clueless penguin

We will have inflation

2010-01-28T03:52:00.000-08:00

Allan Meltzer: Bernanke's Anti-Inflation Exit Strategy Will Fail - WSJ.com

By ALLAN H. MELTZER

Federal Reserve Chairman Ben Bernanke has explained his exit strategy to prevent future inflation. The Fed recently began to pay interest to banks on the reserves they hold in their vaults. Using this new tool, it claims the ability to get banks to keep the money instead of lending it out, thus containing the money supply and inflation.

I don't believe this will work, and no one else should.

The exit strategy is incomplete. Proponents are guilty of practicing economics without prices. They never say what the interest rate on reserves must be to get banks to hold the approximately $1 trillion of reserves above the minimum they're legally required to hold. That's the critical question.

The efforts to reduce inflation during the 1970s failed because they ended prematurely. And they ended prematurely when business, unions, Congress and the administration objected loudly to the rising unemployment accompanying higher interest rates. Today's high current and prospective unemployment rates pose a similar dilemma.

No economist doubts that the Fed can induce banks to hold some more reserves by paying interest. But how much?

Normally, banks' principal business is lending, and the interest rate they can get on their loans is more important than the interest they might get on their reserves. Once borrowing resumes, banks will increase loans and expand deposits. The current massive volume of excess reserves will melt into a greater money supply, and later higher inflation.

When will inflation start? The date is uncertain. But the triggering event will be either a sustained increase in bank lending or a large increase in Fed purchases of government debt. Perhaps both. Either one would trigger a sustained increase in money growth.

With the exception of the early years after Paul Volcker became Fed chairman in 1979, the Fed has paid no attention to money growth. There have always been some Fed bank presidents concerned about too much or too little money growth, but they have not affected decisions. That problem remains.

The Federal Reserve has a well-known dual mandate to prevent both inflation and unemployment. It chooses to act on only one part of its mandate at a time. That cannot be the best way to achieve both targets, and it has failed repeatedly to bring low inflation and low unemployment. For example, the policy implied by the famous Phillips Curve—which says you can trade off higher inflation for lower unemployment—failed in the 1970s. We got rising inflation and higher unemployment.

Mr. Volcker publicly and privately discarded the Phillips Curve in favor of bringing inflation down by high interest rates and better control of the money supply. The result: about 15 years of low inflation and low unemployment. But the Fed abandoned its success by keeping interest rates too low after 2003. And now the Phillips Curve is back in fashion, with strong support from the Fed Board of Governors.

Christina Romer, chairman of the Council of Economic Advisers, reminds us regularly about the Fed and the Treasury's tig ht-money mistakes in 1937 which aborted the recovery, and she warns against repeating these mistakes. The principle drivers behind the recovery in 1934-36 were the veterans' bonus in 1936 and a gold inflow following the 1934 devaluation of the dollar—accomplished by unilaterally raising the gold price. The bonus ended, and the Treasury began to sterilize gold inflows in 1937 by selling securities, while the Fed doubled reserve requirements. Monetary policy shifted from excessive ease to excessive restraint.

Nothing of the kind is called for today. Instead, the Fed should announce a policy for preventing inflation that reduces the enormous stock of excess reserves, such as by selling securities. And the Treasury or the Office of Management and Budget should announce a credible policy for reducing deficits. That would help to reduce the uncertainty about future taxes, spending and inflation.

Policies without prices hide the serious problem posed by excessive debt and reserves, and are not credible. Policy makers should develop and announce credible plans now.

Mr. Meltzer is a professor at the Tepper School of Business, Carnegie Mellon University, and the author of "A History of the Federal Reserve" (Chicago, 2003 and 2010

My Man

2010-01-07T03:59:00.000-08:00

Nouriel Roubini Parties At Roman Abramovich's Mansion With Gwen Stefani, Ron Perelman, And Lots Of Ladies

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China´s social bomb

2009-12-22T08:42:00.000-08:00

BBC News - Social unrest 'on the rise' in China

Social unrest 'on the rise' in China
By Shirong Chen
BBC News China analyst

Burned out bus in Urumqi, China 6/7/09
Large-scale violence, like Urumqi's riots, have spread in 2009

Social unrest is on the rise in China, according to an analysis by a Chinese think-tank.

The country is grappling with more acute social problems than ever before, according to a report from the Chinese Academy of Social Sciences.

Crime is also up, despite a nationwide campaign to shore up social stability.

Although continued economic growth has provided a greater number of jobs, China has seen more social conflict in 2009 than before.

The report on China's social trends sounds a stark warning to policy makers.

The authors believe deep resentment has been accumulating over the past few decades against unfairness and power abuses by government officials at various levels.

They quote six large-scale popular protests - from taxi strikes to unrest in central China in June - involving tens of thousands of people.

This does not include the rioting in the north-western region of Xinjiang, where nearly 200 people were killed in early July.

Urban-rural gap

There has been more crime too - official figures for January to October 2009 show more than four million recorded criminal cases, an increase of about 15% above last year.

The report admits some of China's policies have prevented more people from sharing the benefits of the economic development.

The urban-rural income gap, for example, has become even bigger and the country's phenomenal GDP growth has been achieved at the expense of the rural population, the environment and overall social cohesion.

The report is a damning indictment on the authorities' slogan of building a harmonious society.

But there is one ray of hope in the report - while the Chinese authorities are taking tighter control over the media, people are turning more and more to the internet to expose official failings and abuses.

In the past 12 months, nearly a third of the top stories originated from the internet, pushing the boundaries of press freedo

UKs drama

2009-12-16T03:46:00.000-08:00

FT.com / Columnists / Martin Wolf - Britain’s dismal choice: sharing the losses

Britain’s dismal choice: sharing the losses

By Martin Wolf

Published: December 15 2009 22:11 | Last updated: December 15 2009 22:11

The UK is poorer than it thought it was. This is the most important fact about the crisis. The struggle over the distribution of the losses is going to be brutal. It will be made more so by the second most important fact about the crisis: it has had a huge effect on the public finances. The deficits are unmatched in peacetime.

Happily, the general election would appear to offer a golden opportunity for a debate. Is that not the discussion the country ought to have? Yes. Is it the discussion it is going to have? No. What the government would do if re-elected remains, even after the pre-Budget report, “a riddle, wrapped in a mystery, inside an enigma”, as Churchill said of Stalin’s Russia.

On the Treasury’s current forecasts, the economy will regain 2008 levels of economic activity in 2012. Four years of expected growth would have vanished. In last week’s pre-Budget report, the Treasury forecast growth of 1.25 per cent next year, 3.5 per cent in 2011 and 2012, then 3.25 per cent in 2013 and 2014. Suppose that growth were to continue at 3.25 per cent a year thereafter. It would still take until 2031 before the economy was as big as it would have been if the 1998-2007 trend had continued. The cumulative loss of output would be 160 per cent of 2007 gross domestic product. If growth after 2014 were at the pre-2008 trend rate, lost GDP would be almost three times 2007 GDP by 2030 (see chart). It is easy to imagine worse possibilities.

These losses in output have had a severe impact on the public finances. Indeed, the fiscal deterioration in the UK has been far bigger than in any other member of the Group of Seven leading high-income countries.

The proximate explanation has been the collapse in government revenues. Between the 2008 Budget and the 2009 pre-Budget report, the forecast of total spending for this financial year has risen by just 4.4 per cent. The forecast of nominal GDP has indeed fallen by 9.1 per cent. But the forecast of revenue has collapsed by 18.1 per cent.

Yet the UK’s recession has not been more severe than that of other high-income countries. As Alistair Darling, the chancellor of the exchequer, noted in his speech on the pre-Budget report, the cumulative contraction in this recession, up to the third quarter of 2009, has been 3.2 per cent in the US, 5.6 per cent in Germany, 5.9 per cent in Italy, 7.7 per cent in Japan and only 4.75 per cent in the UK. The reason this not particularly dramatic decline in output, by the standards of this “Great Recession”, has had an exceptionally big impact on revenues is that, in the UK, the financial sector played a huge role in supporting consumer expenditure, property transactions and corporate profits. No less than a quarter of corporate taxation came from the financial sector alone. Receipts from corporate taxes fell by 26 per cent between the 12 months to October 2008 and the 12 months to October 2009. Receipts from value added tax fell by 17 per cent over the same period. Over and above the general effect of the recession, this is, to a significant extent, a result of the vulnerability of the UK economy to the disruption in credit and collapse in profits of financial businesses.

What does this imply for the UK’s future? A good way of thinking about this question is that the UK has not only had a financial crisis, with the usual severe impact on output and the public finances, but that the UK has also been a “monocrop” economy, with finance itself acting as the “crop”.

Countries that depend heavily on output and exports of commodities whose markets are volatile are all too familiar with the cycles these can create. In booms, export revenues and government revenues are buoyant, the real exchange rate appreciates and marginal producers of tradeable goods and services are squeezed out – a fate sometimes known as the “Dutch disease” after the impact of discoveries of natural gas on the economy of the Netherlands. Often, both government and the private sector borrow heavily in these good times. Then comes the crash: exports and government revenues collapse, fiscal deficits explode, the exchange rate falls and, quite often, inflation surges and the government defaults.

The biggest mistake one can make in macroeconomics is to confuse the cycle with the trend. In monocrop economies, the danger is particularly big, because cycles can be so large. This, in retrospect, is the mistake the UK made. Thus, the Treasury has decided that the UK’s potential output suddenly fell by 5 per cent during this crisis. This is nonsense, as Robert Chote, director of the Institute for Fiscal Studies, has suggested. What the Treasury used to consider sustainable output was, instead, the product of the bubble in the UK’s monocrop financial sector, spread, directly and indirectly, to the economy and the public finances.

If this view is right, it has three painful implications: first, properly measured fiscal policy was far looser than was thought during much of Gordon Brown’s period as chancellor; second, it is likely that the UK will suffer not only from a permanent loss of output, but also a permanent decline in the trend rate of economic growth; and, third, a huge fiscal tightening cannot be avoided.

At present, the government envisages a structural fiscal tightening of 5.4 per cent of GDP over two parliamentary terms, much of it unspecified (see chart). It now expects that a third of this will be achieved through higher taxes and two-thirds through cuts in spending. To make this credible, it envisages a fiscal consolidation plan that would, in some incomprehensible manner, be legally binding. Would a defaulting chancellor be taken to the Tower of London? But the problem with the plans is not only that they are barely credible, but also that the envisaged tightening is probably too little and the final level of public sector net debt, at around 60 per cent of GDP, too high for comfort, given the likelihood of further adverse shocks. Even so, cuts in spending are larger than in similar episodes in the postwar period.

While the chancellor has presented overall numbers, he has shied away from exploring the full implications and, still more, the nature of the choices the country faces. This is the debate the UK must have. It must start from a realisation: the country is poorer than was thought. So how should these losses be shared in ways that minimise both the harm done to vulnerable people now and to the country’s economic prospects for the longer term? Those are the big questions in UK politics. Serious politicians must not duck them.

Inflation, yes inflation

2009-12-11T05:59:00.000-08:00

Paper Probes Fed Nightmare — Inflating Away U.S. Debt - Real Time Economics - WSJ

Paper Probes Fed Nightmare — Inflating Away U.S. Debt
By Michael S. Derby

While it may be the stuff of nightmares for central bankers and dollar defenders, a new paper describes how the U.S. could use inflation to reduce the burden of record-high and rising government debt.

The research, published by the National Bureau of Economic Research, is based on a historical look at the interplay between rising prices and government debt burdens. It’s an issue sure to strike a few nerves, as the U.S. government’s debt moves to 50% of the nation’s gross domestic product, amid fears it could rise to 100% within the next decade.

What may lie ahead evokes the experience of the years right after World War II, when the U.S. debt burden did breach 100% of GDP. Much of that weight was taken off the nation by way of inflation. If back then, the U.S. could ride rising price pressures to make its problem go away, then why not now?

To be sure, the paper, which was written by economists Joshua Aizenman and Nancy Marion, isn’t advocating that the U.S. pursue a particular policy path. Federal Reserve officials, for their part, have been worrying in public about what they see as an unsustainable path of long-term government deficits. They believe those deficits could end a multi-year stretch of decidedly low inflation levels.

Others worry for different reasons. Some fear that inflating the nation’s debt away is the path of least resistance for political leaders who can’t make the hard choices on taxation and spending. The paper notes that “inflation reduced the 1946 debt/GDP ratio by almost 40% within a decade” as a sign of the temptation the strategy represents. In any case, there is widespread agreement that the current fiscal outlook is a grim one, even as short-term economic realities make increased government spending logical and welcome.

For those who detest inflation–and that’s most economists and policy makers–the bad news comes first. The paper says a review of the U.S. experience since World War II shows “eroding the debt through inflation is not farfetched.” If the U.S. now had inflation levels of 6%, it could grind the U.S. debt-to-GDP burden down by a meaty 20% in a mere four years. The paper notes that this level of inflation isn’t that far off the average level of price pressures seen since 1945.

It’s even possible that a stillborn recovery could do some of the work. “When economic growth is stalled, the U.S. debt overhang may trigger an increase in inflation of about 5% for several years,” and that “would significantly reduce the debt ratio,” the paper says.

There are notable differences between now and the immediate post-war period. Whereas the average maturity of U.S. debt is now shorter and much more of it is held overseas, in the wake of the war the debt maturity was longer and nearly all was in domestic hands, the paper notes. That said, the two periods both feature “a large debt overhang and low inflation” and that together increases “the temptation to erode the debt burden through inflation.”

But there are also reasons why trying to inflate the debt away might not be viable now. The research says the balance between who holds the debt and its maturity is important. Whereas the fact that more foreigners hold government debt can make it more attractive to inflate your way to a lower debt burden, the shorter maturity of the debt makes it a more expensive proposition over the longer run to do it.

Ultimately, it’s a risky strategy, the paper warns. It notes that there is a decent chance that “modest” inflation can give way to the double-digit percentage inflation that is painful to contain. In the current environment, the U.S. would also run the chance of making foreign creditors angry, and it could also exacerbate the move away from the dollar as the world’s chief reserve currency.

The end of America

2009-12-03T05:39:00.000-08:00

Elizabeth Warren: America Without a Middle Class

Can you imagine an America without a strong middle class? If you can, would it still be America as we know it?

Today, one in five Americans is unemployed, underemployed or just plain out of work. One in nine families can't make the minimum payment on their credit cards. One in eight mortgages is in default or foreclosure. One in eight Americans is on food stamps. More than 120,000 families are filing for bankruptcy every month. The economic crisis has wiped more than $5 trillion from pensions and savings, has left family balance sheets upside down, and threatens to put ten million homeowners out on the street.

Families have survived the ups and downs of economic booms and busts for a long time, but the fall-behind during the busts has gotten worse while the surge-ahead during the booms has stalled out. In the boom of the 1960s, for example, median family income jumped by 33% (adjusted for inflation). But the boom of the 2000s resulted in an almost-imperceptible 1.6% increase for the typical family. While Wall Street executives and others who owned lots of stock celebrated how good the recovery was for them, middle class families were left empty-handed.

The crisis facing the middle class started more than a generation ago. Even as productivity rose, the wages of the average fully-employed male have been flat since the 1970s.

2009-12-03-warren12.jpg

But core expenses kept going up. By the early 2000s, families were spending twice as much (adjusted for inflation) on mortgages than they did a generation ago -- for a house that was, on average, only ten percent bigger and 25 years older. They also had to pay twice as much to hang on to their health insurance.

To cope, millions of families put a second parent into the workforce. But higher housing and medical costs combined with new expenses for child care, the costs of a second car to get to work and higher taxes combined to squeeze families even harder. Even with two incomes, they tightened their belts. Families today spend less than they did a generation ago on food, clothing, furniture, appliances, and other flexible purchases -- but it hasn't been enough to save them. Today's families have spent all their income, have spent all their savings, and have gone into debt to pay for college, to cover serious medical problems, and just to stay afloat a little while longer.
2009-12-03-warren34.jpg

Through it all, families never asked for a handout from anyone, especially Washington. They were left to go on their own, working harder, squeezing nickels, and taking care of themselves. But their economic boats have been taking on water for years, and now the crisis has swamped millions of middle class families.

The contrast with the big banks could not be sharper. While the middle class has been caught in an economic vise, the financial industry that was supposed to serve them has prospered at their expense. Consumer banking -- selling debt to middle class families -- has been a gold mine. Boring banking has given way to creative banking, and the industry has generated tens of billions of dollars annually in fees made possible by deceptive and dangerous terms buried in the fine print of opaque, incomprehensible, and largely unregulated contracts.

And when various forms of this creative banking triggered economic crisis, the banks went to Washington for a handout. All the while, top executives kept their jobs and retained their bonuses. Even though the tax dollars that supported the bailout came largely from middle class families -- from people already working hard to make ends meet -- the beneficiaries of those tax dollars are now lobbying Congress to preserve the rules that had let those huge banks feast off the middle class.

Pundits talk about "populist rage" as a way to trivialize the anger and fear coursing through the middle class. But they have it wrong. Families understand with crystalline clarity that the rules they have played by are not the same rules that govern Wall Street. They understand that no American family is "too big to fail." They recognize that business models have shifted and that big banks are pulling out all the stops to squeeze families and boost revenues. They understand that their economic security is under assault and that leaving consumer debt effectively unregulated does not work.

Families are ready for change. According to polls, large majorities of Americans have welcomed the Obama Administration's proposal for a new Consumer Financial Protection Agency (CFPA). The CFPA would be answerable to consumers -- not to banks and not to Wall Street. The agency would have the power to end tricks-and-traps pricing and to start leveling the playing field so that consumers have the tools they need to compare prices and manage their money. The response of the big banks has been to swing into action against the Agency, fighting with all their lobbying might to keep business-as-usual. They are pulling out all the stops to kill the agency before it is born. And if those practices crush millions more families, who cares -- so long as the profits stay high and the bonuses keep coming.

America today has plenty of rich and super-rich. But it has far more families who did all the right things, but who still have no real security. Going to college and finding a good job no longer guarantee economic safety. Paying for a child's education and setting aside enough for a decent retirement have become distant dreams. Tens of millions of once-secure middle class families now live paycheck to paycheck, watching as their debts pile up and worrying about whether a pink slip or a bad diagnosis will send them hurtling over an economic cliff.

America without a strong middle class? Unthinkable, but the once-solid foundation is shaking.

Elizabeth Warren is the Leo Gottlieb Professor of Law at Harvard and is currently the Chair of the Congressional Oversight Panel.

Dollar

2009-11-30T04:20:00.000-08:00

FT.com / Comment / Opinion - We must get ready for a weak-dollar world

We must get ready for a weak-dollar world

By Jeffrey Garten

Published: November 29 2009 20:02 | Last updated: November 29 2009 20:02

The two most significant structural consequences of the recent financial debacle are the massive deficits and debts of the US and the shift of economic power from west to east. There is only one effective way for governments to address the combined impact of both: press for a sea change in currency relationships, especially a permanently and greatly weakened dollar.

The roots of this situation are well known. The American budget deficit of this past fiscal year reached 10 per cent of gross domestic product, the largest since the aftermath of the second world war. Meanwhile, the net external debt of the US nearly tripled last year to $3,500bn and it is projected to increase by nearly $1,000bn every year for the next decade. All this underestimates the problems of a country where unfunded liabilities for baby boomer entitlements are in the stratosphere, infrastructure deterioration is scandalous and many large states are out of money. To close the gaps, taxes would have to be raised to sky-high levels and spending brutally slashed. It would take a miracle if America’s political system – one rife with vicious partisanship and riddled with well-financed special interests – could do either, let alone both.

Washington will therefore have little choice but to take the time-honoured course for big-time debtors: print more dollars, devalue the currency and service debt in ever cheaper greenbacks. In other words, the US will have to camouflage a slow-motion default because politically it is the easiest way out.

There is another factor pushing America towards a weaker dollar: lacking the domestic consumer demand that came with the unrestrained credit of the past 15 years, the US is desperate to find buyers abroad, especially in emerging markets where the middle class is growing and infrastructure requirements are soaring. A cheaper dollar could make US products and services more competitive.

Meanwhile, in the coming decade, the big emerging markets of Asia will be growing twice as fast as the US and three times faster than the European Union. By 2020, China, India, Indonesia, Korea and Vietnam together could generate more wealth than the the US, Japan and the EU combined. China, India, and South Korea have all been amassing dollar reserves and will be looking to reduce them. While imports into leading industrial countries have slowed, intra-Asian trade is booming and need not be financed only in dollars. The bottom line: Asian currencies are likely to strengthen against the dollar.

A much cheaper dollar is a sad development for the US, even though it is inevitable. It will make the US poorer, since Americans will pay higher prices for everything they buy from abroad – clothes, computers, cars, toys, food, you name it. It will make the US military presence abroad more expensive, since the cost of contractors and local suppliers will escalate in dollar terms. It will slow imports, removing competition that is essential to hold down the general price level in America, thereby making inflation more likely. It will send the wrong price signals for a country that prides itself on creating sophisticated, highly valuable products, for a low dollar will encourage producers to compete on price more than quality. It will diminish the political influence and prestige that the US has had while the dollar has been king.

Moreover, the US dollar has been at the heart of the global economy for well over half a century. Its demise, if not smooth and gradual – hardly certain – could lead to an era of competitive devaluations and other mercantilist trade policies.

An alternative to a global monetary system that has been centred on the dollar is now imperative. That means a multi-currency framework including the euro, the yen, the renminbi and significant issuance of an IMF-backed currency called “special drawing rights”. This regime will take time to devise, but it should start now.

That is why Tim Geithner, US Treasury secretary, should invite his colleagues in the UK, eurozone, Japan and China to meet secretly, perhaps between Christmas and New Year, to start discussions out of the public spotlight (to avoid spooking markets). The big question: what kind of monetary system will best serve the world given deep-seated changes in the balance of economic power, and what process can be followed to develop it?

Since the late 1980s I have believed that a strong dollar was in the US and world interest. Now, however, the context has fundamentally changed. The issue is no longer whether the dollar is in long-term decline but which of two options will be taken. Should Washington and other capitals calmly and deliberately manage the transition to a new era, or, by default, should they let the market do it, with the risk of massive financial disturbances. Today, governments have a choice. Soon they may not.

The writer is the Juan Trippe professor of international trade and finance at theYale School of Management

Goodbye America

2009-11-30T04:17:00.000-08:00

An Empire at Risk | Print Article | Newsweek.com

An Empire at Risk
We won the cold war and weathered 9/11. But now economic weakness is endangering our global power.

By Niall Ferguson | NEWSWEEK

Published Nov 28, 2009

From the magazine issue dated Dec 7, 2009

Call it the fractal geometry of fiscal crisis. If you fly across the Atlantic on a clear day, you can look down and see the same phenomenon but on four entirely different scales. At one extreme there is tiny Iceland. Then there is little Ireland, followed by medium-size Britain. They're all a good deal smaller than the mighty United States. But in each case the economic crisis has taken the same form: a massive banking crisis, followed by an equally massive fiscal crisis as the government stepped in to bail out the private financial system.

Size matters, of course. For the smaller countries, the financial losses arising from this crisis are a great deal larger in relation to their gross domestic product than they are for the United States. Yet the stakes are higher in the American case. In the great scheme of things—let's be frank—it does not matter much if Iceland teeters on the brink of fiscal collapse, or Ireland, for that matter. The locals suffer, but the world goes on much as usual.

But if the United States succumbs to a fiscal crisis, as an increasing number of economic experts fear it may, then the entire balance of global economic power could shift. Military experts talk as if the president's decision about whether to send an additional 40,000 troops to Afghanistan is a make-or-break moment. In reality, his indecision about the deficit could matter much more for the country's long-term national security. Call the United States what you like—superpower, hegemon, or empire—but its ability to manage its finances is closely tied to its ability to remain the predominant global military power. Here's why.

The disciples of John Maynard Keynes argue that increasing the federal debt by roughly a third was necessary to avoid Depression 2.0. Well, maybe, though some would say the benefits of fiscal stimulus have been oversold and that the magic multiplier (which is supposed to transform $1 of government spending into a lot more than $1 of aggregate demand) is trivially small.

Credit where it's due. The positive number for third-quarter growth in the United States would have been a lot lower without government spending. Between half and two thirds of the real increase in gross domestic product was attributable to government programs, especially the Cash for Clunkers scheme and the subsidy to first-time home buyers. But we are still a very long way from a self--sustaining recovery. The third-quarter growth number has just been revised downward from 3.5 percent to 2.8 percent. And that's not wholly surprising. Remember, what makes a stimulus actually work is the change in borrowing by the whole public sector. Since the federal government was already running deficits, and since the states are actually raising taxes and cutting spending, the actual size of the stimulus is closer to 4 percent of GDP spread over the years 2007 to 2010—a lot less than that headline 11.2 percent deficit.

Meanwhile, let's consider the cost of this muted stimulus. The deficit for the fiscal year 2009 came in at more than $1.4 trillion—about 11.2 percent of GDP, according to the Congressional Budget Office (CBO). That's a bigger deficit than any seen in the past 60 years—only slightly larger in relative terms than the deficit in 1942. We are, it seems, having the fiscal policy of a world war, without the war. Yes, I know, the United States is at war in Afghanistan and still has a significant contingent of troops in Iraq. But these are trivial conflicts compared with the world wars, and their contribution to the gathering fiscal storm has in fact been quite modest (little more than 1.8 percent of GDP, even if you accept the estimated cumulative cost of $3.2 trillion published by Columbia economist Joseph Stiglitz in February 2008).

And that $1.4 trillion is just for starters. According to the CBO's most recent projections, the federal deficit will decline from 11.2 percent of GDP this year to 9.6 percent in 2010, 6.1 percent in 2011, and 3.7 percent in 2012. After that it will stay above 3 percent for the foreseeable future. Meanwhile, in dollar terms, the total debt held by the public (excluding government agencies, but including foreigners) rises from $5.8 trillion in 2008 to $14.3 trillion in 2019—from 41 percent of GDP to 68 percent.

