Bank of Ghana intervention to stabilize cedi may not suffice

The recent intervention effort by Bank of Ghana to force the cedi to appreciate against the dollar (the world’s reserve currency) may not be sufficient enough to curtail Ghana’s mounting economic problems in the short to medium term. Injecting about $20million into the market and restrictions on trading in dollar currency is not enough. Why? Because such a strategy only resonates with the supply and demand model for exchange rate economics and its impact may be realized in the very long term. The economic hardship of Ghanaians does not stem primarily from the weak cedi because a weak cedi can stimulate the demand for Ghana products and significantly boost Ghana exports. Additionally, it may reduce the country’s import and put a break on the cascading unemployment rate. However, on a negative note a weak cedi will increase inflation as being witnessed right now [2014 January estimate of 13.50%, source: tradingeconomics.com] in spite of high interest rate averagely 16% [2014 estimate; source: tradingeconomics.com] that Bank of Ghana has put in place. Most importantly, it can exclusively discourage Direct Foreign Investment which is the main job creation sector for the country. On the other hand, the quest for a strong currency may not alleviate economic hardships or better still be the breaking force for the “runaway” economy of Ghana. A strong cedi may place downward pressure on inflation yet it may exacerbate the unemployment rate due to promotion of relatively attractive low prices for foreign goods in the country. The other downside of this will be a drag on the country’s economic growth.So the strength or weakness of a country’s currency is just one of the macro-factors that influence the economic conditions of a country. Consequently, the economic model suggest that weak cedi is not the problem and that a strong cedi alone will also not solve the problem. What the country needs is a stable currency plus government fiscal and monetary policies that will boost investor confidence, attract more Direct Foreign Investment, encourage local investors and create jobs. Pragmatic fiscal and monetary polices that are sustainable, recuperating Ghana’s Global Competitiveness is what the country needs. Bank of Ghana may inject dollar reserves into the system to shift the supply in the country’s favor, putting downward pressure on the dollar and an upward pressure on the cedi. Yet the question Ghanaians need to ask is whether Bank of Ghana has enough reserves to continue doing this. In other words, can reserves of about $2501 million (2009 estimate, source: tradingeconomics.com) do the job. If they don’t have enough reserves then I am sorry to say that it may not be able to exert much pressure and sustain the dollar depreciation, fortifying the appreciation of the cedi. In other words, this is not a sustainable strategy so far as there is not sufficient reserve to keep the pressure on the dollar. It is sad to say that very soon market forces would overwhelm and nullify the gains of the cedi appreciation. China, the world’s second largest economy has substantial amount of foreign reserves that it can use to intervene in its foreign market or currency flow in its economy. However, this may not be true for Ghana. China is more experienced in direct intervention of currency and that is what it has used over the years to maintain its premier position as the world’s largest exporter. There is the need for the Ghana government to focus on boosting exports taking advantage of the weak currency as it seeks to stabilize the Cedi against the dollar. Export driven economy is what Ghana needs. The focus should be on the non-traditional exports a domain of all other export commodities apart from the popular traditional exports of diamond, gold, manganese, timber, cocoa, electricity. There should be incentives to boost non-traditional exports businesses. For a very long time, the foundation of the economy has been built on traditional export which has failed the nation and there is the need for refocus and re-strategizing. Next, the government should review its fiscals by toning down on its spending, effecting some changes in the tax system and most importantly reducing its gross debt or international debt or its negative balance of payment. The VAT system is good but it is having a negative impact on Ghanaians. The VAT system is shifting the “tax burden” from sellers to the buyers. Let me briefly clarify on the issue of tax burden which I believe is deepening the economic woes of Ghanaians. When the government imposes tax on the goods, there are three things that can happen. The price paid by the buyer may rise by the full amount or by a lesser amount or not all. The prices of good have risen significantly since the introduction of the VAT system. That tells me that Ghanaians or the buyers are bearing the brunt of tax burden due to the poorly implemented VAT system. All said and done, God should not be left out of the model to get the economy back on track. Prayer should be included in the fight to redeem the economy. If Prophet Elijah prayed for the rains to cease for three and half years and he prayed again there was rain then I believe prayer will be a significant tool in dealing with the country’s economic problems. For those who don’t believe in the power of prayer, I have news for you. The bible says in Daniel 4 that God rules in the kingdom of men and that He lifts up nations and takes down nations. The nation needs the hand of God and it is imperative we pray and stop the blame game which only leads to tension and vendetta. It is double standards when we seek the power of prayer to avert civil war in times of elections and dispute the potency of prayer to arrest a deteriorating economy. Members of the clergy should not cease to back the economy with prayers in spite of the disparaging criticisms. God is looking for intercessors in Ghana who would stand in the gap and cause a move of the hand of God. Intercessors who would not rest until they see change. Would you be one of them? God bless our homeland Ghana and make our nation great and strong. Charles Horace Ampong Chicago, U.S.A Website: www.charliepee.blogspot.com Read more!

Global Currency Armageddon to continue… (Part 2)

The United States Trade deficit and that of some European countries continues to balloon with no end in sight. According to U.S Labor Statistics reports, the Trade deficit in goods and services increased from $374.9 billion in 2009 to $479.8 billion in 2010 consequently a 32.78% increase. On the favorable end of the Global Trade imbalance spectrum is China which saw a GDP growth of about 10% in 2010 (making it the world’s second largest economy and the first in Asia) whilst at the same time experiencing a decrease in its Trade Surplus.
Reports have it that China’s Trade Surplus contracted sharply from $13 billion in December 2010 to $6.5 billion in January 2011 prompting some questions in connection with the country’s Trade Surplus sustainability. The question that needs to be asked is whether the revaluation of the Yuan has had any impact on its Trade Surplus providing a justification for more pressure by United States and the rest of the world.

According to the reports stronger than expected imports contributed immensely to the drop in the Trade Surplus. Additionally, the country saw a rise in inflation in January 2011 of 4.9% from 4.6% in December 2010. Perhaps a contributing factor to this inflation is the increased domestic demand against a limited supply. In fact it is not good that the Chinese economy is seeing inflation rate of this magnitude at this time of the year. This is because based on projections inflation potentially rises in the second half of the year and so it is my view that the country may face more inflation in the second half of the year if economic policies are not enacted to cool the bubbling economy.

Apparently, these developments may suggest the Chinese economy is facing a supply problem (shortage) with increasing demand. The supply problem may not only be with processed goods but also raw materials for industries. A major supply issue may have to do with oil supply for industrial activities. The rise in material costs internationally including oil prices are all issues that can have a degenerating effect on the export horizon of the country besides having the potential to erode gradually the surplus the country has accumulated over the years. Also, escalating prices can remotely or subtly increase its export prices somehow diminishing its global competitive edge. In fact, the unrest in the Middle East as it continues can escalate China export prices as the country is a major consumer of oil.

Unfortunately, current developments do point to the perpetuation of the unrest and its spread to major oil producers in the region. In the event of that happening oil prices will continue to rise. We have seen the effect the Libya demonstrations has on the oil prices even though Libya the 15th. Oil producer in the world produces about 1.5 million barrels per day amounting to 2% of the world’s supply.

A partial remedy to slowing down the oil price hike may be provided should the U.S pursue its plan of opening up its strategic oil reserves to boost supply and plunge prices. In spite of that the Chinese government must continue to scrupulously tighten its monetary policy and other financial policies including but not limited to interest rate hikes, maintaining pragmatic policies so as to circumvently cushion the debilitating effect of rising oil price on its economy. Any action plan that can prevent an “economic bubble burst” of its resilient industrial economy should be the objective now for the Chinese government. Policies that will equip the industrial sector with “economic buffers” to nullify high oil price impact are a must.

Let us not forget that any bubble burst will spread to other parts of the world as we now have an integrated world economic system. Put in a funny way if major economies like that of China or the U.S sneezes, the rest of the world catches a cold. The bubble burst of the American economy began in its housing sector and rippled into other sectors of the economy and subsequently to the rest of the world. So if there is a sector China has to watch and to prevent a bubble burst initiation then it has to be the housing sector.

Again based on these developments critics of the Yuan depreciation can make a case here that if China continues to revalue the currency then it is likely its exports surge will not be sustainable in the long-term and other countries like the U.S and EU can narrow the trade gap. Unfortunately, the currency Armageddon may be heading for the defining moment as China recently said the Yuan appreciation level is O.K in that it has allowed the market to determine the Yuan value as demanded. In fact a top economist from China asserts that the current exchange rate system being applied which is the “managed floating system” is the best China can offer and should be embraced by the international community. Let’s talk a little about the dynamics of this exchange rate system.

The ”managed floating system” lies between the fixed and floating rate exchange systems. That means in spite of the currency being allowed to float on a daily basis, the Chinese government (China Central Bank) may sometimes be compelled to intervene to prevent the Yuan from moving to far in a particular direction. In that case the currency can be manipulated to benefit the country at the expense of other countries. The currency can be manipulated also to prevent it from becoming a convertible currency consequently abating a highly floating currency. This means the currency Armageddon will not curtail as parties on the offence will not yield to any of these reformations until the impact is felt significantly in their economies.

