Friday, July 27, 2007

Currency adjustments: The way global financial markets works

Currencies connect the economies to each other. On the long run , there is only one price for goods adjusted by parity conditions among different currencies. The Big Mac index is a measure of that unique price, and at the same time any deviation from it .
Those deviations, measure the undervalue and overvalued value of any currency at some point in time, in other words ,its deviation from the unique price long term price.. Thus, while an hamburger actually cost in the USA U$$ 3,22 , in the euro zone cost the equivalent of U$$ 4,06.It follows that at current price parity conditions , the euro would be overvalued by 25,65%.The same exercise applied for the yen show that this currency would be undervalued by 27,95%. These mismatches currency values, implies portfolio adjustment against the dollar. Considering the dollar and the euro , the trend has been in favour of the euro . However,since 2001 up to 2006, productivity in the euro zone has been stable, while the euro has appreciated on average by 14,3% . Therefore, somehow the current high euro value,(appreciation) would reflect the port folio adjustment which is taking place among other variables ,because of expectations of further decrease (depreciation) in dollar value.-
Which are the explanations for such expectation ?:
a.- The interest rate differentials between Europe and US are falling. The Euro zone Central Bank , is increasing the interest rate .-
b.- US economy growth, can be affected by sub prime housing market correction, deeper than expected. (Sub Prime represent no more than 15% of total housing markets credit)
c.- Current account unbalances in the US economy ,which is expected to be up to 5,9% of its 2007 Gdp.-
d.- Portfolio adjustment in favour of the euro issued assets , and carry trade transaction.
Whatever the reasons ,dollar depreciation has effects on global economy. It push upward raw material prices . Most of Latin America economies strongly orientated to primary good exports ,are ,getting an external boost for their growth performance. It also means increasing risks for further inflationary pressures.-
On the other hand, some European countries are started to be worried because of the euro might be getting close to the danger zone, risking loss of competitiveness for exports .A strong Euro, has a positive impact in those economies with high productivity levels, but as long as there are differences in productivity levels, some of them get a better share of the benefit than the others, and some are left behind .At the same time, an undervalue currency (yen) is also risky because it is away from macroeconomic fundamental.-
At present ,it is important to have some perspective. Over the short run, financial flows are more important than trade flow to explain exchange rate fluctuations .It follows that unpredictable financial markets movements, are more important as an explaining factor of currency fluctuations ,than real variables. However ,in the medium and long run it is possible to substitute traded goods, and exchange rates are determined by real forces that influence their relative prices.( A fair exchange?: Theory and practice of calculating equilibrium exchange rates .IMF /WP/ 05 /229.Bayoumi,Faruqee and Lee).
So, it seems that we are looking at the sensitivity and worries of global financial markets , concerning the fundamental of the global economy. Overreaction is a short term phenomena .The long term course, will be determined by the chance of a coordinated adjustment policy between different global currencies.- Whichever these forces is stronger it will mean more or less volatility in financial global markets.-

Friday, July 20, 2007

Priviledge Information: The new ethics for Chilean business man (II)

The following question is the key one :What is considered to be privilege information? No matter the different definitions available , there is one in particular which is quite clear to stress the nature of the privilege : Privilege information is the one which is known by just a few , and it might have an impact on financial markets valuation. In other words, it might help to any of those few potential investor to get higher economic return than it would be otherwise .Thus, the problem arises when such investor are from inside the firm.-
Privilege information includes: future investment plans, financial statement to the public authority, merger approval and the like. In all this cases ,the market value of the firm might go up or down depending upon the nature of such information. For instance, the approval by the executive board for new investment plans, which will impact positively the stock market valuation of such a firm, is the typical example of information shared by a few. Any internal potential investor , would benefit buying before those plans are made public . However, the same opportunity should be available for anyone from the public ,with that information so they can buy stock options and expect its return to be higher in the future. The problem is that it is not always so. The same case apply , whether anyone know the financial results which might show an increase in profit .It is possible to make a profit buying before those results are made public. The ethic dilemma arise because of the gap between those who have the information , and those who do not, or have to wait for it to be public before making their portfolio decisions.
These situations are considered as market failure ,and privilege information is a negative externality , which arise because of the nature of business decision in competitive environment .In this kind of environment, nobody want to give up their privileges of being the first, in favour of their competitor. The social benefit of information is higher than the private benefit, so less information is available and few people have more information for their advantages instead of society ( potential investors).
What is the role of institutional framework?. As long as there are property right concerning information clearly defined; which from the financial market valuation stand point, means that there is a legitimate owner of certain level of key information. Therefore, the issue is to get control of how those owner use that information, without affecting the chance of other investors to benefit also from it, specially if the firm is depending on stock market as a source of financial resources . So, it has been established the black out period, which imply that nobody within those few with access to privilege information, will take advantage of that information .Those who do not fulfil that requirement exposure themselves to heavy fines, usually a proportion of the total transaction. The black out reduce the social benefit of information, because somehow there is no information available for anyone ,therefore nobody can make business transaction with some specific , while the new information is not available yet. As a result, when the information becomes available both private and social benefit are similar ,as long as everyone has the same chance of making profit with it .Another alternative is to increase private benefit arising from information ,making it available on firm ´s web pages as soon as it is useful for market transactions.-
The last question: what about a politician with business interest ,trying to get a higher profit because of its position for getting better information?. In this situation, it is more an ethical problem than a market failure. Therefore, sanctions should be higher .-

