Econs Primer: Inflation targeting, a central bank policy for price stability

Practice, Practice...on the medium term!

Credit: Pete on flickr

Definition:

Inflation targeting is a commitment by the central bank to keep the inflation rate close to an agreed level as a tool of monetary policy, and making this commitment known publicly.

Inflation targeting was started by New Zealand 20 years ago when it announced that it was making controlling inflation its primary policy objective while emphasizing transparency and accountability in achieving that target. Many other developed economies have followed the example of New Zealand, including the United Kingdom and Japan.

Other countries like the United States who have not followed it as of today, March 2015, have imbibed the spirit of inflation targeting in her policy pronouncements.

Goals of Inflation targeting:

1. Price stability.

When the target inflation is known by all the stakeholders in the economy, it helps them in planning for now and the future. Therefore, prices do not move erratically based on the expectations of the market.

2. Operational autonomy:

A central bank that is accountable to the public is usually given a wide margin of operational autonomy by the government to operate freely unless public opinion turns against it. This implies the central banks pursue a unintended policy of public relations with the citizenry in mind. There is a fear that this might politicize the process inadvertently.

3. Avoid high inflation.

Many of the countries with an inflation target, notably the UK, stick to an inflation target of 2%+/- 1.0. High inflation which can destabilize the economy and bring about high unemployment is hence avoided or fought quickly. High inflation also increases the inequality in the country.

4. Effective monetary policy.

By making stakeholders in the economy part of the central banks policy briefings through a transparent and accountable process, its effectiveness in driving monetary policy is enhanced.

Benefits of inflation targeting:

• Policy transparency and accountability.

It is a fact that inflation targeting brings about a progressive increase in policy transparency and accountability. Communication becomes the key of providing public accountability. In the light of the fact that central banks gain a high degree of autonomy, this is the advisable course of action.

• Avoiding recessions.

If high inflation is curtailed, recessions and depressions are avoided. A recession though somewhat ambiguous refers to a period of reduced GDP growth and elevated unemployment while a depression is a large and protracted recession.

• Low inflation expectations.

When have low inflation expectations and they believe it is reasonable to do so, they put less pressure on wages and salaries, thereby prices and margins which firms set become reasonable.

• Central Bank flexibility.

Although inflation targeting is the primary policy objective of the central bank, it gives it the ability of pursuing other objectives like smoothing output. Inflation targeting is usually set within a medium term framework i.e two-to-three years horizon, hence, while the timeline ticks, it pursues other objectives in the short term which would help make its medium term goals, notably low inflation expectations, well anchored.

Challenges of adopting inflation targeting:

Some of the challenges encountered over the 20 year history of inflation targeting are:

• There is a debate over what role the exchange rate will play in an inflation targeting framework.
• The question remains on how to reconcile monetary policy responsibilities and objectives with a responsibility to maintain the stability of the financial system.
• Inflation targets become a “religion” at the expense of other pressing problems. The fixation on inflation and the level of inflation on a daily basis becomes a disadvantage while other problems like unemployment or supply-side shocks suffer. Supply-side shocks and unemployment are also a subject of the medium term.
• The central bank is faced with an uphill task if it faces public opposition.

China will surely lead Asia but how transparent she will remains to be judged?

From what I read in this article on President Xi Jinping’s speech at the Boao forum, it is a speech and the laying out of its future outlines in economic, political and maritime affairs around international altruism.

President Xi - Playing by his own rules.

Credit: thierry ehrmann on flickr

What is striking is her realization and acceptance of the fact that she will be expected to shoulder much responsibilities both in Asia and globally. China is the world’s largest economy by PPP numbers but the second largest by GDP. Though her growth is slowing, China has lots of money to spend and she is spending them around the world.

Why not spend them at home, for her poor neighbors like Indonesia, New Zealand and Malaysia? By doing so, she in essence is saying: “I’m going to help all of you, but you’re going to start looking at me as Uncle Xi. That means, Uncle Sam might be…obliterated soonest from your political and economic radar.”

Those are important words for Asia. Yet, the question remains how open enough will China agree to be? The US knows lots we don’t about China’s political and economic transparency and accountability and is not saying much about the AIIB, Asian Infrastructure Investment Bank, whose membership roster is expected to be closed today. The UK does the same but is looking at the economics. How would China lead the AIIB without being transparent and accountable enough to satisfy the UK, can only be imagined!

By creating a road "...from China to Asia..." President Xi in essence meant to say: "...from now on, all roads lead to China."

