US consumer will face reality

Op-Ed Contributor - Dying of Consumption - NYTimes.com

Since the mid-1990s, vigorous growth in American consumption has consistently outstripped subpar gains in household income. This led to a steady decline in personal saving. As a share of disposable income, the personal saving rate fell from 5.7 percent in early 1995 to nearly zero from 2005 to 2007.

In the days of frothy asset markets, American consumers had no compunction about squandering their savings and spending beyond their incomes. Appreciation of assets — equity portfolios and, especially, homes — was widely thought to be more than sufficient to make up the difference. But with most asset bubbles bursting, America’s 77 million baby boomers are suddenly facing a savings-short retirement.

Worse, millions of homeowners used their residences as collateral to take out home equity loans. According to Federal Reserve calculations, net equity extractions from United States homes rose from about 3 percent of disposable personal income in 2000 to nearly 9 percent in 2006. This newfound source of purchasing power was a key prop to the American consumption binge.

As a result, household debt hit a record 133 percent of disposable personal income by the end of 2007 — an enormous leap from average debt loads of 90 percent just a decade earlier.

In an era of open-ended house price appreciation and extremely cheap credit, few doubted the wisdom of borrowing against one’s home. But in today’s climate of falling home prices, frozen credit markets, mounting layoffs and weakening incomes, that approach has backfired. It should hardly be surprising that consumption has faltered so sharply.

A decade of excess consumption pushed consumer spending in the United States up to 72 percent of gross domestic product in 2007, a record for any large economy in the modern history of the world. With such a huge portion of the economy now shrinking, a deep and protracted recession can hardly be ruled out. Consumption growth, which averaged close to 4 percent annually over the past 14 years, could slow into the 1 percent to 2 percent range for the next three to five years.

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Baltic Dry Index

Shipping Industry Heading for Dry-Dock - WSJ.com

Has world trade ground to a halt? Has the world's shipping fleet been mothballed? The Baltic Dry Index, which measures the cost of shipping bulk commodities from iron ore to rice around the world and is often used as a proxy for international trade, has fallen 94% from its high last May to its lowest level since 1987. But while that may look alarming, the reality isn't so bad.

Goods are still being transported, albeit at a falling rate. Shipping, which accounts for about 90% of world trade is likely to decline by just 0.5% next year, according to the Economist Intelligence Unit. The cost of shipping, as measured by the BDI, may have plummeted -- shipping a ton of dry bulk between Australia and China cost less than $4 a day Wednesday compared to almost $45 in May -- but ship operators still prefer running vessels at a loss than leave them idling. But not many will be able to sustain this level of losses for long.

The dramatic collapse in shipping prices is down to a number of factors. First, the economic downturn has led to a big slump in demand for commodities. The recent boom in dry bulk ended when the underpinning Chinese demand for iron ore began to wane, thanks to local stockpiling and the economic downturn. U.S. grain exports fell by a third, or 3 million tons, month-on-month in September, and Japan's coal imports halved to just 9 million tons. Hardly any iron ore has shipped in the last couple of months. Meanwhile, exporters have been pushing for cheaper shipping rates as their own margins were squeezed by the collapse in commodity prices.

Second, the industry suffers from chronic overcapacity. Over the last two years around 50 million tons have been added to a global fleet capacity of close to 420 million tons. But in 2009 and 2010, over 175 million tons is due to come into service. Some of these orders will need to be cancelled if shipping rates are to rise.

But the most pressing issue is the scarcity of letters of credit, the notes banks provide exporters to finance the goods being transported and guarantee payment on them. Banks' heightened risk-aversion means letter prices have soared, if they're issued at all, and that hits demand as exporters are less willing to ship goods. Addressing this lack of finance should be a priority: without it, world trade could grind to a halt.
—Sean Walters, a Special Writer on Dow Jones' Heard on the Street team, has previously consulted on such areas as operational strategy, marketing and finance.

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China woes

Trabajadores de la fábrica de juguetes Kaida, en Guangdong, intentando volcar una furgoneta durante las protestas

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Farm subsidies in Europe to be redirected

EU Redirects Farm Aid to Businesses as Prices Fall - WSJ.com

BRUSSELS -- The European Union will double the portion of farm subsidies it steers away from farms to other rural businesses, after France abandoned a fight to boost the subsidies rewarding farms for producing more.


European tobacco growers set a pile of tobacco leaves on fire outside EU headquarters in Brussels Wednesday, protesting the talks that would result in cuts to the subsidies they receive.

With world food prices rising recently, France had argued that increasing production -- with the help of government aid -- would be a boon that would help alleviate price pressures. But the move also would have reversed a decade of efforts to cut Europe's state-subsidized agricultural output, which has hampered the agricultural development of poorer nations elsewhere.

On Thursday, with food prices collapsing, Paris abandoned the fight. "The political and economic contexts have changed since June," says Pierre Sellal, France's ambassador to the EU. Wheat prices have fallen to less than $6 a bushel on the Chicago Board of Trade, down from a peak of more than $12 a bushel.

With France's agreement, the EU will go in the other direction and double the portion of the bloc's $75 billion-a-year farm subsidies that it steers to nonfarm rural businesses, to 10% by 2013 from 5% this year. The EU also will increase paying farmers their subsidies as lump sums regardless of what or how much they grow. France also conceded defeat in agreeing to phase out direct aid for tobacco farmers by 2010.

Still, France prevented any cuts to the EU's overall farm budget until at least 2013. It also watered down the proposal shifting funds to rural development, allowing France to keep up direct payments to sheep and goat farmers, and to buy up to three million tons of wheat for bread per year from French growers.
The Food Crisis


France effectively designed the EU's farm-subsidy program in the era of post-World War II food shortages, aiming to guarantee food security and a livelihood for millions of farmers. The EU gave farmers a set amount per ton of crops produced, leading to huge surpluses. Under pressure from the World Trade Organization and from developing nations -- where the EU sold its surplus foods cheap, undercutting local farmers -- the EU cut back subsidies linked to production over the past decade to 12%, down from almost 100% in 2000. Meanwhile, 5% now goes to rural development, meaning rural businesses such as golf courses, farmers' market shops or riding clubs.

Some countries including the U.K. were unhappy with Thursday's compromise, arguing that overall EU farm subsidies -- about 40% of the EU's budget -- still need to be cut. The U.K. earns $7 billion per year in EU farm subsidies, half what France gets.

Write to John W. Miller at john.miller@dowjones.com

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Gold

Citigroup says gold could rise above $2,000 next year as world unravels - Telegraph

Citigroup says gold could rise above $2,000 next year as world unravels
Gold is poised for a dramatic surge and could blast through $2,000 an ounce by the end of next year as central banks flood the world's monetary system with liquidity, according to an internal client note from the US bank Citigroup.


By Ambrose Evans-Pritchard
Last Updated: 7:29AM GMT 27 Nov 2008
woman with gold bar - Citigroup says gold could rise above $2,000 next year as world unravels
An employee of Tanaka Kikinzoku Jewelry K.K. displays a gold bar at the company's store in Tokyo Photo: Reuters

The bank said the damage caused by the financial excesses of the last quarter century was forcing the world's authorities to take steps that had never been tried before.

This gamble was likely to end in one of two extreme ways: with either a resurgence of inflation; or a downward spiral into depression, civil disorder, and possibly wars. Both outcomes will cause a rush for gold.

"They are throwing the kitchen sink at this," said Tom Fitzpatrick, the bank's chief technical strategist.

"The world is not going back to normal after the magnitude of what they have done. When the dust settles this will either work, and the money they have pushed into the system will feed though into an inflation shock.

"Or it will not work because too much damage has already been done, and we will see continued financial deterioration, causing further economic deterioration, with the risk of a feedback loop. We don't think this is the more likely outcome, but as each week and month passes, there is a growing danger of vicious circle as confidence erodes," he said.

"This will lead to political instability. We are already seeing countries on the periphery of Europe under severe stress. Some leaders are now at record levels of unpopularity. There is a risk of domestic unrest, starting with strikes because people are feeling disenfranchised."

"What happens if there is a meltdown in a country like Pakistan, which is a nuclear power. People react when they have their backs to the wall. We're already seeing doubts emerge about the sovereign debts of developed AAA-rated countries, which is not something you can ignore," he said.

Gold traders are playing close attention to reports from Beijing that the China is thinking of boosting its gold reserves from 600 tonnes to nearer 4,000 tonnes to diversify away from paper currencies. "If true, this is a very material change," he said.

Mr Fitzpatrick said Britain had made a mistake selling off half its gold at the bottom of the market between 1999 to 2002. "People have started to question the value of government debt," he said.

