Author Archives: psseo

Introduction of Treasury FRN

The Wall Street Journal reported that the U.S. treasury introduced new type of bonds into treasury bond markets. This new type of bond is a floating rate bond also known as FRN. This FRN provides different interest rates structures to investors. Its maturity is two years, and its interest rates payments depend on short term three-month treasury bill and the spread. The FRN pays out interest rates of three-month treasury bill plus the spread, which is the augmented interest rates on three-month treasury bill. For example, the spread of the FRN is 0.045%, and this week three-month treasury bill is 0.035%. Then, total interest rates of FRN is the sum of the spread and three month treasury bill interest rates, 0.08%.

This characteristic of FRN provides investors an opportunity to reduce potential capital loss, which can result from the increase of market interest rates. As the U.S. economy recovers from the Great Recession, there is a growing concern of the Fed increasing the federal funds rates. Early this year market experienced turbulence due to the Fed decision to taper its bond buying program. Once the Fed shows any signal to raise the federal funds rates in the future, market interest rates will increase rapidly. This increase of interest rates can be disastrous for the bond holders. As interest rates increases, the price of bond decreases.

In this situation, the FRN seems to be a reasonable investment tool for investors, especially for those who seek for short term safe investment opportunities. If the three-month interest rates increases to 0.050% from 0.045% in the coming weeks, then total interest rate of the FRN will increase to 0.085%. So, investors of the FRN will get capital loss from the increase of interest rates, but the interest rates of the FRN will increase too along with the increase of the three-month treasury bill, this increase of interest rates payment will compensate part of the capital loss of the bond.

This FRN also is good strategy for the U.S. treasury. As the economy recovers, the demand for long term bonds decreases. The U.S. treasury should pay more interest rates for issuing bonds to revolve maturing bonds. This worsens the burden of the revolving the current debt. But, with this FRN, whose interest rates are much lower than ordinary vanilla bond, the U.S. treasury can limit the increase of interest rates payments burden. In the meantime, for the long term investors, whose main strategy is to buy and hold, vanilla bond is much better investment option than FRN. Two-year treasury bill still pays $40 for $10,000 while two year FRN pays only $8 for $10,000.

IMF criticize foreign exchange rate manipulation

The IMF once again criticized South Korea for manipulating Korean Won exchange rates below the level of normal market foreign exchange rates. The Wall Street Journal reported that, according to the IMF, Korean Won is estimated to be undervalued up to 8%.

There has been growing tension between big current account surplus countries and current account deficit countries about manipulation of foreign exchange rates. The U.S., which has kept huge trade deficit, often criticized big trade surplus countries like China and Korea for maintaining their foreign exchange rates artificially low. The Wall Street Journal reported that The U.S government this week reiterated its complaints, and asked South Korean government to limit its intervention in foreign exchange markets. The main complaints of the U.S is that, due to artificially low exchange rates, the U.S. exporters are disadvantaged in export markets than its competitors in South Korea and China.

The mechanism for manipulation of foreign exchange rates is done through the government and central bank’s intervention of foreign exchange markets. To maintain undervaluation of its currency, government or central bank sell its own currency and buy foreign currencies, mainly the U.S. dollars in its foreign exchange markets. Then, the government or central bank invest those U.S. dollars in the U.S. assets, mainly the U.S. treasury bills or bonds. This is the example of our international finance. Government and central bank increase net capital outflows and this increase of net capital outflow contribute to the increase of net exports and depreciation of their currencies.

However, South Korean government and central bank argue that they just involved in their foreign exchange markets only for the purpose of smoothing the movement of foreign exchange rates to prevent any shocks from sudden change of exchange rates. In other words, they are arguing that they sell Korean Won in the foreign exchange markets and buy the U.S. dollars to reduce the speed of appreciation of Korean Won not the purpose of maintaining artificially low level of exchange rate of Korean Won. But, when we looked at the huge accumulation of foreign reserves in South Korea and China, and their trade surplus, their explanation of foreign exchange market smoothing may not sound so persuasive to the U.S. exporters.

At the same time, the IMF seems to try to persuade South Korea to give up its foreign exchange markets intervention by showing the empirical evidence of decreasing importance of foreign exchange rates in exports. Anyway, for the country like South Korea, which has been dependent a lot on export growth, it will not be that easy to just follow the guidance of the U.S. and the IMF.