Those are words Nigeria wants to hear. She, like other developing and emerging economies, will be counting on China as assistance of second resort.

Macroeconomics primer: How quantitative easing affects loans, cash, investments and the economy

Definition:

Quantitative easing can be defined as the introduction of new money into the money supply of an economy. In a central banks’ balance sheet, it has the option of either purchasing or selling government bonds in the open market. Rather than utilize this traditional monetary option, the central bank decides to buy the bonds of banks and debt instruments of other corporations.

Learning doesn't end.

Credit: Diego Muller on Flickr

Why implement quantitative easing

When the economy is in a crisis and the conventional attempts to revive it using monetary or fiscal policies have failed, the central bank might be called upon to experiment with a quantitative easing.

As the central bank buys corporate bonds and assets, the prices of these instruments rise while their yields fall. Therefore, the cost of borrowing for businesses and households falls. It is expected that when the banks and other financial institutions lend these money, investments will increase.

These fall in cost of borrowing and availability of easy money for lending increases liquidity in the economy. Liquidity refers to the availability of liquid cash in the economy. As we know, cash is an engine for activity. Availability of these cash is expected to revive the already comatose economy.

On the consumers’ side, there is much money to buy new houses and non-durable goods like cars, toys, computers, laptops, video players etc. Therefore, demand on the aggregate in the economy is expected to rise.

This expected rise in aggregate demand makes businesses borrow money in order to anticipate high demand for their products. Therefore, competitive pressures increases and many companies reduce the prices of their goods in order to gain market share and make more profit.

Eventually, when businesses start making profits, employees or workers start asking for an increase in salary. Eventually, producers raise their prices in order to meet up with the increased wages they are paying and prices rise again. Employees once again ask for higher salaries and to meet up the demand, producers increases the prices of their goods. Eventually, the increase in prices is expected to stabilize.

Therefore, inflation, a general increase in prices and fall in the purchasing value of money, is what central banks expect when quantitative easing programs are introduced.

The above scenario is what makes the economy vibrant after it has been tepid following a financial crisis.

But sometimes it doesn’t work out as in a fairy tale!

Sometimes, it doesn’t work out as calculated.

1. Cash hoarding:

Instead of spending the extra cash in their hands, businesses and households might decide to hoard it. That is, they might decide to amass it. Don’t blame them. After going through a financial crisis where money is hard to find, having easy money is too good to be true and losing it becomes a difficulty. When cash is hoarded, the economy finds itself in a liquidity trap. The expected increase in demand does not kick off.

2. Inequality increases:

It might increase inequality in the economy. The rich in any economy own more stocks and shares; they own more property like houses; they have access to bonds and corporate debt instruments. As the prices of these items increase, their wealth increases, increasing the inequality gap in the country.

3. Extraneous factors:

If eventually fall in prices is not in response to quantitative easing but due to something else, like a fall in the prices of commodities or resources used in the production process, inflation, or the increase in prices as predicted by the central bank, might not really be boosted. Instead, the existence of easy money might cause deflation, a reduction in the general level of prices, rather than inflation.

Overall, quantitative easing is introduced by central banks only when all other conventional monetary policy options have failed or will fail.

[[Links]] OECD defines harmful tax competition; smartphone market share higher than tablets

Today’s links are based on what I have been reading online between Sunday, March 22 and yesterday, Friday, March 27.

• OECD and BEPS: defending the tax cartel?

The OECD defines “harmful tax competition” as a particular tax practice that is so substantial as to conclude that it is poaching on other countries’ tax base. But the writer states that not one evidence of this harm has been found by the OECD. Yet, turning the labeling around, one could find evidence, and much for “harmful international business competition through tax incentives that is substantial so as to poach on other countries’ tax base.”

• Predatory Pricing Doesn't Work But We Still Don't Like Cartels

Predatory pricing is an anticompetitive behavior that fosters monopoly. The author argues that predatory pricing should be encouraged in the Australian Iron ore industry for the following reasons: it makes goods cheaper for consumers since iron ore mines will be subsidizing production to drive away competitors, the future incentive to raise prices when a monopoly or cartel has been established might not cover the cost of subsidies for the mines and by the way, the iron ore industry is a contestable market – the news that an established cartel is raising prices is enough to attract companies to the industry like flies to bees. All well and good. He fails to recognize that cartels once established enhances corruptive practices though lobbies.

