We’re reaching a very interesting point. Nothing has worked to make the markets respond positively. The Paulson $700 billion bailout, the Fed buying commercial paper, the UK bank recapitalization, the coordinated rate cutting by all the world’s central banks — and still the market goes down. The world’s governments and monetary authorities have made it abundantly clear that if one thing doesn’t work, they’ll move on to another — they’ve done in a few weeks more than was done from 1929-1933 to fix things, and still the markets decline.
Oil touches $86 a barrel, and American Airlines trades about where it did when oil was $147 a barrel. The IMF calls for a “global solution,” and most of those steps are underway in one form or another. And after all that, the Dow is off 2% and the FTSE is off 5%. Strange as it may seem, we find this picture encouraging. Bottoms form when very few have any confidence in a bottom forming. That seems to be the case now. Maybe things are unfixable, and the world will go to hell in a handbasket. Otherwise, things might get a little better in coming days — at least for a while.
Martin Wolf wasn’t all that concerned back in January. He didn’t, for example, favor interest rate cuts as one tool in dealing with the credit issues in the US and EU. FT:
In times of panic, grown-ups keep their nerve. In a financial crisis, central banks must be the grown-ups. This week, however, the board of the US Federal Reserve seemed to panic by implementing an extraordinary 0.75 percentage point cut in its interest rates prior to its next scheduled meeting. The move was apparently in response to a falling (though still more than fully valued) stock market. So should the Bank of England follow suit? The answer is: no.
He seems a tad more concerned now about the current world economic situation and now favors rate cuts and a whole lot more, including very expensive recapitalizations of UK banks. FT:
As John Maynard Keynes is alleged to have said: “When the facts change, I change my mind. What do you do, sir?” I have changed my mind, as the panic has grown. Investors and lenders have moved from trusting anybody to trusting nobody. The fear driving today’s breakdown in financial markets is as exaggerated as the greed that drove the opposite behaviour a little while ago. But unjustified panic also causes devastation. It must be halted, not next week, but right now.
The time for a higgledy-piggledy, institution-by-institution and country-by-country approach is over. It took me a while – arguably, too long – to realise the full dangers. Maybe it was errors at the US Treasury, particularly the decision to let Lehman fail, that triggered today’s panic. So what should be done? In a word, “everything”. The affected economies account for more than half of global output. This makes the crisis much the most significant since the 1930s. First of all, the panic must be dealt with…
This panic is also going to have a big impact on economies. So central banks,other than the Federal Reserve, should lower interest rates. Only last week I thought a half-percentage point cut in rates made sense for the UK. If I were on the monetary policy committee today, I would argue for a full percentage point. The world has changed, greatly for the worse.
The finance ministers and central bank chiefs of the Group of Seven leading high-income countries will soon convene in Washington. For once, these are the right people. They must travel with one task in mind: restoring confidence. History will judge their success. These people may go down as the authors of another great depression. It is a destiny they must now avoid, for all our sakes.
Mr. Wolf had a once held a rosy view of the risks of lowering interest rates back in January. FT: “what are the risks? Unfortunately, they are large. One is indefinite continuation of an excessively low rate of US national saving. Others are a loss of confidence in the US currency and much higher inflation.Yet another is a further round of the very asset bubbles and credit expansion that created the present crisis.” Ah, those were the days.
As the Dow plunged 500 points and Jim Cramer warned that the stock market could fall another 20%, the ever excitable Ambrose Evans-Pritchard said: “Unless there is immediate intervention on every front by all the major powers acting in concert, we risk a disintegration of global finance within days.” Telegraph:
We are fast approaching the point of no return. The only way out of this calamitous descent is “shock and awe” on a global scale, and even that may not be enough. Drastic rate cuts would be a good start. Central bankers still paralysed by a misplaced fear of inflation – whether in Europe, Britain, or the US – have become a public menace and should be held to severe account by our democracies. The imminent and massive danger is now self-feeding debt deflation.
The lesson of the 1930s is that any country trying to reflate in isolation will be punished. The crisis will ricochet from one economy to another until every one is crippled. We are seeing it play again in this drama as our leaders fail to rise above their narrow, parochial agendas. The European Central Bank – which raised rates into the teeth of the crisis in July – has played a shockingly destructive role in this enveloping slump. Its growth predictions this year have been, and still are, delusional. Neglecting its global role, it has vastly complicated the fire-fighting efforts of Washington.
It could have offered “cover” to the US Federal Reserve this spring when Ben Bernanke was forced by events to slash rates to 2pc. It could at least have signalled an end to monetary tightening. That is how an ally ought to behave. Instead, it stuck maniacally to its Gothic script, with equally unhappy consequences for both sides of the Atlantic, as well as for China, Japan, and India. The euro rocketed yet further, which it turn set off an oil shock as crude metamorphosed into an anti-dollar with leverage. The ECB policy was self-defeating, even on its own terms. It merely drove headline inflation even higher, while deeper forces of underlying debt deflation pulled the real economies of Germany, Italy, France, and Spain into a recessionary vortex.
