It's Summertime - And The Livin' Gets Easy

Thursday, July 21, 2005

Yuan revaluation, more bombings in London, Greenspan's testimony to the Senate and the FOMC minutes. It has been a busy day on all levels - and it all happened while I was stuck in the hinterlands of Vienna waiting three hours for a tow of my car after an unscheduled breakdown.
The next 3 weeks will be truly different. No internet, no papers, no charts, no magazines and only one econ book amidst lots of history on paper in the travelbag - and hopefully no more breakdowns.
Blogging will resume on August 15.

Highland cow

Greenspan Bends Truth On Stabilizing Effect Of Gold Standard

Wednesday, July 20, 2005

Oh oh Mr. Greenspan! The world has always admired the most intellectual of all central bankers for his art of rhetoric that has yet to be challenged. It is remarkable how Greenspan has circumnavigated tricky suggestive questions without ever leaving the ground of truth. From my memory Greenspan rather resorted to "I cannot answer that question," than to bend the truth.
But at today's exchange with the Senate's goldbug Ron Paul from Texas Greenspan veered off this respectable course.
When Senator Paul asked him why the central banks still held gold although they had gone off the gold standard, Greenspan replied "central bankers have behaved as though we were on the gold standard," and added, "we are acting as we were then."
Sorry, a look at the two charts below paints a very different picture.

Consumer Price Index since 1913

GRAPH: Inflation has taken off since the inception of the Federal Reserve after consumers enjoyed stable prices in the 110 years before. Note the bends upward after the abolition of the gold standard in 1933 and after the closing of the gold window in 1971. Alan Greenspan does not like to be reminded of his essay from 1967, when he wrote, "in the absence of the gold standard, there is no way to protect savings from confiscation through inflation."

Money supply M3 since 1960

GRAPH: Money supply has been steadily accelerating since the closing of the gold window in 1971 with one exception at the beginning of the 1990's.
Greenspan said further that the gold standard is no option nowadays. But he conceded, "in 1981 the answer would have been yes," giving the reasons that gold was then trading at $850 per ounce and that there were huge imbalances.
Leaving the argument of the gold price aside - gold is the second best investment since 1971 with a gain of 1,105 percent compared to Dow which gained 1,160 percent in the same period (dividends excluded) - the answer could be at least "maybe" again. There are more than enough imbalances around now, even when the economy is not contracting. But inflation is accelerating faster than the official CPI figures reveal.
Debt is rising at its fastest pace ever. Not even scarce ink will be limiting future liquidity supply. President Bush's chief economic adviser, Ben "printing press" Bernanke, tipped as one of the three top contenders for Greenspan's succession, has said that in 2001 already.
The world is rapidly approaching the time when other concepts than the one of "the highest possible growth" have to be applied. It won't work for the reason of limited resources that will have to be shared by 6.5 billion people and not only the roughly 800 million who until now have seen the exclusive use of the world's resources as a given birthright.
Looking again at the charts above one also has to question Greenspan's statement, "I think central banking has learned the dangers of fiat money." The charts tell a truly different story.

Greenspan Sees Manifold Dangers Lurking Around The Corner

Cartoon Alan Greenspan used his 3-hour testimonial to Congress to reiterate his already often cited concerns about the future of the economy. Demographics, the education system, the low savings rate, federal spending and the resulting deficits topped the negative list of his topics in the Q&A session. He showed himself pleased with the upturn of federal revenues but cautioned that it is too soon to know where these are coming from. The semiannual Monetary Policy Report (MPR) (PDF-version with lots of charts here) which he presented to Congress contains a key forecast of incrementally lower real GDP growth in 2006 of 3.25 to 3.50 percent while the Fed expects this year's growth rate to come in at 3.50 percent. "Core" inflation is seen contained between 1.75 and 2 percent. The unemployment rate is expected to continue with a 5 before the comma.
Oh, and don't forget to bet the house on more rate hikes to come. His introducing remarks ended with the well known phrase "...believes that policy accommodation can be removed at a pace that is likely to be measured."
Having read both the MPR and his remarks as well as listened to the Q&A session The Prudent Investor notes a telltale of cautioning. The inflation outlook sounds as if the Fed no longer believes in a significant reversal of crude oil prices. If worse comes to worst, "a further rise could cut materially into private spending and thus damp the rate of economic expansion," Greenspan said. He later softened this remark and added that consumers will switch to more fuel-efficient cars but he does not see much flexibility in the mileage driven.
195 days before his scheduled retirement Greenspan still spends sleepless nights over the rate conundrum. In his words the Fed has not yet come to a conclusion whether the low yields on the long end are a result of lower inflation expectations or high savings rates around the globe (with the exception of the US).
Inadequate Savings Rate
He considered the domestic savings rate "inadequate" in the light of the assumption that borrowing from abroad at current volumes cannot go on forever. Nevertheless the financial system is very efficient in transforming the minuscule savings rate into capital investments, he said.
In this context he pointed out that the savings rate and people's complacency with it depends on subjective factors. People realizing capital gains - currently in the property market - would feel as if they were saving because their purchasing power has been rising. But he warned of structural problems since capital gains were not fuelling investment as only book-value savings would do that.

Mortgage Rates Since 1990

GRAPH: There is a clear reason why consumers poured everything into real estate since 2002.
The Fed head warned about the gaining popularity of interest-only mortgages and exotic adjustable rate mortgages, which seem to have led to an "apparent froth" in housing markets and could leave borrowers "vulnerable to adverse events." He said it was not the Fed's task to curtail lending but only to oversee whether banks were lending on a sound basis. Stable delinquency rates in the MPR show this is still the case. But banks have loosened their lending standards to medium and large size borrowers significantly since 2000, the MPR shows too.
Company Profits Not Used For Investments
On the corporate side the MPR noted that profits were still on an upward pace but that the money was rather used for stock buybacks instead of capital expenditures. "Given continued strong corporate profits and the accompanying strength in cash flow, nonfinancial firms'
demand for external financing to fund capital expenditures has remained somewhat subdued. Net equity issuance has stayed negative so far this year, and share retirements have been boosted by considerable stock buybacks and cash-financed merger and acquisition activity. Gross corporate bond issuance has been limited, and the proceeds have been used mainly to pay down existing debt."
Greenspan also warned against protectionist moves against China and called globalization a process of creative destruction. But it would be in China's interest to flexibilize the exchange rate in order to more effectively neutralize the huge capital inflows it has been experiencing.
Representatives asked Greenspan also about the economic effect of the "war on terror." He said that resources for protection cannot also be used to increase production and productivity. The public portion of GDP has climbed to 38 percent recently. Not exactly a level one would associate with a free market economy. Compare this with "socialist infested" India where the government portion lies at 12 percent.
CONCLUSION: All seems more or less OK for the moment but manifold dangers have been lurking around the corner for some time now without one of them being effectively addressed by the administration. Greenspan will be a happy man to retire before all the known problems will begin to exert negative effects on the economic situation.
The maestro did again a good job at keeping markets in equilibrium. Tomorrow's testimony to the Senate will probably bring a repetition of today's key points. The release of the FOMC minutes later in the day can be ticked off as well because all key statements about the state of the economy are already included in the MPR.
But don't idle away because of this outlook: Fed governor Donald Kohn is scheduled to give a speech at the Financial Market Risk Premiums Conference that will focus on market imbalances. Remembering his exceptionally tough remarks from last month, reported here, this could become the main market mover for Thursday.
NOTE: Second post on his remarks about gold coming.

