Local Roots of a Global Crisis

Quote of the week:

1 - 'Crises are now different in that they involve very large amounts of very short-term money. That is one aspect. Second, that the economy is highly leveraged around that money, so that when something happens, the whole house of cards collapses. And thirdly, the world economy is deeply global, through the financial structures and that means that when something happens anywhere, it happens everywhere. So that of course makes international financial crises today something really interesting.' - Rudi Dornbusch (Source)
2 - 'The Argentine case would thus seem to call into question just how valuable a modernized banking sector and capital markets actually are for developing countries.' - The Economist (Source)


Commentary of the week:
The Local Roots of a Global Crisis:

Sticking with our favourite cynical theme that the financial world is coming to an ignominious end then, how are we to make sense of this moment in financial history? After all, financial crises are nothing new and if it wasn't for the fact that correspondents like me have to write commentary, there is some merit in the suggestion that these crises would not even make the midnight news. What a simple life we would have then, if we actually didn't have to worry about our savings and investments and could simply outsource that worrying to earnest young men and women whose sole purpose in life was to make untold fortunes for clients such as us. Yes, a worry-free life. But alas my good friends, this financial nirvana escapes us, perhaps for some fault of our own.
What we do have is the exact opposite. Nobody really knows anymore if house prices are going to keep going up in Canada, why the stock markets are so 'up' here but not so 'up' just South of us or even in China anymore and if there is one theme that is evident from the recent spate of bad news, it is that the financial sector (which sadly includes me I think) is hardly as smart as it would have us believe. Such an economic context is of course crippling for any rational (or even pretend rational) long-term decision-making. As some accomplished speakers at a recent conference told us recently (yes, after many promises of good behaviour regarding cutlery [see the Blog], Ittihad is letting me go to conferences again), the Public markets are quite skittish and so private businesses are avoiding an Initial Public Offering (better known as an IPO - where companies raise money for themselves by selling their shares to the general public through exchanges such as the TSX). The one IPO of note, Sprott Asset Management, did not go off as the huge success that it would have been if they had waited for more certain times. As an exquisite and definitive example of what I mean by uncertainty, any Tom, Dick and Harry can now have an opinion on our financial future that is taken seriously (case in point); and you know that we are on dangerous territory indeed when people like me start second-guessing people like Eric Sprott (of the Sprott Business School fame). So why all this uncertainty then, and where does it come from?
Well, my theory is quite simple (and probably just as wrong, but bear with me). The reason there is such institutional paranoia and experiential deficit as to 'what is to be done' about this present crisis, is that this is really the first time since the 1930's that a North American financial crisis has its roots (both obvious and latent) within North America itself. The first crisis after the depression was really in the 40's and driven by events in WWII Europe and I don't really remember anything remarkable about the 50's except for the Korean War and the storied youth of Baby Boomers so we will have to skip that decade. In the 60's (and 70's) we had the Vietnam war which led to the decoupling of Gold and the US Dollar in the early 70's (a seminal event in finance that generates much contemplation and vituperation). Soon after the Gold Standard was abolished (Gold used to be $35/ounce) we had the Yom Kippur War (1974?) and then the Oil Embargo which did some short-term damage to the North American economy through higher energy prices and inflation. There was also the Revolution in Iran in 1979 which created yet higher oil prices and then the Afghan War in the 1980's where you had untold amounts of illicit drug money enter the financial system along with the already enormous amounts of Oil Money. These funds were of course very methodically deposited with large Western banks because they were simply the best at banking, people didn't know any better and also because there were some Faustian bargains made. These banks then turned around and lent this money to poor third world countries where many politicians' pockets and grandiose, no-use pet projects suddenly found 'cheap' funding. These self-same borrowers then, became subject to interest-rate policies of the US Fed and became unable to service their debt once Paul Volcker raised interest rates in 1986 (?) in order to combat the inflation resulting from the higher Oil prices we already mentioned. This debt and the unconscionable interest payments involved then put spending cramps on poor foreign governments and resulted in poor quality of life in debtor countries. These poor countries could not then spend money on health and infrastructure and this in turn increased immigration to the West, creating both a brain drain and other social problems in the West. It also resulted in many musical concerts and campaigns for Debt-forgiveness (such as Bono's Jubilee 2000), which break out and then peter out from time to time because forgiving astronomical amounts of debt really sets bad precedents in International Finance.
This now, is where the plot thickens, so follow closely. In the 1980s' then, we are on the cusp of having a truly global, technologically interlinked financial system; and even though this is a historic achievement for humanity (questionable, but let us concede this point for now), it just seems that this system is quite prone to unforeseen crises that begin from far-flung areas of the world. In Imperial terms, if the capital of world finance is New York, then the many far-flung provinces such as Tokyo, Moscow, London and Buenos Aires have been quite twitchy and problematic over the years. After 1986, there has been the crash in the Japanese Nikkei (1989), the USSR + Ruble Collapse (1991), the British Pound and ERM crisis (1992-3) the Mexican Peso crisis (1994), the Asian Financial Crisis (1997), the LTCM scandal (which was the loudest crash you never heard - 1998), then the Tech crash (2000-1) which was within the US but dismissed as a sectoral failing and the Argentine Collapse in 2002-3. Now, you have the crowning achievement of this financial era in the SubPrime debacle, which has only somewhat inexplicably, not yet turned into a crash.
Yet what we have now is somewhat different in another way as well. In the long history and story of financial episodes, you have many localized crashes in one market or another. In the short history of this kind of a technical, globalized financial system, you have never had a viral attack that started at the heart of the system. We have only had stress and blow-ups at its extremities, never the pervasive crunch at the absolute Center. Each time something like this has happened before, technocrats even more knowledgeable about such things than yours truly (hard to believe but there you have it) are dispatched from the corridors of Washington's own World Bank and IMF to solve the latest problem that those pesky foreign countries have gotten us into this time around. This time, there is no 'foreign' country at fault. The system rots from within its core. Wall Street has nobody else to blame, no sector, no country, no war, no crisis and not even Main Street (which continues to rack up both spending and debt). This time, it is the very business practice of selling off people's loans to others at the back end (technically called securitization) and the explosive addition of leverage to the mix (primarily in the form of derivatives) that are to blame. It is the very thing that has made Wall Street so successful in the past that is causing it such exacting problems today. Who can they send to fix those? Where will they get the required expertise when the expertise itself is questionable? More importantly, what will be the effect on the periphery or economic provinces that we now console ourselves by calling countries, if the capital itself is found to be on shaky ground? The acute crisis in food supply (see Blog) is one effect perhaps, but what will the others be?
At the moment of course, these are somewhat rhetorical questions. There is really nobody that can say how this will turn out in the end with any degree of planned accuracy. What I have tried to do is situate this particular episode historically, not be tastelessly triumphal in the face of peoples' hardship. I think that there is this difference this time around of rottenness even at the core; whether this small difference becomes amplified as further mistakes are made through the blunt instrument of interest rate policy is for the future to reveal. For us, while much of this is out of our hands and over our heads personally, it nevertheless bears some careful collective thought. I won't be trite and ask you to be careful out there, I am sure you are thinking the same thing if you haven't found a chink in this theory already (and no, the Tech bust does not count). As our friend Ms. Schneider would say, 'Sane Finance' anyone?