Citigroup said the blast-off was likely to occur within two years, and possibly as soon as 2009. Gold was trading yesterday at $812 an ounce. It is well off its all-time peak of $1,030 in February but has held up much better than other commodities over the last few months – reverting to is historical role as a safe-haven store of value and a de facto currency.

Gold has tripled in value over the last seven years, vastly outperforming Wall Street and European bourses.

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KO on commodities

In the Global Crisis, Coke CEO Muhtar Kent Sees Headwinds -- and Tailwinds - Knowledge@Wharton

He sees two big obstacles ahead. One is dwindling energy supplies and higher fuel costs, which he predicts will continue for the next dozen years despite the current short-term collapse of crude oil prices. The other is a shortage of critical food commodities. "The introduction of fuels like ethanol, along with erratic weather because of global warning, will be partly responsible for food shortages as well as rising prices for commodities. That's going to put incredible pressure on the supply chains of countries

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China slowdown

Brad Setser: Follow the Money » Blog Archive » If you only read one thing on China this fall …

If you only read one thing on China this fall …

Posted on Wednesday, November 26th, 2008

By bsetser

Make sure it is the latest World Bank China Quarterly.

David Dollar, Louis Kuijs and their colleagues have outdone themselves – and in the process provided a clear assessment of the sources of China’s current slowdown and the risks that lie ahead. I won’t try to summarize the entire report. Read it. The whole thing. No summary can do it justice.

Here though are seven points that jumped out at me.

1. China was no workers’ paradise during the boom years.

GDP growth has been quite strong. But wages have fallen from around 50% of China’s GDP at the start of the decade to around 40% of GDP. That – not a high rate of household savings – is the main reason why consumption is a very low share of GDP (See Figure 15 of the World Bank Quarterly). If China’s workers had secured a bigger share of China’s output, they could be better off now even if China had grown somewhat less rapidly. There is good reason to think that a world where China subsidies US borrowing (and consumption) isn’t the best of all possible worlds. The fruits of the recent boom weren’t shared broadly in either the capital-exporting countries or the capital-importing countries.

2. China really is a manufacturing and investment driven economy.

Even when compared to Korea in 1990 or Japan in 1980, China stands out. Investment accounts for a large share of GDP than it ever did for the smaller Asian miracles and manufacturing accounts for a higher share of China’s GDP than it ever did in other Asian manufacturing economies (Figure 14). Given China’s size, it is pretty clear that China cannot continue to grow by investing ever more and manufacturing ever more. China ultimately has to produce for Chinese demand not world demand.

3. China’s current slowdown was made in China, not in the world.

Yes, growth in “light manufacturing” (toys, shoes and textiles) has slowed. But electronics and machinery exports are still doing very well – even if they don’t get the press (Figure 3). Or perhaps I should say were still doing well in the third quarter; must has changed recently. China’ problem this year is simple: labor intensive export sectors have slowed more than capital intensive export sectors. Overall though China’s real exports grew at a 10-15% y/y clip in 08 – far faster than the overall growth in world imports. China’s real export growth is forecast to outpace its real import growth in 2008 – which implies that net exports will still contribute positive to China’s GDP growth. True, the net exports won’t provide as much of a positive contribution as in 07, 06 or 05. But they are still adding to growth not subtracting from it.

Why then is China slowing so sharply? Simple, real estate investment has hit a wall. After growing at 20% y/y for a long time, real estate investment stalled – with a y/y growth rate of around 0% (Figure 5). That means that China is in turn producing more steel and cement than it needs, and producers of steel and cement are cutting back. That in turns hurts iron ore exporters …

This though is very much a result of China’s own policy choices. Rather than allowing the real exchange rate to appreciate back when China was truly booming (05-late 07/ early 08), China’s policy makers opted to rely on administrative curbs on credit growth. That left China more exposed to global slump in demand – as it kept exports up by limiting real appreciation even as it credit curbs limited the amount of froth in the real estate market back when China was booming and real interest rates were negative. China invested a lot in real estate, but it is no Dubai. But China’s policy makers still look to have slammed the brakes on a bit too hard. Rather than slowing gradually, real estate investment fell off a cliff (Figure 5).

4. There is more bad news ahead.

While real exports contributed positive to GDP growth in 2008, they won’t contribute in 09. The World Bank forecasts that for the first time in a long time, 2009 real import growth will exceed real export growth. In 2005, real exports grew about 10% faster than real imports (23.6% v 13.4%). Many economists remain – for reasons that to be honest elude me – reluctant to draw the obvious connection: the most likely explanation for China’s strong real export growth is the large depreciation the RMB in 2003 and 2004. That combined with administrative controls – which limited lending, investment and ultimately imports – to create China’s large current account surplus. Real export growth exceeded real import growth by 5 percentage points in 2006 and 2007 – and by 4 percentage points in 2008.

The positive contribution of net exports to GDP is forecast to end in 2009: real import growth will exceed real export growth by 3 percentage points.

That though doesn’t mean that China’s currency isn’t undervalued. China’s exports are forecast to grow faster than the world’s imports, meaning China’s global market share is still increasing (see Figure 2). And if 2008 and 2009 are taken together, China will still be drawing on the world for its growth: the drag from net exports in 09 will be smaller than the contribution from net exports in 08 (see Table 1)

I fully realize that China is appreciating quite significantly now in real terms – just global demand for China’s goods is falling (Figure 11). The tragedy is that this appreciation is coming now – not two or three years ago when domestic Chinese demand was booming and China didn’t need to draw on the rest of the world to sustain strong growth.

5. The fiscal stimulus is real, but modest. China’s fiscal balance is expected to swing from a 0.7% of GDP surplus in 07 to a 2.6% of GDP deficit in 09. That is a 3.3% of GDP swing. In 2009 alone, China’s deficit is forecast to rise by 2.2% of GDP. See Table 1. That shift is important and will help to support China’s growth– but it will likely lag the swing in the US fiscal deficit. Hopes that surplus countries will end doing more than deficit countries seem unlikely to be ratified.

6. The last thing anyone needs to worry about is fall in Chinese demand for US treasuries.

The Treasury market obviously isn’t worried - not it 10 year Treasury yields are under 3%. And there is little reason for the bond market to be worried if current trends continue.

The World Bank forecasts that China’s current account surplus will RISE not fall in 2009, going from an estimated $385 billion to $425 billion. How is that possible if real imports are forecast to grow faster than real exports? Easy – the terms of trade moved in China’s favor. The price of the raw materials China imports will fall faster than the value of China’s exports. China’s oil and iron bill will fall dramatically.

In macroeconomic terms, China’s fiscal stimulus will offset a fall in domestic investment leaving China’s current account (i.e. savings) surplus unchanged. The 2009 surplus is expected to be roughly the same share of China’s GDP (9%) as the 2008 surplus.

In dollar terms, the World Bank forecasts that China will add almost as much to its reserves in 2009 than in 2008. That is a bit misleading: the 2008 reserve growth number leaves out the funds shifted to the CIC (ballpark, $100b in 08) and the rise in the foreign exchange reserve requirement of the state banks (ballpark, another $100b). But it captures a basis truth. Even if a fall in hot money inflows means that China will be adding $500b rather than $700b to its foreign assets, its foreign assets will still be growing incredibly rapidly. China already has – counting its hidden reserves – well over a $2 trillion. It is now rapidly heading for $3 trillion.

In broad terms – if oil stays at its current levels – China will be the only large surplus country in the world, and it will essentially be financing a US deficit of roughly equal magnitude to China’s reserve growth. It makes everything plain to see.

7. The way China manages its reserves matters immensely for the world not just China

China shifted from buying Agencies to buying Treasuries in July. Others did too, but no one has quite the market impact of China. China doesn’t disclose what it is doing with its reserves, but the recent shift in Chinese demand isn’t really in doubt. The market knows it. The TIC data for August showed it. And the latest Fed data strongly suggest large ongoing migration from Agencies to Treasuries.

China now accounts for such a large share of the world’s reserves that it is hard to see how the FRBNY’s custodial data doesn’t reflect, at least in part, a shift in Chinese demand.

A key themes of this blog has been how the internal imbalances of China’s economy are a reflection of its undervalued exchange rate – and that China’s surplus has implications for the world. It has to be balanced by large deficits elsewhere. Another key theme has been that the Fed has been pushed to absorb risks that other central bank reserve managers now shun. Nothing illustrates this more clearly than the Agencies. Foreign central banks are scaling back their Agency holdings. The Fed is gearing up to buy. Big Time.

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Fiat money vs gold standard

Gold Standard Does Not Always Bring Credibility

Gold Standard Does Not Always Bring Credibility

... Monetary policy rules are no short-cut to credibility in situations where vulnerability to economic and political shocks, not time-inconsistency, are overarching concerns for investors.