In other words, there is no end in sight to the borrowing binge. Unless entitlements are cut or taxes are raised, there will never be another balanced budget. Let's assume I live another 30 years and follow my grandfathers to the grave at about 75. By 2039, when I shuffle off this mortal coil, the federal debt held by the public will have reached 91 percent of GDP, according to the CBO's extended baseline projections. Nothing to worry about, retort -deficit-loving economists like Paul Krugman. In 1945, the figure was 113 percent.

Well, let's leave aside the likely huge differences between the United States in 1945 and in 2039. Consider the simple fact that under the CBO's alternative (i.e., more pessimistic) fiscal scenario, the debt could hit 215 percent by 2039. That's right: more than double the annual output of the entire U.S. economy.

Forecasting anything that far ahead is not about predicting the future. Everything hinges on the assumptions you make about demographics, Medicare costs, and a bunch of other variables. For example, the CBO assumes an average annual real GDP growth rate of 2.3 percent over the next 30 years. The point is to show the implications of the current chronic imbalance between federal spending and federal revenue. And the implication is clear. Under no plausible scenario does the debt burden decline. Under one of two plausible scenarios it explodes by a factor of nearly five in relation to economic output.

Another way of doing this kind of exercise is to calculate the net present value of the unfunded liabilities of the Social Security and Medicare systems. One recent estimate puts them at about $104 trillion, 10 times the stated federal debt.

No sweat, reply the Keynesians. We can easily finance $1 trillion a year of new government debt. Just look at the way Japan's households and financial institutions funded the explosion of Japanese public debt (up to 200 percent of GDP) during the two "lost decades" of near-zero growth that began in 1990.

Unfortunately for this argument, the evidence to support it is lacking. American households were, in fact, net sellers of Treasuries in the second quarter of 2009, and on a massive scale. Purchases by mutual funds were modest ($142 billion), while purchases by pension funds and insurance companies were trivial ($12 billion and $10 billion, respectively). The key, therefore, becomes the banks. Currently, according to the Bridgewater hedge fund, U.S. banks' asset allocation to government bonds is about 13 percent, which is relatively low by historical standards. If they raised that proportion back to where it was in the early 1990s, it's conceivable they could absorb "about $250 billion a year of government bond purchases." But that's a big "if." Data for October showed commercial banks selling Treasuries.

That just leaves two potential buyers: the Federal Reserve, which bought the bulk of Treasuries issued in the second quarter; and foreigners, who bought $380 billion. Morgan Stanley's analysts have crunched the numbers and concluded that, in the year ending June 2010, there could be a shortfall in demand on the order of $598 billion—about a third of projected new issuance.

Of course, our friends in Beijing could ride to the rescue by increasing their already vast holdings of U.S. government debt. For the past five years or so, they have been amassing dollar--denominated international reserves in a wholly unprecedented way, mainly as a result of their interventions to prevent the Chinese currency from appreciating against the dollar.

Right now, the People's Republic of China holds about 13 percent of U.S. government bonds and notes in public hands. At the peak of this process of reserve accumulation, back in 2007, it was absorbing as much as 75 percent of monthly Treasury issuance.

But there's no such thing as a free lunch in the realm of international finance. According to Fred Bergsten of the Peterson Institute for International Economics, if this trend were to continue, the U.S. -current-account deficit could rise to 15 percent of GDP by 2030, and its net debt to the rest of the world could hit 140 percent of GDP. In such a scenario, the U.S. would have to pay as much as 7 percent of GDP every year to foreigners to service its external borrowings.

Could that happen? I doubt it. For one thing, the Chinese keep grumbling that they have far too many Treasuries already. For another, a significant dollar depreciation seems more probable, since the United States is in the lucky position of being able to borrow in its own currency, which it reserves the right to print in any quantity the Federal Reserve chooses.

Now, who said the following? "My prediction is that politicians will eventually be tempted to resolve the [fiscal] crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt. And as that temptation becomes obvious, interest rates will soar."

Seems pretty reasonable to me. The surprising thing is that this was none other than Paul Krugman, the high priest of Keynesianism, writing back in March 2003. A year and a half later he was comparing the U.S. deficit with Argentina's (at a time when it was 4.5 percent of GDP). Has the economic situation really changed so drastically that now the same Krugman believes it was "deficits that saved us," and wants to see an even larger deficit next year? Perhaps. But it might just be that the party in power has changed.

History strongly supports the proposition that major financial crises are followed by major fiscal crises. "On average," write Carmen Reinhart and Kenneth Rogoff in their new book, This Time Is Different, "government debt rises by 86 percent during the three years following a banking crisis." In the wake of these debt explosions, one of two things can happen: either a default, usually when the debt is in a foreign currency, or a bout of high inflation that catches the creditors out. The history of all the great European empires is replete with such episodes. Indeed, serial default and high inflation have tended to be the surest symptoms of imperial decline.

As the U.S. is unlikely to default on its debt, since it's all in dollars, the key question, therefore, is whether we are going to see the Fed "printing money"—buying newly minted Treasuries in exchange for even more newly minted greenbacks—followed by the familiar story of rising prices and declining real-debt burdens. It's a scenario many investors around the world fear. That is why they are selling dollars. That is why they are buying gold.

Yet from where I am sitting, inflation is a pretty remote prospect. With U.S. unemployment above 10 percent, labor unions relatively weak, and huge quantities of unused capacity in global manufacturing, there are none of the pressures that made for stagflation (low growth plus high prices) in the 1970s. Public expectations of inflation are also very stable, as far as can be judged from poll data and the difference between the yields on regular and inflation-protected bonds.

So here's another scenario—which in many ways is worse than the inflation scenario. What happens is that we get a rise in the real interest rate, which is the actual interest rate minus inflation. According to a substantial amount of empirical research by economists, including Peter Orszag (now at the Office of Management and Budget), significant increases in the debt-to-GDP ratio tend to increase the real interest rate. One recent study concluded that "a 20 percentage point increase in the U.S. government-debt-to-GDP ratio should lead to a 20–120 basis points [0.2–1.2 percent] increase in real interest rates." This can happen in one of three ways: the nominal interest rate rises and inflation stays the same; the nominal rate stays the same and inflation falls; or—the nightmare case—the nominal interest rate rises and inflation falls.

Today's Keynesians deny that this can happen. But the historical evidence is against them. There are a number of past cases (e.g., France in the 1930s) when nominal rates have risen even at a time of deflation. What's more, it seems to be happening in Japan right now. Just last week Hirohisa Fujii, Japan's new finance minister, admitted that he was "highly concerned" about the recent rise in Japanese government bond yields. In the very same week, the government admitted that Japan was back in deflation after three years of modest price increases.

It's not inconceivable that something similar could happen to the United States. Foreign investors might ask for a higher nominal return on U.S. Treasuries to compensate them for the weakening dollar. And inflation might continue to surprise us on the downside. After all, consumer price inflation is in negative territory right now.

Why should we fear rising real interest rates ahead of inflation? The answer is that for a heavily indebted government and an even more heavily indebted public, they mean an increasingly heavy debt-service burden. The relatively short duration (maturity) of most of these debts means that a large share has to be rolled over each year. That means any rise in rates would feed through the system scarily fast.

Already, the federal government's interest payments are forecast by the CBO to rise from 8 percent of revenues in 2009 to 17 percent by 2019, even if rates stay low and growth resumes. If rates rise even slightly and the economy flatlines, we'll get to 20 percent much sooner. And history suggests that once you are spending as much as a fifth of your revenues on debt service, you have a problem. It's all too easy to find yourself in a vicious circle of diminishing credibility. The investors don't believe you can afford your debts, so they charge higher interest, which makes your position even worse.

This matters more for a superpower than for a small Atlantic island for one very simple reason. As interest payments eat into the budget, something has to give—and that something is nearly always defense expenditure. According to the CBO, a significant decline in the relative share of national security in the federal budget is already baked into the cake. On the Pentagon's present plan, defense spending is set to fall from above 4 percent now to 3.2 percent of GDP in 2015 and to 2.6 percent of GDP by 2028.

Over the longer run, to my own estimated departure date of 2039, spending on health care rises from 16 percent to 33 percent of GDP (some of the money presumably is going to keep me from expiring even sooner). But spending on everything other than health, Social Security, and interest payments drops from 12 percent to 8.4 percent.

This is how empires decline. It begins with a debt explosion. It ends with an inexorable reduction in the resources available for the Army, Navy, and Air Force. Which is why voters are right to worry about America's debt crisis. According to a recent Rasmussen report, 42 percent of Americans now say that cutting the deficit in half by the end of the president's first term should be the administration's most important task—significantly more than the 24 percent who see health-care reform as the No. 1 priority. But cutting the deficit in half is simply not enough. If the United States doesn't come up soon with a credible plan to restore the federal budget to balance over the next five to 10 years, the danger is very real that a debt crisis could lead to a major weakening of American power.

The precedents are certainly there. Habsburg Spain defaulted on all or part of its debt 14 times between 1557 and 1696 and also succumbed to inflation due to a surfeit of New World silver. Prerevolutionary France was spending 62 percent of royal revenue on debt service by 1788. The Ottoman Empire went the same way: interest payments and amortization rose from 15 percent of the budget in 1860 to 50 percent in 1875. And don't forget the last great English-speaking empire. By the interwar years, interest payments were consuming 44 percent of the British budget, making it intensely difficult to rearm in the face of a new German threat.

Call it the fatal arithmetic of imperial decline. Without radical fiscal reform, it could apply to America next.

Ferguson is Laurence A. Tisch professor of history at Harvard and the author of The Ascent of Money.

Correction

2009-11-27T05:45:00.000-08:00

Dubai Crisis Means ‘Correction’ to Mobius, Risk Aversion to Das - Bloomberg.com

Dubai Crisis Means ‘Correction’ to Mobius, Risk Aversion to Das

The yuan is coming

2009-11-24T06:43:00.000-08:00

Project Syndicate - The Irresistible Rise of the Renminbi

Chinese officials have targeted 2020 as the date by which both Beijing and Shanghai should become leading international financial centers, with deep and liquid financial markets open to the rest of the world. By implication, that is the date by which they want to see the renminbi become a leading international currency.

Can the renminbi become a major international currency in as little as a decade? Only time will tell. But US history suggests that this schedule, while ambitious, is not impossible.

Decline but not fall?

2009-11-13T06:49:00.000-08:00

FT.com / Comment / Analysis - Decline but no fall

Decline but no fall

By John Plender

Published: November 11 2009 19:55 | Last updated: November 11 2009
As US president Barack Obama begins a tour of Asian capitals, the standard assumption in the west is that his meetings will be with leaders of nations that rank as America’s junior partners. Yet the reality is more complex. Amid the rubble of the financial crisis, the US position as singular superpower and global economic top dog looks increasingly under threat.

In particular, when he reaches Beijing next week, nothing will be able to disguise the fact that Mr Obama is paying a visit to his country’s biggest creditor.

Those who take pleasure in America’s discomfort point out that this global economic colossus has become shackled to the world’s largest pile of international debt and pulled down by a sinking currency. By common consent China is the chief beneficiary of the financial debacle and a serious challenger to US hegemony.

Since economic might so often goes hand in hand with military strength, this shift in economic power, along with the recent weakness of the dollar, has been heralded as a harbinger of US national decline. Neatly catching this mood was the title of Fareed Zakaria’s recent best-selling book, The Post-American World And The Rise Of The Rest. Then came Mr Obama’s reference in his inaugural speech to “a sapping of confidence across our land; a nagging fear that America’s decline is inevitable, that the next generation must lower its sights”.

Paul Volcker, former chairman of the Federal Reserve and an adviser to the president, chipped in with remarks in a recent interview with PBS, the US public broadcaster, that the rise of emerging markets was “symbolic of the relative, less dominant position the US has, not just in the economy but in leadership, intellectual and otherwise”.

Central banks in the developing countries have rubbed salt in the wounds of the ailing giant. The Reserve Bank of India last week joined the central banks of China, Russia, Mexico and the Philippines in choosing to boost its reserves of gold in preference to dollar-denominated securities. A veritable chorus of policymakers in countries running current account surpluses has declared that the reserve currency role of the dollar is unsustainable.

At which point, it is important to remember that we have been here before. Back in the late 1980s, Paul Kennedy of Yale University stunned the world’s chattering classes with his assertion in The Rise And Fall Of The Great Powers that “the only answer to the question increasingly debated by the public of whether the United States can preserve its existing position is ‘no’.”

This downbeat verdict came around the time of the 1987 stock market crash, when there was continuing concern about the twin US budget and current account deficits. The country had become an international debtor for the first time and was increasingly dependent on European and Japanese capital inflows. A supremely confident Japan was in the ascendant. Declinist sentiment in the US came close to hysterical when Japanese companies snapped up New York’s Rockefeller Center, Columbia Pictures in Hollywood and Pebble Beach golf course in California. “Who owns America?” demanded ABC News.

In one sense Prof Kennedy’s thesis was right. As China, India and the other emerging markets catch up with the developed world, the US is bound to suffer relative economic decline in the shape of a falling share of global gross domestic product, even as it grows faster than most of the developed world’s larger economies and remains the world’s biggest economy in absolute terms.

Globalisation and domestic liberalisation have given these developing countries the chance to establish a share of global GDP commensurate with their size and history. Chinese economic performance before 1978 was, after all, an aberration viewed from the perspective of centuries.

In a study of leading economies, Angus Maddison of the University of Groningen has calculated that China’s share of global GDP in 1820, before the industrial revolution in Europe gathered pace, was more than 30 per cent, which is well above the US’s current share. A return to something more normal may thus be under way.

Where the Kennedy thesis appeared wide of the mark was in suggesting the US was seriously at risk of imperial overstretch, as with Spain in 1600 or Britain in 1900. The more obvious case of overstretch in the 1980s was in fact the Soviet Union, which collapsed, while the US succeeded soon after in restoring its budgetary position under the Clinton presidency without a full-scale retreat from its international commitments.

The Japanese economic challenge, meantime, wilted as equity and property bubbles burst and deflation threatened. The US media’s panic over the Japanese invasion proved a perfect, if inadvertent, indicator of a turning point.

The question now is whether the overstretch thesis was wrong or simply premature. Yet predicting the timing of the rise and fall of nations and economies is notoriously difficult. Charles Kindleberger, the late economic historian, was one of many who believed that national vitality moved in a life cycle. Among the internal causes of decline he identified were increased consumption, decreased savings, resistance to taxation, inequality, corruption, mounting debt and finance becoming more dominant in the economy than industry.

Yet if this chimes with current circumstances, note that many of these things were also present in the US in 1929 when an earlier financial crisis coincided with the long transition from British to American economic hegemony. When Kindleberger wrote his World Economic Primacy 1500-1990 in 1996, he believed the US was slipping. But he had no idea which country was likely to emerge as the next primary world economic power and regarded China as merely a dark horse for the role.

The most powerful argument supporting the declinist hypothesis concerns what Prof Kennedy called “the age-old task of relating national means to national ends”. Since there is a significant long-term correlation between productive and revenue raising capacity, and military strength, much hinges on the sustainability of fiscal policy. Here the omens are not good for the US.

Under the twin pressures of the financial crisis and the longer-term problem of ageing baby boomers, official projections point to budget deficits on an unprecedented scale. The Peterson Institute for International Economics in Washington estimates that after nearing $1,500bn (€1,000bn, £905bn) in the current fiscal year – more than three times the previous record – the deficit is likely to remain close to an annual $1,000bn until 2020 or later.

Looked at from the perspective of the flow of funds in the economy, the counterpart to these deficits will largely be found on the current account of the balance of payments. Here the institute reckons the current account deficit could rise from a previous record of 6 per cent of GDP to an awesome 15 per cent or more by 2030, equivalent to more than $5,000bn annually. It expects net external debt to rise from $3,500bn today to as much as $50,000bn, or 140 per cent of GDP, over the same period.

Such figures pose a daunting challenge for the Obama administration and a conspicuous threat to the dollar, since there is a huge overhang of dollar reserves in foreign hands. From the end of 2000 to mid-2009 the International Monetary Fund estimates that official foreign exchange reserves rose from $1,900bn to $6,800bn, of which $2,300bn is held by China alone. More than 60 per cent of these reserves are in dollars.

Recent Chinese rhetoric, including a call for the replacement of the dollar as the world’s main reserve currency by special drawing rights – an accounting unit used by the IMF in its dealing with its members – suggest a worrying loss of confidence in US monetary and fiscal policy. At the same time Fred Bergsten, the Peterson Institute’s director, argues that it is now very much in the US interest to reduce the role of the dollar and encourage a greater flow of reserves into euros, renminbi and SDRs.

Yet the threat to the dollar can be overstated. China is rattling the bars of a cage of its own making, since the reserves are a consequence of colossal intervention to stop its currency appreciating. In effect, it is trapped in the economic equivalent of the mutually assured destruction described by theorists of nuclear deterrence in the cold war. With exports amounting to two-fifths of GDP, it has been beholden to the US as borrower and spender of last resort in the global economy. And it cannot abandon the dollar without slashing the value of its own dollar reserves.

As for the potential of the Chinese currency to challenge the reserve role of the dollar, it may exist in the very long run but, in the absence of developed financial markets and a much stronger commitment to internationalise the renminbi, it remains pretty remote.

In fact, the weakest element of the declinist view of the US may be the high current estimates of the strength of the Chinese challenge. These have been elegantly punctured in a recent essay in foreign affairs by Josef Joffe, co-editor of Germany’s Die Zeit. China, he says, is a place where the rest of the world essentially rents workers and workspace at deflated prices and distorted exchange rates. Its export dependence, as well as being an economic Achilles’ heel, has political consequences. These include 70,000 civil disturbances each year that are not factored into the linear growth forecasts beloved of investment bankers.

China’s demographics are unhelpful: it will, points out Mr Joffe, grow old before it grows rich. While on Goldman Sachs’s numbers China will long have overtaken the US by 2050 with a GDP of $45,000bn compared with $35,000bn for the US, the median age in the US will by then be the lowest of any of the world’s large powers except India. Indeed, the US’s working age population will have grown by about 30 per cent, whereas China’s will have dropped 3 per cent.

Together with export dependence, this amounts to a huge challenge for Chinese policymakers in what is a very poor country. The US, meantime, still has an unmatched research and higher education establishment. And in 2008 its military budget was $607bn, representing almost half of the world’s total military spending. The military budget of China, so often touted as the next superpower, is less than one-seventh of that.

Nobody can gainsay the extraordinary achievement wrought by China in the fastest industrial revolution in human history. We are clearly moving towards a multipolar world and a multi-currency reserve system, in which US power will be more constrained. Yet the US remains the most flexible of the large economies by far. History does not, except for Marxists, move on tramlines. If US policymakers rise to the fiscal challenge and Americans bring themselves to save more, there is every chance that the country will escape meaningful decline and remain the world’s pre-eminent economic and military power for a long time yet.

That is a very big if. But for many people’s money, the next generation of Americans will not be lowering its sights any time soon.

Imperial overstretch: ‘It has not been given to any one society to remain ahead’

The theory of imperial overstretch, outlined by Paul Kennedy in The Rise and Fall of the Great Powers, asserts that if too large a proportion of the state’s resources is diverted from wealth creation into military spending, national power will be weakened over the long term. The question is whether a given state can strike a reasonable balance between perceived defence requirements and economic means.

That task becomes harder when a nation is suffering relative economic decline. Professor Kennedy argued, too, that the US could not preserve its relative position because “it simply has not been given to any one society to remain permanently ahead of all the others, because that would imply a freezing of the differentiated pattern of growth rates, technological advance, and military developments which has existed since time immemorial”.

He concluded that it was incumbent on American statesmen to recognise this broad underlying trend and to manage the country so that the relative erosion of US ascendancy took place slowly and smoothly, rather than implementing policies for short-term advantage that would be detrimental in the longer term.

This carries a notable echo of the remark by Lord Armstrong, the distinguished British mandarin, who said in the 1970s that “the business of the civil service is the orderly management of decline”.

China, though seen by many as the chief beneficiary of potential US overstretch, has already had its own experience of decline. Until the middle of the previous millennium, it was technologically more advanced than Europe with a more efficient agriculture, and its mandarin class was unrivalled in its professionalism. Even after the west overtook it in economic and technological performance between the 16th and 18th centuries, China’s economy was still the world’s biggest when the industrial revolution began.

Between 1820 and 1952, however, when Europe experienced rates of economic growth unprecedented in history, China’s output per head actually fell while its share of global gross domestic product plunged from one-third to one-twentieth. Per capita income fell from level pegging with the world to a quarter of the global average over the period*.

This dreadful performance has been attributed to several causes, including foreign colonial intervention, internal disorder and the inflexibility of the bureaucracy in the face of the challenges of the western renaissance and enlightenment.

*All figures from Chinese Economic Performance In The Long Run by Angus Maddison (OECD, 1998)

The Dollar Will Lose Its Status As A Reserve Currency

2009-11-12T17:02:00.000-08:00

The Dollar Will Lose Its Status As A Reserve Currency: "I don't think we should have a reserve currency. Well, it's led to a lot of problems in the global economy. When the dollar was backed by gold, and was redeemable by gold, it being the reserve currency was OK. But at the moment, there are no currencies backed by gold. So I think that foreign central banks should hold gold as their key reserve, and not another currency. They can also have some foreign currencies as part of their overall reserves, but I think that gold should play a much bigger role in giving value to currency.

Because remember, you can't have a monetary system without money. And money is gold. Just printing paper—there's nothing behind that. There's nothing intrinsic there. It always leads to chaos. If you can just print money at will, it has no scarcity. Then you have inflation; you have these asset bubbles; and you don't have a well-functioning global economy. Hopefully we don't anoint another reserve currency.

Peter Schiff`s comments on the economy, stock markets, politics and gold. Schiff is the renowned writer of the bestseller Crash Proof: How to Profit from the Coming Economic Collapse.

The real value of gold

2009-11-09T04:55:00.000-08:00

FT.com | Willem Buiter's Maverecon | Gold - a six thousand year-old bubble

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Gold - a six thousand year-old bubble
November 8, 2009 6:02pm

Gold is unlike any other commodity. It is costly to extract from the earth and to refine to a reasonable degree of purity. It is costly to store. It has no remaining uses as a producer good - equivalent or superior alternatives exist for all its industrial uses. It may have some value as a consumer good - somewhat surprisingly people like to attach it to their earlobes or nostrils or to hang it around their necks. I have always considered it a rather vulgar metal, made for the Saturday Night Fever crowd, all shiny and in-your-face, as opposed to the much classier silver, but de gustibus… .

The total stock of ‘above-ground’ gold is about 160,000 metric tonnes (a metric ton is 2,204 lbs. or 35,264 oz, for those of a non-decimal mind-set). About 50 percent of this existing stock of above-ground gold is kept as a pure store of value (for investment purposes), most likely somewhere below-ground, for security reasons. The other 50 percent exists as jewellery. I would argue that most of this jewellery demand is simply small-scale store of value (investment) demand by households, rather than demand driven by aesthetic considerations or other intrinsic sources of joy associated with having gold hanging from your extremities.

From a social perspective, gold held by central banks as part of their foreign exchange reserves is a barbarous relic (Keynes used the expression to refer to the Gold Standard, but close enough is close enough). The same holds for gold held idle in private vaults as a store of value. The cost and waste involved in getting the gold out of the ground only to but it back under ground in secure vaults is considerable. Mining the ore is environmentally damaging, especially if it involves open pit mining. Refining the gold causes further environmental risks. Historically, gold was extracted from its ores by using mercury, a toxic heavy metal, much of which was released into the atmosphere. Today, cyanide is used instead. While cyanide, another toxic substance, is broken down in the environment, cyanide spills (which occur regularly) can wipe out life in the affected bodies of water. Runoff from the mine or tailing piles can occur long after mining has ceased.

Even though, from a social efficiency perspective, the mining of new gold and the costly storage of existing gold for investment purposes are wasteful activities, they may be individually rational. There is no invisible hand here (or elsewhere) to ensure that the aggregation of individually rational behaviour adds up to anything desirable or sensible.

Because to a reasonable first approximation gold has no intrinsic value as a consumption good or a producer good, it is an example of what I call a fiat (physical) commodity. You will be familiar with fiat currency. Unlike what Wikipedia says on the subject, the essence of fiat money is not that it is money declared by a government to be legal tender. It need not derive its value from the government demanding it in payment of taxes or insisting it should be accepted within the national jurisdiction in settlement of debt. Instead the defining property of fiat money is that it has no intrinsic value and derives any value it has only from the shared belief by a sufficient number of economic actors that it has that value.

The “let it be done” literal meaning of the Latin ‘fiat’ should be taken in the third sense given by the Online Dictionary: 1. official sanction; authoritative permission; 2. an arbitrary order or decree; 3. Chiefly literary any command, decision, or act of will that brings something about.

The act of will in question is the collective attribution of value to something without intrinsic value. Being declared legal tender by a government may help achieving that status, but it is neither necessary nor sufficient.

Gold is very close therefore to the stone money of the Isle of Yap. This stone money, known as Rai, consists of large doughnut-shaped, carved disks, consisting usually of calcite, that can be up to 4 m (12 ft) in diameter, although most are much smaller. Apparently, the total stock of Rai cannot be augmented any further. It also depreciates very slowly. This intrinsically useless form of money in the Isle of Yap is in all essential respects equivalent to gold today in the wider world. Another example would be pet rocks, as long as the rock in question is rare and costly to get into its final shape.

Gold has become a fiat commodity or a fiat commodity currency, just as the US $, the euro, the pound sterling and the yen (and a couple of hundred other currencies) are fiat paper currencies. The main differences between them are that gold is very costly to produce, while the production of additional paper money has an extremely low marginal cost. If we count the deposits of commercial banks with the central banks, which together with currency in circulation make up the monetary base, as fiat money, then the incremental cost of fiat base money creation is zero.

