Inflation explained

From Times Online

November 3, 2008

Inflation explained

David Budworth
Savers need to take the threat of inflation very seriously because it can erode the value of deposits at startling speed. If the value of your savings does not keep pace with rising prices, its buying power will be depleted quickly - and you may not be aware of it until it is too late.

Here we explain why inflation matters and what you can do to combat it.

What is inflation?

Inflation is a general rise in prices across the economy. The inflation rate is a measure of the average change over a period, usually 12 months.

There are two main measures. The consumer prices index (CPI) was adopted as the Government's preferred measure in 2003 and is used by the Bank of England for the purpose of inflation targeting. The target is 2 per cent, but inflation is currently a lot higher. In September it hit 5.2 per cent, which means that prices overall are 5.2 per cent higher than in September last year.

The oldest measure of inflation, the retail prices index (RPI), dates back to before the First World War. In September the RPI stood at 5 per cent.

What is the difference between RPI and CPI, and which is more useful?

The CPI excludes most housing costs. Rents are included, but house prices, council tax and mortgage payments are not. This usually means that CPI inflation is lower than RPI inflation, although this is not always the case.

Everyone should keep an eye on the CPI for an indication of whether interest rates are likely to rise or fall.

For anyone in receipt of a pension or benefits, though, the RPI is the one to watch because increases remain linked to the RPI rather than the CPI. Inflation-linked products, such as index-linked gilts, are also linked to the RPI.

Remember, though, that both of these official measures are calculated on the basis of an average notional shopping basket, but an individual’s spending patterns can differ dramatically. The Office for National Statistics has an inflation calculator that enables you to enter your personal expenditure patterns to calculate an approximate personal rate of inflation (see websites below).

Why does this matter to my savings?

Savings must grow by at least the rate of inflation to maintain their value. If they rise in nominal terms but fail to beat inflation, their real value will fall in terms of purchasing power.

With the CPI at 5.2 per cent, higher-rate payers need to earn at least 8.63 per cent gross interest before they start to make a positive return. Basic-rate taxpayers require at least 6.5 per cent.

If your savings account does not match or beat this rate you are effectively losing money.

Here is a guide to the interest that basic and higher-rate taxpayers need to earn to match inflation

Inflation rate of 5%

Basic-rate taxpayers need 6.25%

Higher-rate taxpayers need 8.34%

Inflation rate of 4%

Basic-rate taxpayers need 5%

Higher-rate taxpayers need 6.25%

Inflation rate of 3%

Basic-rate taxpayers need 3.75%

Higher-rate taxpayers need 5%

Inflation rate of 2%

Basic-rate taxpayers need 2.5%

Higher-rate taxpayers need 3.34%

Inflation rate of 1%

Basic-rate taxpayers need 1.25%

Higher-rate taxpayers need 1.66%

Do any savings accounts provide protection against inflation?

Index-linked savings certificates from National Savings & Investments (NS&I), which are backed by the Government, are tax-free and guaranteed to keep pace with the RPI for a fixed term.

The return is made up of a set interest rate plus the RPI figure, fixed for three or five years. You can invest up to £15,000 per issue, so you could shelter £30,000 in both the three and five-year plans.

You have to tie up your money for the fixed term to receive the advertised rate.

Look out for inflation-beating savings accounts and Isas from banks and building societies, too.


Five news stories
Rising gas bills send inflation to 16-year high
Food price inflation spirals to 9.5 per cent
Inflation surge adds £3 billion to welfare bill
Inflation may have peaked
Interest rates to drop to 50-year low
Five features
Sounds like the Seventies
Safeguard your life from rising inflation
How you can beat rising inflation
Inflation is poised to peak then slide
The inflation impact: how we're paying
Five websites
Office for National Statistics (inflation calculator)
Bank of England
Economicsuk ( the personal website of David Smith, Economics Editor of The Sunday Times)
Timesonline's Economics homepage
National Savings & Investments

Related Links
How to save
National Savings & Investments explained

http://www.timesonline.co.uk/tol/money/reader_guides/article5001065.ece

Eastern European crisis may put us all in the goulash

From The TimesFebruary 19, 2009

Eastern European crisis may put us all in the goulash
Ian King, Deputy Business Editor

After building quietly for months, the next stage of the global financial crisis is upon us, with the economies of Eastern Europe the latest to be hit. Hungary's stock market fell by 7 per cent yesterday and its Czech equivalent by nearly 4 per cent - while Poland, earlier down by almost six 6 per cent, rallied only once Warsaw had sold some of its euros on foreign exchange markets to prop up the zloty.

The trigger for this chaos was comments on Tuesday from Moody's and Standard & Poor's, the ratings agencies, articulating the concerns many observers have had in recent months. Having enjoyed a boom in the past decade, demand for the region's exports has collapsed and investment with it, while job losses are rising - one reason why not all the Poles have yet left Britain for home.

All this means that doubts over whether the governments and companies of Central and Eastern Europe will be able to service their debts are very much to the fore. Much of the borrowing in these countries during the bubble was not done in their own currencies but in others, such as the euro and the Swiss franc, which means that there will almost certainly be defaults.

The zloty, for example, has lost a third of its value against the euro since last summer, with Hungary's forint down 23 per cent and the Czech crown down by about 17 per cent in the same period.

The impact of these debt defaults will be felt fiercely in some Western European economies, particularly Austria, whose banks have lent the equivalent of a quarter of the country's GDP to the region. Sweden's banks are also heavily exposed. Consultancy Capital Economics calculates that Swedish banks have lent $90 billion (£63 billion) - nearly one fifth of Sweden's GDP - to “high-risk” countries, mainly in the Baltics, while the banking systems of many of the worst-hit economies, including those of Estonia, Slovakia and Lithuania, are now almost entirely foreign-owned.

While Raiffeisen and Erste Bank, of Austria, are regarded as the two institutions most significantly at risk, it is not just the Viennese who risk seeing their capital waltz off into oblivion. ING, the Dutch bank, Commerzbank, of Germany, and Société Générale, of France - which owns the Russian Rosbank - all saw their shares fall yesterday amid mounting concerns over their exposure to the region. Italy's UniCredit and Belgium's KBC are also heavily exposed.

Apart from the damage to some Western European banks, other companies may also be wounded, such as Telekom Austria, which expanded east amid tough competition in their home markets. And there are other ways in which contagion could spread. Manufacturers in Germany - the linchpin of that country's economy - will suffer as Eastern European rivals enjoy a boost in competitiveness as their currencies collapse in value against the euro.

The bursting of this bubble may damage Britain less severely than other EU nations. While Irish buy-to-let investors were buying up most of Bratislava, Austrian banks were buying their Romanian equivalents and German and French manufacturers were opening plants from Bucharest to Brno, the only British activity in the region seemed to consist of flying to such locations for stag weekends.

That is not to say that this crisis will not drop us in the goulash, too. The crisis was already highlighting the inflexibility of eurozone membership, particularly for those less competitive member states such as Italy and Portugal, who - unlike Britain and Sweden - are unable to devalue their way out of their problems. This has not gone unnoticed - and, in a speech last night, Lorenzo Bini Smaghi, the ECB executive board member, was muttering ominously that the ability of some EU countries to devalue their currency, gaining an economic advantage, was putting the single market's integrity at risk.

Taken to their logical conclusion, his comments sound dangerously like a call to protectionism.

http://business.timesonline.co.uk/tol/business/columnists/article5762544.ece

Corporate bonds: Don't be a fund fashion victim

Corporate bonds: Don't be a fund fashion victim
Bond funds are in vogue – they were the best selling funds last month by a mile. But that might just set the alarm bells ringing...

By Paul Farrow
Last Updated: 6:13PM GMT 18 Feb 2009

Following fashion when it comes to choosing funds can be an expensive mistake.
You could be forgiven for thinking that we have all given up on investing given the torrid performance of shares and bonds over the past year.

But there are early signs that investors' confidence is returning – the latest figures from the Investment Management Association showed that more than £1.5bn was invested in December, a traditionally poor month, for obvious festive reasons.

It could be that investors feel, with significant losses already racked up, that there are opportunities beginning to open up. Or it could be that with returns on cash at pitifully low levels they need to take on a little more risk in a bid to get any sort of return on their money.

Bond funds are in vogue – they were the most popular funds last month by a mile – and that might just set the alarm bells ringing.

