Turkey signs nuclear deal with South Korea

Turkey signs nuclear deal with South Korea
By Saban Kardas

During a Turkish-Korean joint business forum held in Turkey on March 10, a protocol was signed to cooperate on Turkey's second planned nuclear power plant. Turkish Prime Minister Recep Tayyip Erdogan, attending the signing ceremony, welcomed the development as a positive step toward bolstering Turkish trade and economic ties with Eastern Asia.

The Turkish government earlier canceled the tender for its first nuclear power plant, which had been awarded to a Russian-Turkish consortium. Despite the cancelation of the tender in late 2009, the government insisted that it would proceed with its plans to build several nuclear plants in the near future.

Notwithstanding the objections to the nuclear project from various domestic sources, the government developed a new strategy to overcome the legal obstacles and accelerate its plans. Instead of competitive tenders, it opted for an inter-governmental agreement with Moscow, which would enable the Russian-Turkish consortium to build the nuclear plant at Mersin, on the Mediterranean coast. Turkey and Russia are continuing their negotiations on the details of the agreement, and Ankara is speeding up the process in order to finalize the deal in time for Russian President Dmitry Medvedev's planned visit to Turkey in May.

According to Turkish government's projections, Ankara plans by 2020 to build several nuclear plants to produce 10% of its total electricity needs. International leaders in the nuclear power generation industry, including US and French companies, have considered competing over tenders for the subsequent nuclear plants. However, Ankara has opted for an inter-governmental model for the second power plant.

Turkey concluded a protocol agreement with South Korea under which the Korean Electric Power Corp (KEPCO) might be awarded the contract to build a second plant in Turkey's Black Sea coastal city of Sinop.

KEPCO has been pursuing such a deal for some time, as part of its strategy of becoming a global leader in the nuclear industry. A KEPCO-led consortium recently won a contract to build four plants in the United Arab Emirates, thanks to KEPCO's cheaper and faster delivery terms compared with its rivals.

During the signing ceremony for the agreement with South Korea, Turkish Energy Minister Taner Yildiz stressed that both parties would form working groups to determine the details of such cooperation, particularly on the target price. He expects to reach a final decision on this within the next three to four months. If Ankara accepts the conditions, it will conclude an inter-governmental agreement, similar to the one with Moscow.

Turkish and Korean officials indicated that KEPCO might consider entering into partnership with Turkish firms to complete this project. KEPCO has already entered a joint venture with a Turkish company, NUROL AS, to invest in the Georgian energy market.

It was later argued that one of Turkey's leading construction firms, ENKA, will form a 50-50 joint venture to build the nuclear plant in Sinop. Yildiz noted that the government would not become involved in the choice of Turkish partner, and would respect the choice of the South Korean firm, provided that the partner had the necessary expertise.

Concerning the interest expressed by other international players in nuclear power plants, Yildiz said Turkey would be open to offers from other countries and companies and will evaluate them on the basis of competitiveness in terms of financing and construction terms. He noted that so far, there was no other offer.

Ankara's choice of partner has not been independent of political considerations, as Turkey sought to use these lucrative contracts as a means to achieve other political objectives. Thus far, participation by French companies has been hindered due to Ankara's policy of excluding them from major tenders. In the wake of recent signs of rapprochement between Ankara and Paris, French participation in Turkey's nuclear projects might become realistic.

In recent years, US firms were unable to compete for lucrative Turkish defense industry tenders, due to strict demands by the Turkish government concerning technology transfers. It was largely for these reasons, for instance, that Turkey awarded a contract for the construction of its main battle tanks to South Korea.

Similar concerns have arisen over the future of Turkish-American cooperation in nuclear energy. Erdogan cancelled his participation in a nuclear energy summit hosted by US President Barack Obama in Washington in April, to protest against a US House of Representatives committee finding in favor of Armenian genocide claims. If the parties fail to manage the looming uncertainty over Turkish-American relations posed by the genocide issue, Ankara might move to take some retaliatory action in the future, which could threaten the energy partnership. Indeed, Trade Minister Zafer Caglayan recently signaled that Ankara may freeze economic cooperation with Washington over the Armenian genocide claims.

An overarching theme in Ankara's energy policy has been diversification of both energy resources and supplier countries. The government's constant reiteration of its commitment to nuclear energy is a natural extension of this underlying motivation.
Seen from this perspective, the South Korean choice might be an attempt to counter the criticism that Ankara has deepened its energy dependence on Russia in recent years. While Turkey was already dependent on Russian gas and oil for much of its domestic consumption, by awarding the first nuclear power plant to Moscow, the government exacerbated this vulnerability.

The construction of the second plant by South Korea could be a step in the right direction toward diversifying the country's energy suppliers. It also complements its goal of breaking a traditional dependence on the West through cooperation with other emerging economies.

Gazprom Trifecta of Woes a Potential Boon to Europe, the Caspian Sea

Gazprom Trifecta of Woes a Potential Boon to Europe, the Caspian Sea

http://timrileylaw.com/LNG_TERRORISM.htm

Gazprom, the largest natural gas company in the world, is experiencing a moment of truth. And so, by extension, is Russia, which has relied on the behemoth for a large part of its tax revenue, and as a spearpoint of its foreign policy. The main ramifications are a shakeup in security presumptions in Europe and on the Caspian Sea, both of which until recently have seemed to be under Gazprom’s thumb.

The reasons are these: Gazprom’s main market – Europe – is under threat from cheap competition from the Middle East; one of its expected future markets – the United States – is sated by new indigenous gas supplies; and the reliability of its key underpinning – political backing from Russia’s leadership – now seems a bit less full-throated.

We have been discussing the reason for the first two problems – the motherlode of natural gas that is suddenly being drilled from U.S. shale formations; at once the U.S., and not Russia, is producing the largest volume of gas in the world. In Europe – where Gazprom has seemed impregnable – liquid natural gas from Qatar is undercutting the Russian company’s price; barrel-chested Gazprom has had to make unaccustomed concessions to conciliate its European customers. And in the U.S., where Gazprom has boasted that it will control 10% of the market within a decade through the sale of LNG, mainly from Russia’s Shtokman gas field, its braggadocio is ringing hollow. Because the U.S. shale gas has created a glutted market, Shtokman is on ice, and Gazprom’s Houston trading office – opened with fanfare only in October – looks to have more limited potential.

Closing out this list of challenges, Gazprom now must share what was one of its most reliable current sources of supply – the captive gas fields of Turkmenistan, almost all of whose pipelines until recently ran only to Russia; in December, China opened a 2,900-mile-long natural gas pipeline connecting itself to Turkmenistan.

All in all, on all these fronts, the assumptions underlying Gazprom’s business model no longer exist. Catherine Belton and Isabel Gorst provide a very good primer on Gazprom’s overall challenge in a long story last Friday in the Financial Times.

This set of challenges weakens the argument that Gazprom poses a security threat to Europe and greater Caspian Sea countries like Azerbaijan, Georgia, Kazakhstan and Turkmenistan. If LNG keeps flowing into Europe in larger and larger volumes – and especially if shale gas is developed in Hungary, Poland and elsewhere on the continent – Gazprom and its supply dominance seem less menacing. Likewise, the Chinese pipeline has severed Gazprom’s monopoly on Central Asian gas exports.

The new circumstances also weaken the case further for the already-wounded Nabucco pipeline, the U.S.-backed natural gas line meant to augment European supply and weaken Gazprom’s hold.

Belton and Gorst add a new problem to the list of woes. It is the disruptive appearance of market badboy Gennady Timchenko in Gazprom’s accustomed space. Timchenko, a pal of Russian Prime Minister Vladimir Putin, overnight became the third-largest oil trader in the world on the back of crude shipments from Russia. Now, Timchenko has eclipsed Gazprom as the largest shareholder in Novatek, which – in eerie resemblance to the oil trading coup – is now Russia’s second-largest gas producer. He holds almost 21% of the company, compared with Gazprom’s 19%.

On Novatek since last summer.... At the time, it was in the context of the Kremlin abruptly allowing France’s Total into the energy game after Big Oil’s shellacking of recent years – Total was permitted to work in the Termokarstovoye natural gas field, as long as it was in partnership with Novatek. Now, though, that partnership, and not cozying up to Big Oil, appears to be precisely the point – an effort from the top to muscle-up Novatek.

