Bank Liabilities Overwhelm GDP

This figure comes by way of FT Alphaville, and charts the ratio of outstanding bank liabilities to national GDP for Eurozone and G10 countries.

These measures are important because they are an integral part of the bail out process. Governments hoping to backstop their bank's debt must have a national income that can offset balance sheet losses. Once these liability levels start rocketing above the 100% level (outstanding debts exceeding GDP) individual banks become too big to save.

With the economic glitterati in Davos, let's take a look a Switzerland. According to FT, UBS has a balance sheet of $2 trillion and Credit Suisse has about another $1 trillion. While not fully all of these assets are distressed (credit worthy borrowers are still repaying loans), this $3 trillion exposure is some 10 times the Swiss economy.

There has been plenty of deserved blame leveled against the US, and this chart is surely of little comfort to bankers in America. Still, take note of that much smaller block on the right.

Davos Reveals Big Currency Challenges

On Wednesday, Russian Prime Minister Vladimir Putin stood before a smarting crowd in Davos, Switzerland and warned against the reliability of the US dollar (USD) as a reserve currency. Russian officials, and Mr Putin in particular, aren't always the most reliable economic soothsayers. Still, these comments were reflective of a general unease at this week's World Economic Forum.

Indeed, it seems everyone would like to figure out what is happening in foreign exchange markets. This past year saw an epic collapse for the pound sterling (GBP), mounting concerns about the viability of the euro, the staggering free fall of the Russian ruble, and the sharp appreciation of the Japanese yen (now at a 14 year high). In the United States, new Treasury Secretary Tim Geithner even challenged the dollar's exchange rate with the Chinese yuan, formerly a political taboo.

Such renewed focus on currencies is not surprising. With central banks the world over trying to breathe life into the domestic economies, monetary policy is having major forex implications. For managed and free-float currencies alike, the global crisis is giving economic ministers fits. Efforts to stimulate the economy often include interest rate cuts, which in turn make a currency less attractive for investors to hold and risk inflation. On the other hand, cheaper currencies lead to more competitive exports, a critical component of many developing economies.

Such cross-currents are weighing heavy in many foreign capitals. In Moscow, central bankers try to keep the ruble within some reasonable band of a weighted dollar-euro basket. Last week, however, the Russian currency depreciated about 1.4% every day, which dramatically widened this trading band. The weakening oil price and fears about the fundamentals of Russia's economy have only exacerbated the selling pressure. Over the last three weeks, central bankers have had to sell nearly $30 billion in foreign currency reserves to help prop up the ruble.

The situation is perhaps even worse in China. According to most reports, the country's GDP growth slowed to 6.8% in the fourth quarter of 2008. China needs to grow at around 8% to keep up with demographic realities and avoid social unrest. Even so, some analysts are concerned that the Chinese figure is overly optimistic. Some 60,000 factories have closed in China, and in November of last year, China's growth in electricity production was 8% below the 2007 level. Such figures seem to suggest a much more dire picture for the Chinese economy. Exports are falling rapidly, and there is no way for domestic demand to compensate for such a contraction.

In the US, hurtling jobless numbers and shrinking durable goods orders threaten the dollar. Still, the greenback has been the beneficiary of a continued flight to quality. Curiously, the dollar's rally has not had the predictable effect on gold prices, which are rising. In most cases, investors buy gold as a hedge against USD devaluation or inflation. The dollar is strengthening significantly against both the euro and the pound, and there is little concern of inflation in the short term (at one point TIPS were pricing in deflation). Consequently, it seems this dollar-gold relationship has broken down.

What does all this mean for forex markets? No doubt there are choppy waters ahead, and exchange rate volatility is likely to increase. News, to say nothing of rumor, about monetary policy developments will cause great swings in investor confidence. With all this turbulence, gold may find itself in another record ascent. In a potentially prescient move, the hedge fund Osmium Capital Management will allow its clients to denominate their holdings in gold.

On Thursday, Zimbabwe effectively abandoned its currency, as citizens may now use foreign-denominated notes alongside the Zimbabwean dollar. And so begins the dramatic process of an entire world trying to figure out the meaning of money.

Obama Needs Madiba Magic

Nelson Mandela, the former President of South Africa and one of the world's most respected statesman, led an international reception for Barack Obama on Wednesday, calling the first black US president "a new voice of hope." While some 2 million people packed the frigid National Mall in Washington, DC to hear Mr Obama's voice live, his audience truly spanned the globe. After eight years of an administration which often ran roughshod over the international community, many outside the US were expecting a more conciliatory tone from Mr Obama.

