Landowners will be barons again

Food will never be so cheap again - Telegraph

The world's grain stocks have dropped from four to 2.6 months cover since 2000, despite two bumper harvests in North America. China's inventories are at a 30-year low. Asian rice stocks are near danger level.

Yet farm commodities have largely missed out on Bernanke's reflation rally in metals, oil, and everything else. Dylan Grice from Société Générale sees "bargain basement" prices.

Wheat has crashed 70pc from early 2008. Corn has halved. The "Ags" have mostly drifted sideways over the last six months. This divergence within the commodity family is untenable, given the bio-ethanol linkage to oil.

For investors wishing to rotate out of overstretched rallies – Wall Street's Transport index and the Russell 2000 broke down last week – this is a rare chance to buy cheap into a story that will dominate the rest of our lives.

Barack Obama has not reversed the Bush policy on biofuels, despite food riots in a string of poor countries last year and calls for a moratorium. The subsidy of 45 cents per gallon remains.

The motive is strategic. America is weaning itself off imported energy at breakneck speed. It will not again be held hostage by oil demagogues, or humiliated by states that cannot feed themselves. Those Beijing students who laughed at US Treasury Secretary Tim Geithner may not enjoy the last laugh. The US is the agricultural superpower. Foes will discover why that matters.

The world population is adding "another Britain" every year. This will continue until mid-century. By then we will have an extra 2.4bn mouths to feed.

China and Southeast Asia are switching to animal-protein diets as they grow wealthy, as the Koreans did before them. It takes roughly 3-5kgs of animal feed from grains to produce 1kg of meat.

A report by Standard Chartered, The End of Cheap Food, said North Africa and the Middle East have already hit the buffers. The region imports 71pc of its rice and 58pc of its corn. It lacks water to boost output. The population is growing fast. It will have to import, and cross fingers.

The UN says global farm yields must rise 77pc, which means redoubling Norman Borlaug's "green revolution". It will not be easy. China's trend growth in crops yields has slipped from 3.1pc a year in the early 1960s to 0.9pc over the last decade

"We've all heard the stark anecdotes: precious topsoil weakened by over-farming, dust clouds darkening the Asian skies, parched land becoming desert and rivers running dry," said Mr Grice.

Since 2000, China has lost nearly 1,400 square miles each year to desert. Urban sprawl is paving over fertile land in the East. Water supply from Himalayan glaciers is ebbing. The Yellow River has been reduced to "an agonising trickle". It no longer reaches the sea for 200 days a year.

Farmers are draining the aquifers. Environmentalist Ma Jun says in China's Water Crisis that they are drilling as deep as 1,000 metres into non-replenishable reserves. The grain region of the Hai River Basin relies on groundwater for 70pc of irrigation.

China's water troubles are not unique. North India lives off Himalayan snows as well. Nor can we take fertiliser supply for granted any longer since "peak phosphates" threatens.

One can be Malthusian about this. Grizzled commodity guru Jim Rogers certainly is. "The world is going to have a period when we cannot get food at any price, in some parts." He advises youth to opt for a farm degree rather than an MBA, if they want to make serious money.

Mr Grice remains an optimist, believing that human ingenuity will rescue us. You can trade the "Ag" rally by investing in exchange traded funds (ETFs), but this amounts to speculation on food. There are ancient taboos against this practice.

Or you can invest in the bio-tech, fertiliser, and land services companies that will both make money and help to solve the problem. Monsanto, Syngenta, and Potash are popular, but trade at high price to book values. Golden Agri-Resources, Yara, Agrium, and Bunge are at better multiples.

Kingsmill Bond at Moscow's Troika Dialog suggests the Baltic company Trigon Agri as a way to play the catch-up story in the Eurasian steppe. He likes sunflower processor Kernel, grain group Razgulay, and fertiliser firm Uralkali.

Strictly speaking, the world has enough land to feed everybody. The Soviet Union farmed 240m hectares in Khrushchev's era. The same territory now farms 207m hectares. Troika says crop yields could be doubled in Russia, and tripled in the Ukraine using modern know-how. Africa's farms could come alive with land registers, allowing villagers to use property as collateral for credit.

None of this can be done with a flick of the fingers. What seems certain is that the terms of trade between country and city will revert to the norms of the Middle Ages. Landowners will be barons again.

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Grantham prediction for 2010

Grantham: Markets getting silly - The Globe and Mail

“I have some modest hopes for a collective sensible resistance to the current Fed plot to have us all borrow and speculate again,” he said. “I would still guess (a well-informed guess, I hope) that before next year is out, the market will drop painfully from current levels.”

For him, “painfully” implies a dip of 15 per cent – but a drop below fair value is more likely, and that could bring a 22 per cent setback.

“Unlike the really tough bears, though, I see no need for a new low,” he said.

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Economic indicators

7 hidden economic indicators to watch - MarketWatch

7 hidden economic indicators to watch
To get the best view of economy, sometimes you have to 'peel the onion'

By Rex Nutting, MarketWatch

WASHINGTON (MarketWatch) - Anyone who follows the markets or the economy knows about gross domestic product and the consumer price index, but sometimes those well-known indicators don't give us the clearest view of where the economy has been or where it is going.

Like a jeweler using a magnifying glass to look into a gem to see its virtues and flaws, the best analysts dig deeper into the economic reports.

"If you peel back the onion, it can help you figure out what the bigger picture is," said Stu Hoffman, chief economist for PNC Financial. "Sometimes it makes you cry," he said, but you can get a better view.
Seven hidden economic indicators

* 3-month average of durable-goods orders
* Trimmed mean CPI
* Retail sales excluding autos and gasoline
* The U6 unemployment rate
* Core capital equipment orders
* Building permits for single-family homes
* Final sales to domestic purchasers

/conga/economy-politics/hidden-indicators.html 37474

Every analyst has favorite hidden indicators. Here are seven favorites you can use to get a better understanding of the economy.
Look at averages

The first trick, one that can be used with almost any economic indicator, is to use a three-month running average to smooth out monthly fluctuations.

Many of the better-known indicators - such as housing starts, durable-goods orders and retail sales -- can be extremely volatile on a month-to-month basis. They have a high noise-to-signal ratio.

Unless you are a trader who needs volatility in order to profit, it's the underlying trend that matters most.

"To look at any one month is meaningless," Hoffman said. A smoothing average tells you what the trend is. "That's the information that matters; the rest is noise."

Economists often speak about year-over-year changes, essentially a 12-month average. Year-over-year changes are useful in portraying long-term trends, but they can mask turning points that can be revealed by three-month averages.
Look at the core

Many indicators are noisy because one special factor can have an outsized influence on a monthly basis. Gasoline prices go up one month and down the next. Aircraft orders swell in one month, and then shrink the next.

That's why economists talk about "core" measures of indicators such as consumer prices, retail sales or durable-goods orders. Core measurements exclude or ignore special factors in order to focus on underlying trends. It's like an X-ray that shows only bones, not the soft tissues.

The core CPI is the best-known and most widely misunderstood example. The core CPI excludes food and energy costs, which are among the most volatile components in the consumer price index. Economists study the core not because food and energy don't matter, but because they matter too much on a month-to-month basis.

Because of the extreme volatility in food and energy prices, the headline CPI has swung from a 4.9% inflation rate a year ago to a 1.3% deflation rate now. By contrast, the core CPI has slowed more moderately, from a 2.5% inflation rate a year ago to 1.5% now. That's probably a better reflection of the disinflationary environment than the headline CPI.

The Cleveland Fed has a better idea for a core CPI: Rather than automatically excluding food and energy prices, its core gauge excludes only the items that rose or fell the most in any given month. Sometimes it would be gasoline, sometimes tobacco, sometimes chicken.

This so-called trimmed mean CPI published by the Cleveland Fed is probably the best way of looking at the trend in consumer prices. The trimmed mean CPI is up 1% in the past year.

For retail sales, economists look at sales excluding autos and gasoline. For durable-goods orders, it's good to pay attention to capital equipment orders excluding aircraft and defense goods, which tracks business investment trends closely.
Go deeper

Some economic reports are chock full of interesting information that one number cannot do justice to.

The monthly employment report is a prime example of a report where the parts are greater than the whole. Most people pay attention to the number of payrolls lost or gained, and maybe to the unemployment rate.

