RBS cuts 3,500 investment banking jobsT)

A branch of the Royal Bank of Scotland is pictured in London, on August 5, 2011.

STORY HIGHLIGHTS

• Royal Bank of Scotland is to cut an additional 3,500 jobs
• It has already announced 2,000 investment banking job cuts as it shrinks its risky operations
• The investment bank will have 13,400 staff within a year, down from the end of September 2011 number of nearly 19,000

(Financial Times) -- Royal Bank of Scotland is to cut an additional 3,500 jobs as the state-controlled bank rapidly shrinks its investment banking activities in response to the worsening economic outlook and wide ranging reforms of the banking sector due to take effect before the end of the decade.

Stephen Hester, chief executive, on Thursday outlined plans to restructure RBS' wholesaling or investment banking operations into two divisions and withdraw from activities such as cash equity broking and merger and acquisition advisory work that were aggressively expanded by former disgraced chief executive Sir Fred Goodwin.

Risk weighted assets, under Basel III regulatory definitions, will be shrunk to £150bn from £225bn under the restruring plan.

The bank will continue to operate in the fixed income and debt raising markets where it has a strong position but reduce its dependence on wholesale funding markets which have frozen up in the last three years.

Since taking over in 2009, Mr Hester has shrunk RBS's balance sheet by £600bn following the disastrous acquisition of Dutch bank ABN Amro in 2008 by Sir Fred, which forced the bank to seek a government bail-out.

It has already announced 2,000 investment banking job cuts as part of Mr Hester's attempts to shrink the highly profitable but risky operations and focus on lending to corporate and institutional clients.

The investment bank, which will be restructured into a markets division and an international banking unit, will have 13,400 staff within a year, down from the end of September 2011 number of nearly 19,000.

However, people close to the bank have said that the staff numbers could fall to below below 10,000 in a worse case scenario.

The two business units will target a return on allocated equity exceeding the cost of capital, currently estimated at 12 per cent, in the medium term.

The unprofitable cash equities, corporate broking, equity capital markets, and mergers and acquisitions businesses will be closed or sold.

"Our goal from these changes is to be more focused for customers, more conservatively funded, more efficient and with better, more stable returns for shareholders overall," Mr Hester said in a statement.

The investment bank has been RBS's growth engine in the last three years, producing an average return on equity of 19 per cent, but Mr Hester made clear on Thursday the bank had to respond to the challenges thrown up by the current economic crisis.

But pressure mounted on the bank just before Christmas, when George Osborne, chancellor, said the bank, which is 83 per cent-owned by the government, should "scale back [its] risky activities".

The government has also accepted proposals from the Vickers commission, which was set up following the financial crisis and recommended splitting investment banking activities and retail banking operations in the UK's leading banks by 2019.

Shares in RBS were 9 per cent higher at 23.75p in morning London trading.

U.S. acts against Chinese oil trader

The U.S. is taking action against three firms in Asia over oil deals with Iran.

STORY HIGHLIGHTS

• U.S. has slapped sanctions on three firms including a major Chinese oil trader
• US State Department said penalties would be imposed on China's Zhuhai Zhenrong

(CNN) -- The US has slapped sanctions on three firms including a major Chinese oil trader for selling refined oil products to Iran, just days after US Treasury secretary Tim Geithner travelled to Beijing to press for Chinese support on Iran sanctions.

The US State Department announced late Thursday night that penalties would be imposed on China's Zhuhai Zhenrong, the Singapore-based oil trader Kuo oil, and the UAE-based independent oil trader FAL.

While the measures are unlikely to have a big immediate impact on these three companies, they send a strong warning signal to energy companies working in Iran at a time when the US has been canvassing Asian countries for more support in isolating Tehran.

The US State Department called the sanctions against the three firms an "important" step in convincing Iran to change its behaviour, and highlighted the "potential connection between Iran's revenues derived from its energy sector and the funding of its proliferation [of] sensitive nuclear activities."

A spokesperson for Zhuhai Zhenrong said the company had not sold gasoline to Iran. "We've never exported a barrel, not even a wee bit of refined fuel to Iran," said Zheng Mei, director of the public affairs department.