Adopting a new gold standard, or some other hard currency peg, is often touted as a good way for poor, developing nations to attract foreign investors. But if the last era of globalization is any guide, the benefits of doing so are nil. Rather than a "good housekeeping seal of approval," adoption of a gold standard by the poorest developing countries a century ago served as a "thin film" of credibility -- and foreign investors often saw through such maneuvers, according to Niall Ferguson and Moritz Schularick writing in The "Thin Film of Gold": Monetary Rules and Policy Credibility in Developing Countries (NBER Working Paper No. 13918).

This study challenges research over the past decade that has suggested that, prior to World War I, the gold standard helped nations who adopted it because they could borrow money at lower interest rates than countries that didn't use the standard. By examining interest rates and economic control variables for 57 countries from 1880 through 1913 (more than twice the number of countries examined in previous studies), the authors found that while developed nations did see a benefit from adopting the gold standard, developing nations did not. "History shows that monetary policy rules are no short-cut to credibility in situations where vulnerability to economic and political shocks, not time-inconsistency, are overarching concerns for investors," they conclude.

In the late nineteenth and early twentieth centuries, the world saw a spate of globalization that in some ways rivals today's global capital flows. By 1913, foreign investments in Argentina, Chile, and South Africa stood at around 200 percent of those nations' gross domestic product (and at 100 percent or more for the GDPs of Brazil, Mexico, Egypt, and Malaysia), roughly twice the levels of today. Some 40 percent of Britain's capital flows between 1880 and 1913 went to countries other than the comparatively rich settler economies. Today, only 10 to 15 percent of global capital market flows go to less developed nations.

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US Food Prices

Food Prices Expected to Keep Going Up - NYTimes.com

A reason that overall food prices are expected to continue increasing is the lag between price increases for basic commodities and for finished food products in the grocery store, particularly for meat and processed foods. Consider the price of corn, an ingredient in things like cereal and breaded shrimp. It was not too long ago that corn hovered around $2 or $3 a bushel.

But corn prices began climbing last fall and peaked around $8 a bushel in June. They have since dropped to about $3.50 a bushel, still above the historical norm. Some food manufacturers locked in prices for corn and other commodities in the spring and summer, fearing that prices could go even higher. But prices fell instead, and they are now stuck with the higher prices until their contracts expire.



The prospect of more food inflation is inflaming a debate over its
causes. Many food manufacturers and economists maintain that one
culprit is government policies promoting the use of ethanol fuel made
from corn.

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Pretty soon you are talking big money

The New York Times > Business > Image > The Government’s Committments

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Politics

Deal Journal - WSJ.com : The Paulson Plan: 'Truly Idiotic'

November 25, 2008, 10:48 am
The Paulson Plan: ‘Truly Idiotic’
Posted by Dennis K. Berman

Charles Calomiris is angry. Hank Paulson’s plan to save the economy? “Truly idiotic,” says Calomiris, who is the Henry Kaufman Professor of Financial Institutions at Columbia University’s business school. “This whole thing has been complete nonsense. We did it in the 1930s ten times better than this. This isn’t complicated.”

null

Deal Journal caught up with Calomiris late Monday to talk over the state of the financial world. Calomiris has long advised governments, banks, and private investors on financial crises. And while he spoke to Treasury officials during “The Lehman Brothers Weekend” in September, they appear not to be listening. Here’s an edited transcript of parts of the conversation.

Deal Journal: What the heck is going on out there? The Citigroup bailout isn’t a good sign of confidence in the overall financial system, is it?
Charles Calomiris: The key thing we’ve learned during the downward spiral of confidence is that you have to deal with the problem in the mortgage market directly. There are probably 18 million subprime and Alt-A mortgages out of 57 million total. Probably half will end up in foreclosure.

In the middle of a financial crisis, we’re using half measures designed in an inappropriate way, and we don’t accompany them with other measures. This has just been a completely mismanaged policy response.

DJ: There’s this perception that we can “fix” the price of individual mortgages. But shouldn’t the price of homes find its natural equilibrium?
CC: The market price is not decreed by God. The market price is an outcome of a variety of things. Recapitalizing the banks is helpful for giving them breathing room, and for providing credit in the meantime. But it doesn’t resolve the problem.

The problem is the completely opaque distribution of losses because no one knows how to value these mortgage losses. The way to solve the problem is from the bottom up.

DJ: So how can we do that?
CC: There’s loss-sharing to encourage write-downs of mortgages. It was done in Mexico in 1995. If holders can arrive at a write-down in lieu of foreclosure that leads to sustainable mortgage, we as taxpayers would sustain the rest. It lets the market work the problem out and creates the motivation for doing it quickly.

You could also have the government offer to buy any mortgage for 40 cents on the dollar. It would create immediate liquidity, because mortgage backed securities would rise on that scenario, all would be truncated at 40 cents.

Third, we could refinance all healthy mortgages at 5%, at 30-year fixed financing. Allan Meltzer has idea about giving tax credits for buying homes, they’re all good ideas. The problem with what we’re hearing from Paulson does not have much to do with any of this.

DJ: What about creating government incentives for the formation of new banks?
CC: Recapitalizing the banks is a good idea in principle. Starting new banks is a good idea. It’s all fine, but we have to come to grips that unlike any financial crises – and I’m an expert on them – this one is a complete outlier. In other crises, the uncertainty on the total of the losses was resolved in a matter of months. We’ve been trying to resolve mortgages and CDO tranches for a year and a half. It’s not going well.

DJ: So what’s the matter with some of Paulson’s latest ideas?
CC: Warrants are a bad idea. They dilute common stock holders, and make it harder to design common equity. It’s been a design flaw all along. It’s all a part of thinking of these things in terms of deals. They’ve got Warren Buffett envy.

But in terms of ways that truly recapitalize a bank, they’re truly idiotic.

If you attach warrants that are dilutive, it’s harder to issue common stock. If you want to make money, go buy stock. If you want to increase the net worth of a bank, make that coupon as low as possible and require matching common stock issues. If you learn you can’t do it [the common stock match] then have to decide whether to do a common stock injection, an assisted merger, or shut the bank down.

DJ: Why isn’t anyone listening to these ideas?
CC: The point is that they have made huge errors in the design of their assistance plan and they were forecastable errors.

For instance, Paulson doesn’t want there to be a stigma [around capital injections.] Does he really believe that by getting J.P. Morgan to participate, he creates the perception that JPM and Citi are the same?

Does he really believe that injecting preferred stock into banks is socialism but buying assets at above market price isn’t? Does he really believe that?

There actually is a stock of knowledge about this. The scandal is that when Congress has been considering this, not one independent economist has been allowed to testify. Do you know why they weren’t? Paulson and Bernanke didn’t want anyone causing problems.

DJ: Wait, that sounds like a conspiracy.
CC: Democrats didn’t want anyone [economists] testifying because it was before an election and no one was willing to stand before that bulldozer known as Paulson. No one wanted to make tough political decision before the election. They didn’t empower any experts to come in and testify. Why is that? They were playing politics, too. That’s what we’re dealing with–a complete leadership failure in Congress and the administration.

Don’t underestimate the role of politics in the decision not to fix things.

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The developing world is waiting

Obama vows to slash wasteful spending | U.S. | Reuters

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China growth

FT.com / Asia-Pacific - World Bank says crisis will slow China

China’s growth rate will fall to 7.5 per cent next year – its slowest for nearly two decades – the World Bank said on Tuesday as it sharply cut its outlook for the country’s economy.

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Food

Bloomberg.com: Exclusive

Nov. 25 (Bloomberg) -- Food prices will rise next year, prompting a revival of protectionism from food-growing nations and risking a renewed bout of rioting, according to Jochen Hitzfeld, an analyst at UniCredit SpA in Munich.

“Agricultural commodities will outperform the broad commodity indices in 2009,” Hitzfeld wrote in a research note this week. “If key crop-producing countries then impose export bans again and speculators drive up prices via physical stockpiling and futures contracts, new food unrest is even conceivable in the second half of 2009.”

The CHART OF THE DAY shows food prices for the past 10 years as measured by an index compiled by UBS AG and Bloomberg that tracks at least 13 foodstuffs, including wheat, soybeans, sugar, cocoa and coffee. The index has declined 35 percent since peaking in July.

“The prices of many agricultural commodities are now clearly below their production costs,” Hitzfeld wrote. “We expect the coming year to bring a cutback in area under cultivation as well as a decline in the yield per hectare.”