Now, continuing the analysis from the first part of this article, six factors were propounded categorically as being the driving force behind the current currency Armageddon taking place between United States, EU and China. The six factors were further dichotomized as capitulating developments and extrinsic austerity measures. In the next section of this article the extrinsic austerity measures which can produce a dampening effect on the Yuan devaluation will be the talking point. Three factors will be considered in this compendium namely high taxes, international coalition and diplomatic persuasion.

High Taxes or Tariffs

The U.S. may be compelled to impose high taxes or tariff (practically about 25-30%) on imports from China but it must be understood here that this action has a “backfiring effect” of causing loss of jobs (estimated to be about 48,000 jobs) in the U.S. Because of the integrated nature of the global economy, a job created in China is a job lost in the United States and vice versa. Also China’s GDP or economic growth is largely dependent on exports (net export) and fixed investments. So any restriction on imports to the United States can hurt its economy since the Chinese economy is dependent more on exports than domestic demand. Also the U.S is one of the major trading partners of China and the largest market for its products. However, this action plan of import restrictions may not be sustainable since China has established bigger markets in Asia and Africa for its products. In fact, the uncertainty surrounding the cause and effect of this action is huge and it is very important that much thought is given to it before implementation.

Again, history shows that China revalued it currency in response to growing criticism in the past but the country’s avenues for trade has changed with regards to the pervasiveness of its market. So it will be much difficult for the aforementioned plan to have the expected impact on the Chinese economy. Also an austerity measure such as the tariff or quota may be an infringement on free trade or international business because it gives unfair advantage to the businesses which operate in the U.S. Ultimately, it will cause the Chinese government to look for more trade treaties with countries that are ready to pact with them. Already China has several trade treaties with removal of tariff and may be compelled to pursue more if the austerity measures of high taxes or tariff are applied. An alternative will be perhaps for the U.S. to intentionally buy more of the Yuan so as to cause its appreciation. However, this may not be a judicious plan since it is not an easily convertible currency.

Above all with Europe’s debt crisis worsening, it is indisputable that some of the reserves of China are tied up in the EU and more wealth loss is possible. With the reserves tied up in major economies such as U.S. and EU, any significant economic weakening in China will result in global loss of wealth and regeneration of the global financial crisis.

International Coalition

The U.S. can continue to rally other countries, international organizations such as IMF, World Bank to press for effective revaluation of the Yuan at G-20 meetings and alike until the move produces an improvement in the Trade imbalance of all these countries. Unfortunately, the G-20 meetings have always been a blame game with no better results. So far China has been able to weather the storm with regards to the allegations made against the Yuan at these meetings. Also some countries and international organizations are gradually accepting the status quo of China to keep its strategies of maintaining the trade lead. Countries such as Russia, Brazil, India and Japan appears to be withdrawn on this issue and this is suggestive of support for China’s leadership in trade and its currency level fluctuations. With regards to Africa, more economic channels and businesses have open up with China so it will be very difficult to get their attention and support. Indeed, China has established a strong rapport with the continent through the deals which may be difficult to surmount. China also sees such rallying and incursion by an international coalition as a threat against its national sovereignty or inalienable rights and may not succumb to that.

Diplomatic Persuasion

The relations between China and the United States is gradually improving as we saw President Hu Jintao visit United States and a state dinner was performed in his honor. In fact China knows that it cannot do without the U.S considering the immensity of the financial transactions or assets amalgamating these two countries. China may agitate for the replacement of the dollar as the world reserve currency yet it knows that its economy is not isolated and that it is tied to that of the United States. So it is imperative that the U.S continues with persuasions as relation has improved and positive developments in the Trade imbalance may result in future.

China may want to keep some of its strategies that has produced the current formidable economy. It is hoped that with time inherent or natural economic forces will leverage the Trade imbalance discrepancies if the international community does nothing. Ultimately, time will show positive measurable results in the Trade imbalance of countries suffering from the Yuan currency devaluation. However, if the world decides to embark on a dialogue then it should be a diplomatic one. The diplomatic dialogue would have to go beyond the currency revaluation issue producing a broad-based dialogue that will address pervasively global financial and economic discrepancy issues at stake. The broad based dialogue should seek to address not only the trade imbalance issue but also the global financial problems or what may be termed “financial entropy” affecting the economies of the world. Meanwhile, countries involved in this dialogue should exercise restrain whilst working mutually with China towards leveraging global trade imbalances and forestalling future financial meltdown of the Chinese economy. For there are other factors besides currency incongruity that are controlling the global trade imbalance.

Conclusion

The currency Armageddon is set to continue and the trade imbalance stalemate unabated. Capitulating developments and austerity measures (high taxes or tariffs, international coalition and diplomatic) may not suffice in the short term as parties involved are relentless in their strategies for domination or leverage. Each government wants to increase its export because more exports results in higher level of production, income and most importantly generation of jobs. The World may be compelled to live with it and accept the status quo as it waits for the economic forces to cool the Chinese bubbling economy and produce leverage in Trade imbalance in the long term. The international community has two options: That is to press ahead with risky austerity measures or do nothing and allow natural economic forces to level the trade playing field in the long term.


References: TradingEconomics.com
Author: Charles Horace Ampong
Website: http://www.charliepee.blogspot.com/   Read more!

Global Currency Armageddon to continue… (Part 1)

In the next couple of years starting in 2011, the currency Armageddon between China and the rest of the world (the United States at the front) is set to continue. Factions involved in this confrontation are expected not to back-down on their intransigence or demands because of the economic problems or better still trade imbalance problems currency discrepancies is creating among the nations.China to maintain its lead as the locomotive engine driving the world economy may not yield to any more calls for substantial revaluation of its currency the renminbi-RMB(the unit being the yuan) with proclivity of reducing its global competitiveness and supremacy. In nominal and purchasing power parity (ppp) terms, China is the second largest economy in the world after the U.S. Besides, it is the world’s fastest growing economy with a growth rate of about 10%. The exchange rate of the RMB to the dollar is 6.6494 (November 25 2010). Nevertheless in real GDP terms, the economy of the U.S (real GDP $14256 billion in third quarter of 2010) is about three times that of China ($4909 billion in third quarter of 2010).
Despite these statistics, the United States and the EU with its expansive deficit problems are pressing ahead to see leverage in global trade so as to curb it growing deficit. As at the third quarter of 2010, the U.S debt was over $13.5 trillion which is about 94% of the GDP ($14.7 trillion third quarter 2010). The debt which is made up of two-thirds public debt namely in Treasury bill, notes and bonds is said to have spiked from 51% of GDP in 1988 to its current state of approaching 100% of GDP. Now, China circumspectly appears to be on the defensive whiles the rest of the world led by United States is on the offensive. Furthermore, China is not likely to succumb to the offensive tactics being applied by the United States and other large economies due to some intrinsic reasons.
Coming to think of it there are numerous reasons that go to expound the complexity of this currency war and to reveal the difficulty in dealing with this problem. In terms of longevity, this currency war is here to stay and the world should be bracing for long term strategies that can gradually deal with it without any despicable spill-over effects. This article would like to throw some light on some six(6) reasons why the currency pressure on China may not produce the expected impact in terms of leveraging trade imbalance (or balance of payments) and economic growth horizons. The six (6) reasons are classified into (1) Capitulating developments (2) Extrinsic Austerity measures