The outstanding stock of physical gold, at 160,000 tonnes or thereabouts, is very large relative to the maximum amount of new gold that can be mined and refined during a year. The short-run supply curve of new gold is steep and becomes vertical at a volume of production that is small relative to the oustanding stock (annual gold production has been declining from a peak of just over 2,500 tonnes in 2001 to 2330 tonnes in 2008 - only 1.5% of the outstanding stock).[1]

The good news for gold bugs

Since gold is a fiat commodity currency, its value will be determined largely by its attractiveness relative to other fiat currencies - the fiat paper currencies issued by central banks. Gold should not be analysed as one of a set of intrinsically valuable commodities (silver, iron, lead, zinc, platinum, aluminium, titanium etc. etc.) but as part of a set of intrinsically useless and valueless fiat currencies - the US dollar, the yen, the yuan, the euro, sterling, the rupee, the rouble etc. etc.). It is therefore in times that market participants are nervous about the future value of most other fiat currencies, that gold will be at its most attractive.

Such a time is what we are going through now. Many systemically important central banks have expanded their base money stocks and balance sheets massively. The Fed has doubled the size of its balance sheet. The Bank of England has tripled the size of its balance sheet. Many central banks have bought vast amounts of public debt. In the UK, out of the initial £175 bn of quantitative easing, as much as £173 was spent on gilts. The Fed has purchased only about €300 bn worth of Treasury securities, but has acquired a much larger amount of Treasury-guaranteed agency debt.

Although in most of the overdeveloped world (except the UK), deflation is the immediate threat, there is a medium and long-term threat of much higher inflation in all countries with enlarged central bank balance sheets and the prospect of large future fiscal deficits. The great advantage to investors of gold is that, although it is not intrinsically valuable, it is very costly to increase its stock. The tap can be opened at the drop of a hat for fiat paper and electronic currency. The tap produces never more than a trickle in the case of gold.

So when fiscal incontinence threatens price stability in some of the main industrial countries (especially the US and the UK) because the central banks in these countries may be forced to monetise both the stock and large new net flows of public debt, the one fiat money whose quantity cannot be varied at will by a monetary authority will do well. We see that with gold today. We also see that, to a lesser degree, in the strength of the euro. The ECB is by far the most independent of the leading central banks. They also have a heavily asymmetric de-facto interpretation of price stability: inflation is unacceptable, deflation is OK.

So until the risk of serious inflation is removed from the medium-term outlook for the US, the UK and other fiat currencies, gold will be a relatively attractive store of value despite the cost of storing it.

The gold bug’s nightmare

An economy with fiat money can have many different equilibria. To make the point as clearly and simply as possible, consider a stationary economy. Population, endowments, technology, government spending, taxes and preferences are constant. The government budget is balanced. Prices are flexible. There is a constant stock of fiat money (which could be paper money, gold, Rai or pet rocks. This fiat money is perfectly durable and therefore can serve as a store of value. It pays no interest. Assume that, for whatever reason, society prefers it (or even has decided to require) it as a medium of exchange or means of payment.

With a bit of further work, such an economy will have an equilibrium with a positive, constant price of money (a constant general price level). Economists call this the fundamental equilibrium. This stationary economy will, however, also have many other (in fact infinitely many other) non-stationary equilibria, called (speculative) bubbles. They always have equilibria in which the value of money starts at a positive value but falls steadily towards zero - the general price level rises without bound even though the quantity of money is constant. The holders of money anticipate the future inflation and reduce the real stock of money balances they want to hold. This further increases the actual and expected rate of inflation, and the real stock of money balances goes to zero: the general price level goes to infinity or the price of money goes to zero. We have Zimbabwe.

What is often ignored is that this economy has an equilibrium that is even more ‘fundamental’ than the fundamental equilibrium. That is the equilibrium in which the price of money is zero in every period, not just in the long run (as with the speculative inflationary bubble equilibria). Remember, fiat money, including gold, is intrinsically useless. It has value only because people believe it to have value. If everyone expects that money will have no value in the next period, it will have no value this period, because no-one will be willing to take receipt of money to carry it into the next period where it will be valueless. So fiat money with a zero value is always an (unfortunate) fundamental equilibrium.

I would actually call it the only fundamental equilibrium. All other equilibria with a positive price of money - an asset with no intrinsic value - are benign (relatively speaking) bubbles. The constant price of money (constant general price level) equilibrium is also a bubble, based entirely on belief and trust - a beneficial bootstrap equilibrium, lifting itself by its hair, like the Baron von Münchhausen.

In a world with multiple fiat moneys, the zero value of money equilibrium lurks for each of the fiat currencies, including gold. Admittedly, as regards gold, so far so good. Gold has positive value. It has had positive value for nigh-on 6000 years. That must make it the longest-lasting bubble in human history.

I don’t want to argue with a 6000-year old bubble. It may well be good for another 6000 years. Its value may go from $1,100 per fine ounce to $1,500 or $5,000 for all I know. But I would not invest more than a sliver of my wealth into something without intrinsic value, something whose positive value is based on nothing more than a set of self-confirming beliefs.
[1] Since gold is very durable, it is reasonable to assume that virtually all the gold that was ever refined is still out there somewhere. There is no gold ‘consumption’, just its transformation into jewellery and no significant depreciation of the stock.

November 8, 2009 6:02pm in Economics, Environment, Finance, Financial Markets, Monetary Policy | 12 comments

You can´t buck the market

2009-11-09T04:48:00.000-08:00

Which will come out on top: paper or gold? | William Rees-Mogg - Times Online

Gold will be a stronger reserve currency than paper, and the market will increasingly decide national policies. “You can’t buck the market”, whether in taxes, in dollars or in gold.

Carry trade bubble

2009-11-02T04:43:00.000-08:00

FT.com / Comment / Opinion - Mother of all carry trades faces an inevitable bust

Mother of all carry trades faces an inevitable bust

By Nouriel Roubini

Published: November 1 2009 18:44 | Last updated: November 1 2009 18:44

Since March there has been a massive rally in all sorts of risky assets – equities, oil, energy and commodity prices – a narrowing of high-yield and high-grade credit spreads, and an even bigger rally in emerging market asset classes (their stocks, bonds and currencies). At the same time, the dollar has weakened sharply , while government bond yields have gently increased but stayed low and stable.

This recovery in risky assets is in part driven by better economic fundamentals. We avoided a near depression and financial sector meltdown with a massive monetary, fiscal stimulus and bank bail-outs. Whether the recovery is V-shaped, as consensus believes, or U-shaped and anaemic as I have argued, asset prices should be moving gradually higher.

But while the US and global economy have begun a modest recovery, asset prices have gone through the roof since March in a major and synchronised rally. While asset prices were falling sharply in 2008, when the dollar was rallying, they have recovered sharply since March while the dollar is tanking. Risky asset prices have risen too much, too soon and too fast compared with macroeconomic fundamentals.

So what is behind this massive rally? Certainly it has been helped by a wave of liquidity from near-zero interest rates and quantitative easing. But a more important factor fuelling this asset bubble is the weakness of the US dollar, driven by the mother of all carry trades. The US dollar has become the major funding currency of carry trades as the Fed has kept interest rates on hold and is expected to do so for a long time. Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates – as low as negative 10 or 20 per cent annualised – as the fall in the US dollar leads to massive capital gains on short dollar positions.

Let us sum up: traders are borrowing at negative 20 per cent rates to invest on a highly leveraged basis on a mass of risky global assets that are rising in price due to excess liquidity and a massive carry trade. Every investor who plays this risky game looks like a genius – even if they are just riding a huge bubble financed by a large negative cost of borrowing – as the total returns have been in the 50-70 per cent range since March.

People’s sense of the value at risk (VAR) of their aggregate portfolios ought, instead, to have been increasing due to a rising correlation of the risks between different asset classes, all of which are driven by this common monetary policy and the carry trade. In effect, it has become one big common trade – you short the dollar to buy any global risky assets.

Yet, at the same time, the perceived riskiness of individual asset classes is declining as volatility is diminished due to the Fed’s policy of buying everything in sight – witness its proposed $1,800bn (£1,000bn, €1,200bn) purchase of Treasuries, mortgage-backed securities (bonds guaranteed by a government-sponsored enterprise such as Fannie Mae) and agency debt. By effectively reducing the volatility of individual asset classes, making them behave the same way, there is now little diversification across markets – the VAR again looks low.

So the combined effect of the Fed policy of a zero Fed funds rate, quantitative easing and massive purchase of long-term debt instruments is seemingly making the world safe – for now – for the mother of all carry trades and mother of all highly leveraged global asset bubbles.

While this policy feeds the global asset bubble it is also feeding a new US asset bubble. Easy money, quantitative easing, credit easing and massive inflows of capital into the US via an accumulation of forex reserves by foreign central banks makes US fiscal deficits easier to fund and feeds the US equity and credit bubble. Finally, a weak dollar is good for US equities as it may lead to higher growth and makes the foreign currency profits of US corporations abroad greater in dollar terms.

The reckless US policy that is feeding these carry trades is forcing other countries to follow its easy monetary policy. Near-zero policy rates and quantitative easing were already in place in the UK, eurozone, Japan, Sweden and other advanced economies, but the dollar weakness is making this global monetary easing worse. Central banks in Asia and Latin America are worried about dollar weakness and are aggressively intervening to stop excessive currency appreciation. This is keeping short-term rates lower than is desirable. Central banks may also be forced to lower interest rates through domestic open market operations. Some central banks, concerned about the hot money driving up their currencies, as in Brazil, are imposing controls on capital inflows. Either way, the carry trade bubble will get worse: if there is no forex intervention and foreign currencies appreciate, the negative borrowing cost of the carry trade becomes more negative. If intervention or open market operations control currency appreciation, the ensuing domestic monetary easing feeds an asset bubble in these economies. So the perfectly correlated bubble across all global asset classes gets bigger by the day.

But one day this bubble will burst, leading to the biggest co-ordinated asset bust ever: if factors lead the dollar to reverse and suddenly appreciate – as was seen in previous reversals, such as the yen-funded carry trade – the leveraged carry trade will have to be suddenly closed as investors cover their dollar shorts. A stampede will occur as closing long leveraged risky asset positions across all asset classes funded by dollar shorts triggers a co-ordinated collapse of all those risky assets – equities, commodities, emerging market asset classes and credit instruments.

Why will these carry trades unravel? First, the dollar cannot fall to zero and at some point it will stabilise; when that happens the cost of borrowing in dollars will suddenly become zero, rather than highly negative, and the riskiness of a reversal of dollar movements would induce many to cover their shorts. Second, the Fed cannot suppress volatility forever – its $1,800bn purchase plan will be over by next spring. Third, if US growth surprises on the upside in the third and fourth quarters, markets may start to expect a Fed tightening to come sooner, not later. Fourth, there could be a flight from risk prompted by fear of a double dip recession or geopolitical risks, such as a military confrontation between the US/Israel and Iran. As in 2008, when such a rise in risk aversion was associated with a sharp appreciation of the dollar, as investors sought the safety of US Treasuries, this renewed risk aversion would trigger a dollar rally at a time when huge short dollar positions will have to be closed.

This unraveling may not occur for a while, as easy money and excessive global liquidity can push asset prices higher for a while. But the longer and bigger the carry trades and the larger the asset bubble, the bigger will be the ensuing asset bubble crash. The Fed and other policymakers seem unaware of the monster bubble they are creating. The longer they remain blind, the harder the markets will fall.

Steel bubble

2009-11-01T05:57:00.000-08:00

China Can't Cool Down Its Steel Bubble | Research Reloaded

China Can't Cool Down Its Steel Bubble
10/22/2009 by Vincent Fernando

Still going... we're still waiting to see the massive value destruction that overcapacity could realize.

BEIJING – Despite China's campaign to slim down its steel industry, the country's crude steel production in September was the second-highest ever in terms of volume, underscoring the formidable challenge Beijing faces in curbing capacity.

The National Bureau of Statistics said Thursday that steel output rose 29% in September from September 2008 to 50.71 million metric tons.

"The signs point clearly to overcapacity, and we expect output will be maintained at high levels" in the coming months, said Ma Haitian, senior steel analyst with state-owned metals consultancy Antaike Development Co.

In the last three weeks, China's top policy-making bodies -- the State Council and the National Development and Reform Commission -- have singled out overcapacity in the steel sector as a top reform priority, intensifying a campaign that has dragged on fruitlessly for years.

But directives have proven difficult to enforce on the ground, and steel mills have continued to pump out more product, racking up a record 52.3 million tons of crude steel output for August.

Landowners will be barons again

2009-10-31T10:16:00.000-07:00

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.

Grantham prediction for 2010

2009-10-31T10:06:00.000-07:00

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.

Economic indicators

2009-10-29T05:18:00.000-07:00

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.

Value

2009-10-28T07:35:00.000-07:00

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.”

Jamie on the dollar

2009-10-27T13:44:00.000-07:00

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."

Figthing bubbles

2009-10-26T13:58:00.000-07:00

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.

Devaluation Devaluation Devaluation

2009-10-25T06:15:00.000-07:00

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.

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

2009-10-24T09:08:00.000-07:00

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.

Stocks, bonds and gold

2009-10-23T13:18:00.000-07:00

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.

Meltzer and the next crisis

2009-10-23T04:57:00.000-07:00

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).

Improving

2009-10-22T09:59:00.000-07:00

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.

DEATH TO THE DOLLAR

2009-10-21T13:46:00.000-07:00

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

2009-10-19T11:29:00.000-07:00

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.

20%

2009-10-17T06:59:00.000-07:00

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

Excellent post by Econbrowser

2009-10-15T16:25:00.000-07:00

Econbrowser: Dollar Demise and Double Dip: Latest Forecasts

Dollar Demise and Double Dip: Latest Forecasts

Dollar will not prevail

2009-10-15T16:19:00.000-07:00

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.

Dollar devaluation is good

2009-10-12T06:56:00.000-07:00

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

Gold and the dollar devaluation

2009-10-10T09:27:00.000-07:00

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.

More on the devaluation of the dollar

2009-10-09T04:31:00.000-07:00

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.

Dollar devaluation

2009-10-08T14:12:00.000-07:00

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.

No more dollars

2009-10-06T05:33:00.000-07:00

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.

Investing against the dollar

2009-09-26T06:34:00.000-07:00

Five ways to profit from the weaker dollar - MarketWatch

Betting on the weaker buck
Foreign stocks, bonds, currencies -- even Coca-Cola -- are plays on weak dollar

By Laura Mandaro, MarketWatch

SAN FRANCISCO (MarketWatch) -- These days it seems like global investors can't get rid of their U.S. dollars fast enough.

Some timely investing strategies attempt to profit from this distaste. Foreign stocks, bonds and currencies, along with commodities, tend to rise when the dollar declines.
What M&A activity says about the bull market

An uptick in deal flow probably says more about the credit markets than equities, argues Barrons.com's Bob O'Brien.

Even many true-blue American companies, such as Coca-Cola Co. , can take advantage of a falling greenback because so much of their sales come from overseas.

All of these assets can get an easy boost from currency translation. When the dollar falls, another currency rises.

Commodities generally gain when the dollar loses because they are priced in dollars. Buyers of these commodities must spend more dollars to own an ounce of gold or a barrel of oil when the greenback is worth less.

And a U.S. company that sells goods in pesos, for example, gets a bonus when it translates those earnings or its share price into dollars.
Dollar daze

These trends have been in place since March. That's when a surge in demand for stocks and currencies in countries seen as coming faster out of recession -- such as Brazil -- triggered a slide in the greenback.

Many analysts say it will be tough for the dollar to rebound much while the Federal Reserve keeps interest rates near zero percent and extends its special cash programs --two conditions that make the dollar attractive as a currency to borrow rather than buy. See related story on dollar carry trade.
DXY 76.81, -0.09, -0.11%
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The dollar index , which measures the U.S. dollar against a basket of its rivals, has fallen 14% since early March, when it had been trading near three-year highs.

The losses are even steeper against currencies from countries that export a lot of commodities, and which are expected to benefit from a coming wave of infrastructure building.

Since early March, the greenback has lost about 30% against the South African rand, 26% against the Australian dollar and 23% against the Brazilian real.

Meanwhile, emerging markets stocks -- as measured by an exchange-traded fund that tracks the MSCI Emerging Markets index -- have surged 81%. Oil futures have doubled from their February lows.

"The market is focused on emerging markets leading the world out of recession now, which is not helping the dollar," said Richard Batty, global investment strategist at Standard Life Investments, which manages about $200 billion in assets.

Here are five ways to take advantage of further drops in the U.S. dollar:

1. Currencies. Exchange-traded funds from Rydex Investments, WisdomTree Investments, Invesco PowerShares and others provide direct exposure to foreign currencies relative to the U.S. dollar. See related story on currency ETFs.

Interest in currencies has increased over the past year after asset classes that were supposed to perform independently, such as stocks, corporate bonds and real estate, crashed together, said Anthony Welch, a portfolio manager at Sarasota Capital Strategies, a wealth manager in Florida.

With foreign exchange trading, "It's always one currency versus another. There's always something going up," said Welch, who helped start The Currency Fund in May to capitalize on this burgeoning interest.

Other mutual funds focused on currencies include Franklin Templeton Hard Currency Fund , Merk Hard Currency Fund and Rydex Weakening Dollar 2X Strategy Fund.

2. Global bonds. Corporate and sovereign debt, which retail investors can access through mutual funds, are denominated in currencies that may be rising against the U.S. dollar. Investors have also been benefiting from higher yields on this debt.

For the past five years, global bonds as tracked by the Barclays Capital Global Aggregate bond index returned 6.11% on an annualized basis.

That compares with a 5.03% annualized return for its U.S. counterpart. The S&P 500 returned less than 1% per year, annualized, over that time.

Robert Siewert, who oversees some of Philadelphia-based Glenmede Investment and Wealth Management's $17 billion in assets, said he prefers to use mutual funds to spread the risk of a foreign issuer's default and to gain access to local research on the debt. Returns from the three global bond mutual funds Glenmede is using have ranged between 13% to 18% so far this year, Siewert said.

There's wide variety among the strategies fund managers can take in a global bond portfolio: Some focus on government debt; others also buy corporates; some include U.S. debt. This year, emerging market bonds have been a bright spot.

3. Foreign stocks. The weak U.S. dollar has boosted U.S. investors' returns on their overseas investments. It's provided added juice to emerging-markets stocks that are making big gains in their local markets and helped developed markets outside the U.S. outperform the S&P 500. See related story.

The MSCI EAFE index, as of Sept. 24, was up 26% in U.S. dollar terms this year. But in local currencies, the index of developed countries' markets had only risen 18%. The difference came from the fall in the dollar.

4. U.S. multinationals. American companies that generate substantial sales outside of the U.S. are often the choice of stock investors who are leery of overseas investments but want the currency advantage, said Paul Hickey, co-founder of Bespoke Investment Group in Harrison, N.Y.

Earlier this month, his firm looked at the S&P 500 companies that book more than 50% of their revenues outside the U.S. -- a group that tends to do better when the dollar falls.

Among those internationally oriented companies, shares of several had hit new multi-month highs.

These include more obvious international plays, such as General Electric Co. , 3M Co. and Caterpillar, Inc. , along with less well-known health and technology providers such as Xilinx Inc. , Waters Corp. and Teradyne Inc. .
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Energy firms Halliburton Co. and Apache Corp. have also rallied.

"What you generally get is a lot of technology, industrials and energy companies. What you don't tend to have is consumer discretionary and financials," Hickey said.

But some brand-name U.S. consumer companies, such as H.J. Heinz Co. and Coke, also made Bespoke's list. They both make more than half of their revenues outside the U.S.

5. Commodity-linked stocks and funds. A big part of the recent rally in oil, gold and other commodities is the falling dollar, analysts say.

"The dance between the dollar and commodities is becoming wearisome to watch," wrote Mike O'Rourke, chief markets strategist at New York institutional brokerage BTIG earlier this week.

William Van Keulen, an investment manager at Carnick & Co. in Colorado Springs, Colo., says buying mining stocks such as Southern Peru Copper Corp. and commodities is part of a three-pronged strategy designed to benefit from the weaker dollar.

Gold "is a protection against your currency falling," he said.

For all these strategies, it helps to be nimble. The dollar's decline could easily reverse.

A move away from stocks and into some safety assets, such as U.S. Treasurys, actually helped lift the U.S. dollar index for the week. See Currencies.

"The dollar can work under two scenarios: If it's leading the world out of recession or risk aversion remains high," said Standard Life's Batty.

Batty's asset-allocation team looks for the dollar to rebound, in fact, because they expect the U.S. economy, helped by huge monetary and fiscal stimulus, to emerge stronger from recession than Europe and Japan.

"In between," he said, "it's problematic for the dollar -- the market is not sure if the U.S. leading the other dev

BDI

2009-09-25T05:01:00.000-07:00

FT.com / Investor's notebook - View of the Day: Baltic fall reflects China demand

View of the Day: Baltic fall reflects China demand

By James Lord

Published: September 24 2009 17:03 | Last updated: September 24 2009 17:03

The recent sharp fall in the Baltic Dry Index is in part due to an increase in shipping capacity, but primarily reflects waning demand for commodities – especially in China, says James Lord at Capital Economics.

The BDI, which has almost halved since the start of June, reflects the cost of hiring a bulk cargo ship and as such is often seen as an indicator of the health of the global economy.

“But we think the BDI’s drop is due to conditions specific to the shipping industry and to China’s reduced commodity stockpiling,” Mr Lord says.

He notes that orders for new ships rose sharply during the boom years for the global economy – and as it takes up to two years to build these craft, many have only recently become available for lease.

“However, the supply of new ships began to rise in January – well before the recent correction in shipping costs,” he says. “We therefore believe the main driver of the recent BDI decline has been falling Chinese stockpiling of commodities.”

Mr Lord says the global upswing may continue to underpin commodity prices for a while even though Chinese demand has tapered off. “However, commodity markets have already priced in a strong recovery. We expect global growth to slow in the second half of 2010 – and as such we see commodity prices falling next year.

“Indeed, the recent fall in the BDI may be an early warning sign.”

Copyright The Financial Times Limited 2009.

Close to the edge

2009-09-24T10:13:00.000-07:00

King Says British Banks Got Within Hours of Collapse (Update2) - Bloomberg.com

Sept. 24 (Bloomberg) -- Bank of England Governor Mervyn King said two British banks got within hours of a liquidity shortfall on Oct. 6, 2008, and the day after as the U.K. financial system came to the brink of collapse.

“Two of our major banks which had had difficulty in obtaining funding could raise money only for one week then only for one day, and then on that Monday and Tuesday it was not possible even for those two banks really to be confident they could get to the end of the day,” the BBC cited King as saying in an interview to be broadcast later today.

King was referring to Royal Bank of Scotland Group Plc and HBOS Plc, the BBC said. Prime Minister Gordon Brown’s government pledged to invest about 50 billion ($82 billion) pounds in the banking system on Oct. 8, 2008, to save it from meltdown in the aftermath of Lehman Brothers Holdings Inc.’s bankruptcy declared that September.

“It was, it is, probably the worst situation, as I say, we faced in peacetime,” Chancellor of the Exchequer Alistair Darling said, according to a press release from the BBC.

The BBC corrected its original release to say that RBS was one of the two banks in trouble, and not Lloyds TSB Group Plc. In the wake of Lehman’s collapse, Lloyds TSB took over HBOS Plc, the nation’s biggest mortgage lender, to form Lloyds Banking Group Plc. An RBS spokesman declined to comment on the story.

The television program, The Love of Money, is the third in a series looking back on the financial crisis. It will be broadcast on BBC Two today at 9 p.m. in the U.K.

Great Depression

Edward Lazear, chairman of George W. Bush’s Council of Economic Advisers at the time, told the program: “We literally thought that we were on the verge of the Great Depression, and looking back I think we probably were.”

King said that allowing the banks to fail would have brought the economy to a halt, the BBC said.

“Individuals would not have had access to the money in that bank,” he was cited as saying. “Their deposits would have been frozen. The accounts would have not been there for salaries to be paid in to, so many people would not have been paid their salary.

“In turn, they wouldn’t have been able to pay bills to businesses so the businesses would have found that their flow of payments would have come to an end,” King said, according to the BBC.

Emergency Meeting

U.K. business minister Shriti Vadera called a meeting of senior bankers on Oct. 7, 2008, to advise the government on the bailout plan.

“We really only knew by probably about 7 o’clock at night that we, that everyone, was going to get through the next day,” David Soanes, a managing director at UBS AG in London, was quoted as saying in the program.

On Oct. 2, 2008, the Irish government guaranteed all deposits and borrowings at six of its biggest banks to assure customers they could withdraw their money and avoid a bank run. The decision rattled other European governments because it encouraged depositors to move their holdings to Ireland.

Irish Finance Minister Brian Lenihan told the BBC that there was no other choice because of the risk of panic.

“We were anxious to avoid that at all costs,” Lenihan was quoted as saying. “The policy options available to us were to immediately nationalize an institution. If we immediately nationalized that institution the risk was that it could lead to a systemic collapse of all the other institutions.”

French Finance Minister Christine Lagarde said the decision was “a bit of a shock,” the BBC said. Darling told the program that “the lesson that you draw here is you can’t do these things on your own.”

To contact the reporter on this story: Brian Swint in London at bswint@bloomberg.net.

Currency crisis

2009-09-24T08:55:00.000-07:00

FT.com / Investor's notebook - View of the Day: This is not a currency crisis

This is not a currency crisis

By John Normand

Published: September 22 2009 17:35 | Last updated: September 22 2009 17:35

The latest sell-off in the dollar has prompted renewed talk of reserve diversification – but this is not the stuff a currency crisis is made of, says John Normand, global head of FX strategy at JPMorgan.

“Quantifying reserve diversification is financial alchemy – often attempted and never successful,” he says. “But there is decent circumstantial evidence that this process has accelerated since June.”

Mr Normand notes that global foreign exchange reserves are growing at $100bn a month, while official purchases of US assets are running near $50bn. “This sort of divergence is unusual in an environment where rate spreads between the US and the rest of the world are stable,” he says.

Mr Normand points out that official investors are still sizeable net buyers of US assets, even if the dollar share of total reserve recycling appears to be declining.

“We could pander to the dollar-crisis camp and claim that this divergence marks the beginning of the end for the dollar and US asset markets where foreign ownership dominates, but that course would be too easy,” he says. “It would also be wrong.

“The dollar crisis scenario still looks low-probability for the next three to six months since the US manages to attract a high absolute level of official financing, even though the US’s relative share of global reserves may be declining.”