But the report reveals more about the job market than can be summed up in one or numbers. It has information about different demographic groups, industries and occupations. It can tell us something about hours and wages.

The alternative unemployment rate (also known as the U6 rate) has become a favorite because, unlike the regular (or U3) unemployment rate, it measures underemployment; people too discouraged to look for work, or people whose hours have been cut back.

The GDP report is also worth a deeper dig.

GDP -- the total value of all goods and services produced within the United States -- is a useful accounting concept. But it can be misleading during big inventory swings.

A better gauge of the economy's strength is the number that's reported as final sales. Final sales, as the name implies, counts the goods and services that were actually sold, rather than the number that were produced and stuck in a warehouse someplace. A related concept is final domestic sales, which counts goods and services sold within the United States.

"The balance between final sales and inventories is an excellent leading indicator," said John Silvia, chief economist for Wells Fargo Securities.
Don't be distracted

Sometimes, the government, the media and the markets just focus on the wrong number. Instead of paying attention to housing starts, for instance, it'd be better to look at the number of building permits for single-family homes.

Why? Because the monthly housing starts figures are ridiculously inaccurate, compared with the permits figures that are statistically more reliable. Multi-family housing construction is too volatile on a monthly basis to be meaningful.
Avoid the pitfalls

It's fine to find favorite hidden indicators, but you should beware of cherry picking the data to fit pre-conceptions. If you're being honest about trying understanding the economy, you have to be consistent. If you use the three-month averages to prove your point one month, you shouldn't switch to crowing about the monthly figure the next time, if that number suits your argument better.

On the other hand, it's all too easy to cling too tightly to a favorite indicator and become oblivious to trends that are obvious in the headline indicators. Don't let your agenda blind you.

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Value

FT.com / Columnists / Martin Wolf - How mistaken ideas helped to bring the economy down

Mr Smithers proposes two fundamental measures of value – “Q” or the valuation ratio, which relates the market value of stocks to the net worth of companies and the cyclically adjusted price-earnings ratio, which relates current market value to a 10-year moving average of past real earnings. The two measures give similar results (see chart). Professional managers use many other valuation methods, all of them false. As Mr Smithers remarks sardonically: “Invalid approaches to value typically belong to the world of stockbrokers and investment bankers whose aim is the pursuit of commission rather than the pursuit of truth.”

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Jamie on the dollar

JPMorgan Chase's Jamie Dimon supports a strong dollar - Oct. 27, 2009

"The ultimate strength of the dollar will depend on the strength of the United States," Dimon said.

Dimon discussed the dollar and other key financial topics with PBS host Charlie Rose as part of the Securities Industry and Financial Markets Association (SIFMA) annual meeting held in New York.

He said that the dollar needs two things to remain strong: the economy must grow and, equally as important, the government must demonstrate fiscal responsibility.

The fate of the dollar is not about "the deficit over the next year or two," said Dimon, but about proving that the country's long-term plan is to rein in spending and reduce the nation's debt over time.

"We'll be voting on this," Dimon told the crowd. "It's not only a matter of what happens at the [Federal Reserve] but about what happens in Congress."

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Figthing bubbles

FT.com / Columnists / Wolfgang Munchau - A polite discourse on bankers and bubbles

A polite discourse on bankers and bubbles

By Wolfgang Münchau

Published: October 25 2009 19:25 | Last updated: October 25 2009 19:25

Remember the debate about whether central banks should prick bubbles? It was not too long ago that simply asking the question incited abuse. While pricking bubbles is now considered a suitable subject for polite conversion, there is still no agreement on what to do or how to do it. Since bubbles are already building up in several segments of the financial markets, it is time to think about this question in detail.

As I argued last week, there are some deep-rooted causes of the proliferation of bubbles – among them the size of the financial sector; the too-big-to-fail problem; and the banks’ renewed lust for risk. Governments have not been addressing these causes. Central banks will not provide the cure either, but they can address some of the symptoms. Symptoms matter.

Some economists, reluctant to let go of the comforting world of rational expectations, still tell us it is impossible for a central bank – or anyone else, for that matter – to call a bubble. This is baloney. When looking at house prices, just look at price-to-rent and the price-to-income ratios, sales volumes and credit statistics, and you know everything you need to know. Almost everything else central bankers do is more difficult than calling a housing bubble.

The most persistent argument against pricking bubbles is that monetary policy cannot target consumer and asset prices with a single instrument – the short-term interest rate. This statement is both trivially true and misleading. One can use existing instruments more flexibly, and one can also add new ones. Based on these principles, I have four proposals.

The first is the use of alternative regulatory instruments if available. This is not always possible but, where it is, such instruments could be deployed in the housing market, for example, where one could vary the ceiling on the loan-to-value ratio according to market conditions. Since housing bubbles are almost always credit-driven, an anti-cyclical LTV could encourage or discourage risky mortgage lending. Such a tool could be deployed by local central bank branches – or national central banks in the eurozone – since many housing bubbles are regional: east and west coast in the US, Spain and Ireland in the eurozone.

Second, central banks should use existing leeway in their monetary policy. In an ideal world, a single policy instrument should focus on a single target, but this is not an ideal world. Central banks will have to master the art of targeting some measure of price stability, as well as including asset prices in their consideration. In practice this would mean that a central bank should, by reflex, not always choose the lowest interest rate consistent with its definition of price stability. It should choose a higher rate in the presence of a bubble. With hindsight, if central banks had not cut interest rates quite so aggressively in 2003-04, we would probably still have had a bubble, but perhaps a smaller one.

Third, central banks should accompany their model-based economic forecasts with an analysis of monetary and financial conditions. The workhorse economic forecasting models used by central banks are built in such a way that they cannot capture financial shocks and bubbles. This makes them worse than useless in a world characterised by persistent financial instability. An analysis of monetary conditions and financial flows can provide at least a useful complement to now defunct models.

Finally, central banks must co-ordinate with one another. While each has the tools to establish price stability in its own jurisdiction, many asset prices – equity prices and housing prices in particular – tend to correlate globally. It makes no sense for the central bank of a small or medium-sized country to try pricking a domestic equity bubble. But if central banks act jointly, they could send out a strong signal. Just imagine what would happen if the world’s three leading central banks shorted Intel, BMW and Toyota.

I am aware that these measures are not going to solve the problem of financial instability. In the absence of deeper reforms in the financial sector, nothing will. But they might still be useful firefighting tools. It may be better to try out at least some of them than to pretend that the problem will simply go away.

I suspect strongly that we are already in another bubble in the global equity and bonds markets, and also in sections of the commodity markets. These may burst well before the world economy recovers from the most recent bubble. Central banks should eventually prick them before they cause calamity.

It may not be the time yet to deploy an anti-bubble strategy. But we sure need to put one together.

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Devaluation Devaluation Devaluation

Adjustment and the dollar - Paul Krugman Blog - NYTimes.com

So, the bottom line: to narrow international imbalances, we need a lower relative price of US output. Because prices are sticky, by far the easiest way to get there is dollar depreciation.

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China’s growth model is much more about supply than demand

China Economy May Slow Next Year, Stephen Roach Says (Update1) - Bloomberg.com

China Economy May Slow Next Year, Stephen Roach Says (Update1)


By Bloomberg News

Oct. 24 (Bloomberg) -- China may face an economic slowdown in the middle of next year because the nation’s growth model is unsustainable, said Stephen Roach, chairman of Morgan Stanley Asia.

Economic growth in China accelerated to 8.9 percent last quarter, fueled by government stimulus spending and more than $1 trillion of new bank lending. That rebound is causing complacency in China, which still faces “tough challenges in years ahead,” Roach said today at a financial forum in Shanghai.

“China’s growth model is much more about supply than demand,” Roach said. “It’s not a sustainable model for China. It’s not a sustainable model for any nation.”

The “imbalance” created by China’s overdependence on exports for growth was compounded by the government’s efforts to bolster the world’s third-biggest economy as the global recession sapped demand for Chinese-made toys, clothes and electronics, Roach said. China’s stimulus measures have also raised concerns about overcapacity and asset bubbles.

“Macro imbalances are particularly acute right now,” Roach said. “China’s economy risks slowdown again around mid- 2010.”

