ECB and Bank of Canada warn of global imbalances, pressure on dollar

Tuesday, May 31, 2005

The European Central Bank reported(pdf) on Tuesday that M3 growth in the Eurozone has accelerated to an annual rate of 6.7 (6.5) percent in April. While this is a long-term concern to the ECB, see this post, the watchdogs of price stability pointed to more looming risks. In its latest Financial Stability Review the ECB warned of a disruptive unwinding of global imbalances that could result in severe pressure on the US dollar. These warnings were also expressed by Canada's central bank governor David Dodge.
The ECB said, "large and growing financial imbalances continue to pose medium-term risks for the stability of foreign exchange and other financial markets." Asian central banks have so far been willing to continue financing the US deficit, but if they lose their appetite for US assets, this could trigger a disorderly correction. "Such concerns could increase the likelihood of a disorderly rebalancing, involving a capital account adjustment and/or the possibility of severe downward pressure on the US dollar, coupled with significant upward pressure on long-term interest rates," it said according to an AFX report. An underestimation of risk has pushed the prices of bonds and some other assets beyond their intrinsic value, it said further, adding that "some euro-area financial institutions, including banks, would likely endure losses - at least in the short term - from any upturn in long-term interest rates."
Governor Dodge essentially repeated these warnings in a speech, saying that a growing imbalance in the global economy, exacerbated by a rampant US deficit as the rest of the world records surpluses, needs to be addressed soon before it gets resolved "in an abrupt, disorderly way. A country's external indebtedness cannot keep growing indefinitely as a share of its GDP. Eventually, investors will begin to balk at increasing their exposure to that country, even if it is a reserve-currency country, such as the United States." "It is clear that, to date, there has not been enough progress on structural reforms," Dodge said. "This lack of progress is somewhat frustrating, given that there is a reasonable consensus on what should be done domestically in all countries." And he said all countries must look to produce a sustainable public debt-to-GDP ratio.
ECB council meets on Thursday
The ECB is scheduled to hold it's monthly council meeting on Thursday. Squeezed between slowing growth and an official inflation rate that hovers around 2 percent no change of policy is expected, especially in the light of the recent strength of the dollar. The leading interest rate will remain unchanged at 2 percent for the 26th month in a row.
These warnings come on the back of the recent surge of the dollar, its reasons and implications described in this post.

China may use FX reserves to buy oil - plans SPR

China is exploring ways to use some of its huge foreign exchange reserves to buy imported oil, according to a report from Tuesday on This news comes on top of Chinese expectations that the far eastern giant will be able to sustain 8 percent annual economic growth over the next decade.
The Shanghai Securities News reported, citing an unidentified source, that the plan was first proposed as early as 2000 and would help China attain the twin objectives of making better use of its foreign exchange and ensuring vital oil supplies.
The Chinese newspaper quoted Li Yang, a senior economist at the Chinese Academy of Social Sciences and a former member of the monetary policy committee under the central bank, as saying the plan to use foreign exchange reserves to build up strategic oil reserves is reasonable.
Forex reserves grew 67 percent within a year
China had foreign exchange reserves of 659 billion dollars at the end of March. This is 67 percent more than a year ago. Some local economists have recommended that China diversify its reserves, which are still heavily weighted in US dollars.
In March, Guo Shuqing, director of the State Administration of Foreign Exchange, suggested China could use some of its foreign exchange reserves to purchase imported oil.
China already plans to build a strategic oil reserve, though this plan is believed to be making slow progress.
Niu Li, a researcher on global oil issues with the State Information Center, was quoted in the Shanghai Securities News, saying the government should speed up this plan to shift reserves into oil in order to reduce investment risk.
The paper also brought an announcement that China will scrap its sharply increased export duties for textiles, only 10 days after they were introduced. China had imposed export duties of up to 400 percent.
Xinhuanet, the official news agency, quoted 1999 economics Nobel prize winner Robert Mundell extensively. Mundell said that China should ignore outside pressure and keep the Yuan exchange rate stable at a high-profile conference attended by several Nobel laureates in Beijing. If the Chinese currency were to be revalued, overseas direct investment will decrease and lead to more unemployment, affecting even the rest of East Asia, he said.
Vernon L. Smith, the 2002 winner, said the huge and growing trade between America and China greatly benefits both countries. "By outsourcing to foreign countries, US businesses save money that is available to invest in new technologies, new jobs and remain competitive in world markets. We should let it happen," Smith said. However, "many American citizens will not now agree with that."
Robert W. Fogel, who won the Nobel Prize for Economics in 1993, told China Daily that there were two reasons why the global community gained from China's development.
"First, China is producing more and more goods that can be of a very high quality and at a much lower price," Fogel said. "Secondly, China will need more goods and services from other places such as Europe and the United States," he said.

Dollar hits Euro and Yen, oil hits all of them

In the race of the three big ugly ducklings US dollar, Euro and Yen, the US dollar has staged a massive comeback this year.

After finishing 2004 at a record low of 1.3670 dollars against the Euro the greenback has managed to build up an impressive rally that propelled it 10 percent upwards to a seven-month high of 1.2306 dollars.

Against the Yen the US currency incrased 7 percent, with the dollar trading up from 101.65 Yen to a high of 108.80 Yen, before correcting to 104 Yen and recovering again to today's level of above 108 Yen.

The Euro could not hold on to its gains against the Yen seen this spring and plummeted lastly almost as strongly as to the dollar.
I call the three curencies the three big ugly ducklings for the following reasons.
US Dollar:
  • Current account deficit
  • Trade deficit
  • Budget deficit
  • Inflation fears
  • Slower growth
  • Budget deficits
  • Political worries
  • Unemployment
  • Inflation fears
  • Slower growth
  • Budget deficits
  • Stagflation
  • Chinese competition
  • Demographics
  • Dependence on energy imports
All in all there are no compelling reasons to get bullish on any of the three. The duck-march can continue and the least weak one will be the winner of the year.
What has changed the picture the most is the new threat to the Euro that the European constitution will not come into effect. If the Dutch will reject the constitution on Wednesday the common currency is likely to be hit again.
A weaker Euro will in turn burden Europe's economies because of higher commodity and especially oil prices through the exchange rate effect.

Crude oil climbed past the 51.50-dollar mark today. But this effect will hit Japan and the US as well as Europe.

Silver lease rates exploded over the last month

Something is going on in the silver market. 24hpm, a news site with a focus on precious metals, yesterday alerted readers on an explosion in silver lease rates over the last month.

Lease rates for all maturities from 1 to 12 months effectively doubled and tripled within the last 30 days.

Silver spiked to 7.30 dollars an ounce last Friday after reaching a monthly low at 6.80 dollars on May 3. On Monday it closed at 7.21 dollars.
Silver bugs are attributing the rise in silver lease rates to short-sellers who are getting squeezed by the rising silver cash price.
Precious metals loans have been the cheapest way of financing over the last 4 years.
The trade works like this. Lease gold/silver at rates well below 2 percent, sell the physical silver and invest the proceeds in higher yielding securities. At the end of the lease agreement reverse the trade and pocket the yield differential minus/plus the change in the gold/silver price. Profits are guaranteed as long as the upward risk of the cash price is hedged.
The sudden spike in silver lease rates - gold lease rates stayed more or less flat - points to imbalances in the physical market.
Some fundamentals on silver
According to the Silver Institute the surge of digital photography has less impact on silver use than widely estimated. While demand in the photo industry fell last year from 192.9 to 181 million ounces, overall industry use increased 5 percent, from 350.5 to 367.4 million ounces. Jewellery demand declined 10 percent to 247.5 million ounces, while coin sales increased 15 percent to 41.1 million ounces. Silver investment has become fashionable again too: Silver bar sales surged 389 percent to 42.5 million ounces last year. These figures sum up to a silver demand of 698.2 million ounces or 4 percent more than in 2003.
Mine production rose 4 percent to 634.4 million ounces as well. Mexico is the biggest silver producer followed by Peru. Don't see a silver shortage because of this! Primary silver production accounts for only 30 percent of supply. The far bigger part comes from recycling. The Spaniards once looted so much silver from Latin America that they could have built a bridge spanning the Atlantic ocean.
While silver is dug out of dark mines, a lot of fundamentals remain in the dark too. Central banks worldwide do not state their silver holdings in their balance sheets. A search in the database of the Bank for International Settlements (BIS), the central bank of the central banks brings no useful results . But there must be silver holdings as Gold Fields Mineral Services estimates the amount of leased silver in the region of 275 million ounces. The US, once the biggest hoarder of silver, has sold it all. The US Congress had to pass a law last year that permitted silver purchases on the open market in order to continue its program of silver memorial coins.