Over at True/Slant, Mark Adomanis sees this development as Putin carrying out “an effort to improve the efficiency of the state-directed capitalism that he has been loudly and openly building for most of the past decade.”

Belton and Gorst detail the role of Putin’s powerful deputy Igor Sechin in the Novatek juggernaut. Given Sechin’s past (a Forbes magazine piece dubbed him “the scariest person on Earth”), the likelier scenario is a pure power play – Gazprom is vulnerable, and Sechin, a consummate power player, is moving in on its turf.

Gazprom Rejects 'Shale Gas Revolution' That Could Shake Up Its World

The talk these days is of a natural gas revolution shaking up political and economic assumptions everywhere. Not surprisingly, Gazprom – among the biggest beneficiaries of the prior state of affairs, and one of the greatest losers should the ostensible revolution play out – says it’s much ado about nothing.

The debate is over technological advances in drilling that have opened up an estimated 100-year supply of gas that had been hopelessly locked into shale in Texas, New York, Oklahoma, Pennsylvania and elsewhere. It is said that, because of this sudden surge in gas supplies, the political and economic calculus around the globe – in Europe, Russia, China and the Middle East – can no longer be taken for granted.

The scenario goes like this: The arrival of the shale gas has created a glut in the U.S., and thus freed up otherwise-contracted Qatari liquified natural gas supplies for shipment to Europe. That’s made Europe less economically reliant on Russian natural gas supplied by Gazprom. In Russia, this loss of projected U.S. and European gas demand has stirred doubts about an economic model largely dependent on Gazprom, and also about Gazprom’s continued ability to serve as the spearpoint of Russian foreign policy. Moving on to China, the natural gas surplus could result in a breakout of battery-operated electric cars, to be recharged from natural gas-fired power plants, built as substitutes for currently planned coal-burning plants. If that happens -- if a large number of new Chinese cars are electric, and not gasoline-burning -- it would much-reduce China’s projected skyrocketing oil demand. Which brings us to the Middle East, whose future earnings projections – largely reliant on increased Chinese oil demand – would thus be upended.

As a piece, it may sound too grand. But it isn’t. Should shale gas plays work outside the U.S. – specifically in Europe and China – look for the scenario to shake up the equation somewhere along these same lines.

Back to Gazprom. Ultimately, asserts Gazprom chief Alexander Medvedev, the so-called shale gas revolution will peter out, cut short by imperiled water supplies. There is something to what Medvedev says, as Abrahm Lustgarten has been reporting for a year or so over at ProPublica. The industry will have to demonstrate that the gas can be produced safely.

Medvedev is showing the courage of his convictions. This week, he crossed a crucial milepost in Russia’s quest to forever end its reliance on uppity Ukraine and ship its natural gas directly to Europe. This is Gazprom’s announcement that it has raised $5 billion in loans to begin the construction of the Nord Stream natural gas pipeline from Russia to Europe. That 26 banks and three government lending agencies from France, Germany and Italy are party to the loan shows that they, too, are exercising caution before jumping on the revolution bandwagon.

Yet the oil industry is equally demonstrative -- it is putting down a multiple of that loan in investment to back up its conviction that the revolution is real....

The perfect crime

The perfect crime

By Chan Akya

The perfect murder isn't one where the murderer got away; rather it is one where no one knew a murder took place at all ... - Anon

http://www.leap2020.eu/GEAB-N-43-is-available!-The-five-steps-of-the-global-geopolitical-dislocation-phase_a4420.html

Remember those wonderful rating agency "scandals" of 2007-08 when a whole bunch of people opined that that the rating agencies had committed a "crime" against the investment community by publishing what were essentially poorly judged (if not fraudulent) ratings of various securities, that in turn encouraged a vast horde of unsuspecting investors to purchase them and subsequently lose hundreds of billions of dollars?

Remember all the noise and froth at the time about how these agencies were going to be regulated, controlled, sued and whatever other punishment imaginable? Has anyone heard much about a grand global effort to destroy the rating agencies' flawed business model? No? Well, me neither.

What has passed for "reforms" is arcane language in the new US Senate bill on financial sector overhaul, and some toothless ideas from the European Union.

To discuss the rating agency issue, and hopefully bring it center-stage again, we first need to examine what it is that went wrong. Following the precepts of the Heisenberg principle, it is valid then for us to start the discussion by looking at different businesses that operate under similar constraints. As it turns out, given the rating agencies widely circulated view that "credit ratings are merely opinions", comparing them with a typical newspaper's dilemma is valid.

Imagine you were running a newspaper, itself owned by a public company, and generally scratching along a living by selling your publications for $1 each. Supplementing the income from your sales is a bunch of advertisements in your newspaper, with the most prominent one at 40% of your revenues being from a company that makes a water-based fizzy beverage containing a lot of sugar, caffeine and all sorts of positively nauseating chemicals that are designed to extend the shelf life of the product and improve its "taste".

You, as the editor, know all that - but obviously since there is no explicit harm from the product, you go along and say nothing. A few years of this comfortable relationship later, the demand for printed newspapers is plummeting due to this thing called the "Internet" and you find yourself dependent on the fizzy-water company for 80% of your now rapidly declining profits.

Meanwhile, one of your junior reporters, who is too young to know any better, comes along with a startling expose that a bunch of scientists working in a nondescript lab have discovered long-term health problems in people drinking the fizzy water that is regularly advertised on your pages. Getting wind of the expose, the company gets in touch with you and tells you not to publish the "allegations", due to a serious risk of losing future advertisements. So what do you do?

Typically, an editor who chooses to remain silent would retain the advertiser but lose his junior reporter. Eventually, the junior reporter will turn out to be right and find someplace - maybe the Internet if the newspaper is lucky, and a competing newspaper if they aren't - to publish his views. Over the long term, readers may (and I use "may" advisedly) find the editorial bias in favor of fizzy water companies startling and unacceptable and switch loyalties to another newspaper. Once they do switch though they may find that the other newspaper is equally biased, just in favor of a different fizzy water company, and they may well switch back.

The best editors I know would simply slam the phone down on the fizzy water company and publish the expose as is (after considerable fact-checking). There is always the possibility of losing the advertisements of the fizzy water company, but to lose credibility (for such editors) would be unheard of.

Much like the description of the business model of the newspaper above, the basic business model of the rating agencies is to secure payments from the users of credit ratings. A typical license to view credit ratings for a bunch of companies in an industry or a region can cost a fair chunk of money - between US$15,000 and $150,000 per year, depending on the breadth and depth of coverage so required.

Where things get a bit hairy is that rating agencies also charge the companies that are rated by them, charging them an overall corporate (company or firm or partnership) fee as well as for every individual security that is issued by the company and purchased by investors. Such fees are fairly high, at more than $50,000 for even medium-size firms and adapted for an overall fee in the case of larger companies that may have hundreds of securities issued.

Right there, much like the newspaper editor in the above story, a rating agency's employee has an inbuilt conflict of interest, namely between the company he rates (which would want the highest possible credit rating in order to have the lowest possible borrowing fee) and the investor (whose interests are best served by extremely stable credit ratings that avoid declines - or downgrades - for the life of the security, that is, the lowest possible one below which the company's financial performance will not decline under most scenarios).

At this stage, the reader may be puzzled - why would all these fantastic sums of money be paid for a credit rating? The answer is a little artefact of US insurance law that specifies the use of "Nationally Recognized Statistical Ratings Organizations", or NRSOs, in assessing the quality of corporate bond portfolios that were purchased by the insurance industry. Remember that in the "old" days, the industry was the main holder of corporate bonds, while banks held loans from these companies.

There being only three NRSOs - Fitch, Standard & Poor's and Moody's - for much of the past century, intrinsic competition was limited (much like, funnily enough, in the fizzy water companies where two or three players dominated the global market for what is essentially a useless product).

To make matters worse, remember the bit about the companies paying the rating agencies for their ratings: this created, effectively, an upward bias for ratings as agencies competed with each other to push credit ratings up for each company, thereby ensuring that the issuers would retain their services.

Whilst nauseating, this was not the worst conflict of interest that the agencies managed. It was indeed what they did next, namely that they used historical default rates as the basis for creating a new class of ratings for structured finance assets. To do that, they used the historical observations of default rates by rating class, as a forward-looking measure of creditworthiness based on ratings.

