On Fire

The Malta Independent - Friday Wisdom

So many things seem to be on fire.

Let me start with the local equity market. The Malta Stock Exchange Index is up 27 per cent for the year and this follows a gain of 44 per cent in 2004 and 14 per cent in 2003. From a low base at the end of 2002 the MSE index is up a whopping 108 per cent in two years and eight months.

Some individual equities have performed better and some worse, but the general conclusion is obvious. The market is red hot and touching it with new money could burn unless one happens to be a momentum investor. Momentum investors, in contrast with value investors who search fundamental value in equity prices and invest for the long term, stay on their toes to get out in time – market liquidity permitting.

Adriano and Brazil are on fire, annihilating opponents who would be a headache to any other team. The Malta national football team went on fire last Wednesday playing Croatia in a World Cup qualifier. Croatia needed a straight win to keep their qualifying ambitions alive but against our young lads they could only draw. On the other hand, Ericsson seems on the way to being fired as England lost the qualifier match against Northern Ireland who, in a friendly at Ta’ Qali last month, were lucky to get away with a draw against Malta.
America is on fire following the Katrina debacle. It is dawning on public opinion in the US that for all the billions “invested” to enhance homeland security their country remains as exposed as ever. If emergency services could not be marshalled to respond effectively to a hurricane whose threat came with a few days’ advance warning, what confidence can US citizens have that their country can respond effectively firstly to prevent and secondly to address a terrorism debacle that does not come with any advance warning?

The Katrina experience is also setting fire to the modern economic syndrome that smaller government is a better government. The theory goes that if the government reduces its expenditure it could lower taxation thus spurring private investment, which makes the economy grow faster. Some supply-side theorists further argue that economic growth will increase the tax base that more than compensates for the revenue lost through lower tax rates.

People are now rightly questioning whether these numerical arguments are in fact losing sight of the fact that smaller government could involve making dangerous economies with matters of life or death for the citizens even though the outcome would become visible only with a substantial time lag.

The majority of the damage suffered in New Orleans was not the direct result of hurricane Katrina but more the result of a lack of investment in and proper maintenance of the levées that were meant to afford flood protection for a city built below sea level. If smaller government means neglecting such matters, then the New Orleans experience puts a huge question mark on it.

The issue in the US is not really that of promoting a smaller government because, in effect, the US federal budget deficit was running at a record high – although this year pre-Katrina figures were pointing to a positive turnaround. Post Katrina this is now doubtful, as the US federal budget will probably be called to foot a bill as high as one hundred billion dollars (and growing) by first estimates. The Katrina experience is more related to expenditure and resources deflected from homeland security to fighting an incredibly expensive war in Iraq that is costing way, way above any estimates that could have been made when the Iraq venture was first conceptualised.

What else is on fire? The price of oil is on fire. Even though it retreated from its all-time nominal high of $71 per barrel following the disruption caused by Katrina, the outlook for the oil price is still pointing north. When demand increases soon for heating oil in the northern hemisphere at the same time that countries will be forced to re-build the strategic reserves they released to cushion the Katrina disruption, there is a risk that the oil price could re-test record levels in the short term.

On a long-term basis, development in Asia, China in particular, will continue to underpin growth in demand for energy resources at a rate greater than they can be supplied. On an even longer-term perspective, the resources of oil and gas are not infinite and unless renewable energy resources can be developed, energy supply bottleneck could be envisaged in the coming decades.

Renewable energy sources can only be commercially justified by a permanently high price for oil and one can understand then why the price of oil is likely to remain on fire for the foreseeable future. Nobody seems to believe that oil can ever go back to the 20 something dollars per barrel that was factored in most economic projections up to 12 months ago.

The only thing that does not seem to be on fire is our economy and its management. While we continue with an unimpressive economic performance, with little or no growth in tourism and manufacturing, we plod along with the publication of documents and public consultation processes. The latest is the National Reform Programme – Malta’s Strategy for Growth and Jobs for the period 2005-2008. This 74-pager again pretends that we can solve our economic problems by nicely worded reports defining praiseworthy objectives on which there is total consensus. What we need is effective leadership in implementation and achievement rather than competent report writers.

Let’s take a simple example. Nobody can disagree with the objective to make the economy more competitive. To achieve that, one of the major variables is wage flexibility. This is acknowledged in the report and, in fact, Policy Initiative and Measures on Page 12 of the report says: “M05.1 Ensure that current and future employment legislation is consistent with a flexible and dynamic labour market.”

Is it not time to pass from the vague generics to specifics which question in plain and simple language whether we can maintain the legislated COLA system which adds wage costs unrelated to productivity? Can we remain competitive if we do not change? Are we prepared to change? Can change be brought about by public consultation, or by dynamic and inspired leadership capable of persuading that the long-term gain will far outweigh the short term pain?