(Revised) Google in Hotel Booking Service

The Wall Street Journal reported an interesting story of Google’s new hotel business. Google now aggressively increases its involvement in hotel booking business and strengthens virtual tours of hotel rooms and direct promotion of hotel ads. Google also made a deal to use the online hotel booking technologies with a hotel booking software developing company. This Google’s current business plan of hotel booking is directly hurting its own customers of online travel companies like priceline or expedia, which use internet advertisement of Google. Is this the cruel reality of business that old friends become enemies?

In the meantime, this could hurt Google too because online travel and hotel booking sites are among the biggest customers in Google’s advertisement business. The Wall Street Journal reported that expected advertisement revenue from two giant online travel companies of priceline and expedia will be over $2 billion in 2014, which is 5% of Google’s total advertisement revenues.

Some online travel companies are reported to show positive feedback to this Google’s move. But I guess that they would worry a lot about this fighting with giant internet service providers. This competition between Google and other online travel companies probably makes online travel agencies more disadvantaged than Google. That’s because online travel business heavily depend on internet search engines like Google. If traveler uses Google, then the search result of hotels will probably benefit for Google than other competing online travel agencies.

I think that this kind of business expansion of Google is very likely to happen to other kinds of online business too. Especially, businesses, which rely heavily on internet usage, face possible threat of market entrance of internet service providers like Google. It reminds me that some big retail stores now produce lots of their own products and sell them instead of selling goods made by other manufacturing companies.

On the other hand, from the perspective of customers, this change in hotel booking service does not sound so bad. This increased competition is very likely to result in decrease in hotel prices and better promotions for customers. Reasonably, by direct transaction with internet service provider, hotels may be able to reduce the commission being paid to online travel agencies, and this may make them reduce room rates unless Google asks for the same commission like other online travel agencies. I myself often use online travel agency to make a reservation for hotels. Some of their services like bidding process are sometimes fun to play, and make me feel like I make a really good deal. Anyway, I wonder who is going to be a winner in the coming business competitions in online hotel booking business.

Tax increase for the rich

Government fiscal constraints seem to make the rich bear more and more tax burden. The Wall Street Journal reported interesting arguments about tax on the rich. As the government tries to reduce the government deficit, a simple way to achieve that goal is to raise tax and to decrease expenditure.

As income equalities widen, more people fall into poverty trap, and society gets older, social security related spending keeps increasing and government does not have much discretionary budget. There does not seem to be much room to reduce expenditure. So, the answer for the fiscal problem would be to increase the tax for the rich.

Some economists and politicians are arguing that the rich should bear more tax burden because the income gap keeps widening and the rich can bear more tax. Obama administration seems to favor more tax burden for the rich. When it is not easy to increase tax rate, the government tries to limit tax breaks to collect more tax from the rich.

Other economists and politicians are arguing that the rich already bear too much tax burden. If tax rates for the rich increase further, it will cause negative effects on economic activity and tax revenue. They are referring to the Laffer curve, which explains the relationship between tax rates and tax revenues. According to the Laffer curve, if the tax rate increases above the certain threshold, increase of tax rates actually causes tax revenue to decrease. The Wall Street Journal also reported that, according to the nonpartisan tax policy center, top 1% of income earners comprise 29% of total federal tax revenue whereas their income comprises 17% of total incomes. The rich may want to use this statistics to argue for their unfair heavy tax burden. But, this may not be a strong argument for them. Even though they bear higher share of tax than their share of income, top 1% earners’ disposable income after tax is not compatible with rest of income earners. They have much more ability to bear high tax rates than other people.

I am not sure that the current level of taxation is reaching the threshold rate to actually cause counter effects on the total tax revenues. But, considering the fact that the rich people benefited from tax reduction during the previous republican administrations, the rich can bear more tax. Even some super rich people like Warren Buffett and Bill Gates argue for more tax for the rich.

Anyway, the government is in difficult situation to deal with this highly controversial issue. This fiscal and tax debate has become a hot potato. Every trial to make a deal with this issue consumed a lot of political energy, and sometimes caused economically negative effects as we observe the previous debate on increase of the debt ceiling. As economy recovers from the crisis, I hope this tax issue can be solved more smoothly.

Google in Hotel booking service

The Wall Street Journal reported an interesting story of Google’s new hotel business. Google now aggressively increases its involvement in hotel booking business and strengthens virtual tours of hotel rooms and direct promotion of hotel ads. Google also made a deal to use the online hotel booking technologies with a hotel booking software developing company. This Google’s current business plan of hotel booking is directly hurting its own customers of online travel companies like priceline or expedia, which use internet advertisement of Google. Is this the cruel reality of business that old friends become enemies?

