SIMES_Issue_1_2010

SimesSimesSimesSimes
Issue 1, 2010
SIMES Publications
For internal circulation only

Letter FROM The Editor
Greetings from ‘AL’. The joy of a new year is
sweetened by the uniform knowledge that the global
economic crisis of 2008/09 has been successfully kept at
bay. Mankind will not suffer another ‘Great Depression’.
However, the hand that pulled a veil over the mess have to
be removed sooner of later. In order to reduce future shocks,
governments and institutions alike should be looking into
improving prudence in two key areas: systemic regulation
and monetary policies. The issue of moral hazard should be
addressed appropriately to prevent a nose-dive of confidence
in a crisis. Maintaining the health of the global economy
would be meaningless without a healthier world to begin
with. Mankind have long been ignoring the wounds inflicted
upon our planet in his quest for personal gain. Since the
dawn of the 21st century, the forces of nature are fighting
back. Hence, we must remain aware and vigilant in our
efforts to promote ‘green technology’ and reduce pollution.
As a member of SIMES, I am proud to be apart of the
various activities that me and my colleagues have arranged
in the past year. As the new editor, I look forward to
contributions of articles by SIMES members in the future. If
one has an area of interest in economics to write on for the
next issue, please submit your draft by email to me at
arcane517@yahoo.co.uk by 1st March 2010. Thank you.
Contributers for Issue 1, 2010
AL Marzuki Anuar, Jonathan Sim, Tumy Buinguyen,
Larry Tan, Ho Zhenni
What is
SIMES?
• R e -
s e a r c h
on cur-
rent and
historical
e c o -
nomic is-
sues
• G r o u p
d i s c u s -
sions
• Speeche
s, semi-
nars and
c o n f e r -
ences
• Network-
ing
• Quarterly
newslet-
ters
To share
the passion
of econom-
ics!
page 2page 2page 2page 2 Issue 1, 2010Issue 1, 2010Issue 1, 2010Issue 1, 2010

Contents
SIMES Economics Week 2009 page 4
Economics Week Talk by Mr. Manu Bashkaran page 7
The Future of Regulation page 9
End of the Road for the US Dollar? page 15
The ‘Economics’ of Climate Change page 18
Alan Greenspan: Prelude to Power page 22
Economic Humour page 24
Issue 1, 2010Issue 1, 2010Issue 1, 2010Issue 1, 2010 page 3page 3page 3page 3

SIMES Economics week 2009
‘ECONOMANIA’
By Ho Zhenni
The ‘Economics Week 2009’ was the penultimate event in the society’s calendar
for the past year. It was held at SIM HQ on the 29th of October to the 5th of November
2009. We were honoured to host Mr. Manu Bashkaran, Vice-President of the Econom-
ics Society of Singapore. He gave an insightful talk titled ‘Is the economic recovery
for real, and what are its implications?’
For the highlight, our innovative Projects Department came out with a life-sized
Business Monopoly Game. In a nutshell, it involves modified rules of the standard mo-
nopoly board-game, played by teams of four. Much planning was involved – from
gritty little details of the game-play guide to the magnificent platform and models
placed at the school’s Atrium. The game received overwhelming response for partici-
pation. After tedious but fun-filled preparations, trials and briefings, the game went on
smoothly. It was played over two sessions – one in the morning and the other in the
evening – with eight teams in competition for the prize of Capital Mall cash vouchers.
The experience was rewarding for both participants and organizers alike.
Another feature of Economics Week 2009 was information panels describing the
‘Economic History of Singapore’. The objective of the academic venture was to show-
case a timeline of the development strategies, milestone and challenges faced by lead-
ers and institutions in shaping Singapore as it is today. Beginning with post-
independence of the 1960s, the information was categorised by decades. To test their
knowledge, students were given the chance answer daily quizzes.
Last but not least, SIMES collaborated with the SIM Photography Club, to ex-
hibit photos from the theme: ‘Capturing Economics in our Daily Life’. The photo-
graphs were of the highest creativity, capturing ‘a thousand words’ on everyday eco-
nomic life.
In conclusion, we were proud to bring the Economics Week 2009 to a higher
level in both the public’s appreciation of economics and the society’s achievement. We
would like to sincerely thank Mr. Lee Kwok Cheong (CEO of SIM), Ms. Patricia Lee
(Programme Executive, Student Activities and Special Interest Clubs, CCA Admin,
Student Life), Mr. Seet Min Kok (SIMES Advisor), staff of the Student Life Service,
SIMES EXCO members and others who helped make the event a major success.
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Page 6Page 6Page 6 Issue 1, 2010Issue 1, 2010Issue 1, 2010Issue 1, 2010

Economics week talk
Is The Economic Recovery For Real, and What Are Its Implications?
Speaker: Mr. Manu Bashkaran
There are signs of recovery in the immediate outlook. However, future shocks in
the medium-to-long term are unavoidable. Hence, governments and regulators must
develop dynamic resilience within the real economy and financial sector. Such meth-
ods may vary between countries (e.g. regulatory standards, political stability). The talk
about China superseding the US as a leader in global economic growth may be true in
the long run. However, the dependence by most on the US consumers and developed
financial markets for economic prosperity will continue for the coming years.
Possible volatile business cycle patterns in 2010 will be caused by drag effects
of monetary easing and fiscal stimuli by governments. Changes in business strategy
are necessary in the future of economic recovery. MNC’s may start to bring back pro-
duction from cheaper labour countries to advanced economies with larger domestic
markets. Currently, most MNC’s concentrate production in export-orientated countries
with relatively weak consumer demand for their products. They take advantage of
cheaper costs and export their produce to advanced economies where the bulk of mar-
ket share lies.
A shift in production closer to customer bases would indicate a de-globalisation
of businesses. To maintain healthy economic outlook, export-orientated and develop-
ing economies (eg: ASEAN nations) must alter their development strategy to be more
consumer driven. They should also strengthen inherent capacity, in areas such as value
-added production or skill base. Besides that, a more diversified domestic market and
robust financial sector would be incentives for foreign investors. Efforts for regionali-
sation among ASEAN members would be wise in order to pool markets. This can both
increase economies of scale and reduce vulnerability to demand shocks. (e.g.: from US
consumers)
There is no doubt that emerging market countries, noticeably Brazil, Russia, In-
dia, Indonesia, and China (BRIIC) will play a more important role in driving global
economic growth in the future. Subject to proper restructuring of regulations, rebalanc-
ing of surplus vs. deficit economies (e.g. US and China) and political stability, inves-
tors’ confidence in BRIIC can loosen the relative monopoly of financing held by West-
ern economies. There is much room for expansion in businesses within those emerging
economies if they drive consumer spending and develop their financial markets.