Greenspan Sees $60 Oil Shave Off 0.75 % Growth

Tuesday, July 19, 2005

Oil prices above $60 are likely to shave off three quarters of a percentage point from GDP growth, Federal Reserve chairman Alan Greenspan told Reuters in a story published in the Washington Post on Monday:
Although soaring oil prices have hampered U.S. economic growth, the economy is coping well and is set to expand at a moderate pace, Federal Reserve Chairman Alan Greenspan said in remarks released on Monday.
Greenspan said Fed research found that the rise in oil prices since 2003 to above $60 a barrel is likely to shave about three-quarters of a percentage point from the U.S. gross domestic product this year. Rising energy costs sapped growth by a half-percentage point in 2004, he said in written responses to questions from Congressional Joint Economic Committee Chairman Jim Saxton, a New Jersey Republican.
"Aside from these 'headwinds' the U.S. economy seems to be coping pretty well with the run-up in crude oil prices," the Fed chairman said in a letter dated July 11.
Markets and economic analysts are waiting attentively for Greenspan's semiannual testimony before Congress on Wednesday and Thursday to provide clues on how much longer the Fed plans to sustain its string of nine quarter-point interest rate boosts.
The central bank head also said flat long-term interest rates, despite the Fed's short-term rate hikes, should not be interpreted as a clear sign of economic faltering.
"A sharp flattening of the yield curve is not a foolproof indicator of economic weakness," he said.
Greenspan said most statistical models that look at the yield curve - different interest rates along the spectrum of Treasury debt maturities - to forecast economic trends project moderate growth.
"Movements in bond yields should not be assessed in isolation but need to be interpreted in the context of overall domestic and foreign economic and financial developments," he said.

Greenspan's remarks pushed the 10-year yield to a two-month high of 4.22 percent and supported the dollar against the Euro.
UPDATE: Mark Thoma picked up one more piece of Greenspeak about the housing bubble in the Wall Street Journal and Tim Duy says the Fed is on track for more tightening. Who does not agree on this one?

China Will First Invest And Then Revalue

Following the discussions on Brad Setser's and Brad DeLong's blogs about an imminent Yuan revaluation I am astounded that nearly everybody assumes the China export dragon will fly forever and even accelerate on that way while using all cash receipts to buy more US debt. Looking at the US deficits and the staggering consumer/mortgage debt I wonder if we will not see a rather abrupt shift towards foreign direct investments in the commodity sectors.
China already courts all those resource-rich countries considered pariahs in Washington, as laid out in this post. It has begun to build storage tanks for a national petroleum reserve, but has not yet said how much oil it wants to store. The diversification out of the dollar is already under way and I doubt it will be a purely monetary one. With such a huge domestic market they would be well advised to secure vital raw materials and commodities instead of inflation-prone dollars. Those who believe US CPI figures please raise their hands now.
Doubting the solidity of the jobless economic expansion in the US and seeing no solution to Europe's rising unemployment amidst a stagnant economy that now gets additionally burdened by record oil prices to be paid in a higher dollar I do not think China is so naive to gobble up ever bigger parts of the runaway money supply in the west. Their beginning foray into Africa and Russia makes much more sense than to accumulate ever more paper debt as they will have to master a huge energy problem. Undeveloped as Africa - and Russia - is, these countries can provide a pool of commodities that are a much better value in exchange for their goods imports than just paper promises of the "we pay you later" type.
As stated several weeks ago I still believe that China will also want to avoid a painful devaluation of their FX reserves which would cost them at least two Unocals. My guess is they will first go on an investing binge to reduce their dollar holdings, sell off parts of their most troubled banks and then revalue. For this reason they will stay with their standard explanation that they are considering a revaluation but "not now, please."
Kash at Angry Bear already gets carried away on the speculative article in the FT that started all the frenzy about the revaluation being just around the corner and thinks China will revalue to an extent of 10 percent. That would be four Unocals, to introduce a new currency into this discussion.
I think David Altig kept the coolest head. His headline and the first sentence said it all. "Is Remninbi Revaluation Imminent? According to the Financial Times, the Bush administration is saying "yes".
The Chinese have not moved half an inch in the last three years. They will manage to hide their true feelings well past the coming encounter of the two presidents this autumn. I want to remind everybody that the last head-on clash on May 10 between Treasury secretary John Snow and a Chineses delegation on May 10 started with lots of "revalue now" shouts and ended with the Treasury pulling back its claws. The Chinese were so offended that they did not even a set date for a next meeting. All this was only 10 weeks ago. I strongly doubt the Chinese measure periods of time in quarters when getting the dragon in shape for the next decades.

TIC Data Shows More Foreign Purchases Of US Debt Paper

Monday, July 18, 2005

The US president can continue his spending spree as foreigners have been investing more of their money into US long term debt paper in May, the US Treasury reported on Moday. According to the press release, net foreign purchases of both domestic and foreign long-term securities were $60.0 billion in May compared with $47.8 billion in April. Net foreign purchases of long-term securities were $752.1 billion in the twelve months through May 2005 as compared to $737.2 billion during the twelve months through May 2004. Before today's figures, international investors purchased an average net $37.6 billion in U.S. financial assets each month over the past decade. Over the last three years, the average was $59.5 billion a month. For a report from Bloomberg on the TIC data click this link.
NOTE: All links will open in a new window.
For a table of net Treasury paper purchases since 1978, latest figure $55.5 billion, follow this link.
For a table of foreign purchases and sales of all long-term securities follow this link.
For the 2005 list list of major foreign holders of Treasury paper debt follow this link.
For the historical list of major foreign holders of Treasury paper debt follow this link.
For transactions with Bermuda follow this link.
For transactions with all other countries start out here.
If you are getting confused by now, go back to field #1, i.e. the Treasury International Capital System - Home Page, with many many more links. Or go to this other homepage with links to lots of codes.
If this does not help, have a look at the methodology explanations, which has more links.
And in case you will dare to make sense from future TIC data, look up the schedule here.
And don't blame me if your screen looks now like that:

TIC Data Screenshot

I wish the US Treasury would adopt the website design and the data preparation from the BEA which offers their data in all commonly used data formats. Publishing data tables in text format was outphased in most other first class institutions together with the typewriter. In my ranting I shall also include the BLS which does not offer customer friendly data in spreadsheet format either. This applies to the data releases of the Federal Reserve Board too. But at least the Fed St. Louis does a terrific job in terms of data preparation. If they could only close the time gap between actual releases and the inclusion in their data series we would be a step closer to a better financial world.