An example of such a cumulative default rate, this one published by Moody's just before the financial crisis broke out in earnest, is shown below. It has the cumulative default rates, that is the total default for the time period.



The second bit of statistical jiggery-pokery involves something called the "transition" matrix of credit ratings, namely the risk that a security that is rated at X at the beginning of the year sees a rating change to X-1 or X+1 or whatever at the end of that year. The most commonly used such ratings transition matrix, at least as available publicly, and published on www.riskglossary.com, is shown below for the one-year timeline: (One year ratings transition matrix)



One-year ratings migration probabilities based on bond rating data from 1981-2000. Data is adjusted for rating withdrawals. Numbers in each row should sum to 100%. Due to round-off error, they may not do so exactly. Source: Standard & Poor's.

The second table basically implies that a credit starting at say a rating of triple-A would most likely end the year at triple-A (93% probability) and have pretty much no chance of declining in credit rating below double-B. In the middle of the table, the numbers are more volatile, but still relatively acceptable. The essential "lesson" if any from this table is that credit ratings were generally stable. As many investors were to discover from 2007 onwards, that was a significant illusion.

If you could assume that credit ratings would remain stable, it then became fairly trivial to calculate your potential losses. In simpler terms, the logic went, because the five-year default rate of a triple-B rated security was approximately 1.94%, any security rated triple-B was only likely to have a default rate of 1.94%. Extending that bit of "logic", it was then apparent that any security with a historical default rate of 1.94% over five years would deserve to be rated at triple-B. (Note here that such statistical default rates are different for each category of financial asset, and the article uses the example of corporate bonds as published by Moody's; the default rates would be vastly different for other types of securities).

For anyone still counting, that is two leaps of faith in a single act, that is, firstly that the past tends to replicate in the future, and secondly that a historical observation has a causative effect on scores. These aren't idle points for statisticians, but were clearly overlooked in the leap to the world of credit ratings.

The key question is why did the credit rating agencies go for this malarkey? And the answer is simple - the people who issued these securities, namely the Wall Street banks, were the ones paying them for the credit ratings. That is where the random thievery involved in the conflict of interests on corporate bond ratings became an outright systemic robbery when applied to the world of structured finance and, in particular, to securities that were built on the subprime and Alt-A loans made in the US residential mortgage sector.

The rest, as the good bard would say, is history. Brandishing what were essentially fake if not fraudulent credit ratings on a whole bunch of securities, Wall Street managed to peddle the most toxic assets in the financial world to the most risk-averse people. The type of investors who would lose sleep over an "emerging market" bond rated at triple-B went and gladly purchased the "triple-A" mortgage-backed securities issued by Wall Street, completely unaware of the risks entailed due to the false sense of security provided by the credit ratings.

As poetic justice would have it though, most of Wall Street also ended up eating its own cooking, that is, purchasing the very same assets that were designed in other departments of the firm, eventually leading to the closures of Bear Stearns (acquired by JP Morgan), Merrill Lynch (acquired by Bank of America) and Lehman Brothers, and nearly sending the other two large investment banks - Goldman Sachs and Morgan Stanley - to the footnotes of financial history.

Subsequently, much anger has been expended on the surviving banks, on subjects ranging from executive compensation to the quality of toilet furnishings in a chief executive's office. Really.

Yet, apart from a brief flirtation with the infamy of appearing before the US Congress and having a couple of toothless European politicians criticizing them, credit rating agencies have escaped meaningful reforms altogether. Using a term like "cosmetic" doesn't half do justice to the sheer lack of action surrounding potential reforms of the credit rating agencies.

Lexology.com reports on the financial reform bill of senate banking committee chairman Chris Dodd, condensing the provisions on credit rating agencies thus:

Chairman [Chris] Dodd's legislation includes credit rating agency (CRA) provisions similar to those released last fall in his previous draft designed to increase transparency and accountability of CRAs. Most notably, the bill establishes a new Office of Credit Rating Agencies at the SEC [Securities and Exchange Commission]. This office would be given the authority to fine or penalize a credit rating agency for various violations or if the SEC finds that the CRA lacks adequate financial and managerial resources to consistently produce credit ratings with integrity.

To increase transparency, CRAs would be required to issue a report with each credit rating that discloses their methodologies, including assumptions underlying the credit rating, the data relied upon in analysis, the use of servicer or remittance reports, and any other information that can assist users in analyzing the credit rating. Additionally, a CRA would have to reveal when it relies upon diligence review services performed by a third party. Similarly, CRAs would also be required to notify the users of the credit ratings of any material change in procedure or methodology, or errors made in the formulation of credit ratings. Each CRA must also ensure that changes to methodology are applied consistently to all credit ratings.

The legislation further would prohibit CRA compliance officers from working on the formulation of credit rating or methodologies, to minimize any potential conflict of interest. CRAs would also be required to utilize information obtained from third party sources if the CRA deems the source credible.

Notably, the legislation includes a provision permitting a private right of action by an investor if a CRA knowingly or recklessly fails to investigate the quality of data provided or to obtain analysis of the information from a neutral, independent source. It also gives the SEC the authority to de-register an agency that has provided bad ratings over a given period of time.

In effect, the only change is that credit rating agencies can now be sued for their ratings. If that made you laugh out loud for its sheer inadequacy, wait till you read the proposals from the European Union, dated July 27, 2009:

Credit rating agencies
Credit rating agencies play an important role in securities and banking markets, as their ratings are used by investors, borrowers, issuers and governments in taking decisions on investment and financing. They are however considered to have failed to reflect early enough in their ratings the worsening of market conditions in the run-up to the financial crisis.

The regulation is aimed at ensuring that credit ratings used in the European Union for regulatory purposes are of the highest quality, and issued by agencies that are subject to stringent requirements.

Currently, credit rating agencies are only to a limited extent subject to EU legislation and most member states do not regulate their activities, although their ratings are used by financial institutions that themselves are subject to EU rules. The agencies, most of which have their headquarters outside the EU, may however apply a voluntary code of conduct issued by the International Organization of Securities Commissions.

The regulation comes in response to calls from both the European Council and the G-20 (Group of 20 countries). It establishes a common framework for measures adopted at national level, in order to ensure the smooth functioning of the EU's internal market with comparable levels of investor and consumer protection from one member state to another.

It provides for a legally-binding registration and surveillance system for credit rating agencies issuing ratings that are intended for use for regulatory purposes.

It is also aimed at:

Ensuring that credit rating agencies avoid conflicts of interest in the rating process, or at least manage them adequately.

Improving the quality of methodologies used by credit rating agencies and the quality of their ratings;

Increasing transparency by setting disclosure obligations for credit rating agencies.

By this time, the credit rating agencies are quaking in their boots. Or not. After all, it was always possible that governments would do the following to them in the wake of the epic scandals discovered on credit ratings from 2007 onwards:

Shut them down altogether. Force them to choose between investor and issuer-side businesses (effect, same as a above). Revoke their NRSO status (and equivalent in other countries). Send a few rating agency analysts to prison or bar them from the industry altogether going forward. Nationalize them. Whatever has passed so far is far from comforting for future bond investors. While it could just be that government officials are too busy to have noticed the rating agencies, another factor could also be at play. Clearly, what has passed as financial market regulation for the rating agencies has been tempered by the need for the very same governments in the bond markets to continue their borrowings. In other words, there is a conflict of interest in the US and highly indebted European governments being in charge of reforming the credit rating agencies in the first place, given their own borrowing needs, which would be adversely affected by potential rating downgrades should the demands for "truth" in credit ratings become too onerous or even inflexible. If ever there was an issue for Asian countries to take a lead on, this is it. Given the vast holdings of US and European government debt that is held by Japan, China, South Korea, India and other Asian countries, it is time that they bandied about and created their own assessment of what the true creditworthiness of Western nations really was. In the process, whatever new rating agency that is created could well turn out to be an effective replacement of the existing three agencies. If and when these companies pass away into the financial history books, there probably won't be too many tears shed in Asia.

By Chan Akya

The perfect murder isn't one where the murderer got away; rather it is one where no one knew a murder took place at all ... - Anon

Remember those wonderful rating agency "scandals" of 2007-08 when a whole bunch of people opined that that the rating agencies had committed a "crime" against the investment community by publishing what were essentially poorly judged (if not fraudulent) ratings of various securities, that in turn encouraged a vast horde of unsuspecting investors to purchase them and subsequently lose hundreds of billions of dollars?