China’s exports in September fell 15.2 percent from a year earlier, the smallest decline in nine months. The nation has posted export declines for 11 consecutive months.

Stimulus Plan

The government’s $586 billion stimulus plan unveiled in November last year spans earthquake reconstruction work, roads, railways and low-cost housing. Chinese banks doled out a record 8.67 trillion yuan ($1.27 trillion) of new loans in the first nine months, more than double the same period a year earlier.

That helped economic growth accelerate even as exports worsened. China grew 6.1 percent in the first quarter of 2009, the slowest pace of expansion in almost a decade, as shipments abroad fell 17.1 percent during the period. Growth picked up to 7.9 percent in the second quarter as exports slid 21.4 percent.

“While the government is ensuring economic growth, we are also concerned about overcapacity in some industries,” Xiong Bilin, deputy director of the National Development and Reform Commission’s industry department, said Oct. 19. The commission is China’s top economic planning agency.

China is curbing financing for projects in industries including steel, cement and aluminum to prevent the government’s stimulus package and record bank lending from spurring excess investment.

Balancing Needs

In the next few months, the government will focus on balancing the need to maintain stable and relatively fast growth with the need to adjust the structure of China’s economy and better manager inflationary expectations, the State Council, China’s cabinet, said Oct. 21. The nation also faces increasing difficulty in managing liquidity and the structure of loans is “not rational,” the State Council said.

“The global economic recover is still uncertain and unstable,” Wang Huaqing, the disciplinary secretary of the China Banking Regulatory Commission, said at the financial forum in Shanghai today. The regulator “will continue prudent oversight and regulation of banks,” he said.

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Stocks, bonds and gold

Buttonwood: Squaring the circle | The Economist

The real reason why all three asset classes have been rising is simply down to liquidity. Low interest rates are driving investors out of cash and into anything that offers either the prospect of capital gain or a yield that is higher than zero. Investors used to talk about a “Greenspan put” that supported the stockmarket. This time there is a “Bernanke put” supporting all asset prices.

How long can this last? The authorities are inflating the value of “financial wealth” relative to “real wealth”—goods, services and the businesses that produce them. Real wealth has undoubtedly taken a hit. Industrial production in most OECD countries is still showing a double-digit percentage decline year on year.

A policy of bolstering asset prices can work for a while but eventually it leads to tensions and distortions. The problem could show up in the currency markets, where America has been getting a free ride, running a big fiscal deficit with zero interest rates and a depreciating currency. Other countries are feeling the pressure. Brazil is imposing a 2% tax on portfolio inflows in an effort to slow the real’s rise. An adviser to the French president describes a rate of $1.50 to the euro as a “disaster”.

Another possibility is that the authorities see the market rally as evidence of success and withdraw their fiscal-stimulus packages too quickly. The shift is already under way in Europe.

If the trifecta does break down, then the consensus favours government bonds as the asset class to suffer. But is that the right call? After all, 20 years into their crisis, and with gross government debt heading for 200% of GDP, Japanese bonds yield just 1.3%. Perhaps ten-year Treasury bond yields of 3.4% are reasonable after all. Headline inflation is still negative, so in real terms yields are strongly positive. In addition bond yields can be seen as the weighted average expectation for the future level of short rates. Since the Federal Reserve has made it clear that short rates will be kept low for a considerable period, that drags bond yields down. Market expectations for bond yields in five years’ time are around 4.5%, within the range in which bonds traded for much of this decade.

The only other times the three-way bet worked were back in the early 1980s. On each occasion when it broke down, the casualties were equities and the gold price as the economy slipped into a double-dip recession. It could happen again.

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Meltzer and the next crisis

Allan Meltzer: Preventing the Next Financial Crisis - WSJ.com

Preventing the Next Financial Crisis
Don't be fooled by the bond market. Banks are holding prices down because they can buy Treasurys with free money from the Fed.


By ALLAN H. MELTZER

The United States is headed toward a new financial crisis. History gives many examples of countries with high actual and expected money growth, unsustainable budget deficits, and a currency expected to depreciate. Unless these countries made massive policy changes, they ended in crisis. We will escape only if we act forcefully and soon.

As long ago as the 1960s, then French President Charles de Gaulle complained that the U.S. had the "exorbitant privilege" of financing its budget deficit by issuing more dollars. Massive purchases of dollar debt by foreigners can of course delay the crisis, but today most countries have their own deficits to finance. It is unwise to expect them, mainly China, to continue financing up to half of ours for the next 10 or more years. Our current and projected deficits are too large relative to current and prospective world saving to rely on that outcome.

Worse, banks' idle reserves that are available for lending reached $1 trillion last week. Federal Reserve Chairman Ben Bernanke said repeatedly in the past that excess reserves would run down when banks and other financial companies repaid their heavy short-term borrowing to the Fed. The borrowing has been repaid but idle reserves have increased. Once banks begin to expand loans or finance even more of the massive deficits, money growth will rise rapidly and the dollar will sink to new lows. Do we have to wait for a crisis before we replace promises with effective restraint?

Many market participants reassure themselves that inflation won't come by noting the decline in yields on longer-term Treasury bonds and the spread between nominal Treasury yields and index-linked TIPS that protect against inflation. They measure expectations of higher inflation by the difference between these two rates, and imply long-term investors aren't demanding higher interest rates to protect themselves against it. But those traditional inflation-warning indicators are distorted because the Fed lends money at about a zero rate and the banks buy Treasury securities, reducing their yield and thus the size of the inflation premium.

Further, the Fed is buying massive amounts of mortgages to depress and distort the mortgage rate. This way of subsidizing bank profits and increasing their capital bails out these institutions but avoids going to Congress for more money to do so. It follows the Fed's usual practice of protecting big banks instead of the public.

The administration admits to about $1 trillion budget deficits per year, on average, for the next 10 years. That's clearly an underestimate, because it counts on the projected $200 billion to $300 billion of projected reductions in Medicare spending that will not be realized. And who can believe that the projected increase in state spending for Medicaid can be paid by the states, or that payments to doctors will be reduced by about 25%?

While Chinese government purchases of our debt may delay a dollar and debt crisis, they also delay any effective program to reduce the size of that crisis. It is far better to begin containing the problem before we blow a hole in the dollar and start another downturn.

A weak economy is a poor time to reduce current government spending or raise tax rates, but we don't require draconian immediate changes. We do need a fully specified, multi-year program to restore fiscal probity by reducing spending, and a budget rule that limits the size and frequency of deficits. The plan should be announced in a rousing speech by the president. The emphasis should be on reducing government spending.

The Obama administration chooses to blame outsize deficits on its predecessor. That's a mistake, because it hides a structural flaw: We no longer have any way of imposing fiscal restraint and financial prudence. Federal, state and local governments understate future spending and run budget deficits in good times and bad. Budgets do not report these future obligations.

Except for a few years in the 1990s, both parties have been at fault for decades, and the Obama administration is one of the worst offenders. Its $780 billion stimulus bill, enacted earlier this year, has been wasteful and ineffective. The Council of Economic Advisers was so pressed to justify the spending spree that it shamefully invented a number called "jobs saved" that has never been seen before, has no agreed meaning, and no academic standing.

One reason for the great inflation of the 1970s was that the Federal Reserve gave primacy to reducing unemployment. But attempts to tame inflation later didn't last, and the result was a decade of high and rising unemployment and prices. It did not end until the public accepted temporarily higher unemployment—more than 10.5% in the fall of 1982—to reduce inflation.

Another error of the 1970s was the assumption there was a necessary trade-off along a stable Phillips Curve between unemployment and inflation—in other words, that more inflation was supposed to lower unemployment. Instead, both rose. The Fed under Paul Volcker stopped making those errors, and inflation fell permanently for the first time since the 1950s.

Both errors are back. The Fed and most others do not see inflation in the near term. Neither do I. High inflation is unlikely in 2010. That's why a program beginning now should start to lower excess reserves gradually so that the Fed will not have to make its usual big shift from excessive ease to severe contraction that causes a major downturn in the economy.

A steady, committed policy to reduce future inflation and lower future budget deficits will avoid the crisis that current policies will surely bring. Low inflation and fiscal prudence is the right way to strengthen the dollar and increase economic well being.

