Current Account Deficits: Government Investment Or Irresponsibility?

 

Current Account Deficits: Government Investment Or Irresponsibility?

by Reem Heakal

The current account is a section in a country's balance of payments (BOP) that records its current transactions. The account is divided into four sections:

• goods,
• services,
• income (such as salaries and investment income) and
• unilateral transfers (for example, workers' remittances).

 

A current account deficit occurs when a country has an excess of one or more of the four factors making up the account.

• When a current transaction enters the account, it is recorded as a credit; when a value leaves the account, it is marked as a debit.
• Basically, a current account deficit occurs when more money is being paid out than brought into a country.

 

What a Deficit Implies

When a current account is in deficit, it usually means that a country is investing more abroad than it is saving at home. Often, the logic dictating a country's investment decisions is that it takes money to make money.

• In order to try and boost its gross domestic production (GDP) and future growth, a country may go into debt, taking on liabilities to other countries. It then becomes what is termed as a "net debtor" to the world.
• However, a problematic deficit can result if a government has not planned out a sound economic policy and used its debts for consumption purposes, not future growth. (For more insight, see What Fuels The National Debt?)

 

A current account deficit implies that a country's economy is functioning on borrowed means.
In other words, other countries are essentially financing the economy, and hence sustaining the deficit.

When determining the economic health of a nation, it is important to understand

• where the deficit stems from,
• how it's being financed and
• what possible solutions exist for its alleviation.

To do so, we need to look at not only the current account, but also the other two sections of the BOP,

• the capital account and
• the financial account.

 

The Capital and Financial Accounts
Foreign funds entering a country from the sale or purchase of tangible assets - as opposed to non-physical assets such as stocks or bonds - are recorded in the capital account of the BOP. (Again, money entering the account is noted as a credit, and money leaving the account is a debit.)

Financial transactions such as money leaving the country for investment abroad are recorded in the financial account.

Together, these two accounts provide financing for a current account deficit.


Why Is There a Deficit?
Is a current account deficit simply a matter of a government's bad planning and/or uncontrollable spending and consumption?

• Well, sometimes.
• But more often than not, a deficit is planned for the purpose of helping an economy's development and growth.
• It can also be a sign of a strong economy that is a safe haven for foreign funds (we'll explain this below).
• When an economy is in a state of transition or reform, or is pursuing an active strategy of growth, running a deficit today can provide funding for domestic consumption and investment tomorrow.

Here are some of the types of deficits, both planned and unplanned, that countries experience.

 

Balance of Trade Deficit
With the long-term in mind, a country may run a deficit by importing more than it's exporting, with the ultimate goal of producing finished goods for export. In this scenario, the country will plan to pay off the temporary excess of imports at a later time with proceeds made from future export sales. The proceeds made from these sales would then become a current account credit. (To Learn more, read In Praise Of Trade Deficits.)

 

Investing for the Future
Instead of saving money now, a country could also choose to invest abroad in order to reap the rewards in the future. The outing funds would be recorded as a debit in the financial account, while the corresponding incoming investment income would eventually be earmarked as a credit in the current account. Often, a current account deficit coincides with depletion in a country's foreign reserves (limited resources of foreign currency available to invest abroad).

 

Foreign Investors
When foreign investors send money into the domestic economy, the latter must eventually pay out the returns due to the foreign investors. As such, a deficit may be a result of the claims foreigners have on the local economy (recorded as a debit in the current account).

 

This kind of deficit could also be a sign of a strong, efficient and transparent local economy, in which foreign money finds a safe place for investment. The United States capital market, for example, was seen as such when "quality assets" were sought out by investors burned in the Asian crisis. The U.S. experienced a surge of foreign investment into its capital markets. And while the U.S. received money that could help increase domestic productivity and hence expand its economy, all of those investments would have to be paid off in the form of returns (dividends, capital gains), which are debits in the current account. So a deficit could be the result of increased claims by foreign investors, whose money is used to increase local productivity and stimulate the economy.

 

Overspending Without Enough Income
Sometimes governments spend more than they earn, simply due to ill-advised economic planning. Money may be spent on costly imports while local productivity lags behind. Or, it may be deemed a priority for the government to spend on the military rather than economic production. Whatever the reason, a deficit will ensue if credits and debits do not balance.

 

Financing the Deficit

 

Public and Private Foreign Funds
Funding channeled into the capital and financial accounts (remember, these accounts finance the deficits in the current account) can come from both (1) public (official) and (2) private sources.

• Governments, which account for official capital flows, often buy and sell foreign currencies. Credit from these sales is recorded in the financial account.
• Private sources, whether institutions or individuals, may be receiving money from some sort of foreign direct investment (FDI) scheme, which appears as a debit in the income section of the current account but, when investment income is finally received, becomes a credit.

 

Balanced Financing
To avoid unnecessary extra risks associated with investing money abroad, the financing of the deficit should ideally rely on a combination of long-term and short-term funds rather than one or the other.

• If, for example, a foreign capital market suddenly collapses, it can no longer provide another country with investment income.
• The same would be true if a country borrows money and political differences cut the credit line.
• However, by planning to receive recurrent investment income over the years, such as by means of an FDI project, a country could intelligently finance its current account deficit.

 

Capital Flight
In times of global recession, the financing of a deficit can sometimes be traced to capital flight, that is, private individuals and corporations sending their money into "safe" economies.

• This money is recorded as a credit in the current account but, in reality, it is not a reliable source of financing.
• In fact, it is a strong indication that the world economy is slowing and may not be able to provide financing in the near future.

 

Conclusion

• In order to determine whether a country's economy is weak, it is important to know why there is a deficit and how it is being financed.
• A deficit can be a sign of economic trouble for some countries, and a sign of economic health for others.
• To support the current account deficits of countries around the world, the global economy must be strong enough so that exports can be bought and investment income repaid.
• Often, however, a current account deficit cannot be sustained for too long - it is widely debated whether the consumption of today will result in chronic debt for future generations.

by Reem Heakal, (Contact Author | Biography)

 

 

http://www.investopedia.com/articles/04/012804.asp

What is a trade deficit and what effect will it have on the stock market?

What is a trade deficit and what effect will it have on the stock market?

 

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A trade deficit, which is also referred to as net exports, is an economic condition that occurs when a country is importing more goods than it is exporting. The deficit equals the value of goods being imported minus the value of goods being exported, and it is given in the currency of the country in question. For example, assume that the United Kingdom imports 800 billion British pounds worth of goods, while exporting only 750 billion pounds. In this example, the trade deficit, or net exports, would be 50 million pounds.

 

Measuring a country's net imports or net exports is a difficult task, which involves different accounts that measure different flows of investment. These accounts are the current account and the financial account, which are then totaled to help form the balance of payments figure. The current account is used as a measure for all of the amounts involved in importing and exporting goods and services, any interest earned from foreign sources, and any money transfers between countries. The financial account is made up of the total changes in foreign and domestic property ownership. The net amounts of these two accounts are then entered into the balance of payments. (To learn more, see What Is The Balance Of Payments?, Understanding The Current Account In The Balance Of Payments and Understanding The Capital And Financial Accounts In The Balance Of Payments.)

 

In terms of the stock market, a prolonged trade deficit could have adverse effects.

• If a country has been importing more goods than it is exporting for a sustained period of time, it is essentially going into debt (much like a household would).
• Over time, investors will notice the decline in spending on domestically produced goods, which will hurt domestic producers and their stock prices.
• Given enough time, investors will realize fewer investment opportunities domestically and begin to invest in foreign stock markets, as prospects in these markets will be much better. This will lower demand in the domestic stock market and cause that market to decline.

 

 

http://www.investopedia.com/ask/answers/03/110603.asp

What Is The Balance Of Payments?

What Is The Balance Of Payments?

by Reem Heakal

The balance of payments (BOP) is the method countries use to monitor all international monetary transactions at a specific period of time.

