February 26 - March 4, Finance and Economics: Oil Prices have #AdonisDNA, but Portugal and Japan's banks could use some #TigerBlood. Basel 3 is #Winning.

Capital Ignorance, going into its third week is #Winning. Sorry, can't help the Charlie Sheen references, because I find the whole debacle pretty hilarious. Meanwhile, the week in the Middle East was nearly as fascinating as the last, and I can only hope that the situation in Libya concludes with as few casualties and as promising a future as possible. This week's issue (or last week for you pedants out there) continues some now familiar themes - retail banking (this week is Japan), sovereign debt crises (Portugal) and equity market reform, and we have some familiar visitors in the Basel 3 rules and Robert Shiller for the third time in as many weeks. For the latter, you'll all have to wait for mid week in my first basic format change. I'll be looking at the "Economics Focus" section later than Sunday because after I was crushed last week by the Focus on Chinese inflation, I realized that my ADD prevents giving the section's concluding opus the attention it deserves. I hope to include more analysis through the week or at least references to articles I've seen that relate to our discussion here. Just this week, for example, you may have seen this article in the New York Times about China's five year plan, which among other things, describes the goal of raising household incomes. Rather than just speculating that this is a response to concerns over unrest in the Middle East meant to satisfy the Chinese public, we learned last week that this might be a policy to promote "good inflation" (is that like "good" Parkinsons, Larry David fans?), i.e. inflation derived from a boost in consumer spending rather than exports, which is critical to balancing China's growth.

But first, let's get to this week, in which the Economist:

• Speculates on the future of oil price increases caused by supply disruptions, in turn caused by unrest in the Middle East. The section highlights the especially troubling, if not unrealistic, prospects for disruptions to Saudi supplies and reserves. (Ahem, wasn't it just two weeks ago that we were pretty optimistic about oil supplies and OECD reserves?)
• Describes a new perspective on the chaos of pricing and markets between pure market theory and behavioral economics, and touches on the prospect of central bank intervention to prevent asset-price bubbles. Can you see the torches of the free-market-or-bust mobs, Buttonwood?
• Paints a troubling picture of Japan's retail banking sector which seems prone to a good crushing soon between Japan's moribund and declining economy and new Basel 3 rules that may prevent it from moving its cash to foreign market investments.
• Sets Portugal up as the next to fall in the European sovereign debt crisis.
• Briefly touches on a watered down and seemingly intractable G20 discussion on the Gordian knot of economic imbalances.
• Discusses the decline of credit ratings systems and agencies in assessing credit for standards and regulation (not consumer credit, so you can temper that short spurt of excitement.), but bemoans the lack of good existing alternatives.
• Offers a brief glimpse into the entertainment insurance market
• ...and for later this week, provides a Focus on the collection of seminal American Economic Review articles now available on that publication's website. 

This week's fun economic facts: 

• OPEC's share of global oil production has actually decreased from 51% in the 1970's to just over 40% now;
• ...But a halt of exports from Algeria alone could send the price of oil to $220 per barrel (from the current $115)
• This week,  Saudi King Abdullah announced government hand outs of $36 billion in benefits for the people of the Kingdom. 
• The Japanese bank Mitsubushi UFJ Financial Group (MUFJ) has deposits worth $1.6 trillion (129 trillion Yen), making it the second biggest bank in the world.
• Portugal's sovereign debt stands at 83% of national output at the end of 2010, and had a borrowing level (budget deficit) at 9.3% of GDP in 2009. (Remember econ nerds, there are two ways of measuring total economic activity in a country. GDP measures expenditures while national output is the total value of goods and services.)
• Finally, best stat yet, Troy Polamalu's hair is insured up to 1 million dollars by Procter&Gamble. 

So, on with the show - after the jump:

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Oil Pressure Rising:  Although the oil market has diversified and globalized since the oil crisis of the 1970s, and the OECD countries have stockpiled enough reserves to last about 50 days (4.3 billion barrels), the fact remains that OPEC production is still critical to the world's economy, and certainly to the prospects for its recovery. Despite no real disruption in production, speculators and investors do not like uncertainty in the market, and the tremors in the Middle East have already sent the price per barrel from $96 to $115 in one month.  Furthermore, the demand for oil caused by Asia's rise means that the markets are tighter than ever - excess inventory is almost entirely owned by the Saudis, and hence the reason for this article: the Saudi Kingdom, with its monopoly on excess supply, is critical to keeping supplies going for a thirsty market in the event of a disruption if prices are to be kept to a tolerable level.  As mentioned above, even the disruption of Algeria's comparatively measly contribution could send the price per barrel to $220. The west has been generally supportive of the democratic movement across the greater middle east - let's see how committed to principles we all are if the Kingdom ever faces its own upheaval.

