THE CONNECTIVITY APPROACH TO INTERNATIONAL POLITICAL ECONOMY

Material prepared for the assignment on the global credit crisis and international reserve currencies. March 12, 2009.

· The ‘Connectivity’ approach to International Political Economy was pioneered by authors Thomas Friedman, the NYT columnist, and Thomas Barnett. The approach seeks to understand the process of globalization from a variety of perspectives: trade and finance, security, the environment, political cultures, etc. In particular, Barnett seeks to ‘create a new language’ to express the reality of today’s interconnected world: networks, system failure, broadband connectivity, content flows, etc. The connectivity approach deals with familiar IPE categories: individuals, classes, nation-states. It also provides a dynamic view of “core-periphery” relations.

. This guide briefly reviews Barnett’s key ideas on: the center-periphery dynamics (Part I), the security angle (Part II), the connectivity approach as IPE (Part III). Additional info on the rule of law and the emerging political culture inside the ‘new core’ (Parts IV & V).

· References. Books by Thomas Barnett. The Pentagon’s New Map. War and Peace in the XXI Century (Putnam, 2004) [info]; Blueprint for Action. A Future Worth Creating ( Putnam, 2005) [info]; Great Powers. America and the World After Bush (Putnam, 2009) [info] . See also his blog.

I. The Core & the Gap

[1] Connectivity. Barnett defines connectivity as “The enormous changes being brought on by the information revolution, including the emerging financial, technological, and logistical architecture of the global economy (i.e., the movement of money, services accompanied by content, and people and materials)”. In more concrete terms, connectivity can be defined as openness to trade flows (WTO membership, free trade agreements), plus openness to foreign direct investment (FDI) flows, plus access to broadband internet connectivity.

[2] A New Approach to Center-Periphery Dynamics. The ‘Functioning Core’ includes those parts of the world that are actively integrating their national economies into the global economy and that adhere to the emerging consensus of free markets and strong political institutions (the rule of law). The Functioning Core at present consists of North America, Europe both ‘old’ and ‘new’, Russia, Japan and South Korea, China (although the interior far less so), India (in a pockmarked sense), Australia and New Zealand, South Africa, and the ABCs of South America (Argentina, Brazil, and Chile). That is roughly 4 billion out of a global population of more than 6 billion. The Functioning Core can be subdivided into the Old Core, anchored by America, Europe, and Japan; and the New Core, whose leading pillars are Brazil, Russia, India and China [the so-called BRIC countries].

‘Gap nations’ are defined as nations “where connectivity remains thin or absent” (Pentagon’s New Map, p. 4) [See Map]. Some benchmarks: [1] Dictatorship. “As soon as a leader declares himself ‘president for life’, disconnectedness becomes a near certainty” (PNM, p. 133); [2] Frequent leadership changes. (Bolivia, Ecuador, Argentina, Thailand); [3] The curse of raw materials. Venezuela, Bolivia, some Arab oil exporters: “Historically speaking, countries whose economic well-being relies extensively on the exportation of raw materials are some of the least connected states in the world.” (*); [4] Theocracies. They have “a dampening effect on connectivity with the outside world”; [5] Transportation problems. Paraguay lacks a good transportation connectivity with the outside world; [6] The treatment of women. (Blueprint for Action, pp. 256-259).

(*) See Thomas Friedman. “The First Law of Petropolitics”, Foreign Policy, May-June 2006.
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. Life in the (Disconnected) Gap: Thomas Hobbes. “In such condition there is no place for industry, because the fruit thereof is uncertain: and consequently no culture of the earth; no navigation, nor use of the commodities that may be imported by sea; no commodious building; no instruments of moving and removing such things as require much force; no knowledge of the face of the earth; no account of time; no arts; no letters; no society; and which is worst of all, continual fear, and danger of violent death; and the life of man, solitary, poor, nasty, brutish, and short”. [Leviathan, chapter XIII] (Barnett, pp. 161-166). No need to mention too many examples; some cases that come to mind: Guinea-Bissau president assassinated three days ago amid scenes of chaos; slaughter of senior military officers in Bangladesh; rape epidemic in Congo; Angola children tortured as witches. And the list goes on and on.
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[3] Financial Connectivity & the Dollar. The current phase of globalization does have a weak spot: the international monetary system based on the dollar as the key international reserve currency. Barnett:

[REQUIRED READING!]. But the dollar will not remain ‘as good as gold’ forever, if only because the European Union’s euro will invariably rise up as a reserve currency ‘near-peer competitor’. Over the long run, an East Asian equivalent of the euro must inevitably arise, probably a combination of China’s yuan, Japan’s yen, and South Koreas’s won. In short, each pillar of the Core will market its own reserve currency (The Pentagon’s New Map, p. 244).

II. The Security Angle

[4] State-on-State War: a thing of the past. Barnett believes that wars between great powers and even state-on-state wars are extremely unlikely to happen. There are three reasons for this: (1) Nukes (the principle of MAD, or Mutually Assured Destruction); (2) the United States military superiority (America’s defense budget is many times greater than that of any other great power); (3) Connectivity (the financial cost of war).

[REQUIRED READING!]. “The migration of violence downward, or below the level of the nation-state, is fairly easy to express and track. Basically, wars between states have disappeared over the past half century, but especially since the end of the Cold War. Nukes effectively ended great-power war following the Second World War, giving the world as a whole a wonderfully long respite from system-level war that I believe will never end. Meanwhile, state-on-state wars have gone the way of the dinosaur in recent decades. When wars occur now, they are almost exclusively internal wars, where some subsection of a state wishes to break off from the whole or where social violence between groups within a state erupts into full-blown civil war” (The Pentagon’s New Map, p. 85).

Illustration: state-on-state and financial connectivity – the Russia-Georgia mini-war. See Judy Shelton: “The Market will punish Putinism”, Wall Street Journal, September 3, 2008:

Since the attack on Georgia began in early August, the decline in Russian financial markets has accelerated sharply. The benchmark RTS Index of leading Russian stocks has slumped to its lowest level in two years. The ruble has registered its biggest monthly decline against the U.S. dollar in more than nine years as foreign investors rush to retrieve their capital -- some $25 billion in the last three weeks, according to French investment bank BNP Paribas. The amount of debt raised by Russian companies in August has fallen 87% from July levels. The issuance of new equity has come to a virtual halt -- a mere $3 million was raised in August compared to $933 million in July. To combat the alarming magnitude of capital desertion, officials at Russia's central bank have scrambled to raise interest rates, allowing the yield on domestic ruble bonds to increase by 150 basis points. But complaints about the tightened credit situation have already begun among Russia's powerful industrial oligarchs.

In other words: new information altered the behavior of those who supplied loanable resources in Russian credit markets. See also Jonathan Kirschner: “Globalisation, American Power, and International Security”, Political Science Quarterly, Vol. 123, No. 3, 2008, pp. 363-389:

… financial globalization also makes the resort to arms by states less likely (ceteris paribus) because the macroeconomic discipline demanded by world financial markets, lending institutions, and powerful credit agencies is incompatible with military adventurism.

If you open up your financial markets to the world, that connectivity can go both ways. As soon as the Russia-Georgia crisis deepened, the supply of loanable resources collapsed. Credit became scarce; interest rates shot up. Barnett: “I am glad to see the Obama administration seek to reengage Russia now that it's been dramatically weakened by the capital flight after the Georgia smackdown and the general decline in its finances caused by the drop in oil and the financial crisis”.
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[5] Disconnectedness Defines Danger. “Disconnectedness is the ultimate enemy” (PNM, p. 124). “Once isolation is ended, and broadband connectivity is achieved for the masses, the forces of terror and repression can no longer hold sway” (PNM, p. 193). “Disconnectedness defines danger, so connectedness defines safety” (PNM, p. 331).