• Usually, the BOP is calculated every quarter and every calendar year.
• All trades conducted by both the private and public sectors are accounted for in the BOP in order to determine how much money is going in and out of a country.
• If a country has received money, this is known as a credit, and, if a country has paid or given money, the transaction is counted as a debit.
• Theoretically, the BOP should be zero, meaning that assets (credits) and liabilities (debits) should balance.
• But in practice this is rarely the case and, thus, the BOP can tell the observer if a country has a deficit or a surplus and from which part of the economy the discrepancies are stemming.

The Balance of Payments Divided
The BOP is divided into three main categories:

• the current account,
• the capital account and
• the financial account.

Within these three categories are sub-divisions, each of which accounts for a different type of international monetary transaction.

The Current Account
The current account is used to mark the inflow and outflow of goods and services into a country. Earnings on investments, both public and private, are also put into the current account.

• Within the current account are credits and debits on the trade of merchandise, which includes goods such as raw materials and manufactured goods that are bought, sold or given away (possibly in the form of aid).
• Services refer to receipts from tourism, transportation (like the levy that must be paid in Egypt when a ship passes through the Suez Canal), engineering, business service fees (from lawyers or management consulting, for example), and royalties from patents and copyrights.
• When combined, goods and services together make up a country's balance of trade (BOT).
• The BOT is typically the biggest bulk of a country's balance of payments as it makes up total imports and exports.
• If a country has a balance of trade deficit, it imports more than it exports, and if it has a balance of trade surplus, it exports more than it imports. 
• Receipts from income-generating assets such as stocks (in the form of dividends) are also recorded in the current account.
• The last component of the current account is unilateral transfers. These are credits that are mostly worker's remittances, which are salaries sent back into the home country of a national working abroad, as well as foreign aid that is directly received.

The Capital Account
The capital account is where all international capital transfers are recorded. This refers to the acquisition or disposal of

• non-financial assets (for example, a physical asset such as land) and
• non-produced assets,

which are needed for production but have not been produced, like a mine used for the extraction of diamonds.

The capital account is broken down into the monetary flows branching from

• debt forgiveness,
• the transfer of goods, and financial assets by migrants leaving or entering a country,
• the transfer of ownership on fixed assets (assets such as equipment used in the production process to generate income),
• the transfer of funds received to the sale or acquisition of fixed assets,
• gift and inheritance taxes,
• death levies, and,
• finally, uninsured damage to fixed assets.

The Financial Account
In the financial account, international monetary flows related to investment in

• business,
• real estate,
• bonds and stocks

are documented.

Also included are government-owned assets such as

• foreign reserves,
• gold,
• special drawing rights (SDRs) held with the International Monetary Fund,
• private assets held abroad, and
• direct foreign investment.

Assets owned by foreigners, private and official, are also recorded in the financial account.

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The Balancing Act
The current account should be balanced against the combined-capital and financial accounts. However, as mentioned above, this rarely happens.

• We should also note that, with fluctuating exchange rates, the change in the value of money can add to BOP discrepancies.
• When there is a deficit in the current account, which is a balance of trade deficit, the difference can be borrowed or funded by the capital account.
• If a country has a fixed asset abroad, this borrowed amount is marked as a capital account outflow. However, the sale of that fixed asset would be considered a current account inflow (earnings from investments). The current account deficit would thus be funded.

When a country has a current account deficit that is financed by the capital account, the country is actually foregoing capital assets for more goods and services. If a country is borrowing money to fund its current account deficit, this would appear as an inflow of foreign capital in the BOP.

Liberalizing the Accounts
The rise of global financial transactions and trade in the late-20th century spurred BOP and macroeconomic liberalization in many developing nations. With the advent of the emerging market economic boom - in which capital flows into these markets tripled from USD 50 million to USD 150 million from the late 1980s until the Asian crisis - developing countries were urged to lift restrictions on capital and financial-account transactions in order to take advantage of these capital inflows.

• Many of these countries had restrictive macroeconomic policies, by which regulations prevented foreign ownership of financial and non-financial assets.
• The regulations also limited the transfer of funds abroad.
• But with capital and financial account liberalization, capital markets began to grow, not only allowing a more transparent and sophisticated market for investors, but also giving rise to foreign direct investment.
• For example, investments in the form of a new power station would bring a country greater exposure to new technologies and efficiency, eventually increasing the nation's overall gross domestic product by allowing for greater volumes of production.
• Liberalization can also facilitate less risk by allowing greater diversification in various markets.

by Reem Heakal, (Contact Author | Biography)

http://www.investopedia.com/articles/03/060403.asp

Also read:
http://www.investopedia.com/terms/c/currentaccountdeficit.asp

Understanding The Current Account In The Balance Of Payments

 

Understanding The Current Account In The Balance Of Payments

by Reem Heakal

The balance of payments (BOP) is the place where countries record their monetary transactions with the rest of the world. Transactions are either marked as a credit or a debit. Within the BOP there are three separate categories under which different transactions are categorized:

• the current account: goods, services, income and current transfers are recorded.
• the capital account:  physical assets such as a building or a factory are recorded.
• the financial account: assets pertaining to international monetary flows of, for example, business or portfolio investments, are noted.

In this article, we will focus on analyzing the current account and how it reflects an economy's overall position. (For background reading, see What Is The Balance Of Payments?)

 

The Current Account
The balance of the current account tells us if a country has a deficit or a surplus. If there is a deficit, does that mean the economy is weak? Does a surplus automatically mean that the economy is strong? Not necessarily. But to understand the significance of this part of the BOP, we should start by looking at the components of the current account: goods, services, income and current transfers.

 

Goods - These are movable and physical in nature, and in order for a transaction to be recorded under "goods", a change of ownership from/to a resident (of the local country) to/from a non-resident (in a foreign country) has to take place. Movable goods include general merchandise, goods used for processing other goods, and non-monetary gold. An export is marked as a credit (money coming in) and an import is noted as a debit (money going out).

 

Services - These transactions result from an intangible action such as transportation, business services, tourism, royalties or licensing. If money is being paid for a service it is recorded like an import (a debit), and if money is received it is recorded like an export (credit).

 

Income - Income is money going in (credit) or out (debit) of a country from salaries, portfolio investments (in the form of dividends, for example), direct investments or any other type of investment. Together, goods, services and income provide an economy with fuel to function. This means that items under these categories are actual resources that are transferred to and from a country for economic production.

 

Current Transfers - Current transfers are unilateral transfers with nothing received in return. These include workers' remittances, donations, aids and grants, official assistance and pensions. Due to their nature, current transfers are not considered real resources that affect economic production.

Now that we have covered the four basic components, we need to look at the mathematical equation that allows us to determine whether the current account is in deficit or surplus (whether it has more credit or debit). This will help us understand where any discrepancies may stem from, and how resources may be restructured in order to allow for a better functioning economy.

 

The following variables go into the calculation of the current account balance (CAB):

 

X = Exports of goods and services
M = Imports of goods and services
NY = Net income abroad
NCT = Net current transfers

 

The formula is:

 

CAB = X - M + NY + NCT

 

 

 

What Does It Tell Us?
Theoretically, the balance should be zero, but in the real world this is improbable, so if the current account has a deficit or a surplus, this tells us something about the state of the economy in question, both on its own and in comparison to other world markets.

 

A surplus is indicative of an economy that is a net creditor to the rest of the world. It shows how much a country is saving as opposed to investing. What this means is that the country is providing an abundance of resources to other economies, and is owed money in return. By providing these resources abroad, a country with a CAB surplus gives other economies the chance to increase their productivity while running a deficit. This is referred to as financing a deficit.

 

A deficit reflects an economy that is a net debtor to the rest of the world. It is investing more than it is saving and is using resources from other economies to meet its domestic consumption and investment requirements. For example, let us say an economy decides that it needs to invest for the future (to receive investment income in the long run), so instead of saving, it sends the money abroad into an investment project. This would be marked as a debit in the financial account of the balance of payments at that period of time, but when future returns are made, they would be entered as investment income (a credit) in the current account under the income section. (For more insight, read Current Account Deficits.)

