Tag Archives: EU

Rise of European Direct Lending

The Wall Street Journal just released an article discussing the effects the new EU banking regulations are having on Europe’s small and medium companies.  I found it extremely interesting because it illustrates how these new regulations had an unintended consequence.  It found that while the number of loans that banks are able to give out is decreasing, US non-bank lenders are actually filling up the void left by the banks.  Non-bank loans given to small, medium countries has almost tripled from 16 to 56 since the beginning of this year.  The increase of non-bank loans actually illustrates a shift in Europe’s economic structure.  Many of the EU countries are considered coordinated market economies, mainly because the majority of company funding came from banks.  Now that banks are restricting companies access to capital, these new direct lending firms are becoming more and more popular.  The new banking regulation forces banks to hold larger stores of capital which reduces the supply of loans that they have available for small, medium companies.  The idea of direct lending is still fairly new to Europe and hasn’t started to really pick up until this year.  Many investors hoped that the new banking regulations would allow for direct lending to pick up in 2011 and 2012.  Cheap lending from the ECB though provided companies with the lending that they needed.

The economic impact that the increase in direct lending has on the global economy is unknown.  As of right now, I view it as a necessity.  The ability for the market to create new opportunities for companies that need loans when banks are unable to is a sign of a growing market.  While these new loans are new opportunities for small and medium companies, it comes at a high price.  These new loans often come at a higher interest rate and a hefty price tag.  Unfortunately, many companies don’t have any other option and have to take on the loans with higher interest rates.  Many bank regulators worry that these loans though are easy too easy to come by, aren’t as substantial and safe as bank loans and come at too large a price.  One of the worries that I have with the increase in direct lending is the possibilities of another bubble forming in Europe.  Some of the companies that are getting these loans are considered risky by the banks when they act under the new banking regulations.  It looks like the market has taken into account of the increased risk of these loans by having a relatively high interest rate.  As long as these loans don’t become relatively inexpensive, I think the risk of another bubble is relatively low.


General Picture of European Monetary Unification

On March 10, EU and US pressed to drop dispute-settlement rule from trade deal.  After reading the news, I did a research on European Monetary Unification(EMU) and the euro to better understand it.

1. What is EU and EMU?

EMU is the move to a common currency for a group of countries of Europe, originally with 12 countries and now increased to 18. The purpose is to further the economic integration of Europe that began with the European Economic Community and is today called the European Union (EU). The currency is shared by all 18 countries and is not controlled by any one of them – it is controlled by the European Central Bank (ECB), based in Frankfurt, Germany. This group of countries is called the Economic and Monetary Union (EMU), or informally, the Eurozone.

2. Difficulties of Adopting Common Currency

There was need for convergence but there were also difficulties of adopting common currency. First of all, if countries have different rates of inflation, the high-inflation countries will lose markets to low-inflation countries so that the exchange rates won’t adjust to correct for differences. Secondly, if countries have different interest rates, capital will flow to high-interest rate countries seeking higher return. In addition, the uncertainty about exchange rate will not offset this. Thirdly, the unification of currency brings the temptation to run budget deficits when one country is able to borrow from other countries.

From the above three aspect, we can conclude that the success with a common currency requires countries to have similar inflation rates, interest rates, budget deficits, and government debts – achieving these is “convergence”.

3. Pros and Cons of Unification

The proponents believe that the unification will hep complete the internal market and improve competition efficiency. Countries will face a very open market that there are various players from different countries. Also, there would be arbitrage across national borders. The survival of the fittest keeps the market moving forward. The market efficiency could also bring the stability of prices of goods that would benefit the consumers across countries. Considered from the financial market, the unification will lower the interest rate and therefore bring higher investments which will ultimately lead to a stronger growth.

The opponents have negative voices that the unification will lead to the loss of sovereignty. This is controversial because some people worry that the countries may not be able to make their own decisions independently. Secondly, there are difficulties of adjustment to asymmetric shocks. As had happened before, German unification and discovery of North Sea Oil are the sources.