. Conflicts and per-capita income. “Of the thirty-seven major conflicts spread around the world in the 1990s, thirty-four occurred in countries with annual per capita GDP totals of less than $2,936. So it is basically the case that when a country rises above the $3,000 mark, they seem to get out of the mass violence business” (PNM, p. 239, see footnote on p. 411 for details) (*).

(*) As usual, Thomas Friedman puts it more succinctly: “No two countries that both have a McDonald's have ever fought a war against each other” (Thomas L. Friedman: “Foreign Affairs Big Mac I”, New York Times, December 1996).
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[6] Intra-Core Cooperation. Old Core and New Core powers will cooperate, albeit reluctantly, to ease disconnectedness inside the ‘Gap’. Barnett: “The United States cannot simply shrink the Gap by itself” (PNM, p. 58). Case in point: the Somali pirates. According to some sources, piracy off the Gulf of Aden has already cost $15bn (the figure is hotly disputed: some say it’s much less than that); insurance rates are increasing. A large number of nations have announced efforts to combat piracy: the USA (12 warships from the US 5th Fleet in Bahrain), China (2 destroyers, one depot ship), India, Malaysia, Russia. In addition, the EU has launched EUNAVFOR Atalanta, the first naval operation ever conducted under the banner of the EU. Among the participants: UK, France, Germany, Greece (the operation will be run by a UK and a Greek admiral). In late February 2009, both Norway and Switzerland announced they were also send ships and soldiers.

From the connectivity approach perspective, the story affords many insights. The only way to keep trade flows open is through what Barnett calls ‘comprehensive maritime security cooperation among the world’s great powers’. The numbers tell the story: if a thousand ships are necessary to combat piracy on a global basis (Gulf of Aden, Persian Gulf, Malacca Straits, etc.), then it is pretty clear that the US cannot afford to go it alone. Cooperation is bound to take place, albeit reluctantly. There is a diplomatic angle to the story as well: Resolution 1851 of the UN Security Council authorizes the states to “take all necessary measures that are appropriate in Somalia” to suppress “acts of piracy and armed robbery at sea”. And there is a the legal dimension as well:

Arrested pirates could pose a legal problem for the navy that apprehends them, because the EU terms of engagement state that they should be handed for trial to the country where the attacked vessel is registered. This will not always be possible, given the international nature of shipping registration and the block on EU prisoners being sent to countries with capital punishment. Germany said that the EU was in negotiation to hand captured pirates to Kenya for trial but called for debate on whether the United Nations should set up a new court for pirate trials. Moreover we are in favour of reviewing whether the United Nations could use existing international courts or found a new one to conduct such criminal proceedings.

Finally, there’s the unavoidable question about nation-building. Here’s General John Craddock, Nato’s top commander: “You do not stop piracy on the seas. You stop piracy on the land”. In other words, the common enemy is disconnectedness! (Sources: [1], [2], [3]).

III. The Connectivity Approach as IPE

[7] Unit of Analysis: Individuals. The faceless homo economicus of neo-classical economists has vanished; his place has been taken by real-world entrepreneurs and leaders. The emphasis is on: (a) poor people inside the Gap, increasingly able to connect to the world economy; (b) entrepreneurs and innovators of all countries, races, gender, social standing; (c) social leaders: India needs a Bill Gates, i.e. a tycoon who retires and fights poverty and disease; China needs an Erin Brockovich to fight for the environment; (d) founders of nations: successful founders of nations are endowed with a rare combination of ruthlessness (to get things done) and capacity for self-command (to resign voluntarily from power and set a lasting example). Barnett praises Deng Xiaoping – whom he deems more important than Ronald Reagan, Margaret Thatcher and Pope John Paul II together. Less praise for Vladimir Putin, who could have become Russia’s George Washington by declining to act as prime minister after his two presidential terms.

Individuals as entrepreneurs inside the Gap:

. Online micro-lending: www.kiva.org. Note: (a) borrowers are called entrepreneurs: this is a credit market, not an aid agency!; (b) most Kiva entrepreneurs are women. The whole point is to empower people at the very bottom of the pyramid! Question: what do you think is happening here in terms of the supply of loanable resources?

. M-PESA. A mobile payment solution created by Safaricom (the Kenyan telco) and Vodafone that enables customers to complete simple financial transactions by mobile phone. M-PESA has been developed by Vodafone, the world’s leading mobile telecommunications group, with the pilot in Kenya operated by Safaricom. M-PESA is aimed at mobile customers who do not have a bank account, typically because they do not have access to a bank or because they do not have sufficient income to justify a bank account. All they need to do is register at an authorised M-PESA Agent by providing their Safaricom mobile number and their identification card.

. University of Grenoble’s Open Educational Resources provides free online courses, with 4,000 online management students from North Africa [Ross Tieman: “France looks to its neighbors to the south”, Financial Times, March 2].

. Dutch website Ne4Kids: an internet market-place for child aid projects. “With Net4kids you choose for concrete child aid rather than anonymous donations. With regular updates we tell you exactly what difference you make through your contribution”. According to founder Loek van den Boog, the site creates an “emotional link” with the kids involved.
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[8] Unit of Analysis: Classes. Unlike Marxism, which focuses on the extremes, the connectivity approach to IPE has its eyes squarely on the middle class. From The Economist special report on “The new middle classes in emerging markets”:

For the first time in history more than half the world is middle-class—thanks to rapid growth in emerging countries. Following the historical examples of Britain and America, they are expected to be the dominant force in establishing or consolidating democracy. As a group, they are meant to be the backbone of the market economy. And now the world looks to them to save it from depression. With the global economy facing the biggest slump since the 1930s, the World Bank says that “a new engine of private demand growth will be needed, and we see a likely candidate in the still largely untapped consumption potential of the rapidly expanding middle classes in the large emerging-market countries.” This special report argues that many of these expectations are broadly justified; that there is indeed something special about the contribution the middle classes make to economic development that goes beyond providing a market for Western consumer goods. The middle classes can, and sometimes do, play an important role in creating and sustaining democracy, though on their own they are not sufficient to create it, nor do they make it inevitable”.

This is, in a nutshell, what Barnett calls ‘the ideology of the global middle class’ (Great Powers, 2009, p. 99). [See also the article by Goldman Sachs’ chief economist Jim O’Neill. “Boom time for the global bourgeoisie”, Financial Times, July 15, 2008: By 2030, 90 million people a year will enter the middle class –defined as households with annual incomes between $6,000 and $30,000. The global bourgeoisie will by then number 2 billion people].
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[9] Unit of Analysis: Nation-States. Competition between nation-states has moved from the military to the economic level. “Competition has left the military sphere”. Nation-states will also compete for prestige: who organizes the best Olympic Games? Who will be the first carbon-neutral economy? Who will be the leading center for Sharia-compliant bonds or sukuks? (Key contenders: Dubai, Malaysia, Singapore, London). On the other hand, Old Core nations will have to cooperate with New Core powers, albeit reluctantly, to shrink the Gap. iant bonds (sukuks): who will be the leader?
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[10] Core-Periphery Dynamics. Some additional points. (a) The financial connectivity between the Old Core and the New Core is currently too unstable; more reserve currencies are needed; (b) The new rule sets that will emerge in the future –in trade, in finance, in security issues, in immigration matters- will show the growing influence of the New Core; (c) The Old Core and the New Core are bound to find themselves either ‘win/win’ or ‘lose/lose’ situations. The so called ‘decoupling’ economic theories appear to make less and less sense. (d) The Core does not benefit from the disconnectedness of the Gap: disconnectedness defines danger!

. Also: compare with Samir Amin’s views on core-periphery dynamics (Goddard & al., chapter 13).

IV. Focus on the Rule of Law

[11] The Rule of Law as an Emerging Consensus. To attract FDI (Foreign Direct Investment), countries will need to improve governance.