 

A current account deficit is usually accompanied by depletion in foreign-exchange assets because those reserves would be used for investment abroad. The deficit could also signify increased foreign investment in the local market, in which case the local economy is liable to pay the foreign economy investment income in the future.

 

It is important to understand from where a deficit or a surplus is stemming because sometimes looking at the current account as a whole could be misleading.

 

Analyzing the Current Account
Exports imply demand for a local product while imports point to a need for supplies to meet local production requirements. As export is a credit to a local economy while an import is a debit, an import means that the local economy is liable to pay a foreign economy. Therefore a deficit between exports and imports (goods and services combined) - otherwise known as a balance of trade deficit (more imports than exports) - could mean that the country is importing more in order to increase its productivity and eventually churn out more exports. This in turn could ultimately finance and alleviate the deficit.

 

A deficit could also stem from a rise in investments from abroad and increased obligations by the local economy to pay investment income (a debit under income in the current account). Investments from abroad usually have a positive effect on the local economy because, if used wisely, they provide for increased market value and production for that economy in the future. This can allow the local economy eventually to increase exports and, again, reverse its deficit.

 

So, a deficit is not necessarily a bad thing for an economy, especially for an economy in the developing stages or under reform: an economy sometimes has to spend money to make money. To run a deficit intentionally, however, an economy must be prepared to finance this deficit through a combination of means that will help reduce external liabilities and increase credits from abroad. For example, a current account deficit that is financed by short-term portfolio investment or borrowing is likely more risky. This is because a sudden failure in an emerging capital market or an unexpected suspension of foreign government assistance, perhaps due to political tensions, will result in an immediate cessation of credit in the current account.

 

Conclusion

• The volume of a country's current account is a good sign of economic activity.
• By scrutinizing the four components of it, we can get a clear picture of the extent of activity of a country's industries, capital market, services and the money entering the country from other governments or through remittances.
• However, depending on the nation's stage of economic growth, its goals, and of course the implementation of its economic program, the state of the current account is relative to the characteristics of the country in question.
• But when analyzing a current account deficit or surplus, it is vital to know what is fueling the extra credit or debit and what is being done to counter the effects (a surplus financed by a donation may not be the most prudent way to run an economy).
• On a separate note, the current account also highlights what is traded with other countries, and it is a good reflection of each nation's comparative advantage in the global economy.

by Reem Heakal, (Contact Author | Biography)

 

 

http://www.investopedia.com/articles/03/061803.asp

What's the difference between absolute P/E ratio and relative P/E ratio?

What's the difference between absolute P/E ratio and relative P/E ratio?

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The simple answer to this question is that absolute P/E, which is the most quoted of the two ratios, is the price of a stock divided by the company's earnings per share (EPS). This measure indicates how much investors are willing to pay per dollar of earnings. The relative P/E ratio, on the other hand, is a measure that compares the current P/E ratio to the past P/E ratios of the company or to the current P/E ratio of a benchmark. Let's look at both absolute and relative P/E in more detail.

Absolute P/E

The nominator of this ratio is usually the current stock price, and the denominator may be

• the trailing EPS (from the trailing 12 months [TTM]),
• the estimated EPS for the next 12 months (forward P/E) or
• a mix of the trailing EPS of the last two quarters and
• the forward projected EPS for the next two quarters.

When distinguishing absolute P/E from relative P/E, it is important to remember that absolute P/E represents the P/E of the current time period.

For example, if the price of the stock today is $100, and the TTM earnings are $2 per share, the P/E is 50 ($100/$2).

Relative P/E

Relative P/E compares the current absolute P/E to

• a benchmark or
• a range of past P/Es over a relevant time period, such as the last 10 years.

Relative P/E shows what portion or percentage of the past P/Es the current P/E has reached.

• Relative P/E usually compares the current P/E value to the highest value of the range, but investors might also compare the current P/E to the bottom side of the range, measuring how close the current P/E is to the historic low.
• The relative P/E will have a value below 100% if the current P/E is lower than the past value (whether the past high or low).
• If the relative P/E measure is 100% or more, this tells investors that the current P/E has reached or surpassed the past value.

Suppose a company's P/Es over the last 10 years have ranged between 15 and 40.

• If the current P/E ratio is 25, the relative P/E comparing the current P/E to the highest value of this past range is 0.625 (25/40), and the current P/E relative to the low end of the range is 1.67 (25/15).
• These value tell investors that the company's P/E is currently 62.5% of the 10-year high, and 67% higher than the 10-year low.

If all is equal over the time period, the closer the P/E gets to the high side of the range and further away from the low side, the more caution an investor needs since this could mean the stock is overvalued.

• There is, however, a lot of discretion that goes into interpreting relative P/E.
• Fundamental shifts in the company such as an acquisition of a highly profitable entity can justifiably increase the P/E above the historic high.

As we mentioned above, relative P/E may also compare the current P/E to the average P/E of a benchmark such as the S&P 500.

• Continuing with the example above where we have a current P/E ratio of 25, suppose the P/E of the market is 20.
• The relative P/E of the company to the index is therefore 1.25 (25/20).
• This shows investors that the company has a higher P/E relative to the index, indicating that the company's earnings are more expensive than that of the index.
• A higher P/E, however, does not mean it is a bad investment. On the contrary, it may mean the company's earnings are growing faster than those represented by the index.
• If, however, there is a large discrepancy between the P/E of the company and the P/E of the index, investors may want to do additional research into the discrepancy.

Conclusion
Absolute P/E, compared to relative P/E, is the most-often used measure and is useful in investment decision making; however, it is often wise to expand the application of that measure with the relative P/E measure to gain further information.

http://www.investopedia.com/ask/answers/05/051005.asp

The 2007-08 Financial Crisis In Review

 

The 2007-08 Financial Crisis In Review

by Manoj Singh

When the Wall Street evangelists started preaching "no bailout for you" before the collapse of British bank Northern Rock, they hardly knew that history would ultimately have the last laugh. With the onset of the global credit crunch and the fall of Northern Rock, August 2007 turned out to be just the starting point for big financial landslides. Since then, we have seen many big names rise, fall, and fall even more. In this article, we'll recap how the financial crisis of 2007-08 unfolded. (For further reading, see Who Is To Blame For The Subprime Crisis?, The Bright Side Of The Credit Crisis and How Will The Subprime Mess Impact You?)

 

Before the Beginning
Like all previous cycles of booms and busts, the seeds of the subprime meltdown were sown during unusual times. In 2001, the U.S. economy experienced a mild, short-lived recession. Although the economy nicely withstood terrorist attacks, the bust of the dotcom bubble, and accounting scandals, the fear of recession really preoccupied everybody's minds. (Keep learning about bubbles in Why Housing Market Bubbles Pop and Economic Meltdowns: Let Them Burn Or Stamp Them Out?)

 

To keep recession away, the Federal Reserve lowered the Federal funds rate 11 times - from 6.5% in May 2000 to 1.75% in December 2001 - creating a flood of liquidity in the economy. Cheap money, once out of the bottle, always looks to be taken for a ride. It found easy prey in restless bankers - and even more restless borrowers who had no income, no job and no assets. These subprime borrowers wanted to realize their life's dream of acquiring a home. For them, holding the hands of a willing banker was a new ray of hope. More home loans, more home buyers, more appreciation in home prices. It wasn't long before things started to move just as the cheap money wanted them to.