Capitulating Developments

1. Revaluation of China’s currency since July 2005 by more than 22.2% has not worked to reduce substantially the widening trade imbalance or balance of payment between China and the U.S. and other developed countries. As at the third quarter of 2010, the current account encompassing balance of trade for some contending developed economies stood at: U.S -$127. 2 billion, EU -$25 billion, U.K -$10 billion, Germany $14 billion, Japan $1436 billion whereas that of China was $70500 billion. Though in October 2010 for the first time since 2007, China shocked the world market by increasing the deposit and lending rates to about 5.56% it did not reflect in the trade imbalance differential. Perhaps this action was to cool its heated economy and curb inflation which stood at 5.10% with a jobless rate of 4.20%. Obviously, this move has no direct quantifiable effect on currency revaluation and consequently on the increasing trade imbalance between China and the United States or western style economies.
2. The falling value of the dollar is what some nations of the world are waiting for. A fall in the value of the dollar is seen as loss of U.S global economic power and somehow military power. It is also seen as a transfer of power from the Western to the Eastern world and a defeat to capitalism. Opponents of the dollar still being used as the world reserve currency in spite of its fall are energized by these developments to argue their case out for a new world reserve currency. They view these developments as a loss of confidence in the U.S economy to lead the world economy and a justification for new world economy leader and world reserve currency change by the Central Bank. Just as they may have a case, replacing the dollar with another currency may not solve the world’s economic problems. Why? In the opinion of this writer, the solution for leveraging the trade imbalance is to have one currency for the world which may call for the creation of one government perhaps to be followed by one religion. Such developments may conform to biblical prophecy revealed in the book of revelation. In fact, no currency will be sustainable in the long term with respect to unyielding to global economic pressure. So even if the dollar is replaced with another currency such as the Euro, the problem of currency degeneration and the global economic instability will continue unabated. Meanwhile, It is possible that if the currency war perpetuates in the long term a new world order will emerge as world economies will gravitate towards one world currency leading to one government and perhaps one religion.
3. China has huge foreign exchange reserve which makes the country powerful even though such immense reserve has repercussion of triggering inflation locally. Perhaps, this may have been the cause of the 2010 interest rate augmentation by the Chinese government. As at September 2010, foreign exchange reserves for China was $2648.3 billion as against that of the U.S. which was $129 billion (July 2010 estimates). With huge foreign reserves equated to economic power, China has the ability to buy dollars which is a convertible currency as against selling their currency renminbi-RMB (the unit being the yuan) which is not easily convertible. Consequently, the Chinese government can continue to buy the dollars to maintain the dollar’s appreciation as against the depreciation of its currency unit (the yuan). In fact China’s large reserve has some advantages as well as disadvantages. The large reserve of foreign currency allows the Chinese government to manipulate exchange rates – usually to stabilize the exchange rates and provide a more favorable economic environment. This means the country is in a better position to defend its domestic currency (the yuan). It also authenticates China’s ability to pay its foreign debt thereby strengthening its high credit rating. However, such large reserve in U.S. dollar-dominated assets (U.S. bonds and dollar currency) is risky if the U.S. dollar weakens and the country’s debt mountain grows. Ultimately, there could be relative loss of wealth as a result of the weakening dollar and increasing threat of default in repayment. The option for China to deal with this risk is diversification of its foreign exchange reserves. Consequently, the country has resorted to converting some of its foreign reserves into gold reserves thereby increasing the safety of its foreign exchange reserves. The decision of China recently to increase its gold reserves as against holding dollar reserves is gradually producing a resonating effect of a steep rise in gold price on the world market. In fact there is a negative correlation here between the rising price of gold and the weakening of the dollar. That is as the dollar weakens gold price generally rises. The explanation for this trend is that as the dollar weakens, investors are moved to diversify their risk. Ultimately, they will resort to buying gold reserves so as to have a safety seat for their wealth creation. Additionally, the Chinese government and investors diversification into gold to protect their wealth is contributing immensely to the rush for gold invariably helping gold mining companies to accrue huge profits. Unfortunately, analysts do not know when this diversification will be curtailed and this suggest gold futures will continue to be on the ascendency. Nevertheless, investors should take a scrupulous second look at investing in gold if they want to continue their wealth creation and not be caught off guard. The fact is countries with huge gold reserves at some point in time may decide to flood the market with bullions, producing a breaking effect on the price and subsequently bringing it down. Another interesting safety action China has embarked on is to diversify its foreign exchange reserves risk through debt auction by buying treasury debts of some trusted credit-worthy countries such as Japan and some EU member nations. This is interesting because China has decided to buy the treasury debt of Spain in spite of the fact that Spain is on the bail out list of EU. China believes in the success of the economic reforms being pursued by these countries with whom they are engaged in the debt transaction. That is why China is resolute in pursuit of these risky debt transactions. However, there is no guarantee that reforms by these nations will succeed as the EU member debt crisis is not over and is likely to spread. Stake holders know that it is risky deal yet they are going ahead with it. Unfortunately such debt transactions can ignite an “economic bubble burst” for China which may spread to the whole world regenerating another global financial meltdown.
4. The currency war is not only about China since there are other countries such as Japan whose currency the yen is devalued. Since it is a convertible currency, it is easy to manipulate. Japan with a GDP growth of 1.10% (3rd. quarter), interest rate of 0.00%, inflation rate of 0.20%, jobless rate of 5.10% and balance of payments of $1436 billion has the capacity to manipulate its currency also. As at third quarter of 2010, the yen was being traded around 83 to the dollar. Unfortunately, China is seen as the only culprit in the currency manipulation issue. In fact, there are a host of countries involved in this act which is adding to the global trade imbalance. Every one of those countries involved has subtly taken advantage of the sticky situation to stay competitive globally whilst China bears the scolding and pressure.
In concluding the capitulating developments on the currency war, it can be deciphered that the current currency war is more complicated and profound than is considered to be. The problem is not between the United States and China. It is more than China revaluing its currency or the global currency being replaced or leverage in trade imbalance. Consequently, it may be difficult to solve in the short term and so the world must expect more of the impasse in 2011. See part 2 of this article for the rest of the analysis.

References: TradingEconomics.com

Author: Charles Horace Ampong

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Politics & Policies of Economic Management (Part 2)

According to the Bureau of Labor Statistics, increased consumer orders, stock price increases and increased money supply are reflective of increased consumer optimism. Current positive developments of these entities in the economy do suggest a conformation to this assertion and recovery on track. However, more months of data may be needed to validate the sustainability of the gains for these leading indicators as outlined in part 1 of this article. Now let’s talk about the politics and policies encompassing the national debt.

Regarding the national debt, it is a big issue and a bone of contention as one can envisage that Uncle Sam is really in debt. The only remedy could be a cap on spending and increase in taxes. Meanwhile, should the citizens be concerned or worried over the mounting debt? The answer is a yes and a no. Yes, because the debt cannot be kept forever without repayment. The government cannot continue in the long-term to refinance its debt as raising taxes and reducing spending will definitely become a viable option. Also, mounting debt will put a downward pressure on the dollar ceteris paribus and that could retard or derail the recovery.

The U.S GDP is projected to grow from $11,652 billions in 2008 to $14,751 billion in 2018 a ten-year period. This is gives a growth rate of 2.659% annually for the period. However, there is a precarious problem here when this growth rate is compared with the national debt and the gross debt growth rates for the country. The national debt (debt held by the public excluding intra-governmental obligations such as Social Security Trust Fund) is expected to grow from 54.6% of GDP in 2009 to 68.5% of GDP in 2014 or better still from 64% of GDP now(2010) to 77% of GDP in 2020 suggesting a growth rate of 2.03% annually. Similarly, the gross debt (debt held by public plus intra-governmental obligations and foreign investors) is also expect to grow from 86.1% of GDP in 2009 to 99.8% of GDP in 2014 a growth rate of about 2.67% annually. The growth rate for the national debt of 2.03% and gross debt of 2.67% annually should be of concern because these figures are almost equal to the expected growth rate of 2.66% for GDP in the next ten years. A comfortable figure should be a GDP growth rate that is excess or a multiple of the growth rates for the debt (national and gross). In fact, what the government must do is to institute policies that put “breaks” on the growth of the debt subsequently permitting its redemption in the nearer future. Next with regards to the answer of No to the question whether citizens should be worried, it must be said that the government can continue to refinance its debts in the shorter term but in the longer term this may not be feasible. Another non-viable option will be to print money to pay its debtors which of course will escalate inflation from its current figure of about 2.30%.

External debt such as debt to Chinese investors in the form of bond payments should be an issue of concern as it can lead to the transfer of economic power. The question is whether foreign investors (Chinese investors and others) are willing to accept refinancing as against making payments at maturity. Even if it is acceptable, for how long will it be? In fact, mounting debt and deficit could affect the country’s credit rating and create future financing problems. A cue can be taken from the Greece and Spain situation. It’s said that United States owes much of its debt to its citizens and that it can continue to defer payment for sometime. However, this should not be a creditable one as debt accumulation without remedial action can incapacitate a country as it has done to Greece. Greece may not be the last country to be incapacitated as there are several countries on the way to join the train. In fact, Greece debacle would continue to have a ripple effect first to Europe and then to the United States. Also, United States is not exempted from incapacitation that can result from the cumulative effect of rising debt. The country currently has a buffering capacity that has helped sustain it and lessened the negative impact of the rising debt. The economic buffers include the country’s high global competitiveness rating and efficient macro-stability policies that has kept inflation in check and promoted economic growth. However, the question that needs to be asked is the sustainability of these economic buffers in the long term.

Again, with regards to the growing deficit, borrowing to finance the deficit only adds to the accumulated national debt and so there is the need for strict adherence to the national debt “ceiling” (that is the limit on the national debt). Raising the “ceiling” may not be a viable option but rather cutting down on spending and increasing taxes is. It may be a painful action plan but the pay-off is great. Judiciously, remediation of the debt will also call for leveraging of the increasing balance of trade deficit between China and the U.S. As at now, the low value of the Chinese currency is causing some problems for U.S exports invariably affecting net export negatively, exacerbating the balance of trade deficit and dampening economic growth.

Currently, in the pipeline are series of regulations meant to promote leverage, transparency and probity in the financial sector with Wall Street being projected as the beacon of success if these regulations should work. This is a laudable step and should not be politicized if it seeks to leverage risks in derivatives and stock trading. As at now, options seem to be the only derivative with more leverage and consequently the one of choice for risk averse or low risk traders. Consequently, regulations that are pioneered towards leveraging risk in derivatives and financial sector by increasing transparency and promoting ethical transactions in this sector is commendable and should be welcomed. However, to some extent these regulations should seek to have minimal impact on financial innovation in the sector.