[REQUIRED READING!] Foreign investors need to see rule of law, transparency, and good corporate governance before they will put their money at risk overseas. So the countries with the strongest economic rule sets inevitably attract the greatest amount of FDI (Thomas Barnett. The Pentagon’s New Map, pp. 202-203).

[REQUIRED READING!] The political scientist Francis Fukuyama divides governments along two axes: the scope of their power and the strength of their power. In this manner, we can describe the governance ideal as strong states with limited scope. While state-building in failed states is relatively straightforward, meaning you’re trying to extend both scope and power, the real trick comes in maturing the political systems of emerging markets, where governments are often characterized by too much ambition and on scope and not enough strength in their institutions – in other words, they try to do too much with too little. For most of the go-go nineties, when globalization was rapidly extending itself, the reformist notion held that best way to fix such bad governments was by improving their policies (e.g. the Washington Consensus). The new emerging consensus focuses more on the strength of political institutions (rule of law) than on their particular policies, so more focus on good design than –at first- optimal functioning. As a concept, rule of law has long remained rather fuzzy, with some experts offering a ‘thin’ definition of certain basic good laws (e.g. contracts, property rights) that must be put in place, and others offering a more ‘thick’ definition of an overall culture of respect for legality. What’s important about this growing academic debate is this: We’re beginning to see the rise of a global dialogue on government best practices when it comes to income growth creation. Because the global economy has expanded to include such a variety of players now, we’re starting to enjoy the ability to compare and contrast government policies in the same way that businesses have long done with one another in any sector. The growing diversity of capitalism is becoming one of its global strengths, meaning there’s a growing competition among governments. As such, one of the key components of a global progressive agenda should be further collective research and dialogue on what constitutes good rule of law, a concept –unlike democracy- that enjoys widespread global endorsement because of its focus on efficiency. (Thomas Barnett. Great Powers. Putnam: 2009, pp. 409-410).

[12] Some (partial) statistical evidence. Governance indicators: sources. Two important sources are: (1) The World Bank’s Governance Matters 2008; (2) Fraser Institute’s Economic Freedom of the World 2008 Annual Report. Rule of Law: World Bank - http://info.worldbank.org/governance/wgi/index.asp; Credit Market: IMF - http://www.imf.org/External/Pubs/FT/staffp/2006/03/pdf/burger.pdf
(Total bonds outstanding as a percentage of GDP)

[13] Focus on China & the Rule of Law. Recent academic work on the rule of law in China: Randy Peerenboom, Director of the Oxford Foundation for Law, Justice and Society's China Rule of Law Programme. He's an Associate Fellow at Oxford University Centre for Socio-Legal Studies, and Professor of Law at La Trobe University in Melbourne: China Modernizes. Threat to the West or Example to the Rest? (Oxford University Press, 2007) [info] [review]; China’s Long March Toward the Rule of Law (Cambridge University Press, 2002) [review].

. In 2006 China changed its death penalty law: the country's Supreme People's Court will review all capital punishment cases. The change is "an important procedural step to prevent wrongful conviction. There is still, however, a long way to go. According to Barnett:

China’s legal system needs to clean up its act, because the more China’s economy opens up, the more the global business community is going to demand greater transparency and better avenues for legal redress. A couple of decades ago, China’s courts handled several hundred thousand cases a year. Today that demand is running at more than 5 million cases a year (Thomas Barnett. Great Powers, 2009, p. 174).

. China, Connectivity & Rule of Law. See the innovations in terms of sentencing in China Law Blog: “In China, It's Here Come Da (Computer) Judge”]. China is testing judges using computers to determine criminal sentences. Judges using the software are to enter relevant details of the criminal case, such as the crime and mitigating circumstances, and the system suggest the appropriate sentence. Judges still have the power to overrule the computer and hand down their own sentences. The software covers around 100 crimes and has already been used in over 1,500 cases in Shandong Province.

. More Judicial Independence? With data from Canadian think tank Fraser Institute, I checked the change in the “Judicial Independence” grade (from 1 to 10) for a group of Asian countries from 2000 to 2006. These are the results:

2000 2006
China 3.34 4.05
Hong Kong 7.68 8.27
Malaysia 4.51 7.06
Singapore 7.35 7.66
South Korea 4.68 6.89

Was the upgrade in judicial independence a response to the financial crisis of 1997-1998? Will Russia, Eastern Europe, and Latin America take note? Can a country’s financial system work properly when human rights activists and journalists are killed? Will the costs of running politicized judiciaries soon become high enough that reforms will be needed? (Mr. Markelow was running the Rule of Law Institute in Moscow.) [Alan Cullison: “Economic Ills Spur Russian Gestures of Openness”, Wall Street Journal, March 2] [Michael Schwirtz: “Leading Russian Rights Lawyer Is Shot to Death in Moscow, Along With Journalist”, The New York Times].
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V. The Emerging Political Culture inside the New Core

[14] The Emerging Political Culture in the New Core
Social Capital: Tocqueville on Democracy in America. See his chapter on civil associations in America (Democracy in America, 1835, Book II, chapter 5; more info). Checks and balances, judicial independence, and the freedom of the press are all very fine and important things; but what gives American democracy its strength is the community spirit of its citizens. Spontaneous associations –public libraries, charities, clubs of all sorts– provide sustained information flows and help to reduce levels of hate; the likelihood of tyrannical governments is thus sharply reduced.

Putnam on social capital. In Bowling Alone (New York: Simon & Schuster, 2000), sociologist Robert Putnam argues that we have become increasingly disconnected from family, friends, neighbors, and our democratic structures-- and how we may reconnect. Putnam warns that our stock of social capital - the very fabric of our connections with each other, has plummeted, impoverishing our lives and communities.

Virtual Social Capital. Although one has to be cautious –people go online just to have fun, and there are things like cyber-bullying, cyber-fraud, porn, pedophiles, and online government propaganda--, there are some reasons to support the view that social capital has moved … online! This appears to be true in times of crisis and unexpected events. Korean researcher Ji-Young Kim coined the words e-social capital and virtual social capital (“The impact of Internet use patterns on political engagement: A focus on online deliberation and virtual social capital”, Information Polity, Vol. 11, No.1, January 2006, 35-49).

. The Sichuan earthquake in July 2008. Although the authorities were initially praised for their prompt response, everybody could see that some schools had collapsed in neighborhoods that had seen relatively little damage. According to Wikipedia:

Liu Shaokun (刘绍坤),, a teacher at Guanghan Middle School, Deyang City, Sichuan Province (四川省德阳市广汉中学), traveled to heavily hit areas after the May 12 Sichuan earthquake, took photos of collapsed school buildings, and put them online. In a media interview, he expressed his anger at “the shoddy ‘tofu’ buildings.

. Egyptian bloggers. Samantha M. Shapiro: “Revolution, Facebook-Style”, New York Times. (Barnett, by the way, is not very optimistic about Egypt).

. The Orange Revolution in Ukraine. See Josh Goldstein: “The Role of Digital Networked Technologies in the Ukranian Orange Revolution”, Berkman Center for Internet & Society (Harvard University), 2007

. More info on Virtual Social Capital. [1] Lucía Liste Muñoz & Indra de Soysa: “The Blog vs Big Brother: Information and Communication Technologies and Human Rights, 1980–2005”, International Studies Association annual meeting in New York, February 15–18, 2009; [2] Patrick Meier: “Impact of ICTs on Repressive Regimes: Findings”, iRevolution, February 2009; [3] Andrew Nachison: “Social Capital in the Connected Society”, Evaluation Exchange, Vol. XI, No. 3, Fall 2005.

. More resources. iRevolution; SmartMobs; Berkman Center (Harvard University); internet & democracy.

THURSDAY, MARCH 5

. The Pentagon's New Map.

. www.Kiva.org

. Somali pirates: map.