In the meantime, this could hurt Google too because online travel and hotel booking sites are among the biggest customers in Google’s advertisement business. The Wall Street Journal reported that expected advertisement revenue from two giant online travel companies of priceline and expedia will be over $2 billion in 2014, which is 5% of Google’s total advertisement revenues.

Some online travel companies are reported to show positive feedback to this Google’s move. But I guess that they would worry a lot about this fighting with giant internet service providers. This competition between Google and other online travel companies probably makes online travel agencies more disadvantaged than Google. That’s because online travel business heavily depend on internet search engines like Google. If traveler uses Google, then the search result of hotels will probably benefit for Google than other competing online travel agencies.

I think that this kind of business expansion of Google is very likely to happen to other kinds of online business too. Especially, businesses, which rely heavily on internet usage, face possible threat of market entrance of internet service providers like Google. It reminds me that some big retail stores now produce lots of their own products and sell them instead of selling goods made by other retail production companies.

On the other hand, from the perspective of customers, this change in hotel booking service does not sound bad. This increased competition is very likely to result in decrease in hotel prices and better promotions. Reasonably, by direct transaction with internet service provider, hotels can reduce the commission being paid to online travel agencies, and this may make them reduce room rates unless Google asks for the same commission like other online travel agencies. I myself often use online travel agency to make a reservation for hotels. Some of their services like bidding process is sometimes fun to play, and make me feel like I make a really good deal. Anyway, I wonder who is going to be a winner in the coming business competitions in online hotel booking business.

Capital flows to emerging markets

This year many of emerging countries suffered from sudden capital outflow. Their exchange rates were sharply depreciated, and stock markets and bonds markets were also affected a lot. As the U.S. economy almost escaped from the Great Recession, small open economies are still suffering from the fallout of the Great Recession.

Developing economies opened their capital markets for several reasons. They wanted to enhance effectiveness of their financial markets through the increased competition with developed countries’ financial institutions. They expect transfer of advanced financial knowledge and systems from the advanced countries. They also want to have more stable source of funding foreign currencies, which will contribute to the development of their international trade.

But, as time went by, it turns out that those advanced financial institutions seem to bring more negative effects on their financial systems than positive effects. Those multinational financial institutions from advanced economies usually concentrate more on speculative investments in emerging markets. Eventually, what emerging financial markets learn from those foreign investors is advanced speculative skills. That does not sound positive for emerging financial markets.

More seriously, emerging financial markets become more vulnerable to those advanced economies’ situation and economic policies. For example, this year financial market turmoil in emerging markets  originated from the Fed tapering of bond buying and possible monetary tightening as unemployment rate rapidly dropped in the U.S.

Now the Fed clearly signaled that there is no hurry in monetary tightening, and the money which escaped rapidly from the emerging markets just months ago began to return again to emerging markets to search for higher yield. The Wall Street Journal reported that emerging markets stock prices and bond yield recovered from earlier loss of this year. The Wall street Journal described this return of speculative money as beneficial for those emerging economies. In a sense that prices go up, we can say it’s a benefit. But, I doubt these economies really think this price increase as a benefit.

I feel more like that emerging markets get affected by foreign investors and foreign monetary policy once again. By the way, advanced countries’ central banks do not seem to show much sympathy on their friends with small economies. They often say it is your responsibility to manage your financial markets. Yes, truly, those emerging markets countries also have their independent central banks, and they can react to these changes of financial markets.

In the long run, however, I wonder that this will make those emerging economies feel very tired of capital flows which do not seem to provide much benefit to offset its negative effects. Those politicians and government officials in emerging markets who argued for more open financial markets would lose ground more and more because the result of financial markets opening is the more severe fluctuation of their economies and the increase of vulnerability to external shocks.

I know that many emerging economies already adopt some kind of policy measures to address this issue of capital flows. In the future, emerging economies will add more policy measures to stop those negative effects of capital movements. When that time comes, advanced financial markets also lose opportunity to diversify their investments and the chance to get higher yield. At that time, those financial institutions may not deserve complaining about close of emerging financial markets because it was them which induce those economies close their financial markets.

Effect of Unconventional Monetary Policy

The Wall Street Journal reported an interesting working paper about the effects of unconventional monetary policies, which were carried out during the Great Recession by the Fed, ECB, Bank of England and Bank of Japan. The title of the paper is “Evaluating Asset-Market Effects of Unconventional Monetary Policy: A Cross-Country Comparison” written by John H. Rogers and Chiara Scotti from the Fed, and Jonathan H. Wright from Johns Hopkins. The conclusion of the paper is quite pleasing to those central banks which carried out these controversial unconventional monetary policies. This paper explained that these unconventional policies successfully eased the financial markets and contributed to the recovery of their economies.

