Global Risk / Global Opportunity

Ten Essential Tools for Tracking Minds, Markets & Money

Shlomo Maital and D.V.R. Seshadri

RISK

OPPORTUNITY

The Structure of this Book: Chapters Six to Ten

Chapter Six Money Talks - Interest Rates Listen
This chapter explains what money is, how the Central Bank controls the supply of money, how money and the rate at which it changes hands (velocity) determine economic momentum (GDP), and why velocity of money (the rate at which money changes hands) is a crucial and often-overlooked variable. It explains how Central Banks control interest rates and why tracking nominal (not adjusted for inflation) interest rates can be disastrously misleading.

Chapter Seven Tracking Booms and Busts

This chapter explains the forces that drive business cycles (periods of boom and bust), the link between demand components and recession and the role played by two key deficits -- the trade deficit and the budget deficit and how they interact. It explains the 20079 global downturn, and the link between prices of common stock with changes in the real economy. .

Chapter Eight Tracking Trade and Forex

This chapter shows how to analyze the crucial foreign-exchange cash flow performance of countries, using the Balance of Payments statement, and explains why official exchange rates may not reflect true currency value, how to gauge future changes in exchange rates, why exchange rates have become exceedingly volatile, and why global businesses need to carefully track and manage exchange-rate swings.

Chapter Nine Non-economic Risks

This chapter shows how there are many non-economic risks that a manager should simultaneously monitor, and either proactively make moves that mitigate their impact, or capitalize on the opportunities that they create. It presents three of the many important risks that managers must be aware of: Political risks, risks stemming from terrorism, and environment-related risks. Case studies of how great companies assessed and benefited from these risks are given.

Chapter Ten Country Due Diligence: Reading Between the Lines

This chapter provides a systematic checklist of questions that can help analyze the business prospects and potential of any country using the 10 essential macroeconomic tools and adding to them, non-economic factors related to culture, politics and ethics. The chapter explores such key issues as: ease of doing business, perceived lack of corruption and the four dimensions of global competitiveness. This checklist will help global managers systematically conduct due diligence examinations of new geographies, before expanding their organizations businesses into them.

The Structure of this Book: Chapters Six to Ten

Chapter Six Money Talks - Interest Rates Listen
This chapter explains what money is, how the Central Bank controls the supply of money, how money and the rate at which it changes hands (velocity) determine economic momentum (GDP), and why velocity of money (the rate at which money changes hands) is a crucial and often-overlooked variable. It explains how Central Banks control interest rates and why tracking nominal (not adjusted for inflation) interest rates can be disastrously misleading.

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Action Learning:

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Definition:
Varieties of interest rates Federal Funds: money lent overnight among commercial banks, in amounts of $1 million or more. Such lending is often done to meet reserve requirements of the Federal Reserve (see below), hence its name. Prime Rate: Base rate on corporate loans charged by the 30 biggest banks in the U.S. Certificates of Deposit: Rate paid by major New York banks on large-denomination CDs (Certificates of Deposit). London Interbank Offered Rates (LIBOR): average of offered rates for dollar deposits in London, among banks. Treasury bills: yield of 90-day US Govt. Treasury bills: under oneyear maturities. Treasury bonds have longer maturities.
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America's Central Bank: the "Fed

The United States' Central Bank is known as the Federal Reserve System -- known as the "Fed", for short, and "reserve", because it regulates the reserves held by commercial banks, that underpin the banks' lending activities, and actually holds those reserves as commercial bank deposits. It was first established by an Act of Congress in 1913 by President Woodrow Wilson. Monetary policy -- which controls both the quantity of money and credit and the rate of interest -- is set by a 12person committee, known as the Federal Reserve Open Market Committee (FOMC), which meets every six weeks. The chairperson of this committee - officially known as Chairman of the Federal Reserve Board of Governors - was Alan Greenspan, first appointed in 1987; he served for nearly 20 years. He was succeeded by the current Chair, Ben Bernanke, a former Princeton University economics professor, in Feb. 2006. The appointment is for four years, renewable.

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"the Federal Reserve (Fed) lowered the Fed Funds Rate today by 3/4 point to 3.5 percent, in the biggest cut in 18 years. It was a surprising move in that the group is scheduled to meet next week, when they were widely anticipated to lower rates. However, over worldwide fears that the United States is heading into or possibly already in a recession, the Fed got a jump on things and took this key interest rate down this morning in an effort to stimulate the economy."

Jan. 22/2008 ($ billion) Commercial Banks Assets Liabilities Reserves Loans Bonds S. Equity $1,000 7,000 1,000 1,000 Deposits $10,000

Assets Bonds $2,000 Reserves 1,000

Federal Reserve Liabilities Currency $1,000

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IMMEDIATELY AFTER (JAN. 23): $ billion Commercial Banks Federal Reserve Assets Liabilities Assets Reserves Loans Bonds S. Equity $1,100 7,000 900 1,000 ----------------Deposits $10,000

Liabilities

Bonds $2,100 Currency $1,000 Reserves 1,100

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Assets Reserves Loans Bonds S. Equity

ONE WEEK LATER (JAN. 30): $ billion Commercial Banks Federal Reserve Liabilities Assets Liabilities $1,100 8,000 900 1,000 Deposits $11,000 Bonds $2,100 Currency $1,000 Reserves 1,100

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Loans, Deposits

Reserves
Money and Credit Expansion. When Central Banks expand reserves (the red block), by buying bonds, commercial banks MAY then expand loans and deposits (money) by a multiple of the additional reserves (the yellow block). The question mark beside the yellow block emphasizes the word 'may' -- banks are not compelled to lend, and may for various reasons choose instead to hold the reserves rather than lend them. This in fact is 17 what has occurred.

The Table below shows the remarkable shift in the American commercial banks' reserve position between August 2008 (just before the collapse of the leading investment bank Lehman Brothers, on Sept. 15, 2008, and April 8, 2009: Reserves of Commercial Banks, U.S., Aug. 2008, April 2009 $ billion
Total Reserves $ 44,565 $861,537 Required Reserves Excess Reserves $42,571 $ 1,993 $56,733 $804,805

August 2008 April 2009

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Toolbox
Tool #1: Toolbox: Tool #6 Economic Momentum

Economic Momentum (GDP) equals Money times Velocity, or M x V

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Velocity

GDP
Money

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2007-I 9.9

2007-II 10.1

2007-III 2007-IV 2008-I 10.2 10.3 10.3

2008-II 10.3

2008-III 9.9

2008-IV 8.9

Figure 6.3. Velocity of Money (GDP/M1), United States, 2007 - 2008

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V 14,413
14,200

2008 3Q

2008 4Q

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Figure 6.5. Very short-term "Federal Funds" interest rates, U.S. 1952-2009
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country U.S. Japan China Britain Canada Euro Area India Brazil

nominal interest rate * real interest rate * 2.53 3.13 1.31 2.11 3.21 3.41 3.11 2.11 2.86 2.36 3.22 2.62 7.25 1.85 6.16 1.76

Table. Nominal and Real Interest Rates, 8 Countries, March 21, 2009

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%8
7 6

NOMINAL

5 4
3 2 1 0

REAL

Fig. 6.7

Nominal and Real Interest Rates, Selected Countries, March 21, 2009
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The ecology 4-markets model

goods market

capital market

labor market

foreign exchange market

Figure 6.8. The four-market ecology model

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J.M. Keynes radio broadcast

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