Experience shows that man never learned anything from experience (G.B. Shaw)

Monday, May 30, 2005

On the weekend I stumbled across this description of the governing style of a US president. I leave out all names for the sake of thrill, as I have done in the post "Imperial struggles (no fairy tale)." You tell me if this is the past or the present with an outlook into the future.
The era of feeling good was epitomized by the president's relaxed sense of the Presidency.
"If you see ten troubles coming down the road you can be sure that nine will run into the ditch before they reach you," the president is quoted.
The Treasury Secretary found a more sophisticated rationale for the doctrine of laissez-faire.
He argued that the populist idea of progressive taxation was destructive to general prosperity. Instead of using the income tax to compensate for the maldistribution of wealth and income, tax rates on the rich should be cut drastically in order to stimulate economic growth. The rulers devised tax credits, refunds and abatements to benefit corporations and they enacted major income-tax reductions, purposely skewed to benefit upper-income brackets.
The argument was that everyone would eventually benefit as the wealthy devoted the tax cuts to capital investment and new jobs were created. The Treasury Secretary fell short of the ultimate goal - complete elimination of progressive tax rates - but his approach seemed for a time to be wondrously effective in stimulating new enterprises and expanded production. As the prosperity unfolded, the Federal Reserve shared in the applause. Inflation was low. Economic performance was evidently aided by the Fed's stable management.
In the era of self-congratulation a slow slide of economic indicators was largely ignored. After all the stock market was rallying again - a sure sign of more good times ahead.
The Federal Reserve was on a slow path of removing accomodative policy and established another precedent - it's ability to obfuscate and confuse when under attack. Public discontent was blunted by long and technical answers that diverted attention from the Fed's own role in economic distress. The official answers were usually accurate in the narrow sense, but they grossly dodged the questions. This evasive technique was to become standard procedure. After the retirement of the chairman the Federal Reserve suffered a historic disgrace. The stock market fell and fell and fell. The new Fed chairman stood on the sideline, defending former actions of the Fed with the notion that he did not want to suffocate the economy further by tightening monetary policy.
The president looked at the catastrophe with a relaxed attitute. His policy had always been to preserve the old moral and economic precepts amid the material prosperity which many Americans were enjoying. He refused to use Federal economic power to check the growing boom or to ameliorate the depressed condition of certain industries. His message to Congress called for isolation in foreign policy, and for tax cuts. Four years after his retirement he confided to a friend, "I feel I no longer fit in with these times."

Now The Prudent Investor asks:
  1. Did this happen in in the past?
  2. Is this happening right now?
  3. Both.
  4. Toni, you are a moron. Leave me alone with Calvin Coolidge. Here is a dollar and now go away, please!

Please post your answers under comments.

Les Francais disent NON - Euro dives

54.9 percent of French voters have rejected the EU constitution, dealing a huge blow to the process of European integration. Voter participation percent of more than 70 percent was exceptionally high, French authorities reported. EU president Jean-Claude Juncker was "perplexed" about the result, he said in a first statement and added it would be impossible to renegotiate the constitution. He nevertheless wants to proceed with the ratification in the other EU member states. French politicians called it a defeat for Europe and a defeat for France. French president Jaques Chirac announced a "strong impulse" after the rejection, which will likely propel the head of the conservative party, former interior minister Nicolas Sarkozy to the post of prime minister, replacing unpopular Jean-Pierre Raffarin.

The Euro plunged almost a cent to a seven-month low of 1.2507 dollars in Asian trading and recovered a little in quiet European trading. Gold and silver were up.
There is risk of a further weakening as Europe now faces not only economic but mounting political problems as well. The Netherlands will vote on the referendum on Wednesday. Dutch premier Jan Peter Balkenende urged voters not to follow the French decision. A poll from Saturday sees even bigger discontent - 57 percent of the Dutch are opposed to the treaty.
The EU faces an unprecedented crisis anyway as the French result shows a deep rift about the future course of the Union. A first analysis shows that salaried workers and rural voters ticked overwhelmingly "no" on the ballot papers.
High umemployment in France and Germany and sluggish growth in most member states could bring a further political shift to the left as Europeans tend to see no positive impact from the pro-market policies that have been pushed by EU lawmakers.
The EU heads of state will discuss the future course of the Union at a summit on June 16 and 17 in Brussels. British Foreign Secretary Jack Straw said the rejection raised profound questions about the future of the EU, which once started as an economic union that has transformed into a political union as well. The constitution would have established a common European minister of foreign affairs.
The lack of a constitution also blocks a reform of the EU bodies as any step would have to be ratified by all 25 member states. Only nine countries have ratified the constitution so far: Austria, Germany, Greece, Hungary, Italy, Lithuania, Slovakia, Slovenia and Spain.
BBC news has an overview where member states stand in the debate.
European share markets all trended moderately lower in early European trading, France leading the list of losers with a fall of 0.74 percent in the CAC 40. Only German shares were quoted largely unchanged with the DAX index showing a gain of 0.06 percent. The London Stock Exchange was closed on Monday because of bank holiday.
UPDATE: Brad Setser's Web Log has a post on the French "Non", most interesting are the comments there.
A Fistful of Euros dives ever deeper in today's no. 1 topic.

Yield curves signal possibility of a global recession

Friday, May 27, 2005

While the most recent round between the US (Treasury Secretary John Snow) and China (central bank chief Zhou Xiaochuan) on a Yuan revaluation brought just another standoff in the long-running debate, bond markets start to signal far more worrying news ahead. Over the last month only the yield on 10-year notes fell 19 basis points (bp) to 4,07 percent while the yield on 2-year notes softened only two bp to 3,62 percent, reducing the spread to only 45 bp. The spread between 2 and 3-year notes amounts to no more than 5 bp based on Thursday's closing prices. All this flattening stems to the bigger part from the rise on the short end, while the long end continues its puzzling streak that added "conundrum" to common Fed watcher's vocabulary. All US recessions were preceded by an inverse yield curve and the point this could happen is only 4 FOMC meetings away, when one presupposes the Fed will keep it's measured pace of 25-bp hikes.
European bond markets look no better. 10-year German bund yields fell 22 bp to 3.21 percent within a month while 3 to 5-year maturities softened only 16 bp to 2.52 percent, according to Bundesbank data. The picture of flattening yield curves gets repeated in most European nations and one does not need to look at a chart to see that the Japanese government bond yield curve is flat only for the reason that the short end is near zero. We know that for years already.
All these markets share one common perception: Their economies are going to slow soon, as the latest OECD report from Wednesday confirmed.
According to Morgan Stanley economist Ted Wieseman, the rush out of bonds may evolve into a stampede. "In an economy growing at a sustained 4%+ real rate, experiencing near-record low national savings, a corresponding record high current account gap and rising inflation, bubble seems the only reasonable way to describe real short rates of barely over 0%, real five-year rates of less than 1%, real 10-year rates of 1.6%, and real 20-year rates of less than 2%, probably 200 to 300 bp below sustainable fair-value levels depending on maturity," writes Wieseman.
This rush is likely to happen once consumers and investors are pressed into liquidating their long-end lending positions to cover their short-end borrowing. As said before, this may be only 4 FOMC meetings away which is as soon as November 1.
In Europe this move could take a little longer as the ECB tries to stay on autopilot as long as possible, hoping that the low leading interest rate of 2 percent will spur higher growth than the forecasted 1.2 percent at a not too distant point of time. This hope could be spoiled by an uptick of Euro inflation rates soon though. This year's recovery of the dollar and skyrocketing oil prices should show up nastily in the next inflation figures to come as dollar-priced commodities become more expensive, a fear also expressed by ECB head Jean-Claude Trichet.
Precious metals move into the picture
Currency markets will continue their battle of the two sinking ships displaying the names Euro and Dollar, it can be projected. With the meltdown on bond markets looking imminent for the reasons given above, The Prudent Investor wonders where a safe haven can be found as Switzerland just annulled its GDP growth forecast of 1.5 percent, Bloomberg reports.
As there seems to be an asset deflation just around the corner that could also hit commodities because of slowing demand caused by the economic downturn, precious metals could outshine all other asset classes. Gold looks like a steal at current prices and silver even more. Both metals are in a longterm upward trend since five and three years which coincides with the weakest economic recover ever seen in the US and slowing growth in Europe. Gold's 8 percent downturn from last year's high at 455 dollars cannot be seen as a trend reversal but rather as a healthy correction in a secular bull market. In a time where growth prospects are limited to the field of uncertainty, the 6000 year old universally accepted currencies may be rediscovered by investors despite continued central bank sales. The case for silver is made by the historically above average ratio of roughly 60:1 to gold. The average longterm relation is closer to 15:1. Gold additionally seems to be supported by the slowing of central bank sales and huge physical demand in India (600 tons p.a.) and China where gold investments were liberalized only last year. And fears of reduced industrial demand because of digital photography have been over-exaggerated, silver bulls point out. Silver is also used in numerous other industrial applications, especially electronics.
A rise in precious metals could also start the global redistribution of wealth. Reuters reported on Wednesday that developing countries accounted for 72 percent of global bullion output last year. The strongest rise in output was seen in Highly Indebted Poor Countries (HIPCs), whose gold production rose 84 percent between 1994 and 2004. Global gold mine output was 2,464 tonnes in 2004.
SPOTTED IN BLOGOSPHERE: Cynic's Delight shares my worries with more reasons.
Michael Shedlock
points to a commentary of Northern Trust (pdf) that combines gold and China in a novel way.
Mark Thoma picks up an interesting piece on Greenspan's succession, due in 250 days from today.
The Skeptical Speculator provides us with a compilation of the latest econ data.
The world 2 come has all the links regarding the EU constitution.
Mahalonobis discusses the weakest-ever employment growth in a US recovery.
Don't blame me if you spend another weekend in front of your screen.