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Print money

A Billion Here, A Trillion There: Calculating the Cost of Wall Street's Rescue - Knowledge@Wharton

Marston and Blume, too, argue that these future costs present an immense problem. Dealing with it will require some combination of raising taxes or cutting benefits -- or "monetizing" the problem. Essentially, that means printing money to raise inflation, which should push tax revenues up (although higher inflation also could raise Social Security and Medicare expenses, offsetting the benefit). "With the liquidity that's being pumped into the system, and the loose credit that the Treasury and Fed are trying to create, down the line we are going to have to worry about inflation," Marston suggests.

Nearly all economists agree entitlements are a looming threat, according to Marston. "It doesn't matter what the political persuasion is. We are much more worried about the entitlement issue than we are about the cyclical deficit and interest rates."
Many experts' faith in the predictive value of interest rates has been shaken over the past two years. Deficits and debt do matter -- if not today, someday, Smetters says.

To economists, the most frightening fact is that the enormous cost of today's financial rescues is just a drop in the bucket.

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Monetize Fiscal Debt

RGE Monitor

# Buiter: When the government provides a fiscal stimulus to demand, the Treasury has to issue additional debt. If this debt is not bought by the central bank, it will have be be held willingly by the domestic private sector and the public sector. The only way to ensure that larger public sector deficits do not add to the sovereign default risk premia is for the central bank to buy the additional government debt. Assuming the central bank does not finance this purchase of public debt by selling private securities but instead by increasing the monetary base, the deficit is monetized and no financial crowding out occurs
# Buiter: The commitment to both price stability and debt monetization is possible if 1) the central bank will de-monetise again when liquidity preference shrinks, and 2) the government(s) will act countercyclically in good times as in bad times and will raise taxes or cut public spending as soon as the economy is back to normal
# Wilder: The Treasury is sterilizing the Fed's liquidity measures, rather than the Fed monetizing the Treasury's debt, but at some point the Fed may choose to monetize new debt issued by the Treasury
# RTE: In a 2002 speech on preventing deflation, Bernanke suggested financing new tax cuts and spending increases with money printed by the Federal Reserve. If the money is spent, the economy should start to recover
# Roubini, Christiano/Fitzgerald: The "fiscal theory of the price level" suggests that fiscal deficits may or may not lead to high inflation depending on whether there is "fiscal dominance" or "monetary dominance". If there is "fiscal dominance", the deficit policies of a fiscal authority will eventually force the central bank to monetize the deficit, i.e. to increase seignorage and use the inflation tax to finance an exogenous fiscal deficit path. If there is "monetary dominance", the central bank commits not to monetize the deficits and the fiscal authority is forced to adjust its budget policy (i.e. cut spending or raise taxes) to satisfy its intertemporal budget constraint

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Risks can´t be avoided

FT.com / Columnists / Wolfgang Munchau - Double jeopardy for financial policymakers

Double jeopardy for financial policymakers

By Wolfgang Münchau

Published: November 23 2008 19:04 | Last updated: November 23 2008 19:04

In the current turmoil, accidents can pull us in vastly different directions. The unforeseeable bankruptcy of Lehman Brothers, the US investment bank, transformed a lingering financial crisis into a near-systemic meltdown. Depending on how other unpredictable events turn out in the next few weeks and months, we could end up with a deflationary depression, an inflationary boom or even one followed by the other.

In such an environment, economic forecasts are useless – worse than useless, in fact, because they give us a sense of certainty where there is none.

One path-changing accident would be the bankruptcy of one of the large US carmakers. The probability of such an event has clearly risen in the past week. Naturally, this would be bad for the US car industry itself. But it might be even worse for the banks, especially those that got involved with credit default swaps – probably the most dangerous financial products ever invented. CDSs are unregulated shadow insurance products that investors buy to protect themselves against default of corporate and sovereign bonds. Protection against a default by General Motors was among the most sought-after contracts.

The housing market is another potential time-bomb. Until recently, most of the housing experts were content to predict a 25-30 per cent fall in US prices – peak to trough. Such a fall would bring prices back in line with the long-term trend. But this was before an expected mild downturn turned into a big recession, and credit froze up.

Under such conditions, one would expect house prices to overshoot, say at least 10 or 20 percentage points beyond the trend line. So we may be talking about a peak-to-trough fall of 40-50 per cent on average in nominal terms – and more in real terms. There is no reason to see why the downturn should be any different in the UK, Ireland and Spain.

The path might take us elsewhere, however. Suppose the Detroit Three get their bridging loans. Suppose further that the CDS market does not collapse, and governments find effective measures to prevent an extreme overshooting of house prices. Then we might find ourselves in a completely different world. The recession in the western economies might end in the middle of next year. With interest rates close to zero, borrowing would pick up fast. Oil and commodity prices would rise as fast as they came down. I would expect the central banks to be too slow in raising their interest rates for fear of killing off the incipient recovery.

The result would be a sudden rise in inflation, perhaps the mother of all bond market crashes and, quite possibly, a dollar crisis.

So there are risks both ways – asymmetric perhaps, but surely significant, both in terms of their impact and their probability.

Statisticians distinguish two types of errors: type one and type two. Suppose we believe that another Great Depression is about to happen. A type-one error would be to reject our depression scenario when it is true, while a type-two error would be to accept it when it is false.

The US Federal Reserve’s policy is about avoiding a type-one error – underestimating the threat of a depression – at all costs. I was quite surprised last week – though perhaps should not have been – when I learnt that the Fed had quietly adopted a policy of “quantitative easing”.

The Fed conducts open-market operations normally with the goal of keeping the actual Fed funds rate close to the target rate set by the Fed’s open-market committee. The Fed funds rate is the rate at which banks lend their balances to each other overnight. But, more recently, the actual Fed funds rate has fallen much below the target rate, which is 1 per cent. Under a strategy of quantitative easing, the Fed does not care about the rate. The goal is to increase the money supply, by swamping the Fed funds market with liquidity. The calculation is that this would give banks an incentive to buy higher yielding securities, which would reduce long-term interest rates, over which the central bank has no direct influence.

For a central bank, this is comparable to the deployment of the nuclear option – your last or last-but-one policy option. Ben Bernanke, the chairman of the Fed, once co-wrote a paper on the subject of what a central bank can do when interest rates hit the “zero bound”* – a zero rate. The answer is that there are a few options, quantitative easing among them. It is interesting, though, that he has already deployed his weapon of mass desperation while still some distance away from the zero bound.

The US policy establishment regards this crisis principally as carrying a “one-tailed”, or one-sided, risk of a deflationary depression, to be avoided at all costs. But there are also grave risks associated with making a type-two error. A subsequent rise in US inflation could trigger a mass flight out of dollar assets and a large rise in US market interest rates, followed by a huge recession. The main difference is that the policy options would be a lot more constrained under such a scenario. In fact, a type-two error could also give rise to a depression – only later. I still think it is best to treat the crisis as an event with a “two-tailed” risk.

*Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment, B. Bernanke, V. Reinhart, B. Sack, Federal Reserve Board, Finance and Economics Discussion Series, 2004-48

Send your comments to munchau@eurointelligence.com

Copyright The Financial Times Limited 2008

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Inflation as solution

Stephen King: If interest rate cuts cannot solve the money shortage, turn on the printing press - Stephen King, Business Comment - The Independent

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Sachs and the Citi

Bloomberg.com: Worldwide

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The answer is very high inflation

The Downfall of Keynesian Economics and the U.S. (Part 3 of 3) - Seeking Alpha

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Buy a toaster get a free bank

 

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Commodities by RGE Monitor

RGE Monitor

# There have only been two significant super-cycles in the past 150 years. The first, in the late 19th and early 20th centuries, reflected the emergence of the US as a global economic superpower. The second was triggered by the post-war reconstruction of Europe and Japan between 1945 and 1970. If we are in the third super-cycle, its cause is the integration into the global economy of China, India and many other smaller developing countries
# In previous super-cycles, supply has always eventually caught up with demand. But after years of under-investment in a 21-year bear market b/w 1980-2001, there is an enormous amount of catching up still to do
# Many analysts foresee the current downturn as a cyclical correction in commodity prices that will continue next year due to global recession (and the resulting fall in demand) and credit crisis (and the resulting unwind of speculative positions)
# The low prices in commodities has led to production cuts and investment delays, sowing the seeds of a future supply crunch when commodity demand recovers
# Analysts forecast commodity demand to pick back up in China in 2010. India's demand will surpass China's in 2-3 decades. Then Africa will surpass Chindia demand in a few decades after that, keeping the commodity super-cycle intact
# Economic growth in developing countries argues for a secular bull market in commodities. However, the credit crisis may permanently restrict the ability to leverage, keeping the commodity supercycle's uptrend moderate compared to the pre-crisis run-up
# Debt-financed consumption in developed countries and leveraged investments into developing countries and commodities drove the rapid growth of developing countries up until this year

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Global Trends 2025

NIC 2025 Project

# The whole international system—as constructed following WWII—will be revolutionized. Not only will new players—Brazil, Russia, India and China— have a seat at the international high table, they will bring new stakes and rules of the game.
# The unprecedented transfer of wealth roughly from West to East now under way will continue for the foreseeable future.
# Unprecedented economic growth, coupled with 1.5 billion more people, will put pressure on resources—particularly energy, food, and water—raising the specter of scarcities emerging as demand outstrips supply.
# The potential for conflict will increase owing partly to political turbulence in parts of the greater Middle East.