The nature of investment – fund groups want to rake in assets, financial advisers want to sell funds and investors want to make gains – means that fads and fashions become inevitable. The most fashionable fund type each year tends to come down with a mighty bump the following year.

Every year certain types of fund reign supreme. We saw it in the technology boom in early 2000 when millions of pounds were invested in technology funds such as Henderson Global Technology at the top of the market. The bubble burst and people were left nursing huge losses.

In 2006 the commercial property phenomenon provided us with another classic example of investors following a fashion. Tens of thousands of them jumped onto the bandwagon (Norwich Union's fund proved extremely popular) just as the market scaled new heights. But those who joined the party late hoping to make a quick buck will have lost as much as 50pc of their money.

The only time it would have paid to be fashionable was in 2003 when everyone rushed to get a piece of the gold action as markets sank to a new low. Those who bought into gold via the BlackRock Gold & General fund have seen the value of their investment rise by 150pc since.

Peter Jordan of Skandia said: "If you blindly follow the themes and fashions you will get a rougher ride – you should stick to asset allocation based on your attitude to risk. Fund picking is a hazardous activity and if people have been burnt by market volatility and are worried what further impact low inflation will have then they need review the asset allocation within their portfolio."

Corporate bond funds are the new black because they offer lower volatility and a decent yield – attractive selling points amid the turmoil and dire rates of interests. They are also deemed an appropriate investment during times of falling inflation. "Corporate bond funds litter the top 10 funds this year," said Mr Jordan.

Many experts continue to believe that corporate bond funds investing in high quality bonds are a decent bet for this year. The arguments in favour of bonds are strong. Corporate bond markets typically recover before equities after times of economic woe. Bond prices are pricing in default rates of 35-40pc – yet, looking back over the years, the worst default rate for investment grade bonds was 2.4pc. Some bonds are yielding upwards of 8pc and a small narrowing of spreads will double the return. (Comment: Barclay's Bank bond)

Unlike with previous fads, investors aren't piling into bond fund because they have made stupendous gains. "This popularity is not based on good past performance but rather on the poor performance of these funds over the past six months," said Jason Walker of AWD Chase de Vere.

The case for investment grade corporate bond funds looks compelling and is worth considering but the bond story is not a no-brainer. The market is illiquid and some bond managers are stuck with poorly performing bonds they cannot sell. What's more, a surge of gilt issuance by our cash-strapped Government means there will be no shortage of stocks for buyers to choose from.

Mark Piper of Collins Stewart said: "There has been a huge increase in the number of investment articles highlighting the opportunities in corporate bonds in recent weeks. While the valuations are not quite as eye-catching as they were in October and November last year, high quality investment grade corporate bonds are still extremely attractive in our opinion, particularly when compared to government bonds and cash deposits."

He added: "The rush for corporate bonds could have all the hallmarks of an early stage mania but as long as you're focusing on senior investment grade debt then the values is real. Our favoured ways of accessing this asset class are via the M&G Corporate Bond fund and Invesco Sterling Bond fund."

Richard Woolnough, a fund manager at M&G, argues that investors who buy bonds now are locking into a high fixed rate of interest, which will be "extremely" attractive as the Bank of England's interest rate heads toward zero.

"With investment grade corporate bond yields now hovering around all-time high levels, the market is effectively saying that about 40pc of all investment grade bonds will default over the next five years, assuming average historical recovery rates. This view is far too pessimistic, which means that investors are being hugely overcompensated for the actual risk of default."

But not everyone is convinced. Gary Potter, a multi manager at investment boutique Thames River, says: "Everyone is piling into corporate bonds and I'm very concerned. They pay a decent coupon, but no one knows how big a hole we are in. There could yet be liquidity issues with bonds and what happens if your fund manager is forced to sell the bonds – you will lose money.

Mr Potter, whose favourite funds include Jupiter Financial Opportunities, Prusik Asia, BlackRock UK Alpha and Cazenove Income & Growth, added: "In today's market it is not solely about the return on your money – it is the return of your money, which is why I'm not afraid to invest in cash. A flat return is better than a 5pc loss."

Mark Harris, a portfolio manager at New Star, is equally cautious, warning investors hell-bent on buying corporate bonds to do their due diligence before buying.

"It appears that the no-brainers for all investors this year are treasuries [government bonds] and corporate bonds. But what if we enter a period in which defaults balloon to levels only seen previously in the Great Depression? While the investment grade corporates may have priced in this possibility, sub investment grade has not.

"Risks remain and credit analysts will have to tread very carefully," said Mr Harris. "While the risk-reward balance for much of the corporate bond market certainly looks appealing relative to equities, it does not mean that we will all definitely make money over 2009. Be careful with your selection of bond funds."

To avoid falling victim to fashion, investment advisers suggest that investors stick to the tried and tested route of asset allocation. In other words, do not put all your eggs in one basket.

Mr Walker warned corporate bond investors in it for the short term that if they do not actively manage the portfolio they will see capital values rise and then fall. "Our clients are medium-term investors and therefore the philosophy is asset allocation and a minimum five-year holding. So our clients will be holding corporate bonds – both high yield and investment grade – to diversify their portfolio and reduce risk," he said.

Mr Jordan added: "Our analysis shows that fund picking is a hazardous activity. People who have relied on this have portfolios that have no science of objectivity behind them whatsoever. If these people have been burnt by market volatility and are worried what further impact low inflation will have, now is the perfect time to review the asset allocation within their portfolio.

"The key will be to understand their attitude to risk, which is likely to be low if they are worried about low inflation, and select an asset allocation in line with that."

By way of a pointer, an analysis of deflation in the new Barclays Equity Gilt Study suggests that unwittingly diversifying into bonds may be no bad thing, given that the prospect of falling prices looms large.

The study found that in extreme inflation conditions, whether deflation or high inflation, portfolio diversification did not seem to be the best approach, given that returns are so heavily concentrated either in resource-based stocks in the case of inflation or in government bonds in the case of deflation.

http://www.telegraph.co.uk/finance/personalfinance/investing/4690549/Corporate-bonds-Dont-be-a-fund-fashion-victim.html

Global investors see Chinese green shoots

Global investors see Chinese green shoots
The world's fund managers have begun to glimpse the first green shoots of recovery and are betting that a powerful rebound in China will revive demand for commodities and lead global industry out of slump.

By Ambrose Evans-Pritchard
Last Updated: 8:46PM GMT 18 Feb 2009

Investors are betting on some green shoots of recovery in China
The latest Merrill Lynch survey of investors shows the highest level of optimism since the credit crunch began, fuelled by tentative hopes that the global cycle is slowly starting to turn.

Michael Hartnett, emerging market strategist at Bank of America Securities-Merrill Lynch, said fund managers had jumped on early signs that China is through the worst.

"China is the one place where policy seems to be working. Credit and the money supply are both growing, and the local equity markets are going through the roof," he said. "There is a feeling they may just be able to pull a rabbit out of the hat."

However, he added: "We think China is a very narrow base for optimism."

The OECD's leading indicators still point down, raising the risk of fresh disappointments for the over-eager. Merrill said oil and industrial commodities are coming back into favour as "a pure way" of playing China's growth without having pick through company balance sheets. But there is a rising suspicion that gold has risen too far, too fast.

Once again, Europe is viewed as the world's "sick man", with a net 70pc of investors expecting the economy to get worse over the next year. The number overweight in cash has risen to 53pc, the highest since the dotcom bust in 2001.

But things may be looking up for Britain.

Gary Baker, head of the region's equity strategy, said sterling's slide is a tonic for stocks listed in London. "A lot of sterling assets are in energy, materials and metal-bashing. These are starting to look very attractive," he said.

http://www.telegraph.co.uk/finance/financetopics/financialcrisis/4691439/Global-investors-see-Chinese-green-shoots.html

The market gives a thumbs-up to printing money

The market gives a thumbs-up to printing money
Posted By: Edmund Conway at Feb 18, 2009 at 19:58:27 [General]

What would you expect a currency to do when a central bank admits it is about to start printing money imminently? The answer you'll find in the textbooks is pretty clear: it will fall, and fall fast. Just look at Zimbabwe.