China Warns Japan Over Drilling In East China Sea

On the geopolitical stage a new Sino-Japanese row has to be closely watched. Chinadaily reported on the weekend that test drills by Japan's Teikoku Oil for gas and oil in a part of the East China Sea disputed by the two countries could lead to a confrontation with China. Chinadaily reports in an unusually aggressive tone:
Our government's sincere calls to solve the dispute through negotiation have fallen on deaf ears in Japan.
Giving Teikoku the go-ahead to test drill is a move which makes conflict between the two nations inevitable, though what form this clash will take is hard to tell.
Japan's unilateral action to start drilling, which flies in the face of international maritime laws, is not simply about new sources of energy. It reveals plainly the country's intention to take our Diaoyu islets for good.
China and Japan have long been divided over the demarcation of the continental shelf of the East China Sea. China has insisted on negotiation and appealed for joint exploration but Japan drew a "median line" without consulting China.
Lodging a protest over the issue with the Japanese side, Chinese Foreign Ministry spokesman Qin Gang said China would "retain the right to further react."
Given the important role energy issues play in the two countries, communication on the subject is bound to have a huge bearing on state-to-state relations.
Keeping a cool head and flexibility may be the way to shoot down disputes like this.
But Japan has strayed from the path of dialogue. If a confrontation were to result, the blame would sit firmly with Japan.
The Prudent Investor hopes the Iraq war will remain the sole bloody conflict about the globe's dwindling oil resources.
Apart from China's efforts to buy Unocal the Far Eastern giant is improving ties with other oil suppliers. Already a week ago China and Nigeria signed an oil supply pact with a volume of 30,000 barrels per day. This minuscule deal can be seen as first inroad towards more business with the oil-rich African country where China until now was successfully shut out by the western oil firms operating there. There are many more deals to follow, the following excerpts from a Los Angeles Times report show:
China dispatches legions of diplomats, surveyors and engineers across the globe to help quench its insatiable thirst for energy.
During the last two years, President Hu Jintao and Premier Wen Jiabao have taken oil executives on trips to oil-rich countries from Algeria to Uzbekistan to seal major deals. The government in Beijing has welcomed top officials from all 11 members of the Organization of the Petroleum Exporting Countries. A major point of a trip Hu made to Moscow this month was to secure access to Russia's vast reserves.
Chinese crews are building roads in Africa in exchange for the right to extract oil from remote regions. Viewers in Saudi Arabia, a nation that U.S. oil firms once had to themselves, now watch Chinese programs on satellite TV as China drills into Saudi sands. China is also taking advantage of tensions between the Bush administration and Venezuelan President Hugo Chavez to wrest oil from one of the largest U.S. suppliers.
To secure deals worth tens of billions of dollars, Beijing is cozying up to regimes in nations, including Iran and Sudan, that Washington labels pariahs.
Beijing Courts Washington's Pariahs
To secure energy for current and long-term needs, CNOOC and other Chinese firms have pursued a bold strategy: Court oil-rich nations Washington considers pariahs. China moves in when U.S. policy keeps ExxonMobil, Chevron-Texaco and other American companies from drilling in Iran, Sudan and elsewhere.
"They have to go where Western oil companies aren't," said Michael Lelyveld, senior analyst for PFC Energy, a Washington-based consulting firm.
China trades on an asset these countries value: its veto power as a permanent member of the United Nations Security Council.
70 Billion Dollar Investment In Iran
Beijing has reportedly threatened to veto any U.S. attempt to impose sanctions on Iran for pursuing uranium enrichment technology in what Washington alleges is a nuclear arms program. China has also sold Iran weapons, including long-range missile technology, that could threaten shipping in the Strait of Hormuz, through which 40% of the world's oil exports flow.
In October, Beijing used its friendship with Tehran to seal a $70-billion agreement giving Chinese companies a 51% stake in the huge Yadavaran oil field, Iran's largest onshore field, along with a promise to help develop the largely untapped area.
"With the current U.S. threat to refer Iran's nuclear case to the U.N., Iran needs friends in high places," said Reza Zandi, an energy expert and journalist for Iran's Sharq newspaper. "We want to be friends with 'big China,' and they want to be friends with us."
China and Iran Embrace Each Other
Deputy Iranian Oil Minister Seyed Mohammed Hadi Nejad Hosseinian said U.S. pressure had driven Iran into China's arms.
The U.S. Energy Department recently opened an office in Beijing, partly to discuss conservation and China's oil quest. U.S. officials also hope high-level dialogue will address Beijing's dealings with Tehran.
A Stake In Sudan
Friction between Washington and Beijing has also surfaced in Sudan, where state-held China National Petroleum Corp. has a 41% stake in Petrodar, a major Sudanese oil consortium. Sudan's relatively small production is expected to reach 500,000 barrels a day this year.
In September, Beijing frustrated a U.S.-led bid to impose tough U.N. sanctions against Sudan after government-backed militias committed atrocities against the non-Arab population in the Darfur region.
Sudanese Information Minister Abdel Basit Sabdarat said the U.S. had pushed Khartoum to limit its ties with Chinese oil companies. "But we refuse such pressures," he said. "Our partnership with China is strategic. We can't just disband them because the Americans asked us to do so."
Joint Venture In Uzbekistan
When Uzbek President Islam Karimov arrived in Beijing nearly two months ago, Chinese greeters handed him a lavish bouquet and guided him across a bright red carpet as Chinese oil executives waited in the wings to sign a $600-million joint venture.
"This is an important step for energy cooperation," Karimov told the People's Daily, the Communist Party's newspaper.
Weeks before Karimov's visit, Uzbek troops fired on protesters in Uzbekistan's Andijon area, resulting in 700 deaths, according to human rights groups. The government disputed that figure, saying only 187 people died, most of whom were "lawbreakers."
After the clashes, Beijing promptly said it would oppose any U.S. or European calls for a U.N. inquiry, describing the Uzbek crackdown as a justifiable move against "terrorism, separatism and extremism."
Business, Not Finger-Wagging Bigotry
In many parts of the developing world, China has made friends by avoiding the sort of finger-wagging of which Washington is sometimes accused.
"The Chinese don't get involved with religion, they don't get involved with political democracy arguments," said Hassan Husseini, a longtime oil consultant in Saudi Arabia.
"On the subject of women, they accept, and we accept, that we're different," he said. "They're very technically competent and they stay out of politics."
Han Wenke, deputy director-general of the Chinese government-supported Energy Research Institute, said Beijing did not need to apologize for striking deals with governments out of favor with Washington.
"This is just an economic relationship, not political or military cooperation," he said. "Another thing, I don't think China needs to follow the U.S. policy."
Other observers note that the U.S. does business with nations such as Saudi Arabia, which is often cited for torture and other human rights abuses. Human rights groups have criticized some U.S. oil companies for dealing with leaders who repress their people and siphon oil revenue into foreign bank accounts.
Whose Dictatorships?
Drew Thompson, a China analyst at the Center for Strategic and International Studies in Washington, said that "in some ways China is being held to a different standard than other countries."
"If there's a military dictatorship in Nigeria or less than free and fair elections, does that mean that ExxonMobil or Shell do not do business with them?" Thompson asked.
Besides diplomatic clout, China offers low-interest loans and promises of better roads and other aid that Western oil companies typically don't.
Beijing has won friends in Africa with big gestures, including a $1.2-billion, continentwide debt-forgiveness program.
It has also addressed the needs of individual countries.
In the slums of Luanda, the capital of oil-rich Angola, residents living amid garbage and open sewers have witnessed the march of modern electricity pylons through their neighborhood, thanks to the Chinese. A few miles away, on the city's outskirts, a modern village is set off from the surrounding shacks by a security fence, built to house government officials. It too was a gift from the Chinese.
Chinese-built roads, bridges and railroad installations are on the drawing board, part of a $2-billion infrastructure loan program Beijing signed with the country last year in return for oil.
From A(ngola) To Z(imbabwe)
Angola, which is China's second-largest supplier after Saudi Arabia and accounts for about 300,000 barrels a day, may be one of the biggest African recipients of China's largesse, but it's hardly alone. China's African footprint is growing - from the blue Chinese tiles adorning autocratic Zimbabwean President Robert Mugabe's palace roof and the smooth blacktop roads snaking across Rwanda to the new railways in Nigeria and a high-profile port project in Gabon.
The Chinese do what it takes to "lubricate their way into foreign oil deals," said Luft of the Washington-based think tank.
Exploration Deal In Gabon
President Hu's visit to Gabon in February 2004 helped Chinese companies secure an onshore oil exploration deal and a promise to be sold a significant amount of crude.
Even as America has become increasingly critical of Saudi Arabia's government on democracy and terrorism issues, China has courted the kingdom with everything from soccer matches to tourism.
In recent years, the Saudis have opened an office of the state oil company, Aramco, in Beijing and a consulate in Hong Kong and this month invested in a refinery in southern China. Beijing has also hinted at a deal to grant Aramco access to its huge retail gasoline market in return for guaranteed supply.
Saudi Robes Made In China
Today, dishdashas, the traditional white robes worn by Saudis, are mostly made in China, and cable channels in the kingdom broadcast Chinese programs. "I love to watch Chinese humor subtitled in English," said Husseini, the oil consultant. "It's so funny."
China's oil needs also mean it must venture off beaten paths. Sometimes, that means moving into the United States' backyard. Chinese firms have been able to capitalize on discontent with Washington in Ottawa and Caracas.
U.S.-Canadian relations have been strained in recent years by disagreements over the Iraq war, missile defense and U.S. restrictions on Canadian lumber and beef. In granting China access to its oil sands, Canada sends a message that the U.S. isn't the only game in town. The move also helps diversify the nation's customer base.
China's investments in Canada began slowly, with a $124-million stake by CNOOC in MEG Energy, a small, privately held company with a proprietary oil sand technology. PetroChina International signed a deal to participate in the billion-dollar pipeline project that would help bring the oil sand output to West Coast tankers.
Canada: US Not The Only Game In Town
The bitumen found in oil sand is a sticky deposit that must be converted into crude before it can be refined into gasoline or other fuels. Extracting the bitumen is expensive, but experts say it can be profitable, especially with oil prices in the neighborhood of $60 a barrel. Production is expected to jump from the current 1 million to 3 million barrels a day within a decade.
China has also benefited from dissatisfaction with the U.S. to the south. Analysts say Venezuelan President Hugo Chavez has used his growing partnership with Beijing as a way to poke Washington in the eye - Caracas says China will help Venezuela diversify its customer base.
Venezuela Intensifies Ties
During a visit to Beijing last year, Chavez pledged energy assistance to China. And in a reciprocal visit in January by Chinese Vice President Zeng Qinghong, Venezuela promised 100,000 barrels of oil a day and 3 million metric tons of fuel oil a year. No investment figures were given, but a competing bid valued a similar deal at $6 billion.
It's unclear, however, when the shipments will begin or if they will affect delivery obligations to U.S. refineries. The U.S. imports 1.3 million barrels a day from Venezuela, about two-thirds of that nation's output.
This month, China said it would boost Chavez's social programs by using Venezuelan workers to build 10,000 houses on state-owned land in Venezuela in the next two years.
And So Does Brazil
Disillusionment with the United States has also provided China with openings in Brazil, where Beijing and Brasilia are collaborating on projects to develop hydroelectric power and natural gas.
"The U.S. is not...giving attention to the strategic partnership with Brazil," said Luiz Fernando Furlan, Brazil's minister of development, industry and foreign trade. "We cannot stay free waiting for what Washington decides."
U.S. officials stress that they have no intention of blocking China's search for oil.
"We're not going to go across the globe trying to head off China every time we see them going after natural resources," said the State Department official.
Karen Harbert, assistant secretary of Energy for policy and international affairs, says Beijing's quest does not pose a "threat to U.S. interests or a threat to U.S. companies."
But it is expected to figure prominently in a U.S.-China dialogue scheduled for this month, led on the U.S. side by Deputy Secretary of State Robert B. Zoellick.
US Officials Worry About More Oil Wars
U.S. officials say China's reliance on energy from far-flung sources has led it to seek political stability in some regions and safety on the high seas - goals that dovetail with Washington's.
Harbert said the administration was stepping up efforts to work with China, other major energy consumers and oil-producing nations to ease supply problems. Some critics, however, say the administration should better safeguard U.S. national interests and manage tensions.
"In order to sustain this economic growth, emerging economies such as China and India will need more and more supplies of energy and minerals," Rep. Jim Gibbons (R-Nev.) told a congressional panel in March. "The United States must take a serious look at its energy and mineral supply strategy for the long term."
But although officials in both countries emphasize coordination, some analysts say China's hunt for oil could lead to a clash with the United States.
"The competition for oil could lead to armed conflict, particularly with China," Milton Copulos, president of the conservative National Defense Council Foundation, told a House hearing on global energy in March. "Lest this statement seem alarmist or farfetched, I would note that the Chinese are, for the first time, developing a blue-water navy capable of operating beyond their shores."
Some critics fear that, as its global clout grows, China will begin challenging the U.S. for military influence in Asia, a scenario Beijing rejects. Beijing says it has neither the will nor the ability to challenge the U.S. militarily and only wants to develop peacefully.
But the U.S. and China's neighbors worry that Beijing, if faced with shortages, could use its military to grab oil-rich marine fields. Tensions have flared with Japan over mineral rights in disputed islands in the East China Sea. China has used gunboats to force Japanese seismic ships out of the area. And analysts say a Chinese submarine caught on the Japanese side last year was testing Tokyo's vigilance in the resource-rich area.
Frictions With Taiwan and Others In Asia
China is also seeing growing friction over resources with some of its neighbors as its regional power expands. Taiwan has repeatedly chased off Chinese research vessels doing resource surveys in disputed waters off islands variously claimed by Taiwan, Vietnam and China.
Farther south, China said it had rights to the disputed gas- and oil-rich Spratly Islands in Southeast Asia, also claimed variously by Malaysia, the Philippines, Taiwan and Vietnam. In a bid to break the logjam, China early this month called for joint exploration to exploit some of the Spratly resources.
Turning To Russia And Its Neighbors
China increasingly has turned to Russia and its Central Asian neighbors. Russia and China are discussing a 1,500-mile, $2.5-billion pipeline that would supply 700 million tons of Russian crude over 25 years. And Beijing and Kazakhstan recently agreed to work on a $2.5-billion pipeline able to transport 20 million tons of oil a year to western China.
Since it began importing oil in 1993, China has intensified energy exploration abroad, especially in the last few years. It now boasts investments in dozens of oil and gas projects in 30 nations. CNOOC is the most Western of the Chinese oil giants, with USC- and MIT-educated, English-speaking senior managers. The firm has recruited former Secretary of State Henry A. Kissinger and international business leaders to sit on its advisory board.
Analysts say Chinese oil executives, who are beholden to the Communist Party, are not bound to follow the rules of the market. Beijing disputes that.
"Why are other countries' oil imports justified, but it is called 'a threat' when it comes to China?" Zhang Guobao, deputy minister of the National Development Reform Commission, asked at a Beijing forum in May.
Paying Top Dollar For Supply Security
The fact that China has paid top dollar for projects rejected by Western oil companies has left some analysts shaking their heads about what they see as Beijing's willingness to shell out too much for too little.
Harbert, the U.S. Energy undersecretary, said China's large state-owned energy firms had a "different risk profile" than U.S. companies that must answer to shareholders.
"Just by that difference in purpose, [Chinese firms] have the ability to go into areas where private-sector companies cannot bear that risk," she said.
Some of China's more far-flung deals, such as in Venezuela, reflect a "politically driven panic" to secure any source of crude oil without much regard to practical issues such as transportation and refinery capabilities, said Mikkal Herberg, an oil expert at the National Bureau for Asian Research in Seattle.
"The Chinese are in the mode to pay for supply security … and the economics come secondarily," he said.
Until now market forces are determining the race for oil. It is to be hoped the hot commodity will be dealt with by cool heads.