• Kraft Foods Group (KRFT) Stock Continues Rally After Heinz Merger Announcement

The two companies, Kraft foods and Heinz merged to increase customer base by consolidating their shared advantages in selling differentiated products. Kraft and Heinz are in the food packaging industry. The market has seems to think this is a good deal. Shares of the merged companies are higher by 5.01% to $88.62

• Smartphones seize market share as tablet sales slow and PCs struggle

The combined total market of smartphones, tablets plus 2-in-1s, and PCs is set to grow from 1.8 billion units in 2014 to 2.5 billion units in 2019. If asked to own just one connected device, the smartphone is the clear choice. That's a recent survey report.

Central Bankers quantitative easing programs – a hint of financial or currency wars?

The Bank of Japan (BOJ) launched its quantitative easing program two years ago with the intention of recovering from the global financial crisis which rocked it along with other major economies in 2007-08.

America also implemented a quantitative easing program for the same objective. It has made the dollar stronger than other major currencies and it is still going strong. Falling oil prices and the favorable unemployment ratio for 2015 are considered one of the best points of its economy this year.

There are no war bonds in the market!

Credit: Wikimedia Commons

The Eurozone under the European Central Bank kicked off its quantitative easing program earlier this month. This week, there were signs that earlier than expected, production in European factories is at a four-year high, the euro is appreciating and investing in European debt instruments is very attractive.

Is it likely that the Central Bankers in the world’s major economies are at the center of currency wars? Not likely. If you listen to the rhetoric from the BOJ, the Feds and ECB, they are concentrating on a recovery from the global crisis of circa 2008. Quantitative easing is not a sure and tested response for a recovery. Quantitative easing is a response that is accepted when other fundamental monetary policy responses have failed.

If you take a look at the balance sheet of Central Bankers, you will notice that government bonds are one of its major assets. Rather than sell more bonds and increase interest rates, when monetary discipline involves sticking to a target inflation figure (i.e 2%), by buying corporate bonds and bank financial instruments, they are drawing down rates across board and increasing their exposure to foreign investment.

By the way, have you noticed that none of the central banks have the idea of overseas quantitative easing? They think local, only of the banks and the financial situation within their jurisdiction, not with respect to any other.

So, as some writers have propounded on the Internet, it is unlikely that a currency war is going on. The euro’s recent appreciation, this week, is favorable to the Feds. Else, why did the Fed not hike up interest rates as expected in order to stem the expected movement of investors to Europe?

Nintendo games now coming to your mobile devices

The future of gaming is mobility. Nintendo doesn't want to be left behind.

Earlier this week, Nintendo has taken a bold leap into the gaming world by allying itself with DeNA, a Japanese mobile publisher. This translates into Nintendo games appearing in your mobile devices and smartphones soonest.

Now, don't be in a hurry. Nintendo does not intend to just port their classics over to tablets and they have good reasons for avoiding that strategy.

But if I have an option, I'd like to see Super Mario Bros once again; and in my android.

According to informed sources, the first of Nintendo mobile games will be released by the end of the year.

This blog is now on the finance topic in Alltop.com

Search engines are ubiquitous on the Internet. In fact, without one, searching for topics and items of interest might take hours. Search engines make our life efficient. By the way, search engines carry all sorts of advertisements and software placements that can come in the way of a rich user experience.

An alltop.com badge.

Credit: Alltop.com

So, I discovered alltop.com. Alltop is a topical search engine. It is like a magazine rack, where you search for topics of interest rather than do an algorithmic search like would Google. Alltop is a topical news aggregator. You can find blogs and news websites arranged according to topics. Alltop can make your search easier and faster. It can help you do content comparisons with like bloggers and blogs in your topical area; it can help you do site design and headline comparison.

Chris Brogan said Alltop.com was the Internet’s best magazine rack.

I stumbled on Alltop because I wanted to increase blog traffic. You can set the same target by submitting your site or blog.

“Make the Market your income”, this blog, was accepted in Alltop under the finance topic.

By the way, do you know you can receive automatic updates of my posts? Here’s how.

Oil price uncertainty (2): Attired as a bear.

Cheap oil, cheap gas.

Source: Wikipedia.org

The market is glutted with oil. Supply has overshot demand. Global demand is not expected to rise quickly. The textbook solution is to make supply rarer. It’s not an easy solution when reality strikes. It’s about market share. America has had a revolution in oil production since fracking was discovered. It has increased American production of shale. It is reported that US oil industry is presently encountering an oil storage problem. She’s not in a haste to make production cuts; and so are the Saudis.

Saudi Arabia, one of the major producers of oil and a key founding member of OPEC, is going to hang on to its share of the market, whether it encounters losses or not.