Biography of the speaker
A former Chief Economist and Chief Strategist for Asia un-
der Societe Generale Investment Bank, Mr Bhaskaran has devel-
oped an intimate understanding of major companies, sectors and
economies of the region. He is a well-regarded commentator and
columnist on Asian financial and economic affairs, speaking at
major conferences such as the World Economic Forum. He is also
a Council Member of the Singapore Institute of International Af-
fairs, which advises the Singapore Foreign Ministry. Mr. Bash-
karan is currently the director and CEO of Centennial Asia Advi-
sors, Singapore. He is also the Vice President of Economic Society Singapore and
Chairman of the society’s Corporate Events Committee. Mr. Bhaskaran has a Masters
degree in Public Administration from the John F. Kennedy School of Government at
Harvard University and a Bachelors degree in economics from Cambridge University.
He is also a qualified Chartered Financial Analyst.

The future of regulation
By AL Marzuki
The future of financial regulation has
been one of the major talking points since the
onset of the current global financial crisis. There
are claims that the crisis was triggered by a lax
in regulatory oversight, as the excessive risk
taken by banks with innovative instruments are
supposed to be ring-fenced by regulation. The
purpose of this article is to provide a general in-
sight on that argument, and pose suggestions by
intellects within the industry on the future of
‘financial policing’.
Pre-crisis regulatory framework
The prevailing Basel II Accord has been
the main regulating mechanism for the conduct
of banks. Commissioned in 2004, it consists of
three pillars: Minimum capital requirements
categorized by risk weights, adequate supervi-
sory review, and consistent disclosure of banks
activities. The risk weights on minimum capital
requirement vary across different types of invest-
ment, positively correlating with the degree of
risk. There are two methods of quantifying such
risk weights, one being a standardized approach
and the other, internal ratings based approach.
The former relies heavily on ratings of securities
by external agencies (eg: Moody’s). The latter
allows banks to utilise their own risk models to
rate their risk exposures. The first pillar ad-
dresses off-balance sheet activities by converting
them to credit exposure equivalents using an ar-
bitrary credit conversion factor.
Supervisory review applies more strictly
to market and operational risks than in Basel 1. It
recognises the responsibility of bank manage-
ment to not only set capital targets that commen-
surate with its risk profile, but also apply internal
controls to respond to adverse risk. Disclosure of
key components of a banks’ risk assessment and
scope of capital is required to enforce market
discipline on the banks’ decisions. The accord
allows national authorities to place supplemen-
tary measures on top of the minimum require-
ments stated.
However, two key points to note regard-
ing the Basel accord are that it relies heavily on
micro-prudential regulation and it exclusively
applies to banking activities. Micro-prudential
regulation is effective if financial firms exercise
diligence in their activities, and regulatory refer-
ences such as rating agencies provide correct re-
view of risk. These characteristics appeared to be
inadequate in years preceding the crisis. Finan-
cial institutions rode on incentive for short-term
profits from trading books in an environment of
easy credit.
Rating agencies were quasi-monopolists
in that ratings of securities were based on weak
methodologies. They are also free from litigation
and have relatively little competition. This in-
creases likelihood of such agencies making inap-
propriate ratings to please clients (eg: AAA rat-
ings on various securitised mortgages in light of
high credit risk of underlying securities). Finan-
cial innovation gave birth to shadow banking,
whereby hedge funds and insurance companies
can engage in banking activities outside the
regulatory jurisdiction of commercial banks. In
this respect, the complexities of financial activi-
ties overwhelmed micro-prudential regulation.
What about national regulators such as
the SEC and FSA? Why did they fail to foresee
the adverse risk permeating within the financial
sector? The answer may be due to easy credit,
underestimation of leverage ratios and several
pro-cyclical components of regulation. During
the upswing of the 90s, relatively loose monetary

policies flooded the market with liquidity. The
euphoria of the boom period underpriced risks
and increased gearing of financial firms at a
faster rate than the capital backing required to
insure against potential losses. The large propor-
tion of cross-border assets in banks balance
sheets combined with regulatory arbitrage al-
lowed certain portion of risk go unnoticed by
national regulators. Again, the ever-innovative
securitisation processes only widened the gap
between what markets can achieve and what
regulators can oversee.
Responses pertaining to regulation of the fi-
nancial industry
The clear and immediate decision by cen-
tral banks and national administration in major
financial centers worldwide is to prevent institu-
tions deemed as ‘too-big-to-fail’ to go bankrupt
by injecting rescue funds of epic proportions.
The argument behind the bailout was that it was
necessary to maintain the payment mechanism
and ensure credit does not freeze up. However,
markets are still filled with uncertainty, regard-
less of some rallies in the stock market. Such
‘sprouting greenshoots’ served only to point out
that a prolonged slump in the real economy akin
the Great Depression of the 30s have been
avoided.
Besides that, leaders from financial hubs
such as US and UK have recognised that finan-
cial liberalisation has brought the need for more
level field of regulations of cross-border finan-
cial activities. The emergence of G20 as a dis-
cussion platform for financial reform highlights
the fact that Western finance has failed to main-
tain stability in the financial industry. The Pitts-
burg summit produced the following consensus:
1. More stringent and wider scope of capital
requirements for off-balance sheet and secu-
ritised products.
2. Improve management of risk factors that cor-
relate positively with business cycles.
3. Greater disclosure and transparency from
parties whose actions have material impact on
risk-taking.
4. Align compensation packages with long-term
value creation and financial stability.
5. Reform of corporate governance to ensure
appropriate oversight on operational risk
6. Improve insolvency regimes to handle cross-
border bank failures.
The US, UK and EU administration are
currently working on changes in the responsibili-
ties of regulatory bodies. In the UK, there is a
debate on whether to increase the counter-
cyclical powers of the BOE, and if there need be
a separate organisation made up of government
officials overseeing bank bonuses. In the US,
Congress is mulling the creation of a Consumer
Protection Agency with powers to oversee all
financial companies with activities related to or-
dinary consumers. The EU plans to create three
pan-European regulatory bodies to oversee bank-
ing, insurance and securities markets across its
members. Moreover, there is need to clarify and
harmonise the regulatory scope of the SEC and
the CFTC pertaining to securitised derivatives.
The G20 and IMF have agreed to establish the
Financial Stability Board, whose primary role is
to collaborate with the IMF to warn central
banks of global systemic risk levels.