Remember all the noise and froth at the time about how these agencies were going to be regulated, controlled, sued and whatever other punishment imaginable? Has anyone heard much about a grand global effort to destroy the rating agencies' flawed business model? No? Well, me neither.

What has passed for "reforms" is arcane language in the new US Senate bill on financial sector overhaul, and some toothless ideas from the European Union.

To discuss the rating agency issue, and hopefully bring it center-stage again, we first need to examine what it is that went wrong. Following the precepts of the Heisenberg principle, it is valid then for us to start the discussion by looking at different businesses that operate under similar constraints. As it turns out, given the rating agencies widely circulated view that "credit ratings are merely opinions", comparing them with a typical newspaper's dilemma is valid.

Imagine you were running a newspaper, itself owned by a public company, and generally scratching along a living by selling your publications for $1 each. Supplementing the income from your sales is a bunch of advertisements in your newspaper, with the most prominent one at 40% of your revenues being from a company that makes a water-based fizzy beverage containing a lot of sugar, caffeine and all sorts of positively nauseating chemicals that are designed to extend the shelf life of the product and improve its "taste".

You, as the editor, know all that - but obviously since there is no explicit harm from the product, you go along and say nothing. A few years of this comfortable relationship later, the demand for printed newspapers is plummeting due to this thing called the "Internet" and you find yourself dependent on the fizzy-water company for 80% of your now rapidly declining profits.

Meanwhile, one of your junior reporters, who is too young to know any better, comes along with a startling expose that a bunch of scientists working in a nondescript lab have discovered long-term health problems in people drinking the fizzy water that is regularly advertised on your pages. Getting wind of the expose, the company gets in touch with you and tells you not to publish the "allegations", due to a serious risk of losing future advertisements. So what do you do?

Typically, an editor who chooses to remain silent would retain the advertiser but lose his junior reporter. Eventually, the junior reporter will turn out to be right and find someplace - maybe the Internet if the newspaper is lucky, and a competing newspaper if they aren't - to publish his views. Over the long term, readers may (and I use "may" advisedly) find the editorial bias in favor of fizzy water companies startling and unacceptable and switch loyalties to another newspaper. Once they do switch though they may find that the other newspaper is equally biased, just in favor of a different fizzy water company, and they may well switch back.

The best editors I know would simply slam the phone down on the fizzy water company and publish the expose as is (after considerable fact-checking). There is always the possibility of losing the advertisements of the fizzy water company, but to lose credibility (for such editors) would be unheard of.

Much like the description of the business model of the newspaper above, the basic business model of the rating agencies is to secure payments from the users of credit ratings. A typical license to view credit ratings for a bunch of companies in an industry or a region can cost a fair chunk of money - between US$15,000 and $150,000 per year, depending on the breadth and depth of coverage so required.

Where things get a bit hairy is that rating agencies also charge the companies that are rated by them, charging them an overall corporate (company or firm or partnership) fee as well as for every individual security that is issued by the company and purchased by investors. Such fees are fairly high, at more than $50,000 for even medium-size firms and adapted for an overall fee in the case of larger companies that may have hundreds of securities issued.

Right there, much like the newspaper editor in the above story, a rating agency's employee has an inbuilt conflict of interest, namely between the company he rates (which would want the highest possible credit rating in order to have the lowest possible borrowing fee) and the investor (whose interests are best served by extremely stable credit ratings that avoid declines - or downgrades - for the life of the security, that is, the lowest possible one below which the company's financial performance will not decline under most scenarios).

At this stage, the reader may be puzzled - why would all these fantastic sums of money be paid for a credit rating? The answer is a little artefact of US insurance law that specifies the use of "Nationally Recognized Statistical Ratings Organizations", or NRSOs, in assessing the quality of corporate bond portfolios that were purchased by the insurance industry. Remember that in the "old" days, the industry was the main holder of corporate bonds, while banks held loans from these companies.

There being only three NRSOs - Fitch, Standard & Poor's and Moody's - for much of the past century, intrinsic competition was limited (much like, funnily enough, in the fizzy water companies where two or three players dominated the global market for what is essentially a useless product).

To make matters worse, remember the bit about the companies paying the rating agencies for their ratings: this created, effectively, an upward bias for ratings as agencies competed with each other to push credit ratings up for each company, thereby ensuring that the issuers would retain their services.

Whilst nauseating, this was not the worst conflict of interest that the agencies managed. It was indeed what they did next, namely that they used historical default rates as the basis for creating a new class of ratings for structured finance assets. To do that, they used the historical observations of default rates by rating class, as a forward-looking measure of creditworthiness based on ratings.

An example of such a cumulative default rate, this one published by Moody's just before the financial crisis broke out in earnest, is shown below. It has the cumulative default rates, that is the total default for the time period.



The second bit of statistical jiggery-pokery involves something called the "transition" matrix of credit ratings, namely the risk that a security that is rated at X at the beginning of the year sees a rating change to X-1 or X+1 or whatever at the end of that year. The most commonly used such ratings transition matrix, at least as available publicly, and published on www.riskglossary.com, is shown below for the one-year timeline: (One year ratings transition matrix)



One-year ratings migration probabilities based on bond rating data from 1981-2000. Data is adjusted for rating withdrawals. Numbers in each row should sum to 100%. Due to round-off error, they may not do so exactly. Source: Standard & Poor's.

The second table basically implies that a credit starting at say a rating of triple-A would most likely end the year at triple-A (93% probability) and have pretty much no chance of declining in credit rating below double-B. In the middle of the table, the numbers are more volatile, but still relatively acceptable. The essential "lesson" if any from this table is that credit ratings were generally stable. As many investors were to discover from 2007 onwards, that was a significant illusion.

If you could assume that credit ratings would remain stable, it then became fairly trivial to calculate your potential losses. In simpler terms, the logic went, because the five-year default rate of a triple-B rated security was approximately 1.94%, any security rated triple-B was only likely to have a default rate of 1.94%. Extending that bit of "logic", it was then apparent that any security with a historical default rate of 1.94% over five years would deserve to be rated at triple-B. (Note here that such statistical default rates are different for each category of financial asset, and the article uses the example of corporate bonds as published by Moody's; the default rates would be vastly different for other types of securities).

For anyone still counting, that is two leaps of faith in a single act, that is, firstly that the past tends to replicate in the future, and secondly that a historical observation has a causative effect on scores. These aren't idle points for statisticians, but were clearly overlooked in the leap to the world of credit ratings.

The key question is why did the credit rating agencies go for this malarkey? And the answer is simple - the people who issued these securities, namely the Wall Street banks, were the ones paying them for the credit ratings. That is where the random thievery involved in the conflict of interests on corporate bond ratings became an outright systemic robbery when applied to the world of structured finance and, in particular, to securities that were built on the subprime and Alt-A loans made in the US residential mortgage sector.

The rest, as the good bard would say, is history. Brandishing what were essentially fake if not fraudulent credit ratings on a whole bunch of securities, Wall Street managed to peddle the most toxic assets in the financial world to the most risk-averse people. The type of investors who would lose sleep over an "emerging market" bond rated at triple-B went and gladly purchased the "triple-A" mortgage-backed securities issued by Wall Street, completely unaware of the risks entailed due to the false sense of security provided by the credit ratings.

As poetic justice would have it though, most of Wall Street also ended up eating its own cooking, that is, purchasing the very same assets that were designed in other departments of the firm, eventually leading to the closures of Bear Stearns (acquired by JP Morgan), Merrill Lynch (acquired by Bank of America) and Lehman Brothers, and nearly sending the other two large investment banks - Goldman Sachs and Morgan Stanley - to the footnotes of financial history.

Subsequently, much anger has been expended on the surviving banks, on subjects ranging from executive compensation to the quality of toilet furnishings in a chief executive's office. Really.

Yet, apart from a brief flirtation with the infamy of appearing before the US Congress and having a couple of toothless European politicians criticizing them, credit rating agencies have escaped meaningful reforms altogether. Using a term like "cosmetic" doesn't half do justice to the sheer lack of action surrounding potential reforms of the credit rating agencies.