Greenspan To Dominate Otherwise Dull Week

In the absence of any truly important economic data, capital markets are destined to see another week of rangebound trading. All eyes will therefore be set on the two public appearances of Federal Reserve Chairman Alan Greenspan.
On Wednesday Greenspan will deliver his semiannual report on monetary policy to the House of Representatives Financial Services Committee. On Thursday he will report the same to the Senate Banking Committee. Greenspan does two such two-day stints on Capitol Hill each year - in February and July - and his Senate panel appearance will be the second planned for this month and his last ones altogether if he retires on schedule in 197 days.
Taking the latst favourable economic indicators into account that pushed the Dow 2 percent northward last week it can be expected that the Fed chairman will paint an upbeat picture of growth but drop no hint the Fed is ready to pause raising interest rates.
What remains to wonder is whether the Fed will not stop raising rates but when it will actually tighten credit.

Consumer credit and Fed Funds rate

GRAPH: The rise in Fed Funds has so far failed to dampen the appetite for consumer debt. Data: Fed St. Louis
Apart from Greenspan's testimonials the coming week is left with few inspirations to move markets abruptly.
Most important will probably be Monday's release of Treasury Inflow Capital (TIC) data for May. After a slowdown in the two preceding months from 90 to roughly 49 billion dollars in April it will be interesting to see whether foreigners were still willing buyers of the ever expanding debt - never mind last weeks downward revision of the projected federal budget deficit in 2005. At 333 billion it is still a huge mountain of debt.
Tuesday's key event will be housing starts whereas Thursday's data (jobless claims, leading indicators) are likely to be overshadowed by Greenspan's testimonial to lawmakers.
This Week's Data
C = consensus; L = last.
Monday:
TIC data May: no C; L 49.1 billion dollars.
Tuesday:
Housing starts: C 2.05 million; L 2.01.
Thursday:
Jobless claims: C 325,000; L 336,000.
Leading indicators: C plus 0.5 %; L minus 0.5 %.
Philadelphia Fed survey: C plus 11.0; L minus 2.2.