International Political Economy

Department of Political Science – Leiden University
Agustin Mackinlay - amackinlay@umail.leidenuniv.nl
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SESSION 1 – February 5

Theoretical approaches to International Political Economy: A brief introduction

Readings:

. C. Roe Goddard & al. International Political Economy. State-Market Relations in a Changing Global Order (New York: Macmillan, 2003). Chapters 1, 2, 4, 12, 13 and 14 (*)

An Introduction to the credit market

· Demand for credit, supply of loanable resources
· Changes in behavior and long-term interest rates
· Schumpeter’s theory of innovation

Readings:

. Horace W. Brock: “Determinants of interest rates”, Euromoney, 1988 (*)

. Frank J. Jones & Benjamin Wolkowitz: “The Determinants of Interest Rates on Fixed-Income Securities”, in Frank J. Fabozzi (ed.) The Handbook of Fixed Income Securities (Homewood, Ill.: Irwin, 1991), pp. 147-151

. Thomas K. McCraw. Prophet of Innovation. Joseph Schumpeter and Creative Destruction (Harvard University Press, 2007) [web] [prologue].

(*) Required readings.
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SESSION 2 – February 12

The credit market (continued)

· Innovation and the credit market (continued).
· Inflation expectations and the credit market.
· Governance, property rights and the credit market.

Readings:

. Horace W. Brock: “Determinants of interest rates”, Euromoney, 1988 (*)

. Charles G. Leathers & J. Patrick Raines: "The Schumpeterian role of financial innovations in the New Economy's business cycle", Cambridge Journal of Economics, 2004 28 (5): 667-681.

. Hernando de Soto. The Mystery of Capital. Why Capitalism Triumphs in the West and Fails Everywhere Else (New York: Basic Books, 2000).

. John D. Burger & Francis E. Warnock: “Local Currency Bond Markets”, IMF Staff Papers, Vol. 53, Special Issue, 2006, especially pp. 141-142.

(*) Required readings
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SESSION 3 – February 19

The credit market (continued)

· Flight-to-quality episodes
· Credit spreads and country risk
. A debate on risk management

Readings:

. Ambrose Evans-Pritchard: "EU mulls action as Ukraine crumble triggers contagion fears for Europe", The Telegraph

. Ambrose Evans-Pritchard: “Failure to save East Europe will lead to worldwide meltdown”, The Telegraph

. Laura Cochrane & Denis Maternosvky: “Dead’ Russian Bond Market’s 80% Yields Squeeze Firms”, Bloomberg

. Chiara Cavaglieri. “Islamic finance accelerates into motor policies”, The Independent

. Roger Boyes: "Age of Testosterone comes to end in Iceland", TimesOnline

. Gilian Wilmot: “Men have messed up. Let women sort it out”, Financial Times

. Lloyd Blankfein: “Do not destroy the essential catalyst of risk”, Financial Times

. Eric Dash & Julie Creswell: “Citigroup Saw No Red Flags Even as It Made Bolder Bets”, The New York Times

More info:

. For comments on current events (and forecasts) in credit markets, check out Bill Gross’s monthly Investment Outlook. Mr. Gross is the CEO of PIMCO, one of the largest bond investors in the world – these guys do affect the supply of loanable resources! In fact, the whole website is a gold mine in terms of credit market analysis on a global basis.

. For charts and statistics, one of the best websites is FRED, run by the St. Louis Federal Reserve Bank; for U.S. interest rates, click here.
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SESSION 4 – February 26

Central Banks (I)

· A (very brief) history of money & central banks’ balance sheets
· The market for bank reserves & monetary policy
· The Federal Reserve: institutional framework
· The European Central Bank: institutional framework

Readings:

. Madeleine O. Hosli: The Euro. A concise introduction to European Monetary Integration. (Boulder, Colorado: Lynne Riener), 2005. Chapters 3 and 4 (*)

. Federal Reserve Bank of Philadelphia. A Day in the Life of the FOMC. An Inside Look at the Federal Reserve’s Monetary Policy Making Body (*)

. Carl Menger: “On the Origins of Money”, Economic Journal, volume 2,(1892) p. 239-55

. Manuel Johnson & Robert Keleher. Monetary Policy. A Market Price Approach (Newport: Connecticut: Quorum Books, 1996)

. Marius van Nieuwkerk. Dutch Golden Glory. The Financial Power of the Netherlands Through the Ages (Haarlem: Becht, 2006), chapter 7

. John Taylor: “Expectations, Open Market Operations, and Changes in the Federal Funds Rate,” Review, Federal Reserve Bank of St. Louis, Vol. 83, No. 4, July-August 2001, pp 33-48

More info:

. Most central banks’ websites are full of useful information. Check out, in particular: European Central Bank, Federal Reserve Board, Reserve Bank of Australia, Sveriges Riksbank. Another interesting website is provided by the Bank of International Settlements, with its very useful section on “Central bankers speeches”.

. There are countless professional commentators on monetary policy. Among the very best: Paul McCulley’s Global Central Bank Focus.

(*) Required readings

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SESSION 5 – March 5

Central Banks (II)

· Central banks & inflation expectations
· Monetary policy & exchange rate crisis
· Monetary collaboration: swap agreements
· Central Bank independence

Readings:

. Madeleine O. Hosli: The Euro. A concise introduction to European Monetary Integration. (Boulder, Colorado: Lynne Riener), 2005. Chapter 4 (*)

. Stefan Ingves. “The relationship between the Riksbank and the Riksdag”, Bank for International Settlements, June 2007. (*)

. Manuel Johnson & Robert Keleher. Monetary Policy. A Market Price Approach (Newport: Connecticut: Quorum Books, 1996)

. Werner Bonefeld. “Europe, the Market and the Transformation of Democracy”, Journal of Contemporary European Studies, Vol. 13, No. 1, 93-106, April 2005

. John Taylor: “The Need to Return to a Monetary Framework”, Business Economics, Vol. 43, No. 2, January 2009

. Daniel L. Thornton: “The Fed, Liquidity and Credit Allocation”, Federal Reserve Bank of St. Louis Review, January/February 2009, 91(1), pp. 13-21.

. Steve Hanke. “From John Law to John Maynard Keynes”, Globe Asia, February 2009

(*) Required readings

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SESSION 6 – March 12

International Reserve Currencies

· Bretton Woods & the dollar: Jacques Rueff
· China and the “New Bretton Woods”
· The current crisis as a global monetary problem

Readings:

. Robert Mundell: “The Euro: How Important?”, Cato Journal, Vol. 18, No. 3, Winter 1999 (*)

. Madeleine O. Hosli. The Euro. A concise introduction to European Monetary Integration. (Boulder, Colorado: Lynne Riener), 2005. Chapter 6 (*)

. Alan Greenspan. The Age of Turbulence. Adventures in a New World (New York: Penguin, 2007). Chapter 7 (*)

. Michael P. Dooley, David Folkerts-Landau & Peter Garber: “An Essay on the Revived Bretton Woods System”, NBER Working Paper 9971, 2003 (*)

. Gregory Fossedal: “The Lehrman-Mueller Hypothesis”, Policy Review, Winter 1992, pp. 2-12

. Michael P. Dooley, David Folkerts-Landau & Peter Garber: “International Financial Stability. Asia, Interest Rates, and the Dollar”, Deutsche Bank Global Markets Research, October 2005

. Michael P. Dooley & Peter Garber: “Is it 1958 or 1968? Three Notes on the Longevity of the Revived Bretton Woods System”, BPEA, June 2005

. Francis J. Gavin. Gold, Dollars, & Power. The Politics of International Monetary Relations 1958-1971 (The University of Carolina Press, 2004).

