It is not a pleasant start to the new year for Venezuela’s populist strongman Hugo Chavez.  With oil prices in decline there simply is not enough money for him to toss around for his pet domestic projects and to fund his rogues gallery abroad.  Economic trouble at home and rising crime are denting his popularity.

Then he commenced the year with a devaluation of the currency.   One suggested rationale was that it gave him more money to spend domestically to buy goodwill before the Presidential election (something his buddy Iran’s Ahmadinejad tried to do before rigging the elections).

But there are natural effects to such a move.  As Venezuelans worried that imports would double in price (and Venezuela is heavily reliant on them) they started shopping furiously.  So the next diktat went out to store owners warning them not to raise prices.  Now inevitably comes the next phase of nationalizing banks and supermarkets.

Venezuela is yet another country to be cursed with natural resources.  It makes it too easy for corrupt leaders to siphon off the money (Nigeria, Indonesia, Chad) or to blow it on populist largess (Saudi Arabia, Venezuela).  It is easy to sympathize with Chavez’s assertion that the oil wealth has been used to enrich a few, because it is true.  But rather than using the wealth to create sustainable avenues for growth in the future, he has squandered it on populist subsidies and quixotic support to Cuba and other dictatorships to tweak Uncle Sam’s nose.  Venezuela is now facing the effects of his mismanagement.  But with no viable opponent to his regime in sight yet, Venezuela’s caudillo is likely to be re-elected in the elections this fall.

Subscribe to Rashtrakut by Email

Tiny Iceland drew unflattering world attention last year when its overheated real estate bubble burst sending the nation perilously close to bankruptcy.  It was back in the news this week for a presidential veto that infuriated the United Kingdom and the Netherlands which is reflected in the pious declarations by the British papers.

The brouhaha started with the collapse of a subsidiary of an Iceland bank Landsbanki called Icesave that offered deposits in the Netherlands and the United Kingdom.  The key question is whether the government of Iceland was supposed to back all depositor funds beyond the amounts covered by the Icelandic Depositors’ and Investors’ Guarantee Fund set up under European Economic Area rules.  The legal case on whether Iceland’s tax payers are required to back up the deposit fund is shaky as well and not expressly required by the EU.  Even the Dutch have acknowledged that the deposit fund was not intended to cover a systemic collapse as happened with Iceland’s financial system.  Even in the United States where the FDIC covers only up to $100,000 of deposits, the deposit insurance fund simply does not have the wherewithal to bail out an entire banking system.

Then came the British overreaction that still has Iceland’s citizens seething.  When Iceland agreed to cover domestic depositors, it did not cover foreign deposits (it had not agreed to do so before the crisis in any case).  The British and Dutch stepped in to cover the deposits of their nationals.  Next Gordon Brown’s government misused anti-terrorism statutes to freeze all Iceland assets in the United Kingdom, probably the first time such action has been taken against a NATO ally, sending Iceland’s reeling economy into a tailspin and even bringing down another totally unrelated Iceland bank.  Next the IMF was used to bully Iceland to pay up.  British and Dutch grandstanding on the subject is weakened by the fact that their banks benefited from the same loose passporting rules to establish foreign subsidiaries that Icesave employed.  It is hard to imagine that they would have done what they are asking Iceland to do with respect to foreign accounts in the event of a systemic collapse.

The repayment plan forced down by the IMF is  about 5 billion dollars, chump change for Britain and the Netherlands but 40% of Iceland’s GDP and about $18,000 per citizen.  Iceland’s ability to pay is doubtful as well.  Seething from Gordon Brown’s use of terrorism statutes, the Icelandic public overwhelmingly oppose the plan and deluged the President with requests to veto it.  The President obliged and the veto now sends the plan to a public referendum where it is almost certain to fail.