But that's precisely the opposite of what happened this morning when the Bank of England said that within weeks it will have the printing presses roaring away. In fact, as you can see from the graph here, after the Bank announced this in its Monetary Policy Committee minutes at around 9.30, people started buying, rather than selling, sterling. Why? What on earth has happened in the topsy-turvy world of currencies that makes traders believe a good investment is a currency that is about to become all the more plentiful? Has everyone lost their senses?



The answer is intriguing, and helps underline precisely how counterintuitive is the policy challenge we face in this economic crisis. People are buying sterling not out of economic ignorance or bloody-mindedness but as a vote of confidence in the Bank of England's economic policy. In other words, they believe quantitative easing - the technical term for printing money - will, in the long run, bring the economy back to health, even if in the short run it could devalue sterling.

Meanwhile, the market is punishing the euro (against which I plotted the pound in this chart) because of the European Central Bank's neanderthal approach to monetary policy. Of all the central banks they are the most reluctant to slash interest rates and start up the presses. This could be a big mistake.

The explanation for this, by the way, goes back to the genesis of each continent's respective central bank. The ECB is the spawn of the German Bundesbank. Its history was shaped by the horrific experience of Weimar Germany's hyperinflation of the 1920s, so it is naturally inclined to fear the worst about inflation. The Federal Reserve's big bugbear, on the other hand is deflation, since that was what afflicted the US in the 1930s.

Anyway, the point is that the market believes (today anyway) that the Federal Reserve, which is already well down the road towards money-printing, and the Bank of England are right, and that the ECB is wrong. I happen to agree.

Quantitative easing is a hard sell - I know that from your comments whenever I write approvingly about it! But if handled properly I genuinely believe it could help prevent this from turning into the recession to end all recessions.

Whether you agree with me or not about that, the one thing we can surely all agree on is that, should the Bank of England pursue this course, it must, must be ready to raised interest rates and pull money back out of the economy when it looks as if deflation has really been averted.

You can count on us at the Telegraph to do our best to make sure it does.

http://blogs.telegraph.co.uk/edmund_conway/blog/2009/02/18/the_market_gives_a_thumbsup_to_printing_money

Fed downgrades economic forecast for this year

Fed downgrades economic forecast for this year

WASHINGTON – The Federal Reserve on Wednesday sharply downgraded its projections for the country's economic performance this year, predicting the economy will actually shrink and unemployment will rise higher. Under the new projections, the unemployment rate will rise to between 8.5 and 8.8 percent this year. The old forecasts, issued in mid-November, predicted the jobless rate would rise to between 7.1 and 7.6 percent.

The Fed also believes the economy will contract this year between 0.5 and 1.3 percent. The old forecast said the economy could shrink by 0.2 percent or expand by 1.1 percent.

The last time the economy registered a contraction for a full year was in 1991, by 0.2 percent. If the Fed's new predictions prove correct, it would mark the weakest showing since a 1.9 percent drop in 1982, when the country had suffered through a severe recession.

The bleaker outlook represents the growing toll of the worst housing, credit and financial crises since the 1930s. All of those negative forces have plunged the nation into a recession, now in its second year.

"Given the strength of the forces currently weighing on the economy," Fed officials "generally expected that the recovery would be unusually gradual and prolonged," according to documents on the Fed's updated economic outlook.

Against that backdrop, unemployment — now at 7.6 percent, the highest in more than 16 years — will keep climbing and stay elevated for quite some time, the Fed predicted.

Fed officials anticipated that unemployment would remain "substantially" higher than normal at the end of 2011 "even absent further economic shocks."

The Fed forecast calls for the jobless rate to dip to between 8 and 8.3 percent next year, and to between 7.5 and 6.7 percent in 2011. All those projections are worse than the Fed's previous estimates and would put unemployment higher than the normal range around 5 percent.

Employment is usually the last piece of the economy to heal once the country is out of recession and in recovery mode. Businesses are usually reluctant to ramp up hiring until they feel confident that any recovery has staying power.

Under the Fed's new projections, the economy should grow between 2.5 and 3.3 percent next year. Fed officials "generally expected that strains in financial markets would ebb only slowly and hence that the pace of recovery in 2010 would be damped," according to the Fed documents.

Fed officials, however, predicted the economy would pick up speed in 2011, growing by as much as 5 percent, which would be considered robust.

Still, given all the economy's problems, there are risks that the Fed's forecasts could turn out to be too optimistic.

And a few Fed officials — none are identified — feared that it could take five or six years for the economy and employment to get back into a sustainable mode of health.

On the inflation front, the weak economy should mean that companies will keep a lid on price increases this year as they try to lure skittish consumers.

The Fed expects prices to rise between 0.3 and 1 percent this year, down from a projection of between 1.3 and 2 percent in the fall. Prices will pick up slightly in 2010 and 2011 as the economy strengthens.

For now, Fed officials are more worried about falling prices, than rising ones.

The Fed didn't use the word "deflation," which is a dangerous bout of falling prices, but officials noted "some risk of a protracted period of excessively low inflation."

Falling prices sound like a gift at first — at least to consumers. But a widespread and prolonged decline can wreak more havoc on the economy, dragging down Americans' wages, and clobbering already-stricken home and stock prices. Dropping prices already are hurting businesses' profits, forcing them to slice capital investments and lay off workers.

America's last serious case of deflation was during the Great Depression in the 1930s. Japan was gripped with a period of deflation during the 1990s, and it took a decade for that country to overcome those problems.

http://news.yahoo.com/s/ap/20090218/ap_on_bi_ge/fed_economy

Become your own financial planner

Become your own financial planner

By Lisa Mary Thomson

There are always some people who live for the day's pleasures. Amit Gujral, a senior MNC executive, too belonged to this group. No doubt, the 30-year old made investments but more often than not, he spent his generous salary and perks on doing just what he and his family always dreamed of — the honeymoon to Hawaii, a summer holiday in a villa in Tuscany, an antique crib for his firstborn…the list was endless.

Up until the day when Gujral went for his health check-up, only to be told that there was a large growth in his kidney. Further tests revealed that the growth was malignant. Sleepless nights followed, not because Gujral was afraid of death, but more so because he hadn't made any provisions for his family.

Human Life Value



If you're a young person and think that financial planning must be undertaken only when you are older, with a family and have greater liabilities in life, you're sadly mistaken. On the contrary, the earlier you start planning, the better.

While it may be great to have a financial planner to help you out, there is no stopping you from trying to do this yourself. To help you become your own financial planner, SundayET begins with the basic premise of how to calculate your Human Life Value (HLV), based on which you can plan your further investments.

According to Kunj Bansal, senior vice-president (portfolio management services) at Kotak Securities, "Human Life Value (HLV) is nothing but the money that you are going to make over the rest of your life. It is the present value of all that you are likely to earn in the future."

The Defining Number

Over a period of time, however, the process of calculating this has been modified to include the element of expenditure. So, in addition to your salary, it also takes into account the amount you are likely to spend in the remaining years of your life.

Further elements have also been factored in such as already existing savings and bank deposits while other aspects like the house you are living in and the gold that you possess will be discounted.

Finding your HLV

Arriving at this figure can be as complicated or simple as you would like it to be, depending on all the elements that you include in the process of drawing your conclusions.

However, for practical purposes, here’s a very simple way of arriving at this figure.

Keep adding

Start off with a basic figure such as your annual income. Use this to calculate your remaining earning capacity. For instance if you are 30 and are most likely to work till the age of 60, then you would need to work out how much you are likely to earn over the next 30 years of your life.

Add your current savings to this. Savings in this case, would mean what is available to you in the form of liquid cash and fixed-deposits. "Once you have done this, formulate the present value of all the future earnings and you will then arrive at what is called the Gross HLV," says Mohit Thadani, head advisory, wealth management, Motilal Oswal Financial Services.

Begin Subtracting

From the gross HLV, you need to deduct the expenses that you are likely to face on a daily basis such as those required to meet household expenses. You also need to factor in the taxes you are meant to pay if you haven’t already deducted it while calculating your income.

Also deduct current financial assets from the gross figure. Keep a calculator near you because more subtraction follows. "Next, you will need to deduct all the one-time planned expenditures that you are likely to come across in your lifetime," explains Bansal. For this, you will need to know the approximate amount that you are likely to spend on buying your dream house.

If you have kids, you should have an idea of whether you want to set your kid to study abroad or within the country and determine the kinds of costs that will be involved. And then comes the large, but often, unavoidable expenditure that is involved in your child’s marriage. And then, the expenses that could suddenly arise in the case of an emergency.

