March 19-25, Finance and Economics: Japan shakes markets, I learn what the hell re-insurance is, the Europeans come to an agreement (sort of), Credit even you can get, PIMCO's bond selloff, and China throws on the breaks.

Posting one week behind the current issue is starting to catch up with me, and I fear that many of the articles we discuss here are quickly being overtaken by events. Witness Japan, Libya, Yemen, and now Portugal (not to mention the ouster of Canadian tyrant Harper by mobs of angry Canadians) - I'm sure the articles from this week's Economist are probably more current and what I am about to write outdated. But, on principle I refuse to skip an issue to catch up, and as you have probably guessed, doing an extra weeks' entry is about as likely as mid-week posting. Before we get started, I did want to note that the U.S. Treasury Department found and froze a good portion (30 billion worth) of what is ostensibly Libya's sovereign wealth fund that we discussed last week. So a word to the wise, if you're going to become a crazy dictator, you might want to avoid putting your people's money in sovereign wealth funds.

In any case, let's take a look at this week's edition - which, with some really long articles, was a bear (you're welcome).

• The Japanese earthquake has had a severe impact on global equity markets and important elements of global supply chains, and combined with the European debt crisis and the increase in oil prices due to the unfolding events in the Middle East, has sent investors packing. But the magazine offers some reason for hope.
• Re-insurance companies (yeah, I know - I had never heard of this either), which insure the insurers against catastrophic risk, seem poised to absorb the hit from the earthquake based on premium increases from a disaster prone 2010.
• The leaders of the Euro Zone arrive at a deal that exchanges more favorable terms for Greece, but not  Ireland, in exchange for some belt tightening at home - but the analysis suggests that this could be too little, too late (and seems to presage what we know now about Portugal.).
• In the second article in as many weeks about alternative banking, new services Wonga and Klarna allow consumers to borrow and buy on the basis of real time, information-driven credit worthiness.
• Buttonwood does what all of you refused to do in my un-noticed weekly contest from last week: Analyzes the PIMCO Treasury Bond fire sale and its relevance to Quantitative Easing, and goes a step further to speculate on the difficulty of ending the QE process once it has started.
• We get a little more detail about how China is slowing down their inflation through monetary policy and credit tightening, and while retail bank lending is cooling off, the non-conventional loans we discussed some weeks ago still raise the total amounts well over government targets.

But first, impress your friends with:

This Week's Fun Economic Facts:

• The Nikkei 225 average fell by 6.2% and 10.6% in the first two days after the earthquake, and the Dow Jones industrial snuck below the 12,000 mark again, having just made it back for the first time since Lehman collapsed.
• Brent crude oil prices per barrel rose to $116, still $30 short of the $146 in 2008
• Japan is responsible for supplying 90% of an epoxy resin used for the manufacture of circuit boards. It also produces much of the world's lithium batteries and electronic chips. 
• Morgan Stanley estimates that profits for S&P firms should grow by 15.4% this year, following their rise of 39.3% last year.
• Even with re-insurance payouts of between 10 and 20 billion, the non-Japanese re-insurers will still be paying out of profits, and will likely not eat into capital (knock on wood that there's not another major catastrophe.)
• 50 billion Euros: The amount the Greek government intends to raise through privatization of public assets.
• 0: The number of Greek islands currently for sale under this program.
• The annual interest rate on a Wonga loan of as much as $641 (the maximum personal loan) exceeds 4,000%
• Wonga makes over 100,000 loans per month
• The U.S. Federal  reserve is estimated to purchase 70% of issued U.S. Treasury Bonds as part of the Quantitative Easing process
• One ratings agency estimates that China lent over 11 trillion Yuan in 2009, above the official Chinese figure of 7.9 trillion (with the 3 trillion in excess perhaps accounted for by non-traditional lending.

 Yep, a real thrill a minute. Each article, in slightly greater depth for your reading enjoyment, after the jump.
*And if you haven't figured it out, each title in bold is a link to the article discussed.

Aftershocks: It should come as a surprise to no-one, I suppose, that a catastrophe of the magnitude of the Japanese earthquake would have a huge impact on global markets - but I never really stopped to examine why. For one thing, this article explains, as far as equity markets go, Japan was kind of already in dangerous waters by the time the earthquake hit, both as a result of the rising risk within its own economy, and because of global events that have been driving investors for safer shores (I know, lots of water metaphors there.) The danger of inflation has led central banks like the Bank of England and China to raise interest rates, signaling to investors that the traditional instruments of economic stimulus are going to be less active for a while. So investors were already sort of nervous, and when asset prices started to fall, everybody tried to get out at once. But beyond investor expectations, there are two other factors at play. One is the impact on global supply chains, given Japan's role as a producer of critical electronics, including semi-conductors, lithium batteries, chips, and components of circuit boards. In the modern  "just in time" supply chain, inventories are not really available from stockpiles. Somebody is going to have to explain this part to me though - the article claims that another negative consequence will be Japanese investors repatriating assets to Japan to help pay for recovery (presumably by financing the government's efforts in exchange for debt), which will impact other markets in a bad way. Evidently, this was related to the hit on the Australian dollar, which had been traded as a commodities linked asset. On the bright side, as far as global markets go, fund managers currently still believe that the global economy will continue its recovery this year, and so assets should make net gains from the over-exaggerated suppression from the earthquake. Overall, this was kind of a meandering article once I got to the third column.