Friday, July 13, 2007

Priviledge Information: The new ethics for Chilean business man (I)

Ethics has not always been on the core of market decisions .In fact, business are not ruled necessarily by ethics standards unless they are clearly set by laws. This is so , because self interest maximization assumes no restriction other than the impact on others people´ s welfare, which by itself would be a kind of ethic boundary to business, settled down throughout the institutional framework. This aspect of market behaviour, has made market economies , ethically stronger than other alternatives for society to solve the allocation of scarce resources. Markets are neutral. On the aggregate, the self regulated ethic works well, as long as wealth creation get through to everyone ´s benefit.-
This issue has also been considered as a core one, on the debate about the application of new ethics standard on business decisions ,after some high profile cases (Enron and recently Siemens).As long as the benefit of wealth creation, is concentrated on just a few it deserves a penalty whether it is founded on priviledge information .Some would argue that with such approach, there is the risk of overregulated the market with fees and sanctions ,such as the markets based on self regulated behaviour, would have a competitive advantage for financial transaction.
Chilean finance market regulators , has been working hard in the last ten years, to improve the quality of ethics standard for business decisions. Mergers, strategic alliances, hostile take over operations, and higher market concentration have driven them to be alert. New laws and regulations have been part of that effort. However, one thing is to have the law ,and another one is to enforce it.
Chilean business culture, has historically been based on informal networks closely connected to family ,friends ,political and social ties. Laws are not designed to be obey but to be bypassed one way or another . Therefore , any attempt to move ahead to change that culture , have a lot of difficulties concerning market reaction, news media coverage impact on foreign perception, public opinion evaluations and the like. Even more complicated ,when it comes to impose sanction on key political leaders who at the same time are also very active on business activities.-
Some key questions are useful. Is politics by nature, in conflict with business ?.Not necessarily. A lot of politicians have strong ties with business activities ,without being considered it as an unethical situation, as long as there is a clear division between both. On the other hand, politics might be inspired by business consideration, or the other way around as well. A couple of examples. On the first case, politics inspired by business is “ The initiative for the Americas, to foster trade and investment” in the nineties, and on the second case, business inspired by politics ;the “Venezuela Oil supported Bank of the South for Latin America” .It follows ,that at the aggregate level business and politics might have go along quite well, however at an individual specific level , it is a different matter . Politics as a first motivation, deals with the art of what it is possible to serve society expectations; while business first motivation, deal with self interest . From the Political point of view, it does not seems to be the best approach to motivate other people beliefs into any politician project, to concentrate efforts working on self profit maximizing behaviour, above community needs and priorities, worst of all, when there is suspicious of using priviledge information.-

Friday, July 06, 2007

Eastern Island Civilization collapse: An economic point of view (II)

Is it global warming and climate change an accounting problem?. Unfortunately it is not an accounting problem. Environment accounting , might help to register the losses on the environment arising from economic growth ,but it does not solve the core issue of degradation resulting from human intervention on ecological equilibriums . Brazil, has done a lot of progress taking into account the accounting of environment damage , but of course that it is not neither the whole problem ,nor the whole solution. Real prices of environment damage, are higher than the prices economic agent (consumers and producers)are currently paying, so there is over consumption . It follows ,it is rather a market failure which requires a different institutional framework.-
Third lesson arising from Eastern Island experience, is the fact that weak institutional framework for environment protection and policies design, can be as much harmful as it is the human intervention on environment . When societies do not have the proper institutional framework to cope with any challenge coming across to their survival , it is harder to overcome the consequences of it. There is no tools which to get hand on, therefore no possible solution to count on. Eastern Island civilization, did not have such an institutional framework because at one point in time, they probably did not realized how important was the environment, but when they did ,it was too late.-
Actually, there is not a global environment institution, as it is for trade (WTO), world peace (UN),education (UNESCO),labour (ILO) and the like .The UN, has been trying to move forward on the issue based on a political “good willing” approach , but it seems that the time is for deeper commitment which involves new friendly environment technologies, reduction of dioxide carbon emissions , better incentives for “green bonds” trade markets , permanent dialog on the issue and the like. All of these challenges are, quite demanding for any organization with objectives , different to that one connected exclusively with the environment protection.
Fourth lesson. There is a moment for thinking , and a moment for solutions. When the right time is over, there is no way to get it back. It is interesting to mention that even though we can borrow everything we need in excess to current available resources, including time when we extend our life span throughout scientific progress , we can also borrow time for environment purposes. The green bond markets is an effective mechanism to borrow time for environment protection.
The Eastern Island civilization ,realized too late that the time for solutions aimed to avoid the environment damage , was over. Therefore , they moved to a different set of solution. How to make the proper decisions to survive , minimizing the cost of destroying themselves?. The decided to chose someone , capable of imposing the rules under the new conditions .That was their “solution”. Ours ? . It would be to ask for new global environment institutions.-
The Stern report and the recent UN report ,are clear yellow lights indicating that we are at the right time to implement solutions concerning environment better protection. If we do not work for solutions , what would be our legacy left for posterity? .. Eastern Island civilization ,at least left behind the "Moais" (stone made monuments).