Russia Hurt By Ukraine Crisis

The crisis in Ukraine is far from over, even though the major protests have ended and former president, Viktor F. Yanukovych, has fled the country. Yanukovych still claims to be President, but is essentially out of the picture for now. But the troubles in Ukraine, and particularly the possible (and likely) succession of Crimea, are putting a damper on the Russian economy. For those not familiar with the situation, Crimea is a peninsular, autonomous parliamentary region in southern Ukraine which consists of predominantly-Russian peoples. It became a part of Ukraine when it gained independence with the breakup of the Soviet Union in 1991. Crimea mostly sympathizes with Russia, and the elections on Sunday will decide whether they will join Russia. They are expected to decide in favor of this.

So what if Crimea wants to join Russia, why should the world care? Well for one thing, Ukraine does not want to lose Crimea. And since the EU and the United States are sympathetic to the new Ukraine (planning to give $15 billion in loans, grants, and investments), these countries are condemning Russia’s push towards the acquisition of Crimea. The economic implications imply that trade with- and investment in- Russia will be reduced, and the effects will be felt in the Ukraine, the EU, the US, but mostly in Russia.

According to an article from the Financial Times, Russian companies are pulling billions out of western banks, in fear that the US will place sanctions over the Crimean crisis and that this could lead to an asset freeze. The fear alone, something we are well aware of in economic expectations, has had significant impacts on the Russian economy. The yield on Russia’s 10-year government bonds increased from 8% in January, to 9.7% on Friday. Also, the rouble is trading for 36.7 for a dollar (almost at its weakest rate in history). Russia’s top 10 billionaires are suspected to have lost $6.6 billion in their combined net worth, over this past week alone. “Strobe Talbott, president of the Brookings Institution, who served in the State Department under Bill Clinton, said: “The irony is that the Russian banking sector has made quite a lot of progress in plugging into the global system. That means it is vulnerable, and a good lever for applying pressure.”” Evidently, the Russian banking sector is going to suffer deeply – not only from possible sanctions, but from the expectations surrounding them.

Europe and the US are expected to impose travel bans and asset freezes on certain individuals close to Russian President Vladimir Putin, at first. And Russia is thus expected to respond with the same restrictions. Investors have already pulled $33 billion out of Russia in January and February, and that figure is expected to near $55 billion by the end of March, according to Russian investment bank Renaissance Capital. On top of this, Russia will face costs to maintain Crimea: estimates are that it will have to commit to roughly $10 billion per year over the next five years in order to build infrastructure, support pensions and pay social benefits to the region’s 2 million citizens.

Russia will experience a significant effect from all of this, as well as the EU and US. But effects on western countries will be miniscule compared to those in Russia. The EU’s exports to Russia account for 1% of EU GDP, while Russian exports to the EU are worth nearly 15% of Russian GDP. Germany has significant investments in Russia, and its impact is expected to be at most 0.1% to 0.2% on economic growth, over the next 12 months. This would be rather insignificant for the European recovery. The US is expected to see similar effects.

Thus, it is important to consider the vast implications of the crisis in Ukraine. Mostly, we should expect to see the Russian economy suffer after the Crimean decision to join Russia. However, the long-term effects are unclear. I suspect tensions will ease within a year, and sanctions will be reduced, allowing trade and investment to increase close to current levels. This is assuming that Crimea does in fact vote to join Russia, and that the European and American recoveries are not significantly interrupted.

Effects of Russian Intervention in Ukraine

As everyone knows, Russia recently intervened in the Crimean province of Ukraine in order to protect the Russian ethnic majority there from the new pro-western Prime Minister.  Politically, this has created a big crisis due to Russia violating Ukrainian sovereignty.  The US and EU have been forced to toe the line between all out confrontation with Russia and supporting Ukraine through any means possible.  While the political landscape is a complete mess, the economic repercussions aren’t any better.  The Ukraine hryvnia was down .5% against the dollar today while the Russian stock market has been down 22.7% and the Ruble is down 9.9%, the second weakest currency against the dollar of the 24 emerging market currencies.  Citigroup analysts have dropped Russia’s 2014 growth forecast for GDP from 2.9% to 1%.  The effects of the Ukrainian/Russian crisis has been felt in other emerging markets and developed markets as well.  Airlines have cut earnings by 5% due to raising oil prices and a slow down in emerging markets due to the Ukrainian Crisis.  The movement of Russian troops into the Crimean peninsula has also caused the price of Natural gas in Europe to increases.  Russia’s control over the price of natural gas in Europe has the potential to harm the economic comeback.  Right now, the EU is dependent on Russia for over a quarter of their natural gas.  If Russia cut off gas flowing through Ukraine, it would effect 14% of European gas consumption.  The potential energy problem is further exacerbated by Germany’s shift to green energy.  Germany recently issued a moratorium on new drilling which will make it even more reliant on Russian gas.  Poland, which has a strong fracking industry, relies on Russia for 2/3’s of Poland’s gas.  The Polish Prime Minister recently stated that Poland plans on diversifying their energy to make it more difficult for Russia to influence Europe.  Unfortunately, I don’t see Europe being able to diversify their energy quickly enough.  Russia will have a stranglehold on Europe until they are able to become less reliant on Russian gas.