Great expectations were met with grand vision. In his inaugural address, Mr Obama offered a thinly-veiled repudiation of George W Bush's tenure, promising a new commitment to diplomatic relations with friends and foes alike. On his first day in office, Mr Obama suspended military trials at the Guantanamo Bay naval base, and by Wednesday the president had signed an executive order closing the infamous detention camp and the nefarious web of "black site" CIA interrogation facilities across the globe.

In his letter to the American president, Mr Mandela wrote that the inauguration was "something truly historic not only in the political annals of the United States of America, but of the world." While much of Europe, Latin America, and Africa rejoiced, foreign correspondents were trying to gauge the more nuanced reactions in Asia and the Middle East. Indeed, many analysts have commented on the ambivalent reception of Mr Obama's remarks in the Muslim world (some hailing his comments on a withdrawal from Iraq, others lamenting his avoidance of the Israeli-Palestinian conflict).

In North Korea, the highly repressive state media made no mention of the inauguration in Washington, instead choosing to report on presidential proceedings in Equatorial Guinea. Similarly, China Central Television (CCTV) censored parts of Mr Obama's speech. After the president said, "Recall that previous generations faced down fascism and communism," the interpreter's voice was dropped and the picture cut away from the Capitol to an in-studio news anchor. China's online translations of Mr Obama's speech were also edited to remove any references to "communism."

The simple reality is that Mr Obama's overwhelming support comes from non-crisis regions. To be sure, the new president will need European help in fixing the global financial crisis and in strengthening NATO forces in Afghanistan. But in the regions where Mr Obama faces major foreign policy challenges (Iraq, Iran, Gaza, Pakistan, China, and North Korea) his rhetorical skills will have be matched by practical policies.

Mr Mandela proved incredibly adept at finding diplomatic solutions to his most difficult problems. To this day, South Africa's peaceful transition from minority to majority rule is held as an example of leadership for all nations. By all accounts, however, the crises facing Mr Obama are more complicated and more consequential. Let's hope his "new voice" can work the same Madiba magic.

Pay To Play With Manchester United

The troubled insurance giant, American Insurance Group (AIG), has raised plenty of red flags in recent months. Starting in May 2010, however, the company's name will no longer be emblazoned on the world's most popular red jersey. Reports today confirmed that AIG will end their four-year sponsorship deal with English Premier League heavyweights Manchester United.

In the world's richest endorsement, AIG paid 19 million pounds ($26.6m) each season to have the company's logo worn by human billboards like Christiano Ronaldo and Wayne Rooney. With a fan-base that spans the globe, and is particularly prevalent in countries like China and Indonesia, the Man U sponsorship is a lucrative deal that provides massive exposure. Only two other companies have been displayed on the Red Devils jersey, as both Sharp Electronics (1982-2000) and Vodafone (2000-2006) had multi-million dollar contracts with the club.

Back in September, the perils of an accelerating credit crisis caused AIG to reconsider their jersey sponsorship. While AIG executives announced they would be able to honor their existing commitment to the club, it became clear that any further deal was unlikely. As a major holder of mortgage backed securities and credit derivatives, AIG's liquidity crisis triggered alarming write-downs that ultimately required a $100 billion bailout package from the US federal government. After an embarrassingly expensive executive retreat in October, AIG is now desperately trying to cut unnecessary spending.

Man United are not the first club to lose a sponsorship deal as a result of the global financial crisis. Also in September, West Ham United had to drop its contract with XL Holidays, a low-cost airline and tour operator. That three-year deal was worth about $10.5 million, but had to be terminated after the company was placed in administration. Another Premier League club, West Bromwich Albion, struggled to find a replacement sponsor when Deutsche Telekom's T-Mobile dropped its contract.

Many analysts have observed that the financial strains in global capital markets are beginning to manifest themselves in the sporting world. The NBA cut down its number of preseason games in Europe, Formula One racing (the world's most expensive sport) is facing a slew of cost-cutting measures, and many companies will not be buying the exorbitant Super Bowl advertising slots.

Given the club's global prestige, Man U are almost sure to come out of the economic recession unscathed. Indeed, certain marketing experts believe that the club will have little trouble breaking the 20-million-pound mark for their next jersey deal. United officials have already sent sample kits as a sales pitch to a number of potential corporate sponsors. Some reports have pointed towards Sahara India Pariwar, a business conglomerate, which already has several domestic sports sponsorships. Looking for a partner is Asia reflects the interest of many major English clubs to gain popularity in the region.