Unfortunately, due to the perception of some skeptics politicizing government regulations, it has culminated in an increased sensitivity of several companies business model to impending government regulations than to inflationary pressures. That is the business model of some financial companies has become more sensitive to impending regulation than to inflation. Cases in point are credit card companies’ responses to government’s propensity to regulate. There is the belief that government regulation will restrict their ability to make huge profits. So in reaction to that they keep increasing rates resulting in increased credit card cost for consumers. Though expectant inflation increase (called inflation psychosis) may be a contributing factor to rates increases from these companies yet government regulation is fast becoming the determinant for the rate increases. The bottom line is reduced regulation increases aggregate supply (through increased business investment) whilst increased regulation reduces aggregate supply. This presupposes any government regulation in the financial sector should be very “smart” regulations that promote sound attractive business environment consequently increasing aggregate supply.

Conclusion

The statistical figures and analysis presented in part 1 and 2 of this article does present an economy technically out of recession. However, it also suggest the need for intervention and remedial measures (including regulations) to contain the situation in the longer term as inaction will seriously “crowd” the recovery and create hardships in the future. Emphasis was placed on three factors that are critical for the economy whose remediation may require government intervention and policies. They included the growing unemployment rate, rising national debt and the indeterminate consumer confidence. It was iterated that the successful recovery of the economy in the medium-long term will be determined by these three factors. Also the outlook of the economy and the ability of the country to maintain its superior power economically and military-wise will also depend on these factors. The growing debt requires policies (mostly fiscal) that put brakes on the debt growth. There is also the need to protect investors (both foreign and local) through very “smart” regulations that produce the required leverage of risks, ensures transparency and ethical transactions or remunerations in the financial sector.

Author: Charles Horace Ampong [MSc(Eng), MBA]
Blog: http://www.charliepee.blogspot.com/  

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Politics & Policies of Economic Management (Part 1)

Pertinent views about government regulation evolution and how it impacts consumer-investors protection and innovation has been a sensitive subject of discussion, contention especially among analysts and largely investors and other professionals in the financial sector. The bottom line being the fact that government regulation is a double-edged sword because it does affect the cost doing business and the ease of doing business. And that sound government regulations should seek to create a business environment which reconciles the cost of doing business and the ease of doing business consequently setting conducive environment for investors. In this wise stimulating the inflow of investments and creation of jobs.

Strangely, regulations set by government have sometimes failed to convince the masses as to why the regulations are needed in certain sectors. The primary reason being differences in perception of people and an inherent resistance to change. For some skeptics, policies such as reforms at Wall Street and derivatives trading are deeper than they can imagine. They see such pursuits as being more of a political ideology or politically-oriented rather than policies that are healthy for management of the economy. For example, it is known by all economic analysts that fiscal spending is meant to increase aggregate demand and promote growth yet there is contention by some analysts on the massive stimulus spending by the current administration in the last year with regards to its capacity to create jobs. Unfortunately, such economic assertions by analysts may be paradoxical, unfounded and political since it is known by experience that stimulus package at least has been a primer for the rejuvenation of some major economies in the world including but not limited to United States, China, Japan and Brazil. The aftermath the current signs of recovery being witnessed globally. The following are some hard supportive, informative but comprehensive analysis substantiating the signs of recovery, contentions and issues of concern regarding policies for the long term economic management of the country.

The U.S economy according to the Bureau of Labor Statistics recorded a growth of 5.6% in the last quarter of year 2009 beating the expectations of most analysts. On average the country recorded 0.18% increase in 2009 as against a fall of 1.83% in 2008 and an increase of 2.53% in 2007. Perhaps, this is indicative of the recession bottoming out in late 2009. Next, in the month of March 2010, other economic indicators gave the following: Consumer Price Index (CPI) rose only 0.1%. Producer Price Index (PPI) rose 0.7% seasonally adjusted. Payroll employment had 162,000 jobs added in March and 290,000 jobs in April (a 79.01% increase meaning 128,000 jobs added). Productivity rose 6.9% in the last quarter of 2009. Again, productivity increased 3.6% in the non-farm business sector and 2.5% in the manufacturing sector in the first quarter of 2010. In fact, job gains occurred in manufacturing, professional and business services, health care, and leisure and hospitality and also in the government sector. Consumer confidence rose from March (consumer confidence index of 52.3) to April (consumer confidence index of 57.9). To appreciate these economic statistics perhaps there has to be a comparison of these figures with that of year 2007 when the recession is assumed to have officially started. On the other hand, the negative news was the slight increase in unemployment rate from 9.7% in March to 9.9% in April (a 2.06% rise). Let’s do the math here. When the percentage rise of 2.06% is multiplied by the more than 8.5 million people out of work, it translates into something more than 175,258 additionally meaning more than 8.67 million people may be out of work currently. Again, the figure 175,258 obtained is more than the payroll addition of 128,000 (March to April) which further validates the fact that more than 8.5 million people may be out of work. Also March average hourly earning fell by 0.2% even though weekly earnings were up by 0.1%. Interestingly, there is some contention by skeptics on the payroll employment statistic recorded. That the payroll employment included government temporary jobs such as the census workers meaning the payroll employment figures are overestimated. Here also the assertions may be political rather than true economic analyses. As a matter of fact the preceding statistics on the whole offers some blessings with regards to signs of recovery but calls for cautious optimism. We have every reason to remain cautious taking into consideration the sustainability of any gains for the leading economic indicators, the increasing federal deficit, national debt and balance of trade deficit. The balance of trade deficit as at February 2010 stood at $39.7 billion which further translates into an import to export ratio of about 9:1. That means for every dollar of goods exported about $9 dollars of goods is imported.

Now, the three non-trivial economic factors that should be of concern to everyone are an extended period of consumer spending slow growth, the high unemployment rate and the rising national debt. People may develop a funny feeling of recovery optimism considering the rise in consumer spending in April. With a rise in consumer confidence in April (the highest level since September 2008), it is expected to factor positively but not immensely into business hiring producing only a marginal change in employment. Should this trend in consumer confidence continue there is still need for caution regarding any recovery euphoria. In fact there is more saving than spending and also external investors are reluctant to invest in the economy because of the low interest rate of 0.25%. The propensity of the Fed to keep the rate at this level may have serious repercussions for the economy in the long term with regards to attracting foreign investors. Investments predominantly portfolio investment is being affected by this low interest rate. There is also the phobia of the dollar weakening in the future due to the mounting deficit and debt. Obviously, business will be affected and employment reduced leading to increased unemployment rate perhaps to something higher than 9.9% in the nearer future. In reality, whilst there is much worry when the unemployment rate of 9.9% is mentioned, it must also be made clear that unemployment is a lagging indicator which means more time is needed for it to show appreciable improvement. Perhaps it is right to forecast that the unemployment rate will max out in the next few months and then begin to drop. This will be realized when GDP growth becomes sustainable and recovery stabilizes. Over the next eight to twelve months, analyst should watch generally for sustainability of the gains in the leading indicators though some fluctuations are plausible. As a matter of fact, economists should be more interested in leading indicators as against lagging indicators or coincident indicators. The reason is that a leading indicator is a rate-determining factor for the emergence of an economy from recession. Upswings in leading indicators do suggest recovery is on track though lagging indicators such as unemployment rate and coincident indicators such as nonfarm payrolls may show otherwise.

Finally, the strength of the economy includes investor confidence. That is if foreign investors continue to find confidence in the U.S economy, then there is the likelihood of foreign investors still investing in dollar-dominated securities which will also help reduce the downward pressure on the dollar besides creating a surge in investments. Again, regarding consumer confidence there is some bit of mixed news even though it increased in the month of April yet it is purported not to immensely affect business hiring and for that matter reduce the unemployment rate in the short-term. The U.S economy is technically out of recession but growth will be gradual. In fact the situation can be likened to someone who has fallen into a bottomless pit. The way out of the pit for the victim has two levels of incline. The lower level has steep slope incline whilst the upper level has gentle slope. The journey up the lower level incline will be impacted greatly by gravitational and frictional forces on the plane such that progress appears to be stalled. The retardation effect of these forces may present the picture that no progress is being made. Nevertheless, little by little progress is being made up the incline. This is the situation the country is facing now. The economic forces of gravity and friction include the slowed growth in consumer confidence, mounting national debt, trade deficit among others. These may act in such a way it may appear that no progress has or is being been made. In other words, they present a picture of economic deceleration. In spite of this very soon the country will complete its journey up the steep slope and then enter the second level which is the gentle slope. Once it gets to the gentle incline, economic acceleration will be on track and the economic forces of retrogression will have less impact. Of course all these developments will depend on the kind of monetary and fiscal policies that will be in place.

Author: Charles Horace Ampong [MSc(Eng), MBA]
Blog: http://www.charliepee.blogspot.com/

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Evolution of government regulations and its impact on investor protection and innovation!(Part 2)

This article has been published on ArticlesBase.com. Click here to see it

In segment one (1) of this article, I discussed some genesis and chronology of government regulations and the mixed blessings associated with its impact on investors and consumer protection and innovation. In segment two(2) of this article, I would like to discuss some conflict of interest that exist between government and investor proclivities and why corporate tax reduction may not always be the answer to creating jobs or stimulating the investment climate.