EU president: Vote until it is RIGHT

Thursday, May 26, 2005

EU president Jean-Claude Juncker calls for a repetition of the French vote on the EU constitution in the case that the latest polls, which show 53 to 54 percent of the French rejecting the EU constitution, will come true on Sunday, according to the FT. He told the Belgian daily Le Soir, "if at the end of the ratification process, we do not manage to solve the problems, the countries that would have said No, would have to ask themselves the question again." Juncker stressed the point that a No in France or the Netherlands, which votes on the constitution next Wednesday, would be a disaster. The EU president himself does not get elected but is nominated by the member governments.
French premier Jean-Pierre Raffarin had said on Wednesday that there would be no second referendum in the case of a negative outcome. His statements followed speculation that France may organise a second referendum in case the constitution is rejected by a small margin. But "in France's democracy, there is no such thing as a 'little yes' and a 'little no'," Raffarin said. "What matters is victory. Be it 'yes' or 'no', the result cannot be contested. That's democracy", he added. President Jaques Chirac asked the French nation to say "yes" to the constitution in a presidential address on French TV.
The "yes" camp is headed by the leaders of the political establishment: president Jacques Chirac and his supporters in the Union for a Popular Movement (UMP), and the "free market" liberal Union for the French Democracy (UDF), which also belongs to the government camp, on the one side, and the leadership of the Socialist Party under Francois Hollande on the other. Also prominent in the official "yes" camp is the Green Party.
The Socialist Party, which was once regarded as the most prominent French pro-Europe party, is deeply split over the referendum. Former prime minister Laurent Fabius, a right-winger in the party establishment, as well as deputies Henri Emmanuelli and Jean Luc Melenchon, who are both regarded as belonging to the left of the party, are campaigning for a "no" vote. In an internal party vote over the issue at the end of last year, 40 percent of the membership voted against the constitution. The "no"-camp calls for a revised constitution, where the free market liberal economic bias and anti-social character would be given less prominence.
British government officials refused to discuss possible scenarios that could arise in the wake of the French and Dutch ballots.
In the House of Commons, Tony Blair, the prime minister, stressed the UK would not ratify any constitutional treaty without a referendum. He said if any country voted No to the constitution, the issue would first have to be discussed by EU heads of government to find "the way forward".
Less attention is given to the Dutch vote, although polls there vary widely. The constitution has to be ratified by all member states.
The outcome of the referendum is seen as a key to the strength of the Euro in currency markets. The initial reaction could be muted as there is a bank holiday in Britain on Monday. London is the leading currency trading centre in Europe, with Frankfurt being a distant second. But the Euro took a dive already today, marking a seven-month low against the dollar just above 1.25 dollars. European share markets all traded higher today, except for Belgium.

Don't yuanna listen!

Ben "Printing Press" Bernanke today told the Senate Banking Committee that while long-term US interest rates might rise if China stops buying US government bonds, any increase would not be big enough to hit the economy hard, Reuters reported. "I don't think it's really the case that foreign central bank holdings of US securities are the primary reason why our interest rates are as low as they are," he said, playing down concerns over the potential for a spike in interest rates should China move to a freer currency regime, according to the report.
The economy not getting hit hard does not mean he rules out a hit, it has to be underlined. For an extensive sum-up of the Sino-American revaluation debate click here. Bernanke, nominee for the top job of president Bush's Council of Economic Advisers (CEA) added another paragraph to the more than two years old debate about a Yuan revaluation. "I do believe they are now ready to go to a more flexible exchange rate regime and I would urge them to do that," Bernanke said. Shortly after his remarks he was rebuffed, this time by Yu Jianlong, director general of the economic information department for the China Council for the Promotion of International Trade. "The time has not come for us to appreciate the value of the Chinese currency," the official was quoted in this Reuters dispatch.
Higher US interest rates are on their way
Independently from the possibility that China could stop gobbling up ever more US debt papers, Fed Atlanta president Jack Guynn sees higher interest rates on the horizon. In a speech to home builders he said, "I have strongly supported the Fed's actions to gradually remove our policy accommodation. I believe our strategy to act before the appearance of widespread price increases is sound and necessary to keep inflation and inflation expectations firmly in check. The gradual rate hikes at this stage of the economic recovery also reduce the chances that the Fed will later need to take a more painful path of steep hikes."
He went on to say, "we are approaching an increasingly uncertain time for monetary policy. The Fed's goal is to achieve what's often referred to as a neutral policy setting, where rates are at a level that promotes growth without the likelihood of a run-up in inflation. Of course, as economic fundamentals shift over time, our view of neutrality may change. Given my current outlook for the economy, my personal view is that we've not yet reached a neutral policy stance."
He added that the gowing federal deficits have become a long-term concern and that excessive deral spending would eventually add risks to the US economy. Referring to high levels of private debt, Guynn offered the hope that rising interest rates could slow the brisk pace of borrowing and lead to a higher savings rate as well.
UPDATE: Mark Thoma provides the link for a video of Bernanke's hearing on his nomination to the CEA.

If it weren't that cheap to print them greenbacks...

Wednesday, May 25, 2005

This chart compares US GDP growth vs. the CPI vs. M3 growth from 1980 to 2005. Note the difference between CPI (red line) and GDP growth (yellow line). M3 is the blue line. According to the unwritten rules of the German Bundesbank, the best keeper of price stability in the world, I prefer M3 over inflation figures as it gives you a better idea how much money is actually sloshing around in relation to the goods and services produced.
As I am still fiddling around with editing graphics for this blog, here the absolute figures (data source: Federal Reserve Bank of St. Louis):
  • Gross Domestic Product (GDP) rose from 2.725 to 12.182 trillion dollars or 347 percent.
  • The Consumer Price Index (CPI) rose from 78 (100=1983) to 191.3 or 245 percent.
  • Money supply M3 rose from 1.823 to 9.494 trillion dollars or 423 percent.
Note: M3 consists of currency in circulation plus overnight deposits, deposits with agreed maturity up to 2 years, deposits redeemable up to 3 months' notice, repurchase agreements, money market funds and papers plus debt securities issued up to 2 years.