According to the statement, the three firms violated US restrictions on supplying Iran with refined oil products that were passed in 2010. "Under the sanctions imposed today, all three companies are barred from receiving US export licenses, US Export Import Bank financing, and loans over $10m from US financial institutions," the US State Department said.

Importing refined oil products like petrol and diesel is crucial for Iran's economy because the country doesn't have sufficient refining infrastructure to process enough of its own crude into products.

China is the biggest buyer of Iran's crude oil and, according to the US State Department, is also a significant source of gasoline for Iran, but Chinese companies have until now avoided sanctions from the US.

China supported the most recent United Nations sanctions resolution on Iran in 2010, and some analysts believe that in exchange for that support the US may have turned a blind eye to Chinese companies which may have violated US laws. Last year the US placed sanctions on seven companies for selling refined oil products to Iran, but none of those were Chinese.

Zhuhai Zhenrong is a state-owned oil trader based in Southern China. The company has a special mandate from the State Council to do crude trades that offset military trade debt with Middle Eastern countries, according to their website.

Ms Zheng, the spokesperson for Zhenrong, said the company would continue buying Iranian crude. "Zhuhai Zhenrong's trade with Iran is carried out under the two governments. The trade accords with international law and Chinese laws and regulations," she said.

"What we've signed with Iran are long-term contracts and we import around 12m tonnes of crude from Iran each year," Ms Zheng said. "We've never exported gasoline to Iran. This is out of thin air! "

The US State Department said Zhuhai Zhenrong is Iran's largest supplier of refined oil products, brokering sales of gasoline worth more than $500m between July 2010 and January 2011.

The sanctions are likely to have little immediate impact on Zhenrong because the company does very little, if any, business in the US.

Additional reporting by Gwen Chen in Beijing

Thinking big in space

AS A small boy Paul Allen, the co-founder of Microsoft, dreamed of going into space. He even tried to launch the hollow aluminium arm of a chair, stuffed with propellant, into orbit. It didn't work out. But his latest adventure in space travel—a joint venture with Burt Rutan, a famous designer of aircraft—looks more promising. Earlier this month, the two of them said they will build an air-launched orbital delivery system. To do this, Paul Allen’s company Stratolaunch Systems will have to build the world’s largest aeroplane.

The Stratolaunch, as the plane will be called, will be big. Really, really big. It will have six engines, a wingspan of 117 metres (385 feet) and weigh about 544 tonnes. (The wingspan of Boeing's 747 is around half that of the Stratolaunch.) Taking off will require 3.6km of runway, and the aircraft will launch its rocket—a shortened version of the Falcon 9 rocket, built by another private space firm called SpaceX—at around 9,100 metres. The whole contraption will be able to put about 6 tonnes of payload into low-earth orbit.

The idea is to offer a cheaper way of getting medium-sized payloads into orbit, and the system is designed to fill a niche that Boeing's Delta 2 rocket once served. Former NASA administrator, Mike Griffin, who now sits on the board of Stratolaunch, says that besides delivering cargo to the International Space Station, the Stratolaunch will tap a thriving market for launching small to middling communications satellites. There are also other customers in the form of NASA and the Department of Defense. Ultimately, however, Mr Allen wants to see the system launch humans into space.

Of course the obvious question is why not launch the rocket directly from the ground in the first place? It turns out that land-based rocket launches are greatly restricted by irritations such as where one’s rocket pad is, and what the weather is like. Air launch, by contrast, makes orbital access to space much more flexible, a particular bonus for military applications. There will also be a small efficiency gain from launching the rocket from above much of the Earth’s atmosphere. Mr Allen is being cautious about saying how much money he will put into the venture. All he will admit is that an effort of this size requires an "order of magnitude" more money than he invested into a previous collaboration with Mr Rutan, SpaceShipOne. This cost Mr Allen $25m. 