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Brazil by Sebastián Edwards

Project Syndicate

But the most important question is what will happen in Brazil, Latin America’s giant. Over the past few years, analysts and investors around the world began to see Brazil as an economic power in the making. There was mention of a miracle, and many argued that Brazil would grow spectacularly like China and India, and no longer be the eternal country of “the future.” Unfortunately, everything suggests that this was an illusion based on wishful thinking.

Brazil’s boom of the past few years stood on an incredibly weak foundation. President Luiz Inácio Lula da Silva did indeed decide to avoid the rampant populism of Hugo Chávez of Venezuela, and successfully tackled inflation. But it takes more than that to become a great economic power.

What Lula did was simply to decide that Brazil would be a “normal” country. But more than controlled inflation is needed to create a robust economy with a high and sustainable growth rate. Agility, dynamism, productivity, and economic policies that promote efficiency and enterprise are required.

As many studies have shown, Brazil has not been able – or has not wanted – to adopt the modernizing reforms needed to promote a productivity boom. Brazil is still an enormously bureaucratic country, with an educational system in crisis, very high taxes, mediocre infrastructure, impediments to the creation of businesses, and a high level of corruption.

It is sad but true: in recent years Brazil did not opt for modernization and efficiency and will have to pay the consequences during the difficult years ahead.

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Inflation consensus is arising

Real Time Economics : Guest Post: Markets Test U.S. Resolve

One longer term approach may now appeal to the Federal Reserve, i.e., a
more expansionary monetary policy steepens the yield curve, raising
profitability for banks and generating sufficient inflation. This is
not without substantial risks, but house prices recover. Most large
banks can and should survive in that scenario.

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China daily dosis

Marginal Revolution: Facts about China

Facts about China

Exports constitute nearly 40 percent of China's GDP--far too high a figure. (By comparison, in the U.S., exports account for about 10 percent of GDP most years.) And the global financial slowdown is already taking a terrible toll. Some 10,000 factories in southern China's Pearl River Delta area had closed by the summer of 2008. Gordon Chang, a leading China analyst, estimates that 20,000 more will shutter by the end of this year. In the third quarter of 2008, Beijing also reported its fifth consecutive quarterly drop in growth, and several private research firms expect a sharper slowdown next year. Additionally, unemployment is skyrocketing; in Wenzhou, one of the main exporting cities, about 20 percent of workers have lost their jobs, Reuters recently reported.

Here is more. By the way, here is an article on China's retreat from environmental concerns.

I thank Clifton Chadwick for the pointer.

Posted by Tyler Cowen on November 20, 2008

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Once again Brands are dead

As in every recession brands will be under siege, many will claim that this is the end of marketing as we know  it. But then  the economy improves and brands are back, however 2009 will be more than tough.


Private Label Food Will Likely Be King for 2009 - Seeking Alpha

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The future is written

FT Alphaville » Blog Archive » The doomed dollar?

FT Alphaville » Blog Archive » If all else fails, devalue the dollar

FT Alphaville » Blog Archive » Dollar *danger* ahead

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Trade down

FT.com / Companies / Shipping - Dry bulk goods growth to halt in 2009

Dry bulk goods growth to halt in 2009

By Javier Blas, Commodities Correspondent

Published: November 18 2008 23:57 | Last updated: November 18 2008 23:57

The double-digit growth in seaborne trade of dry bulk commodities, such as iron ore and grains, over the past few years will come to a halt in 2009 as economic growth in China and elsewhere slows down, commodity analysts and shipbrokers say.

Peter Norfolk, director of research at Simpson Spence and Young ship brokers in London, says: “We will see some growth next year, but nothing close to the strong increases of the last few years. It is a big slowdown”.

The International Monetary Fund forecasts that the world’s trade volumes – including dry bulk, container shipping and services – will grow next year by 2 per cent, the lowest since 2001, down from 4.6 per cent this year.

The drop comes as the economic slowdown spreads from the US into Europe and Japan and also hits emerging economies such as China and India.

Analysts and shipbrokers are cautious about their forecast for dry bulk commodities trade in 2009 because of changing economic conditions, but most of them forecast little if any growth. Some foresee a decline in trade.

UBS estimated seaborne iron ore trade would drop next year to 741m tonnes, down 4.1 per cent from this year’s record of 775m tonnes, because of the slowdown in Chinese demand, which accounts for almost half of the world’s imports.

The Swiss bank forecast that trading in coking coal – another ingredient in steelmaking – would also fall next year. It said about 222m tonnes of coal would be shipped, down 2.4 per cent from this year’s record 227m tonnes.

But the drop in volumes transported could be also mirrored by shipments being concentrated in a shorter time frame, supporting the market, according to Philippe Van den Abeele of the Castalia shipping hedge fund.

The iron ore and coal markets – the two most important for dry bulk commodities and critical for freight prices for large vessels such as Capesize – will come with a reduction in grains such as corn and rice trading, which are important for smaller vessels.

The United Nations’ Food and Agriculture Organisation forecast that global cereal trade would drop in the 2008-09 harvest season to 264m tonnes, down 2.9 per cent from the 2007-8 ­season.

The Rome-based FAO said in its recent Food Outlook: “Reduced trade in coarse grains is the main reason for the world cereal trade decline, although a small contraction in global rice transactions is also anticipated”.

Copyright The Financial Times Limited 2008

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Everybody is worried about China

Why I'm Worried About China - Seeking Alpha

Current forecasts: 6% growth. Current situation in sectors previously driven by China: below bottom. Commodities are easiest to track, nothing good is going on there. Spot shipping prices, according to CNBC talk, are below costs. Good information from Diana Shipping Inc (DSX): Fleet Employment. As you can see, 7 of 12 Panamax class ships don't have contracts beyond Feb 2009, which is 3 months from now. A year ago, all ships were contracted at least one year forward. This is one of the best dry bulk carriers in the world!

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The US Dollar

FT.com / Markets / Insight - Insight: The dollar is a flawed currency

Insight: The dollar is a flawed currency

By Jim Rogers

Published: November 17 2008 16:05 | Last updated: November 17 2008 16:05

The following are excerpts from this week’s View from the Markets online interview

FT: It’s a year since we last interviewed you. You were aggressively bearish about the dollar, but you thought there would probably be a rebound and you would take that as an opportunity to further get out of the dollar. Have you made a further exit from the dollar?

JR: Not yet, no. And the reason I haven’t is because we’re in a period of forced liquidation of everything. We’ve only had eight or nine periods like this in the past 150 years, where everybody has to reverse their positions on everything. There is a gigantic short position in the dollar and they’re all having to cover as they reverse their positions, so this rout is going to go on much further than I would have expected, to my delight, because then I’ll get to sell at higher prices. I don’t know whether I’ll get out this month or this year even, maybe next year, but I do plan to get out of the rest of my US dollars, because this is an artificial rally caused purely by short covering.

FT: How will you tell when that deleveraging is finally over?

JR: I’m sure I won’t get it right, but I do hope that when there’s a lot of euphoria about the dollar and everybody’s saying, well, see, there’s no problem with the dollar... I hope I’m smart enough to recognise it and finally get out of the dollar, because it is a flawed and maybe, even, doomed currency.

FT: Do you see the sell-offs we’ve seen in commodities as a drastic correction?

JR: Well, we’re in a period of forced liquidation of all assets... we’re getting the business cycle effect on demand right now, certainly, but unless the world’s in perpetual economic decline, commodities are the only thing going to come out of this okay.

FT: Does this mean you’re actually buying back into commodities at the moment, or is this an area you’re standing clear of?

JR: No, no. In October when I started covering my shorts in the US stock market, I started buying Chinese shares, Taiwan shares, I started buying commodities again. No, no, I’ve added to those positions.

FT: What’s your strategy towards emerging market stocks?