Net HLV

After all these deductions, the figure that you finally arrive at will be your net HLV or your expected HLV. Based on this figure, you need to plan your investment pattern.

According to Thadani "It is imperative for an individual to work out his/her own economic value, so as to create replacement for his/her earnings in case of his/her demise – either through insurance coverage or through utilising his/her current wealth or combination of both."

While things may vary according to your risk appetite, the key remains in investing in instruments- be it debt, equity, gold or real estate- which match the time frame that you have in mind and provide you with the adequate returns.

Other adjustments

While the method mentioned above is the most basic, there are a few more points that could come in handy. You would need to make adjustments to the basic calculations to include the possibility of salary rises or even job cuts in the present situation. Some people also include the life expectancy of the spouse while arriving at HLV.

Bansal adds "Individuals also need to prepare themselves for a low-interest regime. As the economy develops, individuals should not expect the high rates of interest that they were used to getting in the past."

http://economictimes.indiatimes.com/quickiearticleshow/4130742.cms

Can Britain's banks afford to be rescued?

Can Britain's banks afford to be rescued?
Government plans to address the toxic assets on lenders balance sheets is going to lead to punitive costs, writes Katherine Griffiths.

Last Updated: 7:29PM GMT 17 Feb 2009

Rumours circulated at the weekend that politicians were fed up of the flow of bad news coming from banks. The chancellor, Alistair Darling, was said to be considering nationalising those in the worst state, in a bid to take control of the dire situation.

If Mr Darling was thinking of pressing the nationalisation button, the temptation passed. While it cannot be ruled out that Royal Bank of Scotland and Lloyds Banking Group might end up in public ownership, the Government again seems determined to stick to its course and to keep at least part of those banks in the private sector.

The rationale is that the banks will recover more quickly if they are still run as commercial operations, even if over the next few years the Government, as a major stakeholder, will make demands over issues including lending levels, repossessions, and bonuses.

Yet it is becoming clear that trying to preserve partial privatisation of the banks will be very difficult. Banking sources have said that Treasury officials and their advisers have become increasingly worried about how to balance dealing with the enormity of UK banks' losses with the need to strike a decent deal for the taxpayer.

At the heart of the action plan is the insurance scheme the Government will offer to banks so that they can cap their losses from toxic assets. However, due to the pace and scale of deterioration of assets, there is an view that the Government will also have to launch a separate bad bank for the most noxious investments.

Neil Dwane, chief investment officer for Europe at RCM, part of insurer Allianz, said: "History shows that almost every banking crisis has had a good bank/bad bank as part of the solution, such as Japan and Sweden in the 1990s, or the Savings & Loans crisis in the USA. This solution works because the toxic assets are placed in a vehicle, underwritten by the state, which can cope with the toxicity over time."

The Treasury left the door open for a bad bank when it announced its latest rescue package for the banks last month, but there has been reluctance among ministers to embrace the idea because it would mean crystalising huge losses and putting them onto the public balance sheet.

However, analysts believe the Government must take the hit. Mr Dwane said the Government should "produce full and clear results for all banks, highlighting the toxic assets".

If a bad bank is launched, it is likely to sit alongside the insurance plan, which has been branded the asset protection scheme. But in a further complication, the Treasury and its advisers at Credit Suisse and Citibank have realised that the scale of the banks' problems mean that it will be very difficult to make the insurance scheme work while keeping part of the banks in the private sector.

Many believe RBS, which has a balance sheet of £2,000bn, may have to put as much as £200bn of toxic assets into the insurance scheme. If the Government follows the US example and charges 4pc for providing insurance to cover losses on these assets after a first loss to the bank, RBS would have to pay a fee of £8bn to the Government.

RBS would be unable to pay the fee in cash without destroying its capital ratio, and so would have to issue some form of capital instruments as payment. However, the bank is in a difficult position because if the capital instruments carry a 10pc coupon - compared to the 12pc the Government charged for injecting equity in the form of preference shares in October - RBS is still looking at a swingeing £800m annual payment.

Alternatively, RBS could pay the Government for the insurance using a different instrument, such as a warrant. While this might not carry a hefty annual fee, the major drawback is that warrants convert into ordinary equity. As RBS is already 70pc owned by the Government, issuing new stock to the state which would further dilute private shareholders could cause its battered share price to plunge to a new low.

Stephen Hester, chief executive of RBS, has said the bank is the "guinea pig" in thrashing out the details of the asset protection scheme with the Government. But Lloyds - which is 43pc state owned - will also have to make heavy use of the insurance scheme.

This will leave Barclays in difficult situation. The bank, which has avoided taking Government money, said last month it was likely to use the insurance scheme. The bank said it would pay in cash, as to pay in certain types of capital instruments would trigger an anti-dilution clause with the Middle Eastern investors who came on board last year. If this clause is triggered, it could give the Middle Eastern group majority ownership of Barclays.

Barclays must now decide whether it can afford to pay in cash. If it cannot, it may have to stay out of the scheme, which could put it at a disadvantage to rivals.

http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/4681836/Can-Britains-banks-afford-to-be-rescued.html

What is deflation?

Q&A: What is deflation?
Gary Duncan

What is deflation?

The dreaded “D” word, one of the most feared economic blights, refers to sustained falls in prices in the economy for goods and services.

Don't we already have falling prices for some products?

Yes. For goods such as many types of clothing, Britain has got used to steadily cheaper prices as a result of intense high street competition and cheap imports from Asia. But deflation is different, meaning falls in prices more or less across the board.

But that sounds good. What's the problem?

The trend can sound like a money-saving bonanza. A short-lived burst of deflation for only a few months might end up like that and need not be a disaster. Problems start when consumers collectively curb spending, constantly waiting for ever-cheaper prices. In turn, this sucks the lifeblood of demand from the economy. With spending falling sharply, businesses sell less and less and are forced to cut wages and lay off staff — leading to even less spending, lower demand and sharper falls in prices. A vicious, downward spiral takes hold that can spell deep and prolonged recession. Once deflation sets in, it can be tough to reverse it, as negative effects feed on themselves. For example, if interest rates have been cut sharply to try to rekindle spending, then once they fall to zero it is impossible to cut them further and, after factoring in falling prices, this means that real interest rates are still higher than zero.

Are there any other effects?

Unfortunately, yes. Debt is a headache. Where prices and incomes generally are falling in a bout of deflation, this means that the real value of people's debts, relative to falling incomes, is rising. So debts become an ever bigger burden, stretching the time that is needed to pay them off to longer periods. This is known as “debt deflation”. In an economy such as Britain's, where households have the highest burden of debt of any leading economy, it poses a particularly severe danger.

How can economies escape?

With great difficulty. Deflation is like quicksand. Once in it, it is very difficult to escape the mire. Solutions to “reflate” the economy are found in flooding the financial system with ultra-cheap money. This can be done by governments printing money to give away in tax cuts, although this risks irreversible damage to a country's finances, or by a central bank buying up assets from banks, effectively handing them extremely cheap cash.

Is deflation likely to take hold now?

There is a significant danger. Headline inflation in the United States could turn negative as soon as this week, after a huge reversal of last year's surge in fuel prices. In Britain, the Bank has said that it expects inflation on some measures to fall into negative territory for at least a few months. This may fall short of full-blown deflation, but will magnify the danger of it.

http://business.timesonline.co.uk/tol/business/economics/article5750994.ece

The Age of Deflation

February 17, 2009

The Age of Deflation
A sustained fall in prices would cause immense economic disruption and hardship; policymakers are right to fear it and to focus all efforts on preventing it .

Figures released this week in the UK and the US are likely to confirm that the annual rate of inflation is decelerating. On some measures, inflation might even turn negative. Lower prices - not just weaker inflation - will sound like good news to households where incomes have been squeezed by tax rises and higher bills. But a sustained period of falling prices (deflation) would have huge economic costs.

While the risk that deflation will take hold of the Western economies is small, it is not trivial. The prospect is powerfully exercising the minds of central bankers and explains the urgency with which the Bank of England and the US Federal Reserve have cut interest rates. Their apprehension is justified: deflation would be the worst of outcomes for the global economy.