Lexology.com reports on the financial reform bill of senate banking committee chairman Chris Dodd, condensing the provisions on credit rating agencies thus:

Chairman [Chris] Dodd's legislation includes credit rating agency (CRA) provisions similar to those released last fall in his previous draft designed to increase transparency and accountability of CRAs. Most notably, the bill establishes a new Office of Credit Rating Agencies at the SEC [Securities and Exchange Commission]. This office would be given the authority to fine or penalize a credit rating agency for various violations or if the SEC finds that the CRA lacks adequate financial and managerial resources to consistently produce credit ratings with integrity.

To increase transparency, CRAs would be required to issue a report with each credit rating that discloses their methodologies, including assumptions underlying the credit rating, the data relied upon in analysis, the use of servicer or remittance reports, and any other information that can assist users in analyzing the credit rating. Additionally, a CRA would have to reveal when it relies upon diligence review services performed by a third party. Similarly, CRAs would also be required to notify the users of the credit ratings of any material change in procedure or methodology, or errors made in the formulation of credit ratings. Each CRA must also ensure that changes to methodology are applied consistently to all credit ratings.

The legislation further would prohibit CRA compliance officers from working on the formulation of credit rating or methodologies, to minimize any potential conflict of interest. CRAs would also be required to utilize information obtained from third party sources if the CRA deems the source credible.

Notably, the legislation includes a provision permitting a private right of action by an investor if a CRA knowingly or recklessly fails to investigate the quality of data provided or to obtain analysis of the information from a neutral, independent source. It also gives the SEC the authority to de-register an agency that has provided bad ratings over a given period of time.

In effect, the only change is that credit rating agencies can now be sued for their ratings. If that made you laugh out loud for its sheer inadequacy, wait till you read the proposals from the European Union, dated July 27, 2009:

Credit rating agencies
Credit rating agencies play an important role in securities and banking markets, as their ratings are used by investors, borrowers, issuers and governments in taking decisions on investment and financing. They are however considered to have failed to reflect early enough in their ratings the worsening of market conditions in the run-up to the financial crisis.

The regulation is aimed at ensuring that credit ratings used in the European Union for regulatory purposes are of the highest quality, and issued by agencies that are subject to stringent requirements.

Currently, credit rating agencies are only to a limited extent subject to EU legislation and most member states do not regulate their activities, although their ratings are used by financial institutions that themselves are subject to EU rules. The agencies, most of which have their headquarters outside the EU, may however apply a voluntary code of conduct issued by the International Organization of Securities Commissions.

The regulation comes in response to calls from both the European Council and the G-20 (Group of 20 countries). It establishes a common framework for measures adopted at national level, in order to ensure the smooth functioning of the EU's internal market with comparable levels of investor and consumer protection from one member state to another.

It provides for a legally-binding registration and surveillance system for credit rating agencies issuing ratings that are intended for use for regulatory purposes.

It is also aimed at:

Ensuring that credit rating agencies avoid conflicts of interest in the rating process, or at least manage them adequately.

Improving the quality of methodologies used by credit rating agencies and the quality of their ratings;

Increasing transparency by setting disclosure obligations for credit rating agencies.

By this time, the credit rating agencies are quaking in their boots. Or not. After all, it was always possible that governments would do the following to them in the wake of the epic scandals discovered on credit ratings from 2007 onwards:

Shut them down altogether. Force them to choose between investor and issuer-side businesses (effect, same as a above). Revoke their NRSO status (and equivalent in other countries). Send a few rating agency analysts to prison or bar them from the industry altogether going forward. Nationalize them. Whatever has passed so far is far from comforting for future bond investors. While it could just be that government officials are too busy to have noticed the rating agencies, another factor could also be at play. Clearly, what has passed as financial market regulation for the rating agencies has been tempered by the need for the very same governments in the bond markets to continue their borrowings. In other words, there is a conflict of interest in the US and highly indebted European governments being in charge of reforming the credit rating agencies in the first place, given their own borrowing needs, which would be adversely affected by potential rating downgrades should the demands for "truth" in credit ratings become too onerous or even inflexible. If ever there was an issue for Asian countries to take a lead on, this is it. Given the vast holdings of US and European government debt that is held by Japan, China, South Korea, India and other Asian countries, it is time that they bandied about and created their own assessment of what the true creditworthiness of Western nations really was. In the process, whatever new rating agency that is created could well turn out to be an effective replacement of the existing three agencies. If and when these companies pass away into the financial history books, there probably won't be too many tears shed in Asia.

EU Commissioner: Nabucco Gas Pipeline Delayed till 2018

EU Energy Commissioner Oettinger says the Nabucco pipeline will be delayed by 4 years; the Nabucco Consortium has not confirmed this information. Photo by EPA/BGNES

The EU-sponsored gas transit pipeline Nabucco will come into operation in 2018 at the earliest, EU Commissioner for Energy Guenther Oettinger.

In an interview for the German paper Sueddeutsche Zeitung, Oettinger says that he is optimistic about the Nabucco project despite the four-year delay (Nabucco was supposed to be completed in 2014). What is more, he calls the gas pipeline “a prestigious EU project.”

The EU Energy Commissioner says he hopes that Nabucco will receive a final construction permit by the end of 2010. He reminds that the EU will invest EUR 200 M in the pipeline, and also announces that a conference with the participation of all Nabucco partners will be held in July 2010 in Brussels or in Instanbul.

The currently existing plans of the Nabucco Consortium state that the pipeline which is to bring Central Asian and Middle Eastern natural gas to Europe via Turkey and Bulgaria should be in operation by 2014. This information has been confirmed on Wednesday by a spokesperson of RWE, the German participant in the project, as cited by the Sueddeutsche Zeitung.

The other partners in the project include the Turkish company Botas, the Bulgarian Energy Holding, the Romanian Transgas, the Hungarian MOL, and the Austrian OMV. Each of them holds a stake of 16,7%. The construction of the pipe is expected to cost EUR 7,9 B.

In his interview for the Sueddeutsche Zeitung, the EU Energy Commissioner Oettinger says that the North Stream gas pipeline between Russia and Germany via the Baltic Sea should be ready in two years.

He also stated the other Russian-sponsored pipeline, South Steam, which goes through the Black Sea and Bulgaria in order to reach the rest of Europe, should also be completed because it will provide an alternative route for Russian gas exports to the EU. In his words, the major gas pipeline running from Russia to Europe will have to be repaired over the next three years because of the risk of technical problems which might lead to a crisis of Russian gas supplies whose dimensions might be similar to the January 2009 dispute between Russia and the Ukraine.

South Stream is widely regarded as a competitor to Nabucco that tightens Russia’s energy grip on the EU.

Turkey strengthens Iraqi energy ties

http://www.fastcompany.com/magazine/144/combustible.html

Turkey strengthens Iraqi energy ties
By Robert M Cutler

National security challenged by Arctic climate change
Russia and the Arctic: Parachuting In
Energy in Saudi Arabia: A Kingdom Running on Empty? ‎
The 15 Oil And Gas Pipelines That Are Changing The World's Strategic Map
http://onlinejournal.com/artman/publish/article_5728.shtml

http://rwor.org/a/v21/1030-039/1035/caspian.htm

MONTREAL - Turkey last week strengthened its energy ties with Iraq by renewing a contract to import Iraqi oil to the Turkish Mediterranean Sea port of Ceyhan, where Azerbaijani oil also arrives via the Baku-Tbilisi-Ceyhan (BTC) pipeline. Earlier this year, it was announced that Iraq will export between 5 billion and 10 billion cubic meters per year of natural gas to Turkey for inclusion in the Nabucco pipeline carrying the fuel to Europe.

The oil will come from Kirkuk in Iraqi Kurdistan, along the route of the already existing 1,000 kilometer Kirkuk-Ceyhan oil pipeline. The pipeline, built in the late 1970s, consists of two trunks, with a combined design design capacity of 1.6 million barrels per day, or more than half as much again as the BTC's design capacity.

The Kirkuk-Ceyhan pipeline was mainly empty from 2003, after the US overthrow of Saddam Hussein, until late 2007, and it has since been the target of disruptive attacks (most recently last November), besides suffering general disrepair as a result of the prewar UN sanctions and subsequent collateral damage. The German firm Siemens modernized the line in 2003 under the supervision of the Turkish firm BOTAS. Since re-entering service, it has operated at roughly one-sixth to, more recently, one-third of project capacity, when it has not been shut down for one or another reason.