Indicators Hint That Soft Patch Is a Thing Of The Past

Friday, July 15, 2005

This week's US economic indicators have all come in on the positive side, jobless claims being the exception confirming the rule.
A= Actual; C= Consensus; L=Last.
Wednesday:
Import Prices June: A 1.0 %; C 1.2 %; L minus 1.3 %.
Export Prices June: A 0.0 %; C none, L 1.2 %.
Trade Deficit May: A 55.3 billion dollars; C 57.5 billion; L minus 56.9 billion
Treasury Budget: A 22.4 billion dollars; C 23 billion; L minus 35.5 billion.
Thursday:
CPI June: A 0.0 %; C plus 0.2 %; L minus 0.1 %.
Jobless Claims: A 336,000; C 323,000; L 319,000.
Retail Sales June: A 1.7 %; C plus 1.0 %; L minus 0.5 %.
Retail Sales ex Autos: A 0.7 %; C plus 0.6 %; L minus 0.2 %.
Friday:
Business Inventories May: A 0.1 %; C 0.2 %; L 0.3 %.
PPI June: A 0.0 %; C plus 0.4 %; L minus 0.6 %.
PPI core: A minus 0.1 %; C 0.1 %; L 0.1 %.
Capacity Utilization June: A 80.0 %; C 79.7 %; L 79.4 %.
Industrial Production June: A 0.9 %; C 0.4 %; L 0.4 %.
Michigan Consumer Sentiment July: A 96.5 %; C 95.0; L 96.0.
NY Empire State Index: A 23.9; C 10.0; L 11.7.
The latest indicators seem to confirm the view of the Federal Reserve that the economy went through a soft patch earlier this year and not even record breaking oil prices could dampen the dynamics of the ongoing expansion.
The further outlook for the US economy therefore seems to hinge on two factors: Real estate prices which are a corner pillar for consumer optimism and their spending; and the ability of the government to succeed on its path toward budget deficit consolidation which so far has only benefitted from higher than expected tax receipts. As these are a one-time factor that is not likely to be repeated next years the administration has to come forward with some innovative ways to achieve that goal.
The Fed will go into a relaxing weekend, seing that the recent slight steepening of the yield curve will enable them to stay with their "measured" pace of rate hikes, now that the 10-year yield has been rising 30 basis points to 4.19 points from its yearly low reached in June. The spread between Fed Funds and the benchmark 10-year Treasury note has widened to 95 basis points after it had reached a low of 71 basis points before the latest Fed Funds hike on June 30. This should not be taken as a sign of complacency though as this is the same spread as before the latest Fed Funds rate hike. What is more important though is that the long end of the bond market does not seem to escompt a weakening economy anymore.

US 10 year yield 2005

CHART: The recent rise in the 10-year yield has just equalized the latest Fed Funds rate hike. The yield curve is more or less as flat as it was before the latest FOMC decision.

EU Growth Shows A Mixed Picture

Thursday, July 14, 2005

Economic growth in the European Union has picked up a little in the first quarter of 2005, Eurostat reports (pdf). Both Euro zone and EU25 GDP grew by 0.5 percent quarter-on-quarter after a rate of 0.2 and 0.3 (EU25) percent in the previous quarter. But a year-on-year comparison shows that GDP growth slowed in the Euro zone to 1.4 (1.5) percent whereas growth in the EU25 slowed to 1.6 (1.9) percent. Eurostat traced the slowdown to slowing private consumption and decreasing investments.
The bright spot in the overall picture comes from imports falling faster than exports. Exports rose most strongly in Germany with a plus of 2.9 percent. A minus of 9 percent in Polish exports and 18 percent in Polish imports may point to severe structural problems in the country formerly hailed for its dynamic economy.
As Europe suffered from the double whammy of rising oil prices and the rising dollar, which is the accounting currency for oil purchases, the outlook for the second quarter has darkened significantly. EU authorities have already announced earlier that annual growth in 2005 will come in well below 1.5 percent. The OECD has projected 1.2 percent growth in 2005.
Euro zone inflation outlook worsens
UPDATE I: ECB chief economist Otmar Issing said late Tuesday evening that the inflation outlook in the Euro zone has deteriorated in the past month, suggesting there is no room for a rate cut. Issing said, "the outlook for prices has clearly worsened since June," Bloomberg reported. Rates were still appropriate in his view and no obstacle to growth, rather quite the opposite, he said. Issing said the chance that inflation will slow below the ECB's limit this year has become "less probable," backing away from the bank's June forecast that the annual rate of price increases would be just below 2 percent.
Issing also said the outlook for growth has improved since the start of June. German and French business confidence rose last month as the Euro's 11 percent decline against the dollar this year boosted export prospects and European manufacturing activity rose from a 22-month low.
ECB Sees Positive Impact On Exports From High Oil Prices

UPDATE II: The ECB sees a positive impact from the high oil prices though. In its latest monthly report (pdf), published today, it noted that OPEC- and CIS-countries did not stash all their oil revenues in bank accounts but started importing more goods.
From the monthly report:
Total OPEC and CIS imports registered an annual average increase of 18% and 22% respectively between 2001 and 2004 in nominal dollar terms. During this period, OPEC and CIS imports increased more than their long-run income and price elasticities of imports would suggest. The euro area seems to have benefited from the strong demand originating from oilexporting countries. The annual growth of OPEC and CIS imports from the euro area was, on average, 22% and 34% respectively between 2001 and 2004, resulting in an increase in euro area market shares in both oil-exporting regions (see table below). China also succeeded in increasing its relative share in total OPEC and CIS imports. These figures contrast sharply with those of the United States, which experienced a significant loss in market share in OPEC and CIS imports.

OPEC/CIS Imports from the EU
Overall, from 1999 to 2004, different patterns emerged as to how oil-exporting economies, in particular the OPEC economies, allocated their additional oil export revenues. First, in the aftermath of the substantial rise in oil prices in 1999, OPEC countries deposited large shares of their oil revenues with international banks, keeping their investment in financial assets and import spending low. However, between 2001 and 2004, OPEC economies increased their imports substantially. A similar increase in import activity since 2001 can also be observed in the case of the CIS economies. It appears that the euro area benefited from this recent rise in imports. Thus, while the elevated price of oil certainly dampens economic activity in oil-importing countries such as the euro area, it appears that the mitigating feedback effects associated with oil-bill recycling have been somewhat more favourable for the euro area in the current oil price cycle than in previous episodes of price increases.

May Trade Deficit Shrinks A Little - June Figures Expected To Jump On Oil Consumption

Wednesday, July 13, 2005

While the headline number for the May US trade deficit, down 1.55 to 55.35 billion dollars, looked encouraging, scrutinizing the data tables results in a sobering experience. The slight improvement can be traced back to a price decrease in the average cost of crude oil to 43,08 (44,76) dollars, a marginally improved surplus of 5.38 (5.12) billion dollars in the services sector, higher food exports of 5.6 (5) billion dollars and higher exports of consumer goods where a good part of the improvement from 9.29 to 9.72 billion dollars came from arts and antique sales, not exactly a production sector. The goods deficit with China increased to 15.8 (14.7) billion dollars, the same deficit with the EU rose to 10.5 (9.3) billion.

nyc sewer made in china

PHOTO: A good part of the trade deficit is Made in China.
The US' obsession with consuming gets confirmed when looking at the import data. Capital goods imports (ex automotive) declined month-on-month to 31.36 (31.94) billion dollars whereas consumer goods imports rose to 34 (33.76) billion dollars. While the trend in consumer goods imports is a steady one, the reduction of capital goods imports reflects a changing pattern. Figures for Advanced Technological Products show a continuing rise of imports and a three-month drop in exports, resulting in a cumulative deficit of 14.66 (Jan-May 2004: 9.02) billion dollars.