The Saudis, I opine, do not rely on the U.S Energy Information Administration (EIA) pronouncement that demand might soon increase due to identified “tentative signs” of a recovery since the beginning of 2015.

Why? Iran and American have advanced on nuclear talks. If sanctions are removed, Iranian oil might increase global output. Libya has reported that the fall in oil prices has affected her GDP in significant ways. She can do nothing but increase output even if. This worries the Saudis. No one thinks they’d give grounds to the Venezuelans and Nigerians who face enormous losses in growth and income earnings if oil prices do not rise again soonest. Last week, Nigeria was downgraded by Standard and Poor’s; oil price declines and election uncertainties were reasons given.

The fortune of multinational companies in the oil and gas industries as well as renewable energy is at stake. It cuts across every facet of energy. Renewable energy has a substitution relationship with natural gas. When gas prices fell, the demand for renewable energy came after. What will happen to the stocks of renewables? They’ll go bearish.

Investments made in shale and renewable energy by lots of investors before the dip of June 2014 is at stake. Texas, an oil producing state in the US, will lose 140,000 jobs in 2015 and its economy will slow to 1-2% from 3.4% in 2014. Two Houston-based companies, BPZ and Dune Energy, have already filed for bankruptcy. Most energy executives are concentrated on one objective: spending cuts to conserve cash and survive the downturn.

If the situation at Yemen becomes more precarious, Saudi Arabian oil will be affected. That, an uncertainty that carries a heavy discount, might well bring the prices of oil down. India has been reported to be taking advantage of low oil prices to insulate itself from supply distortions. Saudi Arabia is the major oil exporter to India. It might well be insulating itself to a foreseen supply distortion that would be caused by the action happening in Yemen.

Previous article in the series: Oil price uncertainty (1): Monetary and fiscal policies might arrive too late to be effective.

Oil price uncertainty (1): Monetary and fiscal policies might arrive too late to be effective.

The slightly more than fifty percent (50%) fall in oil prices since June 2014 seems etched in stone. Oil prices are dipping. To shore up prices, oil exporters are relying on supply side economics. The market is not well understood. When major OPEC countries are sticking to their guns rather than implement expected production cuts, it could only be opined that uncertainty rides the market.

The steep fall of oil prices since June 2014!

Source: Investing.com

For the past nine months, the news is beset with falling oil prices followed by reduction in energy bills – gasoline prices have fallen, fuel prices at the stations have fallen, prices of non-durable goods have also followed suit. Consumers seem to be having a good time. Income after taxes and transfers, what is called disposable income, is now worth more. Globally, the fall in oil prices have benefited consumers. It is estimated that the increase in global GDP due to a decline in oil prices should be around 0.7-0.8%.

But it’s not alright on the economic front for both oil importing and exporting countries despite the burgeoning demand. The sweet story resides in the short-term. What really matters is the medium and long-term effects of a sustained and unrelenting fall in oil prices. What would a Central Banker do if reducing costs of production passes through declining inflation?

According to Raju Huidrom, “the U.S. Federal Reserve has typically chosen to respond vigorously to inflation increases triggered by higher oil prices but has responded less to unexpected declines in inflation following oil price declines.” Expected monetary expansion are already been put in place.

The European Central Bank’s quantitative easing program will give more liquidity to the banks and make the prices on corporate assets rise while their yields fall, therefore kicking in expected increases in investment. It is rumored that Israel might start a quantitative easing program soon.

But the problem, as foreseen in the recent OECD’s interim assessment report that was released last week is that expected investment increases might not be in the right channels. Increased capital expenditures and increased consumption of durable goods is a monetary policy goal but the market might not give them victory on a platter of gold. According to the OECD, the market is not operating on fundamentals.

Therefore, it is advised that fiscal policy should be used to strengthen and safeguard monetary policy. Reduction in the budget deficits of most developed countries and the BRIC countries would be desirable. Spending cuts in government are not easy to implement. It takes a long time. It takes strong political willpower. Even Nigeria, one of the foremost oil exporting member of OPEC, has been rumored to warn civil servants that to kick in spending cuts, they might have to accept some retrenchment.

If oil prices continue to remain adamant, the market will have to surrender to uncertainty. Except OPEC countries like Saudi Arabia agree to production cuts that should prop up oil prices.

Next in the series: Oil price uncertainty (2): Attired as a bear.

Is China’s new stack enough to divide the US-UK alliance?

Obama and Cameron. Is China strong enough to divide this friendship?