Shareholders interests versus Government regulation on company investments

Shareholders for medium and large sized corporations do influence corporate governance in spite of their limited liability. They are interested in pursuits of projects that will increase their earnings and wealth. Consequently, management of companies may be under obligations to pursue projects in a foreign country if cost is low compared to the cost of doing business in the U.S. That means no matter the magnitude of the tax breaks or corporate tax reduction, if the cost of doing business at home is high compared to the cost doing business in foreign land such as India, China, Brazil or South Africa, American firms will continue to outsource jobs. In fact, shareholders may be more interested in management outsourcing jobs if that will increase their returns and equity as against a cut in corporate tax which will give marginal returns domestically. Analysts will bear with me that corporate tax has some degree of direct proportionality with cost of capital which is the determinant for investor’s rate of return ceteris paribus. Nevertheless, financial mathematics hypothesizes the inverse relationship between cost of capital and debt ratio for decreased corporate tax under some given conditions. The hypotheses is that cost of capital decreases with increased debt ratio for decreased corporate tax until a point where a firm’s ratio of debt to capital becomes so huge that the tendency for default or bankruptcy is highly probable. In that situation, any significant reduction in corporate tax may not reduce the cost of capital. The simple reason being that the interest on debt (which is tax deductible) becomes large and any corporate tax reduction by government may not reduce company cost of capital. Ultimately, large companies in America with high debt ratios stemming from the recession may not benefit much from the government’s corporate tax reduction or tax breaks because of the inherent high cost of capital and an expected increase rate of return. In fact there is a trade-off between the rate of return and the cost of capital for these companies. On a positive note, companies with smaller debt ratio may benefit as cost of capital will reduce even with increased debt ratio for decrease corporate tax. For these reasons, the government recent announcement to give tax breaks or incentives may favor companies with favorable cost of capital to debt ratio. What is not clear now is whether such situations will result in massive job creation that will reduce the unemployment rate drastically (halving it from the current rate of 9.7% to about 4.7%). From another dimension, the situation again becomes precarious because of corporate tax differential between United States and other countries. United States currently has comparatively high corporate tax of 39% which makes it one of the western countries with a higher corporate tax. The following are some corporate tax statistics: China has had to cut its corporate income tax from 33% to 25% in the last few years. South Africa also did cut its already low corporate tax from 12.5% to 10% to further stimulate investment inflow. Hong Kong did cut its corporate tax from 17.5% to 16.5% in order to remain competitive for Direct Foreign Investment inflow in Asia. In 2008, Germany cuts its corporate tax by a whooping 8.7% (from 38.9% to 30.18%). The comparatively low corporate tax of these countries puts United States in a disadvantage position when the positive effect of corporate tax reduction on business increase is considered ceteris paribus. United States may have advantage with regards to the ease of doing business but high corporate tax differential may knock that off.

Economics of Corporate Tax with respect to ease and cost of doing business

Now, considering the economics of corporate tax contrast and its impact on the ease of doing business and the cost of doing business, there is much at stake. According to the World Bank Ease of Doing Business Index, a country’s ranking with regards to the ease of doing business is a quantitative measure of its business environment in terms of business friendliness, simplicity of its regulations and also protection of property rights. Seriously, there is a paradox here when the ease of doing business is compared with the cost of doing business. I must emphasize that the ease of doing business and cost of doing business are not the same for a given business environment. From the definition of ease of doing business, it presupposes that the measure is a partial quantification of systematic risk (that is risk due to interest rate, inflation, exchange rate, taxes e.t.c) and unsystematic risk (that is risk due to terrorism, takeover, unrest e.t.c). This means the measure is devoid of the impact of macroeconomic factors (namely interest rate, inflation, exchange rate, economic conditions e.t.c) and security (predominantly terrorism threat). Cost of doing business provides a broader measure of risk (systematic and unsystematic) and that is more non-trivial. Ironically, it is possible for a country to be ranked very well on the ease of doing business scale but the cost of doing business may produce a retardation effect on the progress of its business environment. Most countries that high ranked on the ease of doing business index rating may be low ranked on the cost of doing business index if it were to exist. Investors will not only consider the ease of doing business but also the cost of doing business in their investment proclivities.

United States is currently ranked third on the ease of doing business after New Zealand (2nd) and Singapore (1st). And does it mean that the U.S will be ranked well with regards to the cost of doing business so as to attract more investors to create more jobs? Certainly, much will depend on whether the Fed can maintain the current macro-stability of low inflation and interest rates, low taxes or whether it will be compelled to increase taxes and interest rates in the coming months so as to prevent the economy from climbing the inflation hill. As a matter of fact, the momentum for influx of investments does not depend only on giving tax breaks or incentives but also on maintenance of macro-stability and security in the nation. Remember, terrorism poses an unsystematic risk and threat which increases the cost of doing business. What a country needs to promote a sustainable prosperity are policies that are not only geared towards the ease of doing business but also the cost of doing business. Reconciling the ease of doing business and the cost of doing business provides conducive environment for attraction and retaining of investors. Ultimately, reconciliation of the ease of doing business and the cost of doing business should be the objective of every government. That is what the world and the United States needs.

Conclusion
Government regulation or policies indeed has a ripple effect on investor protection and innovations. It is also a double-edged sword as it provides some form of protection to the market in terms of unscrupulous and unethical transactions and on the other hand infringing on freedom in the market. These regulations has also led to the emergence of financial innovative platforms such as Eurobond, Assets-Backed Security Management and the SOX Act. In spite of these positive developments, government regulations regarding corporate tax do have a marginal effect when shareholders interest is taken into consideration. Additionally, the effect becomes more complex and precarious when the ease of doing business and the cost of doing business are also incorporated in the analysis.

Author: Charles Horace Ampong [MSc(Eng), MBA]
Blog:http://www.charliepee.blogspot.com/  

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Evolution of government regulations and its impact on investor protection and innovation!(Part 1)

This article has been published on ArticlesBase.com. Click here to see it

Over the years, there has been much resentment towards the influence of government regulations on the market and the economy as a whole. The resentments have sometimes resulted in social unrest and resistance culminating in government displeasure. Some believe that the passage of comprehensive regulation for reforms is a form of nationalization and an infringement on one’s freedom. A case in point is the current "tug of war" on the health care Bill in the U.S. It is also possible that a similar situation will arise when the impending financial regulations reforms is brought on the table. We also know of the Greece situation where the government was compelled to enact measures that were unpopular with the people of Greece yet was complimented by the world and the EU. The austerity measures by the state of Greece are meant to protect the identity of the country and satisfy the conditionalities of international funding organizations for financial assistance. Now in whatever form the situation may be, the fact remains that government regulations to impact the economy is a double-edged sword. That is to say, government regulations may offer some form of protection for investors wealth or stakeholders interest, however it may encroach on freedom in other areas. This is because investors and stakeholders alike may not want to be restricted in their market transactions yet they want to be guaranteed property rights protection, wealth and economic security. Furthermore, there is the general perception that their creativity ability is impaired when government regulations goes beyond the boundaries of protecting their wealth or economic security into their dome of freedom. Notwithstanding, in this era of economic uncertainty, national government regulation is taking a new direction in almost every country in the world including United States. In fact, there is an evolution of regulations that are protectionism-oriented than economic liberalism-oriented. The objective here is to stabilize the market economy, prevent economic or financial capital failure or mismanagement, promote equity and remove bottlenecks of unjustified management or corporate remunerations. Now, from a very critical perspective these government proclivities do impact investor protection and innovation and this article seeks to elucidate on the ramifications of such penchantcy. Consequently, in the ensuing discussion, investor protection and consumer protection will be contrasted with innovation with the common denominator being government regulations or policies. Other issues to be discussed in the compendium are the effect of corporate tax reduction and why corporate tax reduction may not be the ultimate solution for investment stimulation in a country. The following provides some deliberations on the genesis and chronology of government regulations and its relation with investor and consumer protection and innovation.

The Genesis and the Chronology

Most analysts will agree with me that technological innovation in the financial sector can be impaired or enhanced by government regulations. In my article titled “World Financial Systems in Limbo- What to expect”, I expatiated on this issue and how it is affecting the world economy. I will not want to go back to that. However, I would like to discuss three other notable cases of financial innovation that came about because of government policies. They are the emergence of the Eurobond, Asset-backed securities and the Sarbanes Oxley Act of 2002 (SOX). The third case which is the SOX Act could not be classified purely as an innovation but it emergence brought sanity into the accounting sector besides adding transparency.

Now, let’s consider the facts of the issues. The interest equalization tax which was instituted by the United States government in 1963 to dissuade U.S investors from investing in foreign securities led to the creation of the Eurobond market. American investors had no option but to invest in these bonds causing the bond to gain worldwide popularity in addition to stimulating other governments and institutions to trade in this market. Strangely, in spite of the default risk associated with the Eurobond and inappropriate documentation governing its transactions, Eurobond market has continued to become a source of financing for governments, banks, global investors, underwriters, traders among others. So, it can be deciphered here that government regulation led to the emergence of this bond which is a sort of financial innovation.