Potential solutions towards a more robust fi-
nancial industry
I shall divide the arguments into two
broad categories. The first being the increased
strength and scope of regulation within the exist-
ing structure of finance i.e. the business models
of banks and other intermediaries. The second
being to completely separate utility banking
from investment banking i.e. create narrow
banking as a new world order. We start by exam-
ining the first proposal.
The existing financial industry consists of
intermediaries and open markets. The bulk of
regulation applies to intermediaries because of
their mixed roles of providing a payment mecha-
nism to the public and channeling funds from
pools of lenders to borrowers. The role of banks
in transforming liquid funds to relatively illiquid
assets creates liquidity risk, the volatility of re-
turns from trade in financial markets creates
market risk, and the uncertain earnings of bor-
rowers create credit risk. The act of leveraging a
bank’s balance sheet is necessary to facilitate
financing, and desirable to provide profits from
investments. However, the use of complex finan-
cial derivatives and failure to manage risk from
leveraged positions can cause huge losses in the
event of external shocks. Worse, the systemic
nature of financial institutions can cause losses at
one bank to disrupt healthy banks, leading to a
liquidity crisis. The final result: payment mecha-
nism in jeopardy, businesses can’t obtain desired
credit, and the real economy falters. Which com-
ponent of intermediation needs attention from
regulators?
Micro-prudential regulation to prevent exces-
sive risk-taking
Securitised derivatives became an important fi-
nancing tool in the past decade. Some were used
in proprietary trading to earn profitable returns,
others used as hedge against potential risk. They
were created based on the basic logic of diversi-
fication of portfolios. However, regulators faced
more difficulty scrutinising the risk of the under-
lying securities. The dependence on rating agen-
cies proved useless; as such agencies provided
over-optimistic ratings. The general suggestion
is for a wider scope of capital requirements for
off-balance sheet items and securitised products.
Besides that, there should be limits on what un-
derlying assets are allowed to be included in a
securitised product i.e. standardisation of deriva-
tives. OTC transactions (which these days con-
sist of various securitized derivatives) should be
moved to clearing houses or exchanges. In that
way, they are exposed to higher market scrutiny.
Another area that needs to be addressed
is the process of pricing risk. Financial institu-
tions have the tendency of under-pricing risk
during upswings due to easy credit conditions
and optimistic views of investors. Hence, a
greater focus needs to be placed by regulators on
banks internal risk pricing models. New trans-
parency requirements should be imposed on
banks’ pricing of tradable assets. Investors
should be wary of wide gaps between fundamen-
tal prices and market prices of securities.

Adequate capital buffers against lever-
aged positions of institutions need to be re-
viewed. Besides increasing minimum capital ra-
tios, deeper scope of risk-weights needs to cover
not only different types of securities, but also
different borrower classes. Banks should be re-
quired to hold contingent capital, a form of in-
surance that automatically converts into common
equity upon the trigger of a fixed threshold set
before the bank faces insolvency. The proposal
states that if Tier 1 capital falls below the thresh-
old amount, the conversion would take place.
This way, there is greater incentive for banks not
to over-leverage within their activities. Existing
Tier 2 capital would only cover losses after the
insolvency of banks, which does not provide
enough discipline to banks. On another note, in-
troducing leverage ratios alongside capital ratios
can reduce the risk exposure of banks’ activities.
In response to the bailouts of certain
large banks by governments in the past year,
there have been claims that the ‘too-big-to-fail’
policy is ‘too-good-for-banks’. Large banks
whose functionality governments deem impor-
tant to the real economy cannot be allowed to go
insolvent. This means such banks, which usually
have extensive proprietary trading alongside util-
ity functions, are subject to moral hazard. They
have the incentive to over-extend their risk as
profits will be reaped but losses will be guaran-
teed by the government (with taxpayers behind).
Allowing such banks to fail would reduce moral
hazard and help increase banks’ own prudence in
risk-pricing and risk management.
Excessive compensation packages have
been blamed for contributing to excessive risk-
taking and over-leveraging of balance sheets.
Categorised as a service sector, the financial in-
dustry is mainly performance driven. Institutions
award bonuses to executives based on their abil-
ity to create positions that increase profitability
of the firm. However, two characteristics of
compensations exacerbate risk-taking. Firstly,
there is at least as much emphasis placed on
short-term compared to long-term profits. Since
receiving bonuses sooner is better than later,
there is a tendency to trade long-term value crea-
tion for short-term profits. Secondly, there is an
unequal playing field of compensations between
proprietary trading and risk management. We
seldom hear of employers within the risk man-
agement department enjoying bonuses as big or
as often as those on the trading floor. Logically,
the incentive for better risk management will not
align with that for greater risk-taking. Hence,
regulation that limits short-term remunerations
on trading positions and align compensations of
trading and risk departments should be given fo-
cus.
The recent announcements by the US,
UK and French administrations regarding bank
bonus couldn’t come sooner. The UK has set a
50% tax on bonuses exceeding GBP25 000
within all banks up to April 2010, with the op-
tion of extending the period if banks attempt to
defer bonus payments to escape the ‘super-tax’.
The French are considering the same model. The
US has slapped a 90% tax on bonuses within
banks in receipt of TARP. In addition to taxes,
some parties within the EU have suggested creat-
ing a pay policy for employers, effectively cap-