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The Crescent Entrepreneurial Association (CEA) is hosting a business plan competition that I think many of you will enjoy attending. This is a volunteer organization that is helping the community get a better handle on its economic future. The exposure and insights gained at the competition will be quite priceless IA so if you have daughters, sons, younger nieces and nephews, cousins etc., try and bring them out to this event on the 31st of May. We at Ittihad are both fans and supporters of CEA and would like to see a large turnout. This wonderful organization will help the community build a critical mass of good, ethical businesses that will contribute to society IA. Please register here.

There is also a conference in NY that our Senior Management will be attending. Our CEO's topic of discussion will be 'Ethical Dimensions of Islamic Finance' and how Islamic Finance and Socially Responsible investing are two pieces of a beautiful solution to many of our financial ailments. It is time for the two movements to learn from each other and collaborate. For those who can make it to NY, it may be an excellent working holiday and an educational experience. Please register Here for your 15% discount.

We have been invited by TARIC mosque (near the 400/401) to present our views on Islamic Finance. This seminar will be held on the 21st of June at 7:00 pm. I encourage both brothers and sisters to attend. The interactive discussion will focus on the place that Islam does / does not and perhaps should have in both 'Islamic' Finance and also in our personal financial choices. This is a discussion that will IA take place outside the logic of a sales presentation so you can leave your cheque-book at home. Come with friends and come with difficult questions - hopefully, we will trade in good ideas that will profit our minds. I will be sending out a flyer shortly with directions and the program - I apologize in advance to all the readers outside Toronto who will no doubt be upset about receiving an invitation to an event halfway across the country or the world.