The EU is not completely helpless against Russia though.  The EU has a three-stage plan in the works to penalize Russia.  The first is to suspend trade and visa liberalization.  I believe that this is the best course of action over military action because 4 out of 5 of their import and export partners are either in the EU or the US.  If the EU and US apply sanctions to Russia, then it would be logical that their allies like Japan would apply sanctions as well.  At the end of the day, I don’t see the EU apply sanctions or Russia cutting off Ukraine and EU oil supply because it would throw both of their economies into crisis.  After the sovereign debt crisis, I don’t see EU risking a rise in interest rates due to a drop in trade with Russia.  If the global economy wasn’t still recovering and the US could supplement Europe’s need for natural gas, I could see the EU and US favoring a tough stance, but now, I don’t see anything changing.

Ukraine’s Fight Isn’t Over

It has been all over the news and has been going on for months. Finally, last week Ukrainian opposition protesters achieved what they were fighting for: the removal of President Viktor Yanukovych. Protests began late last year, when the Ukrainian government rejected a trade agreement with Europe- favoring closer ties with Russia. Among discontent with corruption and social oppression, protesters manifested against the eery relations with Russia, which they felt was dominating their government. Essentially, they want to establish effective relations with the EU as soon as possible. Though protests were relatively uneventful in previous months, they turned very violent last week. At least 88 people died from the clashes last week; most were protesters, but some police officers are also among the deceased. Ex-President Yanukovych now faces an arrest warrant for the scale of violence used to suppress protesters. His whereabouts are unknown, seeing as he fled Kiev soon after the rally.

But the Ukraine now faces a very difficult financial situation. First of all, this political outcome is clearly unfavorable for Russia- which hoped to maintain its control over the formerly-Soviet state. And in reaction to the outcome, Russia has halted its $15 billion bailout package. However, this is quite the predictable reaction from the Kremlin, and I suspect opposition leaders took this into account or where at least aware of this implication. But will this effect be significant? Well, Ukraine’s $176 billion economy is in turmoil following months of protests and last week’s clashes. $15 billion is a considerable proportion of the country’s economy.

Now opposition leaders must find a supplement for this aid, in order to effectively pay back debt and essentially keep the economy running. That is where Western Europe and the United States come in. Sunday, the Obama administration worked with the European Union in order to draw up a bail-out plan for Ukraine. Ukrainians seek $35 billion in assistance – in order to avoid default. Its Finance Ministry said it will first seek a loan from the United States and Poland within the next two weeks, and later hopes to raise it to around $35 billion by the end of 2015. Though specifics on other European’s assistance are not clear at this point, it’s very likely that countries like Germany and France will also be interested in providing aid.

The interesting part of this assistance-package is that the United States invited Russia to participate. Maybe it’s just how I see it- as a slap in the face for Russia- but it does make sense for Russia to be interested in doing so. Putting aside politics (in which the Russians have mainly lost here) it is still in Russia’s best interest to have a sustained Ukrainian economy. Essentially, nobody will benefit from seeing Ukraine bankrupt, and there is enough incentive to keep this from happening. Though it will not be easy for Ukraine after this victory, also considering that some of the Eastern part of the country still supports Russian ties, there is much reason to predict that complete economic turmoil can be avoided.