The main research theme of the paper is about transmission effects of unconventional monetary policies on the asset prices including bonds yield, stocks prices and exchange rates. The paper also found out that the main effects of unconventional monetary policies were realized through lowering term premium. This is quite reasonable conclusion that lowering interest rates to zero and pledge to keep zero interest rates for a substantial period time would induce the term premium to decrease. Long term interest rates include term premium that is the combination of the expectation of future short term interest rates during the maturity. So, when investors expect that short term interest rates are going to stay at the zero level for a long time, investors apply zero interest rates for future short term interest rates and long term interest rates decrease.

However, I think there may be some reduction in risk premiums too. Though it takes time, central banks’ active purchase of bonds will enhance investors’ confidence and reduce unreasonably inflated risk premiums in the financial markets. Though this paper failed to prove this reduction of risk premiums, I expect that the future research on this matter will show that there is reduction on risk premiums too.

They ended the paper by mentioning future research theme of unconventional monetary policy. That is research on measuring the effects of unconventional monetary policy on macroeconomic outcomes. That is really important issue to understand overall effects of unconventional policy. But, those research need to wait more to be done because still those economies are not completely out of the crisis.

I guess that these reviews of the past give us more effective policy options to solve future problems, and make people realize the important function of central banks in their economies. Especially, when the government fiscal policy is limited by the political difficulties, independent central banks can save the economy. I guess these kinds of reviews may end up with discussing limitation of lower zero bound. Then, we may be able to observe the new era of monetary policy of electric money without limitation of lower zero bound.

Sales tax increase in Japan(Revised)

The Wall Street Journal introduced an interesting story of Hideo Noda, an ordinary Japanese office worker, who recently went shopping spree. The reason why he was hurried buying expensive smart phone and other stuffs is to avoid paying more sales tax. Japanese government raised sales tax rate to 8% from 5% in this April. My question is whether it is the appropriate time to raise sales tax now in Japan.

I worry that this increase of sales tax is very likely to weaken Abenomics to stimulate Japanese economy. As tax increases, disposable income decreases and consumption will also decrease. The Wall Street Journal also pointed out that, in the past, Japan already experienced serious decrease of consumption due to the increase of sales tax. In 1997, Japanese government increased sales tax rate to 5% from 3%, and this hurt consumption along with the effects of Asian financial crisis.

The main reason for the increase of sales tax is to reduce huge pile of Japanese government debt, which is more than double of its GDP. As we can see from debt crisis of some peripheral euro countries, debt crisis severely hurts economy. Credit rating agencies also has kept pointing out debt problem as a major negative factor in Japanese economy.

debt

But, I think that more urgent issue for the Japanese economy is to escape from deflation and stimulate consumption rather than to reduce government debt. With aggressive economic policy aka Abenomics since end of 2012, Japanese economy showed some signs of recovery. However, unemployment rate in Japan still seems to be over natural level and CPI is also still very low as shown in the below graph. So, economy surely needs to be supported more by strong stimulus policies.

cpi umemployment

Also, Japanese government should focus on stimulating the consumption more because, in spite of sharp depreciation of real exchange rate induced by Bank of Japan’s easy monetary policy, net exports does not respond much to this. In the meantime, consumption is becoming more important as share of house consumption in GDP keeps increasing trend in the below graph.

current account exchange rate

household consumption

Also, in spite of its huge size, Japanese government debt does not seem to be an immediate threat to Japanese economy. It is known that, in Japan, majority of government debt is held by its own people not by foreign lenders. Outstanding international public debt securities to GDP keep decreasing. So, Japanese government debt is more stable than other countries’ debt which have large share of foreign lenders. Furthermore, Japan is the second largest reserve asset country in the world after China with more than one trillion dollars of reserve asset. I think that Japan can wait for more favorable time to manage its debt problem more effectively.

reserve

When solving problems, we need to start to address the most urgent issue first and then move to other issues. Considering current economic situations, keeping economic stimulus is more urgent and timing of raising sales tax is not right.  Japanese government can solve government debt problem more effectively when economy is in better shape. They can raise tax more easily with less damage on the consumption and general welfare of its people after economy gets better.

Some criticize Abenomics for its easy money policy. Also, export competing countries with Japan complain about its easy money policy and depreciation of Japanese Yen. But, I think this Abenomics is quite reasonable policy choice from the perspective of Japanese government. So, I worry that this tax increase may cause more harm than good for Japanese economy weakening Abenomics.