ping bonuses. Although this appears to be an
ideal scenario, it would receive massive opposi-
tion from the financial industry. The tax has al-
ready drawn the wrath of UK bankers, and there
have been warnings that the city would lose fi-
nancial players to other countries. This can occur
due to regulatory arbitrage, which is our next
point.
Regulation of financial institutions can be
ineffective in this day and age financial liberali-
sation due to regulatory arbitrage. It is the Achil-
les Heel of all national regulatory bodies. Some
countries have larger financial markets (eg: US,
UK), while others rely more on banks to channel
funds (eg: EU, Japan). There is also a gap in in-
frastructure for regulations in different countries,
more noticeably between developed and emerg-
ing economies. A stricter and wider regulation
net in one country may induce financial firms to
move their businesses to a relatively stable coun-
try with less regulation capabilities/requirements.
Hence, greater uniform regulatory standards
across countries need to be adopted to ensure
efficient ring-fencing of risky activities.
Macro-prudential regulation to reduce sys-
temic risk
A major threat facing financial institu-
tions in an interconnected global industry is sys-
temic risk. The losses caused by a failure of any
single bank can permeate through the system,
creating a domino effect that threatens the sol-
vency of healthier institutions. This is mainly
due to uncertainty amongst investors and deposi-
tors alike. The probability of systemic losses in-
creases with the reliance on inter-bank loans to
facilitate funding and the act of institutions un-
derwriting each other’s investments. The exist-
ing ‘too-big-to-fail’ policy intended to prevent
the worse of systemic risk actually increases risk
-taking via moral hazard, as mentioned above.
Hence, other methods have been proposed.
Financial institutions should make ‘living
wills’, documents that dictate the resolution of
the firm in the event it faces losses amounting to
potential insolvency. A ‘business resolution’ of-
ficer should be assigned to conduct an orderly
wind-down of the bank. This includes liquidating
assets, selling off unprofitable business compo-
nents and replacing management. Besides that, a
separate trustee for clients’ assets should be
given the responsibility of getting as much
money back to lenders in the shortest period of
time. In the UK, for example, there have been
calls to create a client assets agency within the
FSA that helps trustees segregate and protect
lenders’ funds during banks’ insolvency. The
rationale behind ‘living wills’ and ‘trustees of
assets’ are to reduce systemic fear within the
public, hence maintaining relative stability in the
system.
Monetary policies should aim not only to
maintain inflation expectations, but to tame busi-
ness cycles. As business cycles often correlate
positively with credit cycles, central banks
should control credit growth during boom peri-
ods and increase credit during slumps. The

worse of the financial crisis has been prevented
so far partly due record low interest rates to en-
tice lending (though not good for future inflation
expectations). If monetary policy was relatively
tight during the past boom, the probability of as-
set price bubbles and under-pricing of risk could
have been reduced. Credit growth is no doubt
desirable for economic growth, but if gone un-
checked, creates complacency against risk in
both investors and intermediaries.
Regulators can help tame credit cycles by
varying minimum capital requirements on banks
over the course of the cycle. In other words, in-
stitutions should use extra capital gains enjoyed
during upswings to strengthen their capital base
(counter-cyclical buffers), instead of refinancing
more risky investments or ballooning bonus
pools. Central banks should share crucial macro-
economic forecast with regulators in order for
the latter to regulate based on the collective im-
plications of individual decisions i.e. promote
dynamic resilience. This is to consolidate the de-
risking effects of capital buffers and prudent risk
management within banks.
Narrow banking
The proposal to separate utility banking
from investment (casino) banking has received
much flak from both governments and financial
firms. In a crux, advocates of narrow banking
claim that regulation will always lag behind fi-
nancial innovations and incentives, as executives
attempt to circumvent regulation. The big idea is
that utility banking would require insuring de-
posits with low risk liquid assets, such as gov-
ernment bonds i.e. 100% reserve banking. These
deposits can only be used for payment purposes,
instead of a portion going to leverage trading
positions. Banks will be forced to hold as much
liquid and safe assets as their liabilities. Among
the implications of narrow banking are that the
supply of funds to riskier, long-term business
activities would be reduced. Trading activities
would be backed by equity funding as opposed
to consumer deposits and other liabilities.
The idea of narrow banking has not re-
ceived much support because of problems draw-
ing a clear distinction between utility and invest-
ment functions (e.g.: in hedging). It remains un-
clear whether a Glass-Steagall type banking
structure would prevail in the future.
Conclusion
The restructuring of regulation remains a
daunting task for any administration. However,
what remains clear is that: 1. Regulators must
lean more on macro-prudential supervision to
address systemic risk. 2. Regulatory arbitrage
must be avoided. 3. ‘Too-big-to-fail’ policies
should be diminished to prevent moral hazard,
instead replaced by orderly wind-down of failed
institutions. Many people claim that there will
always be ways to circumvent regulatory frame-
work. Hence, regulators must practice more dy-
namic resilience instead of merely setting rules.
They must be especially vigil during boom peri-
ods where optimism encourages excessive risk-
taking.
References: The Edge (Malaysia) 1st
edition
2010; The Star Biz Week (Malaysia) 1st
edition
2010; Financial Times special report on G20
Pittsburg summit; Basel II Accord (June 04);
Risk.net interview with Stefan Walter (sec-gen
of Basel II Committee); Ft.com interview with
Prof John Coffee (Columbia Law School);
Ft.com debate on future of finance @ London
Stock Exchange (5th
Nov 2009); Jean-Claude
Trichet speech courtesy of The Economist
(London, 11th
Dec 09); Mervyn King speech
(Edinburgh, 20th
Oct 09); Paul Tucker speech @
Barclays Annual Lecture (London, 22nd
Oct 09);
The Future of Finance column @ Ft.com