US Trade Deficit May 2005

The automotive sector was of no help to the trade figures either. Higher exports with a volume of 8.88 (8.44) billion dollars were more than offset by imports with a value of 20.04 (19.36) billion dollars.
Altogether this most recent set of data does not allow for any complacency. Expect the June trade deficit to be higher because of the seasonal spike in oil consumption. Last year crude imports surged 8.5 percent from May to June, resulting in a 1.1 billion dollar higher oil bill. As monthly oil imports in 2005 have not deviated much from the previous year's monthly figures it can be assumed that the consumption pattern will not have changed much in June despite the steady price rises at the gas pumps.
UPDATE: The BLS released import and export prices for June (pdf). Import prices rose one percent after falling the same a month earlier while export prices were unchanged after falling 0.2 percent in May. This and oil holding above 60 dollars may be taken as a first indication for a worsening trade deficit.

An Interesting Monetary Detail In The Aftermath Of The London Bombings

The Cunning Realist has a very interesting post on liquidity operations by the Federal Reserve in the 48 hours prior to the London bombings. According to his post temporary liquidity hit a multi-year high on July 5 while securities lending saw a huge spike on June 30. Have a look at this chart and then follow this link for his highly recommendable article.

FedSecuritiesLending

The Cunning Realist goes on to ask,
"why the need for all that easy money all of a sudden? The Fed doesn't take this sort of action for no reason, particularly when the price of oil is already at an all-time high. It does so in response to circumstances it predicts will create a need for liquidity, or when it specifically wants to support the stock market as it did after 9/11.
The terrorist attacks in London took place on Thursday. The Fed dramatically increased the pool of liquidity available for stocks to a multi-year high 48 hours before that---an ideal amount of time for that liquidity to filter into the market---and kept it elevated for the next few days. And indeed, it worked. The stock market saw heavy buying right at the opening bell on Thursday and has shot straight up since then.
Why did the Fed do this? Was it just another coincidence in our financial markets that somehow managed to immediately precede a major geopolitical event?
One person can give us some answers easily and quickly: Alan Greenspan. Doesn't it behoove him to do so before he rides off into the sunset a few months from now?"
There is a point to his questions.
UPDATE I: Indymedia UK reported last Saturday that a 1,000-strong London underground bombing exercise took place at the same time and places as the real attack. Excerpts from Indymedia:
A consultancy agency with government and police connections was running an exercise for an unnamed company that revolved around the London Underground being bombed at the exact same times and locations as happened in real life on the morning of July 7.
On a BBC Radio 5 interview that aired on the evening of the 7th, the host interviewed Peter Power, Managing Director of Visor Consultants, which bills itself as a "crisis management" advice company. Peter Power was a former Scotland Yard official, working at one time with the Anti Terrorist Branch.
The transcript is as follows.
POWER: At half past nine this morning we were actually running an exercise for a company of over a thousand people in London based on simultaneous bombs going off precisely at the railway stations where it happened this morning, so I still have the hairs on the back of my neck standing up right now.
HOST: To get this quite straight, you were running an exercise to see how you would cope with this and it happened while you were running the exercise?
POWER: Precisely, and it was about half past nine this morning, we planned this for a company and for obvious reasons I don't want to reveal their name but they're listening and they'll know it. And we had a room full of crisis managers for the first time they'd met and so within five minutes we made a pretty rapid decision that this is the real one and so we went through the correct drills of activating crisis management procedures to jump from slow time to quick time thinking and so on.
Am I wrong to remember that there were terrorist exercises on 9/11 in NYC?
UPDATE II: The Cunning Realist has posted a further clarification in his comments, ruling out a seasonal effect in the liquidity surge:
Before writing the post, I looked at data from the same time of year for several previous years. The only year that saw anything remotely similar to this year was 2004---and even then, the rise in the liquidity pool was not as sharp as this year when it increased by 60% in one day. Second, the far gentler rises in previous years---if they have occurred at all---have dissipated after the 4th of July. The massive increase this year took place after the 4th. Third, and perhaps most importantly, oil was trading in the 60's this year when the Fed took this action---thus it was far riskier for the Fed to print all that money now as opposed to years past, when its monetary policy was not constrained by the price of oil or other commodities.

HSBC: Ditching Euro Could Benefit Germany, Italy, Netherlands

HSBC has warned that Europe's common currency is working so badly that some countries may actually benefit from ditching the Euro, the British Telegraph reported on Tuesday.
In a new paper entitled "European meltdown?", the world's second biggest bank said Italy, Germany, and Holland had all been damaged by the perverse effect of the one-size-fits-all interest rate policy, and might be tempted to leave.
It said the euro had pushed Germany to the brink of deflationary spiral, while causing a "dramatic boom and bust" in Holland. At the same time, Italy was now trapped in slump with a "truly appalling export performance" and exorbitant unit labour costs.
The report said the risks of break-up had now reached a point where it had become necessary to "think more carefully about the costs and benefits of exiting".
HSBC said Germany might choose to leave in order to cut real interest rates, regain control of fiscal policy, and fight deflation by resorting to the sort of "unconventional" monetary methods in vogue in Tokyo and Washington - but denied by EU law to the European Central Bank.
Italy was deemed the prime candidate for exit, despite a belief that no "weak" economy can risk leaving EMU because of the risk of exploding debt-service costs on bonds.
HSBC said Rome might benefit from switching its existing national debt (now 107 percent of GDP) from euros to a weaker "new lira" - even if this amounted to a default. "The thing about sovereign debt is that the sovereign can do just about anything it likes on its domestic debt because it enacts the law that govern those securities," it said.
The report said real bond yields on fresh debt might jump from the current 1 percent to 4 percent, but this would have little impact on Italian growth as Italy's high-saving households would in turn receive a higher income on their bond holdings. With the right mix of policies, Italy might enjoy a "substantial" jump in growth.
HSBC said it was unclear what would happen to private contracts written in euros. "If Italy withdrew, the nature of the euro itself would be different, which could threaten to unravel even non-financial contracts," it said.
Nor is clear whether Italians could be forced to convert their stock of euro cash and bank accounts into new lira. HSBC warned that the "economic case for the re-establishment of the lira is far from overwhelming", arguing that the outcome would depend on whether or not Italy let rip on inflation.
It may be true that some countries could do better without the Euro. But the common currency is direly needed to keep Europe competitive in financial markets as the sheer size of the Euro market lessens the danger of an all-out attack on it. No currency of a single country was able to withstand the attacks in the 1990's. It has also to be remembered that the Euro led to a convergence of bond spreads, effectively reducing borrowing costs of most member countries as yield converged towards the German benchmarks. Smaller currencies are easy prey for speculative attacks which lead to the suffering of whole nations.

Chart Of The Day: Deflation Cycle

Tuesday, July 12, 2005

Compare the two charts below.

Deflation Cycle

Comstock.com has this graph on the deflation cycle.