(*) Required readings

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SESSION 7 – March 19

Connectivity & Globalization

· The Pentagon’s New Map: a review
· Connectivity & globalization
· Trade, financial markets and … power

Readings:

. Thomas P.M. Barnett. The Pentagon’s New Map. War and Peace in the Twenty-First Century (New York: Putnam, 2004). Chapter 4 (*) [info]

. Thomas P.M. Barnett. Blueprint for Action. A Future Worth Creating (New York: Putnam, 2005). Chapter 4 (*) [info]

. Roger Altman: “The Great Crash, 2008. A Geopolitical Setback for the West”, Foreign Affairs, January-February 2009 (*)

. Eriksen, Thomas Hylland. Globalization. The key concepts (Oxford: Berg, 2007) [web] [prologue] [introduction].

(*) Required readings

A PREVIEW OF SESSION # 3. THURSDAY, FEBRUARY 19

International Political Economy – Leiden University

[1] Credit markets & flight-to-safety episodes
[2] What went wrong? A debate on risk-management
[3] Central banks (introduction)
__________

. Please listen to this song. It'll help us understand flight-to-quality episodes in credit markets! Here are the lyrics:

Money’s too tight to mention
Simply Red (1985)

I’ve been laid off from work my rent is due
My kids all need brand new shoes
So I went to the bank to see what they could do
They said son looks like bad luck got a hold on you

Money’s too tight to mention
I can’t get an unemployment extension
Money’s too tight to mention

I went to my brother to see what he could do
He said brother I’d like to help but I’m unable to
So called on my father, father
Almighty father, he said

Money’s too tight to mention
Oh money money money money
Money’s too tight to mention
I can’t even qualify for my pension
Were talking bout reaganomics
Oh lord down in the congress
They’re passing all kinds of bills
From up there on capitol hill, we’ve tried it

Money’s too tight to mention
Oh money money money money
Money’s too tight to mention
Cutbacks!

Were talking bout the dollar bill
And that old man who’s over the hill
Now what are we all to do
When money’s got a hold on you
Money’s too tight etc.

Were talking bout money money
Were talking bout money money

. Take a look at these charts: 10-year Treasury Note [chart]; 10-year Moody's Baa bond [chart]; 3-month US Treasury Bill [chart]. More info on the current episode of flight-to-quality: (a) Ambrose Evans-Pritchard: "EU mulls action as Ukraine crumble triggers contagion fears for Europe", The Telegraph; (b) Ambrose Evans-Pritchard: “Failure to save East Europe will lead to worldwide meltdown”, The Telegraph; (c) Laura Cochrane & Denis Maternosvky: “Dead’ Russian Bond Market’s 80% Yields Squeeze Firms”, Bloomberg; (d) Fred Weir : “Global downturn hammers Ukraine's economy”, The Christian Science Monitor.

. A Debate on risk-management. Chiara Cavaglieri. “Islamic finance accelerates into motor policies”, The Independent; Roger Boyes: "Age of Testosterone comes to end in Iceland", TimesOnline; Gillian Wilmot: “Men have messed up. Let women sort it out”, Financial Times (November 26, 2008); Sharon Reier. “Women take their place on corporate boards”, International Herald Tribune; Lloyd Blankfein: “Do not destroy the essential catalyst of risk”, Financial Times; Eric Dash & Julie Creswell: “Citigroup Saw No Red Flags Even as It Made Bolder Bets”, The New York Times.

. More flight-to-quality data. June 2008: 4.8% (German Bund) / 5.45% (Russia sovereign) / 8.80% (Ukraine sovereign); October 2008: 3.8% (German Bund) / 9.80% (Russia sovereign) / 21.80% (Ukraine sovereign). Calculate country risk. [Brazil v. Russia chart]

SESSION # 2. THURSDAY, FEBRUARY 12

International Political Economy – Leiden University

[1] Innovation & the credit market (continued)
[2] Inflation expectations & long-term interest rates
[3] Governance, property rights & the credit market (introduction)
__________

[1] Innovation & the credit market
Because the second 1500-word assignment will be on innovation –The Political Economy of Innovation– we need to discuss a number of issues in more detail. First, let me mention a couple of interesting "Schumpeterian" cases.

1a. New sources of energy: what’s at stake?
- Norway. The investment policy of the Norwegian government pension fund, managed by Norges Bank Investment Management, aims at “socially responsible investment”. As part of NBIM’s corporate governance work on environmental issues, NBIM focuses on policy positions taken by energy related companies in regards to possible U.S. climate policy. In January, NBIM praised the position taken by the Edison Electric Institute (EEI), which has adopted an updated climate change framework calling for an 80 percent reduction of carbon emissions by 2050, from current levels. Beyond the very deep, long-range emission reduction target for 2050, the EEI document states that near-term targets should be guided by efforts on energy efficiency, renewable energy and, to some extent, new nuclear. REMEMBER: THE NORWEGIANS ARE INVESTORS IN THESE COMPANIES!!!! In 2007, the sold their $400 million-position in Wal-Mart shares, because of ethical concerns over the company’s labor policies. NBIM does not invest in companies involved in the manufacturing of landmines, cluster bombs, atomic weapons, etc. [Norges Bank]

1b. On energy & innovation, see Thomas Friedman. Hot, Flat and Crowded: Why We Need a Green Revolution — and How It Can Renew America (Nueva York: Farrar, Straus & Giroux, 2008) [Chapter 1][Video] [Bjorn Lomborg: "A Chilling View of Warming", The Wall Street Journal]

1c. The Zayed Future Energy Prize. In 2008 the Crown Prince of Abu Dhabi announced The Zayed Future Energy Prize [info] to be awarded to individuals, companies, organizations or NGOs that have made significant contributions in the global response to the future of energy. The aim of the prize is to inspire the next generation of global energy innovators. 2009 winner: Dipal Barua. “The first annual Abu Dhabi based Zayed Future Energy Prize, worth USD 1.5 million, was awarded to the Founding Manager Director of Grameen Shakti, Dipal C. Barua, for his work in financing and installing over 200 thousand solar panels that have electrified the homes of approximately 2 million people in rural Bangladesh. Grameen Shakti, or “Village Energy,” was founded as a non-profit in 1996 as a sister organization of the Nobel Peace Prize winning microfinance institution Grameen Bank. Grameen Shakti’s website says that their solar power program “really took off the ground when rural clients realized (solar panels) are more cost effective than other conventional sources of energy such as kerosene and provide more utilities.” Grameen Shakti hopes to implement 1 million solar panels by 2015”.

1.b The Kindle 2.0
The New York Times is blogging the Kindle 2.0 launch. What kind of innovation is this?

[QUESTION. Is the Kindle a new product, or is it rather a new way to sell an existing product?]
_______

- Schumpeter's views on innovation and the credit market. Fore more info on Schumpeter, see Thomas K. McCraw. Prophet of Innovation. Joseph Schumpeter and Creative Destruction. Harvard University Press, 2007 [web] [prologue]. I've written a review, but it's in Spanish! From McCraw's book: "The core ethos of capitalism looks constantly ahead and relies on credit in launching new ventures. From the Latin root credo —'I believe'— credit represents a wager on a better future ... In the absence of credit, both consumers and entrepreneurs would suffer endless frustrations" (p. 7). Initially, the emergence of innovative entrepreneurs pushes interest rates higher, as demand for credit shifts upward.

[DIAGRAM. IN THE CREDIT MARKET, THE DEMAND SCHEDULE SHITS UPWARD, AS ENTREPRENEURS DEMAND MORE CREDIT AT EACH LEVEL OF THE INTEREST RATE. The result is a higher level of interest rates].

Now, Schumpeter also praised financial innovation — up to a point. In the case of railroads in the second half of the XIXth century, or the automobile industry in the 1920s, he states that “credit creation” in the form of overdrafts and car loans [i.e credit creation on a large scale] made it possible to finance these innovations:

[DIAGRAM. IN THE CREDIT MARKET, THE SUPPLY SCHEDULE SHIFTS DOWNWARD, AS MORE LOANABLE RESOURCES ARE MADE AVAILABLE. Note that the net result is a stable interest rate and more credit! This is the kind of results you want!]