Far from offering reassurance, the weekend mini-summit of EU leaders served only to highlight that nobody is in charge of this runaway train. There is still no lender of last resort in euroland. The £12bn stimulus package is risible. Angela Merkel has revealed her deep limitations. It was she who vetoed French efforts to launch a pan-EU rescue package, suspecting that any lifeboat fund would prove to be Trojan Horse – a way of co-opting German taxpayers into colossal transfers of wealth to Latin Europe.
In that she is right, but it is too late now for dysfunctional EU political games. By demanding that those who caused the damage should pay for it, she crossed the line into caricature, or worse. Her comments echo word for word the “we’re alright Jack” attitudes of Euro-pols during the first US banking crises in 1930-1931, until the storm hit Europe and the entire cast was swept away by furious electorates, or simply shot.
We have said that this situation is considerably more serious than many believe, that the US’s $700 billion bailout was only the beginning, and that more expensive and intrusive emergency measures such as direct purchases of commercial paper and interest rate cuts lay ahead. So far that does indeed seem to be the scenario.
On the other hand, a Real Money columnist has a slightly different view: “What we are seeing today is a very rare thing. This is what capitulation looks like. This is what happens when folks give up on the market and are so afraid that they want out at any price. You don’t see action like this other than at truly historic times, and that what this is. That doesn’t mean you rush in and buy into the teeth of this decline, but the good news is that if you have cash, you are going to have some fantastic bargains to pick from. The bad news is that there is no way to know how long this will continue before we find a low.” We’ll just have to see what happens.
Those who say this is not a crisis that needs intervention by many governments apparently underestimate what happens when leverage meets panic in our intensively credit-driven global business environment. Everything is grinding to a halt, and rather quickly. Bloomberg:
The London interbank offered rate that banks charge each other for loans rose for a fourth day, driving a gauge of cash scarcity among banks to a record. The biggest drop in financial short-term debt outstanding since at least 2000 caused the U.S. commercial paper market to tumble 5.6 percent to a three-year low, according to the Federal Reserve.
The crisis deepened after the worst month for corporate credit on record. Leveraged loan prices plunged to all-time lows, short-term debt markets seized up and even the safest company bonds suffered the worst losses in at least two decades as investors flocked to Treasuries. Credit markets have frozen and money-market rates keep rising even after central banks pumped an unprecedented $1 trillion into the financial system. “The credit window is closed,” Jim Press, president of Chrysler LLC, the third-largest U.S. automaker, said…”It’s going to get much, much worse,” said Gregory Peters, head of credit strategy at Morgan Stanley in New York. “The credit markets are effectively shut, the CP market, which there’s not enough focus on, is under complete duress. That can’t be sustained, as that’s the lifeblood of corporations funding themselves.”…
The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, widened 26 basis points to 3.6 percentage points, the highest since Bloomberg began compiling the data in 1984. Rates on three-month Treasury bills fell 20 basis points to 0.6 percent. The bills touched 0.02 percent on Sept. 17, the lowest since the 1940s…
The Libor-OIS spread, the difference between the three-month dollar rate and the overnight indexed swap rate, widened to a record 260 basis points today. It was 197 basis points a week ago and 79 basis points a month ago…Libor for euros advanced 3 basis points to a record 5.32 percent. Libor, set by 16 banks in a daily survey…is used to set rates on $360 trillion of financial products…The market for commercial paper plummeted $94.9 billion to $1.6 trillion…
The most worrying aspect of the crisis is a growing reluctance among financial institutions to offer basic loans that are the lifeblood of the economic system. The Federal Reserve said Thursday the situation had worsened over the past week. Its data showed lenders reduced short-term loans to companies by a record $94.9 billion, bringing the total decline to $208 billion over the past four weeks.
These loans, known as “commercial paper,” run anywhere from a few days to three months, and are routinely used by businesses of all stripes to fund day-to-day operations — paying the bills, meeting salaries. The market for these loans, which totaled $2.2 trillion last summer, has shrunk to $1.6 trillion. “It’s unprecedented to see the markets shut to so many firms at one time,” says Peter Andersen, a portfolio manager at Congress Asset Management Co., an investment company in Boston.
Indeed, this week, General Electric Co., long hailed as one of the steadiest companies in America, was forced to raise billions of dollars of capital on onerous terms because investors in GE’s short-term corporate debt grew worried about its ability to pay its debts.
The Paulson bailout plan is not sufficient in itself to stem the tide that has now engulfed the financial markets. Nor, in our opinion, are the proposals by George Soros and others to add additional equity capital to further bolster the plan. We are well past the point where it is an excuse for inaction that some politicians may be using the so-called bailout as a CYA of their previous improvident acts; these miscreants need to be held accountable, but that is not an excuse for failing to fix the current problems. We expect the Fed and the ECB and other central banks to cut borrowing rates soon and significantly, in addition to their continuing to add massive amounts to liquidity to the system. And hopefully, at some point, pushing on a string will have some salutary effect. If not, watch out. All bets will then be off.