Copyright The Financial Times Limited 2009. You may share using our article tools. Please don't cut articles from FT.com and redistribute by email or post to the web.

Options explained

2009-09-22T05:16:00.000-07:00

using options as tools for hedging, 4 techniques available to anybody

using options as tools for hedging, 4 techniques available to anybody

September 17, 2009 – Comments (10)

I am of the opinion that in many, although not in all, of the stocks that I hold that it is a good time to take some gains.

However, for one basic reason I am not want to sell them right now and that reason is taxes. Its a 20% difference in tax rate for me if I sell now (have not held even 1 share for 12 months) -vs- january, february, march, and april (some shares bought after that but not all that many).

Could I find an investment that would make more than 20% between now and then and thus make a better return by selling, paying up to the tax man, and then re-investing in this other thing? Of course, but... is it likely that I will successfully find that +20% investment? Maybe... but it isn't guaranteed, and as such at times hedging may be desireable.

Another reason to desire a hedge on a long position would be that you believe the market is going to correct, and stocks you own are going to go lower with it, but you still believe that in time the names you hold can move higher. A hedge can temper the short-term pain or even provideprofts you can re-invest after such a correction takes place, if it does take place.

There are several paths we could take to hedge our bets with options and these are the focus of this blog.

First, some background: there are two kinds of options. A call, and a put.

A call is a contract between you and someone else where one party agrees to give the other the right to buy a share from them by a certain time for a certain price in exchange for a premium. For an example, right now you can buy a January 2011 $45 call for ASH for about 10 bucks. If you buy this call, you pay someone else (maybe me) 10 bucks. You then get the right to buy 1 share of ASH from me for $45 anytime before january 2011. In this case you would profit if ASH went to $56 or higher, because you paid $10 and would pay me $45 for the share, and thus would have $55 into your share, and selling for $56 would yield $1 of profit. If ASH went to $70 your profit would be $15.

You would buy a call if you thought a stock is going to go up. You would short a call if you thought that the stock is going to go down, stay flat, etc.

A put is the opposite. A put gives its buyer the right to sell a share to someone for a given price upuntil a given date. You can buy a $40 put for ASH right now for jan 2011 for about 8 bucks. So you would pay $8, and you would then get the right to sell 1 share of ASH anytime between now and jan 2011 for $40. So by buying the put you are essentially guaranteeing that you can sell the share for $32 anytime between now and jan 2011 (you sell for $40, you paid $8 for the put, netting $32).

Option contracts are sold in lots of 100. So each time you make such a move you are working in lots of 100 shares, you can't buy a contract for 80 shares.

The farther into the future the expiration date is, the higher the premium (cost) of the options are. That $45 call for ASH costs just 30 cents for September 2009 (3 days). For january 2010 it costs about $4.50, and for jan 2011 it costs $10.

From time to time these contracts are executed before their expiration date, but this is rare. On several occasions I have sold covered calls that were in the money and had someone forget to call the shares. Without exxageration, I have kept 100 WYNN shares, several thousand XL shares, and several thousand TCK shares due to such mistakes. As those happened in April... I'd say i've benefitted from someone elses carelessness.

Option 1: buying a put. If I own a share of ASH and I'm satisfied with the gains (from a cost avg of $6 something to $44, pretty satisfied) I could buy a put. I bought all of my shares of ASH between january 2009 and March of 2009. To get to the 12 month i-can-sell-now-and-pay-capital-gains-taxes I could buy a put for April 2010. This gives me the right to sell the shares for $XX at a time when I can pay capital gains.

I buy a put for $45 (close to todays price) and it costs about $7.50. I would then lock in a selling price of net $37.50 anytime between now and april 2010.

If ASH goes to 60 here, I net $52.50. If it goes to $70 I net $62.50. If it goes to 20 I net $37.50. If it goes to$45 i net $37.50. Basically, $37.50 becomes my low and my upside is unlimited.

If ASH corrects temporarily to, say, $30, my put would become worth more, probably about $16 or $17, and I could then sell it for a profit, ... and then experience all the future upside in ASH from $30. My point is you don't have to hold these things to expiration, you can trade them.

Option 2: selling a call. If you own shares of a stock and sell a call against that stock (short the call) that is called a "covered call", you're covered because you own the shares which eliminates any risk of losing money from this transation...

So, I own a share of ASH and i'm satisfied with the gains. I decide to hedge by selling a covered call, say a Jan 2011 $45 call. I take in $10 in premium, and I can do whatever I want with that $10 immediately.

Now my position in ASH looks like this: if ASH goes to $70 I net $55. if ASH goes to $11,080 I net $55. My upside is limited to the strike price + the cash I took in from the call. If ASH goes to $45 I net $55. if ASH goes to $30 I net $40 because I took in the $10 of premium.

My upside is limited here, but I keep the $10 no matter what. I can reinvest it (so I win no matter how limited my upside is if I put it into an investment that does better than my upside loss in ASH) and so forth. If the shares don't move up or down at all I eventually make $10.

Over time if the stock goes sideways, the premium will melt away and you can buy it back at a profit. If the stock goes down the premium will melt away and you can buy it back at a profit. And so forth.

Option 3: a collar. You collar a stockby selling a covered call, and then using the premium to buy a put. You spend $0 on this transaction (or very little anyway, or you may profit very little, depending on what strike prices you choose).

Take a share of ASH again. say I decide that ASH might go up a little bit more, but i'm willing to risk it going down a little bit as well. I could sell an jan 2011 $50 call, which would get me $8 or so of premium. I could then take that $8 of premium and buy a jan 2011 $40 put with it.

I now never get less than $40 for my share, but never more than $50, I have essentially range-bound the stock. This is a slightly bullish, but just slightly, hedge.

Option 4: a synthetic short. I am long ASH, say I've decided thats it, I'm happy with the gains, I just want to lock it right exactly here. I can do that!

To make a short position with options you simply buy a put and sell a call at the same strike price. You are now, with some potential for negative or sometimes positive arbitrage due to bid/ask spreads and relative prices on puts and calls, short the stock. It goes up $1, you lose $1, it goes down $10, you make $10 on these options positions.

So in this case I'd buy an april 2010 put at $45 for about $7.40, I sell an april 2010 $45 call for about $6.30, and I have locked my net sale price for ASH at $43.90 ($45 less the difference in options costs). It costs me $1.10 per share to do so, I wind up about 8 cents ahead of the current price.

So... basically... lets take a look at how we might want to use each of these options, I'll pick some examples from my real life portfolio.

I am long XL capital. It pays a now-modest (huge at the time I was buying XL) dividend of about 2.5%, it may well raise that dividend in the future. It is also trading under book value (insurers historically trade at a small premium to book value) and further it probably is looking at additional mark-ups to its book value in coming quarters, it has a forward p/e of 7.8 (that is hardly rich) and frankly I think in the fullness of time XL goes higher from here. I'm comfortable holding it. I think in the fullness of time XL trades to 1-1.2 of tangible book and a p/e of 10. I think XL goes to 22-25 bucks.

However, I also think that the market is primed for a pullback, and if financials get hit XL gets pounded along with them because its not the largest cap and when someone buys FAZ or SKF XL gets shorted in the process. This makes XL volatile as all get-up and always ripe for a big drop in share price.

So i think XL goes higher but as my position in it is huge (nearly 10% of my total portfolio) i'd like some shelter in case it tumbles down. Its run up to $18 now, I have a few options

1. I could buy a jan 2010 put for about $1.10 at $15.00. If XL tanks to $15 in the next month or 2 that will wind up worth probably only 2 bucks, as every day that goes by some time premium ticks out of the options. But, if XL tanks soon to $15 the value of that will swell to probably about 3 bucks. If XL tanks soon to $12 it'll be worth probably about 4 bucks, etc. (the farther "in the money" an option is th eless time premium it exhibits.

I don't really like buying puts as the best way to hedge as A) time is not on your side. Every day that goes by your asset (the put) becomes less valuable all other things equal. And B) they don't really protect you completely unless you buy one thats already well in the money, and thats expensive.

But doing this would buy you 4 months of more or less secure vacation I guess...??

2. I could sell a jan 2011 covered call at $25. This brings in about $2.20. Time is on my side now, and if XL stays flat I win. If XL goes to $22 soon, the value of that call will swell to probably $3-$3.50. So I'll gain $4 in the share, but lose $1ish, which tempers my on paper gains. If XL then 6 months from now drifts down to $20 again, the value of that call will probably fall to $2 or so again and so forth.

I like this move because I get large upside (40%) + the call premium (meaning net 50+% upside), I get cash in my hand which I can do whatever with, and if the stock dips the cost of buying that put back will drop quickly and I will profit that way if I wish (or i can just let it ride).

If XL really tanks, like say to $5, ... I am not very protected at all... just by $2.20. But XL isn't going out of business and I think its going to do well in the future, and as I'm willing to hold XL i'm not concerned about a disastrous outcome, ... so i'm ok without the big downside protection.

This is a semi-bullish hedge. I'm leaving big upside, don't have completedownside protection, but could profit from the hedge if XL prices stabilize or drop.

3. I could collar XL. Sell the $25 (about the high side of where I think its going so no big deal if it gets there and the shares get called) and then buy the $12.50 put. No downside below $12.50 upside to $25. I can now walk away and just let time run its course, or I could...

imagine XL then dips to $15. The value of that $12.50 put, which I own, will swell and I can sell it at a profit. The value of that $25 call will drop, and I can buy it back at a profit.

So if i'm really sure XL is going to correct, I can do this and benefit more from a pullback than if I just sell the covered call. My upside is lower (because I bought the put).

This hedge isn't really bearish or bullish, but sort of neutral.

4. I could take out a synthetic short. If XL tanks to $12 I make $6 per hedged share essentially staying at $18. I could then cover, re-invest the profits, and experience upside in the futurre (after covering).

this is a bearish hedge. you're betting that more upside isn't in the cars and that at some future date the share will be lower than today.

5. I could sell an in-the-money or at-the-money long term covered call. This brings in alot of premium and provides better downside protection. I could sell a $17.50 call for jan 2011, bring in about $4.50 or about 25% of todays share price, invest that however I wish, still have some slight upside, but have 2x as much downside protection as the $25 call.

recently I've sold covered calls as described above against ASH (alot of them), XL (some), GNW (some) at prices I calculated to about roughly where I think the upper end of fair value for those stocks is, typically with 25-50% upside left from here. I'm bigtime under water on the ASH calls even though none of them are in the money, such is life.

I sold an in the money covered call on every share of WYNN when it hit like $62. I think i got $17or so for the $60 call for jan 2011. So my upside is limited to $77, as WYNN moved up even morme since then I may opt for making my position a collar by buying a put... If WYNN hits $50 say next march that call will probably be worth about 7-8 bucks. I may then cover if I think WYNN will go higher, or I may not.

I am not bullish on WYNN here one bit. I took a similar tact on LVS and may even sort of double-down on the hedges by selling som enaked calls against it as well (i own a mob of LVS so all my calls are covered now). By doubling down on the LVSshort-calls, I am risking alot of LVS goes far higher from here. But I am fairly confident that LVS now discounts a very good outcome from future operations and i'm not too worried about going short a few $35 calls...

I collared a few stocks and so on and so on.

My hedges right now do not provide me with locked-in gains on my portfolio overall. But they do provide me with considerable downside protection (probably about 20% total but thats a WAG and the exact figure would be time consuming to estimate).

Hope that helps somebody. :)

Nasdaq etf

2009-09-22T05:13:00.000-07:00

Ultra 3X ETF’s beat individual stocks again! | Wishing Wealth Blog

Since the current short bounce began September 1, the standard NASADQ 100 index ETF (QQQQ) rose 8%. 3Xcomparison During this same period, the comparable Ultra 2X ETF (QLD) rose 17% and the tech 3x ETH (TYH) rose 21%

Betting on the Baltic Dry Index

2009-09-22T05:08:00.000-07:00

FT.com / FTfm / Columnists - Look beyond the shipping forewarnings

Look beyond the shipping forewarnings

By John Dizard

Published: September 20 2009 09:07 | Last updated: September 20 2009 09:07

Shipping operators have, historically, had two alternating assumptions about their world: 1) we’re all going to be multi-billionaires; 2) we’re all going to die horribly.

The institutional and retail investors who have financed much of their expansion in recent years have their own less-than-fully-rational investment philosophy: whatever the Baltic Dry Index has done between yesterday and today tells us what will happen to our stocks over the foreseeable investment horizon.

A somewhat less febrile, more analytic approach works better for the investor. That goes not only for how you time investments in shipping, but how to make sense of the market indicators, such as that Baltic Index.

The Index is calculated by the eponymous London exchange, which canvasses shipbrokers to find out the shipping rates for three categories of dry-cargo ships along 26 routes around the world.

It reflects demand for transport of such commodities as iron ore, coal, and grains along those routes, as well as the supply of ships to carry them.

In the months before the Lehman crash, it had started to turn down from its high above 11,700, finally plunging by 94 per cent between May and December of last year. Then it headed up again, presaging the other risk markets’ recovery.

Lately, ominously, it has declined to just under 2,400 from its summer high of 4,290. Does this mean that we, along with the shipowners, are going to die horribly after all?

Pankaj Khanna, the chief operating officer of DryShips Inc, the largest publicly traded participant in these markets, says: “I would look at something like the BDI’s three-month moving average, rather than the daily or weekly numbers, which are distorted by port congestion or the Chinese building steel inventory. Personally, I don’t look at the BDI; I look at component indices and component routes.”

Just as 170,000 tonne Capesize dry cargo ships can take over a mile to come to a stop, so the supply of new vessels takes a while to slow after demand withers.

However, the choking off of bank financing has supported the economics of the existing fleet. Originally, more than 70m tonnes of new dry cargo ships were scheduled for delivery in 2009.

With only some 22m tonnes delivered now, only 40m tonnes at the most will be supplied this year, offset by some 10m tonnes of scrapping. Next year, Mr Khanna believes, over half the outstanding dry cargo order book will be cancelled.

For now, he is optimistic about the other force tugging on the BDI level, and DryShips’ profits: demand. For all those routes and sizes, as you might have guessed, this year has been about Chinese imports of iron and coal.

Was it all just a speculative build-up of inventories? “The coal and iron were all turned into steel, and that led to inventory build-up. So steel prices went up to $600 a tonne, then back down to $500, where they are now recovering and stabilising. In another month or two the Chinese will be back in the market. The final demand for the steel products is still there, thanks to their stimulus plan, which will have an effect for another six to 12 months.”

This coincides with my sense of how long this recovery spurt will last in the US. First half of next year good, second . . . not so good. Mr Khanna doesn’t see a strong recovery in shipping, or ship financing, arriving until 2011 and later.

DryShips’ contracting is consistent with this outlook. It is de-risking the business model. Almost all its dry cargo capacity is contracted through the end of next year, with some slack in capacity for 2011 that could take advantage of a recovery in spot rates.

Over the longer term, DryShips is making an ever bigger commitment to huge semi-submersible oil rigs designed to exploit reserves in very deep waters. That’s the energy cycle, which seems more certain than the shipping cycle.

But is there a way to invest, rather than gamble, on the value of ships?

Babis Ziogas thinks so. I’ve been speaking with him for years about the shipping market. A Greek shipping investor with a graduate degree from the Ocean Engineering Department of MIT, he has an interesting ship valuation methodology.

“It’s a filter model,” he explains over the phone from Athens, “and it’s about investment decision making rather than macroeconomics.”

Simplifying, he says: “You take newbuilding prices and prices for ships on the secondary market, and compare the inflation-adjusted, depreciated value of those to the newbuilds.”

This contrasts with even most sophisticated investors, who attempt to discount the revenue stream based on chartering rates.

“This doesn’t have the risk element inside it, including credit risk.”

What does the model tell him now?

“There is not yet a bottom in secondhand ship prices, or in newbuilding. But I am raising money now, because I think the first half of 2010 will be a good time to buy.” By the way, he sold most of the ships his company had owned back in 2007. “Prices lost any connection to the value of underlying assets.”

So don’t jump at every wiggle in the Baltic Dry Index. Think longer term.

johndizard@hotmail.com

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Oil going down

2009-09-21T05:38:00.000-07:00

Oil Options Hit Highs as Verleger Predicts 44% Plunge (Update1) - Bloomberg.com

More than 60 million barrels of fuel is stored on tankers offshore, according to the IEA.

“There’s all this heating oil with no place to go,” Philip Verleger, a professor at the University of Calgary and head of consultant PKVerleger LLC, said in a phone interview. “I’m fairly certain we’ll see prices in the $30s this year.”

Gold ETF

2009-09-16T05:31:00.000-07:00

Gold Rally Spurs a Boom in Funds - WSJ.com

Gold Rally Spurs a Boom in Funds
ETF or ETN. Long or Short. It's All There

Investors worried about inflation and the headwinds facing the global economy have been stuffing cash into gold exchange-traded funds.

SPDR Gold Shares (trading symbol: GLD), an ETF that holds more gold than many nations have in their reserves, has seen assets climb toward $35 billion, just shy of a record set in June.

And with the metal's price again flitting around $1,000 an ounce, investment managers are launching gold ETFs to capitalize on the rally.

"After falling to $700 in early November 2008, the price of gold is now retesting the $1,000 level," said Standard & Poor's global-investment-policy committee last week. "Should prices break strongly above the $1000-an-ounce area, we think prices could rise to the $1,200- to $1,500-ounce [range] over the next nine to 12 months."

Gold closed last week at $1,004, and closed Monday at $999.90.
A New Vehicle

U.S. investors got a new gold-tracking ETF last week amid the hoopla over prices cracking the key psychological barrier of $1,000.

ETF Securities Ltd. launched the ETFS Physical Swiss Gold Shares (SGOL) on the NYSE Arca exchange. Shares represent a 10th of an ounce of gold bars stored in Zurich.

The new ETF has a similar structure and fees to SPDR Gold Shares, its well-entrenched competitor that is sponsored by the World Gold Council. The key difference is that SPDR Gold Shares has its bullion stored in London.

"Investors have been asking us for a long time to develop a product that stores its gold in Switzerland," ETF Securities said. The ETF gives investors "a new way to invest in the gold market and an efficient way to geographically diversify their gold holdings," it added.

ETFS Physical Swiss Gold Shares has an expense ratio of 0.39%, compared with 0.4% for SPDR Gold Shares. Investors also have to pay broker commissions to buy and sell ETFs.

There are several exchange-traded funds and notes that provide exposure to precious metals. The iShares Comex Gold Trust (IAU) is another example of a gold ETF that holds the metal, but some other products are tied to futures contracts.

Commodity ETFs that use the derivatives markets have faced heat from regulators amid concern that they are fueling speculation in commodities. Low-cost, liquid ETFs have opened up commodities and other traditionally difficult-to-reach markets to mainstream investors. However, some say this increased access is contributing to market volatility.
Is GLD a Game Changer?

SDPR Gold Shares "changes the dynamics of the gold price, both to the upside and downside," said Vitaliy Katsenelson, director of research at Investment Management Associates Inc.

"If gold keeps climbing, the ease of buying will drive gold prices higher than in SPDR Gold Shares' absence," Mr. Katsenelson said. "In the event of a significant selloff, there are not enough natural buyers of physical gold. It is a bit like a roach motel -- easy to get in, hard to get out."

State Street Corp., the marketing agent for SPDR Gold Shares, disagreed with the characterization. The ETF "is listed and traded on the NYSE Arca which allows for a continuous two-way market for buyers and sellers of SPDR Gold Shares, much like any other listed equity," the company said.

Even with gold again around $1,000 an ounce, the SPDR Gold Shares fund, has traded above $100 a share only once, on St. Patrick's Day in 2008. On Monday, the five-year-old fund closed at $97.96.
Other Avenues

Investors looking for exposure to gold prices have several choices among ETFs and ETNs, including leveraged offerings and bearish funds that let investors bet against the precious metal.

The list includes E-TRACS UBS Bloomberg CMCI Gold ETN (UBG), PowerShares DB Gold Fund (DGL), PowerShares DB Gold Double Long ETN (DGP), ProShares Ultra Gold (UGL), PowerShares DB Gold Double Short ETN (DZZ), PowerShares DB Gold Short ETN (DGZ) and ProShares UltraShort Gold (GLL).

What went wrong?

2009-09-15T13:35:00.000-07:00

Wall Street’s Math Wizards Forgot a Few Variables - DealBook Blog - NYTimes.com

In the aftermath of the great meltdown of 2008, Wall Street’s quants have been cast as the financial engineers of profit-driven innovation run amok. They, after all, invented the exotic securities that proved so troublesome.

But the real failure, according to finance experts and economists, was in the quants’ mathematical models of risk that suggested the arcane stuff was safe, The New York Times’s Steve Lohr writes.

The risk models proved myopic, they say, because they were too simple-minded. They focused mainly on figures like the expected returns and the default risk of financial instruments. What they didn’t sufficiently take into account was human behavior, specifically the potential for widespread panic. When lots of investors got too scared to buy or sell, markets seized up and the models failed.

That failure suggests new frontiers for financial engineering and risk management, including trying to model the mechanics of panic and the patterns of human behavior.

“What wasn’t recognized was the importance of a different species of risk — liquidity risk,” Stephen Figlewski, a professor of finance at the Leonard N. Stern School of Business at New York University, told The Times. “When trust in counterparties is lost, and markets freeze up so there are no prices,” he said, it “really showed how different the real world was from our models.”

Gold Gold Gold

2009-09-08T05:20:00.000-07:00

China, Bernanke, and the price of gold - Telegraph Blogs

China, Bernanke, and the price of gold

By Ambrose Evans-Pritchard Economics Last updated: September 7th, 2009

55 Comments Comment on this article

China has issued what amounts to the “Beijing Put” on gold. You can make a lot of money, but you really can’t lose.

I happened to see quite a bit of Cheng Siwei at the Ambrosetti Workshop, a gathering of politicians and global strategists at Lake Como, including a dinner at Villa d’Este last night at which he listened very attentively as a number of American guests tore President Obama’s economic and health policy to shreds.

Mr Cheng was until recently Vice-Chairman of the Communist Party’s Standing Committee, and is now a sort of economic ambassador for China around the world — a charming man, by the way, who left Hong Kong for mainland China in 1950 at the age of 16, as young idealist eager to serve the revolution. Sixty years later, he calls himself simply “a survivior”.

What he said about US monetary policy and gold – this bit on the record – would appear to validate the long-held belief of gold bugs that China has fundamentally lost confidence in the US dollar and is going to shift to a partial gold standard through reserve accumulation.

He played down other metals such as copper, saying that they could not double as a proxy currency or store of wealth.

“Gold is definitely an alternative, but when we buy, the price goes up. We have to do it carefully so as not stimulate the market,” he said.

In other words, China is buying the dips, and will continue to do so as a systematic policy. His comment captures exactly what observation of gold price action suggests is happening. Every time it looks as if the bullion market is going to buckle, some big force steps in from the unknown.

Investors long-suspected that it was China. We later discovered that Beijing had in fact doubled its gold reserves to 1054 tonnes. Fait accompli first. Announcement long after.

Standing back, you can see that the steady rise in gold over the last eight years to $994 an ounce last week – outperforming US equities fourfold, even with reinvested dividends – has roughly tracked the emergence of China as a superpower in foreign reserve holdings (now $2 trillion).

As I have written in today’s paper, Mr Cheng (and Beijing) takes a dim view of Ben Bernanke’s monetary experiments at the Federal Reserve.

“If they keep printing money to buy bonds it will lead to inflation, and after a year or two the dollar will fall hard. Most of our foreign reserves are in US bonds and this is very difficult to change, so we will diversify incremental reserves into euros, yen, and other currencies,” he said.

This line of argument is by now well-known. Less understood is how much trouble the Fed’s QE policies are causing in China itself, where they have vicariously set off a speculative boom on the Shanghai exchange and in property. Mr Cheng said mid-level house prices are now ten times incomes.

“If we raise interest rates, we will be flooded with hot money. We have to wait for them. If they raise, we raise.”

“Credit in China is too loose. We have a bubble in the housing market and in stocks so we have to be very careful, because this could fall down.”

Of course, China cold end this problem by letting the yuan rise to its proper value, but China too is trapped. Wafer-thin profit margins on exports mean that vast chunks of Chinese industry would go bust if the yuan rose enough to close the trade surplus. China’s exports were down 23pc in July from a year before even at the current exchange rate, and exports make up 40pc of GDP. “We have lost 20m jobs in this crisis,” he said.

China’s mercantilist export strategy has led the country into a cul-de-sac. China must continue to run its trade surplus. It must accumulate hundreds of billions more in reserves. Ergo, it must buy a great deal more gold.

Where is the gold going to come from?

No more paper

2009-09-05T06:25:00.000-07:00

Gmail - The Elements of Deflation - John Mauldin's Weekly E-Letter - pguenechea@gmail.com

But one last thought, as I have had a lot of questions on gold recently. "Isn't gold telling us that inflation is coming back?" The answer is no. Since the early '80s the correlation between gold and inflation has dropped to zero. Gold has had very little to say in the last 30 years about inflation.

But what it may be saying is that paper currencies are a problem. Gold is going up not only in dollar terms, but in euros, pounds, yen, and more. My view is that gold should be seen as a neutral currency. The dollar is the worst currency in the world, except for all the others. Is it possible the Fed will not respond and print more money next year? Sure. And the dollar could rise as deflation kicks in. The only time we saw the purchasing power of the dollar rise in a sustained manner was during deflation, in the last century.

The race is not always to the swiftest or the fight to the strongest, but that's the way to bet. And right now, my bet is the Fed will print money to fight a double-dip recession and deflation. And gold would be one way to play that bet.

Double dip

2009-09-04T06:19:00.000-07:00

Stiglitz Says U.S. Economic Recovery May Not Be ‘Sustainable’ - Bloomberg.com

Stiglitz Says U.S. Economic Recovery May Not Be ‘Sustainable’
By Michael McKee

Sept. 4 (Bloomberg) -- The U.S. economy faces a “significant chance” of contracting again after emerging from its worst recession since the 1930s, Nobel Prize-winning economist Joseph Stiglitz said.