Investor Emotions

Barry Ritholtz had this one on investor emotions.
Comstock added the following commentary to its deflation cycle chart:
As you can see on the chart, the cycle starts with typical economic investment which during the bubble of the late 1990s evolved into over-investment (or malinvestment) and excess debt. This logically winds up with excess capacity and weakness in pricing power. This has been evident since the bursting of the bubble and continues to show up today (witness the GM incentive plan which allows the public at large to get the same discounts as the GM employees). Although there are remnants of the beginning and middle of the cycle as it evolves, the place on the chart that is the most dominant is Devaluation, Competitive Devaluation and Protectionism & Tariffs. We have had a few instances of some "beggar-thy-neighbor" policies (selling products to trading partners below cost in order to keep plants open and people employed). We can go back over a year to see the dumping of TVs below cost by the Chinese to the USA, as well as dumping of steel in which we retaliated with tariffs. The last stages of Plant Closings and Debt Defaults are by far the most onerous and painful stages of the cycle.
To understand the consequences of attempting to promote lower currencies than your trading partners we will explain by an example. If the US dollar rises relative to the Euro currency or Asian currencies our goods would become more expensive and it would drive the current trade deficit to higher and higher levels as the dollar grows stronger. In other words if our currency declines relative to the Japanese Yen the Japanese goods become more expensive to Americans. The US dollar would have been able to purchase close to 400 Yen 35 years ago, while now it can purchase just over 100 Yen. The strength of the Yen from 400 Yen to the dollar to 130 Yen to the dollar in 1989 was, in our opinion, largely responsible for the depression and deflation Japan has been experiencing since 1990.
Treasury Secretary Snow states in just about every speech he gives, that the USA is promoting a "strong dollar policy." He has to stand for that, since it seems almost "un-American" to have a weak domestic currency policy. On the other hand, why are our congressmen threatening China with close to 30% tariffs if they don't de-link the Renminbi from the US dollar? Again, the competitive devaluations are more subtle than protectionism & tariffs, but just the same, the linkage of the Chinese Renminbi is a way to keep their currency low relative to the currency of their favorite trading partner (USA). Just last week Secretary Snow and Fed Chief Alan Greenspan had a closed session meeting with Senators Chuck Schumer and Lindsey Graham, who were threatening to impose tariffs on imported Chinese goods unless they de-linked their currency.
The situation in Europe is very similar as can be seen by the gyrations of the Euro from 1.17 dollars in 1999 to close to 0.80 in 2000 as their economies were prospering. Then the strength of the Euro from 0.83 to 1,37 dollars at the end of last year brought the European Zone economies to a screeching halt. Now that the Euro has started down since the beginning of the year (which may stimulate their economies) makes you wonder if the reason for this is the free market working, or Euro Union policy.
Clearly, the relationship of competitive devaluations between our country and China (as well as Europe) can be seen in the middle of the “Cycle of Deflation”. If we are correct in our "cycle of deflation" theme, the Alan Greenspan "conundrum" would no longer be a "conundrum," but actually make sense.

Fed's Lacker Sees Ongoing "Measured" Pace

Monday, July 11, 2005

Richmond Federal Reserve President Jeffrey Lacker said on Monday it was too soon to say when the U.S. central bank would halt a year-long campaign of interest-rate rises and indicated more increases were likely, Reuters reports. "I think it is still too early to be foreseeing a pause," Lacker said. "It's going to be data-driven, it's going to depend on how things unfold, but we seem to be on a fairly solid growth path and inflation expectations seem well-contained, and in that kind of situation, following through is probably the order of the day," he added.
The non-voting FOMC-member said he was comfortable with the policy committee's wording that it expected to lift interest rates at a "measured pace."
"I'm not willing to set a timeframe on it but yes, I am comfortable with the measured pace characterization right now."
Lacker said oil price rises had not passed through to core consumer inflation to any large extent over the past several years. Nor is a continued surge in housing prices likely to ruffle the inflation waters.
"I think that the more likely risk, although it is a small one at this point, is an acceleration of unit labor costs," Lacker said. "The recent data are somewhat clouded, probably by the exercise of stock options ... so it is hard to get a real bead on that."
Lacker said unit labor costs could become a threat if growth in productivity, or hourly output from U.S. workers, tailed off.
"In recent months we've had some core PCE numbers that are higher than I would like to see sustained. But I like where we are on a year-over-year basis and I think the general anticipation (is) for those monthly numbers to settle back down in the second half of the year," he said.
Low Long Rates No Conundrum For Lacker
Lacker said he did not think the low level of long-term interest rates - which Greenspan has dubbed a "conundrum" - indicated the bond market has correctly identified a looming economic slowdown the Fed has missed.
"In my view, the level of long rates is understandable," the Richmond Fed chief said. "Business investment spending is coming in a little bit below expected, in dollar terms. Just where it comes in in real terms over the second half is an interesting question."

Survey: US Workers Idle For 2 Hours/Day

33.8 hours of productive time per workweek? Forget it! It's closer to 25 hours. According to a survey (n= 10,044) from Salary.com and AOL the average worker admits to frittering away 2.09 hours per 8-hour workday, lunch and breaks not included. Salary.com comes up with a mind-boggling figure for the economic damage done: 759 billion dollars. The biggest distraction is personal internet-use which accounts for 45 percent or 55 minutes of the time-off while on-the-job. The Prudent Investor hopes they are at least reading blogs like this one or the ones listed in the blogroll in the sidebar. Chatters with co-workers take up another half hour while conducting personal business - is that maybe online-trading - eats up less than ten minutes. "Spacing out" comes in a distant fourth with just 5 minutes a day.
Human relations departments underestimate the time spent unproductive seriously the survey states. They assume idle time at 54 minutes but suspect it to run as high as 1 hour 36 minutes. They better adapt their spreadsheets when workers themselves admit 2 hours 5 minutes.
Older workers, those born before 1949 and eligible for retirement in the next decade, waste the least time, admitting half an hour per day. Those born after 1985 seem to have other things on their mind, spending 2 hours per workday on other business than they are paid for.
Top Time-Wasters By Industry And State
The top time-wasters by industry are insurance companies with 2.5 hours wasted every day, followed by the public non-educational sector where 2.4 hours are spent near the coffee-maker or running errands.
In banking and finance employees admitted to waste away 1.8 hours per day. Seems the time-pressure vanishes with the distance to the trading floor.
Working in Missouri? Don't feel bad if you need up to 3.2 hours every day for your personal matters. You are just average, costing the state's economy 28.1 billion greenbacks in wasted salary p.a.
Don't do that in South Carolina, Rhode Island or Hawaii though. The average worker there needs just 1.3 workhours for his private affairs.
Don't blame the workers solely though. One third gave as the reason, "don't have enough work to do," while 15 percent said their co-workers distracted them.
The bad numbers give reason for optimism though. Federal Reserve chairman Alan Greenspan is correct when being confident about future productivity gains. Weeding out only half of the wasted time should theoretically result in 15 percent higher productivity.

German Executives To Disclose Their Incomes - Shareholders Get More Rights

Executives of Germany's 1,000 biggest public companies will have to disclose their incomes from 2006 onwards. The German Bundesrat, the lower house of parliament, today ratified a law that will sanction those companies who refuse to comply with fines of up to 50,000 Euros per executive. The disclosure rules require companies to detail executives' salaries including all items such as stock options, material and pension benefits. Severance packages will have to be disclosed in the future as well. Currently only 20 of the 30 companies included in the German DAX index disclose managers pay. BMW, DaimlerChrysler, Porsche, BASF and Munich Re so far refused to publish these numbers.
The Bundesrat also strenghtened shareholders rights by adapting another law. Damage claims against the supervisory board or the top management will require only the backing of one percent or 100,000 Euros of issued share capital. The threshold lay at 5 percent until now. On the other hand shareholders will not be able to block resolutions of the AGM with drawn out lawsuits anymore. In the past individual shareholders often blocked AGM resolutions on technical reasons in order to extort compensation.
Will Volkswagen Be The First In Court?
It will be interesting to see whether shareholders will take on Volkswagen which is entangled in a scandal with allegations that executives paid expenses for the services of Brazilian prostitutes via company accounts. It is also alleged that the management board bought the complicity of the work council with fun trips to Brazil on the company's executive jets.
Peter Hartz, responsible for staff affairs on the management board and the mind behind Germany's revised unemployment payments system that carries his name, offered his resignation last Friday. The supervisory board has not yet decided on a meeting where his offer will be discussed. Hartz is alleged to have signed off the payments regarding the amorous services and having enjoyed them himself. His company biography does not elaborate on his marital status.
Volkswagen also faces other allegations of corruption regarding its Czech subsidiary Skoda where some managers have stepped down already.