The AP notes that the Large Hadron Collider will get fired up this week. Lawsuits have been filed to stop the project, due to a fear that the LHC could produce a black hole from the head-on collision of protons at about the speed of light and perhaps destroy the universe:
The first beams of protons will be fired around the 17-mile tunnel to test the controlling strength of the world’s largest superconducting magnets. It will still be about a month before beams traveling in opposite directions are brought together in collisions that some skeptics fear could create micro “black holes” and endanger the planet.
The project has attracted researchers of 80 nationalities, some 1,200 of them from the United States, which contributed $531 million of the project’s price tag of nearly $4 billion. “This only happens once a generation,” said Katie Yurkewicz, spokeswoman for the U.S. contingent at the CERN project. “People are certainly very excited.”
The collider at Fermilab outside Chicago could beat CERN to some discoveries, but the Geneva equipment, generating seven times more energy than Fermilab, will give it big advantages. The CERN collider is designed to push the proton beam close to the speed of light, whizzing 11,000 times a second around the tunnel 150 to 500 feet under the bucolic countryside on the French-Swiss border.
Once the beam is successfully fired counterclockwise, a clockwise test will follow. Then the scientists will aim the beams at each other so that protons collide, shattering into fragments and releasing energy under the gaze of detectors filling cathedral-sized caverns at points along the tunnel.
CERN dismisses the risk of micro black holes, subatomic versions of collapsed stars whose gravity is so strong they can suck in planets and other stars. But the skeptics have filed suit in U.S. District Court in Hawaii and in the European Court of Human Rights to stop the project. They unsuccessfully mounted a similar action in 1999 to block the Relativistic Heavy Ion Collider at the Brookhaven National Laboratory in New York state.
Russian President Dmitri Medvedev defined Russia’s foreign policy (via Stratfor):
First, Russia recognizes the primacy of the fundamental principles of international law, which define the relations between civilized peoples. We will build our relations with other countries within the framework of these principles and this concept of international law.
Second, the world should be multipolar. A single-pole world is unacceptable. Domination is something we cannot allow. We cannot accept a world order in which one country makes all the decisions, even as serious and influential a country as the United States of America. Such a world is unstable and threatened by conflict.
Third, Russia does not want confrontation with any other country. Russia has no intention of isolating itself. We will develop friendly relations with Europe, the United States, and other countries, as much as is possible.
Fourth, protecting the lives and dignity of our citizens, wherever they may be, is an unquestionable priority for our country. Our foreign policy decisions will be based on this need. We will also protect the interests of our business community abroad. It should be clear to all that we will respond to any aggressive acts committed against us.
Finally, fifth, as is the case of other countries, there are regions in which Russia has privileged interests. These regions are home to countries with which we share special historical relations and are bound together as friends and good neighbors. We will pay particular attention to our work in these regions and build friendly ties with these countries, our close neighbors. These are the principles I will follow in carrying out our foreign policy.
Sounds like a swell policy, particularly points four and five. Then again, we’re not living next door to Russia in Ukraine, with its 18% Russian population.
Vladimir Putin called attention to the Black Sea as a potential flash point in the confrontation between Russia and the West. He warned that there could be direct confrontations between Russian and NATO ships should NATO or its member nations increase their presence there. According to NATO there are currently four NATO ships in the Black Sea for a previously scheduled exercise called Active Endeavor. Putin explicitly warned, however, that there could be additional vessels belonging to NATO countries in the Black Sea that are not under NATO command.
It is hard to get ships into the Black Sea unnoticed. The ships have to pass through the Bosporus, a fairly narrow strait in Turkey, and it is possible to sit in cafes watching the ships sail by. Putting a task force into the Black Sea, even at night, would be noticed, and the Russians would certainly know the ships are there.
As a complicating factor, there is the Montreux Convention, a treaty that limits access to the Black Sea by warships. The deputy chief of the Russian general staff very carefully invoked the Montreux Convention, pointing out that Turkey, the controlling country, must be notified 15 days in advance of any transit of the Bosporus, that warships can’t remain in the Black Sea for more than 21 days and that only a limited number of warships were permitted there at any one time. The Russians have been reaching out in multiple diplomatic channels to the Turks to make sure that they are prepared to play their role in upholding the convention. The Turkish position on the current crisis is not clear, but becoming crucial; both the United States and Russia are working on Turkey, which is not a position Turkey cares to be in at the moment. Turkey wants this crisis to go away.
It is not going away. With the Russians holding position in Georgia, it is now clear that the West will not easily back down. The Russians certainly aren’t going to back down. The next move is NATO’s, but the alliance is incapable of moving, since there is no consensus. Therefore, the next move is for Washington to lead another coalition of the willing. It is coming down to a simple question. Does the United States have the appetite for another military confrontation (short of war, we would think) in which case it will use its remaining asset, the U.S. Navy, to sail into the Black Sea?