In Europe and America, the possibility of deflation goes against all postwar experience. During the Second World War, policymakers worried that the postwar economy would suffer prolonged falls in prices as troops were demobilised and capacity constraints were eased. Yet the enduring problem proved instead to be inflation. J.M. Keynes was the great intellectual influence on Western policy till the mid-1970s, yet his writings contained little on countering inflation beyond the view that expansionary policies should be relaxed before full employment had been achieved.

In practice, full employment, upward pressure on wages and earnings, and the willingness of governments to engage in deficit financing caused a build-up in inflationary pressures. Only with punishingly high interest rates and recession did central banks manage to tame inflation in the early 1980s. Since then, and especially since the mid-1990s, inflationary conditions have been broadly benign. Cheap imports from China helped to dampen inflation and allowed central banks to keep interest rates low.

Unfortunately, easy monetary policy also stimulated an unsustainable boom in asset prices and an irresponsible expansion of credit. The collapse of the housing market bubble and the credit crunch are now pulling the global economy down into recession. Inflation is decelerating sharply, helped by falls in commodity prices.

In the UK, the annual rate of consumer price inflation - the measure that the Government targets - declined a full point to 3.1 per cent in December. The Bank of England expects the figure to fall below 1 per cent this year. Annual inflation as measured by the retail price index, which includes mortgage repayments, has been falling even more rapidly and is approaching its lowest level since 1960.

A short period of falling prices would do little damage. Consumers are used to seeing the prices of some items fall consistently - particularly in electronic goods, as computing power has become much cheaper. But a long period of general price falls, as happened in Japan in the 1990s, would be damaging. Consumers would postpone purchases, as they would be able to buy goods more cheaply in a year or two. Employment and investment would collapse. Stock prices would fall as corporate earnings would contract. Most damaging, households with debt - either mortgage debt or unsecured loans - would suffer intense hardship. Adjusted for inflation, the value of their debt burden would rise. Deflation would cause hardship, eviction and widespread corporate and personal bankruptcy.

This is the risk, if not yet prospect, that central banks now contend with. Previous deflations are almost beyond living memory. The Great Depression was marked by hardship and hunger. The Long Depression of 1873-96 generated international friction, trade warfare and financial panic. These precedents are uniformly terrible; the stakes are extremely high.

http://www.timesonline.co.uk/tol/comment/leading_article/article5748227.ece

Roubini tells Geithner to nationalise US banks

Roubini tells Geithner to nationalise US banks
Tim Geithner must nationalise some of America's biggest banks and take the total toll of the US bail-out to around $2 trillion, according to one of the world's most prominent economists.

By James Quinn Wall Street Correspondent
Last Updated: 1:12AM GMT 16 Feb 2009

Nouriel Roubini – the man feted with having foreseen the financial crisis before almost any of his peers – has warned that the US Treasury Secretary must go significantly further than his detail-light bail-out plan delivered last week, and argues that the Obama administration should move swiftly to take public ownership of those major US banks which are failing.

Professor Roubini, who worked with Mr Geithner in the Clinton administration, told The Daily Telegraph: "Many US banks are insolvent, even the major ones." While nationalisation is "a politically- charged decision" which needs to handled carefully, he said it needs to take place "sooner rather than later" for the sake of the wider economy.

Professor Roubini calculated that, on top of the existing $700bn (£491bn) of American taxpayers' money allocated to solving the banking crisis, Mr Geithner may need to ask the US Congress for between $1,000bn and $1,250bn in extra funds. "Sooner rather than later, they'll need more money," he added.

Prof Roubini, professor of economics and international business at NYU Stern, New York University's business school, is highly critical of Mr Geithner's bail-out plan, which he unveiled to much market chagrin last Tuesday.

The New York-based academic believes that although his former boss (the two worked together when Mr Geithner was under-secretary of international affairs at the Treasury in the dying days of the Clinton era) is moving in the right direction, he is either unwilling or unable to be direct enough when it comes to taking the tough decisions.

Prof Roubini also has some stern advice for the British government, itself facing yet another banking crisis this week as it considers whether to increase its ownership of Lloyds Banking Group.

"In the UK, the government has taken over those banks in distress through a number of measures. But the question now is whether they want to go from de facto ownership to de jure?

"It's necessary and I think that's the way we're going in the UK," he continues, saying he would be "supportive" of such a decision. Politicians "might not want it," he adds "but it is strong in action," before going on to explain that it is better for markets that governments nationalise banks quickly, resolve problems whilst in public ownership, before returning them to the market.

Prof Roubini argues that the UK is very similar to the US in terms of its economic position due to its analogous problems – both suffered housing and consumer credit bubbles – but is even more concerned about Germany, which produced dismal gross domestic product figures at the end of last week.

"Germany did not have the same excesses as the UK, but even the German banks had significant exposure to other types of excesses in lending, and they're weak," he says.

http://www.telegraph.co.uk/finance/financetopics/financialcrisis/4634398/Roubini-tells-Geithner-to-nationalise-US-banks.html

Nouriel Roubini trusts Timothy Geithner to get it right on US banks

Nouriel Roubini trusts Timothy Geithner to get it right on US banks
Nouriel Roubini can see that the 'N' word might be a little difficult for Western governments to swallow right now. But for him, it's the right – indeed, the only – route to follow.

By James Quinn, Wall Street Correspondent
Last Updated: 2:34PM GMT 16 Feb 2009

Nouriel Roubini predicted the current financial crisis and now argues that many US banks should be nationalised
The "N" word, of course, is nationalisation: nationalisation of failing banks which are continuing to wreak havoc on the world's economies.

"Many US banks are insolvent, even the major ones," argues Roubini, professor of economics and international business at NYU Stern, New York University's business school, without naming names. "Call it nationalisation, or if you don't like the dirty N-word, use 'receivership' or whatever is palatable."

Call it what you want, says Roubini, but without nationalisation of some of the major banks in both the US and the UK, the banking crisis will get worse and the current recession deepen.

"If the problem of banks is one of liquidity, you can do anything you like, which seems to me what the US Treasury wants to do," he says, with reference to US Treasury Secretary Tim Geithner's slightly-fumbled banking bail-out plan launched last week to much disregard from Wall Street.

"But if the banks are insolvent, none of these will work," says Roubini of Geithner's three-part plan which includes stress-testing major banks to see if they need more public capital.

"To see which banks are insolvent, a stress test is a step to making these tough decisions," he says, tough decisions which are so politically charged that they need to be "done right" due to the number of stakeholders involved who face being wiped out if nationalisation were to occur.

"Triage the banks that are solvent but illiquid, and those that are beyond redemption need to be nationalised. But it's urgent to do it sooner rather than later. Let's not wait another 12 months."

Roubini, one of the world's foremost experts on the current banking crisis, argues that until now, the US government, like many of its European counterparts, has been busy "trying to provide manna to everyone" without actually working out who needs what.

So why, given that Geithner appears to know some of what is needed, does Roubini think he didn't go the whole hog last Tuesday?

"The benevolent view of what they've done is realise the problem, but maybe not go as far as they might like to. A month into the [Obama] administration, saying "we're going to take over most of the US banks" because they're insolvent - that might lead to being accused of being Bolshevik," he surmises.

The second reason Geithner may have held back, Roubini adds, is that perhaps he and the rest of Obama's economic team – including senior adviser Larry Summers and chairman of the White House Council of Economic Advisers Christina Romer – were banking on the economy recovering somewhat later in the year, which might lead to less stress being placed on bank assets. "A sense of cautiousness, perhaps?" he says.

Based on Roubini's forecast for the US economy, such caution is perhaps a little unwise.

He estimates that a "broad recession" – will continue well into next year, with some form of recovery into 2011. But even that is not certain, he argues, saying there is a "risk" that the current recession does not create a U-shaped curve as the majority do, but that the US ends up like Japan of the 1990's with "nasty L-shape stagnation."

"In a banking crisis, some banks are so under-capitalised that they might as well just take them over," he argues, pointing out that often it is better from a capitalist-friendly perspective to take them over, clean them up in public ownership, and sell them off again, than it is to leave them flailing for help on the open market.

Roubini, who turns 50 in March, makes his comments with a degree of inside knowledge. Although he is no way connected to the Obama administration – and is an independent economist whose only commercial tie is as chairman of economic analysis firm RGE Monitor – he did work with Geithner at the tail-end of the Clinton administration.

When Geithner was promoted to under-secretary for international affairs, Roubini became his adviser, working together for just under a year.