Another positive outcome of government regulation with respect to financial innovation is the creation of the risk management tool called Asset-backed Security management. It encompasses the securitization of some underlying assets of banks making it possible for banks to have clean balance sheets as the risk associated with their bad assets can be transferred to a third party in return for cash. For example payments for underlying assets such as mortgage loans, auto loans, and credit cards e.t.c as they become bad debts are sold to a third party by the bank in exchange for cash. In this way, the risk is transferred to the third party who works to liquidate such illiquid assets and use that to pay the bank. Having attained clean balance sheets, banks are then able to invest in new assets and loans. This concept of asset-backed security management was officially instituted by the United States Security Exchange Commission (SEC) on January 18, 2005. It was also the presence of this concept that paved the way for the U.S government in 2008 to buy all the bank bad debts and save them from collapse. As mater of fact, asset-backed security management regulation is a mixed blessing. On one hand, it has provided a debt cleansing insurance methodology for banks but on the other hand it has put tax-payers money at risk indirectly affecting the deficit. Remember the financial resource for buying the bad debts from the financial institutions was predominantly the tax payer’s money.

Next, on the list of government regulations is the Sarbanes Oxley Act of 2002 (SOX) and the Corporate Fraud Task Force which was instituted by SEC to bring sanity, ethicalness in the sector and obviate corporate accounting scandals inadvertently reinforcing the financial accounting sector. As is widely known, the Act was of three objectives; First, to increase accuracy and transparency in Financial Accounting reporting. Second, to buttress corporate or management accountability and probity in the sector. Third, to promote independent auditing procedures so as to curtail fraudulent reporting, conspiracy and deception. Again, though this Act has no direct correlation with innovation yet it reinforced and transformed the accounting sector setting the pace for ethical creativity in the sector. In fact, the presence of this Act has boosted transparency, accountability and probity in the accounting sector in the United States. Interestingly, opponents of this Act argue that the regulation has made the U.S less competitive in terms of financial resource attraction from global investors because of some stringent components of this Act driving away investors. They also contend that the country’s share of international Initial Public Offerings (IPOs) has gone down from 50% in 2000 to single digits recently because of this Act. They predict the country will gradually loose its competitive edge in the financial market and that Wall Street is negatively impacted by this regulation. No matter the sentiments of opponents, one thing is needful and that is investors must be protected. The Act offers this protection to some degree even though complete protection is impossible. For example investors can be protected from fraud but they cannot be insulated from huge bonuses and other immense fringe benefits given to CEOs of financial institutions and Wall Street. Also, complete protection is not desirable in today’s economy for two (2) apparent reasons: First, it can inhibit innovation with regards to the development of human capital in a firm. Second, there is an inherent increased cost of regulation. In other words, the manager’s ability to be innovative will be impaired and also the government will incur high cost due to the running of extensive stringent corporate governance regulations. This also presents another front of the association between financial capital and human capital. And that financial capital should be complemented by human capital for profitability of a firm. It is the human capital that manages the financial capital to ensure profitability.

In my opinion, every regulation or policy (fiscal or monetary) must be assessed from a cost-benefit perspective. A categorical assessment of the regulation will help in its classification as being under-regulation, over-regulation with regards to its expected impact on the market. That means advocates and opponents of the SOX Act must assess it from a cost-benefit analysis. It is commendable that the presence of similar regulations prevailing in the United States has brought the products and operations of the Auto makers GM, Toyota and the rest under the microscope. Toyota has been scolded by congress for the massive recall of over $ 8 million defective products worldwide and misleading information to the public about these products in spite of thousands of complaints. Obviously, the company faces tough times ahead in terms of regaining confidence of its customers and maintaining its competitive edge in the Auto industry.

Regrettably, despite the presence of the SOX Act and other financial regulations, it is absurd that huge bonuses were declared recently for CEOs of some banks and institutions. The move actually incurred the discontentment of the government and most Americans as well. In fact, this revealed the limitations of the SOX Act and the existing financial regulations and set the pace for future revision of them to take care of such recurring contingencies. Again, it provides some justification for the push by the current administration with regards to the augmentation and overhauling of the existing financial regulations. Consequently, regulations that will seek for reinforcement of accountability, probity and forestall unethical gestures such as huge unwarranted bonuses in the financial sector whilst at the same time promoting creativity or innovation in the sector are needed.

Also, currently in the pipeline is the issue of government policy of tax breaks or incentives for companies that employ Americans or companies that do not outsource jobs. The bipolar nature of tax breaks suggests tax increases for firms that outsource jobs and tax decreases for companies that do not. Giving tax breaks judiciously to some employers and denying others is obviously an incentive to increasing investment inflow and reducing outflows. Subsequently, a reduction in corporate tax can stimulate investment and job growth in the green sector including but not limited to the renewable energy sector, biotechnology and healthcare. However, the issue becomes precarious when such tax breaks or incentives are predominantly corporate tax oriented. There are two issues that of concern here namely

• The influence of shareholders interest on companies as against stakeholders, and

• The economics of corporate tax reduction from the dimensions of ease of doing business and cost of doing business.
Now, in the next segment of this article, I will be discussing shareholder and stakeholders interest impact on government regulations and vice versa. Additionally, the economics of corporate tax from the perspective of doing business in the western world will be addressed. Read on from part 2 of this article.

Author: Charles Horace Ampong [MSc(Eng), MBA]
Blog: http://www.charliepee.blogspot.com/  

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Five (5) Scenarios Depicting Government policies as a Two-edged Sword! (Part 2)

In the first part of this article, I discussed the influence of government policies on international trade and nationalization. I also elucidated on the hidden disparity between international trade and national security, nationalization and de-nationalization. In this segment (part 2) of the article, I would like to discuss the scenario regarding the impact of government policies on investor protection and innovation as a double-edged sword.
Also in this segment investor protection and consumer protection will be contrasted with innovation. Other issues to be discussed are the effect of corporate tax reduction and why corporate tax reduction may not be the solution for investment stimulation in a country. The following provides the deliberations on this scenario and perspectives.

Scenario 3: Investors and Consumer Protection Vrs Innovation - Most analysts will agree with me that technological innovation in the financial sector can be impaired or enhanced by government regulations. In my article titled “World Financial Systems in Limbo- What to expect”, I expatiated on this issue and how it is affecting the world economy. I will not want to go back to that. However, I would like to discuss three other notable cases of financial innovation that came about because of government policies. They are the emergence of the Eurobond, Asset-backed securities and the Sarbanes Oxley Act of 2002 (SOX). The third case which is the SOX Act could not be classified purely as an innovation but it emergence brought sanity into the accounting besides adding transparency.

Now, let’s consider the facts of the issues. The interest equalization tax which was instituted by the United States government in 1963 to dissuade U.S investors from investing in foreign securities led to the creation of the Eurobond market. Here, American investors had no option but to invest in these bonds and this caused the bond to gain popularity stimulating other governments and institutions to trade in this market. Strangely, in spite of the default risk associated with the Eurobond and inappropriate documentation governing its transactions, Eurobond market has become a source of financing for governments, banks, global investors, underwriters, traders among others. So, it can be deciphered here that government regulation led to the emergence of this bond which is a sort of financial innovation.

Another causal effect of government regulation in financial innovation is the creation of the risk management tool called Asset-backed Security management. It encompasses the securitization of some underlying assets of banks making it possible for banks to have clean balance sheets as the risk associated with their bad assets can be transferred to a third party in return for cash. For example payments for underlying assets such as mortgage loans, auto loans, and credit cards e.t.c as they become bad debts are sold to a third party by the bank in exchange for cash. In this way, the risk is transferred to the third party who works to liquidate such illiquid assets and use that to pay the bank. Having attained clean balance sheets, banks are then able to invest in new assets and loans. This concept of asset-backed security management was officially instituted by the United States Security Exchange Commission (SEC) on January 18, 2005. It was also the presence of this concept that paves the way for the U.S government in 2008 to buy all the bank bad debts and save them from collapse. As mater of fact, asset-backed security management regulation is a mixed blessing. On one hand, it has provided a debt cleansing insurance methodology for banks but on the other hand it has put tax-payers money at risk indirectly affecting the deficit. Remember the financial input from the government was predominantly the tax payer’s money.

Next on the list of government regulations is the Sarbanes Oxley Act of 2002 (SOX) and the Corporate Fraud Task Force which was instituted by SEC to bring sanity, ethicalness in the sector and obviate corporate accounting scandals inadvertently reinforcing the financial accounting sector. As is widely known, the Act was of three objectives; First, to increase accuracy and transparency in Financial Accounting reporting. Second, to buttress corporate or management accountability and probity in the sector. Third, to promote independent auditing procedures so as to curtail fraudulent reporting, conspiracy and deception. Again, though this Act has no direct correlation with innovation yet it reinforced and transformed the accounting sector setting the pace for ethical creativity in the sector. In fact, the presence of this Act has boosted transparency, accountability and probity in the accounting sector in the United States. Interestingly, opponents of this Act argue that this regulation has made the U.S less competitive in terms of financial resource attraction from global investors because of some stringent components of this Act driving away investors. They also contend that the country’s share of international Initial Public Offerings (IPOs) has gone down from 50% in 2000 to single digits recently because of this Act. They predict the country will gradually loose its competitive edge in the financial market and that Wall Street is negatively impacted by this regulation. No matter the sentiments of opponents, one thing is needful and that is investors must be protected. The Act offers this protection to some degree even though complete protection is impossible. For example investors can be protected from fraud but they cannot be insulated from huge bonuses and other immense fringe benefits given to CEOs of financial institutions and Wall Street. Also, complete protection is not desirable in today’s economy for two (2) apparent reasons: First, it can inhibit innovation with regards to the development of human capital in a firm. Second, there is an inherent increased cost of regulation. In totality the manager’s ability to be innovative will be impaired and also the government will incur high cost due to the running of extensive stringent corporate governance regulations. This also presents another scenario of the association between financial capital and human capital. Financial capital should be complemented by human capital for profitability of a firm. It is the human capital that manages the financial capital to ensure profitability.