(The answer is no, in our opinion, unless the administration has lost its mind.) Meanwhile, the NYT reported on a Russian diplomatic “setback” related to its invasion of Georgia:
Russia suffered a significant setback here on Thursday, as members of a regional security group in which the Kremlin plays an important role offered little support for Moscow’s military action in Georgia…Although the Central Asia states of Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan all fall within what Moscow considers its sphere of influence, and all seem to accept Russian hegemony to a certain degree, they nevertheless strive to limit Moscow’s reach and preserve their own independence of action.
Let’s see just how long that “independence of action” lasts in this new world of Russia’s reasserting its imperial sphere of influence. As in 2001, the world seems to be changing in ways that almost no one predicted even a couple of months ago, with players and a vocabulary we have yet to learn enough about.
In a number of countries around the world, the recommended caloric intake is 2000-2500 calories a day. They say that the average American consumes about 2800 calories a day, clearly overutilizing the earth’s precious resources. But some Americans are much, much worse than that. Here’s one who consumes 12,000 calories a day. NY Post:
Phelps lends a new spin to the phrase “Breakfast of Champions” by starting off his day by eating three fried-egg sandwiches loaded with cheese, lettuce, tomatoes, fried onions and mayonnaise. He follows that up with two cups of coffee, a five-egg omelet, a bowl of grits, three slices of French toast topped with powdered sugar and three chocolate-chip pancakes.
At lunch, Phelps gobbles up a pound of enriched pasta and two large ham and cheese sandwiches slathered with mayo on white bread - capping off the meal by chugging about 1,000 calories worth of energy drinks.
For dinner, Phelps really loads up on the carbs - what he needs to give him plenty of energy for his five-hours-a-day, six-days-a-week regimen - with a pound of pasta and an entire pizza. He washes all that down with another 1,000 calories worth of energy drinks.
It’s shocking that this much eating is still legal in the world. Americans are only 4% of the world population, and eating 12,000 calories a day is clearly not an environmentally responsible practice.
VDH talks about oil and power in his excellent review of the messages sent by Russia in its long and well planned invasion of Georgia:
We talk endlessly about “soft” and “hard” power as if humanitarian jawboning, energized by economic incentives or sanctions, is the antithesis to mindless military power. In truth, there is soft power, hard power, and power-power — the latter being the enormous advantages held by energy rich, oil-exporting states. Take away oil and Saudi Arabia would be the world’s rogue state, with its medieval practice of gender apartheid. Take away oil and Ahmadinejad is analogous to a run-of-the-mill central African thug. Take away oil, and Chavez is one of Ronald Reagan’s proverbial tinhorn dictators.
Russia understands that Europe needs its natural gas, that the U.S. not only must be aware of its own oil dependency, but, more importantly, the ripples of its military on the fragility of world oil supplies, especially the effects upon China, Europe, India, and Japan. When one factors in Russian oil and gas reserves, a pipeline through Georgia, the oil dependency of potential critics of Putin, and the cash garnered by oil exports, then we understand once again that power-power is beginning to trump both its hard and soft alternatives. Military intervention is out of the question. Economic sanctions, given Russia’s oil and Europe’s need for it, are a pipe dream.
The lack of greater energy self-sufficiency is arguably the foremost national security issue facing the United States. Even if Europe were not pacifist, it is held hostage to Russia due to its energy needs. The US imports 70% of its oil; not fixing this constitutes gross negligence and a shocking level of irresponsibility on the part of the American political establishment.
Western interests…are being tested on three overlapping levels: local, regional and global. Georgia is not just a square on a chessboard, but a country that is extremely important in its own right…
First, despite the uncultivated instincts of its President, Georgia’s political culture is fundamentally democratic, its people (80% of whom support NATO membership) profoundly pro-Western, and its sense of national identity almost indestructible. Georgia can be defeated by Russia, but it can no longer submit to it, and therefore war between Georgia and Russia would be a frightening prospect even if no wider interests existed.
Second, the only energy pipeline in the former USSR independent of Russian control passes through Georgia. There will be no meaningful energy security, let alone diversification of energy supplies, if pipelines become vulnerable to sabotage, like those in Iraq, or to takeover by shadow businesses fronting for Russian interests…
[Third] Georgia is equally important to Russia. Russia has only controlled the nationalities of the north Caucasus when it has dominated the south Caucasus. Despite the so-called “normalisation” in Chechnya, the north Caucasus remains, to Russia’s leaders, the Achilles heel of the Russian Federation. Russia’s regional objectives are straightforward. It aims to show its neighbours, by means of the Georgian example, that Russia is “glavniy“: that its contentment is the key to “stability and security”, and that if Russia expresses its discontent, NATO will be unwilling and unable to help.
One has to question the proposed expansions of NATO to include nations like Georgia, given the reluctance of the EU nations to get involved in anything military and the overstretched armed forces of the United States (eg, the number of lawyers in the United States almost equals the size of the entire active duty military).