Meanwhile, Mr Rutan’s company, Scaled Composites in Mojave, will be doing what it is best at: scaling composites. It will be super-sizing its existing White Knight aeroplane, which can carry rockets—such as SpaceShipOne—of suborbital flight. Other components for the Stratolaunch will be scavenged from second-hand 747s. Mr Rutan plans to start work as soon as he has a hanger large enough to build the giant airframe. The current schedule foresees test flights in 2015, and an initial launch by 2016. But the spaceflight business is hard and unforgiving, and the schedule is likely to slip. Mr Rutan has come a long way since he built his first plane, the dinky two-seater VariViggen, in 1972. With its 6-metre wingspan, he would be able to fit 20 along the Stratolaunch.

Not so far apart

A FEW years ago a prominent former treasury official came to lunch at The Economistand predicted that the debt level would become a national preoccupation. He expected Americans would grow weary of a large debt burden, but refused to say whether Americans would demand fewer services or higher taxes as a result. It turns out he was correct: Americans are both concerned about the nation's debt, and confused about how to solve the problem. Often lost in this confusion is the important distinction between the current deficit (not such a big deal) and the long-term structural debt (a big problem). The best solution for paying down America's long-term debt is some combination of spending cuts and tax increases. And if you listen closely to both Republicans and Democrats (at least the non-crazy ones) they actually seem to agree on that. Unfortunately they're talking past each other.

This post by Jonathan Chait illustrates the point. He accuses Glenn Hubbard, an advisor to Mitt Romney and Dean of Columbia Business School (full disclosure: I was once his student), of misunderstanding the extent of the long-term debt problem. Referencing the chart below, Mr Hubbard claims that the debt problem is real, largely caused by increases in future spending, and may result in very high future taxes.

We see two scenarios in these charts. The extended-baseline scenario assumes current laws (like the expiration of the Bush tax cuts and the implementation of Obamacare) will not be changed in the future, while the alternative fiscal scenario assumes that "widely expected" changes to current law (ie, revenue as a % of GDP remains the same and entitlement spending is not meaningfully cut) come to pass. According to the CBO, the extended-baseline scenario—what it takes to keep debt levels stable—poses significant costs.

Revenues would reach 23 percent of GDP by 2035—much higher than has typically been seen in recent decades—and would grow to larger percentages thereafter. At the same time, under this scenario, government spending on everything other than the major mandatory health care programs, Social Security, and interest on federal debt—activities such as national defense and a wide variety of domestic programs—would decline to the lowest percentage of GDP since before World War II.

Mr Chait accuses Mr Hubbard of misreading the chart and pushing a lop-sided agenda focused on cutting spending. But Mr Hubbard's position is simply that long-term spending is unsustainable and that the debt problem cannot be solved by tax increases alone. That conclusion is not so different from the research Mr Chait cites from the Center for American Progress, a liberal think tank. There is more common ground here than Mr Chait lets on.

Cutting entitlements and raising future taxes does not necessarily leave people worse off. People live progressively longer and the quality of health-care services, so far, has increased and gotten more expensive. So in principle, you can decrease the length of retirement or the level of benefits paid (especially to higher earners who live longer) and still provide a similar present value of real benefits to future generations. A problem with entitlements is that each new generation expects more than the last, longer retirement and the latest and greatest in health-care technology.

Record-high levels of revenue as a percent of GDP may not be so bad either, so long as society gets progressively richer. Taxing citizens 30% of GDP is a much bigger deal in Angola than Denmark because Angolans have much less income to spare. Though for developed countries the distributional consequences are tricky if income inequality continues to widen. Also there can be second order effects from higher taxes, resulting in lower growth. Fairness to future generations is also important. Punting reform to the future makes it more expensive and places a large burden on the young. Striking the right balance is hard, but possible, and the sooner the better. It is not clear that the current law, associated with the extended baseline scenario, gets it right. That probably requires a more efficent tax code and redefining retirement expectations. It belabours the point of just how necessary a thoughtful dialogue is.