Negotiations between Iraq and Turkey began last year, and agreement was reached after Turkish Energy Minister Taner Yildiz earlier this month expressed his wish to go ahead. Yildiz agreed with Iraq's deputy oil minister, Ahmad Al Shamma, concerning some changes to the existing contract, which expires at the end of this month. In particular, new transit taxes were agreed and provisions set for possible renovation, rebuilding or re-routing of the line.

The new Iraqi throughput from Kirkuk comes hard on the heels of the announcement three weeks ago that Turkish state firm TPAO is negotiating with the Iraq Southern Oil Company to drill 45 wells in the southern Rumaila oil field. That contract, which could be signed as early as this autumn, according to MEED, a business intelligence website, is worth US$318 million. The work would seek to almost treble field output to 2.8 million barrels per day, from 1 million.

Expansion of the Kirkuk-Ceyhan oil pipeline fits in with recently announced Turkish strategic plans to turn Ceyhan into a fully integrated oil hub over the next five years. Andalou News Agency reported on Tuesday that the country also intends to begin construction of a nuclear power plant by 2014, in addition to diversifying natural gas suppliers and raising the proportion of domestic-sourced power generation.

The government stated its intention to reduce its heavy dependence on Russian natural gas (due largely to the Blue Stream project, carrying gas from across the Black Sea to Turkey) while also constructing coal-fired and hydroelectric power plants to meet projected increases in domestic demand. That intention could be comprised, depending upon the conditions that Ankara allows to be set, upon construction and management of the gas storage facilities that Gazprom is building near Lake Tuz in central Anatolia. (See Iran claim clouds Turkey's energy goals, Asia Times Online, November 6, 2009).

Still, Turkey's announced plans would signify its intention not to be a consumer country for any of the gas transiting its territory from Russia through the projected "Blue Stream Two" project. They explain why, when Turkish Prime Minister Recep Tayyip Erdogan met Russian Prime Minister Vladimir Putin in Sochi 12 months ago, he argued strongly in favor of transforming Blue Stream Two into what is now called MedStream.

MedStream refers to a plan to conduct gas from Russia, after it crosses Anatolia from the Black Sea to Ceyhan, underneath the Mediterranean Sea to Ashkelon in Israel, with the cooperation of French companies.

It was once envisaged that gas from northern Iraq might be a candidate for re-export by Turkey along a MedStream route, before that gas became committed earlier this year to the European Nabucco project. The Russian gas might, after reaching Israel, go to South Asia by tanker, either through the Suez Canal or from the Gulf of Aqaba through the Red Sea and the Bab-el-Mandeb Strait between Eritrea/Djibouti and Yemen.

Dr Robert M Cutler (http://www.robertcutler.org), educated at the Massachusetts Institute of Technology and The University of Michigan, has researched and taught at universities in the United States, Canada, France, Switzerland, and Russia. Now senior research fellow in the Institute of European, Russian and Eurasian Studies, Carleton University, Canada, he also consults privately in a variety of fields.

The End of the Free Market.....?

http://endofthefreemarket.com/author/interview

You’ve written that free markets must now compete with the rise of something called “state capitalism.” What is that?

State capitalism is a system in which the state acts as the dominant economic player and uses markets to advance political goals. It’s a trend we see primarily in China, Russia, and the Arab monarchies of the Persian Gulf, but individual elements of it exist in democracies like Brazil and India. In this system, governments use national oil companies and other state-owned enterprises to create and maintain large numbers of jobs. They use select privately owned companies to dominate certain economic sectors. They use so-called sovereign wealth funds to invest their extra cash in ways that maximize the state’s profits. In all three cases, the state is using markets to create wealth that can be directed as political officials see fit. And in all three cases, the ultimate motive is not economic (maximizing growth) but political (maximizing the state’s power and the leadership’s chances of survival).

National oil companies and even sovereign wealth funds have been around for many years, haven’t they? How and why have they become a threat to free-market capitalism?

Yes, some of these tools have been around—in one form or another—for decades. But the governments that now use them play a much larger role in shaping international politics and fueling the global economy than did the developing states of decades past. For the past quarter century, globalization has been the defining force in political and commercial relations, with capital markets, labor markets, and consumer markets becoming increasingly global. We’ve seen a wave of democratization since the end of the Cold War—in Eastern Europe, East and Southeast Asia, Latin America, and Africa. But some authoritarian governments have bucked this trend. They’ve learned from the failure of communism that to survive, they must embrace capitalism and the power of markets to generate prosperity. But they know that if they leave it entirely to market forces to decide who wins and who loses from economic growth, they risk empowering those who might use the new wealth to challenge their political power.

Even in some democratic countries that face no real danger of becoming authoritarian, the state can use state-owned companies or heavily subsidized privately owned “national champions” to advance political goals. In Brazil, President Luiz Inacio Lula da Silva’s government has used both a state-owned oil company (Petrobras) and a privately owned national champion mining company (Vale) to invest state resources in ways that create and protect jobs at home. These moves have helped Brazil weather the global recession—and they’ve helped the ruling Workers Party maintain its high popularity. But over the longer term, Petrobras may become a much larger and much less efficient company.

The Western financial crisis and global recession have also encouraged governments in some of the world’s wealthiest countries (including the United States) to take a larger and more direct role in attempts to spark growth. That said, the phenomenon we see in places like Brazil, India, and South Africa—to say nothing of the temporary shift toward greater state involvement in economic decision-making that we’ve seen in the US and EU—is nothing like state capitalism as practiced in China or Russia. There, the government’s first priority is political survival and a lack of independent institutions—including courts, media, and rival political parties—enable long-term state dominance of the economy.

Where did this system of state capitalism come from?

The rise of state capitalism began decades ago as crude oil became an essential element of economic and political power. The ability to seize control of valuable domestic assets provided local leaders with unprecedented political leverage, both at home and abroad. The development of state capitalism accelerated in the 1980s and 1990s with the rise of emerging markets and their growing importance for the global economy. Over the past decade, we’ve seen the remarkable growth in importance of sovereign wealth funds. But the crisis of 2008—and the fact that it originated inside Western financial institutions—provided the real tipping point.

The Chinese government can (and does) argue that its approach to economic development and its ability to mobilize a large-scale targeted response to a severe economic slowdown argues for the wisdom of its state-centric model of development—particularly as the free-market West struggles to regain its footing. Other governments around the world are watching. They can compare China’s 10% growth with America’s 10% unemployment and draw their own conclusions about what works and what doesn’t. They see that the Chinese leadership can use its country’s growing wealth to tighten its hold on domestic political power. For insecure political officials in historically volatile countries, that’s an attractive proposition—one that promises sharp economic growth without genuine political sacrifice.

So, is Karl Marx having the last laugh?

Not if he sees what’s really happening here. This is not the return of command economics; it’s capitalism practiced by the state. Those are two very different phenomena. State capitalism makes sense for authoritarian governments, because it allows them to micromanage both political and economic challenges that have a direct impact on their own survival. But in an economic context, state capitalism is not a particularly efficient engine for long-term expansion. State-run companies and state-managed investment funds tend to be burdened with the same sorts of bureaucracy, waste, and corruption that plague their governments. Norway has a national oil company and a sovereign wealth fund. But it is also blessed with an efficiently run, democratic, and transparent government. Russia can’t make the same claim, and this problem is reflected within the institutions that allow its government to manipulate domestic market performance.

That’s an important part of why free markets are worth competing for—and why free-market capitalism may well win out in the end. But that’s a long-term process. We’ll be living with state capitalism and managing the challenges it creates for decades to come.

In the meantime, developing states like China, India, Brazil, Indonesia, Russia, and others will continue to cut into US political, economic, and cultural hegemony. If these emerging powers embraced free-market capitalism, America might still hold a somewhat smaller piece of a much bigger global economic pie. The risk from state capitalism for the United States—and for free-market democracies generally—is that the pie isn’t expanding quickly enough to accommodate all the new mouths it will soon have to feed.

In the United States and Europe, is the government’s bigger role in economic decision-making a part of this same trend?

