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The Fuss about Derivatives

Many of us know the following figure Zerohedge is publishing time and again in revised versions in articles about Deutsche Bank:


For example, when Tyler Durden asks:

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London Lock-in

In one of his latest comments, Paul Krugman mused about the Brexit contribution to the recent decline of the British pound. “Coming at it from the trade side” he first drew attention to what in economic research is called the home market effect. This is a phenomenon which helps explain why industries concentrate in large markets and exports occur:

A trade scenario

“Imagine a good or service subject to large economies of scale in production, sufficient that if it’s consumed in two countries, you want to produce it in only one, and export to the other, even if there are costs of shipping it. Where will this production be located? Other things equal, you would choose the larger market, so as to minimize total shipping costs. Other things may not, of course, be equal, but this market-size effect [my emphasis] will always be a factor, depending on how high those shipping costs are.”

Krugman then argued that the smaller market may not come away completely empty-handed. It may prosper by enhancing its price competitiveness:

“In one of the models I laid out in that old paper, the way this worked out was not that all production left the smaller economy, but rather that the smaller economy paid lower wages and therefore made up in competitiveness what it lacked in market access. In effect, it used a weaker currency to make up for its smaller market.”

For Krugman, the initial situation in Europe can be characterized by this example. The two countries in question are Britain as the smaller market and the rest of Europe as the larger one.

Now, with Brexit looming on the horizon, many observers are expecting a decline of the pound as a consequence of a resulting overall economic recession in Britain. But Krugman argued that a Brexit recession does not, so far, seem to be materializing. He offered an alternative explanation for the pound weakness focusing (1) on financial services as the industry in question and (2) a partial reversal of this industry’s location decisions as a key influence behind the currency decline:

“Now we face the prospect of seriously increased transaction costs between Britain and the rest of Europe, which creates an incentive to move those services away from the smaller economy (Britain) and into the larger (Europe).”

The question is: Is this a realistic scenario?

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Freeports, art and global finance



Getting a grip on problems such as tax evasion and money laundering has become a matter of utmost urgency. In this context, the Panama Papers drew attention to the dubious role of free trade zones (FTZs), and in particular of freeports as repositories of artworks and other valuables. Media reports pointed to the connection between the international art trade and offshore secrecy:
“The documents reveal sellers and buyers of art using the same dark corners of the global financial system as dictators, politicians, fraudsters and others who benefit from the anonymity these secrecy zones offer.” (Jake Bernstein)
But even the legitimate side of freeports is calling for greater scrutiny. With increasing regulations and sanctions in the world of finance the widely unregulated art market is attracting more and more banks, hedge funds and other financial players thereby posing new challenges to financial supervision.

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Crisis instrument central bank swaps

In a recent article, Perry Mehrling drew attention to the global network of central bank swaps:

“In the last few weeks, the ECB has been drawing on its liquidity swap line with the Fed, first $308 million for a week, then $658 million for a week, and last week back down to $358 million. What’s that about?
It’s not such a large amount. Bank of Japan borrowed more in the past, $810 million in March and $1528 million in January. But the question then repeats, what was that about?
Both of these drawings are part of the new set of central bank swap lines linking what I call the C6: the Fed, ECB, Bank of Japan, Bank of England, Swiss National Bank, and Bank of Canada. On October 31, 2013 these lines were made permanent and unlimited … Ever since then I have had a slide in my powerpoints saying “Forget the G7, Watch the C6.””

So, what is going on here?

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An emergency currency regime for Greece

With the agreement of the Eurogroup to accept the Greek reform proposals the latest crisis in the euro area seems averted – for the moment. Apparently, Greece had no other option than to give in and prolong its current bailout program as requested or leave the monetary union. The latter would have been a complete surrender to the challenges of a common currency – not of Greece but of its European “partners”. All can-kicking in recent years, all refusals to face the needs of a functioning monetary system, all costly bank bailouts to prevent a destabilization of national financial markets and policy structures, and all sacrifices made by individual countries under harsh austerity constraints in order to “save the euro” might have been fruitless as a Grexit inevitably would have triggered a chain reaction among other member countries and possibly the union’s breakup.

DrachmeThe danger is not banned yet: Gabriele Steinhauser (Wall Street Journal) wrote immediately after the official consent that the IMF and others still have concerns over the seriousness of the reform measures. Alkman Granitsas (Wall Street Journal) listed five things to know about Greece’s proposed reforms which its creditors might not expect or approve. And in order for the funds to be released the program must be implemented successfully and all its conditions met.

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Perspectives on the Greek challenge

These days, there is a flood of articles and comments of varying quality and importance on Greece and the eurozone. With the following quotes I would like to draw attention to a small selection of contributions which may be relevant beyond the day.

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Black Swan, Dragon King, Greek Tragedy – Lessons from a “Diplomatic Debate”

In his Ted Talk Dragon King beats Black Swan in June 2013 Didier Sornette contrasted his ideas of market predictability to Nassim Taleb’s concept of a Black Swan. As Sornette explained a black swan is a rare bird. Seeing a black swan shatters all beliefs that swans should be white. The Black Swan stands for the idea of unpredictability and extreme events that are “fundamentally unknowable”. Sornette compared this idea with his concept of a Dragon King which is “exactly the opposite”. According to his view, most extreme events are actually knowable and – at least to a certain extent – predictable.

In May 2014, there was a very stimulating ETH-sponsored debate between Nassim Taleb and Didier Sornette which threw further light on their “Diametrically Opposite Approaches to Risk & Predictability”, so the title of the meeting. The following video is an edited version of what Nassim Taleb called a “diplomatic debate”. To him this is a conversation in which one looks for synthesis as opposed to one in which one is trying to win an argument by all means. This is surely benefitting the audience who, if they had not read their books, may know Didier Sornette and Nassim Taleb mainly from their highly technical scientific papers here and here.

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Between the years

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Tankan Japan

The Bank of Japan just published the latest results of its TANKAN survey which observers usually take as an indicator of the state of the Japanese economy and as signal in which direction future monetary policy may go. Here is some background information.

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Foreign Banks in Japan

In 2014, the International Bankers Association of Japan (IBA Japan) celebrates its 30th anniversary. For thirty years IBA Japan has represented the international banking community in Japan. Starting with 12 founding members in 1984 there are now just under 60 banking members from 22 countries and over 25 associate member firms.

In a speech at a meeting commemorating the anniversary, Haruhiko Kuroda, Governor of the Bank of Japan, mentioned the significant role foreign financial institutions played in Japan’s economy. However, relations between the banks and their host country were never free of tensions and compared to other world financial centres their influence is smaller than many believe – and in decline.

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