 

 

Janet Yellen’s labor market indicators

The Fed Chairwoman, Yellen eased the financial markets’ concern that the Fed might raise interest rates sooner than expected. She explained how she evaluated the current economic situation, especially quite confusing labor market condition, and she made it clear that economy still is far below natural level of unemployment. Yellen’s comment contributed to rise of the stock prices. The Dow Jones Industrial Average gained 135 points, or 0.8%, to 16458. The S&P 500 index added 15 points, or 0.8%, to 1872.

Wall Street Journal reported five statistics, which Yellen used to explain that the current labor market still has quite a substantial slack. These are existence of large part time worker, low job turnover rate, modest wage growth, increase of long-term unemployment, and lower job market participation rate. These all explain why unemployment rate can be misleading in interpreting labor market condition.

Among those indicators, the most interesting evidence is the decrease of job market participation rate. Job market participation rate decreased from 66% to 63% during the Great Recession and kept decreasing during the recovery process too. So, even though unemployment rate decreased, that’s partly because some people give up searching for jobs any more. Another interesting interpretation is the decreasing job turnover rate. As people fear successfully getting new jobs, they less quit current jobs. This results in decrease of job turnover rate representing bad condition of labor markets.

There are some people even in the Fed, who argue that the Fed should tighten as soon as possible to prevent adverse effects of easy monetary policy. But I think hasty tightening of monetary policy could cause more harm than good. So, as the Fed begin to taper its bond buying program, I somewhat worried that early tightening may hurt economic recovery. But I feel more relieved that Yellen has strong determination to boost the economy further. Once the economy shows signs of being overstimulated, the Fed has enough power to cool down the economy effectively.

One other interesting thing about Yellen’s speech is that she explained the current economic situation by talking about three ordinary Americans, who had struggled to find jobs. She approached this economic problem easy to understand and emotionally. I think this kind of communication is very effective to convey intention of monetary policy to ordinary people with no economics educational background.

Wall Street Journal even described this way of Yellen’s speech as striking, because central bankers tend to use difficult economic jargon, which only can be understood by professional investor or academics. This make ordinary people to difficult understand monetary policy. It is interesting to watch how the first chairwoman lead the monetary policy, and this new communication style seems quite effective and fresh.

Sales tax increase in Japan

The Wall Street Journal introduced some interesting story of Hideo Noda, an ordinary Japanese office worker, who recently bought expensive smartphone and other stuffs. The reason why he suddenly went shopping those goods is to avoid paying more sales tax later. Japanese government will raise sales tax rate to 8% from 5%. My question is whether it is the appropriate time to raise sales tax now in Japan.

I worry that this sales tax increase is very likely to hurt recovery of Japanese economy and, weaken Abenomics to stimulate Japanese economy. As we learned from basic economic theory, tax increase will cause consumption and output to decrease as disposable income decreases. The Wall Street Journal also reported that in the past, Japan already experienced serious decrease of consumption due to the increase of sales tax. In 1997, Japanese government increased sales tax rate from 5% to 3% and this really hurt consumption along with the effects of Asian financial crisis.

The main reason for the increase of sales tax is to reduce huge pile of Japanese government debt, which is the largest among the advanced economies. As we can see from the examples of other countries like some peripheral euro countries which are suffering from debt problems, debt crisis can really hurt its economy. But even though the government debt is a serious problem in the Japanese economy, I think that more urgent issue for the Japanese economy is to escape from deflation and stimulate consumption.

Japanese government can solve government debt problem more effectively when economy is in better situation. They can raise tax more easily with less damage on the consumption and general welfare of its people after economy gets better. Normally, when economy is in boom, government tax revenue increases even without increasing tax rate. Also, it is known that, in Japanese case, majority of government debt is held by its own people not by foreign lenders. This contribute to reduction of possibility of debt crisis in Japan. And Japanese government can use easy monetary policy to easily revolve its debt by making Bank of Japan buy more government bonds. So, having a large debt is not such an immediate threat to Japanese economy.

With aggressive economic policy aka Abenomics since end of 2012, Japanese economy showed some strong signs of recovery with 4% growth in the first half of 2013, and also began to escape from deflation with the consumer price recording a rise of 1.3% in February for the three consecutive months.

Some criticize Abenomics for its easy money policy. Also, export competing countries with Japan complain about its easy money policy and depreciation of Japanese Yen. But, I think this Abenomics is quite reasonable policy choice from the perspective of Japanese government. So, I worry that this tax increase may cause more harm than good for Japanese economy.