index Japan falls in the category of countries of medium vulnerability, with a score similar to Sweden's and Germany's. The demographics in Japan are far worse than in Europe, but the safety in Japan is not particularly generous, so the overall unfunded pensions liabilities are relatively small.

Clem Snide commented on derivatives scams that are going to blow up in the future. I don't have any knowledge of these (I haven't read the book he mentions), but (to go off on a slight tangent) what amazes me is that we have not seen any big blow-ups in collateralized debt obligations. Usually the equity portion of CDO ended up being a leveraged play on high-yield bonds. With the massive widening of credit spreads and the increased defaults, I would have expected a few CDO deals to go sour by now. Yet nothing big enough has happened to make it to the papers as far as I can remember. Now that credit spreads are tightening again, the worst may be over already. Fingers crossed.