But then Schumpeter adds: “Some of that lending was granted with almost unbelievable freedom and carelessness”. Does that ring a bell? Schumpeter made a distinction between productive & non-productive financial instruments (*). When bankers create financial instruments to “play amongst themselves”, then the risk of a bubble increases dramatically. But is it possible to really make that distinction?

[DEBATE! WERE SUB-PRIME LOANS A “SCHUMPETERIAN” INNOVATION?]

. Alan Greenspan seems to think so. In his 2007 autobiography, Alan Greenspan —a self-delcared Schumpeter fan—had only positive things to say about sub-prime lending: “The gains [he is referring to the percentage of households who own their house] were especially dramatic among Hispanics and blacks, as increasing affluence as well as government encouragement of subprime mortgage programs enabled many members of minority groups to become first-time home buyers” (The Age of Turbulence. Adventures in a New World. New York: Penguin, 2007, pp. 229-230) [info].

. Any ideas?

. Obviously, Greenspan got that one wrong… Warren Buffet, the great investor, had by that time issued his famous warning: “Derivatives are financial weapons of mass destruction”.

. In 2004, Charles G. Leathers & J. Patrick Raines published a brilliant paper: "The Schumpeterian role of financial innovations in the New Economy's business cycle", Cambridge Journal of Economics, 2004 28 (5): 667-681. According to Leathers and Raines, Schumpeter made a crucial distinction between productive and unproductive financial innovations (the latter are created by banks for speculative purposes). As early as 2004, they wrote that Alan Greenspans's optimism was completely misplaced. Bingo!
_____________

- Schumpeter on monopolies. You may remember that one of the key ingredients of Schumpeter’s theory of innovation is the incentive played by the ambition of some entrepreneurs to become monopolists

[DEBATE! Do you remember the litigation that took place between Microsoft and the European Union? How can one relate it to Schumpeter’s theory of innovation? What was Microsoft's chief argument?]

. Clue: bureaucratic meddling creates risks to the whole economy, as it would stifle innovation. Schumpeter thought that monopolists would not be able to keep their privileged position for too long: new competitors would sooner or later emerge!

[QUESTION. Did new competitors emerge?]

. Clue: Google, Linux.
__________

- Schumpeter & Keynes (very briefly). Who’s the leading dead economist nowadays? Keynes.
In times of crisis & depression, when everybody wants to get out of debt and sell assets at the same time, somebody has to take the other side of those trades in order to counter the downward spiral. And that "somebody" is?

[QUESTION. And that "somebody" is?]

. Clue: the State, the government.

. Schumpeter: innovation in a downturn. Innovation provides the solution. Innovation itself stimulates demand, as prices tend to drop, thereby stimulating demand. On that point, see the Financial Times interview of Dave Willis, founder of Whitford, one of the world’s top non-stick coating makers (Teflon, etc). "Is he worried about the global downturn?" Were it not for his FATE IN NEW PRODUCTS, he would be. Says Mr. Willis: "Because of Eterna –a new pan coating- and the coatings we think we can derive from it, I am optimistic we can find $8-$9m of new sales and achieve a growth in revenues of perhaps 8-10 per cent over the year". Plus, he hopes that many of his products will prove attractive to companies and consumers looking to save money. For example, his industrial coatings help to maintain existing equipment; and his durable non-stick frying pans may appeal to households that want to spend less on eating out”. [Peter Marsh: “Entrepreneurship: Turn up the heat in a tough market”, Financial Times].

. Schumpeter on Keynes' exagerated pessimism. Keynes, Schumpeter thought, was too pessimistic about human creativity. As soon as 1919 (The Economic Consequences of Peace), the English economist thought that humans had reached the end of their creative potential. Schumpeter was stunned to note that Keynes’ great 1936 book, the Generaly Theory, did not contain a single mention of a firm or an entrepreneur. Obviously, the Austrian was right on that score. In the long run, innovation would always prevail.

. Keynes on the "long run". To Schumpeter's views, Keynes famously responded ... WHAT ????? “In the long run where all dead”. And here, of course, he was also right.

[DEBATE! Can we have it both ways? Schumpeter for normal times, Keynes for depressions?]

_______________________________________________________

[2] Inflation expectations & long-term interest rates
Not the most exciting of topics, I admit. Nonetheless, it is of critical importance. Only if we understand the dynamics of inflation expectations can we pretend to understand the way the Federal Reserve & the ECB work. Inflation expectations are a key element of the dynamics of the credit market and long-term interest rates. The best way to understand is through an example.

. Scenario: Mexico 1994. The Zapatista movement enters the politica scene; the leading presidential candidate is assassinated; the US Federal Reserva raises short-term interest rates; some Mexican banks fail. Can we expect the Mexican government to react in panic, printing lots and lots of money?

. Changes in the demand schedule in response to the new information. If people expect prices to rise, they would expect to see their income rise, at least in nominal terms, as prices and wages adjust upwards.

[QUESTION. IN SUCH A SCENARIO, WOULD YOU BE WILLING TO DEMAND MORE OR LESS CREDIT, AT A FIXED RATE OF INTEREST?]

[DIAGRAM. Increasing inflation expectations lead to MORE demand for credit at each level of the interest rate, as more income is expected to pay fixed interest costs]

. Changes in the supply of loanable resources. If you have funds to lend at a fixed interest rate, you expect to get paid back in a currency that is worth less (in terms of purchasing power).

[QUESTION. IN SUCH A SCENARIO, WILL THOSE WHO SUPPLY LOANABLE RESOURCES BE WILLING TO SUPPLY MORE OR LESS CREDIT?]

[DIAGRAM. Increasing inflation expectations lead to LESS supply of loanable resources at each level of the interest rate, as lenders are paid back in a currency that is worth less in purchasing power terms].

[DIAGRAM. THE NET RESULT. The net result of an increase in inflation expectations is ALWAYS the same: LONG-TERM interest rates go up! Note that there is NO INCREASE IN THE AMOUNT OF CREDIT!]

. An interesting commentary by an always interesting author, James Madison: “Those who are creditors and those who are debtors, have always formed distinct interests in society” (Federalist No. 10.)

. Let me stress again the importance of this very simple case. In Mexico, the political, economic and social consequences of the high inflation were such that steps were taken to make the central bank independent from the executive. The reward came in late October 2008, as the financial crisis was deepening. The Federal Reserve extended a so-called SWAP agreement to Banco de México (and to the central bank of Brazil as well). More on that soon. In the UK, a fantastic move by Tony Blair & Gordon Brown in 1997. Against all expectations, they declared that the Bank of England would be made independent from the government.

[QUESTION. WHAT HAPPENED TO LONG-TERM INTEREST RATES in the London credit market?]

. They fell sharply, even though, on that very day, the BoE raised short-term interest rates!

[DEBATE & DIAGRAM: THE POSSIBILITY OF DEFLATION. How would credit markets react to news that would sharply increase the probability of a sharp DECLINE in the overall price level?]

[WHAT WOULD THOSE WHO DEMAND CREDIT DO?]

[WHAT WOULD THOSE WHO SUPPLY LOANABLE RESOURCES DO?]

[WHAT IS THE END RESULT?]