“It’s not clear that the U.S. is recovering in a sustainable way,” Stiglitz, a Columbia University professor, told reporters yesterday in New York.

Economists and policy makers are expressing concern about the strength of a projected economic recovery, with Treasury Secretary Timothy Geithner saying two days ago that it’s too soon to remove government measures aimed at boosting growth.

Stiglitz said he sees two scenarios for the world’s largest economy in coming months. One is a period of “malaise,” in which consumption lags and private investment is slow to accelerate. The other is a rebound fueled by government stimulus that’s followed by an abrupt downturn -- an occurrence that economists call a “W-shaped’ recovery.

“There’s a significant chance of a W, but I don’t think it’s inevitable,” he said. The economy “could just bounce along the bottom.”

Stiglitz said it’s difficult to predict the economy’s trajectory because “we really are in a different world.” He said the crisis of the past year was made worse by lax regulation that allowed some financial firms to grow so large that the system couldn’t handle a failure of any of them.

Big Banks

“These institutions are not only too big to fail, they are too big to be managed,” he said.

Finance ministers and central bankers from the Group of 20 nations meet in London Sept. 4-5 to lay the groundwork for a summit in Pittsburgh later this month, where leaders will consider measures to overhaul supervision of the financial system.

The U.S. Treasury Department, in a statement yesterday, said it wants a global agreement requiring banks to increase their capital cushions to be reached by the end of next year.

Stiglitz, 66, said that while $787 billion in federal government stimulus is propelling growth this quarter, there’s no guarantee the economy will maintain its momentum. On whether the U.S. needs another injection of stimulus, Stiglitz said it’s best to “wait and see.”

“We did have a very big stimulus, and that stimulus has added to economic growth and will be adding in the current quarter,” he said. “But the question going forward in 2011 is the stimulus is coming off, and that’s a negative.”

Lehman’s Collapse

A U.S. government bailout of Lehman Brothers Holdings Inc., which filed for bankruptcy a year ago, wouldn’t have prevented the global economy from sliding into a recession, Stiglitz said.

“Whether Lehman Brothers had or had not been bailed out, the global economy was headed for difficulties, a fact that seems increasingly evident as the world sputters in its recovery,” he said.

U.S. GDP shrank at a 1 percent annual rate from April to June, following a 6.4 percent pace of contraction in the first three months of the year.

The drop was the fourth in a row, the longest contraction since quarterly records began in 1947. The world’s largest economy has shrunk 3.9 percent since last year’s second quarter, making this the deepest recession since the Great Depression.

Stiglitz won the Nobel Prize in economics in 2001 for showing that markets are inefficient when all parties in a transaction don’t have equal access to critical information, which is most of the time.

Unused Capacity

With so much excess capacity, the American economy faces a short-term threat of disinflation and possibly deflation, Stiglitz said. Wages may even decline, given recent high productivity and the likelihood of an extended period of high unemployment, he said.

Longer term, he said the Fed’s aggressive monetary policy will mean inflation becomes the greater threat. “With the magnitude of the deficits and the balance sheet of the Fed having been blown up, it’s understandable why there are anxieties about inflation,” he said.

While the Fed says it has the tools to deal with it, there are still concerns, Stiglitz said. Because monetary policy takes six to 18 months to have its full effect, the central bank will have to begin withdrawing monetary stimulus on the basis of forecasts.

The Fed’s record on its economic forecasts isn’t enough to reassure investors and, as a result, the U.S. currency may suffer, he said.

Dollar ‘Weakness’

“Whether or not they’re able to do it, the uncertainty today about whether they can do it can contribute to the weakness of the dollar,” Stiglitz said. “That’s one of the reasons there is increasing interest around the world in discussing alternatives to the dollar system.”

Stiglitz, who is a member of a United Nations commission that will study the global financial system and currency regimes, said “the logic is compelling” for a new global currency.

The current system creates instability, weakens global confidence, and is fundamentally unfair to developing countries that are in essence lending the U.S. trillions of dollars and bearing the risk, he said.

“In most quarters, there is a feeling we should move away from the dollar system. The question is do we do it in an orderly way, or a chaotic way,” Stiglitz said. “The size of the deficit and the size of the balance sheet of the Fed have just increased the anxiety and the desire that something be done.”

While some think it would hurt the U.S. to no longer be able to borrow cheaply in dollars, “that era is over,” he said. “We’re moving to a more multi-polar world.”

Between the fall of the Berlin Wall and the collapse of Lehman Brothers was “the short period of American triumphalism, where we dominated the global scene. That period is over,” Stiglitz said.

Gold is coming

2009-09-03T06:15:00.000-07:00

FT Alphaville » Blog Archive » What’s driving paper gold?

What’s driving paper gold?
Posted by Izabella Kaminska on Sep 03 12:54.

Gold madness is under way, and no one — as far as we can tell — has a good explanation as to why:
Gold - FT

Here are some observations and views we’ve come across:

* MF Global noted a potential knock-on effect from the soon-to-be closed DB double long crude oil fund, as money is reinvested into gold.

* MF Global, however, also said the best explanation they had heard was of possible buying by a central bank.

* We noted, gold lease rates (LIBOR-GOFO) are still negative. On September 2 the lease rate came in at -0.03419 and on September 3 it came in at -0.04116.

* Dennis Gartman of the Gartman Letter — who is not a goldbug — last week alerted readers to some important technical resistance factors in euro-and sterling-denominated gold.

* We noted the IMF’s $250bn SDR injection took place last Friday, meaning there’s an extra $250bn worth of paper that can be exchanged into freely available dollars, yens, euros and sterling by central banks around the world. Would they use the money to beef up their gold reserves?

* Barcap put out a technical note on Wednesday saying gold was on the verge of resuming its bull trend. As they wrote:

Historically, the time is ripe for a sustained advance, as recent bull trends have occurred in odd numbered years, with the breakouts occurring during September. Indeed, September is the strongest month of the year from a seasonal perspective. With price action unfolding in terms very similar to 2005 and 2007, we look for higher gold over the next several quarters in both dollar and euro terms.(Click to enlarge)
Barcap on gold technicals
And then there’s what Dennis Gartman had to say on Thursday, which strikes us as particularly noteworthy (our emphasis):THE DOLLAR IS WEAK and although it is not violently so, it is weak relative to nearly all of its major and minor trading partners, and it is particularly so relative to gold. Indeed, perhaps the most important comment we can make relative to the forex market… and relative to nearly all capital markets generally… this morning is that there is growing disdain for currencies generally and there is growing enamourment of gold as the most important ‘currency” of all. We are not Gold Bugs here at TGL. That is rather obvious, for on balance we’ve long subscribed to the Keynesian notion that gold is indeed a “barbarous relic.” We’ve been disdainful of the Gold Bugs during our entire career, seeing most of them as gun-toting, canned-food hoarding, doomsday-awaiting crotchety old geezers with little good to say about society generally, and much bad. However, with the advent of the spending, entitlement and tax programs being put forth by the current Administration, and with the same sorts of tax/spend programs being embraced so fully abroad, gold’s become the third reservable currency after the US dollar and the EUR, and it is swiftly on its way to becoming the 2nd.The tectonic plates of the global economy shifted rather vividly yesterday when gold soared to the upside and did so not just in terms of the US dollar, but in terms of every currency everywhere. It was as if the flood gates had spilled open and a torrent of buying of gold along with a torrent of selling of dollars, of sterling, of EURs, of Yen, of rupees, of rubles and of Renminbi hit the market.Perhaps this was, as some have tried to explain it away, a result of the less-than-liquid market conditions that prevail as the summer is ending and as the dealing rooms around the world are manned by less-than-full compliments of senior traders. We have argued this case ourselves, having warned our readers/clients and friends around the world of being too active and taking too large positions at this time of the year, preferring to await the return of liquidity that should mark next week’s activity. But that having been said, we cannot discount the seriousness… the violence… the material nature of the moves in favour of gold yesterday across the forex spectrum.Something more than mere illiquidity was and is at work in the gold market, and despite our antipathy toward this “barbarous relic,” attention really must be paid.And that’s the interesting thing: gold has suddenly soared not just in terms of the US dollar, but in terms of every currency everywhere. As the FT’s commodities correspondent noted to us, that comes despite a lack of physical demand.
In which case, perhaps it can be down to that special-drawing-right liquidity injection after all. The SDR wasn’t called paper gold for nothing.

MS: From Inflation Targeting to Price Level Targeting?

2009-08-31T08:47:00.001-07:00

Morgan Stanley - Global Economic Forum

Global
From Inflation Targeting to Price Level Targeting?
July 16, 2009

By Joachim Fels & Spyros Andreopoulos | London

Tougher times for inflation targeters: Over the past two decades, inflation targeting has become the holy grail of modern central banking. Most central banks have adopted some form of inflation target and have set interest rates mainly with a view to stabilising inflation around that target over the medium term. However, the recent experience poses a major challenge for inflation-targeting central banks, for two reasons:

• First, the wild gyrations of commodity prices and the boom-bust credit and economic cycle have caused big swings in inflation. Only a year ago, actual inflation was way above most central banks' targets; now it is far below in most cases. This has contributed to rising uncertainty about the longer-term inflation outlook, as illustrated by more volatile market-implied inflation expectations and by a much greater dispersion of economists' inflation forecasts.

• Second, the asset price bubble and bust has been a useful reminder that stabilising consumer price inflation does not automatically stabilise asset prices. On the contrary, as we have argued repeatedly over the years, by focusing too narrowly on consumer prices, which were kept low for a long time by non-monetary factors such as globalisation, deregulation and IT-led productivity increases, central banks fostered asset price inflation by keeping interest rates too low for too long. Looking ahead, many central banks are thus likely to pay more attention to asset prices in setting monetary policy. This, in turn, may lead to bigger and longer-lasting deviations of inflation from target and thus constitutes a challenge to the credibility of their inflation targets (see "The Morning After", The Global Monetary Analyst, April 1, 2009).

Move to price level targeting would make sense to us: Despite its shortcomings, it would be risky to abandon inflation targeting altogether. A better solution, in our view, would be to modify the existing approach and move from inflation targeting (IT) to price level targeting (PT). Under price level targeting, the central bank aims at a certain path for the price level, with the rate of increase in the price level given by the inflation target. So what's the difference, and why does it matter?

Introducing ‘memory' into inflation targeting: In the case of IT, there are no consequences if the central bank misses its inflation target in one period. Past errors will not be corrected but, at each point in time, the central bank will set the policy rate such that the inflation target is achieved over the next period. Thus, inflation outcomes above or below the average would simply be followed by average inflation. As a result, the price level drifts away from the level implied by the inflation target over time.

With PT, on the other hand, past deviations from the price level target would have to be compensated for in the future in order to return to achieve the target in the medium term. Above-average inflation in one period would have to be followed by below-average inflation in the following period(s).

So PT is like pursuing an inflation target over a longer time horizon, which is why PT is sometimes called ‘average inflation targeting'. And that is how PT could be explained to the public. The central bank's aim would now be to hit the inflation target ‘on average' over a series of years. Overshoots would have to followed by undershoots and vice versa.

PT would help to stabilise long-term inflation expectations: The major advantage of PT is that, if credible, long-term inflation expectations are actually more stable than under IT. During the Gold Standard, which implicitly was a price level-targeting regime, the long-run price level was given by the quantity of gold in the international monetary system. Periods of inflation were followed by periods of deflation because there was a built-in automatic stabiliser, and the price level was stable over the long term. And PT would, if pursued consistently, enhance central bank credibility: monetary policymakers would now be more immediately accountable for past errors - they would have to respond to them directly. Greater accountability would, in turn, increase credibility.

Academic? We think that at the current juncture, this advantage of PT would be particularly useful for central banks, for three reasons:

• Central banks may in future want to - at least occasionally - lean against the wind with respect to asset prices, following the experience with the credit and house price boom-bust. This would probably imply larger and/or longer deviations from the inflation target (see our piece from April 1, 2009, cited above). PT would allow monetary authorities greater flexibility in occasionally responding to asset prices without unanchoring inflation expectations, because they would have committed themselves to correcting deviations from the target at a later stage.

• PT is more helpful at the zero lower bound for interest rates. Under IT, when actual inflation falls below target or even becomes negative, inflation expectations would also fall. But lower inflation expectations would increase real interest rates, while the economy may need stimulus through lower real interest rates. With PT, on the other hand, near-to medium-term inflation expectations would automatically increase, since the public would expect the undershoot in inflation now to be compensated by a later overshoot. Hence inflation expectations act as an automatic stabiliser under PT. (See, for example, Riksbank Deputy Governor Svensson's speech: Monetary Policy with a Zero Interest Rate.)

• PT would also be helpful over the next few years, if inflation were to rise above target but central banks were reluctant to raise interest rates because of fragility in the financial sector or the real economy. With PT, an overshoot of inflation over the target would, rather than being an embarrassment for central banks, be a desired (indeed necessary) correction for the undershoots of the recent past. We looked at the path for the US price level (measured by headline CPI and PCE, respectively) starting from September 2008, the peak of the financial crisis. In the short and medium term (using our US team's forecasts out to 4Q10), the price level is below the level implied by a 2% PCE inflation target. In order to catch up from the 4Q10 level to the level implied by the inflation target by 4Q12, a 3.6% average annual inflation rate between 4Q10 and 4Q12 would be required. Thus, any overshoot would merely be a return to the medium term target level.

Having one's cake and eating IT: To summarise, adoption of PT would potentially allow central banks to deviate from their inflation targets without putting their credibility at stake: they could have their cake and eat it.

Not a popular concept...yet: With so many advantages of PT over IT, why hasn't it been adopted widely already? In fact, there are very few examples of central banks adopting PT or something resembling it. The only country that adopted an explicit price level target was Sweden from 1931 to 1937 (see C. Berg, L. Jonung, "Pioneering Price Level Targeting: The Swedish Experience 1931 - 1937", Journal of Monetary Economics, Vol 43, 1999). Today, the Reserve Bank of Australia probably comes closest to a (somewhat vague) price level target by stipulating that it aims to keep inflation at 2-3% "on average over the cycle". Probably the main reason why PT hasn't been adopted more widely is that a central bank that is targeting a path for the price level would spend approximately half of its time trying to deflate or disinflate the economy. It is easier to let bygones be bygones and start from scratch each period. But here's the catch: with inflation now having fallen significantly below target in many countries, by adopting a price level target with a starting point in, say, the middle of last year, central banks could spend the next few year inflating their economies and sell this as being part and parcel of a credible price level-targeting strategy. Given the fragile state of the global economy and the financial system, this prospect may look quite appealing to some. Stay tuned.

Inflation Targeting vs Price Level Targeting

2009-08-31T08:44:00.000-07:00

RGE Monitor

Overview

In a July 16, 2009, report, Morgan Stanley (MS) asserts that the pre-crisis period showed that "stabilizing consumer price inflation does not automatically stabilize asset prices. On the contrary." Moreover, the OECD notes that several nations have hit the zero bound of nominal interest rates, which highlights the shortcomings of the low-inflation-targeting framework. Among the possible options to reduce the downside risks of deflation are increasing inflation targets and "target[ing] a price level path instead of an inflation rate because a credible price-level targeting regime can practically eliminate the risk that policy rates may be constrained by the zero floor" (June 24, 2009).

Too Much Debt and Leverage
* Anja Hochberg, Credit Suisse: "The carefree granting of credit to consumers and the interest in securitized loans on the investor side were phenomena that could only have occurred under specific conditions: a long period of historically low interest rates." (August 18, 2009)
* Daniel Gros, Stefano Micossi, Jacopo Carmassi (Vox-EU): "Without lax money and excessive leverage, reckless bets on asset price increases would have been much reduced. A repeat of this instability could be avoided in the future by correcting those two policy faults. By and large, there is no need for intrusive regulatory measures constraining non-bank intermediaries and innovative financial instruments." (August 13, 2009)
* Jan Schildbach (Deustsche Bank): "Banks' net interest income has been boosted for the past 30 years by a structural decline in interest rates that fueled an exceptional lending boom. Falling interest rates are beneficial for banks as the pass-through of interest rate changes differs on the asset and liability side of the balance sheet."
* Hyun Song Shin, Tobias Adrian (Princeton U./NY Fed): "Aggregate liquidity can be seen as the rate of change of the aggregate balance sheet of the financial intermediaries. We document evidence that marked-to-market leverage is strongly procyclical as financial institutions seem to target a fixed leverage ratio throughout the cycle."
* Nassim Nicholas Taleb and Mark Spitznagel, Universa Investments: "The core of the problem, the unavoidable truth, is that our economic system is laden with debt, about triple the amount relative to GDP that we had in the 1980s. The only solution is the immediate, forcible and systematic conversion of debt to equity. There is no other option." (FT; July 13, 2009)
* Keiichiro Kobayashi: "The existing theoretical structure of macroeconomics is incapable of addressing macroeconomic performance and the stability of the financial system in an integrated context." The author proposes a paradigm shift. See also Luigi Spaventa, CEPR, reaching similar conclusions.
* see also the evolving Tobin Tax debate set in motion by the FSA's Adair Turner.

Higher Inflation Target?
* Thomas Palley, Director of the Globalization Reform Project, Open Society Institute: Financial innovation and deregulation increase the elasticity of private money creation. The optimal monetary policy and financial stability framework in this setting includes two components. One is an inflation target at the Minimum Unemployment Rate of Inflation (MURI), somewhere between 2% and 5% instead of an a priori "low" level based on the Non-Accelerating Inflation Rate of Unemployment (NAIRU) framework. The second are countercyclical, asset-based reserve requirements that prevent the build-up of credit overextension in the first place (off-balance-sheet items need to be taken into account.) Both MURI and NAIRU are unobservable, but the MURI concept errs on the side of steering clear of deflation traps in the face of easy debt creation, whereas the NAIRU concept errs on the side of structural unemployment and a permanent demand deficit trap--the flip-side of "awash with liquidity" (see the July 19, 2009, Joseph Stiglitz lecture). See Liquidity Trap Revisited.
* Stephen Cecchetti, BIS Chief Economist: Adding "leaning against the wind" and macro-prudential systemic risk provisions in monetary policy "does not mean forsaking central banks’ price stability objectives, as it is not aimed at changing long-term targets or goals." (July 17, 2009) See Systemic Risk Supervision around the World

Price Level Targeting
* FT: "Under a price-level target regime, rather than aiming for an annual inflation rate of 2%, for example, a central bank would target a CPI index of 100 in the first year, 102 in the second year, 104 in the third and so on. While inflation targeting is forward looking and does not attempt to correct for past undershoots or overshoots, a price-level target takes into account past performance–so if the central bank overshoots its target one year it will aim to undershoot in subsequent years in order to bring the price index back on track, and vice versa." (August 26, 2009)
* Joachim Fels & Spyros Andreopoulos, MS: "The major advantage of PT is that, if credible, long-term inflation expectations are actually more stable than under IT. During the Gold Standard, which implicitly was a price level-targeting regime, the long-run price level was given by the quantity of gold in the international monetary system. Periods of inflation were followed by periods of deflation because there was a built-in automatic stabilizer, and the price level was stable over the long term." (July 16, 2009)
* see Will Inflation Targeting Give Way to Price Level Targeting?

Aug 29, 2009
Associated Readings (18 Articles)

Triple time-inconsistent policies

2009-08-31T05:58:00.000-07:00

Triple time-inconsistent policies: "Guillermo Calvo, 31 August 2009

This column introduces 'triple time-inconsistent' episodes. First, a public institution is expected to cave in and offer a bailout to prevent a crisis. Then, in an attempt to regain credibility, it pulls back. Finally, it resumes bailing out the survivors of the wreckage caused by the policy surprise. This column characterises the 1998 Russian crisis and the current crisis as triple time-inconsistency episodes and says that a financial crisis may simply be a bad time to try to build credibility.

Full Article: Triple time-inconsistent policies"

Fear of appreciation in emerging economies

2009-08-29T06:44:00.000-07:00

Fear of appreciation in emerging economies: "Andrea Kiguel, Eduardo Levy-Yeyati, 29 August 2009

After a crisis-induced hiatus, the exchange rate landscape seems to be moving back to a situation that resembles 2007. This column says that fear of appreciation is part of a leaning-against-the-wind exchange rate policy that promises to be the norm for emerging economy currencies for years to come. That may pose difficulties for global rebalancing.

Full Article: Fear of appreciation in emerging economies"

Westfield Results Demonstrate Decline In U.S. Mall Market

2009-08-26T05:05:00.000-07:00

Westfield Results Demonstrate Decline In U.S. Mall Market: "

Westfield, the world's largest mall operator, announced results earlier today, which demonstrated substantially accelerating real estate writedowns, primarily in the US. For the six month period ended June 30, Westfield announced $2.5 billion in property revaluations, after posting $2.6 billion in comparable charges for the entire 2008 year period: the company is finally marking its asset book to something vaguely resembling reality.

As a result of deteriorating operations, the company also announced it would reduce its dividend payout from 100% of earnings to 75%, in anticipation of a liquidity crunch resulting from over $19 billion in debt maturing between 2010 and 2014.

Other notable data: U.S. retail sales on a per square foot basis declined by 6.2% from $437 to $410 just over the past six months, and by 10.8% from June 2008: the worst deterioration of any of the company's regional properties.

Furthermore, cap rates have increased by over 0.3% across Westfield's four regions over the last 6 months, with the U.S. surprisingly representing the highest end range.

Also, notably the weakest retail categories were jewelry, fashion and leisure, all of which declined by over 10% year over year.

Net-net: the news that the deterioration in the U.S. mall market shows no indication of abating, and rent capacity is substantially deteriorating, not only for the company's 8,889 US malls, but for bankrupt GGP and its competitors, will likely be sufficient reason for other garbage REITs with deteriorating performance metrics to see their stocks jump once again for no other reason aside from... well, no other reason, which seems to be same principle that drives stock trading each and every day in all other garbage sectors.

NY Fed Launches Interactive Maps Of Economic Collapse

2009-08-24T16:38:00.000-07:00

NY Fed Launches Interactive Maps Of Economic Collapse: "

The kind folks at the New York Fed have launched a useful service whereby citizens can look at the collapse of the credit economy in real, interactive time as they buy Fannie, Freddie and Citi stock (which at last check had a pro forma market cap higher than Bank of America).

The link for the maps can be found here in case anyone needs ongoing confirmation of the prevlance of red shoots.

At first glance, it seems that delinquent auto loans is where much more red is still due, while the bloodletting in mortgages has reached quite epic proportions and shows no sign of abating.

The charts below demonstrate the year over year deterioration across four key credit verticals:

Auto Loan Delinquency Rate 60 + Days:

Bank Card Delinquency Rate 60 + Days:

Mortgage Delinquency Rate 90 + Days:

Student Loan Delinquency Rate 90 + Days:

For the full interactive charts, don't be shy and check out the Fed's website.

No way out

2009-08-13T06:13:00.000-07:00

Federal Reserve Has No Strategy to Unwind Easy Monetary Policy - WSJ.com

We're beginning to wonder if the Ben Bernanke Federal Reserve isn't populated with French existentialists. A la Jean-Paul Sartre, they have a "no exit" strategy when it comes to unwinding their extraordinarily easy monetary policy. At least they gave no signs of restraint in yesterday's statement after their August Open Market Committee meeting, keeping short-term interest rates close to zero and again promising to maintain current policy for an "extended period."

The Fed is keeping the money pumping even though it also conceded that "economic activity is leveling out," which is an acknowledgment that the recession is all but over. This policy is justified, the FOMC statement said, because the economy still has "substantial resource slack" that will keep cost pressures under countrol "for some time." Unsaid by the Fed, but understood by everyone, is that Mr. Bernanke isn't about to tighten money while he's still auditioning for re-appointment to a second four-year term as Chairman. Fed chiefs who tighten money tend to be unpopular with Wall Street and the political class, though not with the middle class.

The one hint of discipline was the Fed's suggestion that it won't expand its program to buy $300 billion in Treasury debt. The Fed will stretch out its purchases for an additional month into October, but this is probably to reduce the chance of market disruptions when it stops its purchases. The good news here is that the Fed seems to be admitting that this decision to directly monetize the national debt by buying long-end Treasurys was a mistake. It failed to keep rates down and may even have helped increase them as holders of U.S. debt wondered about the Fed's independence from the politicians at Treasury and on Capitol Hill.

Overall, though, the Fed's policy is to keep pressing the money accelerator to the floor. We agree it's hardly time to put the brakes on. But the Fed would be wiser to at least begin slowing to, say, 160 miles per hour from its present Indy car speed of 200 mph. It's a lot safer to slow down gradually than have to screech to a halt to avoid another asset bubble.

Faber and Roubini

2009-08-13T06:09:00.000-07:00

Nouriel Roubini: Risk of Double-Dip Recession Not Quite Past Yet - Economy * Europe * News * Story - CNBC.com

"My view is that the Fed and the other central bankers will leave interest rates far too low and far too long," Faber said.

Farmland price decline in the USA

2009-08-06T05:00:00.000-07:00

Calculated Risk: Farmland Values Decline

From the WSJ: Farm Real-Estate Values Post Rare Drop

The U.S. Agriculture Department said in its annual report that the value of all land and buildings on U.S. farms averaged $2,100 an acre Jan. 1, down 3.2% from last year. The decline in farm real-estate values was the first since 1987, the agency said.

The Chicago Fed had a similar report a couple of months ago: Farmland Values and Credit Conditions

There was a quarterly decrease of 6 percent in the value of “good” agricultural land—the largest quarterly decline since 1985—according to a survey of 227 bankers in the Seventh Federal Reserve District on April 1, 2009. Also, the year-over-year increase in District farmland values eroded to just 2 percent in the first quarter of 2009.

And here was a graph I posted in May based on the Chicago Fed report:

Farmland Prices Click on graph for larger image in new window.

This graphs shows nominal and real farm prices based on data from the Chicago Fed.

In real terms, the current increase in farm prices wasn't as severe as the bubble in the late '70s and early '80s that led to numerous farm foreclosures in the U.S.

And as I noted in the earlier post, it was not surprising that John Mellencamp wrote "Rain On The Scarecrow" in 1985 after the farm bubble burst.