JR: My hope is that I’m smart enough and brave enough at some point along the line to buy some of them back. But I’m not even thinking about it right now... The world’s financial situation is in a mess, and there are a lot of people who have to liquidate. I mean, we must have had 30,000 MBAs flying around the world looking for emerging markets. All of that money has got to come home.

FT: How do you think the world should go about redesigning the regulatory system, and are you worried that we’re going to end up with a swing towards over-regulation?

JR: Well, we probably will, The problem is that people like Alan Greenspan would never let the market work... For 15 years, under Greenspan, and now Bernanke, they would not let the market work. Had they let Long-Term Capital Management fail back in 1998, we wouldn’t have these problems now, I assure you. Lehman Brothers would have been smashed. Goldman Sachs, Bear Stearns, would have been smashed. We wouldn’t have these problems now. That only happened because every time they turned around they propped these guys up, gave them more money, and that’s why we have the problem... But now, of course, they’re going to blame it on other people and cause more regulations.

FT: You’re arguing we need to allow some more big institutions to fail?

JR: One failed. Why didn’t they let Fannie Mae and Freddie Mac? I mean, I was short Fannie Mae, and they should have let it fail, go zero. AIG, they should have let it fail, they should have let all of these guys fail, and we would clean out the system... What they’re doing is they’re taking the assets away from the competent people, giving them to the incompetent people and saying to the incompetent: “Okay, now you can compete with the competent people, with their money.” I mean this is terrible economics. This is outrageous economics.

Jim Rogers is an investor, author and founder of the Rogers International Commodity Index. You can also hear his views on oil, China and the Japanese yen at www.ft.com/vftm

Copyright The Financial Times Limited 2008

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Questionionig the previous post

The food crisis has driven home two important lessons: firstly, that global agricultural production needs to be increased, significantly, and secondly, that short-sighted agricultural and tariff policies can cause mass starvation. The solution to both of these problems is a bigger, freer market in agricultural goods -- not a reversion to some impossible ideal of self-sufficiency.


Food: Against Self-Sufficiency - Finance Blog - Felix Salmon - Market Movers - Portfolio.com

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Agricultural tariffs

Economist's View: "The Perils of Efficiency"

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Me pone recontento que garpen

American Task Force Argentina - Pursuing a Fair Reconciliation of the Argentine Debt Default

By Latin American Herald Tribune Staff

Washington, D.C. Congressman Eliot L. Engel, Chairman of the House Foreign Affairs Subcommittee on the Western Hemisphere, released the following statement regarding Argentine President Cristina Fernandez de Kirchner's announcement yesterday that her country will pay its entire $6.7 billion debt to the Paris Club group of creditors:

"I congratulate President Cristina Fernandez de Kirchner and the Argentine government for pledging to pay its entire $6.7 billion debt to the Paris Club. I had the good occasion to travel to Buenos Aires in February where I met with President Fernandez de Kirchner. I am quite impressed by her leadership of Argentina and also by her excellent Ambassador in Washington Hector Timerman who has played a leading role on this issue.

"I am delighted that Argentina has taken this important step forward, and I hope that it leads to increased investor confidence and economic prosperity for the country. I also believe that yesterday's announcement will help fortify the already strong relationship between the United States and Argentina. Finally, I look forward to building on yesterday's momentum by working with the Argentine government as it takes steps to normalize financial relations with all external creditors and the international financial community."

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Sunday Break

Thousands of Spammers can´t be wrong

Spam gets 1 response per 12,500,000 emails | News | TechRadar UK

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Juan Obama Perón

Targeting Your 401(k) - WSJ.com

You may have heard about Argentina's plan to nationalize private retirement accounts. Some Democrats on Capitol Hill are inspired, and with their big election victory they may get the chance to test Peronist ideas in America.

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More and more

24/7 Wall St.: China, Back To Candles & Rice Farming

A ship broker recently outlines the problems in China. A ship costing over $200,000 per day from South America to China in May went for just over $10,000 a day recently. He noted how the docks and ports in much of China are full, and how they just simply can't accept more inflows of materials. And the quote was the best: "It's like they are going back to being rice farmers again."

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Sorry fellas

Your Spot for Futures Trading, Commodities Info, Ag News, Successful Farming Tips & More

China export plans. China's actions this week to reduce export taxes on some products and eliminate them on others do include ag products. China will eliminate a 5% export tax on corn and soybeans and a 10% tax on corn flour and corn starch exports as of Dec. 1, while reducing the tax on wheat and rice to 3% and on wheat and rice flour to 8%. However, statements by government officials are that the country has no plans for large-scale grain exports in coming years.

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Brazil challenges

BRAZIL: Agribusiness faces multiple anxieties - International Herald Tribune

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By Soros

According to Reuters, Soros said "a deep recession is now inevitable and the possibility of a depression cannot be ruled out."

He added "hedge funds will be "decimated" by the current financial crisis and forced to shrink their portfolios by 50-75 percent."

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Farm Real Estate Sector Headed into a Decline? - Seeking Alpha

According to the data from Economic Research Service, farm real estate comprises nearly 79% of total U.S. farm assets in 2000. Since much of the current attention is focused on the residential real estate and subsequent credit crisis, it is high time to look at another important market, farm real estate. Agricultural land values typically vary from state to state, depending on the quality of soil and demand for its use.

In this article, I compared the average farm real estate values for three states, Iowa, Illinois and Indiana for the period between 1970 and 2008 (see the figure below). These three states together are responsible for more than one third of total corn and soybean acreage in 2008.

Data Source: USDA

The average farm real estate value for these three states in 2008 was $4,485 per acre, an increase of 14.65% when compared to the previous year. Since 1970, farm real estate values have declined only five times during the period 1982 to 1987. Starting from 1991, farm real estate values have increased continuously in all these three states without registering even a single year drop in prices.

Between 1991 and 2004, average increase in farm real estate value was 5% where as the last four years have witnessed, an average increase of approximately 15% per year. If you look at the current agricultural commodity prices, both corn and soybeans have declined nearly 50% from their peak in 2008.

Given the current weakness in financial markets including the commodity sector, are we heading into the first decline in farm real estate sector in recent years?  

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The new auto czar

JPMorgan on China

China stimulus will have little global impact, says J.P. Morgan - General - FinanceAsia.com - The network for financial decision makers

China stimulus will have little global impact, says J.P. Morgan
By Anette Jönsson | 13 November 2008

Increased demand for commodities will affect mainly cement and steel, neither of which will benefit companies outside China, argues Frank Gong.

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The Rmb4 trillion ($587 billion) stimulus package announced by China this past weekend is large enough to cushion the downturn in the domestic economy and ensure that the country’s economy continues grow above 8% a year, but its impact on the global economy and even the rest of Asia is likely to be much smaller than initially anticipated, according to Frank Gong, J.P. Morgan’s head of China research and strategy.

“This package alone will not be able to turn the global commodities markets around,” he said at a press briefing yesterday. “For infrastructure spending you probably need steel, cement, heavy machinery and a lot of cheap labour, but China is still going to see a big slowdown in exports and industrial output. Also, infrastructure doesn’t need much energy or industrial metals like aluminium, nickel, tin, copper etcetera and cement is a commodity that is made locally so the increase in demand will have no global significance.”

Having had a few days to take a closer look at the two-year package, Gong estimates that the incremental infrastructure spending as a result of this fiscal stimulus – on top of what is already included in the current five-year plan for 2006-2010 – will be about Rmb2 trillion to Rmb2.5 trillion, translating into 8%-10% of GDP in total or 4%-5% of GDP per year. While smaller than the Rmb4 trillion headline number (as most commentators have argued it would be) the planned spending dwarfs all previous monetary and fiscal measures and shows that China is serious about maintaining strong economic growth. Or in the words of Gong: “This is really China’s Big Deal.”

Academic research shows that the positive impact on GDP from Chinese government spending is about 1.3 times the amount actually spent, which means that Rmb2.5 trillion of incremental spending could add 6.5 percentage points worth of annual growth. And since China would “easily” grow at 3%-4% per year without this package, this should ensure that the economy will continue to expand at an 8% plus pace.

That said, the domestic beneficiaries too will be limited to a few key sectors, Gong argues. With a large part of the money expected to go towards the expansion and upgrade of China’s railway system, infrastructure companies like China Railway Group and China Railway Construction Corp, both of which have listed in Hong Kong in the past 12 months, should be definite winners. The cement sector should also get a boost as demand will increase and the supply-demand situation in the industry is currently quite balanced. Cement is also quite energy-intensive which means the decline in oil prices is an added positive on the cost side.