Credit: Telegraph.co.uk

The United States probably hopes it can continue to hold back the flood of Chinese insistence. The United Kingdom, its staunchest ally, thinks otherwise. On retrospection, one would conclude that the flood is insistent and could get more so as time goes by. China is the second largest economy in the world. It is one of the largest emerging economies globally although its annual growth is projected to slow down to 7% and one of the most populous nations in the world.

So, it would be natural that China should seek ways to stack itself against the barriers placed on its path to global financial governance. It recently launched the Asian Infrastructure Investment Bank (AIIB) and the New Development Bank. Singapore, United Kingdom and Indonesia have agreed to be members of the AIIB. About 27 nations are expected to be member nations when the March 31 deadline expires. The U.S might be wondering in disbelief but as the UK sees it, that’s how the wind of change is blowing in international financial circles.

The UK believes the world is changing and it has to change with it. In a recent World Economic Forum article, Jim O’Neill, a former chairman of Goldman Sachs Asset Management, clearly states the arguments of the UK government.

He argues that growing resistance to China’s inclusion in International financial governance will fuel and create the development of parallel international financial institutions like the AIIB. China’s economic might cannot be passed over. Its Gross Domestic Product (GDP) is bigger than Germany, France and Italy combined. Even if the US refuses to ratify the agreement reached on agreed changes to the governance of the IMF and the World Bank, BRICS nations which consist of Brazil, Russia, India, China and South Africa, have shown a commitment to have their voices heard outside the channels of the IMF and World Bank.

Those are not easy assertions. Even if the US accepts those arguments, it reluctantly will, if at all. It’d rather address China’s rise to global economic superpower status which is at odds with the UK’s belief that China’s internal affairs should be left as is – internal.

The IMF Managing Director Christine Lagarde is quoted on Reuters as saying she would be "delighted" to cooperate with the AIIB.

So, will these divergent opinions create a rift in the US-UK alliance? It remains to be seen.

Sustainable solar energy in competition with Oil? Not yet Uhuru!

Solar power has many uses. A cursory look at the gadgets that are powered by solar energy, as one can see on this site, can only make you wonder if and when solar energy will take its rightful place as a competitor with oil.

It’s true, in the market for energy, contrary to what many like you and I believe, solar energy is not in competition with oil.

Solar energy and oil are not substitutes. That means if the price of oil falls, the demand for solar energy does not fall at the expense of a rise in the demand for oil. Solar power is a substitute with natural gas, especially in countries that are at the forefront of renewable energy research like China, United States and the Eurozone.

In the recent past, the price of oil has taken a steep downward dive while the market is glutted with oil. Saudi Arabia, one of the highest producing countries in the Organization of Petroleum Exporting Countries, OPEC, will not budge about cutting production costs even though Nigeria, Venezuela and Iran desperately want it to.

Solar Impulse 2: A sustainable future for green energy!

Photo Credit: Charles Barilleaux on Flickr

Concern for the environment, principally climate change and the demand for green energy, will make a push for renewable energies, like solar power, take a prominent position in the energy needs of corporations and the largest consumers of global energy, the military. The success of the first solar powered plane on its epic bid to fly around the world, the Solar Impulse 2, will open doors to a sustainable future for green energy. One foresees a jump in the demand for solar energy as the driver of heavy military gears.

The input cost of producing solar energy is relatively cheap, both economically and environmentally. In countries like India and Africa, where the sun is high and plentiful, the equipment costs that small businesses will have to overcome starts with a solar panel.

It will not be long, if solar energy keeps making these giant strides, before it comes out of its shadow role as an alternative source of energy to become a direct competitor with oil.

Is patience virtuous for Central Bankers?

Fixing the economy can be a headache! Patience!

Credit: Christopher on Flickr.

When an economy’s recovery is cyclical, slowly expanding in jumps and starts, it faces a lot of potholes on its journey.

Where unemployment is admirably low, and consumer confidence now and for the future is high because wages are better; where even the minimum wage is being revised by private initiatives because energy costs are falling and expected to remain so - the economy should be in good standing with investors.

Yet, it is still in the shadows of a storm.

Deflation is an ever present danger. Deflation will take away all the hard fought gains of many quarters. If the inflation target is met, and not some sluggish below average outcomes, Central Bankers will go to bed without an insomnia. Yet, that privilege will not be given. Deflation will always be a terrible headache especially where another competing currency refuses to appreciate. You’d so wish that it does appreciate!

Where the market is aflush with liquidity everyone so detests and not the fundamentals. As a Central Banker one would have wished for fixed investments so that the recovery should rest on firm platforms, but what is foreseen and and the real dreams paint, are financial investments with enough liquidity.