End of the road for the
greenback?
By Jonathan Sim
It seems that many economists are predicting
the collapse of the US dollar. Picture this: The
U.S. government is currently suffering from a
twin deficit. It runs the largest current account
deficit in the country’s history. It coincides with
a large decrease in government savings in the
U.S. i.e. ballooning fiscal deficit. The current
account deficit has been financed mainly by
sales of U.S government debt to foreign central
banks, especially to East Asia. Most economists
agree that the current size of the U.S. current ac-
count deficit is unsustainable. As if that is not
enough, the U.S faces a huge task of absorbing
the extra liquidity it injected into the financial
system in the form of stimulation packages and
the very threat of rising inflation.
In the most profound financial change in re-
cent Middle East history, Gulf economies are
planning – along with China, Russia, Japan and
France – to end dollar dealings for oil, moving
instead to a basket of currencies including the
Japanese Yen and Chinese Yuan, the euro, gold
and a new, unified currency planned for nations
in the Gulf Co-operation Council, including
Saudi Arabia, Abu Dhabi, Kuwait and Qatar. So
is this the end of the road for the U.S dollar?
A dollar collapse occurs when the value of
the currency falls so fast that all those who hold
dollars panic, and sell them at any cost. In this
scenario, sellers would include foreign govern-
ments who hold U.S. Treasuries, traders in ex-
change rate futures who trade the dollar versus
other currencies, and individual investors who
demand assets denominated in anything other
than dollars. The collapse of the dollar means
that everyone is trying to sell their dollar-
denominated assets, and no one wants to buy
them, driving the value of the dollar down to
near zero.
There are good reasons to expect a dollar
decline, perhaps even a sharp drop as markets
start to pay attention to trade numbers again. In
1985, when the U.S. current account deficit was
about the same share of GDP as it is today, a re-
vision of market perceptions caused a deprecia-
tion of USD exchange rate from 240 to 140 Yen,
from 3.3 to 1.8 Deutsche Marks. In today’s
world, there exists a new element which could
amplify dollar decline and cause a truly dramatic
plunge: balance-sheet domino effect. According
to people who ought to know, the ‘carry trade’
that did so much to drive exchange rates last fall
is back in force: a relatively small group of
highly leveraged investors have borrowed in Yen
and invested the proceeds in higher-interest dol-
lar assets. Should the dollar fall sharply, they
will suffer losses - which will force them to con-
tract their balance sheets, selling dollars, and
driving the currency lower still, in what could be
a massive overshoot.
Rube Goldberg effects - mechanical linkages
via balance sheets, producing predictable mis-
pricing – are not supposed to happen in an effi-
cient financial market. Efficient markets theory
would tell us that in the face of an excessive de-
preciation of the dollar, investors would recog-
nise the long-term profit opportunity and buy

greenbacks en masse - long-sighted Buffett’s
compensating for the balance-sheet problems of
the hedge funds. Well, maybe - but maybe not.
Yet again, to the sceptics out there - Curren-
cies rise, currencies fall. Isn't it a zero-sum game,
and for that matter aren’t the stakes pretty small
in any case? Well, in general, yes. Even if we are
now facing an unsustainable dollar overvaluation
comparable to that of early 1985, those who are
well-read enough recall that despite grim warn-
ings of an impending ‘hard landing’, the correc-
tion of that overvaluation was almost entirely
benign. However, matters are a bit different now,
because we start from a different place. Argua-
bly, the state of the global economy right now is
such that a sharp dollar decline would be con-
tractionary almost everywhere.
To understand why, bear in mind that a
currency depreciation (or, more strictly, a revi-
sion of expectations leading to a currency depre-
ciation), with the exchange rate being an endoge-
nous variable, constitutes a positive demand
shock and a negative supply shock to the depre-
ciated country. It is a positive demand shock be-
cause the country's goods become more competi-
tive in world markets; it is a negative supply
shock because import prices increase. The reason
to be concerned about a sudden dollar decline,
then, is that it so happens that the United States
is currently a supply-constrained economy, while
much of the rest of the world is demand-
constrained. So the net effect is negative almost
everywhere.
In the United States, where wages are finally
beginning to reflect a ‘more than full employ-
ment’ labour market, a sudden dollar decline
would at least threaten to produce a wage-price
spiral - and the mere threat would mean that the
Fed would likely be forced to raise interest rates.
Whether this would lead to a substantial contrac-
tion is unclear - who the heck understands aggre-
gate supply behaviour these days? Regardless, a
dollar decline is certainly not positive for the
U.S. right now.
As for the rest of the world, demand
shocks from a currency appreciation are nor-
mally easy to deal with: just cut interest rates,
which among other things limits the apprecia-
tion. But of course Japan is firmly in a liquidity
trap, and cannot cut rates; the Euro-zone is not in
a liquidity trap, but a sufficiently sharp dollar
decline could put it into one. The only places
that clearly benefit from a weaker dollar are de-
mand-constrained economies pegged to the dol-
lar.
Try to remember what is taught in open-
economy macroeconomics. Such a situation tells
us that starting from where we are right now - a
U.S. economy at or beyond capacity, a large part
of the rest of the world well below capacity, and
in or near a liquidity trap - a drop in the dollar
will be a global contractionary force. How strong
a force? Well, it depends on the drop; if markets
were to force the U.S. to move rapidly to current
account balance or beyond, the numbers would
be very troubling. This is unlikely, I think; but
then serious crises usually are, ex-ante.
Yet with all the doom and gloom, several
conditions must be in place before the dollar
could collapse. First, there must be an underlying
weakness. Second, there must be a viable cur-
rency alternative for everyone to rush into.
Third, a triggering event would need to occur.
The first condition does exist. The dollar
declined 40% against the euro between 2002 and
2009. The alternatives for replacing the dollar
look pretty weak. The Euro has its own set of
long-term problems, in some ways more severe