James Traub in the NYT reports on Georgia, a western oriented state that has wanted to join NATO:
Modern Georgian history is a record of submission to superior Russian power. Threatened by the expanding Persian empire, in 1783 the Georgians formally accepted the protection of Russia; this polite fiction ended when Russia annexed Georgia in 1801. The chaos of the Russian Revolution finally gave Georgia a chance to restore its sovereignty a century later. The Georgians were Mensheviks — social democrats, in effect — and for three years enjoyed one of the world’s most progressive governments. The Bolshevik government signed a treaty respecting Georgia’s independence — which Europe, as President Saakashvili pointedly reminded me, naïvely insisted on taking at face value. By the time the Europeans woke up to reality, it was too late.
From the time of Pushkin, Russians viewed Georgia as a romantic, exotic frontier. During the long puritanical deep-freeze of Communism, Georgia served as Russia’s Italy — a warm, lotus-eating sanctuary of singers and poets and swashbuckling gangsters. The elite had their beloved dachas on the Black Sea coast of Abkhazia. At the same time, Stalin, though himself Georgian, kept the republic subdued through brutal purges. The head of the Georgian Communist party was Lavrenti Beria, a cold-blooded killer who would become the master architect of Stalin’s terror. The Georgians, though helpless, never accepted their Soviet identity, and preserved their language, culture, religious practice and sense of national identity, as they had under the czars. And when, at last, the Soviet empire collapsed as the czarist one had, Georgia immediately broke away and declared its independence, in 1991…
During a 10-day visit to Georgia in June, I heard the 1938 analogy again and again, as well as another to 1921, when Bolshevik troops crushed Georgia’s thrilling, and brief, first experiment with liberal rule.
Georgians are a melodramatic people, and few more so than their hyperactive president; but they have good reason to fear the ambitions, and the wrath, of a rejuvenated Russia seeking to regain lost power. Indeed, a renascent and increasingly bellicose Russia is an ominous spectacle for the West too. While China preaches, and largely practices, the doctrine of “peaceful rise,” avoiding confrontation abroad in order to focus on development at home, Russia acts increasingly like an expansionist 19th-century power, pressing at its borders. Most strikingly, Russia has bluntly deployed its vast oil and gas resources to punish refractory neighbors like Ukraine, and reward compliant ones like Armenia…
while Russia has a massive advantage in firepower, Georgia, an open, free-market, more-or-less-democratic nation that sees itself as a distant outpost of Europe, enjoys a decisive rhetorical and political edge. In recent conversations there, President Saakashvili compared Georgia to Czechoslovakia in 1938, trusting the West to save it from a ravenous neighbor. “If Georgia fails,” he said to me darkly two months ago, “it will send a message to everyone that this path doesn’t work.”
We’ll just see how “a decisive rhetorical and political edge” stacks up against firepower and the willingness to use it. “If Georgia fails, it will send a message to everyone that this path doesn’t work.” Well, that seems clear enough at the moment. Question: if Georgia had in fact already joined NATO, would the US have actually warred against Russia because of these attacks? And what if NATO had not responded to attacks on one of its members?
We’ve written about the issue of purchasing power parity (PPP) before, but often with regard to big ticket items. Here’s another approach. Economist:
The Big Mac Index is based on the theory of purchasing-power parity (PPP), which says that exchange rates should move to make the price of a basket of goods the same in each country. Our basket contains just a single item, a Big Mac hamburger, but one that is sold around the world. The exchange rate that leaves a Big Mac costing the same in dollars everywhere is our fair-value yardstick.
Only a handful of currencies are close to their Big Mac PPP. Of the seven currencies that make up the Federal Reserve’s major-currency index, only one (the Australian dollar) is within 10% of its fair value. Most of the rest look expensive. The euro is overvalued by a massive 50%. The British pound, Swedish krona, Swiss franc and Canadian dollar are also trading well above their burger benchmark. All are more overvalued against the dollar than a year ago. Only the Japanese yen, undervalued by 27%, could be considered a snip.
The dollar still buys a lot of burger in the rest of Asia too. The Singapore dollar is undervalued by 18% and the South Korean won by 12%. The currencies of less well-off Asian countries, such as Indonesia, Malaysia and Thailand, look even cheaper. China’s currency is among the most undervalued, though a bit less so than a year ago…
sophisticated analyses come to broadly similar conclusions to our own. John Lipsky, number two at the IMF, said this week that the euro is above the fund’s medium-term valuation benchmark. China’s currency is “substantially undervalued” in the IMF’s view. The dollar is sandwiched in between. The big drop in the greenback’s value since 2002 has left it “close to its medium-term equilibrium level,” said Mr Lipsky.
This is a rather similar point to the one that IBD made at the end of last year. Question: if commodity prices hadn’t gone parabolic, would we generally have the impression that the dollar had lost so much purchasing power?