Germany’s influence over ECB

The ECB and European Union are back in the news recently due to concerns about whether its Outright Monetary Transactions program is constitutional.  German Euroskeptics filed a complaint with the German Constitutional Court arguing that the ECB’s bond buying program over stepped their authority as stated in the EU constitution.  The OMT program, which has never been used, was created by the head of the ECB, Mario Draghi, in July, 26 2012, when he stated that he ECB would do “whatever” was necessary to preserve the Euro.  After Draghi’s announcement, the Euro started to stabilize from the belief of investors that the ECB would step in to save struggling countries.  Draghi’s announcement is believed to be one of the reasons why yields moved downwards.  The German citizens were worried that the ECB would buy bonds of countries who would then default and German taxpayers would be on the hook.  German citizens are also worried about the expansion of the ECBs powers.  The OMT allows for the ECB to purchase unlimited amounts of bonds when a EU country is in trouble.  Unfortunately, this is the other key issue that German citizens and economists are worried about.  The German Court’s on Feb. 7th, 2014 ruled that it was the European Court of Justice’s job to analyze the OMT and find whether it is constitutional or not.  Even though they said that it was the ECJ’s job to decide whether it was legal or not, they did say that the OMT had some potentially illegal passages.  The reason why this is interesting economically, is that it illustrates how Germany has been able to shape the ECBs policies.

When the ECB was first created, the German central bank pushed for price stability to be the main focus of the EU’s monetary policy.  This has caused the EU to maintain an extremely low inflation rate of .5%  This could be potentially harmful to the countries that need monetary growth policies like Greece and Spain.  The question though is Germany right to worry about hyperinflation and price instability?  Since the recession, the money base has increased by more than 50% but the money stock has only increased by 7%.  This means that banks are sitting on reserves instead of lending them out.  Germany’s central bank is still worried about reverting to the hyperinflation that harmed Germany post WWI.  The years after recession has shown that the money multiplier does not play as big a role anymore so Germany does not need to worry so much about an increase Money base because as long as the money stock stays low, inflation will stay relatively stable.

TTIP, I Missed You (So Far)

Somewhere between heralding/denouncing the ACA/Obamacare and debating inequality, US politicians still seem to find time to debate TTIP. I, for one, hadn’t really find the time to get acquainted enough with it to know what to make of it (let alone gain deep insights on its promise or threat). And negotiations are taking their sweet time, which makes it seem less urgent than other topics. That’s a shame, because I don’t think it’s worth being eclipsed by quicker, flashier, more short-lived news. After all, it’s a massive trade deal. Or could be, if it ever becomes law. Which it might not; there’s plenty of opposition, as it turns out.

What I find striking is that after having a (admittedly somewhat brief) look at what TTIP is all about (that’s a euphemism, because this thing is kept tightly under wraps. But some stuff got leaked), I could see some really contentious issues there. Some of what’s going to be in that agreement could be a major game changer for the power balance between states and companies. But that’s not what most people get worked up about! ‘The Public’, I found, still brings to the table the same arguments against free trade that people made, oh, probably around the time Ricardo came up with the idea of comparative advantage. And a lot of those are fallacious.

Take, for example, this Al Jazeera op-ed warning about the dangers of TTIP. It asserts, right at the beginning, that:

“Last year the U.S.’s total trade deficit with just five countries with whom we have “pro-trade” pacts — Canada, China, Japan, Mexico and South Korea — exceeded half a trillion dollars. That amounts to 3 percent of the U.S. gross domestic product transferred out of the United States to these trading partners.”

Which is an obvious case of ‘exports GOOD, imports BAD‘-thinking. I probably don’t need to elaborate here that an excess of imports over exports means you’re consuming more than you’re producing. There’s an argument to be made for long-run balanced trade, but the idea of trade deficits meaning you’re giving stuff away is obvious nonsense. And a lot of people don’t get why.

But politicians know this stuff, right? So they come up with other ideas as to why free trade is a Pandora’s box. The WSJ brings us a quote from Rep. Marcy Kaptur (D., Ohio), insisting that the US needs a “pro-American” trade policy. First of all, you’re not gonna get that with a trade agreement (unless you think the other part is really naive, or really stupid). Secondly, I’d say that’s cheap nationalism, but fine, what would such a pro-American policy look like? What’s the solution? Why, we should “have more exports going out than imports coming in.” Really? Even on Capitol Hill?