Mr. Meltzer is professor of political economy at Carnegie Mellon University and the author of the multi-volume "A History of the Federal Reserve" (University of Chicago, 2004 and 2010).

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Improving

ViewsWire

ROM THE ECONOMIST INTELLIGENCE UNIT

The world economy continues to stabilise. Although the effects of the financial and economic crisis are still being felt and trading conditions remain difficult for many companies, signs of recovery are increasingly visible. The Economist Intelligence Unit has raised its forecast for global growth. We now expect world GDP at purchasing power parity to grow by 3.2% in 2010, up from 2.9% in our forecast last month. This reflects, in particular, a higher forecast for OECD growth. Other key changes to our forecast are for US interest rates and some prices for metals.

As we highlighted last month, one of the main reasons for the improving global picture—and at the same time one of the chief causes for concern—is that policy stimulus is working. In the past year governments and central banks have taken unprecedented measures to tackle the crisis. Initially, the most urgent task was to stabilise the financial system and keep major banks afloat. Now stimulus programmes, including interest-rate cuts and fiscal packages, are feeding through into the wider economy. Recent data show many countries emerging from recession thanks to these policies, with parts of Asia rebounding particularly strongly.

Cyclical factors are playing their part. This time last year, many businesses shuttered plants or halted production in anticipation of lower sales, using up their existing inventories rather than building up excess stocks of new goods. This inventory "drawdown" amplified the decline in GDP. As global conditions improve, however, we expect businesses to start restocking—or at the very least to reduce inventories more slowly. This will have the opposite effect of boosting economic growth temporarily.

Post-stimulus correction?

The big concern is what happens when the effects of stimulus wear off. Government spending cannot support growth indefinitely, as the increasingly politicised debate in many countries about rising budget deficits illustrates. There is therefore a high risk that the recovery could weaken in 2011 if stimulus is withdrawn. Although we are not forecasting a slowdown for the world economy as a whole, we do expect US growth to decelerate in 2011 for precisely this reason.

The recovery story also needs qualifying in other respects. Although financial markets have stabilised, with equity prices rallying strongly in recent months, credit conditions remain difficult. Banks have continued to tighten lending standards, and while large companies have switched to issuing bonds in record amounts to meet their funding needs, small and medium-sized firms will find it hard to obtain credit. Demand for credit will also remain soft, as many households and companies will focus on rebuilding their finances for several years. They will not consume or invest as much as before, and therefore will borrow less.

Partly as a result, world economic growth will not return quickly to its pre-crisis trend level. This will make it harder for those made unemployed during the crisis to find new jobs, and there is a high chance that many countries will experience "jobless" recoveries. We expect the unemployment rate in the US, for example, to remain above 9% in both 2010 and 2011. The longer unemployment remains high, the more likely it is, in turn, that banks will suffer further problems from defaulting borrowers.

US: Inventory boost, but fears of a double-dip slowdown

We have raised our US forecast for 2010 considerably. We now expect the economy to grow by 2.4% in real terms, up from 1.7% in last month's forecast. Yet the "upgrade" is deceptive, as it mainly reflects revised assumptions about inventory adjustments rather than a change of heart about the structural health of the US economy. In particular, we still think private consumption—which accounts for around 70% of GDP—will recover slowly and fitfully. We also assume that the Obama administration will not push through a second large fiscal package, in part because of political resistance in Congress and rising voter concern about the country's public finances. We now also think the US Federal Reserve will raise interest rates slightly earlier (in the third quarter of 2010, instead of in 2011). As a result of these factors, our latest forecast envisages a more pronounced "W-shaped" recovery than before, with growth expected to weaken to 1.1% in 2011.

Western Europe: Slightly improved euro zone prospects

Euro zone economies continue to struggle, and we still expect output in the region to contract by 4.1% this year. Banks are heavily exposed to emerging markets in eastern Europe, where the effects of the downturn have been severe. However, export prospects are no longer so dire and policy stimulus is proving helpful. Recent GDP data for Germany and France showed a return to growth. We now expect real GDP in the euro zone as a whole to expand by 0.8% in 2010, up from 0.5% in last month's forecast.

The UK's prospects remain grim. The economy will contract by 4.6% this year and grow by just 0.5% in 2010. The drastic deterioration in the public finances, now a major political issue, also clouds the country's medium-term recovery prospects because of its implications for fiscal policy, which will have to be tightened.

Emerging markets: Asia leads the recovery

In emerging markets, the picture is mixed. While much of eastern Europe is still extremely weak, prospects in parts of Latin America are improving. Some countries are benefiting from strong Chinese demand for raw materials, while Brazil is weathering the downturn particularly well thanks to a strong financial system and large internal market. Most striking, however, is the upturn in emerging Asia. Given the region's traditional dependence on exports, this seems surprising. But big fiscal stimulus programmes are supporting growth. The corollary is that prospects may weaken once the effects of stimulus fade, unless exports or private-sector demand can take up the slack.

Our forecasts for the Middle East and Africa are little changed. Lower oil prices compared to last year, combined with weaker OECD demand for exports and the bursting of property bubbles, have hurt the Middle East and North Africa, where growth will slow sharply to 0.8% this year. But rising oil prices and output, and an improving global economy, will lead to a strong rebound in 2010 and 2011.

Exchange rates: Dollar weakness

The weakness of the US dollar, now at around US$1.50 to the euro, has been headline news. This weakness partly reflects the US's ultra-low interest rates and a sharp rise in investors' risk appetite, which has reduced the safe-haven appeal that supported the dollar late last year. As a result, we now forecast an average exchange rate of US$1.42 to the euro in 2010 (compared with US$1.39 in our previous forecast). As investors anticipate higher US interest rates in 2010, the dollar is likely to strengthen a little over the course of the year. The European Central Bank is expected to tighten monetary policy more slowly than the Fed, which should also support the dollar. We have also revised our dollar-yen forecasts, and expect the Japanese currency to average ¥90 or stronger against the dollar for the next five years. Overall, the dollar's trajectory looks highly uncertain and will be volatile.

Commodities: Higher metal prices

Our oil-price forecast is only slightly changed from last month. We still expect a barrel of oil to cost an average of US$74 in 2010. Although demand is weak and global stocks are at all-time highs, a number of factors should support prices. They include optimism about the global recovery, the effects of monetary and fiscal stimulus, and OPEC's imperfect efforts to restrict output. Prices will be softer on average in 2011 as the effects of economic stimulus fade, although our new forecast of US$70/b is still slightly higher than before (we were forecasting US$67/b previously).

The more dramatic commodities story is in metals, where we have sharply revised up our price forecasts for copper, aluminium and gold. Copper will average US 281 cents/lb in 2010, a 13% increase on our previous forecast, and aluminium has been revised up 26% to US$1,951/tonne. These changes reflect strong price rises in the past two quarters, driven by huge increases in Chinese imports. However, a concern is that China appears to have been taking advantage of low prices to build stocks, and may buy less as prices rise. Meanwhile, the price of gold has risen to around US$1,060/troy oz, driven by concerns about inflation, a weakening dollar and volatility in other asset markets. We expect gold to average US$1,044/troy oz next year, easing to US$976/troy oz in 2011.