“A very nasty period is soon to be upon us - be prepared,” said Bob Janjuah, the bank’s credit strategist…who became a City star after his grim warnings last year about the credit crisis proved all too accurate…”Globalisation was always going to risk putting G7 bankers into a dangerous corner at some point. We have got to that point…The Fed is in panic mode. The massive credibility chasms down which the Fed and maybe even the ECB will plummet when they fail to hike rates in the face of higher inflation will combine to give us a big sell-off in risky assets…”
It’s not just RBS that is sounding the alarm. Morgan Stanley apparently has a similar report, according to Evans-Pritchard:
“We see striking similarities between the transatlantic tensions that built up in the early 1990s and those that are accumulating again today. The outcome of the 1992 deadlock was a major currency crisis and a recession in Europe,” said a report by Morgan Stanley’s European experts…”The tensions will not disappear into thin air. They will find fault lines on the periphery of Europe. Painful macro adjustments are likely to take place. Pegs to the euro could be questioned”…The point of maximum stress could occur in coming months if the ECB carries out the threat this month by Jean-Claude Trichet to raise rates. It will be worse yet — for Europe — if the Fed backs away from expected tightening. “This could trigger another ‘catastrophic’ event”…
Morgan Stanley says the current account deficits of Spain (10.5pc of GDP), Portugal (10.5pc), and Greece (14pc) would never have been able to reach such extreme levels before the launch of the euro. EMU has shielded them from punishment by the markets, but this has allowed them to store up serious trouble. By contrast, Germany now has a huge surplus of 7.7pc of GDP.
The imbalances appear to be getting worse. The latest food and oil spike has pushed eurozone inflation to a record 3.7pc, with big variations by country. Spanish inflation is rising at 4.7pc even though the country is now in the grip of a full-blown property crash. It is still falling further behind Germany. The squeeze required to claw back lost competitiveness will be “politically unpalatable”.
Morgan Stanley said the biggest risk lies in the arc of countries from the Baltics to the Black Sea where credit growth has been roaring at 40pc to 50pc a year. Current account deficits have reached 23pc of GDP in Latvia, and 22pc in Bulgaria. In Hungary and Romania, over 55pc of household debt is in euros or Swiss francs.
We have wondered for some time what would happen with the euro and EU economies when the stresses of major differences in economic policies, inflationary pressures, and productivity became too pronounced to paper over. Apparently we may find out soon.
(Please see our previous piece on this issue as background.) The Economist has a piece full of interesting facts. The question is whether its central premise, posed in the italicized paragraph below, is correct.
Over half of the world’s infrastructure investment is now taking place in emerging economies, where sales of excavators have risen more than fivefold since 2000. In total, emerging economies are likely to spend an estimated $1.2 trillion on roads, railways, electricity, telecommunications and other projects this year, equivalent to 6% of their combined GDPs—twice the average infrastructure-investment ratio in developed economies. Largely as a result, total fixed investment in emerging economies could increase by a staggering 16% in real terms this year, according to HSBC, whereas in rich economies it is forecast to be flat.
Such investment will help support economic growth this year as America’s economy stalls—and for many years to come.…
Morgan Stanley predicts that emerging economies will spend $22 trillion (in today’s prices) on infrastructure over the next ten years, of which China will account for 43%. China is already spending around 12% of its GDP on infrastructure. Indeed, China has spent more (in real terms) in the past five years than in the whole of the 20th century. Last year Brazil launched a four-year plan to spend $300 billion to modernise its road network, power plants and ports. The Indian government’s latest five-year plan has ambitiously pencilled in nearly $500 billion in infrastructure projects. Russia, the Gulf states and other oil exporters are all pouring part of their higher oil revenues into fixed investment.
Good infrastructure has always played a leading role in economic development, from the roads and aqueducts of ancient Rome to Britain’s railway boom in the mid-19th century. But never before has infrastructure spending been so large as a share of world GDP. This is partly because more countries are now industrialising than ever before, but also because China and others are investing at a much brisker pace than rich economies ever did. Even at the peak of Britain’s railway mania in the 1840s, total infrastructure investment was only around 5% of GDP.
“Never before has infrastructure spending been so large a share of world GDP.” Is that a good thing or a bad thing? The Economist and some analysts assume it is a good thing, and perhaps makes world GDP more stable in the face of slowdowns in the EU and US. But what iron law says that that is true? Perhaps spending so hugely on infrastructure turns out to produce wasted and idle productive capacity in the face of a big downturn in final demand.
Is it not also possible and plausible that the great trade and growth among developing countries is a more fragile thing? China’s exports appear to be holding up quite nicely so far (up 28%, year over year), but doesn’t it remain to be yet seen if the great progress in the developing world is truly self-sustaining? For example, is it not true that by historical measures, a significant correction is long overdue?