When Nature Attacks: So, they say you learn something new every day, and when I write this entry, I always learn something. This week, I learned all about the re-insurance industry, which, to be candid, I had no idea even existed. Evidently, insurance companies take out insurance to insulate themselves from huge losses following massive catastrophes, like the Japanese earthquake, essentially transferring risk beyond a certain acceptable limit to another firm who charges premiums to be able to absorb that risk. It's like one giant risk shock absorber - kind of cool. In any case, here's where it gets kind of interesting. Despite a catastrophe-prone 2010, in which we had earthquakes in Haiti and Chile, floods in Australia and New Zealand, and the Deepwater Horizon (which we've all conveniently forgotten about here), premiums did not go up more than usual, perhaps indicating that the industry had already accounted for an increase in natural disasters. The article suggests that non-Japanese reinsurers will probably see losses from the quake in the neighborhood of $10-20 billion, which will only eat into profits, rather than the re-insurers capital. In the past, the article points out that reinsurers hadn't accounted for enough payouts in their considerations for premiums, and so two reinsurance firms, Munich Re and Hannover Re lost 11% and 21% respectively of net premiums, when the industry standard for the assumed percentage of claims as a proportion of premiums charged sits at 6.5%. What does all this mean?

Well, I think it means that insurance is going to pay for a lot of the damage. 

Muddle, Fuddle, Toil and trouble:  Well, what would the Finance and Economics section be without an article about the European debt crisis. In fact, some, like Robert Samuelson have claimed that it could be a bigger catastrophe for the world than the Japanese earthquake (casualties and sheer terror notwithstanding). So,while we all watched with horror the events in Japan or transfixed on Libya, the European leaders met on March 12 on at least a partial agreement to stem the European debt crisis. If you'll recall, at issue are a few things. First of all, the Irish and the Greeks are not happy about the interest rates hoisted upon them in exchange for bailout funding. Next, the European Central Bank and the European Financial Stability Facility (EFSF) were having trouble raising the funding given concerns about capital ratios to meet the 500 billion euro mark for the rescue fund. Next, bond rates are perilously high and unaffordable in the affected countries, and are now skyrocketing in Portugal. Finally, the Germans, who if you didn't know the Economist loves, are holding elections and Angela Merkel can only go so far to make concessions to other European countries on the backs of her voters. Phew! So, at this meeting, here's what we got: The lending capacity of the European rescue fund will reach 500 billion euros; the Greek government got one percentage point and got their loan extended to 7.5 years in exchange for a private sell off of public assets said to expect 50 billion euros; a new "competitiveness pact", led by the Germans (of course) which stipulates that all Euro Zone countries have to have laws on the books to handle public debt. Here's what did NOT happen: 1) The Irish refused to succomb to pressure to raise their corporate tax rate as a condition for a more favorable rate on their bailout funds, much to the chagrin of the French, who hate the competition; 2) No deal was made for debt buybacks at lower rates, which we have discussed in this space before, and 3) Nothing was done to stem the downfall of Portugal, which I presume will be covered next week.

Go Figure: In the second in as many weeks, an article about a new personal finance option for consumers - last week was the alternative to the retail banking sector, and this week is a kind of modified micro-loan. Wonga is a British firm that will provide about $650 to interested borrowers for 30 days (and after that presumably interest makes the loan pretty profitable) on the basis of information, including a number of non-conventional behavioral patterns, like online shopping habits, submitted by the consumer. Another firm, Klarna, allows customers to shop online providing only their date of birth and address, and then bills the customer and takes a fee. Evidently, firms like this are stringing together complex risk algorithms to approve or disapprove credit, and supposedly it's pretty profitable. The article concludes by suggesting that the start-ups may hit rocky roads if they become noticed and hence more regulated, and privacy concerns may make customers leery of using the services, but nonetheless, the trend they represent may be unstoppable in terms of the future of personal financing.