Now as I mentioned, there’s some actual reason for concern here. But it doesn’t concern trade deficits. I also don’t think this is about job losses – this deal is between the US and the EU. Not exactly model ‘developing’ countries in anyone’s book, so no huge wage differences or labor cost advantages, and certainly none that you couldn’t take advantage off today. There’s also no infant industry argument to be made here (Melitz is a UM alum by the way, in case you didn’t know. So Go Blue! and all that. Smart people writing smarter things than I).

The cause for concern, regarding this deal, is a process it includes called investor-state dispute settlement. Basically, this allows a company to sue a state in case they feel that they’re unjustly being denied the right to sell their product or make an investment (I’m no lawyer, so you might wanna check your favorite international law textbook to back this up). You could see the idea behind putting this in a free-trade agreement, right? It’s supposed to stop governments from defecting and introducing arbitrary non-tariff/quota trade restrictions (‘non-tariff barriers to trade’) and thereby defecting from the spirit of the agreement (although not its wording).

Seems like a smart idea. But there’s a caveat, and it’s big. There are plenty of national policies that countries usually don’t think of as being ‘trade’ policy. Think energy for example (pushing renewables, banning nuclear or fossils). Under TTIP, it’s possible that countries would have to pay reparations to firms because those policies conflict with their business practices. Now the deal isn’t done, and its details are very hush-hush. But if this turned out to be true, that’s a major issue. And not so much because this infringes upon some arbitrary notion of ‘national sovereignty’ (if this were a PolSci class, I might elaborate on that later). But because that’s effectively lawyers making laws. The TTIP only includes the settlements. It doesn’t really limit the domain of things you can try to sue over. That creates a massive number of precedents, and could seriously hamper democratic processes.

So the problem with this free-trade isn’t – as it never is, between ‘developed’ countries – free trade. The problem is the stowaway legislation hiding below this ship’s deck.

(Revised) Cold War politics in 2014?

Ukraine has recently become the new battleground in the ongoing Russia vs the West influence war.  Ukraine is has been facing economic troubles since the latter end of 2013 which saw the Government of President Viktor Yanukovych reject an EU association agreement that would see Ukrainian exports head to the EU and accept a Russian deal that offered Ukraine $15 billion bailout that would tie Ukraine economically and politically to Russia.  The Ukrainian government’s approval of the Russian deal, which forces Ukraine to import a set amount of natural gas from Russia, is what led to the ongoing political unrest and protests that have plagued Kiev.  In response to the protests, the Ukrainian President dissolved his cabinet, which consisted of many pro-Russian politicians, in hopes of stemming the unrest.  Unfortunately, Russia this past week decided to withhold the rest of the bailout money due to Yanukovych removing the pro-Russian Prime Minister.  The US and EU have come forward with a new plan that would require Ukraine to enact political and economic reforms.  The economic reforms that Ukraine would have to face are a devaluing of its currency, and rising natural gas prices and signing the association pact with the EU that would open up the EU to Ukrainian exports.

While I do believe that the Russian bailout pact restricts Ukraine’s sovereignty, the US and EU plan may be too painful to implement with such low political stability.  The further devaluation of the hryvnia, Ukraine’s currency, would harm the Ukrainian public and reduce their ability to consume.  Though top US officials believe that the Ukrainian public’s problem with devaluation may not be as large as believed.  Due to recent Fed tapering and the flight of investors out of emerging markets, the Ukrainian hryvnia has already become substantially devalued.  This would mean that it would be less of a shock to the Ukrainian public if the devaluation continued a little bit longer.  The raising gas prices are also a sticking point when it comes to public sentiment.  As the weather begins to heat up in the spring though, the falling demand for gas would allow the Ukrainian government to increase the price of natural gas without causing the public to feel the pain of the increase.  Unfortunately for Ukraine, while the US and EU plan is the best in the long run, because it has Ukraine’s long run economic benefits in mind, the plan hinges on political reforms that are too difficult to implement.