Buttonwood: Killing off the Monster:  At some point, I'm sure this blog will encounter more articles about the clash of the titans of economic theory: markets vs behavior. This week, Buttonwood's column provides an overview of a new book that tries to navigate between the two streams to explain the inefficiencies of markets, i.e. why market pricing often lags behind or misrepresents the value of securities, leading to phenomena like the housing bubbles, by providing their own conclusions that investors react to the chaos of the market in ways that defy a universal unifying theory. According to the authors, Roman Frydman and Michael Gold of the University of New Hampshire (Beyond Mechanical Markets, Princeton, 2011), investors not only lack insight into what is fundamentally going on or what will happen with the market at any given time, but they tend to focus or emphasize different variables at different times. When growth looked good in the 90's the markets soared in response - but as equity valuations got higher, investors started to get spooked, leading to the market correction of 2000. In any case, "duh", right? Well, before I come to that conclusion, I should mention that the book also recommends that central banks should be able to intervene by defining a pre-existing market range and take action if prices start to surpass limits. The authors evidently argue that this could prevent things like the housing bubble from happening again. I tend to think that the policies we looked at in Brazil - better transparency, higher liquidity and better reporting requirements - may be the better bet, but hey, maybe there's some combination. Anyway, who's got time to read this book anyway? Isn't it kind of like Malcolm Gladwell meets Keynes?

Home and Away: A nod to the upcoming baseball season or the NCAA tournament? Not so lucky, I'm afraid - but nonetheless an interesting piece on Japan's banks. Let's see, we've looked at the Spanish and Russian banks and we've talked about German pressure on the European Central Bank to require better policies in the EU, so let's look at Japan for a welcome reprieve from a bias toward the Eurasian continental mass. Japan's banks are in trouble, or so it seems. Sitting on a massive cash reserve of about 200 trillion yen (does anybody know how to make the little Y sign in Microsoft?), unable to loan due to a poor reputation among Japanese firms, and unable to convince Japanese savers to either borrow or shift savings to higher yield (and higher risk) instruments, Japan's retail banks have started to buy Japanese government bonds. However, with a declining credit rating (see the article on credit ratings later) from Moody's and Standard and Poor's, Japan's government bond s are becoming riskier and the bank's bond holdings therefore become a riskier portfolio. Therefore, despite past poor performance in international forays and a bad reputation for management overseas, the banks are increasingly looking internationally. Japanese banks bought arms of Lehman Brothers, and several failed American banks - but there are troubled waters in foreign ventures as well from a global policy perspective. As we discussed last week, among other requirements for capital holdings, the new Basel 3 rules (do I need to explain this again - just go back and read last week's article...oh, very well.) will require new capital ratios for institutions designated as "Global Systematically Important Financial Institutions", which probably include Japan's largest banks, but they don't know what the ratios will be yet so they can't start making large investments abroad to diversify the risk of their holdings - and to evade the murky future of Japan's domestic economy. There's no reward for being important, I guess.


The Winter of Living Dangerously: Well, I have a conspiracy theory that the Economist has a teutonic crush on Germany, and takes it out by beating down the southern Europeans for their fiscal indiscipline. Of course, there's not much about the Portuguese economy that suggests they don't deserve a little bit of a flogging this week. The Economist suggests that after Ireland and Greece, Portugal may be the next Euro-area country to get the sovereign debt smack down. Unsustainable and unaffordable yields on Portuguese government bonds (now at 7%, which is a full point above what Barclay's recommends, and 3 points separated from German "bunds"), dangerously low capital ratios held by Portuguese banks,  public debt and government fiscal policy similar to its predecessors, and a non-existent level of GDP growth, provides reason for concern. In response, the government of Portugal has enacted plans to cut its budget deficit from 9.3% to 7.3% and on to 4.6% in 2011, in part by some restructuring of pension plans and by cutting public sector salaries and raising taxes  - but those policies have to walk the tight rope, much like in the U.S., of not disrupting or worsening low GDP growth.  The Economist, like the good German magazine it portends to be sometimes, recommends a vast overhaul of the labor market to improve competitiveness and diversifying away from products like textiles that are sensitive to competition from emerging markets. I guess we'll see what the Euros say in March when they will presumably discuss what they plan do do with the Euro area's debt crisis (which we covered two weeks ago. Pay attention.)