On the pitch, United are again tops in league play and are among the favorites to defend their Champions League title in Europe. To the disappointment of lesser clubs across the world, AIG's financial troubles will have little effect on the fleet-footed superstars at Old Trafford.

Oil Price: More Than Just Another Number

Quick, what is the price of oil? For a number that is so frequently quoted by market analysts and casual observers alike, the market price for a barrel of petroleum is actually rather confusing. Not only is this value constantly changing, but the question is woefully unspecified. The price is highly dependent on the type of oil, as determined by its specific gravity, sulfur content, and location. As a result, the price of Saudi light sweet crude (which requires less refining) is higher than Venezuela's heavy sour quality.

To complicate matters, most oil is not traded on exchanges, but through over-the-counter contracts in which two parties settle on a price for future oil delivery. In general, however, the oil price references one of the major benchmarks like WTI Light Crude, ICE Brent Crude, or the OPEC basket. For the most part, these benchmarks trade within a close range of one another allowing industry analysts to create a composite "world oil price."

More recently, however, a yawning WTI-Brent spread has begun to alarm traders. Under normal economic circumstances, the higher-grade WTI trades at a premium of $1-$2 per barrel over Brent. But last week, WTI was priced at a record $11.73 discount against the North Sea-based Brent benchmark. According to financial reporters, this price reversal is a logistical artifact, and does not reflect true market realities.

The problem can be traced to Oklahoma of all places. West Texas Intermediate (WTI) is shipped to Cushing, OK where US suppliers store the oil until the delivery contracts are settled. JBC Energy reported that inventory stocks in land-locked Cushing were at 27 million barrels, almost triple their number back in November. Two forces are causing inventories to rise. First, demand is slumping and thus suppliers are drawing less oil from the Cushing facility. Second, there is currently a "super cantango" in the WTI oil market. This phenomenon results when the spot contract (immediate delivery) is much cheaper than the future contract. Oil traders are hereby encouraged to buy discounted WTI, store it in Cushing, and then take the profits on a futures contract.

The Financial Times is reporting that the current WTI-Brent price dislocation could spell trouble for one of the world's most popular benchmarks. If WTI is dominated by technical variables like inventory stock, its ability to reflect broader market conditions is diluted. By definition, this distortion threatens the viability of WTI as an indicator of oil fundamentals.

While there is considerable difficulty in finding suitable benchmarks for the oil price, there is a growing consensus around the cause of its rise and fall: hedge funds. In early 2008, sensing an economic slowdown, hedge funds moved trillions of dollars out of equities and stashed their money in energy Exchange Traded Funds (ETFs). These ETFs are basically tax-efficient, tradeable mutual funds whose profitability was based on hydrocarbons. With global oil demand rising (estimates were based development in China and India), hedge fund managers saw these energy ETFs as a rare safe haven in a bleak trading year.

In just a few months, however, an economic slowdown became a full-blown credit crisis. To cover losses in the stock market, hedge funds were forced to raise cash and begin a painful deleveraging process. As they liquidated their positions in energy ETFs, hedge funds sent the oil price into a fantastic downward spiral. It is important to note that as oil lost three-quarters of its value, demand was trimmed less than 10%. Clearly the petro-bubble was exacerbated by market speculation.

Now, with the oil price lower than the cost of production, there is a dearth of new investment for exploration, extraction, and refining capabilities. Once inventories are sold off, it could be difficult for oil suppliers to meet future demand, even with a global recession. What is more, many analysts suggest that oil is vastly oversold, with Goldman Sachs predicting a rapid price reflation in late 2009.

Just this week, there are reports that several banks have purchased supertankers that will store cheap oil until the price advances again. According to Bloomberg reports, Morgan Stanley is paying $68,000 per day for its tanker. At that rate, you can bet their analysts have thought long and hard about our opening question.

Major Headwinds for the €uro

The euro celebrates its tenth anniversary this January, but there has been little to celebrate for this putative reserve currency. Used by 16 of 27 member states in the European Union, the euro is coming under intense pressure on foreign exchange markets as the global economic crisis hurtles on.

Europe's single currency has historically been a safe haven during financial storms, as its member economies were thought to provide a diverse bulwark against economic hardship. Purchasers of the euro were, in theory, spreading their risk across Germany, France, Spain, and other big EU markets. What is more, economic coherence and the coördination of monetary policy were billed as the pillars of supply-side reforms spurring growth and productivity.

