Friday, 9 October 2009

Rio Has Got It

Rio has Got It

9th October 2009

The Malta Independent - Friday Wisdom
Alfred Mifsud

During the week I tend to jot down bullet points with ideas to consider for this column. This week’s jotter note reads: Oil price and US$ value; Brown and British Labour; Power moves east; Jobs jobs jobs; Rio for 2016.

These are prima facie unconnected topics but on deeper analysis they are different parts of a complex collage which makes up the current state of affairs of the turmoil in the financial and economic world.

Let me try to pass the common thread while discussing these separate topics.

The oil price has topped US$70 per barrel from the below US$40 it had hit during the worst of the financial turmoil last December. The obvious conclusion is that if oil is commanding US$70 in the midst of a recession it is pretty rational to expect the price to go well north of US$100 when the economy recovers. Two factors influence most directly the price of oil. First is that its price is directly and inversely correlated to the fortunes of the US$. As oil is internationally traded and priced in US$, its price moves inversely to the foreign exchange value of the dollar in an effort to maintain real value. If the dollar falls the price of oil goes up and conversely if the dollar rises the price of oil goes down. The other factor is the strength of demand from China who seems on a mission to secure their energy supplies by stockpiling reserves and buying strategic oil related assets.

The US$ is suffering from a denied policy of benign neglect by the US Treasury and the Federal Reserve. The US economy is under so much stress following the disastrous handling of Lehman’s collapse last year by Hank Paulson, the most irresponsible Treasury Secretary the US has ever had, that it requires ultra loose monetary policy and low interest rates for as far as the eyes can see. In the context of other countries that have not been as damaged by the financial crisis, countries like Australia who are confident enough of their economic recovery that they already started raising interest rates, the US$ harbours very grim prospects for its external value. Indeed it is even clear that the US economic recovery depends on a substantial downward adjustment of its currency and ideally without such adjustment being reflected by pegged currencies like the Chinese Renminbi and other Asian currencies.

Whoever is in charge of oil procurement should adopt some longer term hedging of the oil price without hedging the US$ currency exposure.

The financial turmoil has seriously hurt the British economy which had grown addicted to a raving financial sector and a strong property sector. Both sectors were deflated by Lehman’s collapse. With an election due within nine months Prime Minister Brown and his Labour Party are badly trailing the Conservatives in the polls as people tend to judge their government’s performance by the money in their pocket.

Yet Gordon Brown is accredited as the person who led the financial world from the brink of collapse when he gave a lesson to Hank Paulson that significantly important banks that get into trouble should be recapitalised by the State, as happened in case of Royal Bank of Scotland and Lloyds Bank/HBOS, rather than allowed to damage the system by filing for bankruptcy as in the case of Lehman.

Brown has a mountain to climb if he is to win the next election. However I don’t share the view that the election is already lost and that Cameron can order the drapes of his taste for No. 10. As we approach decision time Brown can show the international recognition he earned for saving the world’s financial system and expose his conservative opponents as having no serious policy to get the economy out of recession. It may well be, especially if Brown breaks the tradition and engages Cameron in televised direct debates, that British voters in the end will decide that the more serious the economic problems, the more risky it is to leave the country in the hands of the untried and untested.

The financial crisis has brought a steep change in the redistribution of regional political power. There is no doubt that this has shifted towards Asia and other developing countries. The transformation of the G7 into G20 and the redistribution of power within the IMF and World Bank structures are symbols of such power shift.

Equally symbolic of this shift is the decision to award the 2016 Olympic Games to Brazil’s Rio de Janeiro, shrugging loaded competition from Chicago, Tokyo and Madrid which used their big chips to lobby for the award. The US first couple, the Prime Minister and the King of Spain and the Prime Minister of Japan with US$4 billion already in the bank in support for Tokyo’s bid, could do nothing to thwart the strong appeal by Brazilian President Lula da Silva:

“It’s Brazil’s time. Among the top 10 economies of the world, Brazil is the only country that has not hosted the Olympic and Para-Olympic Games. For the Olympic movement, it will be an opportunity to feel the warmth of our people, the exuberance of our culture, the sun of our joy and it will also be a chance to send a powerful message to the whole world: The Olympic Games belong to all peoples, to all continents and to all humanity.”

It is almost unbelievable that as recently as August 2002, just before Lula was elected president, Brazil’s bonds were priced for a default. They are now investment grade! Brazil has come a long way under Lula and they deserve the Games.

Coming nearer home the international financial crisis has caused a sharp slowdown in the economy, a considerable price drop in certain sectors of the real estate market and a destruction of a substantial platform of government revenue leading to increase in budget deficit well in excess of that planned this time last year. Yet this is not the time to worry about the deficit. Priorities demand that the 2010 Budget addresses the economic slowdown not the deficit. The deficit will correct itself when the economy eventually recovers. The priority now should be jobs, jobs and jobs which depend on government investment in infrastructure and stimulation of private sector investment.

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