[DEBATE! Inflation expectations today! What elements would suggest to market participants that the price level will increase –or decrease- over the foreseeable future?? Suggestions: commodity markets, exchange rates, money supply, policy measures. Ireland to cut wages of public servants!]
_____________

[3] Governance, property rights & the credit market (introduction)
The best way to start looking at this crucial issue is to start with the writings of Peruvian economist Hernando de Soto. In 2000, de Soto published his book The Mystery of Capital [info] in which he summed up his research in the field of … slum economics. What did De Soto find inside Peruvian slums in the 1980s? Drug dealers & criminals, but also … entrepreneurs in need for credit! De Soto’s key finding: slum entrepreneurs may physically possess a given piece of land, but they lack formal property rights to it. Suppose that this room here is a part of a slum, and that I am in possession of it. Say that I am an entrepreneur in need for capital: I sell hats made by my family. I need to invest in equipment!

[QUESTION. How much credit can I get if I pledge my POSSESSION as COLLATERAL? To put it slightly differently, how much more credit would I be able to get if, instead of the simple possession, I could show a FORMAL TITLE TO THE PROPERTY OF THE PIECE OF LAND? Please reason in terms to the size of the credit market].

In the first case, the supply of loanable resources would be limited to people that actually know me & trust me: my cousins, my uncle, etc. In the second case, many more people would be attracted by the investment. [Hernando de Soto’s biography; website].

[DIAGRAM. Supply & Demand for credit in slums: show the supply of loanable resources much greater with legal property rights than with legal possession].

This is Hernando de Soto’s key finding: with official, tradable and liquid property rights, entrepreneurs can get credit on a much larger scale than with just physical possession. Moreover, such rights give you access to the formal judicial system in case of litigation. De Soto is now a super-star in the economics of slums (I wouldn’t be surprised if he’d be awarded the Nobel Prize in Economics one day; in 2004 the Cato Institute’s Milton Friedman Prize was awarded to the Peruvian economist). De Soto has now extended his work to a number of cities with big slums, like Cairo, Mexico City, Jakarta, Manila, etc. He estimates that the potential increase in the supply of loanable resources could reach … $10 TRILLION, which at the time of writing (2000) was about the size of US GDP.

[DEBATE! What would a person like Hernando de Soto think about MICRO-CREDIT; Muhammad Yunus, winner of the 2005 Nobel Peace Prize; princess Máxima; etc.]

. Clue: the foundation of Cisco Systems! Cisco Systems founders Len Bosack and his then-wife, Sandra Lerner, are credited with making major design enhancements to one of the technologies that makes the Internet possible—the router. Bosack, Lerner, and the Stanford colleagues who helped them didn’t invent the first router. That credit goes to William Yeager, a Stanford Medical School engineer, who wrote the software to drive a specialized computer controlled by an Internetwork Operating System (IOS). Bosack and his group took the original router code, enhanced the design, and capitalized on it, creating the first commercially successful router. [Note the difference between the inventor and the entrepreneur].

[QUESTION. HOW DID BOSACK & LERNER FIND CREDIT?]

Answer: by mortgaging their house! [Leonard Bosack]. So there you have it. The great thing about micro-credit is that it highlights the tremendous capabilities of poor people in terms of entrepreneurship. The problem, at least from De Soto's perspective, is that it fails to provide and answer to the problem of scale. By definition, micro-credit cannot take you very far. To create the Cisco Systems of the developing world, much more will need to be done in terms of creating and protecting property rights.
­­­­­­­­_____________________

CREDIT MARKET. INFO ON HERNANDO DE SOTO
. IDL

In 2004, Peruvian economist Hernando de Soto was awarded the Cato Institute's Milton Friedman Prize:

From his Peruvian roots, de Soto now can be seen traveling throughout the world, meeting with current and future heads of state. President Vicente Fox of Mexico sought out de Soto for help when he was the governor of the state of Guanajuato, and today de Soto is working with the Fox administration on property rights reform. Egyptian president Hosni Mubarak's son, Gamal, approached de Soto and today a property rights program is about to be implemented in Egypt. Both Philippine presidents Joseph Estrada and Gloria Arroyo have invited de Soto to help. The New York Times reports that African presidents are faxing him. De Soto tells these heads of state that their poor citizens are lacking formal legal title to their property and are unable to use their assets as collateral. They cannot get bank loans to expand their businesses or improve their properties. He and his colleagues calculate the amount of "dead capital" in untitled assets held by the world's poor as "at least $9.3 trillion"—a sum that dwarfs the amount of foreign aid given to the developing world since 1945.

CREDIT MARKETS. GOVERNANCE & PROPERTY RIGHTS: THE LORENZETTI PAINTINGS
. Frescos by Ambrogio Lorenzetti

Magnificent!

CREDIT MARKET. THE BOOM IN EAST ASIA'S BOND MARKET
. Andrew Wood: "East Asia’s bond market grows 15%", Financial Times

The value of local currency bonds outstanding in emerging east Asia grew by nearly 15 per cent in 2008, driven mainly by growth in China, the region’s biggest market, according to the Asian Development Bank. The amount outstanding at the end of 2008 was $3,692bn – a rise of 14.9 per cent in local currency terms and 8.2 per cent in dollars according to the ADB’s Asia Bond Monitor, which will be published on Tuesday. The report covers the 10 members of the Association of Southeast Asian Nations, mainland China, Hong Kong and South Korea. China accounts for about 60 per cent of total bonds outstanding in emerging east Asia and is the source of most of the growth in the region’s local currency bond market. Without China’s 22.5 per cent growth in local currency terms to $2,213bn outstanding, emerging east Asian bond markets expanded by just 5.1 per cent in 2008. Asian governments issued about three-quarters of the amount outstanding, but turmoil following the collapse of Lehman Brothers in September meant there was a slowdown in sovereign issuance as the year drew to an end.

Companies also slowed their bond sales during the last quarter of the year as risk premiums spiked and credit conditions remained stressed.The ADB expects issuance to rise this year as governments need to pay for stimulus packages and companies have to refinance existing borrowings. However, there is a danger of businesses being crowded out of the market. Increased competition from government and government-guaranteed financial institutions could raise corporate borrowing costs if investors prefer the relative safety of sovereign issues. “The big challenge now is whether Asian governments can use local bond market to promote economic stimulus,” said Lee Jong-wha, head of the ADB’s Office of Regional Economic Integration in Manila in the Philippines. “The risk is that borrowing costs become elevated but I think corporate bond issuance would increase, even though there’s some uncertainty about yields.” Local currency bond markets have lagged behind Europe and North America in sophistication, size and depth. East Asian corporate borrowers have traditionally relied on banks for financing and investors have preferred buying shares to trading debt. Governments have tended to have large surpluses and it has not been necessary for them to issue bonds, although the need for economic stimulus packages is changing that. Regional bond market growth is also hampered by the presence of a wide range of countries in very different states of economic development, and the lack of a single currency such as the euro or the dollar.

CREDIT MARKETS. SAMA SUPERSTAR!
. Abdulrahman Al-Hamidy: "Ratings in the context of market reform in Saudi Arabia", SAMA

The Saudi Arabia Monetary Authority is increasingly the subject of praise in Western financial media. Here's how H.E. the Deputy Governor Dr. Abdulrahman Al-Hamidy puts it: "We expect that the financial system will continue strong growth for the rest of this decade, despite the current international difficulties".

CREDIT MARKETS. DUBAI & ISLAMIC FINANCE
. Dubai International Financial Center

Many conventional forms of banking and insurance have been prohibited or restricted in the Arab world on the grounds that they contravene the tenets of Islam. In recent years, however, there has been a dramatic growth in Islamic or Sharia compliant financial products, reflecting a number of trends including:

. economic development in the Arab world giving rise to infrastructure and other projects which require Sharia compliant forms of financing
. the emergence of an international market in Sukuk (Sharia compliant) bonds
. rising incomes among the Arab population resulting in the need for Islamic consumer financial products (insurance, mortgages, pension plans and investment funds)
. changing demographics in the Arab world resulting in the growing need for pensions and other retirement savings products
. changes in Islamic law such as the approval in1985 by the Grand Counsel of Islamic scholars of the Takaful system as the alternative form of insurance written in compliance with Islamic Sharia

The market opportunity
The current market for Islamic financial products is estimated in excess of $260 billion and is forecast to grow at 12 to 15 per cent per annum over the next ten years. Currently, market penetration amounts to an estimated 20 per cent of the Arab population. This figure is expected to rise dramatically and it is expected that within the next decade, 50 to 60 per cent of the total savings of the world's 1.2 billion Muslims will be in the form of Sharia compliant products.