than those of the dollar. Over the next decade or
two, Europe will be dealing with a declining
population, a lack of defensive capability, social
unrest due to immigration and cultural segrega-
tion and the fiscal cement shoes of an out-of-
control welfare state. Nor is the yen ready for
prime time, with Japan's economic behaviour
erratic and the Bank of Japan viewed as incom-
petent. China's Yuan, according to Professor
Nouriel Roubini, of New York University's Stern
business school, is preparing to overtake the US
dollar as the world's reserve currency. Known as
‘Dr Doom’ for his negative stance, Mr. Roubini
argues that China is better placed than the US to
provide a reserve currency for the 21st century
because it has a large current account surplus,
focused government and few of the economic
worries the US faces. Other economists on the
other hand argue that the Yuan is not yet sup-
ported by a fully functional financial infrastruc-
ture and has too long been pegged to the dollar
to suddenly go it alone. As for the third condi-
tion, only time will tell.
On our way to a post-collapse, post-
dollar world (if it ever happens), the fall of the
dollar might just be the beginning of the rise of
Asia. Asia has the 'second mover advantage' of
being privy to all the Western World's mistakes.
They are able to see where profligacy and run-
away entitlement programs have led. Their top-
down orientation will enable them to rein in ex-
pensive entitlement programs or, better yet, cur-
tail young ones before they grow bigger. Not be-
ing as mentally and emotionally tied to the work-
ings of empire and the capitalist welfare mental-
ity, Asia will successfully cut the cord faster. In
doing so, Asia will also rely on its citizens' natu-
ral propensity to trust precious metals and hoard
them as a store of value in the first place.
So is this the end of the road for the U.S
dollar? It seems like a long and uncertain road
ahead.
References:
The Twin Deficits in the United States and the
Weak Dollar. http://www2.hu-berlin.de/hiti/w/
upload/pdf/hiti_bericht_6en.pdf
The demise of the dollar. Robert Fisk.
http://www.independent.co.uk/news/business/ne
ws/the-demise-of-the-dollar-1798175.html
Is the Collapse of the U.S. Dollar Imminent?
K i m b e r l y A m a d e o .
http://useconomy.about.com/od/criticalssues/p/d
ollar_collapse.htm
Crisis of the U.S. Dollar System. F. William
E n g d a h l .
http://www.globalresearch.ca/index.php?context
=va&aid=3482

The ‘economics’ of
climate change
By Tumy Buinguyen
Over the past decade, the frequency and
severity of natural disasters have increased.
From the South/South-East Asian tsunami to
Hurricane Katrina, warning signs of impending
disaster could not prevent catastrophic losses.
The real economy has received more attention
than the fragility of the environment, and man-
kind may face the consequences sooner than ex-
pected. Studies agree that over the next century,
in the absence of emission control policies,
global temperature would increase on average by
3 degrees Celsius.
So far, the world has only one legally
binding treaty to mitigate adverse effects on the
climate, the Kyoto Protocol (KP). KP aims at
reducing green house gases emission to an aver-
age of 6%-8% below 1990 level for ‘the first
emission budget period’, which is between 2008
and 2012.
According to Stern Review, a well recog-
nised economics study conducted by Nicholas
Stern, former Senior Vice President of World
Bank; the cost of doing nothing is higher than
the cost of mitigating emission and adapting to
the remained consequences. Potential economic
consequences of climate change include produc-
tivity changes in agriculture and other climate
sensitive sectors (e.g.: fishing, tourism), damage
to coastal areas, stresses on health and water sys-
tems, change in trading patterns and international
investment flows, financial market disruption,
increased vulnerability to sudden adverse
shocks, and alter migration patterns.
This year, 192 countries came together to
the Copenhagen Summit (7-18 December 2009)
to negotiate a global solution and commitment
for the period after 2012. The concerns of 3 main
groups emerge: The developed countries, re-
sponsible for 80% of the accumulated green-
house gas stock over centuries of polluting
which lead the world to current risks of climate
change. Secondly, the emerging economies
(BRIIC) that are envisaged as future big pollut-
ers, therefore, are under pressure from advanced
countries to cut their emission even though they
are still developing countries. Last but not least
are developing countries such as African and is-
land nations whose emissions are miniscule
compared to the two groups above but are ex-
tremely vulnerable victim for consequences of
climate change.
Physical estimates confirm that in Africa
and Asia, almost 1 billion people would experi-
ence shortages of water by 2080, more than 9
million could fall victim to coastal floods, and
many could face increased hunger. Pacific island
countries are perhaps the most immediately vul-
nerable among the poor countries, as further
rises in sea level would dramatically affect their
environment.
The Copenhagen process was far from
smooth. After ten days of mismatched demands
and indirect accusations over emission cutting
and appropriate funding, the conflicts of interest
lead to no consensus. The Copenhagen Summit
of 192 Countries end up with a draft called
‘Copenhagen Accord’ written by only 5 coun-

China and India press on for the 2 degree target.
Eventually, the Accord came up with 2 degree
target in favor of the ‘Accord writers’. The vul-
nerable countries accused it as a ‘suicide pact’.
In future assessment of the Accord by 2015, a
1.5 degree limit would be considered as a long-
term target.
Submission of Commitment
Not having any legally binding treaty is
the biggest failure of the Summit. The amount of
emission cuts in proposed pledges by countries is
seen inadequate by scientists. Throughout the
negotiation, countries accused each other for put-
ting too little national emission targets on table
but they themselves are not willing to raise their
own. Negotiations came to a deadlock. This
raises concern for the environmentalists: will the
2 degrees target be met?
The deadline to legally bind the treaty is
still uncertain but the cost of waiting is high. The
International Energy Agency found that each
year of delay in the climate fight will add $500
billion annually to the tab. An international
agreement to curb the dangerous impacts of
global warming largely depends on the two key
players: US and China. Serious progress on
curbing carbon emission between US and China
may happen only when, and if, Congress passes
a climate bill.
The bill is likely to include a border tax,
which is set by the countries with relatively more
stringent carbon pricing to retain competitive-
ness of domestic output. This may apply heavily
on Chinese imports if China fails to take suffi-
cient emission reduction actions by a certain
date. It would also create a cap-and-trade market
for GHG emissions in China, opening up eco-
nomic opportunities for ‘green technology’. Un-
der cap-and-trade system, the government sets a
cap on the amount of pollutants that can be emit-
ted. Firms hold the rights to emit up to a certain
amount based on allowances. Allowances are
bought by firms who need to pollute more from
those who pollute less as the aggregate amount
tries: US, China, Brazil, India, and South Africa.
It does not set a deadline to complete, by the end
of 2010, the international treaty that will go into
force after the first commitment period for the
Kyoto Protocol, nor does it specify what legal
instrument will extend or replace the Kyoto Pro-
tocol.
There was no final agreement by all par-
ties to the UN Framework Convention on Cli-
mate Change, which means that the countries
can freely to choose whether it should follow or
not. So what does the Accord do? It sets the
emission target for the next decade by 2 degrees,
sets deadline for submission of countries emis-
sion target for 2020 on 31 Jan 2009, establishes
financial mechanism and technology mechanism,
decides to pursue various approaches for mitiga-
tion and adaptation, and calls for assessment of
the Accord by 2015.
Summary of the Copenhagen Accord
The 2 Degrees Celsius Target
Facing climate change affecting their sus-
tenance, the developing countries (other than
China and Brazil), especially the African bloc
and other vulnerable island nations insisted on
1.5 degrees limit. However, arguing that the ac-
cumulated stock of GHG emission on the atmos-
phere is already enough to guarantee a rise of 1.4
degrees over next decade, developed countries,