With the recent crisis in Ukraine, I thought it would be a good time to revisit Ukraine.  Since Ukraine ousted the pro-Russian prime minister for a pro-Western prime minister, Russia has intervened in the Crimean province of Ukraine.  The Crimean province is predominantly Russian ethnicity but was gifted to Ukraine back in 1994.  The Russian presence in Crimea has caused ripples around the EU and world markets.  NATO members and EU member states worry about how to respond to Russia’s show of force.  The United States is in a tight position because they need to show NATO and EU that they can protect the other members.  The crisis in Ukraine has caused EU stock prices to drop because investors believe the crisis will go on for a long time.  Russia has used its Gazprom ties to apply pressure on Ukraine by stating that they may shut off their energy due to unpaid bills.  To combat Russia’s mounting pressure,

the EU plans to provide an 11 billion-euro ($15.3 billion) aid package and is prepared to drop tariffs on about 85 percent of the bloc’s imports of Ukrainian goods, according to EU Trade Commissioner Karel De Gucht. Ukraine wants as much as $15 billion from the International Monetary Fund.

I believe Ukraine needs this package otherwise they face a repeat of 2009 when Russia shut off energy and caused the world economy to stutter.  It looks as of now, the only thing the US can do without causing direct conflict, is to support Ukraine through economic and monetary funds.  The US doesn’t want to directly confront Russia but they are pushing for the IMF to agree on a bailout package.  The next few weeks will be crucial to see what happens in this resurrection of Cold War politics.


Ban on Proprietary Trading for Banks too big to fail in EU?

European Union policy makers, lead by EU financial services chief Michel Barnier, are considering drafting legislation that curbs the European Union’s biggest banks from trading with their own money.  Barnier’s proposed legislation would strengthen bank-structure rules and give power to supervisory institutions like the European Central Bank.  Barnier’s goal is to create more legislation to prevent European Banks that are too big to fail from making risky bets that could potentially put customer’s deposits in harms way.  “Barnier’s proposals, which also include tougher transparency rules for trading in repurchase agreements, or repos, and other securities financing transactions, would apply to banks whose activities exceed certain financial thresholds.” (http://www.businessweek.com/news/2014-01-06/eu-s-barnier-weighs-proprietary-trading-ban-for-large-banks)

The EU’s ban on proprietary trading is viewed very similar to the US’s bill that passed last year known as the Volcker Rule which banned commercial banks from participating in proprietary trading.  It restricts banks from making speculative investments that do not benefit their customers.  The European Union and the United States created this legislation to prevent a repeat of the 2007-2009 financial crisis.  They want to keep tax payers away from having to bail large financial institutions out when they make risky, speculative investments that put customer’s deposits in harms way.

“Policymakers want to rein in excessive trading risks in the EU banking sector, whose assets total some 43 trillion euros ($59 trillion), that could threaten depositors if trades go wrong and potentially put taxpayers on the hook in a rescue.” (http://www.reuters.com/article/2014/01/06/eu-banks-idUSL6N0KG1QZ20140106)

The issue with the European Union’s proposed ban on proprietary trading is that it is no where near as strong as the US Volcker rule and is viewed by many to be “too watered down” (Reuters).  The proposed legislation allows French and German large universal banks to keep from splitting up into deposit only and investment only banks.  Instead of creating legislation that restricts banks that are considered too big to fail, the legislation protects and allows these banks to continue to be too big to fail.  The main reason that the EU wants to stop short of the Volcker rule is to protect and keep European banks competitive.  Barnier’s proposal is heavily influenced by Finish central bank minister Erkki Liikanen who believes that there should be a mandatory separation between deposit taking services and proprietary trading services.  Britain, Germany and France, countries with the largest financial sectors in the EU, have unilaterally opposed this idea.  This brings again brings into question the sustainability of the European Union.  Many view the legislation as a compromise between Liikanen’s proposal and Germany, Britain and France’s opposition but Alexander Carr, a regulatory lawyer from london, believes that by seeking to please everyone, Barnier has made it near impossible for the legislation to pass through the EU commission.  In the end, this questions whether the EU has the ability to sustain itself through another economic crisis with only Monetary policy unity.  If the EU had control of fiscal policy, maybe we would be seeing another Volcker rule pass in the EU, instead of a compromise between everyone that produces a “cop-out compromise” (Reuters).