To those who say that nothing like that is apparent on the horizon, we respond: everyone thought the good times were here to stay in internet stocks, housing prices, commodities of all sorts, subprime mortgages, and LBO loan syndication almost up to the very moment that they went over the cliff. It is when articles like the one above seem so unquestioning of their basic premise that we wonder most just what lies around the corner. (For example, if everyone saw the future so clearly and correctly, every energy dependent company in the US would have hedged almost all of their fuel needs a year ago.)
Is it speculators or supply and demand that have caused oil to spike $16 or so in two days? WSJ:
“If you asked me why oil prices are so high, the answer would be “I don’t know,’” said Royal Dutch Shell PLC Chief Executive Jeroen van der Veer.
The fellow makes quite a lot of money, and his company makes quite a bit more than that. You’d think as CEO part of the job description would be to have a view of why this was all happening.
When it comes to analyzing speculative hedge fund investments, perhaps it’s not a bad idea to ask the man who owns one. According to the FT, investment fund owner George Soros is to tell Congress that the oil market is experiencing a “bubble in the making.” (Of course given his past track record, there’s always the question of which side of the trade he’s really on):
“I find commodity index buying eerily reminiscent of a similar craze for portfolio insurance which led to the stock market crash of 1987…In both cases, the institutions are piling in on one side of the market and they have sufficient weight to unbalance it. If the trend were reversed and the institutions as a group headed for the exit as they did in 1987 there would be a crash.”…
Mr Soros said index-buying was based on a misconception and commodity indices are not a legitimate asset class. “When the idea was first promoted, there was a rationale for it…But the field got crowded and that profit opportunity disappeared…Nevertheless, the asset class continues to attract additional investment just because it has turned out to be more profitable than other asset classes. It is a classic case of a misconception that is liable to be self-reinforcing in both directions.”
Author and consultant Daniel Yergen says that oil has reached its “break point,” where alternatives on both the supply and demand side will be brought to market relatively quickly (although he says that a “missing generation” of investment and people will prolong the oil supply side a bit).
Finally, we note that the phrase “ask the man who owns one” was originally an advertising slogan for Packard. Today’s update of that should probably take note of the forecast that 25% of European cars could be hybrids within a decade. Even if prices were to fall again, as they did in the 80’s and 90’s, we get the sense that people are pretty fed up with OPEC and its posturing this time around, and that trends like hybrids may have found their moment.
A piece of Morgan Stanley research shows that Emerging Market countries now export roughly as much to each other as they do to the EU and US. A central economic question of our time is whether this seemingly greater independence of the EM countries from the the US and EU means a real “decoupling” has happened. No one really knows the answer to this question, which is indeed perhaps the central economic question of our times, because of its implications for the global economy over the next five years at least.
If a decoupling really has occurred, the EM countries can feed on each other for good growth while the West languishes in recession or near recession for a while. This would give continued support to the boom in commodities and oil, which otherwise appears extremely long in the tooth.
As you know, we are very skeptical of the “decoupling” thesis. China’s rather dodgy numbers and other irregularities raise the issue of what happens if growth should slow and people start turning over the rocks to see what has been covered up during this ultra-long, ultra-rare period of hypergrowth. Moreover, China may be a model of transparency and good corporate practice compared to some of the other EM countries.
The Morgan Stanley chart above includes not only China but Argentina, Brazil, Chile, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Russia, South Africa, Thailand, and Turkey — so there is plenty of room for mischief, cooked books, bad loans, and all the rest, which tend to get revealed, to further ill effect, during periods of recession and economic duress. All the projections of a continued super-boom in commodities and oil are premised, to one extent or another, on the decoupling hypothesis. We don’t believe it. We shall just have to see who is right.
“America’s workers should build America’s defense,” announces the Clinton campaign commercial below. But nothing is quite as simple as it seems.
The Clinton campaign in Indiana is featuring an ad (via Gateway Pundit) of a plant that was closed in 2003. The jobs were outsourced to China, and Clinton blames the Bush administration. Run of the mill trade policy ad, you say. Not quite.
The Magnequench plant that was closed was not making waffle irons. The plant apparently manufactured 80% or more of the sintered NdFeB magnets that are used in the US military’s smart bomb guidance systems. Sounds sinister, yes? And an even better ad for the Clinton campaign. But it gets more complicated. All the transactions that resulted in ownership of the plant by Chinese interests occurred during the Clinton administration.
In 1995, according to ABC, “China National Non-Ferrous Metals…and San Huan New Material High-Tech Inc…joined with other interests to purchase the Anderson, Ind.-based Magnequench…The two Chinese companies were headed by the husbands of the first and second daughters of then-Chinese leader Deng Xiaoping.” The 1995 transaction was approved by CFIUS, the responsible government agency. Then, in 2000, Magnequench bought the factory that appears in the campaign ad. So it would appear that if there is an issue about the transfer of sensitive technology to China, it occurred before George Bush was President, rendering some of Senator Clinton’s claims in the ad moot or ridiculous.
