Jeffrey Frankel writes:   World oil prices, which have been highly volatile during the last decade, have fallen more than 50% over the past year. The economic effects have been negative overall for oil-exporting countries, and positive for oil-importing countries.

The answer is that countries should seek to do both: Lower the price paid to oil producers and raise the price paid by oil consumers, by cutting subsidies for oil and refined products or raising taxes on them.

Consider this: America’s roads and bridges are crumbling, and the national transportation infrastructure requires investment and maintenance. And yet the US Congress shamefully continues to evade its responsibility to fund the Federal Highway Trust Fund and put it on a sound long-term basis, owing to disagreement over how to pay for it. The obvious solution, which economists have long advocated, is an increase in America’s gasoline taxes. The federal gas tax has been stuck at 18.4 cents a gallon since 1993, the lowest among advanced countries. And yet, on July 30, Congress adopted only a three-month stopgap measure, kicking the gas can down the road for the 35th time since 2009.

Fossil-fuel pricing is a striking exception to the general rule that if the government has only one policy instrument, it can achieve only one policy objective. High oil consumption also leaves a country vulnerable to oil-market disruptions arising, for example, from instability in the Middle East. If gas taxes are high and consumption is low, as in Europe, fluctuations in the world price of oil have a smaller effect domestically.

The conventional wisdom is that it is politically impossible in the US to increase the gas tax. But other countries have political constraints, too. Indeed, some developing-country governments have faced civil unrest, even coups, over fuel taxes or subsidies. Yet Egypt, Ghana, India, Indonesia, Malaysia, Mexico, Morocco, and the United Arab Emirates have all reduced or abolished various fuel subsidies in the last year.

Besides raising taxes on fuel consumption, the US should also stop some of its subsidies for oil production.

For the US and other advanced countries, it is also a good time for reform from a macroeconomic standpoint. In the past, countries had to worry that a rising fuel tax could become built into uncomfortably high inflation rates. Currently, however, central bankers are not worried about inflation, except in the sense that they want it to be a little higher.

The US Congress will have to come back to highway funding in September. If other countries have found that what was politically impossible has suddenly turned out to be possible, why not the US?

Tuesday’s upgrade of Greece is after the nation of Greece requested and received consent, in principle, from the Eurogroup for a 3-year loan program under the European Stability Mechanism whereby it received 7.16 billion in three month bridge financing. That was used on July to 20 clear its arrears with the International Monetary Fund (IMF) and the Bank of Greece, and was used to repay the European Central Bank.

S&P further went on to say that it now thinks Greece’s chances of leaving the Eurozone has now fallen to less than 50% within a horizon to 2018 but still is higher than one-in-three. Still, S&P does warn that the risk  of a Greek euro exit is still high if the Greek government fails to implement an ambitious program.

Lastly, S&P now believes that a Greek default on its commercial debt is no longer inevitable in the next six months to twelve months: It sees the opportunities for Greece to default on its commercial debt this year are few. Redemptions owed on commercial debt this year, excluding Greek Treasury bills, amount to a single payment of 176 million euro on a state-guaranteed Hellenic Railway bond which comes due in October. SP said that interest payments on commercial debt due in the last seven months of 2015 total 1.5 billion euro — less than 1% of GDP.

National Bank of Greece S.A. (NYSE: NBG) has been the real-time trader proxy for Greece, and its ADSs in New York trading were up 2.25 at $0.93 right after the news. NBG’s 52-week range is $0.85 to $3.69. NBG’s trading volume was 8.9 million shares as of 2:40 p.m. Eastern Time.

Global X FTSE Greece 20 ETF (NYSEMKT: GREK) was last seen up 1.4% at $10.07 against a 52-week range of $9.42 to $22.62. Volume there was only about 520,000 shares as of 2:40 p.m. Eastern Time.

A Greek debt upgrade may seem hard to fathom when you consider how close the nation came to being stuck with the drachma all over again. That being said, there are still no assurances that negative Greece news will not be right back in the media’s daily news flow in the days, weeks, or months ahead.

S&P said:

Greece’s financial commitments appear to us to be unsustainable over the long term, if and when the current official concessional loans are replaced by market funding and the current interest rate holiday on a significant part of Greece’s debt to official creditors lapses.

We believe the probability of Greece leaving the eurozone remains higher than one in three but less than 50%, although we think the agreement between Greece and its creditors announced last week has reduced this risk. The probability would increase if Greece doesn’t successfully implement the new ESM loan program. We see the risk of such non-implementation as high, given the weakness of the economy, and the implications this might have for further political and social instability.

If Ireland, Portugal, Spain, and Italy had to swallow the bitter pill of austerity, the argument goes, so should Greece. But are the situations similar? When it comes to GDP impact none are close to Greece (first graph below). Only with unemployment, and then only for Spain, has there been comparable pain.

June 29: Recalling the Bundestag

The primary reason a deal must be concluded by June 25 is so there is enough time for eurozone parliaments to approve an extension of the existing bailout programme.

Jeroen Dijsselbloem, the Dutch finance minister who heads the negotiations for his 17 eurozone counterparts, has said there is simply no longer time for Greece to legislate and pass all the “prior actions” needed to win bailout money before the rescue programme runs out at the end of the month. So it will have to be extended for a third time in seven months.

Under national laws, any extension must be approved by a handful of eurozone parliaments — most importantly the German Bundestag, which is due to be on recess next week. Although the centre-right bloc of Chancellor Angela Merkel has become increasingly restless over Greece, they are likely to back any extension she endorses — even if they have to return from holiday to do so. But the vote must be held either the 29th or 30th, giving legislators precious little time to review the agreement.