A boom in real estate investment (clubs)

Not only home sales are booming, but so is the real estate investment club scene. USA Today has this report, saying the number of these clubs went elevenfold, from just 44 in 2002 to approximately 500 by now. In comparison data from BetterInvesting shows a 46 percent drop in the number of stock market clubs from a 1999 peak of 36,151 to 19,646 at the end of 2004. A poll (actual sample 4500) on the same page shows that 8 percent are worried as they've "got a lot of money in real estate." Another 22 percent fear that the housing bubble could bring the economy down. 20 percent are ready to jump in the market. Their answer: No worries, if the bubble pops I can buy a house. 18 percent think house prices won't drop. 32 percent don't care as they live in their house. If you believe this time it will be different from the crash of '25 stop reading here. Or else...
USA Today quotes Robert Shiller, author of "Irrational Exuberance", "the explosion of real estate groups is symptomatic of the shift of our exuberance from the stock market to the housing market."
While the jump in wannabe real estate investors smacks of a "bubble-icious" market, it "is not a portent of imminent demise," says Bob Barbera, chief economist at ITG/Hoenig. "What you need to temper things is a full percentage point rise in mortgage rates." That is all it needs?
The clubbers are learning such things as:
  • "Rehabbing," or fixing up properties and selling for a profit.
  • "Landlording," or buying properties for rental purposes.
  • "Wholesaling," or buying inventory at steep discounts and flipping it quickly at a profit.

The Prudent Investor wonders when such issues as
  • "Flipping," or changing your ARM for a fixed rate version,
  • "Flatting," or waiting for buyers to show up, and
  • "Flopping," or how to handle a foreclosure
will creep up the list of topics.
Florida crash of '25
To add a historical comparison: The crash of '29 was preceded by a real estate boom in Florida in 1925 when prices quadrupled within a year. From Stock Market Crash:
Starting in 1920, many Americans became enamored by the materialistic and prosperous lifestyle of the time. During this time, the stock market was moving forward at an extremely fast pace. Many investors were becoming quite wealthy. Florida became a hot spot for these newly rich people. Many whole families took vacations to Florida, tourism started booming and land prices skyrocketed. Many astute investors took notice and started buying Florida real estate. The population in Florida was growing exponentially and housing couldn't meet the demand. Florida became the "playground of the rich and famous."
Credit was easy and plentiful - then and now
At this point, almost anybody could invest in Florida, even without much money. Credit was plentiful and soon everybody in Florida was either a real estate investor or a real estate agent. In 1922, the Miami Herald became the heaviest newspaper in the world as a result of its humongous real estate advertisements. People in the North heard about the real estate prices "doubling and tripling", causing a snowball effect. Capital was rapidly pumped into the real estate market. Whole golf communities were developed, such as Temple Terrace. Resorts and retirement communities were developed almost overnight. Mansions were sprawling in every area, as were swimming pools. As always, waterfront property was the most desirable. Florida was seen as a veritable Utopia.
Real estate prices quadrupled in less than one year. An elderly man invested $1,700 in property and by 1925 the property was worth over $300,000! It seemed you could do no wrong by just buying any property in Florida and become a millionaire. By 1925, real estate prices had become so exorbitant that buying land wasn't affordable any longer. New investors failed to arrive and old investors started to sell. Panic arrived, as it always does, and the real estate market crashed. Prices kept moving downwards as heavily indebted investors tried to sell to avoid bankruptcy. In most cases, no buyers arrived, and the investors were bankrupt from the enormous mortgages. Florida was barely affected in the stock market crash of 1929 and the Great Depression, because of its poor financial state from the start.
Let's jump to the list of counties that enjoyed the steepest annual rises in the first quarter of 2005: 8 of the top 10 counties are in - you guessed right - Florida. Bradenton plus 45 percent, Sarasota, West Palm Beach and Boca Raton plus 36 percent. Fed chairman Alan Greenspan must have seen this list to conclude, "it's hard not to see that there are a lot of local bubbles." I am confident they have a sprawling local real investment club scene in Florida as well.
NOTE: New home sales data is due today at 10:00 ET.
UPDATE: General Glut has anecdotal proof that the real estate market is hot. Anybody got some more tips for the estate market from his/her taxi driver or postman recently?
UPDATE 2: Sales of new U.S. houses were essentially unchanged in April, rising 0.2 percent to a seasonally adjusted annual rate of 1.316 million, the Commerce Department reported. This a new record after March's sales pace was revised sharply lower to 1.313 million annualized from 1.431 million.

FOMC minutes warn of higher current account deficits

Tuesday, May 24, 2005

The members of the Federal Open Market Committee (FOMC) seem to get a bit more concerned about the inflation outlook due to anticipated brisk growth in imports that is likely to stay. As the high imports are not matched by export growth due to economic weakness in other countries "the US economy was expected to continue run quite substantial current account deficits," although the (recently reversed) depreciation of the dollar should help exports.

According to the FOMC minutes from the May 3 meeting released today, members interpreted the recent weak economic data as a soft patch that has to be seen in the context of the high noise high frequency indicators can produce. While the economic outlook remained to be seen as robust, energy prices will remain on the high alert list as they were responsible for an uptick in core inflation rates, the participants agreed. High energy prices were mentioned several times in the minutes. Interestingly the latest minutes describe some sectors of the real estate market with the word "hot", while the previous minutes mentioned only a "softness" in the housing market.
As always the meeting contained the note that the Fed was on guard and would "respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability."
Interest rate policy is likely to remain on its measured path regarding the overall tone of the FOMC minutes that stayed in equilibrium between continued solid growth and inflation concerns voiced in the previous minutes as well, although inflation seems to be a growing concern for a growing number of FOMC members.
A compilation of the forward looking paragraphs of the FOMC minutes
In their discussion of current conditions and the economic outlook, meeting participants observed that incoming data over the intermeeting period hinted at possible upside risks for inflation and downside risks for economic growth. Earlier increases in energy prices seemed to be an important factor contributing to an uptick in core inflation and a slower pace of economic activity. With energy prices leveling out more recently, however, and the behavior of compensation suggesting a lack of pressure in labor markets, underlying inflation appeared to remain contained. The weakness in spending was widespread and could not be completely dismissed, but it had appeared only very recently and could be a product of the inherent noisiness of high-frequency economic data. On balance, economic fundamentals including low interest rates, robust underlying productivity growth, and strengthened business balance sheets were expected to support economic growth at a pace sufficient to gradually eliminate remaining slack in resource utilization. Although the economic outlook generally seemed favorable, there was also broad recognition of greater uncertainty attending the outlook for both inflation and output growth.
Capital expenditures advanced briskly over the first quarter, but at a pace significantly below that registered over the latter half of last year.
Incoming data for the household sector were viewed as mixed. Higher gasoline prices seemed to be sapping consumer confidence and consumer spending. The pace of consumption growth had fallen off appreciably toward the end of the first quarter, and some participants worried about the potential for continued sluggishness in consumer spending if increasingly cautious households sought to raise their saving rate rapidly. On balance, though, strong income growth and low interest rates augured well for household spending. Although housing starts had dropped of late, home sales and other indicators of activity in the residential real estate market remained at very high levels. House price appreciation was expected to moderate over coming quarters, but a number of local real estate markets were still regarded as "hot," with signs of possible speculative excesses in some areas.
A relatively high proportion of demand had continued to be met by imports. Some concern was expressed that incoming data suggested weaker growth in some of our major trading partners, which posed a downside risk to forecasts for U.S. exports. Moreover, advances in domestic income were expected to contribute to brisk growth in imports. Looking ahead, the U.S. economy was expected to continue to run quite substantial current account deficits, although the impact of past dollar depreciation should work to boost exports and slow the rise in imports to some extent. NOTE: The dollar has risen from 1.29 to 1.26 Euros since the latest FOMC meeting.
Recent energy price developments garnered considerable attention. Declines in energy prices in recent weeks were viewed as welcome, but participants noted that far-dated futures prices for oil remained quite elevated and that persistently high energy prices could trigger a range of deleterious effects on the economy. High energy prices appeared to be taking a toll on household and business confidence and might be beginning to crimp corporate profits.
Participants voiced concerns about recent price trends; they expected inflation to remain contained but also perceived that the risks to that inflation outlook now might be skewed somewhat to the upside. Core measures of price inflation had moved up over recent quarters and particularly so over the last few months. A discernable upcreep was apparent in survey measures of short- and, to a limited extent, long-term inflation expectations over recent months. Moreover, there were risks that the relative stability of long-term survey measures of inflation expectations could simply reflect lags in households' perceptions of changing economic prospects. The success that some businesses seemed to be encountering in passing through cost increases raised the possibility that competitive pressures and resource slack were exerting somewhat less restraint on inflation than had been anticipated.
Although downside risks to sustainable growth had become more evident, most members regarded the recent slower growth of economic activity as likely to be transitory. In this regard, the ability of the U.S. economy to withstand significant shocks over recent years buttressed the view that policymakers should not overreact to a comparatively small number of disappointing indicators, especially when economic fundamentals appeared to remain quite supportive of continued solid expansion.
Recent energy price developments garnered considerable attention. Declines in energy prices in recent weeks were viewed as welcome, but participants noted that far-dated futures prices for oil remained quite elevated and that persistently high energy prices could trigger a range of deleterious effects on the economy. High energy prices appeared to be taking a toll on household and business confidence and might be beginning to crimp corporate profits. In some cases, firms seemed to be more successfully passing on energy costs to their customers. Indeed, some portion of recent elevated inflation readings probably represented, at least partly, such pass-through effects from higher energy costs. However, while pass-through effects could leave the overall price level higher, their impact on inflation should fade over time, as long as inflation expectations remain well contained. Still, considerable uncertainty surrounded the degree of pass-through from energy prices to core consumer prices, and pass-through effects might be more pronounced when energy price increases were perceived as more likely to be permanent. Persistently high energy prices were mentioned as a factor that could trim the level of potential output to a small degree over time, possibly contributing to additional upward pressure on consumer prices at the margin.