 

This environment of easy credit and the upward spiral of home prices made investments in higher yielding subprime mortgages look like a new rush for gold. The Fed continued slashing interest rates, emboldened, perhaps, by continued low inflation despite lower interest rates. In June 2003, the Fed lowered interest rates to 1%, the lowest rate in 45 years. The whole financial market started resembling a candy shop where everything was selling at a huge discount and without any down payment. "Lick your candy now and pay for it later" - the entire subprime mortgage market seemed to encourage those with a sweet tooth for have-it-now investments. Unfortunately, no one was there to warn about the tummy aches that would follow. (For more reading on the subprime mortgage market, see our Subprime Mortgages special feature.)

 

But the bankers thought that it just wasn't enough to lend the candies lying on their shelves. They decided to repackage candy loans into collateralized debt obligations (CDOs) and pass on the debt to another candy shop. Hurrah! Soon a big secondary market for originating and distributing subprime loans developed. To make things merrier, in October 2004, the Securities Exchange Commission (SEC) relaxed the net capital requirement for five investment banks - Goldman Sachs (NYSE:GS), Merrill Lynch (NYSE:MER), Lehman Brothers, Bear Stearns and Morgan Stanley (NYSE:MS) - which freed them to leverage up to 30-times or even 40-times their initial investment. Everybody was on a sugar high, feeling as if the cavities were never going to come.

 

The Beginning of the End
But, every good item has a bad side, and several of these factors started to emerge alongside one another. The trouble started when the interest rates started rising and home ownership reached a saturation point. From June 30, 2004, onward, the Fed started raising rates so much that by June 2006, the Federal funds rate had reached 5.25% (which remained unchanged until August 2007).

 

Declines Begin
There were early signs of distress: by 2004, U.S. homeownership had peaked at 70%; no one was interested in buying or eating more candy. Then, during the last quarter of 2005, home prices started to fall, which led to a 40% decline in the U.S. Home Construction Index during 2006. Not only were new homes being affected, but many subprime borrowers now could not withstand the higher interest rates and they started defaulting on their loans.

 

This caused 2007 to start with bad news from multiple sources. Every month, one subprime lender or another was filing for bankruptcy. During February and March 2007, more than 25 subprime lenders filed for bankruptcy, which was enough to start the tide. In April, well-known New Century Financial also filed for bankruptcy.

 

Investments and the Public
Problems in the subprime market began hitting the news, raising more people's curiosity. Horror stories started to leak out.

 

According to 2007 news reports, financial firms and hedge funds owned more than $1 trillion in securities backed by these now-failing subprime mortgages - enough to start a global financial tsunami if more subprime borrowers started defaulting. By June, Bear Stearns stopped redemptions in two of its hedge funds and Merrill Lynch seized $800 million in assets from two Bear Stearns hedge funds. But even this large move was only a small affair in comparison to what was to happen in the months ahead.

 

August 2007: The Landslide Begins
It became apparent in August 2007 that the financial market could not solve the subprime crisis on its own and the problems spread beyond the United State's borders. The interbank market froze completely, largely due to prevailing fear of the unknown amidst banks. Northern Rock, a British bank, had to approach the Bank of England for emergency funding due to a liquidity problem. By that time, central banks and governments around the world had started coming together to prevent further financial catastrophe.

 

Multidimensional Problems
The subprime crisis's unique issues called for both conventional and unconventional methods, which were employed by governments worldwide. In a unanimous move, central banks of several countries resorted to coordinated action to provide liquidity support to financial institutions. The idea was to put the interbank market back on its feet.

 

The Fed started slashing the discount rate as well as the funds rate, but bad news continued to pour in from all sides. Lehman Brothers filed for bankruptcy, Indymac bank collapsed, Bear Stearns was acquired by JP Morgan Chase (NYSE:JPM), Merrill Lynch was sold to Bank of America, and Fannie Mae and Freddie Mac were put under the control of the U.S. federal government.

 

By October 2008, the Federal funds rate and the discount rate were reduced to 1% and 1.75%, respectively. Central banks in England, China, Canada, Sweden, Switzerland and the European Central Bank (ECB) also resorted to rate cuts to aid the world economy. But rate cuts and liquidity support in itself were not enough to stop such a widespread financial meltdown.

 

The U.S. government then came out with National Economic Stabilization Act of 2008, which created a corpus of $700 billion to purchase distressed assets, especially mortgage-backed securities. Different governments came out with their own versions of bailout packages, government guarantees and outright nationalization.

 

Crisis of Confidence After All

• The financial crisis of 2007-08 has taught us that the confidence of the financial market, once shattered, can't be quickly restored.
• In an interconnected world, a seeming liquidity crisis can very quickly turn into a solvency crisis for financial institutions, a balance of payment crisis for sovereign countries and a full-blown crisis of confidence for the entire world.
• But the silver lining is that, after every crisis in the past, markets have come out strong to forge new beginnings.

 

To read more about other recessions and crises, see A Review Of Past Recessions.

 

 

by Manoj Singh, (Contact Author | Biography)

 

Manoj Singh is a central banker and a freelance writer. Apart from writing for Investopedia, he and his spouse write a weekly column on economics and finance for a financial daily.

 

http://www.investopedia.com/articles/economics/09/financial-crisis-review.asp

The Dangers of Unmanaged Growth: What Lessons Should You Learn?

 

What Lessons Should You Learn?

 

The Dangers of Unmanaged Growth.

Let's say you get a huge promotion and raise at work. You look at everything you own and think about upgrading your lifestyle. Should you get a bigger house, hire a personal trainer, or replace all your clothes in one Neiman Marcus shopping spree?

• Before you adjust your lifestyle, you should think about how long the raise could last. Maybe you should wait a year or two and see if your higher income persists.
• And even if your company does well, what happens to your job when the rest of the country cuts back on expenses?

Just as with Iceland, in a globalized world, no person, company or even country is a self-contained and independent entity. Therefore, Iceland's troubles showed that thinking ahead, even in the best of times, is an important survival strategy.

Iceland's Near Collapse: What Can We Learn?

Iceland's Near Collapse: What Can We Learn?

by Reyna Gobel,MBA (Contact Author | Biography)

While it's common to hear of companies going bankrupt, many were shocked when the entire country of Iceland almost fell into a state of bankruptcy in 2008. How could a country get to this point? And, once there, what could be done to mitigate the problem? Read on for a cautionary tale's description of what preceded Iceland's near economic collapse.

Cause of the Crisis
During the mid-1990s, Iceland flourished. Business was booming as financial products such as bank loans, investments and entrepreneurship became Iceland's biggest export. The country's economic reach became greater than ever. In fact, when you walk into the posh Handley's toy store in London to buy a five-foot-high plush Kangaroo, you're standing in an Icelandic company's investment.

Other new things were shaping up for Iceland during this time as well. For the first time in history, Iceland established its own domestic stock market in 1985. The growing economy greatly improved income for citizens, and wages increase by 45% between 1995 and 2000.

But with much of the banks' capital being loaned outside of the country, Iceland became overly dependent on other countries' economies staying afloat and those countries' residents and businesses paying off their debt.

Iceland's problems really began when it became a victim of poor currency trading rates, called carry rates. When currencies dropped in other markets, the Icelandic krona's value fell catastrophically. (For more information on what causes a country's currency to fall, read What Causes A Currency Crisis?)

Impact on the Average Icelandic Citizen

•Skyrocketing Interest Rates. Banks and the Icelandic government - which was forced to nationalize to stabilize some of Iceland's banks - needed to raise capital. Banks raise capital either by selling stocks or bonds. Unfortunately, both options were impossible in this situation. The third option was to raise interest rates, which limits lending in difficult times and encourages people in other countries to once again invest in Iceland's banking systems in the hope of a high return on a now-risky investment. But for the average Icelander, this rate hike caused mortgage rates to skyrocket, hitting a key interest rate of 18% in October of 2008, the highest level in Europe.

•International Travel Woes. When a national currency and homeland banks aren't viewed as very stable, traveling outside of the country becomes difficult for citizens. This is because other countries will have issues with accepting large amounts of Icelandic krona as payment.