June 30: Expiration date

The date Greece’s bailout expires and when it is due to repay €1.5bn in loan repayments to the International Monetary Fund. Even if a deal is in place before the deadline expires, it remains unclear how — or whether — Greece will find the money to pay the IMF, since there is not enough time for Athens to pass all the economic reforms necessary to gain access to any of the €7.2bn in bailout funds.

One option to quickly raise funds would be for the ECB to lift its existing cap on the amount of short-term debt the Greek government can issue by about €2bn. This would enable Athens to quickly raise cash to make the IMF payment.

The ECB imposed the cap in February because of signs Greek banks were the only buyers of such Treasury bills. Because Greek banks are only staying open through ECB-approved emergency loans, increasing the t-bill cap would essentially mean central bank money was being used to fund the Greek state — a violation of EU law.

But the ECB could decide that an agreement on a new economic reform plan means that new money, in the form of bailout aid, is on its way to Athens, meaning T-bill sales to Greek banks are not directly funding government operations. That would allow them to raise the cap.

It is also possible Athens just misses the payment. Although technically this is not a default, since IMF rules consider a non-payment “arrears”, Greece would join a motley crew of developing countries — Somalia, Cuba and Zimbabwe — that have current or former “overdue obligations” to the IMF.

But credit rating agencies have said that non-payment to the IMF is not formally a default, and the ECB is unlikely to decide it means Greece is bankrupt. If it did, much of the collateral used by Greek banks to obtain their emergency loans — particularly Greek government bonds — would be worthless. That would mean the ECB having to cut off emergency funding, probably forcing a Grexit.

July 1: The extended bailout

If a deal is reached and all the legislative approvals are voted in time, Greece’s bailout would be extended for anywhere from three to nine months. For the EU’s portion of the bailout, the extension is expected to include a bit more money as well.

Of the €7.2bn in the current bailout tranche, the eurozone is due to contribute about half (the other half would come from the IMF). On top of that, €10.9bn in rescue funds that had been set aside to recapitalise Greece’s banks remains unused and eurozone leaders are likely to approve a “repurposing” of those funds as general bailout aid.

In addition, another €1.5bn in profits on Greek bonds held by the ECB — which are to be refunded to Athens as part of a deal reached three years ago — come online July 1. All told, that’s about €16bn in EU aid available to Athens as part of the extension. The length of the extension will depend largely on how long officials determine that money can last.

There is also about €16.4bn remaining in the IMF’s portion of the bailout, which runs through March 2016.

July 20: Drop-dead deadline

This may be the real drop-dead deadline: the date two bonds totalling €3.5bn fall due to the ECB.

Although credit rating agency Standard & Poor’s said recently it would not consider a failure to pay these bonds a full default — it said only non-payment on bonds held by private creditors constitutes a default in their books — it would be virtually impossible for Greece to survive inside the eurozone if it defaulted on the ECB.

That means Greece must legislate for and implement the entire reform programme before this date so that it ensures it has bailout funding in time to repay the ECB. Another €3.2bn is due for two more bonds held by the ECB on August 20.

Courtesy Financial Times

On 22 March 2015, Christine Lagarde — the managing director of the International Monetary Fund (IMF) — made an important speech in Beijing. Madame Lagarde outlined the dangers of US Federal Reserve tightening for emerging markets. Her warning was stark:

‘The world has yet to achieve full economic recovery. Global growth continues to be weighed down by high debt, high unemployment and lacklustre investment…

‘The recovery remains fragile because of significant risks. One such risk emanates from the expected tightening…of US monetary policy at a time when many other countries are easing…

‘The divergence of monetary policy paths has already led to a significant strengthening of the US dollar. Emerging markets could be vulnerable, because many of their banks and companies have sharply increased their borrowing in dollars…

‘The potential spillovers would affect China mostly through its trade relationships with other emerging markets…Chinese exports would certainly be affected.’.

The problem is that Madame Lagarde has only addressed half the problem for China — the impact on trade. She has glossed over the more dangerous half of the problem — the impact on China’s debt.

The analysis is straightforward. The Federal Reserve has been flirting with tightening policy since Ben Bernanke’s May 2013 speech in which he introduced the idea of reducing, or ‘tapering’, Fed bond purchases.

This led to the infamous taper tantrum of May–July 2013 in which leveraged investors involved with the dollar carry trade dumped stocks and currencies in emerging markets and repaid dollar-denominated debt.

Through late 2013 and all of 2014, the Fed did follow through with its tapering plans, but borrowers in emerging markets did not reduce their dollar debts. The problem now was not US-based leveraged traders, but the emerging-market borrowers themselves. They borrowed US dollars even though their central banks had no ability to print dollars — only the Fed can do that.

The result was what I call the ‘New Big Short’. Emerging-market borrowers are ‘short’ over US$9 trillion…with no ability to print.

That’s half right. Distress in emerging markets will hit Chinese exports. But Lagarde ignored the fact that China is itself an emerging market and has one of the most highly leveraged economies in the world, including the largest amount of dollar-denominated debt of any emerging-market borrower.

Here’s a chart showing the recent increase in private leverage in China:

When you add government leverage to private leverage, the picture is even more dangerous:

As the Fed prepares to raise rates, a dual crisis confronts China. Its export markets will dry up, exactly as Lagarde suggests, but it will also face a debt crisis. Blind to the risks