of carbon emission cannot exceed the predeter-
mined cap.
Funding for Adaptation
The cost between 2010 and 2050 for
adapting to an approximately 2 degree rise in
global temperature is estimated in the range of
$75 billion to $100 billion a year. So far, the cur-
rent financing flows to developing countries
cover less than 5% of the estimated amounts that
would be needed over several decades. More-
over, a majority of the funds are channeled to
leading emerging economies (e.g.: China, India),
leaving an insufficient share to poorer countries
with greater environmental degradation.
To meet the demand, COP 15 has suc-
cessfully called for quick-start adaptation fund of
annual UD$10 billion for 3 years with balanced
allocation between adaptation and mitigation.
Funding for adaptation will be prioritized for the
most vulnerable developing countries. More en-
couragingly, in the context of meaningful mitiga-
tion actions and transparency on implementation,
developed countries commit to a goal of mobiliz-
ing jointly USD 100 billion a year by 2020 for
the need of developing world.
The US repeatedly emphasised transpar-
ency as the vital criteria for the access to long
term funds. Instead of keeping explicitly refusing
allocating funding toward China as it had done
during the negotiation process, at the time of set-
ting the deal, US uses the bureaucracy as an ob-
stacle to the rival emerging economies. Hillary
Clinton firmly stated“…if there is not even a
commitment to pursue transparency…there will
not be that financial commitment (by US)”.
The Summit also gave introduction of the
Reduction of Emissions from Deforestation and
Forest Degradation (REDD), base on the ac-
knowledgement that deforestation accounts for
about 17% of emission, and is often reckoned as
a particular cheap form of abatement.
Approaches to Mitigate Carbon Emissions
The Accord emphasised the importance
of using the market as an effective approach,

which may be established through carbon pricing
and insurance. While the financial crisis reduced
business confidence and tightened credit
amongst financial institutions, the global carbon
market doubled to USD 126 billion in 2008 com-
pared to 2007. Carbon pricing can be imple-
mented through carbon taxation. A carbon tax is
simply one levied at a specific rate on all emis-
sions, which could be charged on fossil fuels
themselves. It has been applied successfully by
eco-tax leaders such as Denmark, Netherlands,
Norway and Sweden. Indonesia is envisaging a
carbon tax in 2014. However, carbon tax is not
likely to commit to a certain standard of emis-
sion.
The prominent advantages of cap-and-
trade are its certainty and effectiveness in keep-
ing emission at a predetermined rate. Under
Kyoto Protocol, EU set up the Emission Trading
Scheme, which is an international cap-and-trade
system, projected to reduce emission by 2.4%
compare to a business-as-usual scenario by 2010.
The volume of trading in the market was about
1.6 billion tons of CO2 in 2007 and was valued
at about 28 billion euro. The US draft of climate
legislation also provides the provision of cap-and
-trade system, in order to commit to its pledge of
cutting emission it proposed at Copenhagen
Summit. However, there are 2 main design flaws
in this system: the volatility of allowance price
and the high share of free allocations.
There are some ways to overcome the
severe price fluctuation. One option is to include
a safety-valve mechanism, under which the regu-
lator authorized to sell whatever additional al-
lowances to prevent allowance’s price rising be-
yond the certain ceiling price. Another option is
to allow firms to borrow permits from the gov-
ernment during periods of high permit prices and
to deposit such permits when there is downward
price pressure. Those could help to stabilise the
market for permits while also provide greater
confidence in the achievement of longer-run
emission goal.
Full fiscal benefits of cap-and-trade re-
quires that rights be sold, not allocated freely.
The EU-ETS and a recent US proposal have
been marked by extensive ‘grandfathering’ of
emission rights (allocating them to firms without
charge in amounts based on their past emis-
sions). This risks undermining incentives to miti-
gate. Firms will be less inclined to abate if they
feel this will reduce their future free allocation,
but forgoes a sizable benefit to the public fi-
nanced- US$130-370 billion in 2015 for the re-
cent US proposal.
Insurance is another form of market base
other than carbon pricing. Disaster losses could
reach over USD 1 trillion in a single year by
2040. In that context, insurance emerged as a
high priority for developing countries in adapt-
ing to climate change in the sense of enhancing
financial resilience to external shocks and pro-
viding a unique opportunity to spread and trans-
fer risk.
Possible cost-effective insurance initia-
tives are weather derivatives, catastrophe (CAT)
bonds, multi-state risk pooling mechanisms, in-
ternational insurance pool. The insurance pay-
ment is typically triggered by the occurrence of a
natural event of a certain magnitude (e.g.: a cer-
tain wind speed), rather than by a calculated of
the losses suffered.
Conclusion
Regardless of its shortcomings, the Co-
penhagen summit does make progress in calling
for the participation in cutting emission of US
and major emerging countries. Hopefully, seri-
ous commitments of all the governments in
working toward a long-term solution remain.
References: Copenhagen Climate Coun-
cil, The Fiscal Implications of Climate Change.
(imf.org), US and China Trade Taunts at Sum-
mit. (Politico.com), World Economic Outlook,
April 2008 (Chapter 4: Climate change and the
global economy)