The Rescuers: The International Monetary Fund
The International Monetary Fund is an international organization of 186 countries that aims to help nations avert financial crises by providing loans to countries with balance of payment issues, along with technical assistance. In October 2008, IMF announced a $2.1 billion loan plan with Iceland with the goal of restoring confidence in the banking system. Iceland must also adhere to an IMF-supported economic program. By March 2009, conditions in Iceland appeared to be improving, although it was maintaining very stringent controls on the flow of capital. (Chances are you've heard of the IMF. But what does it do, and why is it so controversial? See What Is The International Monetary Fund?)

What Lessons Should You Learn?

•The Dangers of Unmanaged Growth. Let's say you get a huge promotion and raise at work. You look at everything you own and think about upgrading your lifestyle. Should you get a bigger house, hire a personal trainer, or replace all your clothes in one Neiman Marcus shopping spree? Before you adjust your lifestyle, you should think about how long the raise could last. Maybe you should wait a year or two and see if your higher income persists. And even if your company does well, what happens to your job when the rest of the country cuts back on expenses?

Just as with Iceland, in a globalized world, no person, company or even country is a self-contained and independent entity. Therefore, Iceland's troubles showed that thinking ahead, even in the best of times, is an important survival strategy. (For related reading, check out The Globalization Debate.)


•One Country's Problems Can Impact the Global Economy. In a world where global economies are as important as national economies, one country's woes can either echo across the world, or the world's woes can encroach on any country worldwide. Iceland's banks had account holders and investors in a variety of countries shivering out of fear of losing their money. (For information on the global economy read Taking Global Macro Trends To The Bank.)


•Government Oversight of the Banking Industry. After the U.S. credit crisis of 2007-2008, mortgage rates didn't rise above 18% as they did in Iceland. However, pension and mutual funds dropped rapidly in value, home foreclosure rates skyrocketed and banks lost money to the extent of needing federal bailouts. The situation in Iceland questions the balance between a deregulated banking system and securing the stability of financial institutions that provide most of the funds for citizens' personal and professional lives. Iceland's crisis, as well as the one in the U.S., suggests that a line has to be drawn showing exactly when and how to intervene and stabilize a financial crisis. (To learn more, read Free Markets: What's The Cost?)

Conclusion
Iceland went to the brink of bankruptcy due to unmanaged, rapid growth of the banking industry in the mid-1990s. Icelandic citizens deal with high interest rates and some difficulty using their currency in other countries. Learn from this unfortunate event, and avoid the chill of unmanaged growth by analyzing and planning for major purchases in your own life - because you never know when a financial ice storm will hit your personal economy.

by Reyna Gobel (Contact Author | Biography)

Reyna Gobel is a freelance journalist and self-professed financial geek, who realized in her finance classes that personal finances weren't nearly as complicated as she thought they'd be and set out to spread the word.Gobel is also the author of "CliffsNotes Graduation Debt: How To Manage Student Loans And Live Your Life", which will be hitting the shelves in March of 2010.

http://www.investopedia.com/articles/economics/09/iceland-bankruptcy.asp

Evaluating Country Risk For International Investing

Evaluating Country Risk For International Investing

 

by Brian Perry

 

Many investors choose to place a portion of their portfolios in foreign securities. This decision involves an analysis of various mutual funds, exchange-traded funds (ETF), or stock and bond offerings. However, investors often neglect an important first step in the process of international investing. When done properly, the decision to invest overseas begins with a determination of the riskiness of the investment climate in the country under consideration. Country risk refers to the economic, political and business risks that are unique to a specific country, and that might result in unexpected investment losses. This article will examine the concept of country risk and how it can be analyzed by investors. (For more, read Finding Fortune In Foreign-Stock ETFs.)

 

Economic and Political Risk
The following are two main sources of risk that need be considered when investing in a foreign country.

 

•Economic risk: This risk refers to a country's ability to pay back its debts. A country with stable finances and a stronger economy should provide more reliable investments than a country with weaker finances or an unsound economy.
•Political risk: This risk refers to the political decisions made within a country that might result in an unanticipated loss to investors. While economic risk is often referred to as a country's ability to pay back its debts, political risk is sometimes referred to as the willingness of a country to pay debts or maintain a hospitable climate for outside investment. Even if a country's economy is strong, if the political climate is unfriendly (or becomes unfriendly) to outside investors, the country may not be a good candidate for investment.

 

Measuring Economic and Political Risk

 

Just as corporations in the U.S. receive credit ratings to determine their ability to repay their debt, so do countries. In fact, virtually every investable country in the world receives ratings from Moody's, Standard & Poor's (S&P), or the other large rating agencies.

• A country with a higher credit rating is considered a safer investment than a country with a lower credit rating.
• Examining the credit ratings of a country is an excellent way to begin the analysis of a potential investment.

 

Another important step in deciding on an investment is to examine a country's economic and financial fundamentals.

• Different analysts prefer different measures, but almost everyone looks at a country's gross domestic product (GDP), inflation and Consumer Price Index (CPI) readings when considering an investment.
• Investors will also want to carefully evaluate the structure of the country's financial markets, the availability of attractive investment alternatives, and the recent performance of local stock and bond markets.
• (For more insight, see The Consumer Price Index: A Friend To Investors and The Importance Of Inflation And GDP.)

 

Sources of Information on Country Risk
There are many excellent sources of information on the economic and political climate of foreign countries.

• Newspapers, such as the New York Times, the Wall Street Journal and the Financial Times dedicate significant coverage to overseas events.
• There are also many excellent weekly magazines covering international economics and politics; the Economist is generally considered to be the standard bearer among weekly publications.

  

For those seeking more in-depth coverage of a particular country or region, two excellent sources of objective, comprehensive country information are the Economist Intelligence Unit and the Central Intelligence Agency (CIA) World Fact Book.

• Either of these resources provides an investor with a broad overview of the economic, political, demographic and social climate of a country.
• The Economist Intelligence Unit also provides ratings for most of the world's countries. These ratings can be used to supplement those issued by Moody's, S&P, and the other "traditional" ratings agencies.

 

Finally, the internet provides access to a host of information, including international editions of many foreign newspapers and magazines. Reviewing locally produced news sources can sometimes provide a different perspective on the attractiveness of a country under consideration for investment.

 

Developed Markets, Emerging Markets and Frontier Markets
When considering international investments, there are three types of markets from which to choose.

 

•Developed markets consist of the largest, most industrialized economies.

 

1. Their economic systems are well developed, they are politically stable, and the rule of law is well entrenched.
2. Developed markets are usually considered the safest investment destinations, but their economic growth rates often trail those of countries in an earlier stage of development.
3. Investment analysis of developed markets usually concentrates on the current economic and market cycles; political considerations are often a less important consideration.
4. Examples of developed markets include the U.S., Canada, France, Japan and Australia.

 

•Emerging markets experience rapid industrialization and often demonstrate extremely high levels of economic growth.

1. This strong economic growth can sometimes translate into investment returns that are superior to those that are available in developed markets.
2. However, emerging markets are also riskier than developed markets; there is often more political uncertainty in emerging markets, and their economies may be more prone to excessive booms and busts.
3. In addition to carefully evaluating an emerging market's economic and financial fundamentals, investors should pay close attention to the country's political climate and the potential for unexpected political developments.
4. Many of the fastest growing economies in the world, including China, India and Brazil, are considered emerging markets. (For related reading, see What Is An Emerging Market Economy?)

 

 

•Frontier markets represent "the next wave" of investment destinations.

1. Frontier markets are generally either smaller than traditional emerging markets, or are found in countries that place restrictions on the ability of foreigners to invest.
2. Although frontier markets can be exceptionally risky and often suffer from low levels of liquidity, they also offer the potential for above average returns over time.
3. Frontier markets are also not well correlated with other, more traditional investment destinations, which mean that they provide additional diversification benefits when held in a well-rounded investment portfolio.
4. As with emerging markets, investors in frontier markets must pay careful attention to the political environment, as well as to economic and financial developments.
5. Examples of frontier markets include Nigeria, Botswana and Kuwait.