Why shouldn’t the journey to recovery be full of potholes.

Patience on the potholes would be a virtue. When Google makes good its promise of a driverless car, maybe there'd be no more potholes, or maybe a flying car.

[OECD interim report] India should be the fastest-growing economy in the world only if…

The Interim economic assessment report released by the OECD yesterday is nothing but a forecast of moderate outlook for the major economies in the world.

In brief, two of the highlights I find interesting are:

• Indian GDP growth is expected to surpass China in 2015-16. China is slowly getting close to its 7% target; private demand due to real estate weaknesses is slowing down the Chinese economy. The report used the term “fastest-growing” major economy in 2015-16 for India. What India needs to spur or accelerate that growth are structural reforms. See a critique of India’s present touted reforms by Deepak Lal, Professor Emeritus of International Development Studies, UCLA.
• While monetary policies are the center piece of the recovery, excessive reliance on Central Bank policies should be avoided to mitigate risks. Technological innovation coupled with fiscal policies should serve as synergistic mechanisms to maintain this global recovery.

The report also speaks of lower oil prices as spurring the boom in consumer demand but decries the incessantly abnormal low inflation in the major economies of the world which risk is exacerbated by low or even negative interest rates. This places a burden on fixed investment at the benefit of financial investments.

To cap it all, economies dependent on commodities have a weak growth prospect for 2015. One should not fail to mention - including oil dependent countries like Nigeria.

What does gender equality and high oil prices have in common in Nigeria?

Low oil prices wouldn't make her happy!

Photo credit: Trocaire on Flickr

An economist.com article quoting a 2008 “Demographic and Health Survey” that looked at the human impact of oil price changes makes one to conclude that there exists a relationship between gender equality and high oil prices. Even low oil prices! With low oil prices, there should be a rise in gender inequality in the Southern states of Nigeria when compared to their Northern colleagues.

High oil prices were linked to childhood malnutrition and high primary school drop-out rates in the Southern States. One wonders if the same correlation follows now that low oil prices have kicked in.

Furthermore, as every Nigerian knows, high oil prices were the doom of the agriculture industry. The article makes interesting reading.

Apple will be the latest addition to Dow Jones today

After markets close today, Wednesday, Apple , (AAPL), will be added to the Dow Jones Industrial Average (DJIA). Apple has been reporting consistent record breaking earnings, even though earnings for oil companies on the index, like Exxon Mobil, (XOM), are expected to fall due to falling oil prices.

Some links on the story:

1. What Apple’s Addition To the Dow Means for Earnings. The WSJ’s MoneyBeat concludes that the DJIA is better with Apple than AT&T. By its calculations, if it had swapped AT&T for Apple two weeks ago, the DJIA would have been 700 points higher.

2. What Apple’s Dow addition will do to its stock. Jennifer Booton, writing for MarketWatch, wonders whether Apple will follow tradition: share prices rally when added to the DJIA but fall weeks after induction.

3. Will Apple Overcome the Curse of the Dow Jones Industrial Average? Simon Maierhofer writing for thestreet.com wonders if the curse of the DJIA will befall the world’s largest company. He reports that on average, all new components to the Dow Jones have an average loss of 2.5% one month after inclusion.

It is worthy to note that the Dow Jones Industrial Average is an exclusive club and only 30 companies are registered on it. That testifies to the current strength of Apple who kicked out AT&T (T).

If America doesn’t want more power, no country is more willing to take it away than… you guessed right!

The Economic Power Button?

Credit: Frédéric BISSON on flickr.

Speculation is rife that the Federal Reserve’s policy meeting tomorrow will occasion the announcement of a rise in interest rates. It’s not speculation because reading today’s news points to that fact.

First, the dollar is very strong and will get stronger. The real exchange rate, not just the nominal one, is also high, propped up by falling oil prices and a weak inflation in the country.

Second, the quantitative easing regime which the European Central bank just kicked in last week will make European corporate stocks very attractive. If the Fed doesn’t raise interest rates soon, investors might push their money towards Europe and they’ll be the loser for it if the euro appreciates in the near future.

As I mentioned before, falling oil prices means the cost of production is falling globally. Too bad for OPEC countries! Profits will soar and there will be more money in the hands of American citizens. Employment is not a big issue; it’s a political advantage for President Obama.

Take a happy workforce with money in their pockets, corporations posting profits and a financial system that is one of the best in the largest economy in the world and there’s only one way to go – hold on to that power.