World economy: Forecast summary
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Real GDP growth (%)
World (PPP exchange rates) a 4.4 5.0 5.0 2.8 -1.3 3.2 3.4 3.8 4.0 4.1
World (market exchange rates) 3.6 4.0 3.8 1.7 -2.5 2.3 2.3 2.8 3.0 3.0
US 3.1 2.7 2.1 0.4 -2.4 2.4 1.1 1.9 2.3 2.3
Japan 1.9 2.0 2.3 -0.7 -6.2 1.3 1.0 1.1 1.0 0.9
Euro area 3.5 3.0 2.6 0.6 -4.1 0.8 1.0 1.5 1.8 2.0
China 10.4 11.6 13.0 9.0 8.2 8.6 8.4 8.5 8.2 8.2
Eastern Europe 5.6 7.3 7.3 4.7 -6.0 1.6 3.5 4.1 4.2 4.1
Asia & Australasia (excl Japan) 7.2 7.9 8.7 5.5 3.7 5.7 6.3 6.5 6.4 6.5
Latin America 4.9 5.6 5.5 3.9 -2.9 2.7 3.3 3.7 3.8 3.9
Middle East & North Africa 6.4 6.1 5.6 6.0 0.8 4.4 4.4 4.8 4.7 4.9
Sub-Saharan Africa 6.6 6.6 6.8 4.5 -1.7 3.0 4.9 5.0 4.9 4.9
World trade growth (%) 7.5 9.1 7.5 3.6 -9.4 3.7 4.6 5.2 5.7 5.9
World inflation (%; av) 3.0 3.2 3.4 4.9 1.2 2.1 2.6 2.8 2.8 2.9
Commodities
Oil (US$/barrel; Brent) 54.4 65.4 72.7 97.7 62.0 74.0 70.0 80.0 82.5 89.5
Aluminium (US$/tonne) 1,900 2,594 2,661 2,621 1,671 1,951 2,017 2,100 2,250 2,350
Copper (US cents/lb) 167 306 322 316 226 281 299 300 305 310
Gold (US$ /troy oz) 445 604 697 870 960 1,044 976 900 850 825
Exchange rates (annual av)
¥:US$ 110 116 118 103 94 90 89 88 87 86
US$:€ 1.25 1.26 1.37 1.47 1.40 1.42 1.40 1.42 1.44 1.45
a PPP = purchasing power parity
Source: Economist Intelligence Unit.

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DEATH TO THE DOLLAR

DEATH TO THE DOLLAR: "

Everyone loves a good funeral, no? The dollar, as you know it, is about to get its lights punched out, for good. The daily dips of 0.5% will soon be replaced with 2-3% drops, all thanks and praise to the Federal Reserve and Executive branch for such gifts of fiat.

To hedge your wallet, once again, you should be long basic material stocks. Names like BHP Billiton Limited (ADR) (BHP: 73.54 +0.77%) , (VALE: 26.92 +1.78%) , Southwestern Energy Company (SWN: 48.70 -1.54%) , Arena Resources, Inc. (ARD: 43.45 +1.45%) , Suncor Energy Inc. (USA) (SU: 37.91 -0.11%) , POSCO (ADR) (PKX: 115.95 +0.62%) , Allegheny Technologies Incorporated (ATI: 34.84 -8.29%) etc, can be bought in size. Howsoever, when I say “size,” I do not mean right away. Only idiots buy everything at once. Measure your buys over a period of time. There is no rush to own anything. The likelihood of you hitting a homerun is far less than you striking out.

With commodities running higher, it’s only a matter of time before the shippers respond in kind. Names like Genco Shipping & Trading Limited (GNK: 22.70 +0.22%) , TBS International Limited (TBSI: 9.54 -0.73%) , DryShips Inc. (DRYS: 7.13 -3.26%) and Diana Shipping Inc. (DSX: 15.02 +0.20%) can be owned as well.

Truth be told, I am not buying anything. Into this rally, I will lighten up, in order to build my cash position back up to 25%. Selling is a process too, by the way.

In short, as long as the dollar (UUP: 22.33 -0.58%) is weak, equities are free to run with the wind. If you are short stocks, you are in for a very arduous Halloween.

Top picks: Equinix, Inc. (EQIX: 97.71 -0.49%) , Sociedad Quimica y Minera (ADR) (SQM: 38.77 -0.51%) and Guess?, Inc. (GES: 38.17 -2.35%)

"

Munchau and the awful exit

Munchau: Next Crisis Coming Sooner Than You Think « naked capitalism

Financial Times:

On the surface, this looks like 2003 and 2004 when the previous housing, credit, commodity and equity bubbles started to inflate, helped by low nominal interest rates and a lack of inflation. There is one big difference, though. This bubble will burst sooner.

So how do we know this is a bubble? My two favourite metrics of stock market valuation are Cape, which stands for the cyclically adjusted price/earnings ratio, and Q. Cape was invented by Robert Shiller, professor of economics and finance at Yale University. It measures the 10-year moving average of the inflation-adjusted p/e ratio. Q is a metric of market capitalisation divided by net worth…

…they both tend to agree on relative market mispricing most of the time. In mid-September both measures concluded that the US stock market was overvalued by some 35 to 40 per cent. The markets have since gone up a lot more than the moving average of earnings….

The single reason for this renewed bubble is the extremely low level of nominal interest rates, which has induced people to move into all kinds of risky assets…

But unlike five years ago, central banks now have the dual role of targeting monetary and financial stability. As has been pointed out time and again, those two objectives can easily come into conflict. In Europe, for example, the European Central Bank would under normal circumstances already have started to raise interest rates. The reason it sits tight is to prevent damage to Europe’s chronically under-capitalised banking system, which still depends on the ECB for life support. The same is true, more or less, elsewhere.

Now, I agree there is no prospect of a significant rise in inflation over the next 12 months, but the chances rise significantly after 2010.

Once perceptions of rising inflation return, central banks might be forced to switch towards a much more aggressive monetary policy relatively quickly – much quicker than during the previous cycle. A short inflationary boom could be followed by another recession, another banking crisis, and perhaps deflation. We should not see inflation and deflation as opposite scenarios, but as sequential ones. We could be in for a period of extreme price instability, in both directions, as central banks lose control.

This is exactly what the economist Hyman Minsky predicted in his financial instability hypothesis.** He postulated that a world with a large financial sector and an excessive emphasis on the production of investment goods creates instability both in terms of output and prices.

While, according to Minsky, these are the deep causes of instability, the mechanism through which instability comes about is the way governments and central banks respond to crises. The state has potent means to end a recession, but the policies it uses give rise to the next phase of instabiliy….The world has witnessed a proliferation of financial bubbles and extreme economic instability that cannot be explained by any of the established macroeconomic models. Minsky is about all we have.

His policy conclusions are disturbing, especially if contrasted with what is actually happening. In their crisis response, world leaders have focused on bonuses and other irrelevant side-issues. But they have failed to address the financial sector’s overall size. So if Minsky is right, instability should continue and get worse.

Our present situation can give rise to two scenarios – or some combination of the two. The first is that central banks start exiting at some point in 2010, triggering another fall in the prices of risky assets. In the UK, for example, any return to a normal monetary policy will almost inevitably imply another fall in the housing market, which is currently propped up by ultra-cheap mortgages.

Alternatively, central banks might prioritise financial stability over price stability and keep the monetary floodgates open for as long as possible. This, I believe, would cause the mother of all financial market crises – a bond market crash – to be followed by depression and deflation.

In other words, there is danger no matter how the central banks react. Successful monetary policy could be like walking along a perilous ridge, on either side of which lies a precipice of instability.

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20%

Dollar May Drop 20% More, Harvard’s Ferguson Says (Update1) - Bloomberg.com

Dollar May Drop 20% More, Harvard’s Ferguson Says (Update1)
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By Cordell Eddings and Thomas R. Keene

Oct. 16 (Bloomberg) -- The dollar will extend its drop versus the euro over the next two to five years, falling as much as 20 percent to an all-time low under a widening U.S. budget deficit, Harvard University’s Professor Niall Ferguson said.

Policy makers favor the dollar’s slide as a means of supporting a recovery from the worst economic slump since the Great Depression even as they voice support for a strong greenback, Ferguson said in an interview on Bloomberg Radio.

A weak dollar is “the simplest solution to most of America’s problems right now,” said Ferguson, author of “The Ascent of Money: A Financial History of the World.” “We are likely to see 1 percent to 2 percent growth unless exports take off, and that’s what everyone in Washington is quietly hoping: If the dollar keeps sliding, then maybe we can get some traction on exports.”

The dollar increased 0.4 percent to $1.4888 versus the euro today after depreciating yesterday to $1.4968, the weakest level in 14 months. The U.S. currency touched $1.6038 on July 15, 2008, the weakest level since the euro’s 1999 debut.

The world’s largest economy shrank at a 0.7 percent annual rate in the second quarter, the Commerce Department reported last month. Gross domestic product contracted at a 6.4 percent pace in the first three months of 2009.

Economists forecast the current-account deficit will rise to 3.2 percent of gross domestic product in 2010 and 3.3 percent in 2011, compared with 2.9 percent this year.

‘Terrible News’

The weakening of the dollar is “terrible news for practically all of the rest of the world’s economies,” except the U.S. and China, said Ferguson. China, which manages the yuan’s appreciation, will “intervene to make sure the dollar does not weaken” relative to its currency, Ferguson added.