That was then. There are now real concerns that the eurozone could split up, or that one of its member states could suffer a sovereign debt default. Traditionally, the spread on government bonds between countries using the single currency are paper-thin. Over the last ten years, the interest rate on, say, Belgian bonds has not been much greater than the safest German government bonds (called bunds). Low bond spreads have been one of the major attractions of using the euro, especially for new EU members looking to finance their domestic spending.

Some analysts, however, claim that the bond spread convergence is misleading, as there is no legal way for one eurozone country to backstop the debt of another. While they may use the same currency, Germany's economic vitality cannot prevent Slovenia from defaulting. As a result, sovereign debt should be analyzed individually, not part of an EU blend.

This revaluation is precisely what now threatens the single currency. The extra yield on Greek government bonds over German bunds has risen dramatically during the financial crisis (not to mention the weeks of social turmoil in Athens). On Friday, Standard & Poor's put Greece's credit ratings on notice for a potential downgrade, sending both CDS contracts and bond spreads on Greek debt to historic levels.

Similarly, both Spain and Ireland have had their credit ratings cut by S&P in recent days. As a result, these countries will have to pay investors a higher interest rate to finance government spending for economic recovery. With European governments scheduled to sell a record €41 billion in Treasuries this week, bond spreads will be on the mind of central banks throughout the EU.

Most analysts are worried about countries at Europe's periphery that might be tempted to opt out of the euro in an effort to pursue self-interested monetary policy. One of the major criticisms of the single currency is that its rising strength (before the financial collapse) eroded the appeal of European exports and put pressure on domestic spending. To complicate matters, many EU governments have policies that automatically link wage increases to inflation. As a result, Italy and Greece are facing acute strains on their federal budgets, with no way to devalue their currency and boost trade.

In a more striking omen, the likelihood that any country currently using the euro will drop the single currency in the coming year is now at 30%, according to the Intrade prediction market. What once may have seemed an unthinkable development is now a significant concern for policy makers across Europe. To be sure, any country that decides to opt out of the euro would face major economic hardship. Investor confidence would plummet, and local citizens would rush to transfer their euro holdings to more stable accounts outside the country. These costs should outweigh any problems with the euro, but there is no way to predict the domestic political pressures that many European leaders might feel in 2009.

If the EU can successfully navigate this next year and prove its mettle in the face of a financial calamity, then it will likely reassure investors that the euro is a bonafide reserve currency. If, however, one of its member states decides to leave the eurozone, it will likely spell the end for the euro as a major fixture on the forex market. Happy 10th, euro, and good luck in the year ahead.

Kenyan Coalition Stress: Potential Omen

The governing coalition in Kenya is facing new strains after President Mwai Kibaki approved a controversial media law last week. The measure establishes a new communications commission that will regulate broadcasting content and impose tougher jail sentences for press offenses. International observers and local activists had bitterly opposed the law, staging demonstrations and protests in December.

For Mr Kibaki, the measure is designed to balance the media's freedom with its responsibility to "account [for] the overriding interest and safety of Kenyans." Many within the country, however, fear that the communications law will return Kenya to authoritarian government. Indeed, Kenya's vast array of media outlets is now subject to office raids and electronic wiretapping.

Kenya's Prime Minister, Raila Odinga, has openly opposed the bill saying that the expanded federal powers would be "oppressive to the democratic gains achieved" in Kenya. Messrs Odinga and Kibaki fought a tense election battle last spring, in which political violence claimed some 1,500 lives and displaced 300,000 Kenyans. A UN-brokered agreement brought Mr Odinga's Orange Democratic Movement (ODM) and Mr Kibaki's Party of National Unity (PNU) together into a power-sharing deal, but it has proved an uneasy alliance.

Not surprisingly, many analysts are concerned that a dispute over the communications law will send Kenya backsliding into political turmoil. Many officials with the ODM have complained that major decisions (such as diplomatic appointments) are being made without their consent. While the relationship between Messrs Odinga and Kibaki still appears cordial, mounting tensions will make it difficult for these leaders to hold their country together.