 

Important Steps When Investing Overseas

 

Once country analysis has been completed, there are several investment decisions that need to be made. The first choice is to decide where to invest, by choosing among several possible investment approaches, including:

 

•Investing in a broad international portfolio
•Investing in a more limited portfolio focused on either emerging markets or developed markets
•Investing in a specific region, such as Europe or Latin America
•Investing only in a specific country(s)

 

It is important to remember that diversification, which is a fundamental principle of domestic investing, is even more important when investing internationally.

 

• Choosing to invest an entire portfolio in a single country is not prudent. In a broadly diversified global portfolio, investments should be allocated among developed, emerging and perhaps frontier markets.
• Even in a more concentrated portfolio, investments should still be spread among several countries in order to maximize diversification and minimize risk.

 

After the decision on where to invest has been made, an investor has to decide what investment vehicles he or she wishes to invest in.

• Investment options include sovereign debt, stocks or bonds of companies domiciled in the country(s) chosen, stocks or bonds of a U.S.-based company that derives a significant portion of its revenues from the country(s) selected, or an internationally focused exchange-traded fund (ETF) or mutual fund.
• The choice of investment vehicle is dependent upon each investor's individual knowledge, experience, risk profile and return objectives.
• When in doubt, it may make sense to start out by taking less risk; more risk can always be added to the portfolio at a later date.

 

In addition to thoroughly researching prospective investments, an international investor also needs to monitor his or her portfolio and adjust holdings as conditions dictate.

• As in the U.S., economic conditions overseas are constantly evolving, and political situations abroad can change quickly, particularly in emerging or frontier markets.
• Situations that once seemed promising may no longer be so, and countries that once seemed too risky might now be viable investment candidates.

 

Conclusion

 

• Overseas investing involves a careful analysis of the economic, political and business risks that might result in unexpected investment losses.
• This analysis of country risk is a fundamental step in the process of building and monitoring an international portfolio.
• Investors that use the many excellent sources of information available to evaluate country risk will be better prepared when constructing their international portfolios.

 

For more on investing internationally, read Going International.
by Brian Perry, (Contact Author | Biography)

 

Brian Perry is vice president and investment strategist at an asset management firm and an accomplished author and public speaker. He has published several articles and is a frequent presenter for several professional associations. Brian received a bachelor of science degree in finance from Villanova University in 1996, an MBA in International Business from National University in 2006, and is pursuing a master's degree in international affairs from Tufts University. Brian is also a candidate in the chartered financial analyst (CFA) program, has previously held Series 7 and 63 securities licenses, and taught an introductory class on investing at the International Center in New York City.

 

http://www.investopedia.com/articles/stocks/08/country-risk-for-international-investing.asp

Economics Basics: What Is Economics?

Economics Basics: What Is Economics?

In order to begin our discussion of economics, we first need to understand (1) the concept of scarcity and (2) the two branches of study within economics: microeconomics and macroeconomics.

1. Scarcity
Scarcity, a concept we already implicitly discussed in the introduction to this tutorial, refers to the tension between our limited resources and our unlimited wants and needs. For an individual, resources include time, money and skill. For a country, limited resources include natural resources, capital, labor force and technology.

Because all of our resources are limited in comparison to all of our wants and needs, individuals and nations have to make decisions regarding what goods and services they can buy and which ones they must forgo. For example, if you choose to buy one DVD as opposed to two video tapes, you must give up owning a second movie of inferior technology in exchange for the higher quality of the one DVD. Of course, each individual and nation will have different values, but by having different levels of (scarce) resources, people and nations each form some of these values as a result of the particular scarcities with which they are faced.

So, because of scarcity, people and economies must make decisions over how to allocate their resources. Economics, in turn, aims to study why we make these decisions and how we allocate our resources most efficiently.

2. Macro and Microeconomics
Macro and microeconomics are the two vantage points from which the economy is observed. Macroeconomics looks at the total output of a nation and the way the nation allocates its limited resources of land, labor and capital in an attempt to maximize production levels and promote trade and growth for future generations. After observing the society as a whole, Adam Smith noted that there was an "invisible hand" turning the wheels of the economy: a market force that keeps the economy functioning.

Microeconomics looks into similar issues, but on the level of the individual people and firms within the economy. It tends to be more scientific in its approach, and studies the parts that make up the whole economy. Analyzing certain aspects of human behavior, microeconomics shows us how individuals and firms respond to changes in price and why they demand what they do at particular price levels.

Micro and macroeconomics are intertwined; as economists gain understanding of certain phenomena, they can help nations and individuals make more informed decisions when allocating resources. The systems by which nations allocate their resources can be placed on a spectrum where the command economy is on the one end and the market economy is on the other. The market economy advocates forces within a competitive market, which constitute the "invisible hand", to determine how resources should be allocated. The command economic system relies on the government to decide how the country's resources would best be allocated. In both systems, however, scarcity and unlimited wants force governments and individuals to decide how best to manage resources and allocate them in the most efficient way possible. Nevertheless, there are always limits to what the economy and government can do.

http://www.investopedia.com/university/economics/economics1.asp

Macroeconomic Analysis

by Reem Heakal

When the price of a product you want to buy goes up, it affects you. But why does the price go up? Is the demand greater than the supply? Did the cost go up because of the raw materials that make the CD? Or, was it a war in an unknown country that affected the price? In order to answer these questions, we need to turn to macroeconomics.

What Is It?
Macroeconomics is the study of the behavior of the economy as a whole. This is different from microeconomics, which concentrates more on individuals and how they make economic decisions. Needless to say, macroeconomy is very complicated and there are many factors that influence it. These factors are analyzed with various economic indicators that tell us about the overall health of the economy.

Macroeconomists try to forecast economic conditions to help consumers, firms and governments make better decisions.

•Consumers want to know how easy it will be to find work, how much it will cost to buy goods and services in the market, or how much it may cost to borrow money.
•Businesses use macroeconomic analysis to determine whether expanding production will be welcomed by the market. Will consumers have enough money to buy the products, or will the products sit on shelves and collect dust?
•Governments turn to the macroeconomy when budgeting spending, creating taxes, deciding on interest rates and making policy decisions.

Macroeconomic analysis broadly focuses on three things:

• national output (measured by gross domestic product (GDP)),
• unemployment and
• inflation. (For background reading, see The Importance Of Inflation And GDP.)

National Output: GDP
Output, the most important concept of macroeconomics, refers to the total amount of goods and services a country produces, commonly known as the gross domestic product. The figure is like a snapshot of the economy at a certain point in time.

When referring to GDP, macroeconomists tend to use real GDP, which takes inflation into account, as opposed to nominal GDP, which reflects only changes in prices. The nominal GDP figure will be higher if inflation goes up from year to year, so it is not necessarily indicative of higher output levels, only of higher prices.

The one drawback of the GDP is that because the information has to be collected after a specified time period has finished, a figure for the GDP today would have to be an estimate. GDP is nonetheless like a stepping stone into macroeconomic analysis. Once a series of figures is collected over a period of time, they can be compared, and economists and investors can begin to decipher the business cycles, which are made up of the alternating periods between economic recessions (slumps) and expansions (booms) that have occurred over time.

From there we can begin to look at the reasons why the cycles took place, which could be government policy, consumer behavior or international phenomena, among other things. Of course, these figures can be compared across economies as well. Hence, we can determine which foreign countries are economically strong or weak.

Based on what they learn from the past, analysts can then begin to forecast the future state of the economy. It is important to remember that what determines human behavior and ultimately the economy can never be forecasted completely.

Unemployment
The unemployment rate tells macroeconomists how many people from the available pool of labor (the labor force) are unable to find work. (For more about employment, see Surveying The Employment Report.)