Yuan growing fast very fast

2009-08-03T05:51:00.000-07:00

China moves to internationalise its currency - Times Online

China moves to internationalise its currency
Leo Lewis, Asia Business Correspondent

China is rapidly accelerating its efforts to internationalise its currency with a series of manoeuvres that could see the renminbi soar to become one of the top three traded monetary units in the world.

By 2012, say analysts in Shanghai, as much as $2 trillion (£1.69 trillion) worth of trade flows may be settled using the “redback” as China stretches its commercial tentacles throughout the commodity-producing world and the emerging economies of Asia, Latin America and the Middle East.

The radical change in attitude may arise from a desire to protect China from the “dollar trap” — the problem that emerges when exporting countries are effectively forced to shovel large chunks of their reserves into the US treasury and suffer the consequences in times of high volatility.

The rising financial power of the renminbi may also prove to be the salvation of Hong Kong in its intensifying rivalry with Shanghai for international relevance.

The former British colony, say economists at Barclays Capital, may be able to secure its status as a premier global financial hub by rebranding itself as China’s offshore renminbi banking centre. Renminbi internationalisation is essential if Hong Kong “is to have any long-term hope of being like London or New York,” according to the bank.

Political analysts believe full international currency status for the renminbi could take some time to become politically acceptable to the full spectrum of views within the Communist Party, warning that there would be significant policy hurdles surrounding the perceived loss of currency control.

However, China’s soaring economic growth and global financial turmoil could be pushing the process ahead faster than the market expects. Recent measures, including currency swap agreements with several central banks and the allowing of renminbi-denominated crossborder trade, have significantly changed the environment, HSBC said in a research note.

If, as some predict, China overtakes Japan to become the world’s second biggest economy next year, the pressure for the renminbi to internationalise will mount faster. Wensheng Peng, chief China economist at Barclays Capital, believes that market turmoil and the Wall Street crisis has changed the terms of a debate on the renminbi that has been brewing for years.

“The global financial crisis, and along with it increased concern from the Chinese perspective on the reliance of the global monetary system on the US dollar has brought to the fore the importance of increasing the use of the renminbi in international trade and finance,” he said.

A consensus among policymakers has grown from the grudging acceptance that one of the fundamental reasons the country has fallen into the dollar trap is that China’s currency is not international and the global crisis has made the dollar less predictable.

Others believe that raw economic growth makes the globalisation of the renminbi inevitable. “If the history of sterling and the dollar’s ascendancies as international currencies are any guide, said Hongbin Qu, HSBC’s chief China economist, the internationalisation of the renminbi is “long overdue” because of China’s rising economic power relative to the limited use of the renminbi overseas.

Most significant are the policy gambits in the past few months as the global financial crisis has given motive and opportunity for Beijing to test out renminbi internationalisation. China has signed bilateral currency swap agreements with Korea, Malaysia, Indonesia, Belarus and Argentina worth 650 billion renminbi (£57 billion). Last month, China selected five mainland cities — accounting for 45 per cent of the country’s foreign trade — that can trade with Hong Kong and Macau in renminbi. The programme, said Mr Qu, could be rolled out to cover all of China’s trade with Asia except Japan.

OK

2009-08-03T05:48:00.001-07:00

Dr. Doom Sees Double-Dip Recession Risk, in Remarks Down Under - Real Time Economics - WSJ

By WSJ Staff

By Elisabeth Behrmann

Advanced economies are showing signs of bottoming in response to massive financial and fiscal government stimulus but the global economy will stay in a recession until the end of the year, U.S. economist Nouriel Roubini said Monday in Kalgoorlie, Australia.
roubini20090803_E_20090803035728.jpgBloomberg News/Landov
Nouriel Roubini delivers the keynote address at the Diggers and Dealers Mining Forum in Kalgoorlie, Australia, on Monday

His comments came a day after Alan Greenspan said in an ABC interview that he is “pretty sure we’ve already seen the bottom” and that “Collapse now, I think, is off the table.”

In Roubini’s remarks, he predicted the global economy would contract by 2% in 2009, staying in a recession until the end of the year, but would grow by 2%-3% next year, he said.

That will offer a boon to commodity prices, which should trend higher from current levels but still run the risk of a correction should the global recovery surprise on the downside.

“In addition to the green shoots, we see worrying signs. There’s a risk of relapse, of a double-dip recession in the second half of next year,” Roubini said, tipping U.S. house prices to contract another 13% next year, on top of a drop in prices of 27% since their highs in 2006.

With the U.S. still the world’s largest economy by far, consumption trends will be key for the global recovery, and signs from labor markets and the outlook for consumer demand remained worrying, he said.

He said he expects U.S. unemployment to rise further to reach 11% next year - unemployment had reached 9.5% in June - and that, while the labor market continued to show signs of severe weakness, the U.S. consumer would remain ’shopped out’ and keen to increase the rate of household savings.

With the global economy tipped to recover next year, commodity prices should benefit and trend higher. However, there’s a risk of correction should that recovery surprise on the downside, while waning Chinese restocking and strategic inventory builds during the second half of this year should take some steam out of commodity markets. Turning to record levels of Chinese bank lending during the first half of this year, Roubini said he wasn’t concerned about a financial crisis on the scale of the U.S. crisis happening in China, but said that excessive liquidity was wasteful and ultimately damaging to the economy. The Chinese government’s stepping up bank lending was necessary but it’s time for the excessive lending to be scaled back, Roubini told reporters.

Devil itself

2009-07-03T06:57:00.000-07:00

The Great American Bubble Machine : Rolling Stone

From Matt Taibbi's "The Great American Bubble Machine" in Rolling Stone Issue 1082-83.

Fast-forward to today. It's early June in Washington, D.C. Barack Obama, a popular young politician whose leading private campaign donor was an investment bank called Goldman Sachs — its employees paid some $981,000 to his campaign — sits in the White House. Having seamlessly navigated the political minefield of the bailout era, Goldman is once again back to its old business, scouting out loopholes in a new government-created market with the aid of a new set of alumni occupying key government jobs.

Gone are Hank Paulson and Neel Kashkari; in their place are Treasury chief of staff Mark Patterson and CFTC chief Gary Gensler, both former Goldmanites. (Gensler was the firm's co-head of finance.) And instead of credit derivatives or oil futures or mortgage-backed CDOs, the new game in town, the next bubble, is in carbon credits — a booming trillion- dollar market that barely even exists yet, but will if the Democratic Party that it gave $4,452,585 to in the last election manages to push into existence a groundbreaking new commodities bubble, disguised as an "environmental plan," called cap-and-trade. The new carbon-credit market is a virtual repeat of the commodities-market casino that's been kind to Goldman, except it has one delicious new wrinkle: If the plan goes forward as expected, the rise in prices will be government-mandated. Goldman won't even have to rig the game. It will be rigged in advance.

Food prices

2009-07-03T06:42:00.000-07:00

World food prices: Whatever happened to the food crisis? | The Economist

On the face of things, markets last year were adjusting exactly as economic theory predicts they should: prices rose, drawing investment into farms; supplies then rose sharply, pushing prices down. But that was not the whole story. The price fluctuations of 2007-09 suggested that uncertainty in the world of agriculture was deepening under the influence both of oil prices and capital flows. The fact that prices are still well above their 2006 average, even in a recession, suggests that the spike of 2008 did not signal a mere bubble—but rather, a genuine mismatch of supply and demand. And this year’s price increase suggests that there is a long way to go before that underlying mismatch is eventually addressed. “I don’t see that anything has fundamentally changed,” says Mr Abbassian. “That means we cannot go back to where we were in 2007.”

McAmerica by PIMCO

2009-07-02T05:29:00.000-07:00

PIMCO - Investment Outlook July 2009 Gross Appetit

Our economy’s lights, if not switched off in a rehash of the 1930s Depression, have certainly been dimmed in a 21st century version likely to be labeled the Great Recession. Much like John McSherry, U.S. and many global consumers gorged themselves on Big Macs of all varieties: burgers to be sure, but also McHouses, McHummers, and McFlatscreens, all financed with excessive amounts of McCredit created under the mistaken assumption that the asset prices securitizing them could never go down. What a colossal McStake that turned out to be. Now, however, with financial markets seemingly calmed and an inventory-based recovery in store for the balance of 2009, there is a developing optimism that we can go back to the lifestyle of yesteryear. PIMCO’s driving thesis however, if not a juxtaposition, is succinctly described as a “new normal” where growth is slower, profit margins are narrower, and asset returns are smaller than in decades past based upon the delevering and reregulating of the global economy, which in turn should substantially inhibit the “gorging” of goods and services that we grew used to in decades past.

Fed´s exit strategy

2009-06-24T18:37:00.000-07:00

RGE Monitor

The Fed's aggressive monetary easing has led to a sharp rise in money supply. This has sparked concerns of high inflation should the Fed fail to roll back easing once an economic recovery is underway. The Fed may be afraid to tighten monetary policy too early and kill the recovery. In the medium-term, deflationary pressures will most likely outweigh inflationary pressures. But in the longer-term, will the Fed be able to exit from balance sheet expansion in time to avoid breeding high inflation, particularly asset bubbles?

Exit strategies from the Fed's credit crisis intervention programs:
# 1) Wait for demand to wane: Many Fed lending programs extend credit primarily on a short-term basis and thus could be wound down relatively quickly. In addition, since the lending rates in these programs are typically set above the rates that prevail in normal market conditions, borrower demand for these facilities should wane as conditions improve. (Bernanke)
# 2) Reverse repo or sale of securities: The Fed can conduct reverse repurchase agreements against its long-term securities holdings to drain bank reserves or, if necessary, it could choose to sell some of its securities. Of course, for any given level of the federal funds rate, an unwinding of lending facilities or a sale of securities would constitute a de facto tightening of policy, and so would have to be carefully considered in that light by the FOMC. (Bernanke)
# 3) Supplemental financing from Treasury: Some reserves can be soaked up by the Treasury's Supplementary Financing Program. (Bernanke)
# 4) Raise interest rate on reserves: In October of last year, the Federal Reserve received long-sought authority to pay interest on the reserve balances of depository institutions. Raising the interest rate paid on reserves will encourage depository institutions to hold excess reserves with the Fed, rather than lending them into the federal funds market at a rate below the rate paid on reserves. Thus, the interest rate paid on reserves will tend to set a floor on the federal funds rate. (Bernanke, Woodward/Hall)
# 5) Time commitment: The Fed needs to issue a pronouncement to assure the public that there is no need for concern about inflation after the recovery and to reaffirm its historical commitment to stable and low inflation (Woodward/Hall)
# 6) Raise reserve ratio: The Fed could increase liquidity requirements up to the point where excess reserves are fully sterilized. Once this is done, the money supply can be expanded as much as needed to reactivate the economy via open market purchases or by allowing financial institutions controlled access to the rediscount window (Cottani/Cavallo)
# 7) Issue debt: Fed could issue its own bills, as other central banks do. It could rely on a wider variety of investors, not just primary dealers, to manage its balance sheet. It would restrict the maturity of such bills to less than 30 days to avoid interfering with Treasury's longer-dated issuance. The hitch is that Congress has to authorize it (Economist)
# 8) Wait for asset markets to correct themselves: Risky assets - such as commodities, corporate bonds and equities - rallied this year on 'green shoots' but may correct their overshoots when it becomes clear that the economic rebounds around the world were inventory-driven and a recovery in global demand growth has not yet begun

Commodities outlook

2009-06-22T06:37:00.000-07:00

RGE Monitor

# Commodity prices have rallied since February on the belief that putative 'green shoots' around the world validated a V-shaped economic recovery in 2009. However, these 'green shoots' merely signal the stabilization of economic activity at low levels, rather than a return to trend growth. Even if GDP growth around the world has bottomed, growth will continue to be negative or sluggish until 2011. As such, commodity price gains are a false sign of economic recovery - like the recent spate of bear market rallies in stock markets. The strong uptrend in commodity prices has been propelled more by technicals (investment demand - arbitrage, opportunistic stockpiling at low prices) than fundamentals (real growth in physical demand and production). Commodity prices will likely snap back to reality before resuming a more moderate uptrend in line with a U-shaped global growth path2 factors to mitigate global slowdown impact on commodities: 1) Growth to continue to be strongest in EM economies whose consumption is most commodity-intensive and 2) Investment to raise production capacity takes time - investment cuts and delays due to lower prices may lead to supply crunch in the future
# Sectoral performance: Traditional sectors (metals, energy) remain fundamentally cyclical as they are more closely tied to industrial production than agriculturals. Agricultural commodities may outperform metals and energy due to less elastic demand and the increasing rarity of very good harvests

Review
# Mar 19 2009: Commodities surged the most this year, led by precious metals and energy, on speculation that the Fed's steps to revive the U.S. economy will spur demand for raw materials as a hedge against inflation. Silver jumped 13%, the most since 1979. Gold had the biggest increase since September, and crude oil topped $52 a barrel. Every commodity in the Reuters/Jefferies CRB Index of 19 prices climbed
# Worst annual performance: Reuters/Jefferies CRB Index of 19 raw materials fell 36% in 2008, the most since the gauge debuted in 1956, to 229.54. It rose to a record 473.97 on July 3, then dropped to the lowest since August 2002 on Dec 5
# Biggest 1-day drop since 1956: Sep 29, Reuters/Jefferies CRB Index fell 21.35 points or 5.8% to 343.2 after the House voted against US bailout plan
# Steepest monthly drop since 1980: In July, CRB Index fell 12%

Outlook

# UniCredit: Despite current correction, the secular trend remains upward due to tight supply/demand fundamentals. In the medium term though, focus will be on global slowdown, easing inflationary pressures, dollar recovery, and credit tightening - all bearish for commodities
# Danske: There is a risk that some commodity markets have decoupled from fundamentals. The fundamental outlook represented by e.g. stocks for aluminium, nickel and lead has not changed significantly in the last month. Demand for oil in the US is also still pretty weak. It seems that the commodity market has run a bit ahead of the fundamental picture. Both base metals and oil are quite vulnerable if we get a set-back in risk sentiment.
# UBS: Supply has been a big support for industrial metals. Demand destruction has led to a correction in energy prices. Agricultural prices have corrected significantly based on improved crop conditions and concerns regarding increased regulation of commodities markets in the US. Prospects for higher inflation has been muted by the correction in energy and has depressed the gold price
# Citi: There is only so much demand to accommodate price increases amid tightening in credit markets, falling asset prices and slowing nominal incomes. Maintaining the bull run in commodities in the face of sharply slowing US demand will require that decoupling theories hold

Brand equity

2009-06-21T16:03:00.000-07:00

FT.com / Companies / Personal Goods - Brands left to ponder price of loyalty

Brands left to ponder price of loyalty

By Andrew Edgecliffe-Johnson in New York

Big brands’ best customers have been defecting in droves since the beginning of the US recession, according to a study. By this year, more than half of a typical US brand’s most loyal shoppers in 2007 had switched to rival products.

Brand loyaltyA two-year analysis of 685 grocery and pharmacy-stocked brands, using data from 32m consumers’ supermarket loyalty cards, found that in 2008 the average brand lost a third of its formerly highly loyal customers.

The study will alarm packaged goods groups, as the most loyal customers – those choosing one brand for more than 70 per cent of their purchases in a category – should also be their most lucrative.

“Defection is top of mind for brand managers now because they’re the most profitable customers,” said Eric Anderson, associate professor of marketing at Kellogg School of Management, Northwestern University.

“Price and promotion have become so salient at retail, that what we thought was the loyal customer can be moved with discounts,” he added.

Past recessions have seen similar defections from top-tier national brands to stores’ private-label goods, Mr Anderson said. Academic research showed that customers could be quickly persuaded to switch by a cheaper price but took far longer to switch back.

The study was conducted by the CMO Council, which represents chief marketing officers, and Catalina Marketing’s Pointer Media Network, which has equipment in 25,000 stores analysing buying behaviour. Catalina can provide a two-year anonymous purchasing history on individual customers. Brand managers and retailers who had seen the data had been startled by it, said Todd Morris, senior vice-president at Catalina.

“They’ve always known there was churn but could never put their finger on how big the issue is.”

The study comes as marketers are leaning more heavily on research and on targeted advertising, as they seek to improve on the “spray and pray” approach of mass media marketing formats, such as 30-second television advertisements.

Copyright The Financial Times Limited 2009

"Buy China" risks

2009-06-18T06:19:00.000-07:00

China risks trade suicide - Telegraph

China risks trade suicide
Beijing is playing with fire by issuing a `Buy China' edict for its stimulus package.

By Ambrose Evans-Pritchard
Published: 6:08PM BST 17 Jun 2009

As the world’s top exporter with a $400bn current account suplus and an economy that lives off the America and European market, it will pay the highest price if it triggers a global retreat into protectionist blocs.

The Chinese elite no doubt feel provoked by what they call the “poison” of the US `Buy American’ clause, but the Obama White House managed to tone down the worst excesses of Capitol Hill and in any case the Chinese version is more restrictive.

It bans the purchase of foreign equipment for investment projects unless a special exemption is obtained. The measures apply to European goods, even though EU states have not imposed any such “Buy Europe” clause of their own. EU producers of wind turbines have already been excluded from a $5bn wind project, whether or not they have factories in China.

Beijing risks making the same catastrophic error as the US Congress when it passed the US Smoot-Hawley Tariff Act in 1930. America was then the rising surplus power, like China today. It was the chief beneficiary of an open global system.

By imposing tariffs, Washington triggered massive retaliation. While nobody escaped the Great Depression that ensued, the effects were unequal. The US suffered a far steeper decline in output than the rest of the world. Britain muddled through relatively well in a trade bloc behind Imperial Preference.

China’s action is extremely disturbing. It confirms what we have long feared, that the Chinese government is sufficiently worried about rising unemployment to adopt suicidal measures. Nor does this episode instill confidence in the `China recovery story’.

While exports fell 26pc in April, imports were down by almost as much. There is no real rebalancing under way from external to internal demand. China is still running a massive surplus. It is flooding the world with excess goods, and exporting deflation. This is untenable. At some point, the West will react.

Land shortage?

2009-06-18T05:25:00.000-07:00

Gulf Times – Qatar’s top-selling English daily newspaper - Opinion

Unlearned lessons from the housing bubble
Every major country of the world has abundant land in the form of farms and forests, much of which can be converted someday into urban land

By Robert J Shiller/New Haven, US

There is a lot of misunderstanding about home prices. Many people all over the world seem to have thought that since we are running out of land in a rapidly growing world economy, the prices of houses and apartments should increase at huge rates.

That misunderstanding encouraged people to buy homes for their investment value – and thus was a major cause of the real estate bubbles around the world whose collapse fuelled the current economic crisis. This misunderstanding may also contribute to an increase in home prices again, after the crisis ends. Indeed, some people are already starting to salivate at the speculative possibilities of buying homes in currently depressed markets.

But we do not really have a land shortage. Every major country of the world has abundant land in the form of farms and forests, much of which can be converted someday into urban land. Less than 1% of the earth’s land area is densely urbanised, and even in the most populated major countries, the share is less than 10%.

There are often regulatory barriers to converting farmland into urban land, but these barriers tend to be thwarted in the long run if economic incentives to work around them become sufficiently powerful. It becomes increasingly difficult for governments to keep telling their citizens that they can’t have an affordable home because of land restrictions.

The price of farmland hasn’t grown so fast as to make investors rich. In the United States, the price of agricultural land grew only 0.9% a year in real (inflation-adjusted) terms over the entire twentieth century. Most of the benefit from land for investors has to be from the profit that agribusiness can make from their operations, not just from the appreciation of the price of land.

Despite a huge 21st century boom in cropland prices in the US that parallels the housing boom of the 2000’s, the average price of a hectare of cropland was still only $6,800 in 2008, according to the US Department of Agriculture, and one could build 10-20 single-family houses surrounded by comfortable-sized lots on this land, or one could build an apartment building housing 300 people.

Land costs could easily be as low as $20 per person, or less than $0.50 per year over a lifetime. Of course, such land may not be in desirable locations today, but desirable locations can be created by urban planning.

Many people seem to think that the US experience is not generalisable, because the US has so much land relative to its population. Population per square kilometre in 2005 was 31 in the US, compared with 53 in Mexico, 138 in China, 246 in the United Kingdom, 337 in Japan, and 344 in India.

But, to the extent that the products of land (food, timber, ethanol) are traded on world markets, the price of any particular kind of land should be roughly the same everywhere. Farmers will not be able to make a profit operating in some country where land is very expensive, and farmers would give up in those countries unless the price of land fell roughly to world levels, though corrections would have to be made for differing labor costs and other factors.

Shortages of construction materials do not seem to be a reason to expect high home prices, either. For example, in the US, the Engineering News Record Building Cost Index (which is based on prices of labour, concrete, steel, and lumber) has actually fallen relative to consumer prices over the past 30 years. To the extent that there is a world market for these factors of production, the situation should not be entirely different in other countries.

An even more troublesome fallacy is that people tend to confuse price levels with rates of price change. They think that arguments implying that home prices are higher in one country than another are also arguments that the rate of increase in those prices should be higher there.

But, the truth may be just the opposite. Higher home prices in a given country may tend to create conditions for falling home prices there in the future.

The kinds of expectations for real estate prices that have informed public thinking during the recent bubbles were often totally unrealistic. A few years ago Karl Case and I asked random home buyers in US cities undergoing bubbles how much they think the price of their home will rise each year on average over the next ten years. The median answer was sometimes 10% a year.

If one compounds that rate over 10 years, they were expecting an increase of a factor of 2.5, and, if one extrapolates, a 2000-fold increase over the course of a lifetime. Home prices cannot have shown such increases over long time periods, for then no one could afford a home.

The sobering truth is that the current world economic crisis was substantially caused by the collapse of speculative bubbles in real estate (and stock) markets – bubbles that were made possible by widespread misunderstandings of the factors influencing prices.

These misunderstandings have not been corrected, which means that the same kinds of speculative dislocations could recur. - Project Syndicate

lRobert Shiller, Professor of Economics at Yale University and Chief Economist at MacroMarkets LLC, is co-author, with George Akerlof, of Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism.

Roubini on deflation vs inflation

2009-06-11T10:08:00.000-07:00

RGE Monitor

Overview:German Chancellor Merkel on June 3: “We must return to independent and sensible monetary policies, otherwise we will be back to where we are now in 10 years’ time.” So far, government policies are replacing shrinking private demand in order to stave off a deflationary spiral. Crowding out occurs in a situation of full employment as opposed to the current situation of low capacity utilization (Krugman). However, sustained QE and loose fiscal policy need credible government backup (Buiter). Ultimately, deleveraging requires the writing down of debt as reflationary policies are not a free lunch and won't solve the debt overhang problem (Roubini). Important case study: Japan back into deflationary territory despite huge public debt and QE (Chinn). Rather than a sign of inflation, higher long-term yields may be pointing to higher real interest rates which are compatible with a deflationary environment (BofA).
# Ben Bernanke: “I respectfully disagree with her views”-->Exit Strategies from Monetary Easing: Will the Fed Avoid High Inflation?
# Jean-Claude Trichet: "I told her that we were very strongly determined to both, taking the appropriate decision in the current exceptional circumstances and being absolutely crystal clear on the exit strategy."--> ECB Unconventional Monetary Policy: QE to Begin July 2009
# Bank of America via ATX Markets, June 8: Between the inflation vs. deflation debate stands another possibility: rising interest rates. They reflect an increase in borrowing costs. A rise in real interest rates would be consistent with both rising nominal yields and a continued disinflationary environment accompanying a prolonged economic recovery.
# Spiegel Online: Unlike 1929, debts are being fought with debts, meaning that not only banks but entire countries could end up bankrupt. Perhaps the efforts to combat the current crisis are merely laying the foundations for the next crisis, which will be bigger still.--> 1929 vs. 2009: Parallels And Differences To The Great Depression
# Willem Buiter: 1) The nominal zero-bound need not restrict monetary policy in practice as central banks engage in quantitative easing (QE). However: 2) Central banks engaged in QE need a long‐term credible fiscal partner; 3) Central banks engaged in CE need a full fiscal indemnity for capital losses due to private sector asset purchases or secured lending
# Buiter: Problem in Europe: The ECB has no fiscal back-up. There is no guarantee, insurance or indemnity for any private credit risk it assumes. This huge error and omission in the design of the ECB. See Who Is The ECB's Recapitalizer Of Last Resort?
# June 1, Menzie Chinn (Econbrowser); Japan was facing rapidly rising net debt-to-GDP ratios (rising from 60.4 ppts of GDP to 84.6 ppts from 2000 to 2005), and was embarking upon a policy of quantitative easing in an attempt to stave off a deep recession. And yet opponents of quantitative easing worried about hyper-inflation, even as y/y inflation at the time remained mired in the negative range. I didn't understand the fears at the time; and I still don't. --> Japan: Worries Over Huge Public Debt, Is It Sustainable?; and Japan Is Facing Deflation Yet Again
# Chinn: Main difference to Japan: America is a big net debtor to the rest of the world, with extremely large holdings of US Treasurys by foreign private and state actors. This is why high real interest rates are more detrimental for the U.S. than higher inflation. Still, real yields according to TIPS seem fairly low in historical perspective.
# Niall Ferguson: The running of massive fiscal deficits in excess of 12 per cent of gross domestic product in 2009, and the issuance therefore of vast quantities of freshly-minted bonds is likely to push long-term interest rates up, at a time when the Federal Reserve aims at keeping them down. This may lead to a “painful tug-of-war between our monetary policy and our fiscal policy."
# Paul Krugman: "What I hear again and again is either the assertion that all this borrowing must drive up interest rates, or worries that the Chinese won’t be willing to lend us the money. We know as a matter of principle that these concerns are misplaced: if there were a shortage of savings, the economy wouldn’t be depressed. Indeed, one way to think about our current problem is that the world as a whole wants to save more than it’s willing to invest." --> Back to Global Reserves Accumulation?
# Axel Weber: Call for a more symmetric monetary policy across asset price cycles. To be more specific, a more symmetric policy would also realize implicit risks in times when money and credit growth is dynamic, asset prices go up and risk perceptions decline, possibly creating a need to act despite current inflation rates being sufficiently low.--> Should Central Banks Fight Asset Bubbles?
# Mohamed El-Erian (PIMCO), June: Relative to where it is coming from, the financial system will be de-levered, de-globalized, and re-regulated. Global growth will be lower and unemployment higher, notwithstanding the continued rotation of dynamism away from industrial countries and toward emerging economies.

art

2009-05-28T08:39:00.000-07:00

FT.com / Columnists / Lunch with the FT - Lunch with the FT: Tracey Emin

Lunch with the FT: Tracey Emin

By Jackie Wullschlager

Published: May 22 2009 18:03 | Last updated: May 22 2009 18:03

Illustration of Tracey EminScott’s of Mayfair is full of braying voices, too-wide smiles, glinting sunglasses and, looking down from every wall and alcove, the brash, bright Young British Art aesthetic. I pass a Rebecca Warren sculpture as I enter and am shown to a table beneath a Gary Hume gloss painting. “Tracey is running late,” a waiter confides but, almost immediately, a bird-like figure in cool linen blouse fastened with a safety pin, demure knee-length skirt, fishnet stockings and cowboy boots darts in and lands beside me.