Holding off raising interest rates might seem a strategic option, but that option will leave Americans with no option but to import goods and more foreign goods. They’d rather export financial assets and make the balance sheets cleaner. On the other hand, raising rates makes American citizens stronger and corporations more competitive.

So, which way would the Fed go: take a hawkish tone and watch as the markets unfold post Eurozone’s quantitative easing, or take the plunge, do what the markets expect? It could be any one’s guess.

2015 will probably be the year of the unemployed in Nigeria

Unemployment must surely be on the mind of the President and his financial team, else why should it take a year before the bereaved families of the Nigerian Immigration service (NIS) tragedy be compensated?

Confronted with three daring devils that are ready to strangulate its economy: low oil prices, conflict in the North Eastern part of the country and forthcoming elections that have already been once postponed, many Nigerians wonder if there is trouble lurking in the wings?

Unemployed adults looking for work.

Credit: flickr.com

Surely, Nigeria is not going to record the glowing productivity growth of 2014. She might possibly encounter a steep fall in production and exports. Income from oil has already fallen as reflected in the budget for 2015. The reported “pro-common man focus…” as expressed by the Coordinating Minister for the Economy and Minister of Finance, Dr Ngozi Okonjo-Iweala, is for the sake of the Goodluck Jonathan’s election campaign. The government and those before it have not expressed a deep founded “pro-common man focus!” Boko Haram has made the North Eastern part of the country non-viable economically, if not politically and educationally.

The elections of March 28 and April 11? Typically Nigerian, the elections have been surrounded with uncertainty, notably whether Jega, the Chairman of the Independent National Electoral Commission (INEC) will be removed.

The Central Bank of Nigeria’s Governor, Godwin Emefiele, must have foreseen this drama come the election period, hence his decision to devalue the naira and increase interest rates in November of last year.

If he had not devalued, he might have to reduce interest rates drastically. Too bad for the country! Or start printing money fast. Can he maintain that?

Increasing the interest rates will at least maintain the attractiveness of the naira against lesser competitive currencies, but not the dollar. It will also make Nigeria attractive to investors, possibly European banks who are currently faced with a high liquidity problem. Yet, the interest rate will not be enough.

Foreign exchange reserves have fallen by 8% as at the time of the devaluation and are expected to fall further since the price of oil, the mainstay of the Nigerian economy, is not rising either. Unemployment will have a free ride this year. Goodluck Jonathan must have foreseen that; so why remind us of the NIS tragedy? Why not earlier?

If the CBN Governor, Emefiele, expects devaluation to shore up expected fall in production and consumption, he might be playing a risky game. Devaluation takes a long time to kick off. Nigeria is an import dependent country. Does Nigeria have the necessary infrastructure such that agriculture and tourism, or an alternative industry, can replace the oil industry before October, a year after the devaluation?

As prices of foodstuffs and other goods begin to rise, wages will surely follow suit. Expect to see a rise of unemployment. 2015 will probably be the year of the unemployed.

By the way, it’s not even on the politicking agenda this year! Have you noticed?

A three question financial test you should try out

What is your financial IQ?

Try out this quiz and see if you can pass all three questions. I did.

As you read to the bottom of the page, you'll see the principles each of the questions tests:

1. Compounding interests.
2. Understanding of inflation.
3. Risk diversification.

Even if it's a scam, fund managers could be given the benefit of the doubt.

I found this on the urban dictionary:

I’m constantly given false hope that me and my ex will get together.

False hope, according to that dictionary, is the belief passed on from someone that something may happen in the future when the chance that it might not happen is high and you do not know that chance is high.

Trust builds confidence.

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I was reading this economist.com article last week and the author thought this was another example of a false hope. It is a scam created around a statistical principle that was misused.

The scam: A fund manager randomly sends emails to thousands of people telling them that a stock will rise or fall. If it turns out positive, he sends another email to that group of people. If it turns out negative, that email is discarded and replaced. This round robin exercise on the positive group is carried out until one of them builds trust and makes a buy from the fund manager. It’s a scam but it’s a practice that many fund managers engage in.

The author says the problem lies with the misuse of a statistics rule. What would you call a fund manager who realizes he’s engaged in a scam and doesn’t make the appropriate corrections?

Is Africa going to have free money?

All that glitters is not gold.

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The ECB announced recently that it’ll kick off its 60 billion euro-a-month bond purchases ($66.3 bn) today. This stimulus program, a quantitative easing, is expected to involve euro-denominated public sector securities in the secondary market, as well as securities from the corporate arena such as asset-backed securities.