Macroeconomists have come to agree that when the economy has witnessed growth from period to period, which is indicated in the GDP growth rate, unemployment levels tend to be low. This is because with rising (real) GDP levels, we know that output is higher, and, hence, more laborers are needed to keep up with the greater levels of production.

Inflation
The third main factor that macroeconomists look at is the inflation rate, or the rate at which prices rise. Inflation is primarily measured in two ways: through the Consumer Price Index (CPI) and the GDP deflator. The CPI gives the current price of a selected basket of goods and services that is updated periodically. The GDP deflator is the ratio of nominal GDP to real GDP. (For more on this, see The Consumer Price Index: A Friend To Investors and The Consumer Price Index Controversy.)

If nominal GDP is higher than real GDP, we can assume that the prices of goods and services has been rising. Both the CPI and GDP deflator tend to move in the same direction and differ by less than 1%. (If you'd like to learn more about inflation, check out All About Inflation.)

Demand and Disposable Income
What ultimately determines output is demand. Demand comes

• from consumers (for investment or savings - residential and business related),
• from the government (spending on goods and services of federal employees) and
• from imports and exports.

Demand alone, however, will not determine how much is produced. What consumers demand is not necessarily what they can afford to buy, so in order to determine demand, a consumer's disposable income must also be measured. This is the amount of money after taxes left for spending and/or investment.

In order to calculate disposable income, a worker's wages must be quantified as well. Salary is a function of two main components: the minimum salary for which employees will work and the amount employers are willing to pay in order to keep the worker in employment. Given that the demand and supply go hand in hand, the salary level will suffer in times of high unemployment, and it will prosper when unemployment levels are low.

Demand inherently will determine supply (production levels) and an equilibrium will be reached; however, in order to feed demand and supply, money is needed. The central bank (the Federal Reserve in the U.S.) prints all money that is in circulation in the economy. The sum of all individual demand determines how much money is needed in the economy. To determine this, economists look at the nominal GDP, which measures the aggregate level of transactions, to determine a suitable level of money supply.

Greasing the Engine of the Economy - What the Government Can Do

Monetary Policy
A simple example of monetary policy is the central bank's open-market operations. (For more detail, see the Federal Reserve Tutorial.) When there is a need to increase cash in the economy, the central bank will buy government bonds (monetary expansion). These securities allow the central bank to inject the economy with an immediate supply of cash. In turn, interest rates, the cost to borrow money, will be reduced because the demand for the bonds will increase their price and push the interest rate down. In theory, more people and businesses will then buy and invest. Demand for goods and services will rise and, as a result, output will increase. In order to cope with increased levels of production, unemployment levels should fall and wages should rise.

On the other hand, when the central bank needs to absorb extra money in the economy, and push inflation levels down, it will sell its T-bills. This will result in higher interest rates (less borrowing, less spending and investment) and less demand, which will ultimately push down price level (inflation) but will also result in less real output.

Fiscal Policy
The government can also increase taxes or lower government spending in order to conduct a fiscal contraction. What this will do is lower real output because less government spending means less disposable income for consumers. And, because more of consumers' wages will go to taxes, demand as well as output will decrease.

A fiscal expansion by the government would mean that taxes are decreased or government spending is increased. Ether way, the result will be growth in real output because the government will stir demand with increased spending. In the meantime, a consumer with more disposable income will be willing to buy more.
A government will tend to use a combination of both monetary and fiscal options when setting policies that deal with the macroeconomy.

Conclusion

• The performance of the economy is important to all of us.
• We analyze the macroeconomy by primarily looking at national output, unemployment and inflation.
• Although it is consumers who ultimately determine the direction of the economy, governments also influence it through fiscal and monetary policy.

by Reem Heakal, (Contact Author | Biography)

http://www.investopedia.com/articles/02/120402.asp?viewed=1

Economic Indicators: Jobless Claims

Economic Indicators: Jobless Claims Report


By Ryan Barnes

Release Date: Weekly; Thursdays, prior to market open
Release Time: 8:30am Eastern Standard Time
Coverage Previous week (cutoff date is previous Saturday)
Released By: U.S. Department of Labor
Latest Release: http://www.dol.gov/opa/media/press/eta/main.htm



Background
The Jobless Claims Report is a weekly release that shows the number of first-time (initial) filings for state jobless claims nationwide. The data is seasonally adjusted, as certain times of the year are known for above-average hiring for temporary work (harvesting, holidays).

Due to the short sample period, week-to-week results can be volatile, so reported results are most often headlined as a four-week moving average, so that each week's release is the average of the four prior jobless claims reports. The release will show which states have had the biggest changes in claims from the previous week; the revised edition shows up about a week later, at which time a full breakdown by state and U.S. territory is available.

Also released with this report are the relatively minor data points of the insured unemployment rate and the total unemployed persons. These are not seen as valuable indicators because the total unemployed figure tends to stay relatively constant week to week. (To learn more, read Surveying The Employment Report.)

What it Means for Investors
New jobless claims for the week reflect an up-to-the-minute account of who is leaving work unexpectedly, reflecting the "run rate" of the economy's health with little lag time. The Jobless Claims Report gets a lot of press due to its simplicity and the theory that the healthier the job market, the healthier the economy: more people working means more disposable income, which leads to higher personal consumption and gross domestic product (GDP).

The fact that jobless claims are released weekly is both a blessing and a curse for investors; sometimes the markets will take a mid-month jobless claims report and react strongly to it, particularly if it shows a difference from the cumulative evidence of other recent indicators. For instance, if other indicators are showing a weakening economy, a surprise drop in jobless claims could slow down equity sellers and could actually lift stocks, even if only because there isn't any other more recent data to chew on.

A favorable Jobless Claims Report can also get lost in the shuffle of a busy news day, and hardly be noticed by Wall Street at all. The biggest factor week to week is how unsure investors are about the future direction of the economy.




Most economists agree that a sustained change (as shown in the moving averages) of 30,000 claims or more is the benchmark for real job growth or job loss in the economy. Anything less is deemed statistically insignificant by most market analysts.

Strengths:

•Weekly reporting provides for timely, almost real-time snapshots.
•As a tightly-presented release, investors can easily pick up the raw release and quickly apply the information to market decisions.
•Initial claims are provided gross and net of seasonal adjustments, and give a breakdown for every state's individual results.
•Some states' figures are shown along with a comment from that state's reporting agency regarding specific industries in which noteworthy activity is happening, such as "fewer layoffs in the industrial machinery industry".

Weaknesses:

•Summer and other seasonal employment tends to skew the results.
•Highly volatile - revisions to advance report can be very big on a percentage basis
•Jobless claims in isolation tell little about the overall state of the economy.
•No industry breakdowns are provided, just the national figure.

http://www.investopedia.com/university/releases/joblessclaims.asp

Markets and the US Dollar Turn Higher Sign in to Recommend

Markets and the Dollar Turn Higher Sign in to Recommend

By DAVID JOLLY
Published: December 4, 2009

Stocks and the dollar rose Friday and bonds fell after the release of a much-better-than-expected jobs report in the United States.

The Dow Jones industrial average reached a high for the year, gaining 95 points, or 0.9 percent, in late morning trading. The Standard & Poor’s 500-stock index rose 1.1 percent, and the Nasdaq 1.5 percent.

On the year, the Dow is up 19 percent while the S.&P. 500 is 23 pecent.

The Labor Department said in Washington that the United States lost 11,000 jobs in November, less than a tenth of the roughly 125,000 job losses economists had been expecting. The unemployment rate improved to 10 percent from 10.2 percent in October.

While companies are still shedding workers, the pace was the best since the recession began in December 2007, and suggested to some analysts that the economy is headed toward recovery.

Jeffrey Saut, chief investment strategist for Raymond James, characterized the November job-loss number as “an outlier.”

“There’s no doubt the recession is in the rear-view mirror,” he said, “but I wouldn’t be surprised to see the jobless rate ticking up again in the months ahead.”