Finance News:

1. Is this the next crisis? Trouble in foreign exchange markets? ... read more here

2. Why is the TSX breaking record highs? Are you confident about this economy? Think about this question a bit ... read more here

3. Trading in Carbon credits takes off in a big way as US companies join the movement ... read more here

4. This is why mining stocks are so risky ... their hold over their mining claims is so tenuous (and borderline illegal pending judgement) that investing in them sometimes approaches pure speculation ... read more here


Economic News:

1. A Harvard Business School article on the future of state-led capitalism ... read more here

2. An FT report on the Economics of Food ... excellent follow-up to the last commentary ... read more here

3. An Economist Special Report on International Banking ... too funny sometimes ... read more here


Islamic / Middle East / Emerging Markets:

1. If you are new to financial economics and want to know in 5 minutes why 'interest' is considered wrong by so many people from so many different faiths and political views (Hat-tip to Siddiq Mohamed) ... read more here

2. This is what happens when Sovereign Wealth Funds invest on the way down. Yes, a whole lot of nothing. Nobody is disciplined, nobody is fired, it all taxpayer money after all and there is plenty more where that came from, except nobody in the ME pays tax and all this is Oil money ... read more here

3. Even China has it's own indigenous cars while we drive Gas-Guzzling Gizzards to and fro from work. Interview with Cherry's CEO ... read more here

4. How did Islamic Finance become a human interest story as opposed to a finance story? (Hat-tip to Imtiaz Ahmed) ... read more here

5. The race is on for investment in Africa. I do not know if you have ever travelled over the grasslands of the Rift Valley, but you better go soon. Before yet more plunder of a beautiful continent ... read more here


Interesting but not all Finance:

1. This article from MIT seeks to answer whether it pays for Companies to be ethical. Of course, I take severe issue with the way this question is framed. Ethics are hardly meant to be a cost to take into account when designing a product, but who in their right mind listens to me? ... Also, this article shows how it really is the fault of the consumer that companies are able to get away with so much ... read more here

2. Startling stats on which countries have the highest cultures of private philanthropy ... read more here
3. Who's to blame for the food crisis? ... read more here or here

Economic Complexity and the Price of Food

Quotes of the week:
"The biggest question is whether the sovereign-wealth funds, some of which rushed prematurely into the distress market last year and are now treading more carefully, will now stay out, when arguably they should be returning to it. Some of their investments last year in private-equity firms, such as Blackstone and Wall Street banks, have since plunged in value." -

The Economist opines on the timing of Middle Eastern investments in the US.
To what would you ascribe such faulty Middle Eastern decision-making? Bad luck or consistently bad advice? You decide ...

Commentary for the Week:
Economic Complexity and the Price of Food:

Today's commentary is going to be a bit more ambitious than usual. While there is a profusion of many crises in the financial sector on the one hand and nascent trouble in the real economy of foodstuffs and commodities etc. on the other, it is really the connections between the two that should be of interest to us at the moment. If you read some of last week's links, you would have noticed that there seems to be a food shortage in many places of the world. This is reflected in both the quantity of food such as rice available and the price that is being charged (Economists among us will want to collapse these two measures into one, but allow me the latitude to separate the two for a minute - I will reconcile the two below). Similarly, on the financial sector side, lenders and investment banks are in some serious trouble and Central Banks are slashing interest rates and encouraging cheaper loans on their respective populations. So, are these two phenomena connected? If they are, how are they connected and what does all this mean for us? Is this really one problem masquerading as many?

One way to make sense of this is to look at the financial sector first. There is a severe overhang of non-performing investments and confidence has been severely shaken with the failure (or dressed up buyout for the technically minded) of Bear Stearns, the loss provisions of Countrywide, the failure and subsequent nationalization of Northern Rock in Britain, the severe multi-ten Billion losses at Citibank, SocGen, UBS and now RBS. Add to this the fact that the largest insurers in the world such as AIG have declared (too quietly for my liking) historic losses even though Insurance is supposed to be and was always a cash-cow business and you begin to see what is happening. The absolute last thing that the authorities want is for people to begin to worry about their investments (Retirement Savings, 401k's etc.) and begin to call their broker's and advisors to start pulling some cash out. The cascade effects of such actions are too terrible to contemplate. That is why Central Banks have been feverishly providing credit to any bank that asks and new rules are being put in place to provide credit to investment banks as well (Canada is a bit 'ahead' of the game here because here the banks are everything rolled into one and such pedestrian distinctions are unnecessary). This printing of money and provision of loans is having some of its intended effects. The investing public's confidence has not been shaken, stirred perhaps, but not shaken. The fund managers / hedge funds and private equity firms have an open line of credit at easy rates so they are continuing to buy stocks. In this sense, the declining stock market trend is being managed quite well, with no spectacular collapses on a daily / weekly basis.