Congregate, Implicate, Obfuscate: Well, the G20 has turned into a veritable tower of babble on the concept of economic balancing - and why wouldn't it? Every country has its own national requirements and domestic constituencies to contend with, so why would anybody think that a group of 20 of the largest economies could come together to come to consensus over foreign currency reserves and exchange-rate adjustment. Even having China and the United States in the same room trying to agree seems like a bridge too far. Nonetheless, during the G20 meeting in Paris, the G20 ministers agreed to set "indicative guidelines" rather than "targets", which will take "due consideration of exchange rate, fiscal, monetary and other policies" (quotation marks wryly provided by the editors of the Economist, presumably to highlight the futility of the whole non-binding commitment exercise so familiar in multilaterals facing tough and divisive issues like human rights). The Saudis and the Japanese say that surpluses are overstated, the Americans say that emerging markets are to blame for saving too much and creating artificially low interest rates, Russia and Argentina claim that foreign currency reserves are strategically important and a good self-insurance mechanism, and the Canadians, Italians, and French argue for exchange rate rebalancing, ostensibly targeting China, who argues that savings are not influenced by nominal exchange rates. So, nobody seems to agree - and we're surprised? But I should mention that this is one of the worst kinds of Economist articles - too short to really get a sense of what the hell they're getting at - but complicated enough to feel unsatisfied and generally perplexed.

Downgrading Expectations: I have a secret - I hate the credit score people - whether it's Transunion or Experian, I find their assessments so out of touch and not able to respond to real time economic transactions, income, and other variables, irresponsibly negligent. (I have an excellent credit score, but have horror stories about refinancing and other experiences that merit my ire.) So I'm hoping that this article, about a move afoot to work away from credit agencies Moody's, Standard and Poor's, and Fitch for their recent history of bad appraisals of structured securities and sovereign debt is a positive sign that somebody will reign in the consumer side some day. In any case, the G20's Financial Stability Board has prioritized decoupling standards and regulations, at least in part, from the ratings that these firms provide. In the United States, the Congress has passed the Dodd-Frank act on financial reform, which requires the removal or replacement by alternatives within two years. Ah, but there's the rub - what alternatives? The SEC proposed replacing ratings systems with a "minimum volume of past issuance" for debt securities, and in one sector, insurance, the National Association of Insurance Companies has hired a large fund manager (PIMCO) to develop alternative risk-based capital requirements for the industry's holding of residential mortgage securities.  There are downsides to many if not all of the alternatives that the original process also faced - for one, procyclicality (aggravating negative fluctuations) - you don't want the rating itself creating larger problems in the market than they were designed to resolve. Also, the article concludes, the U.S. and presumably others, will have trouble meeting Basel 3 requirements which rely more, not less, on ratings. Wait, does this mean that the G20 and the Basel Committee on Banking Supervision will have a big throw down over ratings? Stay tuned.


Break a Leg:  Finally, a short, and somewhat trivial (in the best sense of the word) article about entertainment insurance. Clearly written to capture the Oscars vibe (once again, I apologize for being one week behind in the print edition cycle.), we learn that all sorts of things are insured in the entertainment industry - like Steelers Troy Polomalu's hair (1 million) and even leaks of videos over the internet - and many variables are included, such as the volatility of a director's temperament, the number of stunts, and the location where a film or show will be shot. As the 65 million dollar Broadway show Spiderman continues to see actors and actresses sent to the hospital, one has to wonder if they are pulling some kind of "The Producers" stunt by cashing in on insurance claims....

Well, that's all for this weekend.  I don't think there were enough terms to create a terms index this week - most have been covered, and I was pretty comfortable this week in reading the section.  Like I said, I'll try to get a mid-week posting up on some good mid-week relevant articles and the Economics Focus section. George Mason lost today, leaving a sour taste for the weekend, I'm behind in my reading, and the Avalanche are just terrible. And I'm sitting at home waiting for the plumber to come fix my hot water heater and missing an excellent dinner with friends. Hope you all had a better weekend, but I'm optimistic for tomorrow.

Oh, and Michael Scheuer is kind of a pompous and I might add somewhat crude jerk for writing this article. What do you want Scheuer, more tyrants to create more Zawahiris? Let's not get Americans thinking again that everybody should have political rights except for Arabs. Go back to rubber masks and grappling hooks and leave the thinking to Paul Pillar.