In hindsight of today's OECD forecasts for the major industrialized countries the US economy will have to rely on a new dollar weakness in order to support the worrying trend in exports which stayed flat according to the latest trade figures. This in turn might be prevented by the recent strength of the US dollar that might continue to hold on to its recent gains in light of the growing interest rate differential that will continue to attract capital inflows as long as growth rates will stay in line with the current solid projections.
Share and bond markets presented themselves almost unmoved after the release of the minutes.
NOTE: For some interesting Fed insights jump to Tim Iacono's young blog The Mess That Greenspan Made.
Elsewhere in blogosphere so far only Mark Thoma commented on the FOMC minutes.
ADVICE: David Altig's macroblog features a weekly forecast for the future Fed Funds rate.

Oil prices and Fed Funds diverge strongly

Waiting on the FOMC minutes, due in less than an hour, I came across this very interesting long term chart that that compares oil prices (blue line) with the Fed Funds rate (red line) over the last 30 years. Pink shaded areas show recession periods.

Until 1999 they had a pretty good positive correlation. That changed since. According to chart theory the huge divergence in the last five years can be seen as a temporary aberration of a longterm convergence. As nobody expects oil prices to ease significantly this leaves a lot of skyward potential for the Fed Funds.
In order to see a better version of the chart, click here.

OECD slashes growth forecasts - ECB rejects rate cut advice

The OECD (Organisation for Economic Cooperation and Development) slashed its growth forecast for the Euro zone from 1.9 to 1.2 percent in 2005 and sees a soft landing in the USA, where GDP growth should be around 3.6 percent, according to its semi-annual forecast (pdf) published today. In 2006 growth in the US is expected to slow to 3.3 percent whereas the Euro area should record 2 percent. This forecast is based on the assumption that short term interest rates in the US will rise on average to 3.42 (2004: 1.58) percent this year and to 4.69 percent next year. Euro short term rates are seen flat at 1.85 percent this and next year. The OECD sees a further worsening of the US current account deficit to 6.4 (2004: 5.7) percent in the current year that will expand to 6.7 percent of GDP next year. This is a level never seen before in history. The Euro zone will continue its marginal current account surplus with a level of 0.1 percent this year and 0.35 percent in 2006. The Japanese economy is expected to crawl along with growth rates of around 1.5 percent on the basis of unchanged near-to-zero interest rates.
The OECD advised the public on its website that its outlook no. 77 will include one special chapter, highlighting "Measuring and accessing underlying inflation" which will be available in early June. For the detailed country figures download this Excel file.
In its handout (pdf) to journalists the OECD stressed the point that the recovery problems in the Euro zone cannot be explained anymore with the known arguments, such as the Iraq war and higher commidities prices. "As a result, and looking ahead, growth prospects seem bound to differ widely across the OECD and the world economy, ranging from solid in Asia to back on trend in the United States, and weak and uncertain in Europe," it said and added, "policy must address this chronic pattern of weak resilience and diverging activity within Euroland as thoroughly and promptly as possible. It is of course a matter of central importance for the growth prospects of the countries involved but also, to some extent, for the credibility of the Economic and Monetary Union itself."
Call for more self-discipline in respect of deficits
"With domestic demand sluggish, resilience feeble and possible upward pressures on the euro looming ahead, the balance of risks on growth and inflation is clearly tilted to the downside, calling for an early easing of monetary policy," the OECD said.
Suggestions for such a rate cut in the Euro zone were immediately repelled by the European Central Bank, Reuters reported. Austrian ECB council member Klaus Liebscher said, "a rate cut would hurt credibility and raise inflation expectations." The benchmark Euro rate of 2 percent, unchanged since two years, just about matches the current inflation rate of 2.1 percent.
The OECD urged the US to correct the current account deficit as this was needed to protect the world from another sharp drop of the dollar exchange rate and also suggested that the US make a move on fiscal consolidation.
High oil prices are here to stay, it also said, forecasting that a barrel of oil will continue to cost 48 dollars until the end of 2006.
French referendum could change all that
The big question mark hovering above these projections is the French referendum on the drafted EU constitution. If the French vote against the constitution next Sunday, the whole project of the European Union is in imminent danger which could weaken the Euro significantly as it would create huge uncertainties about Europe's future.
The Swiss Franc appears more and more attractive as an investment when one does not forget that the US outlook is anything then rosy despite the relatively healthy growth expectations which are based on too many uncertainties as well. In times of crisis money has always been flocking to the safety of Swiss bank vaults. Of course, one can argue "this time it will be different."
China will roar ahead
The outlook on selected non-OECD (pdf) members looks better. China is expected to hold on to growth rates above 9 percent and should see its current account surplus grow to 100 (2004: 68.7) billion dollars this year. Inflation is projected to remain at 4 percent.
Another coungry with strongly improving macroeconomic indicators is the Russian Federation. The OECD sees a growth rate of 6 percent for both 2005 and 2006 while the current account surplus is projected to jump to 92 (58.2) billion dollars or 12 (10) percent of GDP. But Russia will have to continue its fight against double-digit inflation rates. The rouble's purchasing power is expected to fall 13 (11.7) percent this year.

Market moving factors for this week

Monday, May 23, 2005

Tomorrow's release of the FOMC minutes from the last meeting on May 3, the release of the second reading of GDP figures for the first quarter on Thursday and the PCE deflator on Friday are the top potential market movers in the US for this week. But there is a truckload of other interesting news and events that will provide insight in the future of the global economy.
According to CBS Marketwatch,
Incomes probably increased about 0.7% in April as wages and salaries surged on higher hourly wages and a longer workweek. Consumer spending rose about 0.7%, the economists say. Core inflation likely eased back to 1.6% year-on-year from 1.7%.
First-quarter GDP likely will be revised to 3.6% from 3.1% previously. Trade wasn't nearly the drag originally assumed, pushing GDP higher. On the other hand, inventories didn't build up as much as assumed, giving a better balance to the growth mixture.

NOTE: After all those positive surprises with the latest economic indicators which were far above analysts estimates, there are questions arising how reliable these figures really might be. I refer you to this post: RED ALERT - Don't trust TIC data
US businesses meanwhile dread slower economic growth. From a Reuters dispatch:
"The National Association for Business Economics said its panel of 50 forecasters trimmed its growth outlook for 2005 and 2006 from three months ago, taking the consensus for both years to 3.4 percent growth from the 3.6 percent forecast in February.The survey consensus called for a 2.5 percent increase in the Consumer Price Index excluding food and energy in 2005, up from a 2.3 percent forecast three months ago. The panel also projected a sharp acceleration in unit labor costs from 2004 to 2005 due to slowing productivity growth.