As a matter of policy, it is not really clear why a government should back all deposit accounts.  It seems an invitation to moral hazard and can cripple an economy in a financial crisis like Iceland’s, particularly when (as noted in the article linked earlier) the legal arguments are shaky.  Gordon Brown’s overreaction made it harder for Iceland to pay back this debt and it is not clear why the United Kingdom should not be penalized for its disgraceful misuse of anti-terrorism statutes and the collateral harm they caused to Iceland’s economy.  Given the small size of the loan by British standards and the financial stress a long term ally was under, Gordon Brown should have resisted the temptation to flex his muscles for domestic opinion and tried to work out a deal.  Instead he made a bad situation worse and now threatens Iceland with financial isolation.

The legal principle employed by the British and the Dutch is a dangerous one too.  Evidently now the taxpayers of the country of formation have to bear the burden of the obligations of a corporation abroad.  Its time for cooler heads to prevail and pull the British and Dutch back from their overreaction and threats to financially ruin a NATO ally.

Subscribe to Rashtrakut by Email

Former Fed chairman Paul Volcker chides the banking industry on their belief that financial innovation contributed to economic growth and their failure to come to grips with excessive pay packages.  Sage words that will probably fall on deaf years in the United States.  Meanwhile the British have gone ahead and passed a windfall bonus tax on its financial sector, probably under the theory that taxpayer largesse in the past year enabled these bonuses to begin with.

Subscribe to Rashtrakut by Email

• Christopher Hitchens complains about how the saga of the party crashers overshadowed the visit of Manmohan Singh to the United States and vents about the state of media coverage.  This is hardly a new phenomenon, though it seems to have got worse in the last 20 years.  From my viewpoint the O. J. Simpson circus, I mean trial, was the start of this nonsense.  It showed when the media cut away from Clinton’s state of the union address to announce the civil verdict against OJ.
• The Economist’s Banyan on how North Korea in the finest traditions of bankrupt regimes “revalued” its currency and robbed its citizens.
• More Afghan perceptions on Obama’s speech.
• A depressing read on how the Taliban is wrecking the rich Buddhist heritage of the region and threatening museums in Pakistan.
• The Economist cites a Stephen Walt column on how German unifier Otto von Bismarck’s realism may be a guide on a realistic foreign policy to ease tensions in the world and tackle Iran.  It is an interesting theory, but historical analogies don’t always fit.  Bismarck’s concert of powers was ultimately doomed because Russia and Austria-Hungary’s ambitions (along with their proxies Serbia and Bulgaria) clashed in the Balkans and an over-powerful Germany clashed with the traditional British agenda since the Spanish Armada of preventing any one power from dominating the European continent.  These tensions were already evident by the time of Bismarck’s unceremonious dismissal.
• How far will Dubai’s woes rein in Sheikh Makhtoum’s ambitious agenda?  It gives conservative Abu Dhabi a lot more leverage.

Subscribe to Rashtrakut by Email

The request by Dubai World (the investment flagship for the emirate) for a debt standstill rocked global markets this week.  The latest fallout from the bursting of the real estate bubble brings with it contagion fears and questions about how deep the problems may go.

Dubai World also raises questions regarding “quasi-sovereign debt.”  Investors who previously relied on an “implied sovereign guarantee” for debt issues by these government owned ventures may want a stronger government guarantee in the future.  Government owned entities from South Africa to Russia may find it harder to borrow funds without a risk premium unless their governments explicitly guarantee the debts (relying on the fact that essentially insolvent countries like Iceland have also not stopped paying their debts).

In political terms this also strengthens the position of Abu Dhabi within the United Arab Emirates.  Until the real estate meltdown Dubai was positioning itself as the Hong Kong and Singapore (and with some of the ridiculous buildings coming up, Las Vegas) of the Middle East.  In the process it was upsetting the delicate power balance in the UAE.  With yet another bailout now needed, the more conservative Abu Dhabi will likely extract another pound of flesh to restrain the ambitions and presumptions of Dubai.

If it were needed, Dubai World is just another example of how intertwined the global financial system is and how problems on the other side of the world can have immediate impacts at home.