Instantly friendly, flustered, mopping her neck, Tracey Emin leaps up again within seconds to fling her arms round the maître d’. She has piercing eyes, delicate, mobile features and teeth less wonky than photographs suggest. Gold rings, earrings and several necklaces all flash as she talks, breathless and animated in an intense Estuary English, for the next three hours.

“This is absolutely my favourite restaurant,” she opens. “I come here every Saturday when I’m in London. My powerful lady friends – Virginia Ironside, Lynn Barber – lunch here. You see everyone – Charles Saatchi and Nigella eat here. I love lunch more than dinner. I always get too pissed in the evening.” Without a glance at the menu, she orders caviar and oysters. “There, you can write that she orders from the menu without looking! And that the whole restaurant stands up when I come in.” This last is not quite true but certainly she turns heads and is welcomed by every passing waiter. “You’d better behave,” she tells one, “because this is the FT.” Trying to match her pace, I order the first things that catch my eye from the extensive, fish-strong menu: asparagus tart followed by Dover sole.

The waiter interprets “any white wine” as the cheapest on offer: a crisp Sauvignon Blanc arrives speedily and Emin raises her glass to toast Carol Ann Duffy, whose appointment as poet laureate has just been announced. “She was up for it 10 years ago and didn’t get it because Tony Blair didn’t like her private life. Now a self-sufficient, openly gay woman has become poet laureate – it’s f***ing brilliant. Things are changing.” Duffy is 53 and one of Emin’s pet themes is that “women go on getting better. It’s like a light bulb, women burn and burn and burn, with men it’s just one big flash. At about 40, a male artist has this massive ejaculation and then the work – though not the prices – goes down. It goes back to the sex thing: women keep coming and coming, men just do it once. It’s a metaphor for life.”

Emin turns 46 in July and her new show, Those Who Suffer Love, is about sex in middle age. It centres on a short animation film of a woman masturbating. Emin shows me an image on the invitation card and we agree that the headless figure, drawn in her characteristic spidery lines, looks like a frog. “Masturbation is supposed to be self-appreciative but it’s also about self-loathing,” she explains. “For women coming up to 50, the mind isn’t as agile as it used to be. What was once possible isn’t. You know, one minute you’re being gang-banged by Hell’s Angels, the next minute you’re being f***ed by a dog. The film is about what happens to your mind in middle age. So it’s honest.” She finishes with a pleading smile that makes me realise – recalling her two iconic pieces, the embroidered tent “Everyone I Have Ever Slept With 1963-1995” and “My Bed”, an installation of unmade sheets surrounded by a detritus of condoms and blood-stained knickers – that it is the fragile, childlike, almost ingratiating quality of her art, rather than its outrage or shock, that is most memorable.

A tower of tiny blinis appears. She peels off each one slowly and deliberately, dotting it with caviar with a subdued delight that recalls a child absorbed in a pack of sweets. Checking that my asparagus tart is acceptable – it is delicious – she continues: “Middle age and sex – it’s taboo. This film is supposed to relate to all women. When you see it, you’ll think, ‘F***ing hell, I wish it was me!’”

In an age where self-exposure – reality television, confessional memoirs – is standard, Emin’s autobiographical bravado stands out. “I was suicidal up to 10 years ago,” she says. Her drawings, paintings, films, neon and textile works document broken love affairs, loneliness, desire, and depression following two abortions. She cites Edvard Munch, Egon Schiele, German expressionism and Louise Bourgeois as influences, though I reckon she depends most on post-minimalist conventions and installation media. Although nothing in her art is formally radical, her impression of emotional authenticity evokes both passionate responses – mostly from women “and a hell of a lot of gay men”, she grins – and stinging criticism.

Saatchi’s search for the next big thing

This autumn art collector and gallerist Charles Saatchi will become the latest canny entrepreneur to engage in hours of televised self-promotion (see also Sir Alan Sugar’s The Apprentice and Lord Lloyd-Webber’s How do You Solve a Problem like Maria? and Any Dream will Do!) when his contemporary art show/talent contest launches on BBC2, writes Jonathan Openshaw.

Saatchi’s Best of British hopes to unearth the next Tracey Emin or Damien Hirst from a batch of unknown hopefuls and – considering Saatchi’s role in the rise of the Young British Artist movement during the 1990s – the idea may not be as far-fetched as it sounds.

The famously media-wary Saatchi seems a surprising choice to front this type of project, but he has made a public statement professing his excitement about the series, “because nobody knows where the next art star will emerge from”.

Not that Saatchi is about to become the art world’s answer to Simon Cowell. There will be no taking centre-stage with pithy pronouncements on the competitors’ efforts. Rather, his thoughts and feedback will be relayed to the students (and cameras) via two course tutors, who will also act as advisers (think along the lines of Sugar’s indomitable Margaret and acerbic Nick). There will also be guest judges from across the industry, including artist Emin, collector Frank Cohen, gallerist Kate Bush and writer/artist Matt Collings.

The competition was announced in January and resulted in thousands of applications from artists working across all media including installation, painting, digital media, sculpture and performance. The judges will select 50 of these “undiscovered” artists (not having gallery representation is a condition of entry) to be presented to Saatchi at a private staged exhibition, from which he will choose the six whom he views as most promising. These students will then be installed in a bespoke “art school” in east London for the summer, with the tutors on hand to offer technical advice and to “facilitate creativity”.

There will also be numerous studio visits from the great and the good of the contemporary art world, including curators, gallerists, collectors, artists and critics, who will provide masterclasses for the students as well as leading discussions covering key issues in contemporary art.

The series will culminate in a group show held in September, from which Saatchi will select one winner to exhibit at the “Newspeak: British Art Now” exhibition to be held in October at the Hermitage in St Petersburg.

She represented Britain at the last Venice Biennale in 2007, where her exhibition of intimate drawings was widely panned. “I cried about Venice because people were so cruel,” she admits. Did she get her revenge? “You know what Vogue said – the party of the century was Tracey Emin’s party in Venice, the whole canal was blocked for my boats, Fatboy Slim was the DJ ... Jerry Hall was there in her boat – it made Britain look so glamorous.” Yet the criticism still rankles. “You know what? I’ll do Venice again. When I was there I imagined myself as a really old woman walking up the steps of the pavilion. When I’m 80 I’ll have a great f***ing machine there” – she pounds her arms together suggestively – “or a swimming pool. I’ll fill the British pavilion with water and I’ll swim in it every day and it’ll be a performance thing: a bit wanky but so lovely.”

Is her whole life not a performance piece? “I only show what I want to show. Do you remember how fuzzy the drawings in Venice were? It’s like Daphne du Maurier, everyone said she was so open. In fact, she only gave you what she wanted you to see – there were so many layers.” An astrologer recently gave a talk on similarities between her and du Maurier’s birth charts, since when she has been reading her way through the novelist’s oeuvre. “She’s like a female Edgar Allan Poe, very dark.” I note the parallels between her text-based works and du Maurier’s – both are storytellers, both tread a line between psychological disturbance and sentimentality.

Emin slips down oysters alternating with spicy cocktail sausages – “the fat of sausages with oysters is a nice sensation” – and leans forward eagerly, tapping my arm. “Do you ever write stories? My favourite favourite time is in the winter, when the morning dark is a different colour from the night dark, not the darkness which is coming but the darkness which is leaving. Then, I live in bed and write stories in my head.” Ed Victor is her literary agent and she is planning a collection of stories, Hotel International, “that are a bit f***ed up. That’s where I’m going to vent my spleen. They say never summon the devil because he’ll come. Well, I’m going to sit down with the devil and battle it out. I’m not afraid!”

Hotel International refers to her parents’ hotel in Margate, Kent, where she was brought up with her twin brother Paul, at first “like a princess”, then in poverty when the business went bust. Her Turkish father – who had lived with them half the week, spending the other half with his wife and family – “left my mum with absolutely nothing”. Emin suffered abuse and neglect, her father was “phenomenally cruel – he has no sense of ethics or moral judgement” and “we had an electric fire with one bar; two meters, one for gas, one for electricity. We couldn’t run them at the same time because there wasn’t enough change. I washed in a bowl because there was no hot water. We squatted for six and a half years. I was down there hanging on for dear life” – she makes a ladder with her hands, and stabs a fingernail at the bottom – “I was suicidal. When Saatchi asks why I never send him any work, I say, ‘You put Margaret Thatcher in power. Thatcher should be tried for crimes against humanity.’”

Yet, to her own surprise, she “voted for Boris” in London’s last election. Her “favourite prime minister of all time is Ted Heath, health and education were his priorities. He wrote poetry, sailed, wore pink shirts and wasn’t ashamed”. She groans about Gordon Brown’s income tax rise and recently attended a Conservative arts dinner, where her neighbour was [Tory MP] Ed Vaizey. “When he realised he was sitting next to me, he was petrified, he started shaking.” This seems far-fetched: Emin, elected a Royal Academician last year, increasingly belongs to the establishment. In 2010 her first London retrospective opens at the Hayward, followed by a show at Margate’s new Turner gallery in 2011. “The prodigal daughter returns. Then I’ll have gone full circle, I’ll be back where I started and be able to reassess my life.”

Last Christmas, she got ill – a tapeworm, some chest and kidney infections – and her doctor advised five years off from the stress of making exhibitions. “A year ago, I got so upset about not having children, I stopped drinking to make me look more mummyish. I wanted to be more conformist, to give the idea of ordinariness. I always said I’d have kids when I had £1m in the bank and passed my driving test.” Why didn’t she? “I wasn’t with anyone. But if you don’t have children, you’re cut off from a major part of society. Sometimes I wake up and think, ‘What’s it all for?’ I could just disappear into obscurity. But when I was ill, I realised part of my desire to have children was that I want to escape my responsibilities to myself.” She is currently in a relationship with photographer Scott Douglas, who lives in Scotland, and they spend alternate fortnights together. “I understand now that my children will not hang as pegs in a tent but on the walls of Tate.” She has five godchildren and among many charitable ventures is the “Tracey Emin Library” in Uganda, where “lots of little children are reading books”.

Emin says she “wouldn’t be where I am now if I’d had those children. But no woman wants to have an abortion.” Accidents happen, I venture. “Condoms split – but actually, no they don’t if you don’t move.” She sits up rigid, arms pinned to her sides, mock-puritanical, then swings round to discuss desserts. Can she have the prosecco jelly without the wild strawberries because “I just want jelly”? The staff, who will clearly do anything for her, are willing to make it but warn it will take hours to set. She opts for raspberry ice-cream and mint tea, advises that my chocolate fondant “will kill you” and orders more wine. Finishing it, she looks accusingly at my still full glass. “You’re not going to drink that, are you?” she asks, pouring the contents into her own and downing it as I request the bill.

“I don’t pay here,” she boasts. “Well, I’ve paid already – with my art.” Nevertheless, she apologises as we leave that my tip is too meagre (she has no cash on her to supplement it), compliments one doorman on his tie and collects a lost umbrella with another, then suggests we share a taxi home. As we crawl east to Shoreditch, she floods me with background information, details I might have missed (“It’s good for you to see me in my world”) before courteously opening the door to let me out. “Also,” she reminds me as I step on to the pavement, “people expect me to be rude, but I’m really polite.”

‘Those Who Suffer Love’, White Cube, London SW1, May 29-July 4

Jackie Wullschlager is the FT’s visual arts critic

Inflation panacea

2009-05-25T07:47:00.000-07:00

FT.com / Columnists / Wolfgang Munchau - We cannot inflate our way out of this crisis

We cannot inflate our way out of this crisis

By Wolfgang Münchau

Published: May 24 2009 20:05 | Last updated: May 24 2009 20:05

“The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists.”

Ernest Hemingway, “Notes on the Next War: A Serious Topical Letter” , 1935

What I hear more and more, both from bankers and from economists, is that the only way to end our financial crisis is through inflation. Their argument is that high inflation would reduce the real level of debt, allowing indebted households and banks to deleverage faster and with less pain.

To achieve the desired increase in inflation, the US Federal Reserve should either announce an inflation target or simply keep interest rates at zero when the recovery begins. That way, real interest rates would become strongly negative. The advocates of such a strategy are not marginal and cranky academics. They include some of the most influential US economists.

Four immediate questions arise from these considerations. Can it be done? Can it be undone? Can it be done at a reasonable economic cost? Last, should it be done?

Of course, it can be done, but only for as long as the commitment to higher inflation is credible. Inflation is not some lightbulb that a central bank can switch on and off. It works through expectations. If the Fed were to impose a long-term inflation target of, say, 6 per cent, then I am sure it would achieve that target eventually. People and markets might not find the new target credible at first but if the central bank were consistent, expectations would eventually adjust. In the end, workers would demand wage increases of at least 6 per cent each year and companies would strive to raise their prices by that amount.

If, however, a central bank were to pre-announce that it was targeting 6 per cent inflation in 2010 and 2011, and 2 per cent thereafter, the plan would probably not succeed. We know that monetary policy affects inflation with long and variable lags. Such a degree of fine-tuning does not work in practice. My own guess is that one would have to make a much longer-term commitment to a higher rate of inflation for such a policy shift to be credible. I suspect that the greater the distance between the new rate and the current rate, the longer the commitment would have to be.

Could it be reversed, once it had been achieved? Again, the answer is yes; again, the commitment would have to be credible. But herein lies precisely the problem. If the central bank were honest from the start and pre-announced that it would eventually reverse its policy, it might never reach its goal of higher inflation in the first place. If the central bank were dishonest, it might achieve the goal. But it would lose credibility the moment it decided to reverse. So any new credibility would have to be earned through new policy action. This might imply nominal interest rates significantly above 6 per cent for an uncomfortably long period.

What would happen then? I can think of two scenarios. The best outcome would be a simple double-dip recession. A two-year period of moderately high inflation might reduce the real value of debt by some 10 per cent. But there is also a downside. The benefit would be reduced, or possibly eliminated, by higher interest rates payable on loans, higher default rates and a further increase in bad debts. I would be very surprised if the balance of those factors were positive.

In any case, this is not the most likely scenario. A policy to raise inflation could, if successful, trigger serious problems in the bond markets. Inflation is a transfer of wealth from creditors to debtors – essentially from China to the US. A rise in US inflation could easily lead to a pull-out of global investors from US bond markets. This would almost certainly trigger a crash in the dollar’s real effective exchange rate, which in turn would add further inflationary pressure.

Under such a scenario, it might not be easy to keep inflation close to a hypothetical 6 per cent target. The result could be a vicious circle in which an overshooting inflation rate puts further pressure on the bond markets and the exchange rate. The outcome would be even worse than in the previous example. The central bank would eventually have to raise nominal rates aggressively to bring back stability. It would end up with the very opposite of what the advocates of a high inflation policy hope for. Real interest rates would not be significantly negative, but extremely positive.

Should this be done? A credible inflation target of 2 or 3 per cent, maintained over a credibly long period of time, is useful. But I doubt that a 6 per cent inflation target could be simultaneously credible and sustainable. Tempting as it may be, it is a beggar-thy-neighbour policy unless replicated elsewhere and would come to be regarded as such by many countries in the world. It would produce a whole new group of losers, both inside and outside the US, with all its undesirable political, social, economic and financial implications. It would also fuel the already rampant discussions about the inevitable death of fiat money.

Stimulating inflation is another dirty, quick-fix strategy, like so many of the bank rescue packages currently in operation. As Hemingway said, it would feel good for a time. But it would solve no problems and create new ones.

munchau@eurointelligence.com

The case for gold

2009-05-25T06:54:00.000-07:00

Gold bugs at last have their perfect trinity - Telegraph

Gold bugs at last have their perfect trinity
China has doubled its bullion reserves and left us in no doubt that it will spend more of its $40bn monthly surplus on hard assets rather than the toxic paper of Western democracies.

By Ambrose Evans-Pritchard
Last Updated: 9:36PM BST 23 May 2009

Comments 34 | Comment on this article

The world's top hedge fund manager John Paulson has built a gold position of at least $5.5bn, the biggest such move since George Soros and Sir James Goldsmith bet on Newmont Mining in 1993.

Britain has become the first of the Anglo-Saxon "AAA" club to face a downgrade. As feared, the cancer of bank leverage is spreading to sovereign cores.

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Gold prices tend to slide in late May and languish through the summer, because of the seasonal ups and downs of jewellery demand. The trader reflex would be to short gold at this stage after its $90 vault to $959 an ounce over the past month. They may think again this year.

Paulson & Co has bought $2.9bn in SPDR Gold Trust, the biggest of the gold exchange traded funds (ETFs), which now holds 1106 tonnes − three times the Brown-gutted reserves of the United Kingdom.

Mr Paulson has also built up a $2.3bn holding of Anglo Ashanti, Goldfields, Kinross Gold, and Market Vectors Gold Miners. The fact that he is launching a "Paulson Real Estate Recovery Fund", reversing the bet against sub-prime securities that made him rich, tells us all we need to know about his thinking. This is a liquidity-reflation play.

He may be wrong, of course. In his early fifties, he belongs to the baby-boom cohort most psychologically vulnerable to the 1970s "paradigm-error". And perhaps he has never lived in Japan.

It is striking how many of those most alert to the deflation danger are either veterans of Japan's Lost Decade or close students of it: Albert Edwards at Société Générale, Russell Jones at RBC Capital, Nobel laureate Paul Krugman, the Fed's Ben Bernanke, and Athanasios Orphanides, who helped draft the Fed's study on the Japan trap. "People always thought Japan's bond yields had to rise, but they kept falling and Japan is still not really out of deflation," said Mr Edwards. Indeed, 20 years after the Nikkei peaked at over 39,000 it stands today at 9,280. Interest rates are 0.01pc. The yield on two-year state bonds is 0.34pc. Still there is not a whiff of inflation.

A number of readers have written to me in tones of polite reproach asking why I fret about deflation when governments everywhere are spending and printing as if there was no tomorrow. I admit to being tortured by self-doubt, like others grappling with this extraordinary situation.

What we know is that inflation is already negative in Ireland (-3.5pc), China (-1.5pc), Thailand (-0.9pc), Korea (-0.5pc), US (-0.7), Japan (-0.3), Switzerland (-0.3, Spain (-0.2pc). The eurozone may be negative by July. Alistair Darling said Britain's retail RPI inflation used to set wage deals will be minus 3pc by September.

Does this constitute deflation in a meaningful sense? Not yet, perhaps. But it is moving too close for comfort in a world stretched by extreme leverage. The economies of the US, Japan, the eurozone, and Britain have been contracting in "nominal" as well as "real" terms – which smacks of the 1930s.

The "yen GDP" of Japan has shrunk by 10pc in one year; the "euro GDP" of Germany has shrunk 6.2pc, and Italy's by 4.7pc ; the "dollar GDP" of the US has shrunk 3.3pc. Debts are not shrinking, however.

GMO's Jeremy Grantham says in his latest note, Last Hurrah And Seven Lean Years, that the market value of equities, houses and commercial property in the US reached $50 trillion in the boom. This "perceived wealth" sustained $25 trillion of debt.

The crash has cut this wealth to $30 trillion, but the debts are still there. America's debt-gearing has exploded, as it has in the UK and Europe. This looks awfully like Irving Fisher's "debt deflation" trap of 1933. It will be a long slog for households to bring their debt-to-wealth ratios down to manageable levels.

You can argue – as do UBS, Merrill Lynch, ING, and Capital Economics, to name a few – that massive global stimulus is merely struggling to off-set a massive deflationary shock.

So how will gold fare in a "Japanese" stalemate world where neither inflation nor deflation gets the upper hand? The eight-year rally that has lifted gold from $254 to $959 may lose momentum for a while.

"The air is getting thin up here," said John Reade, precious metals guru at UBS. "Rich investors are no longer rushing out to buying gold bars as they did after the Lehman collapse. Still, we think it is highly significant that both China and Russia – two of the biggest holders of foreign reserves – are both buying gold," he said.

Personally, I remain a gold bug out of fear that the most corrosive phase of this crisis lies ahead. There are two more boils to lance: Europe and China. As the IMF keeps telling us, Europe's banks are still covering up their vast toxic debts. Nor has the G20 begun to address the root cause of the global crisis, which lies in excess exports from East (aided by currency manipulation) to an over-spending West. China is putting off the day of reckoning with its crisis response, which is to build yet more plant to flood the world with yet more over-capacity.

For "political bears" the risk is that the EU polity fragments under strain, and that governments restrict basic markets to defend themselves – whether by imposing exchange controls to stop bond flight, or shutting derivatives markets used as hedges, or putting up trade barriers. We will find out if and when unemployment hits 10pc in America, 12pc in Germany, and 20pc in Spain, or if migrant workers rampage in Shenzhen.

Some call this the "Armageddon case" for gold. That is going too far. However, gold has outperformed Wall Street's S&P 500 index by 500pc so far this century, as if able sniff out trouble in advance. Such runs tend to finish with a "parabolic" blow-off before they die. Mr Paulson may yet make another fortune, whatever his reason.

Nervous

2009-05-21T08:41:00.000-07:00

What You Don’t Know Makes You Nervous - Happy Days Blog - NYTimes.com

What You Don’t Know Makes You Nervous
By Daniel Gilbert
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CAMBRIDGE, Mass. — Seventy-six years ago, Franklin Delano Roosevelt took to the inaugural dais and reminded a nation that its recent troubles “concern, thank God, only material things.” In the midst of the Depression, he urged Americans to remember that “happiness lies not in the mere possession of money” and to recognize “the falsity of material wealth as the standard of success.”

“The only thing we have to fear,” he claimed, “is fear itself.”

As it turned out, Americans had a great deal more to fear than that, and their innocent belief that money buys happiness was entirely correct. Psychologists and economists now know that although the very rich are no happier than the merely rich, for the other 99 percent of us, happiness is greatly enhanced by a few quaint assets, like shelter, sustenance and security. Those who think the material is immaterial have probably never stood in a breadline.

Money matters and today most of us have less of it, so no one will be surprised by new survey results from the Gallup-Healthways Well-Being Index showing that Americans are smiling less and worrying more than they were a year ago, that happiness is down and sadness is up, that we are getting less sleep and smoking more cigarettes, that depression is on the rise.

An uncertain future leaves us stranded in an unhappy present with nothing to do but wait.

But light wallets are not the cause of our heavy hearts. After all, most of us still have more inflation-adjusted dollars than our grandparents had, and they didn’t live in an unremitting funk. Middle-class Americans still enjoy more luxury than upper-class Americans enjoyed a century earlier, and the fin de siècle was not an especially gloomy time. Clearly, people can be perfectly happy with less than we had last year and less than we have now.

So if a dearth of dollars isn’t making us miserable, then what is? No one knows. I don’t mean that no one knows the answer to this question. I mean that the answer to this question is that no one knows — and not knowing is making us sick.

Consider an experiment by researchers at Maastricht University in the Netherlands who gave subjects a series of 20 electric shocks. Some subjects knew they would receive an intense shock on every trial. Others knew they would receive 17 mild shocks and 3 intense shocks, but they didn’t know on which of the 20 trials the intense shocks would come. The results showed that subjects who thought there was a small chance of receiving an intense shock were more afraid — they sweated more profusely, their hearts beat faster — than subjects who knew for sure that they’d receive an intense shock.

That’s because people feel worse when something bad might occur than when something bad will occur. Most of us aren’t losing sleep and sucking down Marlboros because the Dow is going to fall another thousand points, but because we don’t know whether it will fall or not — and human beings find uncertainty more painful than the things they’re uncertain about.

But why?

A colostomy reroutes the colon so that waste products leave the body through a hole in the abdomen, and it isn’t anyone’s idea of a picnic. A University of Michigan-led research team studied patients whose colostomies were permanent and patients who had a chance of someday having their colostomies reversed. Six months after their operations, patients who knew they would be permanently disabled were happier than those who thought they might someday be returned to normal.

Similarly, researchers at the University of British Columbia studied people who had undergone genetic testing to determine their risk for developing the neurodegenerative disorder known as Huntington’s disease. Those who learned that they had a very high likelihood of developing the condition were happier a year after testing than those who did not learn what their risk was.

Why would we prefer to know the worst than to suspect it? Because when we get bad news we weep for a while, and then get busy making the best of it. We change our behavior, we change our attitudes. We raise our consciousness and lower our standards. We find our bootstraps and tug. But we can’t come to terms with circumstances whose terms we don’t yet know. An uncertain future leaves us stranded in an unhappy present with nothing to do but wait.

Our national gloom is real enough, but it isn’t a matter of insufficient funds. It’s a matter of insufficient certainty. Americans have been perfectly happy with far less wealth than most of us have now, and we could quickly become those Americans again — if only we knew we had to.
Dan Gilbert

Daniel Gilbert is professor of psychology at Harvard University and author of “Stumbling on Happiness.” More of his writing and videos of his appearances can be found at his Web site.

Very Good

2009-05-20T07:36:00.000-07:00

FT.com / Columnists / Martin Wolf - This crisis is a moment, but is it a defining one?

This crisis is a moment, but is it a defining one?