"I trust him," he says, despite acknowledging that he may not quite have got his ducks in a row yet. "He's someone I know well and I have great respect for him."

Why then did Geithner get it so wrong, with his ill-timed and ill-structured banking bail-out which was in many ways smothered by the ongoing debate on the now-passed $787bn fiscal stimulus package?

"You cannot blame him," says Roubini, pointing out that he's facing the "worst economic crisis since the Great Depression" and also that he is just one of a number of high-level economic advisers working under Obama. Although he does concede that his old boss could have waited for a few weeks to "get it right."

Getting it right, in Roubini's eyes of course, means nationalisation, which will invariably involve Geithner returning to the US Congress for additional funds on top of the existing $700bn bail-out fund. "Sooner rather than later, they'll need more money," estimating that $1 trillion to $1.25 trillion of extra money needs to be injected in to the US financial system to revive it, having previously warned that credit losses from US institutions will total $3.6 trillion by the time the crisis is over.

"If you do it fast, you will get private money. But if you take time, and mix good apples with bad apples, then private investors won't want to get involved," he warns.

Aware that going back to the US Congress for an extra $1 trillion of taxpayer's money will be a hard sell for Geithner, Roubini stresses that sum would not necessarily be the final cost. "That's not necessarily the total loss for the taxpayer, as the net costs are less than the headline number due to interest payments and the hope that most of the capital will be repaid."

"They'll get to that point, it's just a matter of when," shrugs Roubini, who, nationalisation or not, will no doubt be watching the actions of his former boss with keen interest.


http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/4639504/Nouriel-Roubini-trusts-Timothy-Geithner-to-get-it-right-on-US-banks.html

China is right to have doubts about who will buy all America's debt

China is right to have doubts about who will buy all America's debt
Chinese doubts about the value of US Treasury bonds highlight a crucial question: who will buy the estimated $2.7 trillion (£1.9 trillion) to $4.2 trillion of debt expected to be issued over the next two years?

By Martin Hutchinson
Last Updated: 12:14PM GMT 13 Feb 2009

With annual foreign purchases accounting for less than a tenth of the low end of that range, and domestic investors unable to bridge the gap, the Chinese are right to worry.

Yu Yongding, former adviser to the People’s Bank of China, recently demanded guarantees for the value of China’s $682bn of Treasury securities. Then Luo Ping, director of the China Banking Regulatory Commission, said that China had misgivings about the US economy, but despite this it would continue to buy Treasuries. The two statements appear designed to raise the issue non-confrontationally before new chief US diplomat Hillary Clinton’s visit to Beijing on February 20.

China worries about the dollar’s value against other currencies, particularly the yuan. With US interest rates so low, the dollar’s value may slide. However, President Barack Obama has repeatedly said he wants a strong dollar, and indeed its trade-weighted value rose 13.9pc between April and December 2008.

The other area of concern for China is the value of its Treasuries. Given the US borrowing requirement and its lax monetary policy, Treasury bond yields could well rise sharply, causing a corresponding price decline. If China’s holdings match Treasuries’ average 48-month duration, then a 5pc rise in yields, from 1.72pc on the 5-year note to 6.72pc, would lose China 17.5pc of its holdings’ value, or $119bn.

Foreign buyers have absorbed a little over $200bn of Treasuries annually, a useful contribution to financing the $459bn 2008 deficit, but only a modest help towards the $1.35 trillion minimum average deficit forecast for 2009 and 2010.

Unless that changes substantially, there will be $1trillion annually to be raised by the Treasury from domestic sources, more than double the previous record from domestic and foreign sources together, plus whatever is needed to bail out the banks.

Even if the US savings rate were to rise from zero to its long-term average of 8pc of disposable personal income, that would create only an additional $830bn of savings -- not enough to fund the domestic share of the deficit. Interest rates would probably have to rise substantially to pull in more foreign investors.

Yu is right to worry.

For more agenda-setting financial insight, visit www.breakingviews.com

http://www.telegraph.co.uk/finance/breakingviewscom/4611408/China-is-right-to-have-doubts-about-who-will-buy-all-Americas-debt.html

The buy/sell ratio in Lloyds Banking Group was 7:1 on Friday

Private investors pile into Lloyds shares
Private investors who bought shares in Lloyds Banking Group outnumbered sellers by seven to one at one London stockbroker as the shares plunged following news of huge losses at HBOS.

By Richard Evans
Last Updated: 6:11PM GMT 16 Feb 2009

"The buy/sell ratio in Lloyds Banking Group was 7:1 on Friday," said TD Waterhouse, a broker that specialises in "execution only" trades – those where investors make their own decisions.

Strong demand for the bank's shares continued on Monday – the ratio was two to one in favour of buyers, after Lloyds shares fell by 20pc on the opening of the market in London. By midafternoon, the shares were trading at 57p.

Investor interest was first triggered on Friday when Lloyds' share price fell by 32pc, closing at 61.4p as institutional investors sold the shares following news of losses of almost £11bn at HBOS, the troubled bank that Lloyds bought last year.

TD Waterhouse said: "Lloyds Banking Group accounted for 40pc of the top 10 trades by our customers on Friday. On Monday Lloyds again was the most traded stock."

It added: "The data indicates that our frequent traders are looking to turn a quick profit on the volatility of banking stocks, and Lloyds in particular."

Tom Diavolitsis, a director of TD Waterhouse, said: "Lloyds was the number one traded stock by our customers on Friday last week and in the first two hours of trading today [Monday].

"It is clear that our investors are hoping to take advantage of the recent volatility in the Lloyds share price. Some will be looking to make a short-term profit, others may be looking to gain by holding the stock for the longer term."

It was a similar story at Stocktrade, the execution-only division of Brewin Dolphin, another stockbroker. Lloyds accounted for 25pc of the division's trades on Monday morning; 56pc of the Lloyds orders were buys and 44pc were sells.

Royal Bank of Scotland accounted for 7pc of trades – 63pc of them buys and 37pc sells. Buy orders for Barclays shares outnumbered sales by three to one.

Brewin Dolphin said its view for investment management clients was that the Government would nationalise Lloyds only as a very last resort. "We are not that close to a last-ditch scenario just yet, though very much aware of the strong economic head winds.

"The current Lloyds share price is acting like a warrant; if they can survive we believe there is significant longer-term upside."

http://www.telegraph.co.uk/finance/personalfinance/investing/shares/4640868/Private-investors-pile-into-Lloyds-shares.html

Europe has reached acute danger point.

Failure to save East Europe will lead to worldwide meltdown
The unfolding debt drama in Russia, Ukraine, and the EU states of Eastern Europe has reached acute danger point.

By Ambrose Evans-Pritchard
Last Updated: 2:05AM GMT 15 Feb 2009

Comments 91 Comment on this article

If mishandled by the world policy establishment, this debacle is big enough to shatter the fragile banking systems of Western Europe and set off round two of our financial Götterdämmerung.

Austria's finance minister Josef Pröll made frantic efforts last week to put together a €150bn rescue for the ex-Soviet bloc. Well he might. His banks have lent €230bn to the region, equal to 70pc of Austria's GDP.

"A failure rate of 10pc would lead to the collapse of the Austrian financial sector," reported Der Standard in Vienna. Unfortunately, that is about to happen.

The European Bank for Reconstruction and Development (EBRD) says bad debts will top 10pc and may reach 20pc. The Vienna press said Bank Austria and its Italian owner Unicredit face a "monetary Stalingrad" in the East.

Mr Pröll tried to drum up support for his rescue package from EU finance ministers in Brussels last week. The idea was scotched by Germany's Peer Steinbrück. Not our problem, he said. We'll see about that.

Stephen Jen, currency chief at Morgan Stanley, said Eastern Europe has borrowed $1.7 trillion abroad, much on short-term maturities. It must repay – or roll over – $400bn this year, equal to a third of the region's GDP. Good luck. The credit window has slammed shut.

Not even Russia can easily cover the $500bn dollar debts of its oligarchs while oil remains near $33 a barrel. The budget is based on Urals crude at $95. Russia has bled 36pc of its foreign reserves since August defending the rouble.

"This is the largest run on a currency in history," said Mr Jen.