But is there a legitimate national security angle to the story in the first place? Former Magnequench vice president Andy Albers says no, via ABC. “‘Nothing was done by Magnequench that aided the Chinese military program or hurt the U.S. military program,’ says Albers, who adds that Clinton’s focus on his former company ‘concerns me because it doesn’t address the main issue, which is how to make U.S. companies more competitive globally at’s the question we should be asking, that’s what we should be addressing. We should not be twisting the truth about that this is a national security issue, because it’s not a national security issue, it’s about global competitiveness’.” Former counsel to Congressman Duncan Hunter, Jeff Green, agrees that the matter is not a national security issue: “‘I think it’s more accurate to say that all the technology and production of these Neo magnets comes from overseas,’ he says, including Japan, Finland, Germany and China.”
So either both the Bush and Clinton administrations are to blame, or neither one did anything wrong. It’s a bit hard to say at the moment, but it appears from the news reports that, on a micro level, the system apparently functioned normally, although there are dissenting voices on left and right alike. However, on a macro level, the picture looks a little different, and raises the question as to whether the procedures in place at the CFIUS arm of the Treasury Department are adequate in a world that changes rapidly. At first blush, they do not appear to be.
One obvious question: does CFIUS track purchases or consolidations that occur after it has approved the sale of a company? For example, there are apparently sources for the Neo magnets in Japan, Finland and Germany, as well as in China. But what if a Chinese company or companies were to subsequently purchase those operations in Japan, Finland, and Germany? Would we ever know? Before it was too late to do anything about it? How? The current transactional approach of CFIUS, even as modified by FINSA, looks sort of like Hart-Scott-Rodino procedures for defense related industries. CFIUS procedures do not seem to take into consideration certain plausible or likely future events which could render its decisions unwise in retrospect. This would appear to bear looking into.
The US economy is at a near standstill, growing 0.6% in the first quarter primarily because of inventory accumulation, which is a problem in itself. The Eurozone is rapidly decelerating too, back to levels not seen in some countries since 2005. FT:
The European Commission’s eurozone “economic sentiment” index has fallen sharply from 99.6 in March to 97.1 in April – the lowest level since August 2005. With the indicator regarded as good guide to growth trends, the unexpectedly steep decline pointed to a marked deceleration in economic activity…
eurozone countries show varying performances. Economic sentiment in Spain, which is at risk of a serious house price correction, has fallen to the lowest level since late 1993. But sentiment in Germany and France remains relatively robust – falling to the lowest levels since February 2006 and December 2005 respectively.
2005 isn’t a long time ago, but you might be a little surprised just how bad things were in much of the eurozone in that year.
89 year old author, investment adviser, and former professor Peter Bernstein’s three “classics” from the 1960’s are being reissued this year with introductions from Paul Samuelson, Paul Volcker and Arthur Levitt, which itself is a certain testimonial to the man. His 1996 book, Against the Gods: The Remarkable Story of Risk, won a number of awards and was well reviewed in both the popular and academic press. He was interviewed in the WSJ on the current outlook, and sees protracted problems:
You don’t get into a mess without too much borrowing. It was sparked primarily by the hedge funds, which were both unregulated by government and in many ways unregulated by their owners, who gave their managers a very broad set of marching orders. It was a real delusion…
When you think about how all of this will work out in the long run, we are going to have an extremely risk-averse economy for a long time. The lesson has painfully been learned. That’s part of the problem going forward. You don’t have a high-growth exit from this, as you’ve had from other kinds of crises. We won’t have a powerful start, where the business cycle looks like a V. Here, the shape of the business cycle is like an L, where it goes down and doesn’t turn up. Or like a U, a flat U. The reason for that is that people aren’t going to get caught in this bind again. They will tell themselves, “I’m too smart to do that again.” And everyone else is going to be saying the same thing…
I’m a child of the Depression, and I am thinking about what the early years were like after World War II. It took a very long time to get the memory of the Depression out of business decisions, and certainly banking decisions. I think this is going to be the same. The Fed, too, is going to be less decisive and is going to feel that what it should do is less clear. One of the things that gave people a sense that they could afford to take risks was the sense that the central bankers more or less know what they are doing. But I don’t think we are going to feel that way going forward…
If China goes into a recession, God knows…Before, it was investment that made the V at the bottom of the business cycle. I don’t see real investment turning enough without some sign from the consumer side. Maybe the foreign countries will do it for us. That is a substitute for consumption here. Maybe. But I think that they won’t do enough for us, and maybe will be too infected by us to do it. But maybe growth in Asia will help us. The Asian thing is tremendously exciting.
We quote Mr. Bernstein because he sees a number of the same risks we do, and he too does not know how it will all turn out. It is fervently to be hoped that Asia picks up the slack and its growth is not derailed by the slowdowns present in the US and coming shortly to the Eurozone. But it is not at all clear that this can happen in a region so highly dependent on exports for its growth. It is certainly possible that we are nearer to the end than the beginning of the “one-shot adjustment” boost to non-inflationary growth from China and the other nations similarly situated. We’ll keep our fingers crossed that it really will be different this time.