Tomorrow' release of the FOMC minutes will have Fed watchers seeking for clues how heated the debate about the inflation outlook inside the Fed is, remembering the highly unusual alteration of the latest FOMC release on May 3, when the belated addition of the sentence "Longer-term inflation expectations remain well contained" caused an uproar in the markets.
Outgoing Fed governor Ed Gramlich will elaborate on "The Politics of Inflation Targeting" in Paris on Thursday and Vice chairman Roger W. Ferguson, Jr. will talk about "Asset Price and Liquidity" in Berlin on Friday. Be on alert for some additional statements on current issues as journalists will most certainly press the Fed members into a short Q&A session after their speeches.
On Tuesday the release of (sluggish) German GDP growth figures for the first quarter will confirm that the European Central Bank will stay on autopilot for the foreseeable future.
The OECD will publish its most recent economic outlook for Germany on the same day. Don't expect any positive surprise from this one either. German inflation figures are due on Wednesday.
OPEC: Oil demand to rise to 85 million bpd
OPEC president Shaikh Ahmed Fahd al-Sabah said on the weekend that oil demand does not pause. "The culture of the market has changed and in the second quarter (where demand normally drops) there is a growth in demand," he said and added that global demand for oil grew 2.6 million barrels per day to 82.5 million bpd in 2004, and by the fourth quarter this year demand is expected to increase to 85 million bpd, Al-Jazeera reported. "Last year demand grew 4 to 5% while this year it is growing 3 to 4%. We've normally had such an increase in four years (in the past), while we had it in one year," the Opec chief said. Opec officials have said that current Opec's capacity is approaching 32.7 million bpd and it will reach 33 million bpd by the end of 2005. The IEA in contrast forecasts demand in 2005 at a level of 84.3 million bpd.

China to US: Stop bullying here and now

China will take its time for the reform of its currency controls and will not give in to any outside pressure. Responding to last weeks aggressive comments by the Bush administration, requesting a quick revaluation and threatening China could be branded a manipulator of currency, China stood up and basically said, stop bullying us. Reuters reported that "Chinese Vice Premier Wu Yi said on Monday that China remains committed to reforming its currency but no timetable has been set for when the reform will take place. 'We will not reform the yuan until the time is right even if there is external pressure. As for when to reform the yuan, there is no timetable yet,' she said, adding that the county is fully committed to such reforms.
A revaluation of the Yuan hinges on the success of China's efforts to shore up its ailing banking sector. China's banking system is burdened by non-performing loans (NPL) amounting to 1.83 trillion yuan or 220 billion dollars, the China Banking Regulatory Commission (CBRC) reported last week. This amounts to 12.4 percent of all outstanding loans.
China has been trying to improve risk controls and corporate governance at its banks, many of which are looking for tie-ups with overseas banks and listings as part of efforts to become sound entities capable of taking on growing competition. A revaluation of the Yuan would make these NPL's more costly to any potential investor in China's banks.
Overheating economy may lead to higher inflation
China's rapid growth in excess of 9 percent annually meanwhile raises the eyebrows at the Asian Development Bank (ADB). According to ADB's senior economist Zhuang Jian said 2005 would be key to the stable and sustainable development of China's economy and macro-control policy should continue to cool down the economy. "The continuous three-year GDP rate over 9 percent will lead toa 5-plus percent rise in consumer price index (CPI), which most residents cannot bear," Jian said.
Currently Chinese enterprises and local governments are still very eager to invest, and the inflation pressure is enormous, he said.
Fixed asset investment in China's urban areas went up by 25.7 percent year-on-year in the first four months this year, according to China's National Bureau of Statistics.
The government should increase its support for agriculture and improve the market environment to stimulate consumption. This will boost the development of agriculture and services industries and balance the relationship between investment and consumption, Jian said.
Investment talks to become less entertaining
Potential investors or purchasers of Chinese goods might see their local meetings turn more formal in the future. The State Administration of Industry and Commerce issued a notice over the weekend banning meals like sushi served on naked bodies, the Beijing Times reported Sunday. The state body also banned nudity for other dining and entertainment purposes, including "meals on breasts." Read the full report here. PC has finally reached China, it seems.

Oil eases after Greenspan speech on energy - warning on housing bubble

Friday, May 20, 2005

Crude oil prices eased below 47 dollars and the Dow managed to lock in the biggest weekly gain (3.3 percent) since six months after Federal Reserve chairman Alan Greenspan said that private crude oil inventories rose to the highest level since 3 years. In his speech on energy issues given before the Economic Club of New York Greenspan said the fact that higher oil prices have modestly slowed the growth of oil demand had resulted in this build-up of inventories which he expects to continue until demand rises again. Greenspan's energy bets for the future seem to lie with natural gas and a change of consumer's preferences towards lighter or hybrid vehicles. Greenspan warned that geopolitical uncertainties could materially affect oil prices in the future. The status of world refining capacity is also a cause for concern, he said. This was discussed in this post.
Note: the total energy use of hydrogen powered cars is even less efficient than conventional combustion engine powered cars as hydrogen has to be produced as well through other forms of energy.
A compilation of the most important paragraphs of Greenspan's speech
World markets for oil and natural gas have been subject to a degree of strain over the past year not experienced for a generation. Increased demand and lagging additions to productive capacity have combined to eliminate a significant amount of the slack in energy markets that was essential in containing energy prices between 1985 and 2000.
Reflecting a low short-term elasticity of demand, higher prices in recent months have slowed the growth of oil demand, but only modestly. That slowdown, coupled with expanded production also induced by the price firmness, required markets to absorb an unexpected pickup in the pace of inventory accumulation. The initial response was a marked drop in spot prices for light, sweet crude oil. But that drop left forward prices sufficiently above spot prices to create an above-normal rate of return for oil bought for inventory and hedged, even after storage and interest costs are accounted for.
As I indicated in early April, this emerging condition could encourage the buildup of enough of an inventory buffer to damp the price frenzy. Indeed, since early April, private crude oil inventories in the United States have been accumulated at a seasonally adjusted rate of around 250,000 barrels a day, rising as of last week to the highest seasonally adjusted level in three years. A somewhat lesser, but still important, accumulation of crude oil is evident in other major countries. Inventory accumulation is likely to continue unless demand rises, output declines, or we run out of storage capacity.
Altering the magnitude and manner of U.S. energy consumption will significantly affect the path of the U.S. economy over the long term. For years, long-term prospects for oil and gas prices appeared benign. When choosing capital projects, businesses in the past could mostly look through short-run fluctuations in oil and natural gas prices, with an anticipation that moderate prices would prevail over the longer haul. The recent shift in expectations, however, has been substantial enough and persistent enough to direct business-investment decisions in favor of energy-cost reduction.
Of critical importance will be the extent to which the more than 200 million light vehicles on U.S. highways, which consume 11 percent of total world oil production, become more fuel efficient as vehicle buyers choose the lower fuel costs of lighter or hybrid vehicles.
We can expect similar increases in oil and energy efficiency in the rapidly growing economies of East Asia as they respond to the same set of market incentives. But at present, China consumes roughly twice as much oil per dollar of GDP as the United States, and if, as projected, its share of world oil consumption continues to increase, the average improvements in world oil-intensity will be less pronounced than the improvements in individual countries viewed separately would suggest.
Aside from uncertain demand, the resolution of current major geopolitical uncertainties will materially affect oil prices in the years ahead. The effect on oil prices, in turn, will significantly influence the levels of investment over the next decade in crude oil productive capacity and, only slightly less importantly, investment in refining facilities.
In the more distant future, perhaps a generation or more, lies the potential to develop productive capacity from natural gas hydrates. Located in marine sediments and the Arctic, these ice-like structures store immense quantities of methane. Although the size of these potential resources is not well measured, mean estimates from the U.S. Geological Survey indicate that the United States alone may possess 200 quadrillion cubic feet of natural gas in the form of hydrates. To put this figure in perspective, the world's proved reserves of natural gas are on the order of 6 quadrillion cubic feet.
To be sure, energy issues present policymakers and citizens with difficult tradeoffs to consider and decisions to make outside the market process. The concentration of oil reserves in politically volatile areas of the world is an ongoing concern. But that concern and others, one hopes, will be addressed in a manner that, to the greatest extent possible, does not distort or stifle the meaningful functioning of our markets. We must remember that the same price signals that are so critical for balancing energy supply and demand in the short run also signal profit opportunities for long-term supply expansion. Moreover, they stimulate the research and development that will unlock new approaches to energy production and use that we can now only barely envision.

UPDATE: CalculatedRisk highlighted the Q&A session after Greenspan's speech where the Fed head said he sees quite a lot of local bubbles in the housing market. William Polley adds his comments about Greenspan's remarks about the want/need for a Yuan revaluation and links to this Reuters dispatch. According to it "Greenspan poured cold water on the idea that a revaluation will shrink a record bilateral deficit with China that hit $162 billion last year. It will mean that suppliers will turn to other countries like Malaysia or Thailand for cheap textiles and other goods that China now supplies. 'So essentially what we will find is we are importing from a different area but we'll be importing the same goods,' Greenspan said."