The other key commodity for railway construction is steel, but China’s steel industry is already facing 20%-30% of overcapacity because of weakening of external demand which means prices in the domestic market (which has to absorb this extra capacity) are likely to be pushed down significantly. At the same time, the Chinese steel companies locked-in iron ore deliveries for one year at a price equal to a 97% increase in the iron ore price in June/July – almost at the peak of the cycle. As a result, the steel manufacturers are likely to see a huge margin squeeze and almost the entire sector will be loss-making, Gong says. Consequently, he advises investors to stay away from steel stocks.

“My position is that if there is a good bounce in commodities – sell,” he says. “The only beneficiary in commodities these days is cement.”

Meanwhile, banks are likely to benefit as the government usually only puts up 20%-30% of its infrastructure spending upfront, while the rest is typically financed by bank loans. This, according to Gong, should help to cushion the slowdown in loan growth and since these loans will be guaranteed by the government, it should also improve the risk profile of the banks’ loan portfolios. And if the increased fiscal spending does help to stabilise the financial markets, then insurance companies – which are large holders of listed securities – may also benefit. China Life, which is often regarded as a proxy for the A-share market, is one name to watch, Gong says.

However, the package alone won’t be able to turn the economy around and Gong warns that it is unlikely to have much impact on discretionary spending, since China will be replacing high-paying jobs within the export and industrial sectors with low-paying jobs in the construction sector.

“The employment level may not change much, but the structure of employment will change and the result is that the wage flow will slow down and discretionary spending will continue to slow down, although consumer staples will do better,” Gong says. The demand for cars is already declining with auto sales growth having slowed to single digits this year for the first time since the pickup began in the early part of this decade and in August and September, monthly sales actually declined on a year-on-year basis.

Since much of the infrastructure work will be in rural areas and is likely to provide jobs for peasants, the income for this group can, however, be expected to increase and that will be positive for consumer staples and telecom companies such as China Mobile which has been aggressively expanding in rural areas.

With regard to the rest of Asia, China’s demand for heavy machinery used in the infrastructure industry is likely to increase and while the country is largely self-sufficient on this front, it does import some machinery from South Korea and Japan. On the other hand, demand for high-end and luxury consumer goods that China imports mainly from Korea, Japan and Taiwan are likely to slow as the fiscal stimulus package is focusing primarily at supporting low-income earners.

“But if China can prevent a sharp slowdown, it means that its imports won’t collapse. And we are talking about a slowdown in high-end consumption growth. The Chinese economy will probably still grow at about 8% and China will continue to buy what it has been buying,” Gong says. The fiscal stimulus “will cushion the downside for the rest of Asia and if investors have been pricing in a collapse they may have to rethink their expectations, but it won’t provide a boost”.

Gong also argues that China should have no problem to finance the stimulus package since the upfront spending will only amount to about 2%-3% of GDP. And with its current and expected budgets almost in balance, this should only lead to a budget deficit of about 3% in 2009 – an amount that it can easily offset by selling Treasury bonds. With a current national debt/GDP ratio of only 15%, even two years of budget deficits in the range of 3% would push this just above 20%, which compares with 50%-100% in most other emerging markets, 75% in the US and 150% in Japan.

Gong notes that this is an “ideal time” for the government to step up its spending on infrastructure, not only because there is no longer any risk that it will lead to overheating (private sector spending has stopped due to the downturn), but because the fall in commodity prices will ensure that it gets more for its money.

It may also increase China’s bargaining power in the international community at a time when world leaders are debating various means, including increased regulations and a restructuring of global financial institutions like the IMF, to ensure the current financial crisis and credit crunch is never repeated.

Announced just in time for the G20 summit this weekend, where China is sure to face pressure to contribute money to help “save” the global economy, the fiscal stimulus package will enable President Hu Jintao to argue that China is doing everything it can to keep up demand at home, which it views as the biggest contribution it can make to fend off the financial crisis.

“China is expected to contribute more money to the International Monetary Fund, but at the same time, it will ask for more power and say in restructuring the global financial system,” argues Gong.

© Haymarket Media Limited. All rights reserved.

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One more time

China continues to be the big question ahead

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Why is the IMF asking for more money?

Save the Emerging Markets, by Dani Rodrik, Project Syndicate: If the world were fair, most emerging markets would be watching the financial crisis engulfing the world’s advanced economies from the sidelines... For once, what has set financial markets ablaze are not their excesses, but those of Wall Street. ...

Instead, emerging markets are suffering financial convulsions of possibly historic proportions. The fear is ... that their economies could be dragged into much deeper crises than those that will be experienced at the epicenter of the sub-prime debacle.

Some of these countries should have known better and might have protected themselves sooner. There is little excuse for Iceland... Several other countries ... such as Hungary, Ukraine, and the Baltic states, were also living dangerously...

But financial markets have made little distinction between these countries and others like Mexico, Brazil, South Korea, or Indonesia, which until just a few weeks ago appeared to be models of financial health. ...

[E]merging-market countries are victims of a rational flight to safety, exacerbated by an irrational panic. The public guarantees that rich countries’ governments have extended to their financial sectors have exposed more clearly the critical line of demarcation between “safe” and “risky” assets, with emerging markets clearly in the latter category.

Economic fundamentals have fallen by the wayside.

To make matters even worse, emerging markets are deprived of the one tool that the advanced countries have employed ... to stem their own financial panics: domestic fiscal resources or domestic liquidity. Emerging markets need foreign currency and, therefore, external support.

What needs to be done is clear. The International Monetary Fund and the G7 countries’ central banks must act as global lenders of last resort and provide ample liquidity — quickly and with few strings attached — to support emerging markets’ currencies. The scale of the lending that is required will likely run into hundreds of billions of US dollars, and exceed anything that the IMF has done to date. ... Moreover, China, which holds nearly $2 trillion in foreign reserves, must be part of this rescue mission. ...

In the absence of a backstop for emerging-country finances, the doomsday scenario of a protectionist vicious cycle reminiscent of the 1930s could no longer be ruled out. ...

So when the G-20 countries meet in Washington on Nov. 15 for their crisis summit, this is the agenda item that should dominate their discussion. ... The priority for now is to save the emerging markets from the consequences of Wall Street’s financial follies.

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Obama, the new Perón?

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CommodityOnline

China's soybean imports in October is learn to have declined by 25% on year to 2.13 million tons on comfortable supply and reduced demand

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Wheat prices by The Goods a commodity especialized newsletter

Dr Sherry Cooper, Chief Economist We expect wheat to average US$11.20/bu. in 2008 – reflecting the very high prices earlier in the year – and US$7.70/bu. in 2009.

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Ice land

Jon Danielsson, 12 November 2008 Iceland’s banking system is ruined. GDP is down 65% in euro terms. Many companies face bankruptcy; others think of moving abroad. A third of the population is considering emigration. The British and Dutch governments demand compensation, amounting to over 100% of Icelandic GDP, for their citizens who held high-interest deposits in local branches of Icelandic banks. Europe’s leaders urgently need to take step to prevent similar things from happening to small nations with big banking sectors.

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Brad Seter worries

So what do I worry about? The risk that China’s surplus will prove far smaller than announced – and that the fiscal stimulus won’t be strong enough to offset China’s domestic slowdown. China’s current account surplus could rise even as China’s exports start to fall if China’s imports start to fall even faster. I agree with Martin Wolf: China should, ideally, be doing more to stimulate its economy than the US, as that would help to facilitate global adjustment. Wolf writes: If the US external correction is to be consistent with global growth, demand must expand vigorously elsewhere, particularly in chronic surplus countries. The new administration should lead the world towards an understanding of a point that concerned John Maynard Keynes: it is hard to accommodate countries with massive and persistent current account surpluses. The counterpart deficits, if prolonged, almost always lead to financial crises. The way out is for most surplus countries to spend more at home. The expansion programme announced by the Chinese government early this week is just a beginning. Instead of toying with protection, the Obama administration needs to focus on global imbalances. The immediate way to deal with this challenge is to demand a global fiscal stimulus, with surplus countries implementing the biggest packages. I also worry about the risk that once current pressure on say Korea’s exchange rate diminishes, Korea will conclude that a depreciated won is in its own interest - -and resume intervening in the foreign exchange market both to rebuild its reserves and to support its export sector. Ragu Rajan of Chicago outlines this scenario in his contribution to VoxEU’s G-20 spectacular.* He writes: “If we do nothing to address this issue (the absence of sufficiently large multilateral pools of foreign exchange reserves) we will set up serious problems for the future. We will emerge from the crisis with many countries attempting to build reserves through export-led strategies and managed exchange rates, aggravating the demand imbalances at the heart of the current crisis.” A sustained effort to maintain undervalued exchange rates would tend to increase demand for US Treasuries. But it would slow needed adjustments in the global economy. I am still among those who thinks that a shortfall in foreign demand for US goods is a bigger worry than a shortfall in foreign demand for US Treasuries. *Dani Rodrik’s G-20 communique is also worth reading; alas, the odds that the actual communiqué will be as substantive are rather slim.