Nevertheless, the law of unintended consequences must have its pound of flesh as well. While the stock markets are staying afloat in a way that does not display much of the bad news, the bad news is showing up at the grocery store. The problem is that the places where these financial crises are taking place are printing money like there's no tomorrow (primarily the US). The places where these financial crises are not present (primarily Brazil, China, India etc. ) hold lots of US$'s already. As they try and exchange those dollars for actual resources that their growing middle classes now demand, both the value of the dollar and the price of real stuff is affected. There is excess paper money and there is a shortage of real stuff such as metals / foods and energy. Both trends reinforce each other, creating an inflationary cycle the likes of which most people only read about in history books but never pause to witness personally.
Of course, this is not the whole picture at all. Even within the economy of real assets and products such as food, there is an internal dynamic that we have to keep in mind. The sheer technical complexity of our economies and economic growth strategies is such that we are voracious consumers of energy. We use it not only to power our homes and washing machines but also to grow the food that we eat. If farming were fashion, mechanized and high-input, high fertilizer methods would be the new black. We have simply stopped using natural seeds and native species of foods. Over 90% of the world now grows maybe 7-8 different staple foods that absolutely require high energy inputs. With the collapse of the US$ against the price of energy (Oil barrels), food production has not only suffered in absolute quantity terms (why produce food when you can produce biodiesel?), but also in monetary measures such as food affordability (Economists - please notice the reconciliation). Fertilizer prices and food transportation charges have simply overwhelmed many small producers in many parts of the world where they remain unable to receive the kinds of agricultural subsidies as farmers and food companies find available in the G-8. Many have simply been driven out of not just the business, but also the process of producing food.

So getting back to the question about the connections between the food and financial crises then - do you remember that our grandmothers would explain to us how their previous generations had no real cash but that good food was abundant. Look how far we have come as a species, we are rich beyond our wildest dreams, but have substituted paper for food, and Oil for water. We are unable to feed the planet unless the financial system works and the oil rigs keep pumping. Sometimes one must pause and think deeply about this my friends, isn't there a real cost to our many mortgages, credit cards and leveraged investments that cannot be captured or explained away by conventional cost measures such as the 'Prime Rate'?
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MAP Canada is hosting an event for young businesses on the 10th of May. Some great local entrepreneurs from successful public (and private) businesses will be there to speak and provide mentorship to the up and coming successes of tomorrow. Within a set of true luminaries, MAP Canada has also taken a humungous risk and invited your humble correspondent as a speaker. I hope that many of you will attend. My contribution to the festivities are supposed to address the question of 'How to Raise Capital for Your Business', so you know there will be some fireworks. This is a volunteer organization that deserves our support and it is always interesting to see where the community is headed economically. Lunch will also be served. Please register here


Finance News:

1. RBS - (Isn't this the bank that just bought ABN AMRO for $100B last year?) wants to raise $24B through a share offering. As Citibank comes out with bad news each quarter, RBS realizes that this is another arena in which to compete and comes out with really bad news ... read more here


Economic News:

1. After the credit crunch, comes the 'cereal crunch' (not my phrase, but genius nevertheless) ... read more here

2. Solar Power is coming to Ontario in a big (well, not too big) way ... read more here

3. Home sales in the US fall 2% in March ... read more here

4. The property market in Spain falters as well ... read more here


Islamic / Middle East / Emerging Markets:

1. Do you know if you are invested in a company that has helped create this problem in Afghanistan? ... If you don't know, isn't it time to ask yourself why not? ... read more here

2. Islamic Finance sector in 'danger'? ... Personally, I think we are beyond danger. The traffic on the highway with which IF is merging will swallow us whole ... read more here

3. How the Gulf States are spending their wealth this time around (the last time they were this wealthy was in the oil embargo days of the seventies) ... read more here


Interesting but not Finance:

1. I won't say much about this story except that it has to do with the key to the Kaaba ... read more here

2. The economics of the federal government's despicable policy on the seal hunt ... read more here