CONNECTIVITY. A REVIEW OF "GREAT POWERS"
. Dwight Garner: "U.S. as Parent to Countries in Their Teens", The New York Times

The New York Times publishes a review of Thomas Barnett's latest book, Great Powers. America and the World After Bush (New York: Putnam, 2009). The review is less than enthusiastic. [Blog]

CREDIT MARKETS. UKRAINE SEEKS NEW LOANS
. Polya Lesova: "Ukraine looks for new loans amid funding crisis", MarketWatch

The government of Prime Minister Yulia Tymoshenko has sent letters to the United States, the European Union, China, Japan and Russia, requesting financial assistance to cover the budget deficit, according to a statement posted on Tymoshenko's Web site. Tymoshenko made the announcement at a briefing in Munich over the weekend.

EVALUATION - First Assignment: A 1500-word essay on THEORETICAL APPROACHES IN INTERNATIONAL POLITICAL ECONOMY: SIMILARITIES AND CONTRASTS. Readings: C. Roe Goddard & al. International Political Economy. State-Market Relations in a Changing Global Order (New York: Macmillan, 2003), chapters 1, 2, 4, 12, 13 and 14.

. Deadline: Monday, February 16.

. Please do not attempt to just summarize the views of the authors. Concentrate en the task at hand: similarities and contrasts. Focus on the key issues. You may briefly discuss relevant current events.

CREDIT MARKET. AN INTERESTING SET OF NEWS
. Saksia Scholtes: "US credit card use dented by job cuts and slow economy", Financial Times
. Michael McKenzie: "Avalanche of Treasury bonds", Financial Times

These two articles provide us with a interesting opportunity to look at various key elements of the credit markets. On the one hand, it looks like private demand for credit is in deep trouble:

US consumers dramatically cut back their credit card spending in the fourth quarter , according to results from credit card lenders and payment processors ... MasterCard, the second-largest payment processor after Visa, said yesterday that spending volumes from US holders of their branded credit cards fell by 11.4 per cent in the fourth quarter of 2008 year on year.

Talk about a reduction in credit demand! On the other hand, however, the same newspaper tells interesting stories about an upcoming "avalanche of Treasury bonds". Thus, the ever-larger budget gap puts upward pressure on long-term rates:

It would be unprecedented to see every Treasury security sold each month [a reference to three-year notes and 30-year bonds, issues that had been suspended for a number of years]. We expect $1,900bn in net borrowing for this financial year and this is the only way the Treasury can get there.

MONETARY POLICY. THE BANK OF ENGLAND CUTS SHORT-RATES TO 1%
. Bank of England: News release

The "Old Lady" cuts the target for the interbank rate from 1.5% to 1.0%. Note the numerous references to the impact of global economic forces:

The global economy is in the throes of a severe and synchronised downturn. Output in the advanced economies fell sharply in the fourth quarter of 2008, and growth in the emerging market economies appears to have slowed markedly. Business and household sentiment in many countries has deteriorated. The weakness of the global banking and financial system means that the supply of credit remains constrained [italics mine].

INNOVATION. INTEROPERABILITY!
. Michael Schrage: "Interoperability: the great enabler", Financial Times (*)

Global financial markets are in disarray but prospects for innovation in the real economy have never been more robust. Innovations once crafted to stand alone are increasingly built to work together, or “interoperate”. The interoperability quotient, or IQ, of discrete components and systems to influence constructively the behaviour of other systems and components increasingly determines economic value. A low IQ indicates innovation destined to underachieve. Playing well with others, not just ingenuity, has become the new standard for innovation excellence. Look no further than the internet for the inspiration for interoperable innovation. The misunderstood genius of the internet is that interoperability makes “networks of networks” possible. Protocols permitting diverse data to mingle creatively explain why the internet’s influence as a multimedia, multifunctional and multidisciplinary environment for innovation remains unsurpassed.

Consider “mash-ups” as a model: Google Maps can easily be mixed and mashed with property, seismic or epidemiological data to produce novel applications that might launch a company or an industry. Greater inter­operability invites greater innovation – and vice versa. But interoperability as a core innovation investment principle extends well beyond the internet into power-grid systems, defence technologies and medical devices. More innovators in more disciplines are investing more in interoperability as both a business and research strategy. Nascent nanotechnologies are being mashed up with biotechnologies. Facebook pages mash up with Global Positioning System mobile phones. Rechargeable batteries can mash up with programmable solar cells. Seemingly disparate devices and disciplines that ordinarily would have zero interest in interoperating creatively, or zero capacity to do so, might find novel relationships cheap and easy. Successful interoperability dramatically cuts the costs, risks and complexities of hooking up.

Barriers to interdisciplinary innovation tumble. Favourable economics of interoperable innovation will tempt ambitious “inter-preneurs” to test their ideas. How might interoperability between Siemens cochlear implants, Apple iPhones, Nike running shoe accelerometers, LG microwave ovens, Nintendo Wiis and BMW Series 3 Sedans create bold entrepreneurial, or diversification, opportunities? Who knows? But the fact that the question piques curiosity reveals fundamental changes in the global innovation climate. The interoperability imperative creates a new innovator’s dilemma: will greater market share or profitability come from making one’s innovation more interoperable . . . or less? What IQ do current customers and potential prospects prefer? How should we collaborate, and compete, in the context of inter­operability?

How much interoperability is enough, or too much, is impossible to know in advance. What is easier to anticipate is the growing need for innovators and customers alike to customise the interoperability they offer and use. For ins­tance, this might involve giving people the power to determine whether their cardiac pacemakers should be able to influence their running shoes or allowing the breathalyser in their mobile phone to disable their car’s ignition. Creating cost-effective rules of engagement for customised interoperability will be a fantastic business challenge. Pervasive interoperability in both in­dustrial and consumer markets suggests that a new generation of interfaces will be essential. Simple interfaces that allow access to complex interoperability promise to be the great enabler, or the horrendous bottleneck, to innovation. The incompetent design of video remote control devices will give way to more iPhone-like and Google-esque streamlined access. Interface technologies – whether keyboard, touch-sensitive, voice or visual – will prove crucial to interoperable innovation. Interoperability’s economic potential is stunted without easy ways to gain access to it. Of course, increased interoperability means increased vulnerabilities. The viruses, spam and malware that pollute today’s laptops could crash fuel delivery trucks or implantable insulin pumps tomorrow. Wicked innovators, more than failed inter-preneurial ingenuity, may be the dominant threat to interoperability’s future.

Unsurprisingly, as interoperability be­comes the technical locus of innovation strategy worldwide, regulators may feel compelled to enshrine, loosen or shatter market standards. Interoperability standards can create, or destroy, innovation oligopolies and monopolies. Interoperability represents a challenge to competition policies in Europe and America. But where interchangeable parts enabled the mass production era more than a century ago, tomorrow’s interoperable systems promise richer, more diverse and more customisable innovation. Economic historians and post-industrial pundits alike observe that high-impact innovations come less from scientific breakthroughs than from clever recombinations of existing inventions. While trend should never be confused with destiny, interoperability potentially offers the best of both innovation worlds: a medium that gives scientific breakthroughs the opportunity to connect with other disciplines and a method for exploring more combinations more quickly and cheaply. That is a recipe for economic growth in difficult times.

(*) The writer researches the economics of innovation at MIT’s Sloan School and at Imperial College’s Business School.