Treasury Secretary Timothy Geithner said on Oct. 3 after attending a meeting of Group of Seven finance officials that it’s “very important” for the U.S. to have a strong dollar.

The administration of President Barack Obama pushed the nation’s marketable debt to an unprecedented $6.78 trillion in an effort to spur economic growth and support the financial system.

The U.S. government’s annual budget deficit widened to a record $1.42 trillion for the 12 months ended Sept. 30, the Treasury Department said today in Washington. The shortfall was more than triple the $455 billion record set a year earlier, the department said.

To contact the reporters on this story: Cordell Eddings in New York at ceddings@bloomberg.net; Thomas R. Keene in New York tkeene@bloomberg.net

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Excellent post by Econbrowser

Econbrowser: Dollar Demise and Double Dip: Latest Forecasts

Dollar Demise and Double Dip: Latest Forecasts

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Dollar will not prevail

Treasury: Dollar Will Prevail As Long As U.S. Policies Are Sound - Real Time Economics - WSJ

Meanwhile, Fred Bergsten, who served in the Carter Treasury and is now head of the Peterson Institute for International Economics, is arguing that the dollar’s days are numbered. Writing in Foreign Affairs, he says, the dollar’s position as the default international currency has made it “much easier for the United States to finance, and thus run up, large trade and current account deficits with the rest of the world.” But the U.S. trade deficit, along with the huge U.S. budget deficit, laid the groundwork for the current financial crisis. So he says it is now time for Washington to realize that “large external deficits, the dominance of the dollar, and the large capital inflows that necessarily accompany deficits and currency dominance are no longer in the United States’ national interest.” It’s time to start creating an international currency system that does not rely on the dollar, he concludes.

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Dollar devaluation is good

FT.com / Columnists / Wolfgang Munchau - Making the case for a weaker dollar

Imagine a world with a small current account deficit in the US, a somewhat larger deficit in the eurozone and a not too excessive Asian surplus. In such a world, economic commentators would no longer bang on about global imbalances and would have to find a different subject.

In the long run, such a world would require significant reform of the international monetary system. In the short term, a fall in the dollar’s exchange rate would help get us there. And I note with some satisfaction that it is happening.

A lower dollar is desirable because it would help America achieve the right kind of recovery. The US economy is severely constrained by household and financial sector deleveraging and possibly by a permanent fall in potential growth. In the absence of another housing bubble and consumer boom, an export-led recovery is the best growth strategy the US could employ.

I do not buy the strong-dollar pledges by Tim Geithner, Treasury secretary, and Larry Summers, director of the National Economic Council. They have to say that. It is the official policy line. The bond markets would go crazy otherwise. But a strong dollar is the last thing the US economy needs right now.

There are two further factors that support a weaker dollar. The first is, of course, the double-digit public sector deficit, which has already unnerved investors and which is not going to come down with any haste. The second is monetary policy.

There is little risk of inflation in the short run but a very significant inflation risk beyond the crisis. I doubt the Federal Reserve will set itself a target of a 6 per cent inflation rate, as some US economists are now proposing. But I suspect the Fed will not lean too heavily against the wind, should inflationary pressures emerge.

The latest published comments from Bill Dudley, president of the New York Fed, confirmed my suspicion about the Fed’s asymmetric bias when he said he was more concerned about deflation than inflation and that interest rates would stay low for a long time. This is 2003 and 2004 all over again, except this time the chances are higher that it will end in inflation rather than in a housing and credit bubble.

What about the rest of the world? Would the Europeans, for example, not fight tooth and nail against a weakening dollar? Not necessarily. Just look at the situation from the perspective of the European Central Bank. Ideally, it would like to exit early by withdrawing liquidity support and raising interest rates, but it is severely constrained because many European banks are still dependent on low interest rates and ECB life support operations for their survival.

Fiscal policy is also extremely loose and likely to remain so. From the ECB’s point of view, a strong euro is probably the most effective insurance against resurgent inflation, at a time when interest rate policy remains constrained.

A strong euro would nicely take care of Germany’s persistent current account surplus. The surplus countries will never adopt policies to get rid of their surpluses. The exchange rate will have to do the job for them. Last week’s announcement of a surprise fall in German exports during August tells me that the hopes of another export-led recovery, as in 2006, are unrealistic. I expect a much reduced current account surplus for Germany in the next few years and, for the eurozone, a sizeable, probably not excessive, current account deficit.

The sensible goal of a more balanced world economy is entirely consistent with a weaker dollar and a stronger euro. I am not trying to make a short-term prediction. Foreign exchange markets are crazy, and I have been wrong too many times. But what persuades me that the dollar has further to devalue is the observation that, for once, politics and economics are pushing in the same direction.

Exchange rates cannot solve the problem of global imbalances. They did not in the past. Reform of the global monetary system is necessary for sustained balance. I agree with the views of Fred Bergsten, director of the Peterson Institute for International Economics in Washington, that the world will ultimately have to move to maximum targets for current account imbalances.

In a forthcoming article in Foreign Policy, he proposes a current account deficit ceiling of 3 per cent of gross domestic product for the US. He also argues that a reduced international role for the dollar would be in the best strategic interests of the US as continued imbalances would end up producing intolerable instability, no matter whether they are financed or not.

Several proposals are floating around for how this could be achieved, for example the creation of special reserve baskets or the use of the International Monetary Fund’s special drawing rights. I expect we will see neither but are moving towards a dual system in which the dollar and the euro act as the world’s de facto reserve currencies.

The rise in the euro’s international role, which is already formidable, is not a reflection of the strength of the eurozone economy but of the liquidity of its bond markets and the need of foreign investors to diversify.

It is important not to confuse the international role of a currency and its exchange rate at any particular time. But in the case of the dollar, there is a link. A fall in the dollar’s exchange rate would be a very useful contribution to global balance. A reform of the global monetary system is needed to ensure that imbalances do not return. We are not there yet, not even close. But some of the parameters are slowly falling into place.

munchau@eurointelligence.com
More columns at www.ft.com/wolfgangmunchau

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Gold and the dollar devaluation

FT.com / Comment / Opinion - Paranoid theories can’t take the shine off gold

Paranoid theories can’t take the shine off gold

By John Dizard

Published: October 9 2009 20:21 | Last updated: October 9 2009 20:21

They asked me to write about the goldbugs’ point of view, including the paranoia and conspiracy theories about gold. You know. “Them”. The request could have come in any number of ways: a note composed from cut-up newspaper headlines, or a “suggestion” from a muffled voice over the phone. In this case, it was an “FT editor”. I can only speculate about his true identity.

If you immerse yourself in the world of goldbuggery, the nothing-is-what-it-seems worldview can become that infectious. The paranoia of the goldbugs, die-hard believers in the value of the metal, has been with us a long time, intensifying since the collapse of the last great gold bull market in the early 1980s. Now, though, the goldbugs’ resolute disbelief in the legitimacy and value of official currencies is influencing mainstream market opinion, helped by this week’s record price of $1,061 per Troy ounce.

The fundamental premise of goldbug conspiracy theory is that the metal would have continued to hold and even increase its value over the years against the “fiat” currencies if there had not been a sustained, secret intervention on the part of some powerful group of market manipulators. The speculated-upon identity of the “Hand”, or “Seller”, or “Manager” varied over the years, from JPMorgan, the US Federal Reserve and Goldman Sachs (of course), to miner Barrick Gold or George Soros.

Underlying all the conspiracy theories are two convictions: gold is the only true measure of value, and the people in charge share the goldbugs’ belief in the centrality of the gold market in the organisation of the economic and financial world.

The first premise has both a material and a religious aspect. In the material world, gold’s chemical stability, rarity and ductility have in all societies made it a precious asset. However, that very scarcity and weight, along with the need to re-assay gold offered as payment, limit its usefulness as a medium of exchange for a world with today’s volume of trade. While it is a useful, and, over the longest term, essential, store of monetary value, there is a limit to the degree to which it can substitute for paper or electronic currencies.

The utility of gold as a store of value can, for the obsessive, verge on religious devotion, or even love, despite the Bible’s admonition that “the love of money is the root of all evil”. A true goldbug would probably say this applies only to the government’s money.