Alan greenspan:
prelude to power
By Larry Tan
“I guess I should warn you, if I turn
out to be particularly clear, you've probably
misunderstood what I've said.” The 20th
cen-
tury marked the success of one pandering politi-
cian and clever opportunist: Alan Greenspan,
one of the most influential economist and admin-
istrator ever.
Greenspan’s success was partly due to
good timing. He reached maturity at mid-
century. His strengths attracted an America in
which the process of thinking was changing.
He grew up in New York City, a me-
tropolis that illuminates the changing tendencies
and aspirations of Americans. Greenspan spent
his young adulthood near or on Wall Street. Af-
ter graduating from New York University in
1948, he took a job at the Conference Board. He
received a master’s degree from NYU in 1950;
then studied economics under Arthur Burns at
Columbia University. The two become lifelong
friends. Arthur Burns served as a chairman of the
Council of Economic Advisers under President
Dwight D. Eisenhower. He would then become
Federal Reserve chairman under President Rich-
ard Nixon. Greenspan headed President Gerald
Ford’s Council of Economic Advisors when
Burns was Federal Reserve Chairman.
Greenspan is sometimes described as a
disciple of Ayn Rand’s Objectivist philosophy or
as a libertarian. However, he may not even have
understood what Rand was talking about. Na-
thaniel Branden, who was closest to Greenspan’s
mind during this period, reflected decades later:
“I wondered to what extent he was aware of
Ayn’s opinions.” Admirers of Rand, however,
generally see Greenspan as a traitor, since he
never advocated anything that approaches Rand's
absolute laissez-faire capitalism. Alan Greenspan
was not philosophical; he was practical and,
either by nature or design, vague, remote, and
impenetrable.
Greenspan used his Randian acquaintan-
ces to climb the political ladder. He joined Mar-
tin Anderson’s policy research group during
Richard Nixon’s 1968 campaign for the presi-
dency. Anderson, who travelled in Objectivist
circles, later introduced Greenspan to Ronald
Reagan.
Soon after, Greenspan was riding the
wave of the growing influence of accredited
economists. By the late 1950s, Greenspan’s
stock market predictions and economic forecasts
were quoted in Fortune and the New York
Times. His forecasts were usually wrong, as are
those of most economists. Accuracy was less
important than publicity.
Observing that Federal Reserve Chair-
man William McChesney Martin, Jr. lost the
fight against inflation, Greenspan seemed to un-
derstand that permanent, underlying inflation
supported asset prices. In 1959, he told Fortune
than an ‘artificial liquidity in our financial sys-
tem’ could power an explosive speculative
boom. According to the Fortune reporter, Green-
span reasoned that with Federal Reserve: money
supply never really got short. With one eye nec-

essarily cocked towards politics, the Fed has al-
ways maintained a more than adequate money
supply even when speculative booms threaten.
Richard Nixon was introduced to Green-
span during the 1968 campaign. The candidate’s
evaluation: “That’s a very intelligent man.”
Greenspan was nominated by Nixon as Council
of Economic Advisers chairman in 1973. Gerald
Ford was president when Greenspan passed his
confirmation hearing in 1974.
This was an ideal time for a pub-
licity-minded economist to enter government. It
was the same time that Time introduced People
magazine. Greenspan, who had cultivated the
press for many years, moved his portrait on to
the front cover of Newsweek – the first econo-
mist to gather such attention. Greenspan set an
example that flattery could get one anywhere.
Greenspan is classified as a Republican.
In practice, however, his flattery was nonparti-
san. At the 1980 Republican convention, Green-
span almost corralled Ronald Regan into offer-
ing him the position of treasury secretary.
Remaining in the public eye during the
early Reagan years, he was called a
‘superstar’ (New York Times) on the speaking
circuit, making 80 speeches a year for up to
$40,000 a speech. His record, however, as an
economic forecaster was unimpressive. Senator
William Proxmire castigated the nominee at
Greenspan’s Federal Reserve confirmation hear-
ing in 1987. He recited Greenspan’s economic
predictions as CEA chairman. His Treasury bill
and inflation forecasts were the worst of any
CEA director.
Nobody contributed more to the concen-
tration of finance than Alan Greenspan. As Fed-
eral Reserve chairman, Greenspan, who had re-
cently resigned as a director of J. P. Morgan to
take the post, permitted Morgan to underwrite
debt, then equity – the first time either had been
permitted by a commercial bank since 1933.
The capital foundations were growing
unstable. Greenspan could (and would) salute the
economy’s flexibility. The economy was, in fact,
vulnerable to collapse and needed constant infu-
sion of money and credit to sustain it. Hands
trembled at the word ‘recession’, and rightfully
so: balance sheets – government, corporate, and
personal – were no longer constructed to weather
a storm. This was capitalism with little respect
for capital.
An error-prone but malleable Federal Re-
serve chairman was a predictable choice for the
most influential financial position in the world.
References: Nathaniel Branden, My Years with
Ayn Rand, (San Francisco: Jossey-Bass, 1999)
p.160
Business Week, 16-Dec-2002, DETAILS: The
Future of the Fed -- The Greenspan Legacy --
The Big Changes Ahead
Gilbert Burck “A New Kind of Stock Market”
Fortune, March 1959 p 201
Justin Martin, Greenspan: The Man behind
Money (Cambridge, Mass, Perseus, 2000) p. 69
Committee on Banking, Housing, and Urban Af-
fairs Transcript, July 21, 1987, p41
Frederick J. Sheehan, Panderer to Power: The
Untold Story of How Alan Greenspan Enriched
Wall Street and Left A Legacy of Recession.

Economic humour

A special message
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