Quantitative easing, not new to most Central Banks these days, although common with Japan some decades ago, is a monetary policy undertaken by Central Banks when the standard monetary policy, purchasing bonds and thereby expanding the money supply, has proved ineffective. In recent years, we have seen European countries reduce their rates to much below the lower bound, to negative values.

Why quantitative easing? As I said earlier, because standard monetary policy has failed. When Central Banks are purchasing corporate bonds and assets in lieu of its own issued bonds, the prices of those assets rise and their yields fall. The monetary base increases and thence the money supply. That means there will be much money in circulation. Many persons claim this is tantamount to printing money. It is also done to stimulate spending, discourage savings and stimulate the economy to a recovery. Eventually, all these measures prove effective when banks lend this liquid money.

Quantitative easing is also used to curtail deflationary pressures on the economy.

So, with banks having high liquidity, they’re ready to give out money both locally and globally. Africa will not be left out of the lending spree.

Nigeria, South Africa, Ghana, Kenya and other African economies that have been in favorable ratings recently will expect to receive European money as loans. Will it be free?

Even when those lending rates are low, it is not free. Like in the past, it could create a spirit of “cheap loans” amongst developing country borrowers, making them increase their debt portfolio unreasonably. To maintain or increase growth, they’d have to do with some rise in inflation. Not so bad, though.

Until European recovery occurs as expected.

Too bad if the Governors of African Central Banks are not prudent. A former Indian foreign secretary, Shyam Saran, believes most of this money flowing to developing economies will be in portfolios, and not foreign direct investments. Thence, developing countries have to anticipate distortions and manage them appropriately. Portfolio investments can take flight on a whim. African economies do not have the investment climate that fosters much confidence.

Policy responses by developing countries matter when European economies start going back to tighter monetary policies. African economies should be expecting negative spillover effects when this happens. Capital inflows will reduce. Although this might not be significant but they are cautioned to exercise prudential economic management and investment in the sectors that will best allow structural change.

So, the money will not be free after all. The ECB is looking for a way to give herself time to bounce back and be competitive again.

We will always have the poor

Eliminating poverty is a good thing. The World Bank says it can be done by 2030.

Congo refugee girl suffering Kwashiorkor. Wikimedia Commons

Can she? I thought I'd share this article for two reasons:

• If the World Bank succeeds, it has solved a challenge that has not been breached for millennia.
• It should have elevated itself to an Institution that can foretell and prophesy events.

A closer reading of the Economist.com's article shows that the WB has given itself a tough job, and a long fight.

Let's not eliminate poverty. The 3% estimate might be too high. Why not let it be, say, 5%, or 6% - just take away so many innocent persons from penury and want. Let them live above $1.5 per day for starters.

By 2030!

Why negative interest rates might not seem scary after all!

Why would anyone want to deposit or invest his money when nominal interest rates are negative?

Would you prefer to hold cash, like the Argentine currency above, or keep your account when rates are negative?

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For years, economists have dubbed imposition of negative interest rates as “a tax on holding money.” No one cherishes losing money. Under a negative nominal interest rate of -2.0%, $100 in an account will be worth $98 a year's time.

Negative nominal and real interest rates have been part of monetary history.

When inflation and bank charges on your checking accounts are accounted for, your money might eventually turn out to be under a negative nominal returns regime. Zero interest rates, which most persons tend to accept, turn out to be real negative interest rates. Other reasons why you might not realize you are already accepting negative interest rates, according to an article by Nouriel Roubini are:

• Banks having excess cash reserves will have no option but to accept negative interest rates.
• In Switzerland and Denmark where the capital gains are large compared to the price to pay for negative rates, negative interest rates have been allowed to exist.
• If the Eurozone encounters a deflation, then the negative nominal interest rates become positive real rates of return.

Yet, many would cringe at the prospect of losing money in the bank. Negative rates are attractive to many countries especially when the economy is in a downturn. One, it reduces savings because the opportunity cost of savings, consumption, has become higher. Boosting consumption will jumpstart growth and induce positive inflation. Central banks and banks will impose negative interest rates to try to stabilize the economy.

This implies that countries that impose negative interest rates should be launching projects or investments that offer alternatives to bank checking accounts and deposits especially productive infrastructure projects before people run the risk of saturating themselves with cash. Thomas Hirst thinks banks might be hardest hit. They might have to endure reduced profits or raise the interest rates on their loans.

The potential for a storm is evident. The ECB is aware of this. So, why should investors worry when the Swedish and eurozone experiment hasn’t failed?