These are important times for Kenyan politics. Across the continent, Ghana has (for now) peacefully settled a December presidential election that produced razor-thin margins. The challenger, John Atta Mills, defeated the ruling-party candidate, a feat which Mr Odinga called a "rare example of democracy at work in Africa." Farther south, Africa is host to one of the world's most horrific heads of state, Robert Mugabe, who plans to unilaterally form his own government next month. Mr Mugabe appears to be doing everything in his power to drive a final stake through his earlier power-sharing agreements with Morgan Tsvangirai.

In recent weeks, Abdullahi Yusuf Ahmed resigned from his post as president of Somalia. While the flagrant anarchy in the Horn of Africa rendered this announcement largely ceremonial, Kenya should be concerned about the political forces in its northeastern neighbor. Should the coalition in Nairobi falter, there would be cascading fallout for democratic movements throughout the region. Even in South Africa, the recent democratic lodestar of the continent, there are populist tensions heading into 2009 election. Indeed, much depends on the ability of Messrs Odinga and Kibaki to manage Kenya's fragile coalition.

These are all significant challenges for Africa in 2009, and this review ignores the larger structural problems affecting Sudan, the Democratic Republic of Congo, and the Niger Delta. Certainly all of these political hot spots do not hinge on the Kenyan governing coalition, but leaders in Nairobi must make every effort to start the year off right.

Gazprom Supply Threats Part of Larger Standoff

Back in August, Europeans were concerned that the brief war between Russia and Georgia would lead to cold winters in Berlin, Rome, Istanbul, and Paris. Sovereign leaders throughout the European Union are highly dependent on Russian gas exports, and the rising political tensions between Moscow and the West threatened to spill over into economic relations.

By all accounts, these concerns were legitimate. Since the 1990s, Russia's quasi-capitalist economic climate has been riddled with powerful oligarchs, corrupt middlemen, and a general proclivity for mixing business and politics. OAO Gazprom, which is Russia's largest extractor of natural gas, controls about a third of the world's gas reserves and pipes in about a quarter of Europe's supplies. To be sure, EU leaders are reminded of this market share whenever Gazprom threatens to cut gas exports. Such threats have come thick and fast over the past several years, often during price disputes with Georgia, Ukraine, Belarus, and other neighboring states.

On New Year's day in 2006, Gazprom actually followed through and shut down the Ukrainian pipeline. As much of the EU's gas comes from distribution facilities in Ukraine, major consumers faced more than two days of supply limitations. Now three years later, there are fresh concerns about gas supplies coming from Russia.

The economic backstory is familiar: for the 2009 contract, Ukraine offered to pay $235 per 1,000 cubic meters while Russia was demanding $250 per 1,000 cubic meters. Moreover, Gazprom officials claim that Ukraine has $2.1b in outstanding debt from gas imported in 2008. Ukrainian officials also want to charge Gazrpom a higher fee for transporting Russian gas into the rest of Europe.

After weeks of economic brinkmanship, Gazprom announced that its disagreements with Ukraine would not disrupt gas supplies to European markets. The news was designed to reassure both politicians and investors, but there are several complicating factors. First, the global economic slowdown has put significant pressure on commodities prices. Over the summer, the bullish futures market for oil and natural gas bouyed economies in Russia, Iran, and Venezuela, but now the bubble has burst. As a result, Gazprom (and by extension, the Kremlin) will look to wring every last penny out of gas sales.

Second, Russia's Prime Minister Vladimir Putin recently announced the formation of the Gas Exporting Countries Forum (GECF) along with Iran and Qatar. This OPEC-style cartel is designed to band together gas exporters and, in the words of Mr Putin, end "the era of cheap energy resources." Most analysts suggest that it could take some time for the group to significantly reflate energy prices, especially in the face of a depressed economic climate. Still, the GECF brings Moscow closer to Tehran, a strategic alliance that troubles many Western observers. As a consequence, future price disputes with Gazprom may bleed into negotiations with Iran.

Third, Ukraine's gas negotiations are part of a domestic political saga between President Viktor Yushchenko and Prime Minister Yulia Tymoshenko. The two were allies in the 2004 Orange Revolution, but they have drifted steadily apart. Ms Tymoshenko has positioned herself closer to Russia, and the Gazprom price dispute has only sharpened the differences between these rivals. It is likely that the natural gas deal will be a significant campaign issue as both leaders run for the presidency in the coming year.

For its part, Europe seems prepared for a supply cut, should Gazprom reneg on its New Year's resolution. Many governments learned from the 2006 freeze and have stockpiled reserves that provide at least some stopgap measures. Nevertheless, recent political and economic developments have made for chilly relations between Russia and the West.