Unemployment, he added, is a lagging indicator, so investors who wait for the labor market to turn around have historically missed out on major market gains.

Lawrence Glazer, managing partner at Mayflower Advisors in Boston, said would-be stock buyers remained somewhat cautious, despite the surprising data.

“Investors are still seeing a divergence between Wall Street’s gains and Main Street’s malaise,” he said. “The market has been anticipating better data all along. The question hasn’t been ‘is the market pricing in a recovery,’ but ‘is the market pricing in too big of a recovery.’ ”

Mr. Glazer said institutional investors had already begun to close positions and did not want to be reshuffling portfolios toward the end of the year, damping the effect of the positive surprise.

In other economic news, the Commerce Department reported that orders to American factories unexpectedly rose 0.6 percent in October, which was better than the flat reading that economists had expected.

In Europe, the Dow Jones Euro Stoxx 50 index of euro zone heavyweights was trading 1.4 percent higher after the data, while the FTSE-100 index in London was up 0.7 percent. In Asian trading, the Tokyo benchmark Nikkei 225 stock average rose 0.5 percent. European markets had been down before the American jobs report was released.

The yield on the benchmark 10-year Treasury rose one-tenth of a percentage point to 3.5 percent.

The dollar rose against other major currencies. The euro fell to $1.4911 from $1.5053 Thursday, and the British pound fell to $1.6572 from $1.6540. The dollar rose to 89.81 yen from 88.26 yen.

Spot gold fell 2.3 percent to $1,180.20 an ounce.

http://www.nytimes.com/2009/12/05/business/05markets.html?_r=1&ref=business

Malaysia's economy stagnant, needs reform

By Agence France-Presse, Updated: 12/1/2009

 

Malaysia's economy stagnant, needs reform: finance minister
Malaysia's economy has been stagnating for the past decade and is now trailing badly behind its neighbours, a senior minister said Tuesday, calling for "urgent" and wide-ranging reforms.

 

Malaysia's economy has been stagnating for the past decade and is now trailing badly behind its neighbours, a senior minister said Tuesday, calling for "urgent" and wide-ranging reforms.

 

Malaysia's export-dependent economy has been hit hard by the global recession, contracting by a forecast 3.0 percent this year and jeopardising its ambitions of becoming a developed nation by 2020.

 

"Malaysia is trapped in a low-value-added, low-wage and low-productivity structure," Second Finance Minister Ahmad Husni Hanadzlah told an economic outlook conference.

 

Among its peers China, India, Vietnam, Indonesia, Philippines and Thailand, Malaysia's economic growth over the past three years was second-lowest, he said.

 

"Our economy has been stagnating in the last decade. We have lost our competitive edge to remain as the leader of the pack in many sectors of the economy. Our private investment has been steadily in decline."

 

"While Singapore and Korea's nominal per capita GDP grew within the last three decades by 9 and 12 times respectively, ours grew only by a factor of four."

 

In a withering assessment, Ahmad Husni said

• the services sector is underdeveloped,
• private investment is half the levels before the 1997-98 Asian crisis, and
• the manufacturing sector is suffering from lack of investment.

 

"The (need for) transformation is particularly urgent when we take the external environment into account," he said.

 

"The global environment is changing. We can no longer rely on our traditional trading partners and we need to address the competitive pressure from other emerging markets on our existing exports."

 

He called for sweeping measures including an emphasis on meritocracy and ensuring all Malaysians are given "equal opportunity to participate in the economy".

 

Malaysia has for decades practiced a system of positive discrimination for Muslim Malays who dominate the population, but critics say the policy is fuelling corruption and is hurting the nation's competitiveness.

 

"We must also consider the gradual dismantling of our open-ended protection of specific sectors and industries which have introduced a climate of complacency and artificial levels of supply," the minister said.

 

"The long-term success of the nation's economy must take precedence over the short term interests of a few protected groups."

 

Prime Minister Najib Razak -- who is also finance minister -- came to power in April with plans to tackle graft which is endemic in the ruling party and society at large.

An anaemic recovery should be welcomed, not feared.

Bill Mott: 'An anaemic recovery should be welcomed, not feared'

Fundamentalist view: our series in which an expert at making money grow analyses the financial world and gives his advice to savers and investors.

By Bill Mott
Published: 12:05PM GMT 26 Nov 2009


Bill Mott: 'This autumn 2009 rally cannot continue much longer' Any fans of late Fifties and early Sixties American music will know the Drifters song Save the Last Dance for Me. The plaintive boyfriend tells his girlfriend that she can enjoy the party without any cares, but ultimately her price for this enjoyment is to ''save the last dance for him''.

As a fund manager, I am watching the party become increasingly boisterous as market momentum powers ahead. I would like to be well on my way home with my portfolio positioned away from areas of excess optimism before the last dance is played. Looking at the British economy, it seems there are three possible scenarios from here.

Scenario one is a long period of anaemic growth during which the economy gradually rebalances, avoiding "Armageddon'', but does not rally very strongly. I believe this outcome has a 75pc probability.

Scenario two is a ''double dip'' – or W-shaped – recovery in which the market and the economy experience a further downturn as recovery fails to take hold, and has a 15pc chance.

Scenario three is a V-shaped recovery, namely a continuation of the current near-euphoric, liquidity-driven rally and has a 10pc probability of occurring.

As it became clear, at the end of last year and during the first quarter of 2009, that Britain and the global economy were on the brink of meltdown, authorities worldwide began co-ordinated action to stabilise the economy. Generally, a ''kitchen sink'' liquidity policy was introduced. In effect, policy-makers were telling us that long-term economic policy was being suspended to tackle immediate economic dangers.

As a result, the current early signs of economic stability or recovery are dependent on the largesse of governments and central banks. Investors have responded aggressively to these government actions, fuelling a robust asset price reflation in all types of asset across the spectrum from equities to commodities to bonds. This rise in asset prices is itself supporting the economic recovery. The Deputy Governor of the Bank of England recently suggested that one of the expected consequences of quantitative easing – printing money to buy back government gilts – was to raise asset prices.

Clearly a rise in asset prices from March 2009 lows was desirable to improve confidence, but when does a ''helpful rise'' in asset prices evolve to the beginning of a new ''asset bubble'' and where are we in this process?

It is our view that the UK market rally has gone too far, too quickly. Many investors, lamenting that the ''train has left the station'' without them, are playing catch-up. The trouble with this approach, as in all bubble situations, is that continuing to buy overvalued assets now requires you to believe that, although the drivers of the market are not sustainable, you will be able to sell before the inflection point at the peak.

This autumn 2009 rally cannot continue much longer, simply because very low interest rates were not the sole cure that helped us recover from the last bust. So while we have avoided globally a Thirties-style Depression, we need to implement a partial exit strategy to avoid another asset bubble and more financial turbulence. Ideally, we must have an anaemic global recovery (Scenario one) so global imbalances can be slowly corrected without too much dislocation. The dilemma is that tightening policy through tax increases and interest rate rises could result in a double-dip recession, but if loose policy continues, with no action taken, then an asset bubble is more likely.

An anaemic recovery should be welcomed, not feared. Monetary policy must not neglect asset-price movements. If premature tightening of policy causes a mild double-dip recession, this would be better than another asset bubble.

We have avoided the very worst and if the price of us all not dying from pneumonia is a blocked nose for a few years, then it will not have been a bad price to pay.

We have positioned the PSigma Income fund as a hybrid between defensive UK equities with limited economic sensitivity and UK equities that we believe can grow faster than average in a ''bracing but not impossible'' global economy. Putting quantitative easing on hold would be a good first step and would signal that the authorities are determined not to let another asset bubble develop.

As any West Ham United football fan will tell you, liquidity-driven bubbles are not forever…

Bill Mott manages the PSigma Income fund.

http://www.telegraph.co.uk/finance/personalfinance/investing/shares/6636435/Bill-Mott-An-anaemic-recovery-should-be-welcomed-not-feared.html