Deeper and more direct state intervention in rescuing failing financial institutions and other companies is a temporary phenomenon in the West. It has grown from the immediate need to jumpstart growth and job creation following the global slowdown. In the fall, we’ll certainly see plenty of election-year political rhetoric on this subject in the United States—and there’s a real risk of over-regulation in the US, Europe, and Japan. On the other hand, it’s highly unlikely that any of these countries will embrace state capitalism. The real conflict between free markets and state capitalism will be fought in the international marketplace of ideas, as these competing models create friction between governments as well as between governments and privately owned companies.

Looking at the headlines, don’t those who say free markets have failed have a point...?

Anyone who has read a newspaper in the past 18 months is aware that under-regulated markets can generate turmoil throughout the global economy. The free-market capitalism we’ve seen in recent years in the United States is hardly a model for consistent long-term growth—in part because there are too many incentives within the current system for short-term expansion at the expense of sustainability. There’s a delicate balance between these two economic systems that policymakers all over the world will have to find. But the engine best capable of powering the global economy through the future will be powered primarily by the forces that fuel globalization: the innovation, creativity, and talents of entrepreneurs and workers outside the public sector.

Let’s not allow the financial crisis, serious as it was, to make us forget the quarter century that came before. Between 1980 and 2007, the global economy grew by almost 150%. That’s the global economy. The world’s wealthiest countries saw a serious increase in their standards of living. In developing states, hundreds of millions of people moved from poverty into the marketplace. The slowdown has temporarily pushed some of those people back toward poverty, but decades of growth have created rising expectations that, over the long term, only free markets can meet.

State capitalism deserves some of the credit for the expansion, especially in a place like China, which has grown from a very low base. But the broader story of the past three decades is one of command economies embracing capitalism and of states loosening their grip on economic activity. As I argue in the book, the strength and durability of recovery will depend on the willingness of those who believe in free markets to learn from the failures that triggered the crisis, to practice the kind of capitalism they preach, and to renew their commitment to the principles that have helped them prosper.

Post-Apocalyptic zombie finance

Post-Apocalyptic zombie finance


By 2014, International Monetary Fund official John Lipsky remarked March 21, the debt-to-gross domestic product (GDP) ratio of the Group of Seven countries will reach 100%, and the governments of the industrial world will carry the highest debt burden since shortly after the end of World War II.

That is bad news; worse news is that governments are shoveling money into the world banking system to finance the debt expansion. Following the great bank bailout of 2008, the global banking system is socialized de facto, shifting its resources towards government debt and away from private sector financing.

Governments averted a financial apocalypse in 2009 by bailing out the bankrupt banking system. But who will bail out the governments? The answer for the time being is that they will bail themselves out at the expense of the private economy. In the post-apocalyptic financial world, private banks have turned into flesh-eating zombies that cannibalize the private economy in order to finance government borrowing requirements not seen since World War II.

The shift in economic power toward governments and their auxiliaries, the major banks, is unprecedented in peacetime. And it seems to be the intention of the Barack Obama administration "not to let a crisis go to waste", as the president’s chief of staff, Rahm Emanuel, famously declared. The trillion-dollar federal health plan on which the US House of Representatives voted March 21 will effectively nationalize a sector comprising 14% of the US economy - on top of the de facto nationalization of the banking system.

Figure 1: Government debt replaces loans on the books of American banks



American banks have reduced their loan book by US$350 billion - more than a fifth - since early 2009 and bought $300 billion of Treasury securities. Remarkably, the most aggressive buyers of US government debt during the past several months have been global banks domiciled in London and the Cayman Islands. They borrow at 20 basis points (a fifth of a percentage point) and buy Treasury securities paying 1% to 3%, depending on maturity.

This is the famous "carry trade", by which banks or hedge funds borrow short-term at a very low rate and lend medium- or long-term at a higher rate. This works as long as short-tem rates remain extremely low. The moment that borrowing costs begin to rise, the trillion-dollar carry trade in US government securities will collapse.

Between November and January, the last month for which Treasury data are available, foreign private investors (overwhelmingly banks) bought $60 billion a month of Treasury notes and bonds - an annual rate of $720 billion, or about half the total annualized borrowing requirement of the US government.

Figure 2: Foreign purchases of US Treasury securities, private banks vs central banks



Note that the central banks of the world have not increased their holdings of US government securities to a significant extent. Their net purchases are running at a modest $20 billion a month, or an annual rate of $240 billion.

The US Treasury has become dependent on global private banks. According to Treasury data, $108 billion of the $180 billion in net foreign purchases of US Treasury securities during the three months through January came from London and the Cayman Islands.

Figure 3: Yield on inflation-index five-year US Treasury securities



Most remarkable is the willingness of the world to finance the American deficit at real interest rates of less than 0.5%, as measured by the yield on five-year inflation-indexed Treasury notes. The extremely low real yield implies very low growth expectations over a five-year horizon. We appear to have something like Japan’s "lost decade" of the 1990s, in which banks purchased government securities at yields of less than 1% with effectively free money from the central bank.

Figure 4: Net purchases of US Treasury securities by geographic origin, three months through January 2010



Where are the banks getting the money to lend to the US government? From the US government itself. The Federal Reserve has increased bank reserves by $1.4 trillion since the beginning of the crisis, feeding funds into the banking system which the banks immediately lend back to the government, along with $300 billion of additional funds freed up by the reduction in loans to the private sector.

Figure 5: Monetary base



The monetary base is growing at a 40% annual rate. Under normal circumstances, this would lead to double-digit inflation. As long as banks reduce lending to the private sector, and buy government securities that replace lost tax revenues, the result is a so-called liquidity trap. With 20% under- or unemployment in the United States, according to a February 2010 survey of 20,000 US households, labor costs will remain depressed. Commodity price inflation will not translate easily into consumer price inflation.

This sort of zombie equilibrium persisted for two decades in Japan's moribund economy; in theory, the US Treasury and the financial system could keep it going indefinitely. But there are a hundred ways in which this arrangement could go wrong.

Weaker governments like Greece and Spain, or even the United Kingdom, could snap the chain. A shift out of US dollars in response to monetary inflation could force the Federal Reserve to raise interest rates. An attempt by investors to ease out of the carry trade could provoke a stampede for the exits. Japan has managed to keep its bubble going for 20 years. But Japan did so on the strength of its domestic banking system under the supervision of the Bank of Japan; the United States depends on the reserve status of the dollar, which makes less and less sense when the Treasury is flooding the world with US liabilities.

We have never seen anything quite like this before, and one hesitates to make forecasts about an arrangement so absurd and unstable that the list of potential break-points is endless. Now that the whole world is buying US government debt on borrowed money, it makes no sense to own it. It will end badly - but it is too early to specify just how and when.

Spengler is channeled by David P Goldman, senior editor at First Things (www.firstthings.com).

Washcon Syndrome

http://www.huffingtonpost.com/arianna-huffington/when-it-comes-to-innovati_b_512280.html

http://www.istockanalyst.com/article/viewarticle/articleid/3986846

Washcon Syndrome or Washington Consensus Syndrome is similar to the Stockholm Syndrome in many ways. But a major difference is that victims of Stockholm Syndrome recover when freed from captivity , but those suffering from Washcon Syndrome , mostly remain afflicted all their life with this illness. A large number of Indians suffer from this syndrome specially those who have served in US controlled international institutions implementing Washington Consensus and hence have been in constant touch or under psychological influence or monetary temptations or pressure of the Americans . The illness becomes more acute if they have been educated in English media schools and universities and worse if in English and US universities.

What is Stockholm Syndrome

Stockholm Syndrome is an extraordinary phenomenon when a hostage begins to identify with and grows sympathetic to his captor. It was named for an event in Stockholm in August, 1973 when an armed Swedish robber took some bank workers captive, held them for six days and exercised control over their hearts and minds. Another famous example of the Stockholm Syndrome is Patty Hearst, heir to the US publishing fortune, who was kidnapped in 1974 by the Symbionese Liberation Army. She later joined the SLA and participated in a bank robbery with them. More recently in 2002 , a US girl Elizabeth Smart was kidnapped by a couple for 9 months. Elizabeth repeatedly had the chance to run away or ask for help but did not. It is another example of the Stockholm Syndrome, where the victim had formed emotional bonds with her captors.

Stockholm Syndrome is created when captives begin to identify with their captors initially as a defensive mechanism, out of fear of violence. Small acts of kindness by the captor are magnified, since perspective in a hostage situation is by definition impossible. Rescue attempts are also seen as a threat, since it's likely the captive would be injured during such attempts.