Why is it that everything around us is on fire except where we need it most – a burning sense of urgency in our economic reform programmes where we need change managers rather than yet another report written in the vague theoretical style of university professors.

Worst Behaviour

The Malta Independent of Sunday

How can they give beautiful names like Ivan or Katrina to such destructive monstrous hurricanes?

How is it possible that the sole super power left, which has no qualms playing super-cop around the globe and pretending to have the capacity to establish democracy in desert kingdoms and caliphates that probably cannot even spell the word let alone appreciate it and embrace it, is so incapable of protecting its own against a relatively small natural calamity?

Compared to the Asian tsunami hurricane Katrina is small change. But whereas the tsunami ravage was a one shot resulting from an act of God, which destroyed hundreds of thousand of lives but produced relatively small material damage (because the poor Asian countries had little material to damage), Katrina’s aftermath is contrastingly different. The storm itself was pretty mild on the Asian tsunami scale, and there is absolutely no comparison as regards loss of life. However, in terms of material damage and economic disruption the costs will be astronomically higher than the tsunami damages purely because it hit an area where there is concentration of economic activity and huge industrial plants, busy ports and a nerve centre for the distribution of energy and commodities.

The tragedy is that much of this damage is not quite the result of the hurricane itself but the result of human abuse of Mother Nature. Abuse in building cities below sea level. Abuse in finding the billions required to fight unnecessary foreign wars on false pretexts but not finding the few millions necessary to maintain the damns or levees to keep cities, dangerously built below sea level, safe and protected.

Only time will tell why the emergency services have proven so gaspingly ineffective that journalists were forced to sympathise with looters, who were described as being forced to steal because it was a matter of survival given the failure of the emergency services to respond effectively. How can the richest and most technologically advanced nation in the world be capable of landing men on the moon, building a manned base lab in space, sending spacecraft to the farthest corner of our solar system, keeping satellite watch on every corner of the world, responding to 9/11 attacks by bringing back its financial systems up and running in less than a week and then prove so ineffective in airlifting emergency supplies to so many thousands of New Orleans citizens who were ordered to leave their water-logged homes without any supplies or belongings?

How can it be that America could let its citizens suffer such degradation and deprivation in such an hour of need, which in its experience is comparable to the suffering of the children of Beslam a year earlier though hopefully the ending will be less tragic?

Closer to home, how can the EU leave its tiniest member State to fend on its own as it tries to grapple with the problem of illegal immigration? Is it not clear to one and all that the problem this year has taken on a totally different dimension now?

It is no longer a case of the odd boatload of immigrants landing on our shores by mistake on their way to Sicily and the European mainland. It has now become an organised system of immigrants coming purposely to Malta to join the friends or relatives who had arrived earlier.

Can’t the EU be made to realize that a small country like us doesn’t have the skills and resources to cope with this problem without putting the life of such illegal immigrants at risk by abandoning them to their own destiny on the high seas?

For the EU as a whole this is a small problem. Illegal immigration from the Balkans, mostly Albania and the former Yugoslav Republic and from former communist countries is now history. Illegal immigration from former UK colonies into Britain and francophone colonies into France has also largely diminished as many such colonies have improved domestic economic conditions.

So if our geography is condemning us to become the first port of call for the last remaining source of illegal immigration, the African continent, why should we be left to fend for ourselves? Where is the European solidarity we were promised?

The developed world, and Europe in particular, has an obligation to promote development in Africa to reduce and eventually eliminate the flow of illegal immigration. But until his happens Europe must help Malta and Sicily to tackle this problem with a sense of solidarity. Otherwise, Sicily and Malta will be constrained to continue dumping responsibility for the occasional mishaps on one another and will continue to play at passing the parcel to each other, that is, the responsibility for housing the immigrants. This is not a Sicilian problem or a Maltese one. It is a EU problem, or if you will, a European problem that even involves countries outside the EU. It is the lack of real aid to Africa that has brought about this unbearable situation which has disproportionately burdened the central Mediterranean islands.

As a minimum, the EU should invest in a proper detention centre in Malta, resourced as an EU-wide project both in terms of funding as well as in terms of equipment and skilled human resources, and setting up efficient systems to distinguish between genuine asylum seekers who could be absorbed inside the EU and abusive economic immigrants who should be returned to their country of origin.

Like the poor souls stranded with just the clothes they are wearing in the New Orleans Super-dome and Convention Centre, which is bringing the worst out of humans who feel threatened and abandoned, we should not be abandoned by the EU to face the problem of illegal immigration single-handedly. If they do that they can hardly be surprised if it brings out our worst side, as happened to Minister Tonio Borg when he said that if we are not helped we could be forced to renege on our international agreements.

Rather than be chastised for saying it I think it should be said more forcefully until someone listens.