By Martin Wolf

Published: May 19 2009 19:48 | Last updated: May 19 2009 19:48

Pinn illustration

Is the current crisis a watershed, with market-led globalisation, financial capitalism and western domination on the one side and protectionism, regulation and Asian predominance on the other? Or will historians judge it, instead, as an event caused by fools, signifying little? My own guess is that it will end up in between. It is neither a Great Depression, because the policy response has been so determined, nor capitalism’s 1989.
EDITOR’S CHOICE
Martin Wolf: Why Obama’s conservatism may not prove good enough - May-12
Economists’ forum - Oct-01
Martin Wolf: Tackling Britain’s fiscal debacle - May-07

Let us examine what we know and do not know of its impact on the economy, finance, capitalism, the state, globalisation and geopolitics.

On the economy, we already know five important things. First, when the US catches pneumonia, everybody falls seriously ill. Second, this is the most severe economic crisis since the 1930s. Third, the crisis is global, with a particularly severe impact on countries that specialised in exports of manufactured goods or that relied on net imports of capital.

Fourth, policymakers have thrown the most aggressive fiscal and monetary stimuli and financial rescues ever seen at this crisis. Finally, this effort has brought some success: confidence is returning and the inventory cycle should bring relief. As Jean-Claude Trichet, president of the European Central Bank, remarked, the global economy is “around the inflection point”, by which he meant that the economy is now declining at a declining rate.

Global economy

We can also guess that the US will lead the recovery. The US is again the advanced world’s most Keynesian country. We can guess, too, that China, with its massive stimulus package, will be the most successful economy in the world.

Unfortunately, there are at least three big things we cannot know. How far will exceptional levels of indebtedness and falling net worth generate a sustained increase in the desired household savings of erstwhile high-spending consumers? How long can current fiscal deficits continue before markets demand higher compensation for risk? Can central banks engineer a non-inflationary exit from unconventional policies?

On finance, confidence is returning, with spreads between safe and risky assets declining to less abnormal levels and a (modest) recovery in markets. The US administration has given its banking system a certificate of reasonable health. But the balance sheets of the financial sector have exploded in recent decades and the solvency of debtors is impaired.

We can guess that finance will make a recovery in the years ahead. We can guess, too, that its glory days are behind it for decades, at least in the west. What we do not know is how far the “deleveraging” and consequent balance-sheet deflation in the economy will go. We also do not know how successfully the financial sector will see off attempts to impose a more effective regulatory regime. Politicians should have learnt from the need to rescue financial systems stuffed with institutions deemed too big and interconnected to fail. I fear that concentrated interests will overwhelm the general one.

What about the future of capitalism, on which the Financial Times has run its fascinating series? It will survive. The commitment of both China and India to a market economy has not altered, despite this crisis, although both will be more nervous about unfettered finance. People on the free- market side would insist the failure should be laid more at the door of regulators than of markets. There is great truth in this: banks are, after all, the most regulated of financial institutions. But this argument will fail politically. The willingness to trust the free play of market forces in finance has been damaged.

We can guess, therefore, that the age of a hegemonic model of the market economy is past. Countries will, as they have always done, adapt the market economy to their own traditions. But they will do so more confidently. As Mao Zedong might have said, “Let a thousand capitalist flowers bloom”. A world with many capitalisms will be tricky, but fun.

Less clear are the implications for globalisation. We know that the massive injection of government funds has partially “deglobalised” finance, at great cost to emerging countries. We know, too, that government intervention in industry has a strong nationalist tinge. We know, as well, that few political leaders are prepared to go out on a limb for free trade.

Most emerging countries will conclude that accumulating massive foreign currency reserves and limiting current account deficits is a sound strategy. This is likely to generate another round of destabilising global “imbalances”. This seems an inevitable result of a defective international monetary order. We do not know how well globalisation will survive all such stresses. I am hopeful, but not that confident.

The state, meanwhile, is back, but it is also looking ever more bankrupt. Ratios of public sector debt to gross domestic product seem likely to double in many advanced countries: the fiscal impact of a big financial crisis can, we have been reminded, be as costly as a large war. This, then, is a disaster that governments of slow-growing advanced economies cannot afford to see repeated in a generation. The legacy of the crisis will also limit fiscal largesse. The effort to consolidate public finances will dominate politics for years, perhaps decades. The state is back, therefore, but it will be the state as intrusive busybody, not big spender.

Last but not least, what does the crisis mean for the global political order? Here we know three important things. The first is that the belief that the west, however widely disliked by the rest, at least knew how to manage a sophisticated financial system has perished. The crisis has damaged the prestige of the US, in particular, pretty badly, although the tone of the new president has certainly helped. The second is that emerging countries and, above all, China are now central players, as was shown in the decision to have two seminal meetings of the Group of 20 leading nations at head of government level. They are now vital elements in global policymaking. The third is that efforts are being made to refurbish global governance, notably in the increased resources being given to the International Monetary Fund and discussion of changing country weights within it.

We can still only guess at how radical the changes in the global political order will turn out to be. The US is likely to emerge as the indispensable leader, shorn of the delusions of the “unipolar moment”. The relationship between the US and China will become more central, with India waiting in the wings. The relative economic weight and power of the Asian giants seems sure to rise. Europe, meanwhile, is not having a good crisis. Its economy and financial system have proved far more vulnerable than many expected. Yet how far a set of refurbished and rebalanced institutions for international co-operation will reflect the new realities is, as yet, unknown.

What then is the bottom line? My guess is that this crisis accelerated some trends and has proved others – particularly those in credit and debt – unsustainable. It has damaged the reputation of economics. It will leave a bitter legacy for the world. But it may still mark no historic watershed. To paraphrase what people said on the death of kings: “Capitalism is dead; long live capitalism.”

Big Brother

2009-05-16T09:24:00.000-07:00

What Does Your Credit-Card Company Know About You? - NYTimes.com

What Does Your Credit-Card Company Know About You?
Thomas Hannich for The New York Times

A 2002 study of how customers of Canadian Tire were using the company's credit cards found that 2,220 of 100,000 cardholders who used their credit cards in drinking places missed four payments within the next 12 months. By contrast, only 530 of the cardholders who used their credit cards at the dentist missed four payments within the next 12 months.

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By CHARLES DUHIGG
Published: May 12, 2009

Rudy Santana’s day began recently, as almost all his working days begin, with a name on a screen. The name that April morning belonged to a Massachusetts man in his mid-30s. He owed money on a credit card and a second mortgage, the screen told Santana, and was separated from his wife. He was behind in paying back $28,900.97 in debt. Which was why he was on Santana’s screen.
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When Santana reached him by phone, the man quickly began talking about his ex-wife. “Listen,” the man said. “I called her about this debt, and a guy picked up — a guy I’ve never heard before — and when I asked for her, he hung up on me. Can you believe that? We used that money to renovate the kitchen! And now she won’t even talk to me! Who the hell was that guy who answered the phone?”

“So you’ve spoken to your wife?” Santana asked, his voice soft and gentle. “Were you able to have a good talk with her? Even when you’re angry, it’s important to talk. Did you talk about the debt?”

“Yeah, we talked about it,” the man replied. He paused and released a small sob. “You know, she told me we would be together until we died. I know I have to pay this. But I’m not going to pay her half. I won’t damn pay it.”

“I know,” Santana said. “This is difficult, and I’ll be honest — I think you’re doing a great job. You’re really strong. But the thing is, to the bank, they don’t make a distinction between you and your wife. To them, it’s just debt. They just want to get paid.

“I think I can do something for you, though,” Santana continued, glancing at his screen. It was filled with information about the man, including the fact that he had recently sold his home at a loss. Some of this information had been sent by the man’s bank to Santana’s employer, Sunrise Credit Services, which collects delinquent debts for companies like Citigroup, Bank of America and HSBC. Santana’s company had added notes, too, including helpful tips — he is easier to reach in the mornings, for example — and new ways to contact him.

“Look,” Santana said. “I know you’re angry at your wife. One step to ending that anger is putting this debt behind you. It will really help you find peace. You owe about $29,000. How much do you think you can pay?”

“Well, how much are you gonna help me?” the man shot back. “These banks got all this taxpayer money from the government, and they’re the ones who ruined the market for my house! I helped bail them out. I think the banks should be paying me, instead of trying to suck all the life out of us they can!”

It was the first of numerous blowups that Santana would confront that day. Bill collectors don’t tend to encounter many pleasantries, even in the best of times. And these are nowhere near the best of times, for borrowers or for the banking and credit-card industries that lend to them. After two decades of almost constant expansion and profitability, card companies today are in deep trouble. Monstrous losses — estimated to top $395 billion over the next five years — are growing as cardholders, brought low by the recession, walk away from their debts. And Congress and President Obama are pushing for legislation that would make it much harder for companies to hike up interest rates and charge many of the sneaky fees that have been an easy source of revenue for years.

So credit-card firms are changing their business plans. Gone are the days of handing out cards willy-nilly and hoping that the cardholders who dutifully pay up will offset the losses from those who default. Today companies are focusing on those customers most likely to honor their debts. And they are looking for ways to convince existing cardholders that if they only have enough money to pay one bill, it’s wiser to pay off their credit card than, say, the phone.

Put another way, credit-card companies are becoming much more interested in understanding their customers’ lives and psyches, because, the theory goes, knowing what makes cardholders tick will help firms determine who is a good bet and who should be shown the door as quickly as possible.

Luckily for the industry, small groups of executives at most of the large firms have spent the last decade studying cardholders from almost every angle, and collection agencies have developed more sophisticated dunning techniques. They have sought to draw psychological and behavioral lessons from the enormous amounts of data the credit-card companies collect every day. They’ve run thousands of tests and crunched the numbers on millions of accounts. One result of all that labor is the conversation between Santana — a former bouncer whose higher education consists solely of corporate-sponsored classes like “the Psychology of Collections” — and the man from Massachusetts. When Santana contacted the man last month, he was armed with detailed information about his life and trained in which psychological approaches were most likely to succeed.

Eventually, the man from Massachusetts called Santana back with a proposal. He had spoken to his ex-wife, he said. They wanted to wipe out their debt by paying just $10,000 — only 35 percent of what they owed.

Santana had actually already sought permission from the bank to settle for as little as $10,000. It’s an open secret that if a debtor is willing to wait long enough, he can probably get away with paying almost nothing, as long as he doesn’t mind hurting his credit score. So Santana knew he should jump at the offer. But as an amateur psychologist, Santana was eager to make his own diagnosis — and presumably boost his own commission.

“I don’t think that’s going to work,” Santana told the man. Santana’s classes had focused on Abraham Maslow’s hierarchy of needs, a still-popular midcentury theory of human motivation. Santana had initially put this guy on the “love/belonging” level of Maslow’s hierarchy and built his pitch around his relationship with his ex-wife. But Santana was beginning to suspect that the debtor was actually in the “esteem” phase, where respect is a primary driver. So he switched tactics.

“You spent this money,” Santana said. “You made a promise. Now you have to decide what kind of a world you want to live in. Do you want to live around people who break their promises? How are you going to tell your friends or your kids that you can’t honor your word?”

The man mulled it over, and a few days later called back and said he’d pay $12,000.

“Boom, baby!” Santana shouted as he put down the phone. “It’s all about getting inside their heads and understanding what they need to hear,” he told me later. “It really feels great to know I’m helping people in pain.”

***

To understand how the credit-card industry got interested in psychology, you have to go way back, to a time when many Americans didn’t have a credit card, when almost every company charged the same interest rate regardless of a cardholder’s riskiness and when people often paid off their entire balance each month. All the way back, that is, to the 1980s.

Just a little more than two decades ago, the credit-card business was a quiet, slightly boring industry dominated by banks looking for easy revenue. Card issuers made money by collecting annual dues and interest payments from cardholders as well as fees from merchants each time a customer used a card. Then the math whizzes arrived. They emphasized that the biggest profits didn’t come from people who always paid off their bills but rather from less-responsible clients who never paid their entire balance, and thus could be milked through silently skyrocketing interest rates, late fees and other penalties. Since 1995, the percentage of the industry’s income from cardholder fees has more than doubled to 40 percent. In 2005, as the push to sign up cardholders peaked, the industry sent out more than 10.2 billion credit-card solicitations, which would cover more than the entire world’s population. Two years later, card companies collected $40.7 billion in profits before taxes, according to R. K. Hammer, a credit-card advisory firm. Today Americans carry an average of 5.3 all-purpose cards in their wallets, and the average household has $10,679 in credit-card debt, according to the industry publication The Nilson Report.

But giving credit cards to riskier customers posed a problem: How do you know which cardholders will pay something each month, providing fat profits, and which will simply run up a huge tab and then disappear?

The Ph.D.’s arrived at two solutions. The first was to create thousands of new kinds of cards with their own credit limits, terms and interest rates. Such a strategy theoretically protected companies by limiting how much a cardholder could buy and by charging sufficiently high interest rates to ensure that if a few cardholders walked away, the companies still made plenty of money.

The other solution was learning to predict how different types of customers would behave. Card companies began running tens of thousands of experiments each year, testing the emotions elicited by various card colors and the appeal of different envelope sizes, for instance, or whether new immigrants were more responsible than cardholders born in this country. By understanding customers’ psyches, the companies hoped, they could tell who was a bad risk and either deny their application or, for those who were already cardholders, start shrinking their available credit and increasing minimum payments to squeeze out as much cash as possible before they defaulted.

The exploration into cardholders’ minds hit a breakthrough in 2002, when J. P. Martin, a math-loving executive at Canadian Tire, decided to analyze almost every piece of information his company had collected from credit-card transactions the previous year. Canadian Tire’s stores sold electronics, sporting equipment, kitchen supplies and automotive goods and issued a credit card that could be used almost anywhere. Martin could often see precisely what cardholders were purchasing, and he discovered that the brands we buy are the windows into our souls — or at least into our willingness to make good on our debts. His data indicated, for instance, that people who bought cheap, generic automotive oil were much more likely to miss a credit-card payment than someone who got the expensive, name-brand stuff. People who bought carbon-monoxide monitors for their homes or those little felt pads that stop chair legs from scratching the floor almost never missed payments. Anyone who purchased a chrome-skull car accessory or a “Mega Thruster Exhaust System” was pretty likely to miss paying his bill eventually.

Martin’s measurements were so precise that he could tell you the “riskiest” drinking establishment in Canada — Sharx Pool Bar in Montreal, where 47 percent of the patrons who used their Canadian Tire card missed four payments over 12 months. He could also tell you the “safest” products — premium birdseed and a device called a “snow roof rake” that homeowners use to remove high-up snowdrifts so they don’t fall on pedestrians.

Testing indicated that Martin’s predictions, when paired with other commonly used data like cardholders’ credit histories and incomes, were often much more precise than what the industry traditionally used to forecast cardholder riskiness. By the time he publicized his findings, a small industry of math fanatics — many of them former credit-card executives — had started consulting for the major banks that issued cards, and they began using Martin’s findings and other research to build psychological profiles. Why did birdseed and snow-rake buyers pay off their debts? The answer, research indicated, was that those consumers felt a sense of responsibility toward the world, manifested in their spending on birds they didn’t own and pedestrians they might not know. Why were felt-pad buyers so upstanding? Because they wanted to protect their belongings, be they hardwood floors or credit scores. Why did chrome-skull owners skip out on their debts? “The person who buys a skull for their car, they are like people who go to a bar named Sharx,” Martin told me. “Would you give them a loan?”

Some credit-card companies began using these and other discoveries to find new customers and to scrutinize existing cardholders. A few firms began sending offers to people who had registered for baby showers or weddings, for example, since data showed that getting married or having a child — in addition to making people buy lots of new stuff — often also makes them more responsible. Other companies started cutting cardholders’ credit lines when charges appeared for pawnshops or marriage therapy because data indicated those were signs of desperation or depression that might lead to job loss.

But on the whole, companies, including Canadian Tire, stuck to more traditional methods of managing risk, like raising interest rates when someone was late paying a bill, because they worried that customers would revolt if they found out they were being studied so closely.

“If you show us what you buy, we can tell you who you are, maybe even better than you know yourself,” said Martin, who now works for Wal-Mart Canada. “But everyone was scared that people will resent companies for knowing too much.”

Then last year, the economy blew up. Three things became obvious very quickly. First, all those extra charges that theoretically protected credit-card companies from losing money? Well, the worst-case models were way off, and some companies started hemorrhaging cash. Second, many of the predictions that card companies built around their understandings of people’s psyches were surprisingly accurate, even during an economic tsunami. And finally, when people start losing their jobs and feeling poor, it suddenly becomes very, very important to figure out how to persuade them to pay their credit-card bills.

Data-driven psychologists are now in high demand, and the industry is using them not only to screen out risky debtors but also to determine which cardholders need a phone call to persuade them to mail in a check. Most of the major credit-card companies have set up systems to comb through cardholders’ data for signs that someone is going to stop making payments. Are cardholders suddenly logging in at 1 in the morning? It might signal sleeplessness due to anxiety. Are they using their cards for groceries? It might mean they are trying to conserve their cash. Have they started using their cards for therapy sessions? Do they call the card company in the middle of the day, when they should be at work? What do they say when a customer-service representative asks how they’re feeling? Are their sighs long or short? Do they respond better to a comforting or bullying tone?

“It’s really hard to get clean insights of a cardholder’s state of mind,” said Andy Jennings, the head of research and development at FICO, one of the biggest and oldest analytic firms. “The more subtle the insight, the more cleverness finding it requires. If someone pays for a big cable television package each month with their card, are they rich? Or does it signal they don’t have the sense to avoid products they can’t afford? If they check their balance three times a day, are they worried or uptight? We may look at 300 different characteristics just to predict their delinquency risk.”

If a credit-card company detects unsettling patterns, it might start cutting credit lines, raising interest rates or accelerating repayment schedules. (Companies are expected to withdraw $2.7 trillion of credit by the end of 2010, according to a March report from the Meredith Whitney Advisory Group, a banking-analyst firm.) But the most useful information the card companies are deriving from their data are the insights that help them deepen their relationships with customers, particularly when a cardholder is going through a rough time. One of the strongest conclusions of the psychological studies is that cardholders are most likely to pay the bills of those companies with which they have an emotional connection.

“Today the goal is for customers to get a warm-and-fuzzy feeling from their credit-card company,” said Carl Pascarella, a former chief executive of Visa USA. “If we have a deep relationship with you over a range of products and experiences, if we trust each other, you’ll listen when we give you advice.”

***

It was the first day of training for Bank of America’s newest credit-card customer-assistance employees, and some of the 12 new hires sitting around the classroom were a little confused.

At another company, these employees — who earn about $35,000 a year — might be called “collection agents” or “at-risk account reps.” But at Bank of America, “our whole program is built around assisting the customer,” explained Ric Struthers, president of the credit-card division. “We call it assistance, because we’re here to find a solution.”

To see how one company transforms thousands of low-paid employees into telephone psychiatrists, I attended a day of Bank of America’s four-week training program at the company’s Delaware offices. (I was allowed to attend on the condition that I neither identify nor interview the trainees during the course.) At the front of the classroom, a poster explained the company’s “Customer Delight Model.” The trainees were supposed to “provide a delightful opening,” “employ delightful words,” “acknowledge and empathize” and “personalize with a POWER close.” They spent the morning discussing hypothetical cases, like a cardholder with twins whose husband announced he had fallen in love with another woman. He handed over divorce papers, had a moving truck outside and in short order took over the house and left the cardholder with two kids, only $400 a week and a ton of credit-card debt.

“I would tell her to castrate the man,” one trainee said to the others in her assigned group. “You know, Mel Gibson is getting a divorce, and what he’s doing to that poor woman, he should get his gut hacked up with a rusty knife. I would tell her to cut the husband where it matters, and then ask the new girlfriend what she thinks of what’s down there now!”

These were not, apparently, the “delightful words” that Bank of America had in mind. A much younger male trainee opined that there might be more delicate ways of handling the conversation.

“What do you know?” the woman retorted. “You’ve never been married! You spent your whole life on vacation! Why don’t you learn something instead of moving your mouth all the time?”

Score one for the power close.

As the class discussed how to talk to someone who has recently lost her husband or her job, a young man raised his hand.

“Uh, when we hear a story like this, how are we going to ask them for money?”

“We’ll get to that later,” the instructor, Sheri Roberts, replied.

Then the trainees listened to a recording of an actual call with a cardholder who was about $10,000 in debt, divorced and couldn’t pay her bills. The Bank of America representative was chipper and positive and after 10 minutes offered to cut the woman’s minimum monthly payments in half and drop her interest rate to 5 percent.

“Oh, my God,” the cardholder sobbed on the tape. “Oh, that would help so much. I’m not a bad person.”

“No, of course you aren’t,” the representative replied. “We’re going to figure this out together.”

Such conversations, credit-card companies say, happen all the time. Indeed, just days earlier I spoke to Donna Tiff, a 49-year-old Missouri woman. We were introduced through the Center for Responsible Lending, an advocacy organization that Tiff contacted after companies began hounding her about the $40,000 she owed on multiple cards.

“The phone would ring nonstop,” she told me. “I would get on, crying, and tell them I don’t believe in suicide, but I’m close. That I’m going to file for bankruptcy, and then you’ll get nothing.”

And then Tracey came along. She worked for a company that today is a subsidiary of Bank of America. Tracey had talked to Tiff several times and noticed that there was a mistake on her account — an automatic payment was going to be deducted twice from her checking account. If that happened, Tiff’s other checks would bounce.

“I told her, thank you so much for catching that,” Tiff recalled. “And then we talked for over an hour about my problems and raising kids. She was amazing. She was so similar to me. She gave me her direct number and said that I should call her directly anytime I had any questions or just needed to talk about what was going on.”

Over the next three years, Tiff paid off the entire $28,000 she owed Bank of America and spoke regularly with Tracey, she said. And the $12,000 she owed on other cards? Well, those companies didn’t have a Tracey. They never got fully repaid.

It’s a heartwarming story. Unless you’ve seen how people like Tracey are schooled in the art of bonding. What are the odds that the random customer assistant who dealt with Tiff would have so much in common with her and manage to strike such a close bond? I tried to call Tracey myself, using the information Tiff provided. But I was told she didn’t work there anymore.

One Bank of America executive acknowledged that Tiff — and the caller on the recording in the training course — probably could have cut her debt in half just by asking. Much of what they’re paying, after all, is fees and interest that Bank of America itself tacked on.

“Some cardholders are not as savvy as others,” said Tony Allen, a company spokesman, who added that the company tries to educate cardholders about their options. “I’m sure some people feel like we have conflicted interests and that we’ll only educate as much as it helps us get paid. But we take our responsibility seriously.”

I asked Tiff if she ever asked Tracey to write off the late fees and the interest charges.

“Oh, no,” she told me. “She was so kind to me. How could I ask her for something like that?”

***

If you ask credit-card executives about the current financial crisis, they’ll admit things aren’t good right now. But what really has them worried is what’s going on in Washington.

Just last month, President Obama invited 14 credit-card executives to the Roosevelt Room and told them he planned to ask Congress to outlaw “anytime, any-reason rate boosts and late-fee traps” and to increase scrutiny of the industry. A week later, the House passed the “Credit Cardholders’ Bill of Rights” by a margin of 287 votes. The legislation would force companies to give advance notice of interest-rate hikes, ban most retroactive rate increases and stop companies from issuing cards to people under 18 years old. And if that fails to become law, in 2010 new Federal Reserve Board rules will bar issuers from changing interest rates on existing balances in most cases. In other words, once you get a credit card, it will be much harder for the company to suddenly start charging you more.

The industry has responded by warning that interest rates will rise for everyone. Already, some issuers, including American Express, Bank of America and Citigroup, have started rejecting more card applications. You’re almost sure to get fewer offers in the mail, and the days of interest-free cards for six months (followed by soaring interest rates) are probably gone.

Despite their woes, it’s hard to feel sorry for the card companies. A survey conducted last year by Consumer Action, an advocacy group, revealed that the average penalty interest rate for cardholders who had missed a payment was 26.87 percent. And for years companies have also denied consumers the right to go to court by requiring arbitration, have aggressively marketed to college students and have adopted policies like “universal default,” which allows them to hike your interest rate if you miss a payment on a card issued by a completely different company. Some of their innovations, like cash-back rewards for unpaid balances, were designed to get cardholders to stop paying the full amount they owe.

Meanwhile, as they prepare for an uncertain future, the card companies are scurrying to find the next breakthroughs in credit-card psychology. Take, for instance, Capital One’s Card Lab, a festive Internet site that lets customers design their own cards. I ordered one with my son’s photo on it.

The site is interactive. If I indicate I don’t want to pay an annual fee, for instance, the Web site tells me I must pay a higher interest rate. If I want a low rate, the site tells me I can’t get any rewards points. In essence, the Web site offers a series of choices that determine the relative values I place on different options. Capital One can watch as I navigate the site, learning more and more about me. The industry doesn’t have to drop rats in a maze anymore. We’ve started going there on our own.

“Card Lab is at some level an enormous real-time, ongoing experiment,” says Jack Forestell, senior vice president of marketing and analytics at Capital One. By observing people’s choices and then tracking how they use their cards, the company has learned who is more willing to pay annual fees and who wants airline miles badly enough to pay higher interest rates. “We’ve learned interesting things, like people are more loyal to cards that have their kids’ photos on them,” Forestell says.

What the card companies realize — and what legislation most likely won’t change — is that no matter how much we say we dislike credit cards, they’ve become an essential part of our lives. It’s really hard to rent a car without a card. Or shop online. Or buy plane tickets. Often, executives say, we are just looking for an excuse to use our cards, and so companies are becoming experts in figuring out which excuses we each most want to hear. They’ve let me transform my card into an expression of love for my son. They’ll let you tell yourself that charging a meal gets you closer to a free flight to Tahiti.

Before I left the Bank of America training session in Delaware, the instructor gave the class a little pep talk.

“You’re going to have some days when you help customers, and you’re going to walk out and feel really, really good,” she told them. “It’s O.K. to help people know that we are all working to make the world a better place. It’s O.K. to help them believe.”

Then she turned to the young man who had previously inquired about bringing up the indelicate topic of money with someone who had just lost her job, her house or her husband.

“We are the ones who let them know that there’s always a brighter tomorrow,” she told him. “That’s how we get paid back.”

Charles Duhigg is a business reporter for The Times.