The zero lower bound in our minds

PRIOR to the crisis, there was a general (if tenuous) accord among macroeconomists of many different stripes, that the Federal Reserve could and would act to stabilise the economy when necessary. Then, in December of 2008, the Fed hit the zero lower bound, when it dropped its target for the federal funds rate to between 0% and 0.25%, where it has sat ever since. At the time, the unemployment rate was 7.3%. It eventually peaked at 10% about a year later, and it has come down, very slowly and fitfully, to just 8.5% since then. For fully three years, America has been a zero lower bound world.

During that time, economists have been working very hard to figure out what the implications of the zero lower bound are for macroeconomic policy and unemployment. Are we stuck, or what? 

At a session this morning, I saw a few presentations on the topic. There was a general agreement among them on the nature of the zero lower bound problem and the liquidity trap. There are two different kinds of people in the economy: savers and borrowers. The borrowers borrowed heavily until the shock of the crisis changed the nature of their borrowing constraint and forced them to rapidly deleverage. Without an increase in demand elsewhere, the high rates of saving of the borrowers will plunge the economy into a deep recession. Normally, the real rate of interest should adjust downward until the savers cut their desired saving enough to offset the increase in desired saving of the borrowers; that is, they spend more to make up for the others furiously trying to pay off their bills. But in some cases, the extent of the deleveraging by borrowers may be great enough to drive the market-clearing real interest rate into negative territory. Since the Fed can't cut rates below zero, savers don't spend enough, there is excess saving, and the economy is stuck with high unemployment.

What then? Paul Krugman, who presented a paper in the session with Gauti Eggertsson, noted that fiscal policy was likely to prove effective in such a situation. The government could borrow from those wishing to save more and provide the economy with needed additional demand. At the zero lower bound, government spending doesn't generate crowding out of other investment activities via higher interest rates, so policy is even more effective than usual. And so on. There are other potential solutions, as well; one presenter noted that "unconventional fiscal policy" could replicate an ideal monetary policy through a combination of tax changes—a consumption tax scheduled to rise over time alongside a tax on labour that would decline over time.

But Stanford economist Robert Hall really nailed the crux of the question, so far as I was concerned. At the AEA meetings a year ago in Denver, I listened to Mr Hall speak a few times on this issue and point out that with the market-clearing interest rate below zero the economy was stuck with high unemployment. At the time, I wondered why, if that were true, that the answer wasn't simply a higher rate of inflation, which could combine with a zero nominal interest rate to move the real interest rate below zero.

This time around, Mr Hall addressed the point head on. He noted that in a liquidity trap, the real rate of interest was simply equal to the negative inflation rate. In other words, if the Fed's nominal rate is at 0% and the inflation rate is 2%, then the real rate of interest is -2%. If a -3% real interest rate is necessary to clear the economy, then all that's needed is a higher rate of inflation—3% rather than 2%. Mr Hall noted that this was an important point because potentially the Fed could have an enormously helpful impact on the economy simply by raising inflation just a little. And here's where things got topsy-turvy. Mr Hall argued that:

1. A little more inflation would have a hugely beneficial impact on labour markets,
2. And a reasonable central bank would therefore generate more inflation,
3. And the Federal Reserve as currently constituted is, in his estimation, very reasonable; therefore
4. The Federal Reserve must not be able to influence the inflation rate.

Now, perhaps there was a political economy subtext to this argument; if so, I missed it. Rather, he seemed to be saying (as others, like Peter Diamond, have intimated) that at the zero lower bound it is simply beyond the Fed's capacity to raise inflation expectations. Now admittedly I haven't done a rigorous analysis, but it seems clear to me that the Fed has been successful at using unconventional policies to reverse falling inflation expectations. Why is Mr Hall—why are so many economists—willing to conclude that the Fed is helpless rather than just excessively cautious? I don't get it; it seems to me that very smart economists have all but concluded that the Fed's unwillingness to allow inflation to rise is the primary cause of sustained, high unemployment. And yet...this is not the message resounding through macro sessions. Instead, there are interesting but perhaps irrelevant attempts to model the funny dynamics of a macro challenge that actually boils down to the political economy constraints (or intellectual constraints) facing the central bank. Let's focus our attention on that, for heaven's sake.