The second premise, that the committee or committees which run the economy do so through their setting of the gold price, had some basis in truth when governments or central banks were willing to buy and sell gold to set their currency’s exchange rates. The US government’s willingness to do that with the public ended in 1933, and its sales of gold to official counterparties ended in 1971.

For a few years after the 1971 “closing of the gold window”, the end of US government gold sales, there was residual interest in foreign governments’ valuation of their gold reserves. A website popular with goldbugs, Zero Hedge, recently revealed a 1975 Federal Reserve memorandum to President Gerald Ford, in which an argument between the Treasury and the Fed is outlined. Zero Hedge describes the memo as a “smoking gun”, and goes on to say: “So to all conspiracy theorists claiming that gold is being manipulated on a daily basis by the Federal Reserve: when it occurs over and over, and is so well documented, it is no longer a theory.”

The memo itself is rather less dramatic and has nothing to do with manipulation on a daily basis. Essentially, the Fed chairman, then Arthur Burns, was telling Mr Ford that if the French buy lots of gold it will lead to an increase in world liquidity and more inflation. As usual, Mr Burns was wrong. Gold was not necessary to inflate or deflate world liquidity; that could be done through money market operations by government currency issuers, including the French and the Americans.

Gold could move the larger financial world directly if central banks tied the level and rate of currency issuance directly to their gold reserves or to the metal’s price. Central banks, or a shadowy Doctor Evil, do not need to manipulate the price of gold if the price does not limit their freedom of action. What matters to governments is their ability to finance themselves through bond sales. This would be hampered if the bonds’ value was being eroded by higher inflation, or by devaluation of the currency relative to other currencies.

And that is what the gold price is beginning to tell us. The investing public may be too worried about imminent inflation; more likely, given the continued weakness in employment and wages, not to mention housing, we will have weak dollar-measured general price inflation. However, in spite of mantra-like official statements to the contrary, it would seem that the US government wants to competitively devalue its way to national prosperity.

That hasn’t worked yet, since the trade-weighted dollar is about where it was at the beginning of the crisis, but I am confident that if a government wants to debase its currency, it can ultimately succeed in doing so.

One of the advantages of being a goldbug now, or becoming one soon, is that it is one commodity whose price is not likely to be manipulated below its market-equilibrium level by the US government (“Them”, if you prefer). There will be attempts to limit speculation in such essential commodities as oil, grains, or base metals, but a gold price rise would simply represent a successful devaluation.

So while the goldbugs’ conspiracy theories are chimerical, their investment strategy is at last aligning with that of the real world.

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More on the devaluation of the dollar

The Dollar Adrift - WSJ.com

The Dollar Adrift
A global vote of non-confidence.

The biggest story in the world economy is the continuing fall of the U.S. dollar, or at least it is everywhere outside of Washington, D.C., the place most responsible for its declining value. For good reason, the world is wondering if America has cast the dollar adrift.

A passel of Asian central banks—South Korea, Taiwan, the Philippines and Thailand—intervened yesterday to stop the greenback's fall against their currencies. European Central Bank President Jean-Claude Trichet also tried to buoy the buck, telling reporters that "A strong dollar is extremely important in the given circumstances." Neither effort made much difference.

Meanwhile, the London Independent created a splash this week with a thinly sourced and not very credible story that several nations were working secretly to trade oil in currencies other than the dollar. The alleged conspirators all quickly denied it, but the tizzy the story created suggests the global mood of concern about holding American currency.

The attempts at intervention are probably futile, save for the short-term scare they give to currency traders. Currency interventions are typically "sterilized," which means that while a central bank extinguishes a currency (say, Thai baht) in the foreign-exchange markets it creates more baht through domestic monetary operations. Thus there's no underlying change in the relative supply of baht versus dollars. The point of intervention is to frighten traders about the risks of speculating and getting burned. Everything else is commentary.
[1dollar]

The value of any currency is ultimately determined by the supply and demand for that currency. And the problem for the dollar at the moment is that there is a much larger supply of dollars than there is global demand for them. The solution rests not in Manila, Bangkok or Paris, but in Washington.

Start with dollar supply, which is entirely a function of America's central bank, the Federal Reserve. The Fed has been flooding the world with dollars in the name of preventing a U.S. deflation after last year's panic, and it shows no sign of tightening any time soon. Last week's awful September jobs report convinced markets that the Fed will keep the money spigot wide open well into 2010. And yesterday, Richard Fisher, president of the Dallas Fed and thought to be a rare hawk on the Fed's Open Market Committee, chimed in that no one at the Fed thinks this is the time to raise interest rates.

All of this is a signal to world markets that holding dollars is a risky proposition, which in turn contributes to falling global demand for dollars. The Fed is telling the world that it is concerned primarily—perhaps only—with the domestic U.S. economy. If the dollar falls against other currencies, that's their problem. The Fed will let the dollar fall.

For a time in the wake of the panic, the dollar benefitted from a flight to the relative safety of U.S. Treasurys and other dollar assets. (See the nearby chart.) In a storm, the dollar was thought to be less risky than other investments. But as this overall global risk aversion has ebbed, the risk calculus has turned and the dollar itself has become more dangerous to hold than nondollar investments.

The world's investors can also see the arc of overall U.S. economic policy, which is becoming less inviting to global capital. Higher taxes on capital gains and income; new entitlements that will require trillions of dollars in new U.S. borrowing; a wave of new antitrust enforcement, more telecom regulation ("net neutrality") and trade protection, new restrictions on energy production, easier rules for union organizing, and so much more. All of these are signals that U.S. growth is likely to be slower than it otherwise would be, and that the returns on investing in America will be lower than they should be. This too is a reason to sell greenbacks.

For many in the Washington establishment, alas, the falling dollar is considered a virtue. They believe it will help U.S. exports and therefore reduce the trade deficit and bring back manufacturing jobs. But as David Malpass argued on these pages yesterday, capital flows dwarf trade flows as a source of wealth creation. The only way to build wealth and create more high-paying jobs over time is through the productivity gains that come from greater investment and innovation. As the dollar falls and capital flees the U.S. for other countries, those global competitors reap its benefits and become more productive and relatively more prosperous.

The more immediate danger—in the coming months—would be if the fall of the dollar becomes a rout. This could cause a spike in commodity prices, such as oil, that are traded in dollars and jeopardize the nascent economic recovery. But even if there is no dollar panic, the volatility of currency markets is distorting investment decisions and creating more economic uncertainty. It could also lead to a round of competitive devaluations, as other nations try to placate their own domestic export constituencies.

Washington may not care to notice, but the sell-off in the dollar is a daily global vote on U.S. economic policy. It is not a vote of confidence.

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Dollar devaluation

David Malpass: The Weak-Dollar Threat to Prosperity - WSJ.com

  OCTOBER 7, 2009, 9:06 P.M. ET

The Weak-Dollar Threat to Prosperity
Measured in euros, U.S. per capita GDP is down 25% since 2000.
By DAVID MALPASS

If you want to know why the dollar has been falling this week and gold hit a new high, look no further than the weak jobs numbers last Friday and the weak communique issued over the weekend at the G-7 meeting in Istanbul. Deploring "excess volatility and disorderly movements in exchange rates" isn't exactly a ringing defense of the greenback. And 9.8% unemployment convinced markets that monetary policy will remain loose regardless of dollar weakness.

Bond buyer Bill Gross of the Pimco fund summed up the situation nicely in a recent CNBC interview. Asked whether low interest rates will weaken the dollar, the influential allocator of global capital said: "I think that's part of the administration's plan. It's obviously not announced—the 'strong dollar' is always the policy, so to speak. One of the ways a country gets out from under its debt burden is to devalue."

On the surface, the weak dollar may not look so bad, especially for Wall Street. Gold, oil, the euro and equities are all rising as much as the dollar declines. They stay even in value terms and create lots of trading volume. And high unemployment keeps the Fed on hold, so anyone with extra dollars or the connections to borrow dollars wins by buying nondollar assets.


Investors have been playing this weak-dollar trade for years, diverting more and more dollars into commodities, foreign currencies and foreign stock markets. This is the Third-World way of asset allocation.