In Poland, 60pc of mortgages are in Swiss francs. The zloty has just halved against the franc. Hungary, the Balkans, the Baltics, and Ukraine are all suffering variants of this story. As an act of collective folly – by lenders and borrowers – it matches America's sub-prime debacle. There is a crucial difference, however. European banks are on the hook for both. US banks are not.

Almost all East bloc debts are owed to West Europe, especially Austrian, Swedish, Greek, Italian, and Belgian banks. En plus, Europeans account for an astonishing 74pc of the entire $4.9 trillion portfolio of loans to emerging markets.

They are five times more exposed to this latest bust than American or Japanese banks, and they are 50pc more leveraged (IMF data).

Spain is up to its neck in Latin America, which has belatedly joined the slump (Mexico's car output fell 51pc in January, and Brazil lost 650,000 jobs in one month). Britain and Switzerland are up to their necks in Asia.

Whether it takes months, or just weeks, the world is going to discover that Europe's financial system is sunk, and that there is no EU Federal Reserve yet ready to act as a lender of last resort or to flood the markets with emergency stimulus.

Under a "Taylor Rule" analysis, the European Central Bank already needs to cut rates to zero and then purchase bonds and Pfandbriefe on a huge scale. It is constrained by geopolitics – a German-Dutch veto – and the Maastricht Treaty.

But I digress. It is East Europe that is blowing up right now. Erik Berglof, EBRD's chief economist, told me the region may need €400bn in help to cover loans and prop up the credit system.

Europe's governments are making matters worse. Some are pressuring their banks to pull back, undercutting subsidiaries in East Europe. Athens has ordered Greek banks to pull out of the Balkans.

The sums needed are beyond the limits of the IMF, which has already bailed out Hungary, Ukraine, Latvia, Belarus, Iceland, and Pakistan – and Turkey next – and is fast exhausting its own $200bn (€155bn) reserve. We are nearing the point where the IMF may have to print money for the world, using arcane powers to issue Special Drawing Rights.

Its $16bn rescue of Ukraine has unravelled. The country – facing a 12pc contraction in GDP after the collapse of steel prices – is hurtling towards default, leaving Unicredit, Raffeisen and ING in the lurch. Pakistan wants another $7.6bn. Latvia's central bank governor has declared his economy "clinically dead" after it shrank 10.5pc in the fourth quarter. Protesters have smashed the treasury and stormed parliament.

"This is much worse than the East Asia crisis in the 1990s," said Lars Christensen, at Danske Bank.

"There are accidents waiting to happen across the region, but the EU institutions don't have any framework for dealing with this. The day they decide not to save one of these one countries will be the trigger for a massive crisis with contagion spreading into the EU."

Europe is already in deeper trouble than the ECB or EU leaders ever expected. Germany contracted at an annual rate of 8.4pc in the fourth quarter.

If Deutsche Bank is correct, the economy will have shrunk by nearly 9pc before the end of this year. This is the sort of level that stokes popular revolt.

The implications are obvious. Berlin is not going to rescue Ireland, Spain, Greece and Portugal as the collapse of their credit bubbles leads to rising defaults, or rescue Italy by accepting plans for EU "union bonds" should the debt markets take fright at the rocketing trajectory of Italy's public debt (hitting 112pc of GDP next year, just revised up from 101pc – big change), or rescue Austria from its Habsburg adventurism.

So we watch and wait as the lethal brush fires move closer.

If one spark jumps across the eurozone line, we will have global systemic crisis within days. Are the firemen ready?

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/4623525/Failure-to-save-East-Europe-will-lead-to-worldwide-meltdown.html

Classic Question: Annuities or Bonds?

Classic Question: Annuities or Bonds?
Sponsored by by Don Taylor
Saturday, February 14, 2009
provided by

Dear Dr. Don,

I have been considering an immediate annuity, but was wondering what the benefit is over buying a long-term corporate bond or bonds with a similar yield.

Assuming I seek 30 years of income, it seems the annuity is implying something like a 4.5 percent to 5 percent yield. Wouldn't I be better off buying a corporate bond that yields a similar amount? That way, I'd still have the principal to spend at maturity in case I lived longer than planned.

Am I not taking the same default risk with either investment since the insurance company could go out of business just like any other company? And finally, are there tax reasons that would make an immediate annuity better?

-- Laurence Longevity



Dear Laurence,

Yours is a classic question in retirement planning. To restate: "If you can invest at the same yield and the same risk as the immediate annuity, aren't you better off investing in the bonds versus buying the immediate annuity?"

For many the answer will be "no," but making it an apples-to-apples comparison is more difficult than just comparing the interest income from the bonds with the income from the annuity.

In addition, getting the risk levels equal is nigh impossible. State insurance commissions have reserve and other requirements that make an investment in an annuity from a highly rated insurance company safer than an investment in a highly rated corporate bond.

You purchase an immediate annuity with a lump sum and buy an income stream that lasts for your lifetime. The immediate annuity allows you to achieve a higher income stream than you could earn from living off the interest income paid by the bonds. That's because a straight life immediate annuity doesn't return principal when you die, and the annuity only lasts for your lifetime.

There are a multitude of options in how you structure the annuity. You can have it pay over your lifetime, over a joint lifetime or over a set time horizon. The payment can be indexed to inflation. There may or may not be a death benefit to a beneficiary. There may be a guarantee that you or your beneficiaries will at least receive in distributions the amount of money you have invested.

As soon as you start adding options, however, the value of the annuity payment declines because you have spent part of the purchase price to buy that option.

I used the annuity quote function on ImmediateAnnuities.com and assumed a $1 million investment for a 66-year-old male. (The annuity calculator on Vanguard.com is also recommended.) You can do your own calculation based on your age and the money you have available to purchase the annuity. The site will return almost two dozen different monthly payments based on typical annuity options.

I'm going to focus on the straight life annuity, which is the type of annuity that ensures a fixed income for the rest of the purchaser's life. The $1 million purchase secures a monthly income stream of $7,397. If you assume a 30-year life, it equates to a yield of roughly 8.4 percent (assuming the 66-year-old lives to 96). The longer you live, the higher the implied yield on the annuity.

A portfolio of 30-year, single-A rated corporate bonds isn't currently yielding in that ballpark. However, even if the two products were yielding a similar rate, the bonds are riskier than the annuities (for the reasons stated earlier).

I'm going to beg off on the tax discussion between the two investments and leave that to you and a tax professional. However, there's more to consider here than just taxes. Two other considerations are how the choice of an annuity versus the bond portfolio could impact your eligibility for Medicaid and potential estate-planning issues.

The bottom line is that the law of large numbers should allow an insurance company to pay a higher income stream on a single life annuity than you can earn off a similar amount invested in a high-quality bond portfolio.

This is true because the insurance company doesn't have to return your principal if you die sooner than expected, and dealing with a large pool of annuity owners means it can use mortality figures to estimate the average life of that pool to price the annuity.

Annuities are going to make the most sense for people who are worried about outliving their income and don't have a large retirement nest egg as a backstop.

Before signing an annuity contract, get a second opinion on the decision from a fee-only financial adviser. The National Association of Personal Financial Advisors maintains a listing of fee-only advisers.

Copyrighted, Bankrate.com. All rights reserved.

http://finance.yahoo.com/focus-retirement/article/106589/Classic-Question:-Annuities-or-Bonds?mod=retirement-post-spending

Paradox of thrift

Go ahead and save. Let the government spend.
By Robert H. Frank

Sunday, February 15, 2009
A psychotherapist friend says that several of her patients are fretting about whether they have an obligation to help the nation spend its way out of the current downturn. Some of them are having a hard time making ends meet, she said, yet are reluctant to cut back for fear they would cause the economy to slide further.

The role of consumers has had considerable attention in the press because the economy desperately needs additional spending right now. But it is not — and should not be — the responsibility of middle-income families to provide that spending. If financially comfortable families want to support their favorite restaurants during hard times by eating out more often, who could object? But if others are inclined to pay down their bills or save a little more, concerns about the economy shouldn't stop them.

Government is in a far better position to provide immediate economic stimulus. It is in fact the only player that can significantly alter the economy's short-run trajectory. In a recession, as in ordinary times, a family's first economic priority should be to spend its income prudently.

The "paradox of thrift," a celebrated chestnut first described by John Maynard Keynes in the 1930s, has been the source of much confusion about how saving affects the health of the economy. Intuition suggests, correctly, that if any one family saves an extra $100 this year, its bank balance at year's end will be higher by that amount. According to the paradox of thrift, however, if everyone tries to save more at once, total savings will actually fall.