In my opinion, every regulation or policy (fiscal or monetary) must be assessed from a cost-benefit perspective. A categorical assessment of the regulation will help in its classification as being under-regulation, over-regulation with regards to its expected impact on the market. That means advocates and opponents of the SOX Act must assess it from a cost-benefit analysis. It is undisputable that the presence of similar regulations prevailing in the United States has brought the products and operations of the Auto makers GM, Toyota and the rest under the microscope. Toyota has been scolded by congress for the massive recall of over $ 8 million defective products worldwide and misleading information to the public about these products in spite of thousands of complaints. Obviously, the company faces tough times ahead in terms of regaining confidence of its customers and maintaining its competitive edge in the Auto industry.

Regrettably, despite the presence of the SOX Act and other financial regulations, it is absurd that huge bonuses were declared recently for CEOs of some banks and institutions. The move actually incurred the displeasure of the government and most Americans as well. In fact, this revealed the limitations of the SOX Act and the existing financial regulations and set the pace for future revision of them to take care of such recurring contingencies. Again, it provides some justification for the push by the current administration with regards to the augmentation and overhauling of the existing financial regulations. As a matter of fact, regulations that will seek for reinforcement of accountability, probity and forestall unethical gestures such as huge unwarranted bonuses in the financial sector whilst at the same time promoting creativity or innovation in the sector is commendable.

Also, currently in the pipeline is the issue of government policy of tax breaks or incentives for companies that employ Americans or companies that do not outsource jobs. The dipolar nature of tax breaks suggests tax increases for firms that outsource jobs and tax decreases for companies that do not. Judiciously, giving tax breaks to some employers and denying others is obviously an incentive to increasing investment inflow and reducing outflows. Again, a reduction in corporate tax can stimulate investment and job growth in the green sector including but not limited to the renewable energy sector, biotechnology and healthcare. However, the issue becomes precarious when such tax breaks or incentives are predominantly corporate tax oriented. There are two issues that of concern here namely

• The influence of shareholders interest on companies as against stakeholders, and

• The economics of corporate tax reduction from the dimensions of ease of doing business and cost of doing business.
Shareholders for medium and large sized corporations do influence corporate governance in spite of their limited liability. They are interested in pursuits of projects that will increase their earnings and wealth. Consequently, management of companies may be under obligations to pursue projects in a foreign country if cost is low compared to the cost of doing business in the U.S. That means no matter the magnitude of the tax breaks or corporate tax reduction, if the cost of doing business at home is high compared to the cost doing business in foreign land such as India, China, Brazil or South Africa, American firms will continue to outsource jobs. In fact, shareholders may be more interested in management outsourcing jobs if that will increase their returns and equity as against a cut in corporate tax which will give marginal returns domestically. Analysts will bear with me that corporate tax has some degree of direct proportionality with cost of capital which is the determinant for investor’s rate of return ceteris paribus. Nevertheless, financial mathematics hypothesizes the inverse relationship between cost of capital and debt ratio for decreased corporate tax under some given conditions. The hypotheses is that cost of capital decreases with increased debt ratio for decreased corporate tax until a point where a firm’s ratio of debt to capital becomes so huge that the tendency for default or bankruptcy is highly probable. In that situation, any significant reduction in corporate tax may not reduce the cost of capital. The simple reason being that the interest on debt (which is tax deductible) becomes large and any corporate tax reduction by government may not reduce its cost of capital. Ultimately, large companies in America with high debt ratios stemming from the recession may not benefit much from the government’s corporate tax reduction because of the inherent high cost of capital and an expected increase rate of return. Also, there is a trade-off between the rate of return and the cost of capital for these companies. On a positive note, companies with smaller debt ratio may benefit as cost of capital will reduce even with increased debt ratio for decrease corporate tax. For these reasons, the government recent announcement to give tax breaks or incentives may favor companies with favorable cost of capital and debt ratio. What is not clear now is whether such situations will result in massive job creation that will reduce the unemployment rate drastically (halving it from the current rate of 9.7% to about 4.7%). From another dimension, the situation again becomes precarious because of corporate tax differential between United States and other countries. United States currently has comparatively high corporate tax of 39% which makes it one of the western countries with a higher corporate tax. The following are some corporate tax statistics: China has had to cut its corporate income tax from 33% to 25% in the last few years. South Africa also did cut its already low corporate tax from 12.5% to 10% to further stimulate investment inflow. Hong Kong did cut its corporate tax from 17.5% to 16.5% in order to remain competitive for Direct Foreign Investment inflow in Asia. In 2008, Germany cuts its corporate tax by a whooping 8.7% (from 38.9% to 30.18%). The comparatively low corporate tax of these countries puts United States in a disadvantage position when the positive effect of corporate tax reduction on business increase is considered ceteris paribus. United States may have advantage with regards to the ease of doing business but high corporate tax differential may knock that off.

Now, considering the economics of corporate tax contrast and its impact on the ease of doing business and the cost of doing business, there is much at stake. According to the World Bank Ease of Doing Business Index, a country’s ranking with regards to the ease of doing business is a quantitative measure of its business environment in terms business friendliness, simplicity of its regulations and also protection of property rights. Seriously, there is a contention here when the ease of doing business is compared with the cost of doing business. I must emphasize that the ease of doing business and cost of doing business are not the same for a given business environment. From the definition of ease of doing business, it presupposes that the measure is a partial quantification of systematic risk (that is risk due to interest rate, inflation, exchange rate, taxes e.t.c) and unsystematic risk (that is risk due to terrorism, takeover, unrest e.t.c). This means the measure is devoid of the impact of macroeconomic factors (namely interest rate, inflation, exchange rate, economic conditions e.t.c) and security (predominantly terrorism threat). Cost of doing business provides a broader measure of risk (systematic and unsystematic) and that is more non-trivial. Strangely, it is possible for a country to be ranked very well on the ease of doing business scale but the cost of doing business may produce a retardation effect on its business environment. Most countries that high ranked on the ease of doing business index rating may be low ranked on the cost of doing business index if it were to exist. Investors will not only consider the ease of doing business but also the cost of doing business in their investment proclivities.

United States is currently ranked third on the ease of doing business after New Zealand (2nd) and Singapore (1st). And does it mean that the U.S will be ranked well with regards to the cost of doing business so as to attract more investors to create more jobs? Certainly, much will depend on whether the Fed can maintain the current macro-stability of low inflation and interest rates, taxes or whether it will be compelled to increase taxes and interest rates in the coming months so as to prevent the economy from falling off the cliff again. As a matter of fact, the momentum for influx of investments does not depend only on giving tax breaks or incentives but also on maintenance of macro-stability and security in the nation. Remember, terrorism poses an unsystematic risk and threat which increases the cost of doing business. What a country needs to promote a sustainable prosperity are policies that are not only geared towards the ease of doing business but also the cost of doing business. Reconciling the ease of doing business and the cost of doing business provides conducive environment for attraction and retaining of investors. Ultimately, reconciliation of the ease of doing business and the cost of doing business should be the objective of every government. That is what the world and the United States needs. Watch out for part 3 of this article which will discuss the dogmatism of monetary and fiscal policies as opposed to the politics of managing an economy.

Author: Charles Horace Ampong [MSc(Eng), MBA]
Blog: http://www.charliepee.blogspot.com/  

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Five (5) Scenarios Depicting Government policies as a Two-edged Sword! (Part 1)

In these times of economic uncertainty, governments under a cowering atmosphere may develop the phobia of actuating policies and regulations in a desperate attempt to contain the situation. From a global perspective, the use of policies in the form of regulations and tax breaks to influence a country’s economic position has been rave about by some transformational leaders as a form of insurance for their economies even though in some cases it transcends the rules of the international trade game or globalization in the bigger context. Whichever policies are made in country, the fact remains that government policy in terms of reality is always a two-edged sword. Unfortunately, most in the world especially the capitalist countries are resentful of government regulations and policies. They see these policies as a threat to the progress of capitalism and also to their freedom. However, much as it appears to be a threat in some aspect, there are beneficiation dimensions when its economics of social cost and social benefits are evaluated. It is in the light of these fundamental truths that this article seeks to discuss the convolution surrounding the two-edged nature from the following scenarios and perspectives: national security versus international trade, nationalization versus de-nationalization, investors and consumer protection versus Innovation, monetary and fiscal policies versus Politics and finally environmental protection commitment versus Nash equilibrium.