Corporations play this game for bigger stakes, borrowing billions in dollars to expand their foreign businesses. As the pound slid in the 1950s and '60s and the British Empire crumbled, the corporations that prospered were the ones that borrowed pounds aggressively in order to expand abroad. Though British equities rose in pound terms, they generally underperformed gold and foreign equities. At the end of empire, the giant sucking sound was from British capital and jobs moving offshore as the pound sank.

Some weak-dollar advocates believe that American workers will eventually get cheap enough in foreign-currency terms to win manufacturing jobs back. In practice, however, capital outflows overwhelm the trade flows, causing more job losses than cheap real wages create. This was the lesson of the British malaise, the Carter malaise, the Mexican malaise of the 1990s, Yeltsin's Russian malaise through 1999 and the rest. No countries have devalued their way into prosperity, while many—Hong Kong, China, Australia today—have used stable money to invite capital and jobs.

The more the dollar devalued against the yen in the 1970s and '80s, the more Japan gained share in valued-added manufacturing, using the capital from weak-currency countries to increase productivity. China is doing the same now. It watches in chagrin as the U.S. pleads with it to strengthen the yuan, adding productivity fast with the dollars rushing its way in search of currency stability.

If stocks double but the dollar loses half its value, who beyond Wall Street are the winners and losers? There's been a clear demonstration this decade. The S&P nearly doubled from 2003 through 2007. Those who borrowed to buy won big-time. Rich people got richer, seeing their equity bottom line double. At the same time, the dollar's value was cut nearly in half versus the euro and other stable measures. Capital fled, undercutting job growth. Rent, gasoline and food prices rose more than wages.

Equity gains provide cold comfort when currencies crash. From the euro perspective, the S&P peaked at 1700 in 2000, finally reattained 1100 in the 2007 bubble, fell below 600 in March and now stands at 700 (see nearby chart). With most of the market capitalization of U.S. stocks held by Americans, the dollar devaluation has caused a massive decline in the U.S. share of global wealth.

Measured in euros (a more stable ruler than the ever-weakening dollar), U.S. real per capita GDP is down 25% since 2000, while Germany's is up 4% and tops ours.

The solution is a strong U.S. jobs and wealth program. It has to include stable money, a flatter, more competitive tax structure, spending restraint, and common-sense bank regulation so small business lending can restart. Treasury has to rapidly lengthen the maturity of the national debt and take steps to protect the Fed from market losses on its long-term debt holdings.

Instead, Washington's current economic program pushes capital away by weakening the dollar, threatening higher tax rates, borrowing short (the Fed's near trillion-dollar overnight debt, Treasury's mounds of bill and note issuance) to lend long (mortgages, student loans, entitlements), doubling down on government subsidies, and rechanneling bank loans to governments and big businesses instead of the small business job-growth engine.

It's possible global bond vigilantes will call Washington's bluff, reducing their bond purchases until we stop devaluing and restart job growth, which is the ultimate source of tax revenues to repay our bond debt. This would create a Volcker moment when the U.S. might tighten even as the economy slowed (as then Fed Chairman Paul Volcker did back in 1979).

But the accepted outlook is the almost-as-gloomy new norm. If all goes according to current plans, the dollar devalues slowly and bond buyers come back for more even as national debt heads toward $15 trillion. World living standards grow faster than ours, as does global wealth. The Fed chases inflation as the dollar sinks, but not so fast as to stop the recovery. More capital moves abroad, leaving U.S. unemployment too high too long.

A better approach would start with President Barack Obama rejecting the Bush administration's weak-dollar policy. This would invite capital and jobs to come back before interest rates have to rise.

Mr. Malpass is president of Encima Global LLC.

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No more dollars

The demise of the dollar - Business News, Business - The Independent

Exclusive report
The demise of the dollar


By Robert Fisk

Tuesday, 6 October 2009



Iran announced late last month that its foreign currency reserves would henceforth be held in euros rather than dollars.

Rex

Iran announced late last month that its foreign currency reserves would henceforth be held in euros rather than dollars.



In the most profound financial change in recent Middle East history, Gulf Arabs are planning – along with China, Russia, Japan and France – to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar.

Secret meetings have already been held by finance ministers and central bank governors in Russia, China, Japan and Brazil to work on the scheme, which will mean that oil will no longer be priced in dollars.

The plans, confirmed to The Independent by both Gulf Arab and Chinese banking sources in Hong Kong, may help to explain the sudden rise in gold prices, but it also augurs an extraordinary transition from dollar markets within nine years.

The Americans, who are aware the meetings have taken place – although they have not discovered the details – are sure to fight this international cabal which will include hitherto loyal allies Japan and the Gulf Arabs. Against the background to these currency meetings, Sun Bigan, China's former special envoy to the Middle East, has warned there is a risk of deepening divisions between China and the US over influence and oil in the Middle East. "Bilateral quarrels and clashes are unavoidable," he told the Asia and Africa Review. "We cannot lower vigilance against hostility in the Middle East over energy interests and security."

This sounds like a dangerous prediction of a future economic war between the US and China over Middle East oil – yet again turning the region's conflicts into a battle for great power supremacy. China uses more oil incrementally than the US because its growth is less energy efficient. The transitional currency in the move away from dollars, according to Chinese banking sources, may well be gold. An indication of the huge amounts involved can be gained from the wealth of Abu Dhabi, Saudi Arabia, Kuwait and Qatar who together hold an estimated $2.1 trillion in dollar reserves.

The decline of American economic power linked to the current global recession was implicitly acknowledged by the World Bank president Robert Zoellick. "One of the legacies of this crisis may be a recognition of changed economic power relations," he said in Istanbul ahead of meetings this week of the IMF and World Bank. But it is China's extraordinary new financial power – along with past anger among oil-producing and oil-consuming nations at America's power to interfere in the international financial system – which has prompted the latest discussions involving the Gulf states.

Brazil has shown interest in collaborating in non-dollar oil payments, along with India. Indeed, China appears to be the most enthusiastic of all the financial powers involved, not least because of its enormous trade with the Middle East.

China imports 60 per cent of its oil, much of it from the Middle East and Russia. The Chinese have oil production concessions in Iraq – blocked by the US until this year – and since 2008 have held an $8bn agreement with Iran to develop refining capacity and gas resources. China has oil deals in Sudan (where it has substituted for US interests) and has been negotiating for oil concessions with Libya, where all such contracts are joint ventures.

Furthermore, Chinese exports to the region now account for no fewer than 10 per cent of the imports of every country in the Middle East, including a huge range of products from cars to weapon systems, food, clothes, even dolls. In a clear sign of China's growing financial muscle, the president of the European Central Bank, Jean-Claude Trichet, yesterday pleaded with Beijing to let the yuan appreciate against a sliding dollar and, by extension, loosen China's reliance on US monetary policy, to help rebalance the world economy and ease upward pressure on the euro.

Ever since the Bretton Woods agreements – the accords after the Second World War which bequeathed the architecture for the modern international financial system – America's trading partners have been left to cope with the impact of Washington's control and, in more recent years, the hegemony of the dollar as the dominant global reserve currency.

The Chinese believe, for example, that the Americans persuaded Britain to stay out of the euro in order to prevent an earlier move away from the dollar. But Chinese banking sources say their discussions have gone too far to be blocked now. "The Russians will eventually bring in the rouble to the basket of currencies," a prominent Hong Kong broker told The Independent. "The Brits are stuck in the middle and will come into the euro. They have no choice because they won't be able to use the US dollar."

Chinese financial sources believe President Barack Obama is too busy fixing the US economy to concentrate on the extraordinary implications of the transition from the dollar in nine years' time. The current deadline for the currency transition is 2018.

The US discussed the trend briefly at the G20 summit in Pittsburgh; the Chinese Central Bank governor and other officials have been worrying aloud about the dollar for years. Their problem is that much of their national wealth is tied up in dollar assets.

"These plans will change the face of international financial transactions," one Chinese banker said. "America and Britain must be very worried. You will know how worried by the thunder of denials this news will generate."

Iran announced late last month that its foreign currency reserves would henceforth be held in euros rather than dollars. Bankers remember, of course, what happened to the last Middle East oil producer to sell its oil in euros rather than dollars. A few months after Saddam Hussein trumpeted his decision, the Americans and British invaded Iraq.

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