It must be noted that these symptoms occur under tremendous emotional and often physical duress. The behavior is also considered a common survival strategy for victims of interpersonal abuse, and has been observed in battered spouses, abused children, prisoners of war, and concentration camp survivors.

What is Washington Consensus!

"Stabilize, privatize, and liberalize" became the mantra of a generation of technocrats sent from Washington to control and manipulate the economies of poor countries .

The phrase Washington Consensus was originally coined in 1989 by John Williamson to describe a set of ten economic policy prescriptions that he considered to constitute a "standard" reform package promoted for crisis-racked countries by Washington-based institutions such as the International Monetary Fund, World Bank and U.S. Treasury Department. ( In fact it could cover other institutions where US ,UK and other Western nations decide policies for their continued domination and hegemony)

Later Williamson realised that the term came to be used in a different and broader sense; as a synonym for market fundamenatlism.In this broader sense, Williamson admits, it was criticized by even by George Soros (!). The Washington Consensus has also been criticized by many nationalist leaders in Latin Amrica, Africa and Asia and non-neo-liberal economists .The phrase has become associated with neoliberal policies in general and drawn into the broader debate over the expanding role of the free market, constraints upon the states, and Washington/US influence on other countries' national soveriegnty.

IMF ‘s "austerity programmes," demand increasing taxes even when the economy is weak, in order to generate government revenue and balance bidget deficits. They are often advised to lower their corporate tax rate. These policies have been criticized by Joseph E.Stiglitz, former chief economist and Senior Vice President at the World Bank, in his book Globalisation and its Discontents . He argued that by converting to a more Monetrist approach, the fund no longer had a valid purpose, as it was designed to provide funds for countries to carry out Keynesian reflations, and that while the IMF "was not participating in a conspiracy, but it was reflecting the interests and ideology of the Western financial community".

Many critics assert that the ‘reforms’ led to destabilization as in the Argentine economic crises ( of 1999-2002 ) and in exacerbating Latin America's economic inequalities. Critics of the Washington Consensus are often accused of being associated with socialism ( as if it is crime) and/or anti-globalism ( Never mind that under the charade of globalisation , over a US trillion dollars were transferred out of Russia to the West following the collapse of Communism and implementation of neoliberal economic policies during Yeltsin regime)

US scholar Dani Rodrik, Harvard Professor of International Political Economy, in his paper Goodbye Washington Consensus, Hello Washington Confusion?,also joined the critics. Williamson himself has summarized the overall results on growth, employment and poverty reduction in many countries as "disappointing, to say the least".

Rodrik pointed out that while China and India increased their economies' reliance on free market forces to a limited extent, their general economic policies remained the exact opposite to the Washington Consensus' main recommendations. Both had high levels of protectionism , little privatisation with extensive industrial policies planning, and lax fiscal and financial policies through the 1990s. But they turned out to be successes. This was perhaps a result of resistance against agents of Washington Consensus institutions by Indian civil servants much maligned in Western and Indian corporate media.

According to Rodrik: "While the lessons drawn by proponents and skeptics differ, it is fair to say that nobody really believes in the Washington Consensus anymore. The question now is not whether the Washington Consensus is dead or alive; it is what will replace it. Many economists claim that among other things those policies involved major turns in the direction of greater reliance upon market forces.

The Washcon Syndrome

In 1960s when I joined the Indian diplomatic service , after a fiercely competitive civil service examination , one reason was the lure of foreign postings ,travel and acquiring west produced whitegoods , then a status symbol as locally produced goods were shoddy .Officers from other civil services say the powerful Indian Administrative Service (IAS) would try to join the economic affairs department in the Ministry of Finance .They were almost sure to join and do well , if they learnt the mantra of Washington Consensus and religiously and unambigously followed it .To the best of the author’s knowledge , except one or two , most of them then went on deputation to IMF , World Bnak . Asian development Banks and whatever their tenure , came back loaded with foreign goodies and a hefty pension marked in US dollars .This assured Washington of loyalty of these Indians till they retired and even there after.

In other ministries too , say of Industry , Commerce , even Agriculture , all officers , even other than IAS tried to join the international relations division , where if they imbibed and followed the tenets of the Washington Consensus , they could be get clearance from Washington for highly paid jobs in UNDP ,UNIDO ,FAO and other international organisations and hefty pensions and other benefits . Thus an important cadre of of Washington Consensus followers was formed and inducted into the steelframe of Indian bureaucracy.It is there for all to see and their proclivity to promote US interests at the cost of India is crystal clear. The tradegy is that with the brainwashing and a lifetime of positioning to follow the precepts of Washington Consensus and please their American masters , these Indians suffering from the malaise of Washcon Syndrome , behave like well trained circus dogs and automatically do the master’s bidding. In the words of George Orwell , "Circus dogs jump when the trainer cracks the whip. But the really well-trained dog is the one that turns somersaults when there is no whip."

As for sold out Indians in media , academia and socalled thinktank and intelligence agencies watch for this space .While Buddhists , Sikhs , Muslims and others try to reach Godhead collectively, a Hindu under Brahmanical guidance tries to arrive at even his spiritual salvation alone .In material world , the self is above everything else , with most Indians becoming very focusssed in gaining their financial salvation with little consideration for the interests of the collective community.

Victor Yushchenko

Washington has positioned such personnel all around the world , say the outgoing President of Ukraine Victor Yushchenko . As the head of the newly-formed National Bank of Ukraine , Yushchenko enforced in 1993 IMF's usual shock therapy economic medicine which impoverished its economy. As it has been done all over the world for Washington’s benefit. He created a new Ukrainian national currency, which resulted in a dramatic plunge in real wages, with bread, electricity and transportation prices increasing by three, six and nine times respectively. The standard of living tumbled.

Yushchenko was appointed Prime Minister in 1999 because of loans which IMF promised. In the now discredited IMF programmes, he closed down part of the country’s manufacturing base. Yushchenko also tried to undermine bilateral trade in oil and natural gas with Russia and demanded that this trade be conducted in US dollars rather than in terms of commodity barter. In 2001, he was dismissed following a non-confidence vote in the parliament-"Viktor Yushchenko has fulfilled obligations to the IMF better and more accurately than his duties to citizens of his our country, Olena Markosyan, a Kharkiv-based analyst, opined in Ukrainian centrist daily Den" (BBC Monitoring, 16 Nov 2004).

Yushchenko was installed as President –a US proxy, five years ago by Washington franchised street revolution similar to those in Serbia and Georgia with massive financial support and training and other inputs from US based institutions. In recent elections as a result of following Washington Consensus policies , only five percent of Ukrainians voted or him.

Yushchenko’s wife Kateryna, an American citizen born in Chicago, had been an official in both the Reagan and George H.W. Bush administrations, and in the US State Department. She had come to Ukraine as a representative of the US-Ukraine Foundation controlled by conservative Republicans in Washington.

Conclusion;

India is full of personnel suffering from Washcon Syndrome in very key positions, specially in the UPA government , not that the BJP dominated NDA government was any better .Just look around to see all those who worked for Washington Consensus institutes and the damage they are now causing to India’s long term vital interests , whether in regard to energy security or the very soveriegnty of Indian territory and security of its people .

India has gone out of its way to annoy Iran , a possible ally against Pakistan in Afghanistan and for energy security ;and Russia , a steadfast friend in our hours of peril and unlikely to have adversial position to our strategic interests .Why annoy or irritate Beijing to please Washington , which has shown scant regard for India’s concern in Afghanistan or any where else and India’s interests . Even in economic domain , except that the Indian banks have not been allowed to indulge in reckless investment banking as in USA , more or less policies similar to Washington which are unravelling the US economy are being followed in India .Mani Shankar Aiyar , a younger colleague and friend from the Indian foreign service was relieved of his Petroleum and Gas portfolio , for attempting to ensure energy security , with US ambassador in Delhi braying for his head publically and succeeding. Mera Bharat Mahan (My India is great)

K Gajendra Singh, Indian ambassador (retired), served as ambassador to Turkey and Azerbaijan from August 1992 to April 1996. Prior to that, he served terms as ambassador to Jordan, Romania and Senegal. He is currently chairman of the Foundation for Indo-Turkic Studies. Copy right with the author E-mail kgsingh@yahoo.com