Buttonwood: The old Bill: Well, I have to say, I'm a little disappointed with you. Last week, I challenged you all to write a guest essay on the sell-off of Treasury bonds by PIMCO and its relationship with Quantitative Easing. You all failed. But hey, that's ok, because Buttonwood went ahead and wrote the whole thing up in a tidy article. Bill Gross, the manager of PIMCO's Total Return fund, which has about $237 billion, sold off all of the funds Treasury bonds, causing quite a stir in the market watching community. Mr. Gross, according to Buttonwood, is skeptical of the process of Quantitative Easing, in which the Fed prints money to buy mortgage backed securities and bonds, and has even gone so far as to call it a kind of ponzy scheme. The question provoked by Mr. Gross is who exactly will be buying bonds when the Fed stops doing so, given that currently 70% of bonds are being bought by the Fed. Gross also points to some kind of interesting, in a geeky way, indicators of trouble and is concerned about a spike in bond yields when investors want some compensation for the risk of inflation. First of all, the bond yields are too low based on the rate of economic growth. Next, real rates have been about 1.5% in the past and are currently negative. Finally, the fed funds rate (altogether now, the rate at which banks lend to one another) is below GDP growth. But his critics have said that quantitative easing is near its end, and the Fed has suggested as much. In fact, Buttonwood does point out that the bond selloff is consistent with the actions of a fund that would expect the QE to end soon. But, Buttonwood continues, it is worth asking if QE will be as easy to stop as has been suggested by Mr. Bernanke. For one thing, it's not as easy as just not buying any more bonds - the Fed has to figure out what to do with the ones it has. And selling them off will be no easy task. As the article points out, the most likely time for investors to buy bonds would be when the economy is not doing well (to capitalize on higher interest rates) - but the whole point of QE is that it creates a buyer for bonds when one does not exist, and as the economy starts to improve, the incentive for private investors to buy bonds actually goes down. Mr. Bernanke, in a lengthy section of his March 1 testimony, quotes equity price increases as evidence of QE working (and we've covered that before if you'll recall the P/E ratio discussion we had about Mr. Shiller), which Buttonwood believes is troubling - if stock market confidence is key to recovery, the Fed is not likely to do anything to risk that, and may be caught in a never ending spiral of QE.

Decelerating: For the love of god, another China banking article. Will somebody please end my misery and write a guest article explaining this place for me please? Here we go: We've discussed Chinese inflation, and the need for China to keep growing, but at manageable rates and balancing its inflation across sectors and diversifying away from export growth only (i.e. higher wages and more consumption). At fault for some of the higher-than-wanted growth has been a massive credit flood and much is based on missing the targets for the money supply, M2.  The People's Bank  of China has managed to reign in the money supply pretty well, and is close to where it wants to be to meet an M2 growth rate target of 16% for the year. But let's talk credit. China's banks lent about 535 billion Yuan ($81.5 billion) last month, which was lower than expected - that's good, right? But as we learned a few weeks ago, non-conventional lending, such as securitized loans funneled through less-regulated trust companies added about 3 trillion Yuan in 2009 alone above the 7.9 trillion official figure, making targets elusive. But according to this article, firms suggest that credit is tightening, which will eventually slow down new business growth. The government has also imposed certain taxes, which it had lifted during the economic crisis, in order to restore some of the out of control growth that had been created by bank lending. So, we'll see, but sounds like the 5-year plan is off to a good start. Good job Mr. Hu!


Random Musings: Ok, well that's it for this week. Took me longer to get out this week because I went out to dinner on Sunday night. Had amazing fried chicken on waffles at Marvin. Very happy to see Virginia Commonwealth make it into the Final Four - second CAA team since 2006 when my Patriots were in it. If you didn't catch Secretaries Gates and Clinton on the morning talk shows, definitely try to get the clips - this is compelling history we're watching before our eyes, and the security theorists are getting all tangled in knots about what it all means and what to do about it - Responsibility to Protect advocates are pitted against Moral Hazard theorists, and the air war power debate of the Kosovo intervention is back on the op-ed pages. Meanwhile, Africanists are left wondering why DRC, Liberia, and Ivory Coast have gone un-noticed, and even Ted Koppel this morning said that Libya had won the "humanitarian intervention sweepstakes". I'm just glad I'm not the President, and so should you be (that I'm not the President.) I do have a response to Greg Johnsen's op-ed in the New York Times that I am actually going to try to get printed, but Yemen might be too niche, and I'm certainly not in a great position to be jousting with him in any paper of real repute. On a last side note, I was also shocked to learn that Richard Burton never won an academy award - if Spy Who Came in from the Cold isn't deserving, than I don't know what is. But at this point, I'm off to have sweet dreams of a sojourn through Belgium and the Western Front, eating mussels and drinking great Belgian beer with you during better times. Have a great week, I leave you with my favorite Burton quote from Spy Who Came In From the Cold:

"What the hell do you think spies are? Moral philosophers measuring everything they do against the word of God or Karl Marx? They're not! They're just a bunch of seedy, squalid bastards like me: little men, drunkards, queers, hen-pecked husbands, civil servants playing cowboys and Indians to brighten their rotten little lives. Do you think they sit like monks in a cell, balancing right against wrong?"