Scenario 1 - National Security Vrs International Trade: Interestingly, the trade-off between economic gains, national security and sovereignty presents a very dicey situation especially in this era of terrorism rise and threats of rising military prowess of certain countries. Thus, governments in some instances are eclipsed between national security defense and their policies governing international trade. A paradigm of the case is when a country incapacitated by financial crisis or debt is torn between fulfilling budget constraints and national security. Take the case of United States or United Kingdom. In this epoch of mounting budget deficit when United States or United Kingdom has to choose between buying warplanes or national defense equipments from a low-cost country such as China or Brazil as against securing such gadgets from manufacturers in the United States or the EU at a higher price. Obviously, these countries will pay the higher price of increased budget deficits if they decide to buy the planes from manufacturers on its own soil. Nevertheless, they gain because national security and sovereignty is protected. On the other hand, if these countries should buy the defense items from manufacturers in China or Brazil, there is reduced budget deficit but national security is threatened. Subsequently, the decision on the path to take will depend on the contribution margin of the cost to be incurred with respect to the budget deficit versus the highly valued national security. Strangely, the scenario of national security and trade is absurd when social cost and social benefit are assessed from the perspective of international trade in Arms. International trade in Arms which used to be antipathized is fast becoming an acceptable norm in globalization. The driving force being threat of invasion and some countries desire for military prowess. Over the years the world has witnessed Arms being sold openly by some developed and developing nations to other nations as part of international trade. Information also has it that technology is being sold secretly to nations to augment their military capability. The curiousity surrounding such esoteric trade in Arms becomes more stronger when the investors from one country choose to export technology to another country as part of selling services to the country or customers or partners in that country. Regrettably, trading in Arms and secret technology puts the national security of the seller country and recipient country all at risk. On one hand, the technological secrets of seller country may be exposed to the recipient (buyer) country. On the other hand and in the long term, the seller country may become a threat to the recipient country because of an inherent access to its security intelligence. Undoubtedly, the security of the world is being marred by sale in Arms and secret technology both of which implicitly associates with the much dreaded activity “terrorism”. In fact, the world cannot be a safe place until the esoteric sale in Arms and secret technology is constrained and strongly repudiated by United Nations prompting every nation to come clean on any nefarious trade in Arms and nuclear technology. People are of the view that such an agenda is too ambitious and inconceivable judging from the fact that some nations have resisted similar attempts by the UN in the past. Nations cryptically trading in nuclear technology tend to be the most perpetrators of this kind of trade. I am an advocate of nuclear technology application in nuclear reactors for production of energy for social beneficiation purposes and will always identify with governments policies that promote that. However, any policy that circumvents energy production for beneficiation but promotes usage for antagonistic purposes is absolutely unacceptable and deleterious. Enriching Uranium by centrifuging for production of nuclear bombs is detestable and the world must boldly speak against it. United States is doing well by speaking against it but it needs the massive support of the whole world to deal with this growing menace. It is possible those countries that fall into the domain of nuclear technology abusers may feel isolated because of UN sanctions against them. They will try to placate their anger by pursuing policies that might enrage the world. But the world should not be perturbed by such tendencies and must still maintain the sanctions. Some contend that sanctions are not working but I am of the view that sanctions backed by constructive criticism and dialogue will immobilize these autocratic regimes and bring their unpopular pursuits to an end. I also believe the spread of democracy will definitely catch up on the whole world and help eradicate the bad “nuts” in the system. Only time will prove this assertion right. We are the world and we must not let a few dictate our future and freedom. Freedom is a gift from God and we must enjoy it.

Generally, sale in Arms and technological secrets has made the world unsafe and implicitly exacerbated terrorism in the world. Additionally, international trade restrictions have broken down because of some nation’s policies of self-centeredness and indifference to safety and freedom of the world. Sadly, some nations policies of neo-colonialism or economic imperialism for solidification of their national security pose a threat not only to international trade but also to the spread of democracy in the world.

Scenario 2 – Nationalization Vrs De-nationalization: Presently, there is the conglomerate effort by governments of some major economies to propagate global regulations for the financial markets and banks so as to prevent a repetition of the global financial meltdown. To some analyst this is called nationalization and an infringement on the current supposed de-nationalization existing in the capitalist economies. Again, on the pessimistic side of this issue are the analysts who see the predisposition by the leaders as protectionism and an inordinate desire to influence the economy to the detriment of market efficiency. They also see such tendencies as generally not resonating with stakeholders’ interest especially when the country concerned is of capitalistic proclivity. Howbeit, government regulations whether in financial, educational, health and industrial sectors suggest a form of influence of globalization and have several connotations associated with it. Unfortunately, in a period of economic uncertainty, governments may assume a desultory characteristic which makes them more susceptible to enforcement of regulations in educational, health, financial and even the industrial sectors. For example, the current administration of the United States governments and certain western countries are compelled to press for policies and regulations to control some salient sectors of the economy including financial and health center because of the current global economic uncertainty which has incapacitated a lot of families and made them liabilities on the government. It is true that times are hard and government will want to empathize with the masses by pressing for regulations. However, skeptics are worried about how far the regulations can go and its projected negative impacts on the market and most importantly factors of production. Again, such pursuits are seen as an inclination towards nationalization as against de-nationalization of the market economy. In America some economists have described the handling of the GM financial crisis issue as a proclivity towards nationalization. Recall when GM filed for bankruptcy, the government provided more than $50 billion (tax payers money) for its redemption besides taking a stake of 60% ownership of the company and the replacement of its CEO with a government approved one. Coincidentally, further down the road pockets of nationalization has taken place in the country. For example the interstate rail service takeover to form Amtrak and also Airport Security management take over by the federal government after September 11. All these are forms of nationalization that has beneficiation. For example, the recent changes in airport security with regards to whole body scanning of travelers infringe on our privacy and freedom yet it can be effectual in preventing terrorist from getting into flights to cause harm. Should we blame the government for nationalizing the airport security? No. Must we applaud the government for instituting the measure of effective scanning? Yes. What would have happened if the government had not taken over the management of airport security after the September 11, 2001 disaster? In fact, it is quite impossible for a country to exist without any pockets nationalization. In this period of financial failures and global uncertainty, at least some pockets of nationalization even in free-capitalist countries is inevitable. A little nationalization will not kill even though extreme nationalization like what is happening in Venezuela and certain parts of Africa is unacceptable and vicious. Currently, the question that is being debated is whether the domain of nationalization includes turning a private sector indirectly into a public good. For example the allegation currently by some that the health sector is being made a public good with the presumption of the act being synonymous with nationalization. Others believe that government intervention in the health sector may not correct the failing health system. I am of the view that the health sector will only become a public good if only all in America including illegals benefit from it and there is no way to prevent anyone unqualified from benefitting from it. Also there is immense additional cost to be incurred here if checks and balances are not in place. Unfortunately, after much publicized and heated debate in congress, a consensus has still not been reached on the reform proposals. There is an argument of an increased role by government in the sector affecting efficiency in the sector. Another contention is that employers will be burdened with huge healthcare costs. Whatever the healthcare reforms package will entail, it must be judged based on the economic principle of social cost and social benefit and not on the economics of externalities.

Globally, the predilection by some countries for international regulations for banks has been fueled by the recent developments of bad debts at Dubai Bank and also the huge national debts or financial crisis of some European countries with Iceland and Greece at the front. Though, the debt belongs to the individual countries yet it is turning to be a pervasive problem with consequences likely to affect Europe and the rest of the world. The coming of the EU to the aid of Greece will go a long way to reveal the strength of the relationship between the EU countries and the authenticity of the cordiality governing them. Meanwhile, Greece in order to win the approbation of the EU and satisfy the European Stability Pact that enjoins all members to maintain a debt level of 3% of GDP has decided to take some austerity measures including but not limited to VAT increases, freeze on pension funds and working rights limitations, reduction in healthcare benefits. Though this is going to create hardships for the people of Greece with upsurge in social unrest in the coming days, authorities emphasized the measures as being the heady way for the country to deal with its mounting debt and refinance its 17 billion debt bond. In addition to the Stability Pact, the EU may argue that there is too huge a price to pay to remedy Greece from its predicaments. Perhaps, the EU has decided to follow the footsteps of the United States where generally the rescue of states in financial crisis by the federal government is not popular because the tax payer prefers not to bear the cost of a state’s mismanagement. On few occasions the federal government may come to the aid of a state only if there is a justification for that. Sorry to say, EU is not considering the effect their inaction will have on the confidence of the member countries. But the facts are clear. There are a number of EU countries hanging in an imbalance with regards to debts and economic problems. So if the EU cannot extend some minimal level of credit to Greece to help ease the country’s debt burden then it presupposes in future any EU country that finds itself in a similar situation will be allowed to go bankrupt and collapse. In fact, some level of credit should have been extended by the EU to Greece to show to the world the strength of the Union and the care for its members. Indeed, this is a testing time for the EU and the Union’s ability to deal with such problems will go a long way to substantiate the competency of their unity and to brighten the way forward. Perchance any EU intervention to remedy the Greece situation is being categorized as nationalization by the Union.

Finally, it is feared globally that more of such bad debts and financial failures will occur in the near future with repercussions of consumer and investor confidence reduction if nothing is done. Watch out for part 2 of this article which discusses this phobia.

Author:  Charles Horace Ampong [MSc(Eng), MBA]
              GLG Consultant
    Blog:  http://www.charliepee.blogspot.com/

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