How could that happen? The explanation begins with the observation that, to save more, a family must spend less. Because consumption spending is part of national income, which in turn is the total amount spent by everyone in the economy, more saving causes national income to fall. Income will actually fall by more than the initial decline in consumption, because when one family spends less, other families earn less and respond by cutting their own consumption. When the dust settles, the story concludes, each family ends up saving less than before.

But that doesn't mean that people should stop saving for retirement or their children's education. If we're going to ask people to make sacrifices, it should be for something that will actually make a difference. (My colleague David Leonhardt wrote a column on Wednesday suggesting that by making certain kinds of investments — like making their homes more energy efficient — families could boost current spending while also increasing their long-run savings, despite the paradox of thrift.)

But even by mortgaging itself to the hilt (as many families have indeed already done during the recent national spending spree), no family could spend enough to affect the current downturn.

Nor is it reasonable to demand that individual businesses pick up the slack, since most of them already have more capacity than they currently need. At moments like these, government is the only actor with both the motivation and the ability to jump-start the economy.

Passage of a robust stimulus bill has rightly been the Obama administration's highest priority since taking office last month. As Keynes explained during the Great Depression, increased public spending would help end the downturn even if it were for useless activities like digging holes and filling them back up. It would obviously be better if the extra spending went for something useful. And as it happens, decades of infrastructure neglect, combined with huge state and local government budget shortfalls, provide more than enough valuable projects to put everyone back to work.

Bizarrely, however, some congressional critics have denounced the administration's stimulus proposals as "mere spending programs." Of course they're spending programs! More spending is exactly what we need. The imperative is to get this legislation passed and get the spending started right away.

The paradox of thrift has been a pernicious idea. By casting saving in such a negative light, it has encouraged people to think that thrift no longer matters. And most Americans have been only too happy to spend more freely. Household savings rates have fallen sharply for several decades. For two of the past three years, they have actually been negative, meaning that spending has exceeded income.

By fueling the housing bubble, this spending not only helped cause the current crisis, but also led to substantially increased borrowing from abroad. We're poorer each year by the hundreds of billions of dollars that we must pay in interest on these loans.

The "paradox of thrift" applies only during economic downturns, and even then only when government fails to stimulate spending. Most of the time, however, the economy operates near full employment. Before long, it will again. Under those circumstances, if every family saved a little more, extra money would flow into the capital market, causing interest rates to fall and investment spending to rise.

Because the fall in consumption from increased savings would be exactly offset by the rise in investment, total demand would still be sufficient to maintain full employment. The extra investment would boost productivity, causing national income to grow faster in the long run. As a result of the spending spree of recent decades, however, our growth rate has fallen sharply. Much of the nation's credit-card debt is now carried at annual interest rates of 20 percent or more. In just five years, each dollar invested in paying down such debt would support more than $2.50 of additional consumption; in just 10 years, more than $6. It is unreasonable to ask families to spend more when government can stimulate the economy so much more efficiently.

THE financial health of the nation and the financial health of individual families are not conflicting goals. A family that wants to help put the economy back on its feet while increasing its own future standard of living should consider saving a little more or paying down debt. Those who want a tangible symbol of their patriotism can buy additional government bonds, which will help repair an extra bridge or hire an extra math teacher.




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Copyright © 2009 The International Herald Tribune www.iht.com

http://www.iht.com/articles/2009/02/15/business/15view.php

A generation shy of risk?

A generation shy of risk?
FEB 15 – You did what you were supposed to do. College. Graduate school, maybe. Bought a home. Invested in mutual funds. Bought a house.

And now? You have student loan debt. Your degree has not shielded you from unemployment (or the fear of it). The house is worth 20 per cent less than two years ago, and your retirement portfolio is down 40 per cent from its peak.

So at this moment, can you blame people in their 20s and 30s for giving up altogether on risk of any sort? It’s one of the bigger questions preoccupying those who think about money management all day.

Are we in the process of minting a new generation of adults who are averse to taking chances, whether it’s buying real estate or investing in stocks?

“We trained people that if you took risk and diversified and played by the rules that you’d have a great life for yourself,” said Howard L. Simons of the bond specialist Bianco Research. “But all of that can disappear in a hurry. And most of us can look in the mirror and say, ‘What did I do to cause this?’ And nothing springs to mind.”

I’m not sure we can say for sure whether there has been some permanent change in attitudes toward risk. It’s easy to overestimate the extent to which the world – and our perception of it – has changed in the middle of a crisis. But this one has not lasted long. And its duration does not come close to matching the period in the 1930s that left a permanent imprint on so many people’s financial habits.

Even before the downturn, younger adults were not necessarily enthusiastic about riskier forms of investing, even though they are far from retirement.

A joint study by the Investment Company Institute and the Securities Industry and Financial Markets Association noted that just 45 per cent of households headed by people under 40 held 51 per cent or more of their portfolios in stocks, mutual funds and other, similar investments last spring. That is less than what households headed by those 40 to 64 owned. Fifty per cent of them invested more than half their money in equities.

Data from Vanguard, however, suggests that its investors under 45 who use target-date mutual funds, which allocate assets among stocks and bonds for the investor, tend to have significantly more money in stocks than those who do not use these mutual funds.

As more employers automatically sign up younger workers for 401(k) plans and use fairly aggressive target-date funds as a default investment, those employees’ exposure to stocks will grow.

So perhaps a better question to ask is not whether people in the first half of their working lives are becoming more risk-averse, but whether they should be.

On Thursday night, Kevin Brosious, a financial planner in Allentown, Pa., polled the students in his financial management class at DeSales University on the percentage of their portfolios they would allocate to stocks right now. The majority would put less than half in stocks; among their reasons were fear of job loss, lack of accountability on Wall

Street and economic fears amplified by the news media.

The problem with their approach, according to Brosious, is that by investing conservatively they are probably guaranteeing themselves a smaller return and a more meagre standard of living in retirement.

Or, as Robert N. Siegmann, chief operating officer and senior adviser of the Financial Management Group in Cincinnati, wrote to me in an e-mail message, “Why would you consider taking less risk NOW after most of the risk has already been paid for in the market over the past 12 months?”

If investing still seems too risky to you right now, you’re not alone. At Charles Schwab, according to a spokesman, younger 401(k) participants are not making many big investment moves. But there is a sense that at least some younger investors may divert 401(k) contributions to other uses, especially as more companies reduce or suspend their 401(k) matches.

In that case, one sensible way to reduce overall risk is to pay down high-interest debt, like credit cards or private student loans. That, at least, offers a guaranteed return, since every extra dollar you pay now keeps you from having to pay more interest later. Also, the sooner you rid yourself of debt payments, the less you would need in your monthly budget if you lost your job.

“I think the only thing younger people should be more risk-averse about is the leverage they take on,” said Jeffrey G. Cribbs, president of Chicago Wealth Management in Oak Park, Ill.

In particular, he suggested they buy real estate and cars at levels below what they can actually afford.

So what kind of risk should you take on with the savings you have left over? To Moshe A. Milevsky, the author of “Are You a Stock or a Bond?,” risk should have less to do with the era in which you live and more to do with what you do for a living.

If you are a tenured professor, a teacher, a firefighter or other government employee, you have better job security than most other people. Your income stream is stable, like a bond. Certain service providers, like plumbers and doctors, have similar security.

Investment bankers and many technology and media workers, however, have more volatility in their career paths. A chart of their income might bounce around like one showing a stock’s price.

“The idea is that we should focus on our human capital and invest in places where our human capital is not,” Milevsky said. “It’s not about risk tolerance or time horizon but about what you do for a living.”

As a tenured professor, he invests entirely in equities. Other people with bond-like characteristics who are far from retirement could take similar risks, and withstand 2008-level losses, because their incomes are fairly stable. Those who have more stock-like careers, however, probably ought to invest a bit more conservatively, in both their retirement accounts and in their primary residences.

For most young people, however, their biggest asset is not a 401(k) account or a home but the trajectory of their career and the value of 20 or 30 or 40 years of future earnings. It makes nearly everyone a millionaire on paper.

So whether you are taking on too much risk right now or not, all of that money will provide many more chances to fix any mistakes you have already made.

Has your risk tolerance changed forever? – NYT