RED ALERT - Don't trust the TIC data

I have voiced my concerns about the reliability of the most recent macroeconomic data issued by the US administration repeatedly in earlier posts here, here and here. Other bloggers like Barry Ritholtz and CalculatedRisk have also been puzzled about some indicators. Leave suspicions aside and open your data archive, here comes the proof that the administration is altering data in a way that cannot be excused with statistical adjustments. All it needs is a comparison of the latest Treasury Inflow Capital (TIC) data, published on May 17 with the data published on March 15, which I reported on in this post. I apologize for still not being able to publish tables and graphics due to my average-only computer skills. But read on and follow the links and I am confident you will have to wipe some foam off your mouth and what will likely remain is a bitter taste.
Readers will remember that markets jumped (surprisingly) on Tuesday when the latest official set of data showed that net capital inflows fell roughly by half to 45 billion dollars within a month. TIC data cannot be disregarded as meaningless. After all they are a good measurement of how much a country is trusted in the international investment community. But the numbers do become meaningless when their new historic values deviate up to 38 percent from preceding historic values. Analysis on the basis of flawed data makes as much sense as turning to an astrologer for the future direction of capital markets.
While the grand total of inflows was changed downwards from 1,960 to 1,908 billion dollars or 2,7 percent less, the detailed country figures of America's biggest lenders show amazing changes. All figures below are in billion dollars. New is the amount stated in the May release, old are the figures from the March release of the US Treasury.
Japan new: 679.3 old: 701.6 difference: minus 22.3 or 3.2 %
China new: 223.5 old: 194.5 difference: plus 29 or 14.9 %
Caribbean new: 94.2 old: 92.5 difference: plus 1.7 or 1.8 %
UK new: 100.3 old: 163 difference: minus 62.7 or 38.5 %
Taiwan new: 68.3 old: 59.2 difference: plus 9.2 or 15.4 %
OPEC new: 67 old: 64.7 difference: plus 2.3 or 3.6 %
Korea new: 53.6 old: 67.7 difference: minus 14.1 or 20.8 %
Germany new: 53.8 old: 57.1 difference: minus 3.3 or 5.8 %
Hongkong new: 45.3 old: 59.2 difference: minus 13.9 or 23.5 %
Switzerland new: 41 old: 50 difference: minus 9 or 18 %
Luxembourg new: 41.8 old: 29.3 difference: plus 12.5 or 42.7 %
Canada new: 35.4 old: 43.4 difference: minus 8 or 18.4 %
All other new: 125.8 old: 141.3 difference: minus 15.5 or 11 %
The US Treasury has not published an explanation for the changes in the data sets, which are not limited to the January data. The data of earlier periods has been altered as well. Data of the smaller lenders were omitted whereas small means below 30 billion dollars.
If you want to read more doubts and details on this matter, I recommend Rob Kirby's article on Financial Sense. Mr. Kirby has included facsimiles of the two differing datasheets in his story that dives much deeper into the matter, outlining some irregularities in the development of bond yields.
What is most interesting is the change of the UK detail data. Tony Blair and the Bank of England are faced with enough problems at home than to spend taxpayer's money on US debt paper purchases. The Bank of England has already gambled away enough billions by selling a big part of its gold reserves around the millennium for no apparent reason. At these times gold traded below 300 dollars.
As the British pound has risen against the dollar even stronger than the Euro did, purchases by the British central bank must have brought sizable paper losses so far. If the Bank of England has been able to hedge its currency risk, some other market participants must be sitting on these losses now. Is it a coincidence that rumours of a big hedge fund about to go bust have surfaced in the very recent past?
Truth is always the first victim in times of war
Remembering the careless handling of truth by the Bush administration in so many matters like the reason for the invasion of Iraq, the gross disrespect for human rights in the torture camps Guantanamo and Abu Ghraib and now also in Afghanistan, the difference between exit polls and the actual presidential election outcome 2004 (in the Ukraine the US demanded - successfully - a new vote for exactly this reason), the idea that officials are tempted to fiddle with some data in order to keep the game running cannot be pushed out of the window.
Looking into the carefree spending habits of the White House and its affiliates and the foreseeable problems like energy supply, discussed in this post, the state of a slowing economy that has outsourced its productive capacities and a nation that constantly spends 6 percent more than it takes in leaves room to some second thoughts. Add into the picture the huge growth in US money supply and there is more than just one reason to worry about the future of the global economy. Too big to fail does not work out on the international level. Debts and war have always been the two main reasons that brought empires to their knees. No country has ever amassed so many debts as the US who will owe the rest of the world 8 trillion dollars by yearend. At the same time the US are engaged in a war with no exit strategy and are confronted with rising hostility in the Muslim world and Latin America.
One blogger attributed my suspicions about the recent economic data with the quote "the Prudent Investor smells a rat." I would rather say, I cannot pretend to ignore the smell of a heap of elephant droppings in financial and political matters.
UPDATE: Mark Thoma (economistsview) enriches blogosphere with the latest approval ratings of president Bush and his handling of the US' most pressing problems. In short they slid to much lower levels since January and except for the fight against terrorism are all below the 50-percent mark. The question what is influencing his overall approval most brought the economy to the top of the list.

Two oriental giants will compete for economic dominance

Blame me for having ignored India in my latest posts, having mentioned the biggest democracy in the world last time in this post. India will become a global power according to professor Deepak Lal from the UCLA, who looks at number of factors that will favor India over China in the long term. Literacy, demographics and a yet economically still mostly unexplored region could be the foundation for century long growth on the Indian subcontinent, he argues in the follwing article, originally published in India's Business Standard last March and which can also be accessed at the website of the Cato institute. For a compact version, read on.
What are the lessons from the Chinese economic miracle for India? Who is likely to win the race for economic growth - the hare or the tortoise?
There are great similarities in the policies followed and their outcomes in both the periods of economic repression and reform in India and China.
China carried its repression further as it has its reforms than India. But in both countries the liberalization of foreign trade gave a boost to growth.
The major difference has been in their respective investment rates, with China’s at over 40 per cent of gross domestic product (GDP) being roughly twice that of India’s.
India's growth rate closes in on China
But, given the continuing deadweight of the State Owned Enterprises on the Chinese growth path, this has not led to a commensurate difference in their growth rates during their reform periods, with Chinese growth between 1978-98 being 9.7 per cent per annum on official and over 7 percent per annum on the best independent estimates, whilst India grew by 6.1 percent annually from 1991-2000.
But the growth in China has been more labor intensive than India's. This was the unintended consequence of the end of collectivization in agriculture which led to an explosion of labor intensive small-scale rural industry for export.
This export led industrialization was facilitated by the much better and more extensive infrastructure created in China, and by the absence of any social burdens carried by firms in the fast growing non-state sector.
India by contrast continues to hobble the development of small-scale and labor intensive industries with its policy of reservations.
China produces, India leads in information technology services
In both China and India the dynamics of their growth have been provided by areas which the State had overlooked as being of little importance: the small-scale rural industries in China, and the information based service sector in India.
These were the areas where capitalism was allowed to take its natural course and once foreign markets were opened with the liberalization of foreign trade, the native wit and entrepreneurship of the economic agents not subject to the dead hand of the State, generated a dynamism which no planner could have created.
Unlike the Indian, the Chinese policy elite has fully embraced capitalism. The new (often Western trained) mandarins who run the Chinese state recognize, as many in India still do not, that this is the only route to both prosperity and power for their nation - and like mandarins of yore, it is the Chinese State and not any ideology that they serve.
They are desperately seeking ways to remove the remaining vestiges of their dirigiste past: the loss making state enterprises.
India by contrast seems stuck with its 'Left' still unwilling to abandon its past dirigisme.
These differences in the embrace of global capitalism are reflected in both the much greater trade liberalization undertaken by China and its more relaxed attitudes to foreign investment.
Thus whereas exports were 19 per cent of Chinese GDP in 1998, they were about 8 per cent in India. Whilst the stock of foreign direct investment (FDI) was 261 billion dollars in China in 1998, it was a mere 13 billion in India.
Moreover, the foreign investment in China which has flowed to the non-state sector from the Chinese diaspora to finance industrial exports has loosened the constraint on its growth from its weak domestic capital markets.
The multinationals, by contrast, have been lured into joint ventures with state enterprises to service the large domestic market and have usually lost their shirts.
In both countries wherever growth has occurred there have been dramatic reductions in poverty.
India has to overcome fiscal deficits
The fragility of the Chinese financial system is a case in point. Though India's financial system is healthier, it shares with China the problem of unsustainable fiscal deficits fuelled by economically unjustifiable subsidies.
As I have suggested, China might be able to tackle this problem more easily if it used its foreign exchange reserves creatively. By contrast, the political roadblocks to ending the subsidies debauching the Indian budget remain significant.
There are two other advantages which India has over China as part of the legacy of the Raj: the rule of law, and the English language. Even though China has in the most recent revision of its Constitution put private firms on an equal footing as state owned firms, entrepreneurs are still suspicious of the State.
It explains why most of these new entrepreneurs rely on self or foreign financing and are reluctant to put their head above the parapet by listing their companies on the stock exchange. This cannot bode well for the future of Chinese growth.
India's advantage in having a large pool of English speaking people is likely to be eroded in a generation. Apart from the much higher literacy rate in China, it has now decreed that all pupils will have to learn English.
Given its fiercely meritocratic education system, without any quotas or affirmative action, it is on the way to producing one of the most highly skilled populations in the world. This is a danger India needs to guard against, by helping the spread of private schools in the rural areas.
Demographics favour India
Last, but not least, whilst China with the ageing of its population is likely to see an end to the savings bonanza promoted by the demographic transition accompanying its one child policy, when the dependency ratio declines as the birth rate and population growth rate fall, India is just entering its own demographic transition.
These life cycle effects will raise Indian savings for the next few decades. This should allow a substantial rise in India's investment rate, just as after 2010 demographic effects lead to falling Chinese savings rates.
If by then India has completed the second generation of reforms, built up its infrastructure and fully integrated itself into the world economy, we might find that the tortoise overtakes the hare.
This race between the two Asian giants is set to be the most dramatic event of this century.