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Nouriel Roubini RGE Monitor

The recession will continue until at least the end of 2009 for a cumulative GDP drop of over 4%; the unemployment rate will likely reach 9% The prospect of a short and shallow 6-8 months V-shaped recession is out of the window; a U-shaped 18-24 months recession is now a certainty and the probability of a worse multi-year L-shaped recession (as in Japan in the 1990s) is still small but rising The world economy will experience a severe recession: output will sharply contract in the Eurozone, UK and the rest of Europe, in Canada, Japan, and Australia/New Zealand; there is also a risk of a hard landing in emerging market economies. Expect global growth – at market prices – to be close to zero in Q3 and negative by Q4. Leaving aside the effects of the fiscal stimulus China could face a hard landing growth rate of 6% in 2009. The global recession will continue through most of 2009. The advanced economies will face stag-deflation (stagnation/recession and deflation) rather than stagflation as slack in goods markets, slack in labor markets and slack in commodity markets will lead advanced economies inflation rates to become below 1% by 2009. Downside risks to global equities of the order of 20-30% Credit losses will be well above $1 trillion and closer to $2 trillion Expect a US fiscal deficit of almost $1 trillion in 2009 and 2010 In this economic and financial environment it is wise to stay away from most risky assets for the next 12 months: they are downside risks to US and global equities; credit spreads – especially for speculative grade – may widen further; commodity prices will fall another 20% from current level; gold will also fall as deflation sets in; the US dollar may weaken further in the next 6 to 12 months as the factors behind the recent rally weather off while medium term bearish fundamentals for the dollar set in again; government bond yields in US and advanced economies may fall further as recession and deflation emerge but, over time, the surge in fiscal deficits in the US and globally will reduce the supply of global savings and lead to higher long term interest rates unless the fall in global real investment outpaces the fall in global savings. Expect further downside risks to emerging markets assets (in particular equities and local and foreign currency debt) especially in economies with significant macro, policy and financial vulnerabilities. Cash and cash like instruments (short-term dated government bonds and inflation-indexed bonds that do well both in inflation and deflation times) will dominate most risky assets.

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The party is over for the overvalued sterling

British desperado

LONDON (MarketWatch) -- British Prime Minister Gordon Brown on Tuesday urged a worldwide round of tax cuts in order to stave off a deep global recession.

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The Baltic Dry Index explained by Slate magazine

Slate magazine October 24, 2003 Baltic Dry isn't a Latvian deodorant or an Estonian cocktail. Rather, it's a number issued daily by the London-based Baltic Exchange, which traces its roots to the Virginia and Baltick coffeehouse in London's financial district in 1744. Every working day, the Baltic canvasses brokers around the world and asks how much it would cost to book various cargoes of raw materials on various routes—150,000 tons of iron ore going from Australia to China or 150,000 tons of coal from South Africa to Taiwan. Brokers are also asked to consider variables such as the type and speed of the ship and the length of the voyage. The answers are melded into the BDI, which appears in shipping publications such as Lloyd's List and on the screens of information vendors such as Reuters and Bloomberg. Because it provides "an assessment of the price of moving the major raw materials by sea," as the Baltic puts it, it provides both a rare window into the highly opaque and diffuse shipping market and an accurate barometer of the volume of global trade. The BDI is a good leading indicator for economic growth and production. After all, it doesn't deal with container ships carrying finished goods. It deals with the precursors to production: bulk carriers carrying building materials, cement, grain, coal, and iron. Unlike stock and bond markets, the BDI "is totally devoid of speculative content," says Howard Simons, an economist and columnist at TheStreet.com. People don't book freighters unless they have cargo to move. Because the supply of cargo ships is generally both tight and inelastic—it takes two years to build a new ship, and ships are too expensive to take out of circulation the way airlines park unneeded jets in the Arizona desert—marginal increases in demand can push the index higher quickly. And significant increases in demand can push the index sharply higher. That's precisely what happened earlier this fall. As this chart shows, the Baltic Index doubled in September and October—an unprecedented jump. Does this chart represent a Nasdaq-style bubble or a demand-led structural change? The summer did see a pick-up in coal and grain shipments to Europe, due to the heat wave, and China's humming steel factories are consuming massive quantities of iron ore. Those could be blips. "But it's not just iron ore and coal," says Michael McClure, vice president of Navios, a ship broker. "The strength can be seen among all the major commodities that ocean freight is carrying." The real force behind the BDI's rise may be China. "To put it in extremely simplistic terms, China is importing huge amounts of raw materials and exporting manufactured goods, and that's drawing ships into the Pacific," says Jim Buckley, chief executive of the Baltic Exchange. The Wall Street Journal led today's "Money and Investing" section with an article on China's insatiable demand for raw materials. The Baltic index divined this trend several weeks ago. As they say on CNBC, what does this mean for you? In this article from late last year, Howard Simons charted the index against the Dow Jones World Equity Stock Market Index and U.S. Treasury 10-year notes. His conclusion: "It's a very good leading indicator." Movements in the Baltic Index tend to precede movements in global stock markets. But the index also tends to presage higher interest rates. When more stuff is being shipped around the world, it needs to be financed. And that creates a greater demand for credit. So the shipping news—at least as measured by the BDI—is largely good. Even better, it may be a sign that China's trade deficit may be declining. The downside: China isn't sucking up raw materials in vast quantities from the United States. (We export grains and soybeans to China, but not coal or iron ore.)

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Sunday Break

Quantum TP52

Bloomberg:China Announces $586 Billion Stimulus Plan to Boost Economy

By Li Yanping

Nov. 9 (Bloomberg) -- China's government announced a $586 billion stimulus plan to spur growth in the world's fourth- largest economy, helping sustain expansion as the U.S., Europe and Japan teeter on the brink of recession.

The government will spend 4 trillion yuan by the end of 2010, the State Council said in a statement on its Web site.

Argentina

Financial Times by Judd Weber, Nov 08, 2008
Argentine savers seek cash havens
Link: http://www.rgemonitor.com/redir.php?sid=2&tgid=7&cid=301787

From the Time Online

 "Respected analyst Eric Fishwick says that China may be heading for a severe economic slowdown":

China must be radically reassessed by investors and could be lurching towards a more dramatic economic slowdown than Beijing authorities will admit,...

Even with aggressive government measures, growth in 2009 could plunge to 5.5 per cent, [Eric Fishwick] said.

The super-bearish forecast depends on certain weak signals that may emerge in the fourth quarter of 2008, but comes amid reports from the Chinese electricity sector that suggest the country’s mighty manufacturing engine-room is already sputtering badly.

More than 70 per cent of the electricity generated in China is consumed by industry and according to reports, monthly national power output in October fell for the first time in a decade.

Traders in Singapore said it could be a slump that would have a huge negative impact on global commodity demand: ferrous and nonferrous metal-processing industries are among the heaviest consumers of electricity in China and it is their slowdown that is reflected in the drop in power usage....

IMr Fishwick dismissed the idea that the authorities in Beijing would be able to manipulate the economy as effectively as other analysts believe.....

In the report, Mr Fishwick acknowledges that the 5.5 per cent growth forecast theory will be resisted: the market has come to believe that Beijing will simply “not allow” growth to slow below 7 per cent.

But he argues that while Beijing has greater influence over China’s economy than most other Asian governments have over theirs, the breakneck expansion of the private sector - now two thirds of the economy - means that large parts of China’s growth machinery are beyond Beijing’s direct control and subject to the same rules and laws as other market economies. “Investors need to analyse China as ‘Just Another Capitalist Country’ and question whether government policy will actually work,” he said.

“China is revealed as extremely cyclical with the volatile expenditure components much larger compared with the stable ones. Our 5.5 per cent GDP forecast has already factored in a broad and aggressive government stimulus.”

Capitalist economies, he added, are hard to control and respond slowly and unpredictably to government policies.

Although China does have more mechanisms to influence economic activity than elsewhere in Asia, because GDP composition is biased towards exports and investment, external conditions will hold sway.

Also limiting Beijing’s influence on economic growth is the relatively low contribution to GDP of consumer spending and government investment - 37 per cent and 2.3 per cent respectively.

In that light, said the CLSA report, both measures to boost spending and any proposed fiscal policy gambits will be of limited overall effect.

Even when China ramped up spending in 1998 in response to the Asian Crisis, it did not manage to maintain growth levels above 8 per cent..