Do We Have a Housing Bubble

The Malta Independent - Friday Wisdom

This question is often asked in relation to the sharp increase in property prices experienced over the last few years. An authoritative answer thereto is well nigh impossible, as experience shows that it is difficult to identify a bubble in real time. In fact, even if an asset price bubble exists there is no assurance that this bubble will keep inflating to the point of bursting and unless it bursts, its prior existence cannot be proven by subsequent events. Only a bubble that bursts can be proven a posteriori.

The responsibility for avoiding the creation of dangerous asset price bubbles lies primarily with the monetary authorities, in our case the Monetary Policy Council of the Central Bank of Malta, with ultimate responsibility on the Governor. The objective of monetary policy is not only to achieve price stability at the retail/consumer level but also to have an orderly market at the asset price level, particularly regarding immoveable prices (read “house prices”) and financial capital assets prices (read “quoted equity prices”).

One could be forgiven for forming the impression that monetary authorities are much more focussed on retail price stability and only give attention to the asset price inflation when it is often too late to prevent it. This is not restricted to domestic experience. The US Federal Reserve chairman Alan Greenspan, its factotum for the last 18 years and now nearing the end of his tenure, has in the past maintained that central banks should not use monetary policy to spike a bubble, but only to cushion its aftermath effects. This, however, says little about the obligation of central banks to use monetary policy to avoid the formation of the bubble in the first place or to deflate the forming bubble before it enters the bursting risk area.

In recent years, the Bank of England and the Federal Reserve of Australia have used monetary policy instruments (read “rising interest rates”) to calm down property prices, even though the consumption economy could have performed better with, and probably deserved, lower interest rates. Pitching the interest rate level at a fine balance, so that it is low enough to promote economic growth and high enough to promote savings and orderly asset market price development, is immensely tricky. Interest rates decisions are based on past and current experience, but the effects are felt after a substantial time lag. By the time the effects could hit the economy the scenario which had originally justified the interest rate decision could be quite different, requiring a different approach.

In the local context, we are experiencing quite a novel market reality which makes the interest rate decisions of the monetary authorities particularly complex and hazardous. The economy is growing well below its potential, a situation that normally calls for a reduction in domestic interest rates. However, in the international markets nobody is really talking about reducing interest rates and the US is on a seemingly unstoppable course of raising short-term interest rates. Going against the grain could expose us to capital flight eroding our foreign reserves at a time we need them to lend credibility to the plan to join the Euro at current ERM II rate.

The near zero savings ratio and the unhealthy increases in equity and property prices would, on the other hand, suggest the need for an increase in interest rates which would act as a further brake on the real productive economy.

There is a new phenomenon working out in the economy. In spite of slow growth in productivity and earnings, people have maintained their consumption by reducing their savings and, in many cases, by incurring consumer debt. Low interest rates and increasing wealth through higher values commanded by residential property (plus the availability of second mortgages and equity release loans to translate this increase in value into ready liquidity) is leading to consumption levels which would otherwise by unsustainable by current earnings and productivity.

The government recently requested the MFSA to conduct an exercise to establish whether more flexible home-loan facilities with little or no up-front contribution by the borrower and a repayment programme spread over 40 years is leading to an undue stimulation of property prices.

This is an odd request – both in it being made and in the way it has been addressed. MFSA are regulators for individual institutions, but the direct responsibility for monetary policy and financial stability rests with the Central Bank. If any organisation should be conducting such an exercise it should be the Central Bank and, given its autonomy, it should need no prompting from the government to do it. Indeed, such an exercise should be a continuing one – with the data being regularly fed to the Monetary Policy Council thus enabling it to take it into consideration with other economic data in arriving at decisions related to the implementation of monetary policy.

Is the government losing confidence in the ability of the Central Bank to contain asset price inflation? Could not the very fact that government felt the need to make its odd request to the MFSA increase instability in a hot market leading to a disorderly price adjustment process?

It is in everybody’s interest that order is restored in the property market without destabilising one of the few sectors contributing to economic growth. The object-ive should be to cool down the upward price spiral without imposing high interest rates and without causing the property market to crash under the weight of over-development.

Reducing flexibility in the home mortgage package is the wrong place to start to restore order. Provided that borrowers ability to repay over the working life is established, more generous mortgage terms do not worry me. Interest only loans and consumption loans based on second mortgages or equity release scare me much more. Killing off demand could be counter-productive to the aim of restoring price stability in the property market. Dangerous build-up on unused housing stock could become a dangerous powder keg which could prove explosive when domestic interest rates eventually have to respond to international pressure or domestic retail inflation.

Given the substantial development pipeline, probably the best way to begin preventing the bursting of the property bubble is for government to direct Mepa to take a brief moratorium in the approval of fresh condominium development.