In order to understand the grasp of the rapid developments in India, follow also this link. Details on the Indian economy can be found in this post.

Dollar rises 45 % - in Zimbabwe

Thursday, May 19, 2005

This item found on Bloomberg shall not be construed as an awkward comparison for what happens to a currency that gets devalued on a long term basis. Zimbabwe certainly has a host of uncomparable problems due to gross political errors. But hey, interest rates rise and the currency still needs to get devalued in order to keep the last remainders of foreign direct investment in the country!?
Monitoring one of my darlings in the commodities sector, Australian platinum producer Aquarius Platinum (domiciled in tax friendly Bermuda), and its recovery from the 52-week low, I am still amazed how fast monetary political decisions can translate into share price movements.
From the Bloomberg dispatch:
Zimbabwe devalued its currency by 45 percent (TPI notes: the dollar has devalued against the Euro about the same) and increased the subsidized prices it pays exporters to ease foreign exchange shortages and boost production as the economy faces its sixth year of contraction.
The Zimbabwe dollar, which is set by the central bank at bi- weekly foreign exchange auctions, was adjusted to 9,000 per US dollar from 6,200, central bank Governor Gideon Gono said today in his monetary policy review in the capital, Harare.
The devaluation will boost the earnings of Zimbabwe's main export industries of tobacco and mining, helping to ease shortages of foreign exchange needed to pay for food and fuel...
Gono also increased the price paid per gram of gold to 175,000 Zimbabwe dollars from 130,000. Gold production declined 16 percent to 4.27 metric tons in the first quarter as industry costs increased. Johannesburg-based Metallon Corp. is the biggest miner of Zimbabwean gold.
The central bank had allowed the Zimbabwe dollar to depreciate by only 27 percent in the year through April, while consumer prices leaped 129 percent over the same period.
Gold producers had called on the central bank to cut the currency to 12,000 per dollar, or for the government to increase the guaranteed price per gram by 62 percent to 210,000 Zimbabwe dollars.
David Brown, finance director at Impala Platinum Holdings Ltd., the world's second-largest platinum producer, said May 17 that the company may review expansion plans if the central bank didn't devalue the currency. The southern African nation has the world's second biggest deposits of platinum, the price of which has increased 31 percent in the past two years.
Gono raised the benchmark overnight interest rate to 160 percent today from 95 percent in a bid to slow inflation, which he forecast would fall to between 50 percent and 80 percent by the end of the year. The economy will expand between 2 percent and 2.5 percent from an earlier forecast of between 3 percent and 5 percent, Gono said. The IMF expects the economy to contract 1.6 percent this year.

Before the bubble bursts - Fed calls for tighter supervision of GSE's

Fed chairman Alan Greenspan called for tighter supervision of the Government Sponsored Entities (GSE's) on the grounds that the sprawling growth of mortgage backed securities (MBS) is largely based on the wrong perception of investors that these MBS are guaranteed by the US government. The three industry behemoths Fannie Mae, Freddie Mac and Ginnie Mae have seen their outstanding mortgages grow from one trillion in 1990 to 3.5 trillion dollars last year. Total outstanding mortgages rose from 6.8 trillion in 2000 to 10.1 trillion last year, rivalling the total market cap of US stocks. Daily trading volume in Agency backed securities (ABS) ranged around the quarter-trillion mark in the first two months of 2005 after an annual daily average of 207 billion last year. This is roughly ten times the size of the corporate debt market. In 2000 trading volumes of ABS averaged a mere 69.4 billion per day. This growth rate roughly resembles the growth rate seen in trading of technology (internet) shares on the Nasdaq up to the new millennium. To put this in another perspective, average daily trading volumes in US Treasury debt paper rose from 206.6 billion in 2000 to 497 billion in 2004. For more detailed data, jump to
In his televised speech Greenspan stressed the point that "financial instability coupled with the higher interest rates it creates is the most formidable barrier to the growth, if not the level, of homeownership. Huge, highly leveraged GSEs subject to significant interest rate risk are not conducive to the long-term financial stability that a nation of homeowners requires." This clear warning can be interpreted as a precursor of higher interest rates that could put the huge volume of ABS at risk when interest volatility rises.
40 basis points yield advantage
Greenspan added that the "the government guarantee for GSE debt inferred by investors enables Fannie and Freddie to profitably expand their portfolios of assets essentially without limit.4 Private investors have granted them a market subsidy in the form of lower borrowing rates, which staff at the Federal Reserve Board has estimated at 40 basis points in recent years. This market subsidy is a formidable advantage in our highly competitive Aaa market, where a few basis points are often competitively determinant. Unlike subsidies explicitly mandated by the Congress, the implicit subsidies to the GSEs are initiated wholly at the discretion of the GSEs. They choose when to borrow and gain the advantage of the subsidy, and because markets perceive such debt as government guaranteed, GSEs can effectively borrow without limit."
"Today, the interest rate and prepayment risks inherent in mortgages with a low-cost refinancing option is concentrated in the large portfolios at Fannie and Freddie. These concentrations cannot be readily handled by private-market forces because there are no meaningful limits to the expansion of portfolios created with debt that the market believes to be federally guaranteed," the Fed chairman said.
Crisis mentioned three times
The agencies activities in the secondary market could pose further risk as their portfolios consist almost entirely of MBS. "During a crisis, the GSEs' portfolios of mortgage-backed securities (MBS), in contrast to portfolios of liquid assets such as Treasury bills or cash, cannot provide liquidity to either the primary or the secondary mortgage market. To sell mortgaged-backed securities to purchase other mortgage-backed securities clearly adds no net support to the mortgage markets. GSE portfolios could act as a source of strength to the mortgage markets only if they contained highly liquid, non-mortgage assets such as Treasury bills, which can be readily turned into cash under all possible scenarios without importantly affecting the prices of home mortgages. Indeed, only such highly liquid portfolios would be consistent with the GSEs' mission of providing primary mortgage market liquidity during a crisis, particularly during a financial crisis," Greenspan said.
He opposed the Congress' plans to legislate a mission-only supervision of the agencies and said the GSE's would "need a regulator with authority on par with that of banking regulators, with a free hand to set appropriate capital standards, and with a clear and credible process sanctioned by the Congress for placing a GSE in receivership, where the conditions under which debt holders take losses are made clear. However, if legislation takes only these actions and does not limit GSE portfolios, we run the risk of solidifying investors' perceptions that the GSEs are instruments of the government and that their debt is equivalent to government debt." Greenspan had stressed the need for a GSE regulator in his most recent two testimonials to Congress.
The Fed chairman used the word crisis three times in his speech.

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