Enough Data To Push Markets Out Of Balance

The coming week will bring a slew of data that might wash markets out of their recent trading ranges. Having forecasted last week's trading range of the Dow Jones correctly between 10,200 and 10,450 points The Prudent Investor projects a slightly weaker bias for this week. In my opinion the Dow Jones will not move higher than 10,500 whereas the downside risk reaches to 10,100 as there are lots of dangers lurking at the price front. Don't ask for a projection of the bond market's performance. I refer you to Alan Greenspan's classic; the conundrum is still here and will mainly depend on how much longer the Fed will keep pouring liquidity into the market. No relief to be seen on the oil markets either: The holiday season and no slowdown of demand in the Far East seem to be just the right ingredients for new crude records. Find a table of this week's data below.

FedFunds and Inflation

GRAPH: Inflation (red) and Fed Funds (green) and their difference (yellow) over the last 40 years.

Given that last Friday's employment report benefitted mostly from the birth/death model as there would have been job losses otherwise retail sales won't be able to show a positive surprise.
The same applies to the new trade balance figures where high oil prices and continuing lame exports could result in a figure significantly higher than the consensus forecast of an unchanged 57-billion dollar deficit. Remember that last month's trade deficit declined mainly on non-recurring aircraft orders.
As all new data are lagging indicators markets could also get strong headwinds from hurricane Dennis which has ploughed exactly through that area of the Mexican gulf where US oil companies expect to find more oil on the weekend. The hurricane could disrupt oil supplies from this region and burden insurance companies.
This Week's Data
C = Consensus; L = Last
Wednesday:
Import Prices June: C 1.2 %; L minus 1.3 %.
Export Prices June: C none, L 1.2 %.
Trade Deficit May: C 57.5 billion dollars; L minus 57 billion
Treasury Budget: C 23 billion dollars, L minus 35.5 billion.
Thursday:
CPI June: C plus 0.2 %; L minus 0.1 %.
Jobless Claims: C 323,000; L 319,000.
Retail Sales June: C plus 1.0 %; L minus 0.5 %.
Retail Sales ex Autos: C plus 0.6 %; L minus 0.2 %.
Friday:
PPI June: C plus 0.4 %; L minus 0.6 %.
PPI core: C 0.1 %; L 0.1 %.
Capacity Utilization June: C 79.6 %; L 79.4 %.
Industrial Production June: C 0.4 %; L 0.4 %.
Michigan Consumer Sentiment July: C 95.0; L 96.0.
NOTE I: All consensus estimates from Bloomberg.
NOTE II: So called "core" prices are not included as The Prudent Investor thinks that one cannot exclude food and gas prices from the CPI. These two are the most unflexible items in consumer spending as consumers cannot live in the cold dark eating indexes while commuting less to work.

A GAAP Look At The US Budget Reveals Multi-Trillion Deficit

Friday, July 08, 2005

Being depressed by the London bombings I lack the energy for a post today.
In order to provide some weekend reading I point you to a highly interesting article by John Williams from Shadow Government Statistics who looks at the US budget deficit from a GAAP angle.
Williams concludes that the deficit reported in the 2004 Financial Report of the United States Government (pdf) amounts to a stunning 11.1 trillion dollars and not the comparatively paltry 413 billion dollars reported officially, based on the numbers given in the government's report.

ECB Stays On Autopilot - Inflation Picks Up Speed In June

Thursday, July 07, 2005

The European Central Bank has left its leading interest rates unchanged. Although inflation in the Euro area accelerated to an annual rate of 2.1 (1.9) percent in June, ECB-president Jean-Claude Trichet said he sees no significant underlying pressures regarding inflation, only to backtrack from this statement immediately. Risks to prices were related to oil prices and wage demands, he said in a webcasted press conference on Thursday after the ECB governors meeting. Regarding the explosions in London he said he was in permanent contact with the Bank of England's head Mervyn King, but markets and payment systems were unaffected. He did not expect the explosions to have any significant impact on the markets.
Trichet said again that liquidity in the Euro are was ample and pointed to strong growth of money supply M1 which grew at an average rate of 9.5 percent in the March-May period. The Prudent Investor notes such high growth rates were last documented in post-unification Germany.
Trichet urged Euro-members to shore up their runaway budget deficits as the current situation would not leave much room to maneuver in the case of - unspecified - adverse effects.
Regarding oil prices Trichet asked consumers and producers to act as responsible as possible. Surveys in European media show that consumers have been reducing their driving because of high gasoline prices already. And what is the prime responsibility of a nationalized Middle Eastern oil producer? Is it
a) to provide the west with cheap energy; or
b) to secure as much money as possible for his respective country in order to provide for the long-term future once the oil fields dry up?
High oil prices are beginning to take their toll on European growth expectations already. Trichet projected lower growth rates for the second half of 2005 than the 0.5 percent (quarter-on-quarter) seen in the first half.
Euro CB's Sold 240 Tons of Gold In 1st Half of 2005
Euro area central banks stepped up their gold sales during the recent period when gold traded around 440 dollars an ounce. Including last week's sales with a volume of 360 million Euros by 3 member central banks total gold sales reached a volume of 2.572 billion Euros in the first half of 2005, The Prudent Investor's calculations show.
At an assumed average price of 430 dollars and an average Euro rate of 1.25 dollars this represents 7.477 million ounces gold or almost 240.
China announced today that it will introduce physical gold buying for individuals soon. Until now Chinese were only allowed to buy gold certificates, Reuters reports. China consumed 234 tons of gold in 2004 of which 9.8 tons were for investment purposes.
The biggest physical buyer of gold is India which imports somewhere in the region of 600 tons annually.

France Will Overshoot Deficit Limit

France's public sector deficit will again breach the eurozone limit of three percent of gross domestic product (GDP) in 2005, despite recent government assurances of a 2.9 percent deficit, according to Le Monde.
The paper bases it's report on a "confidential study" from the French treasury, reporting that the trend at present points to a deficit of 3.5 to 3.6 percent in 2005 and 3.5 percent in 2006.
The French government had previously foreseen that the public sector deficit would not exceed 2.9 percent of GDP in 2005.
But it changed its forecast for 2006, saying that the deficit would be at 2.7 percent, compared with previous expectations for it to be around 2.2 percent.
If France's deficit exceeds the EU limit in 2005 and 2006, it will do so for the fourth and fifth consecutive years.
French public debt will also breach the EU limit of 60 percent of GDP, as it is set to hit 67 percent in 2007, according to Le Monde.
Under the EU's budget rules - the Stability and Growth Pact - no member state can run a budget deficit, calculated as tax receipts minus public spending, greater than three percent of GDP.
Governments that breach the three-percent limit can be fined, but no country has been punished so far despite repeated violations of the deal.
In practice, member states can get up to five years to correct their deficits.

Next Fed Head Will Face Credibility Test

Reuters reports the following remarks from Fed St. Louis president William Poole about the difficult tasks the successor to Federal Reserve chairman Alan Greenspan, who will retire in 209 days, will face.
From the Reuters dispatch:
Whoever replaces Federal Reserve Chairman Alan Greenspan when his term ends will face a test of inflation-fighting credibility as markets weigh future policy.
St. Louis Federal Reserve Bank President William Poole said markets currently expect a period of low US inflation to continue well after Greenspan departs office early next year, but said that confidence would likely weaken somewhat.
"The next chairman will start with a base of institutionalized market confidence, but the market will naturally be somewhat skeptical until the new chairman has established his or her own track record," he said during a panel discussion on the post-Greenspan Fed.
"The Fed's inflation-fighting credibility may be somewhat more fragile over the next few years than it has been over the past few years."
Poole touched on four attributes that have come to characterize the Fed under Greenspan, who took the helm in August 1987 and is due to depart at the end of January - credibility in fighting inflation, successful crisis management, a depth of understanding on the economy and the increased predictability of interest-rate policy.
"Alan Greenspan has an astounding command of data," Poole said. "Greenspan's highly informed intuition has enabled him to adjust the stance of policy ... in timely fashion."
Nonetheless Poole, who did not address the current economic situation in his remarks, said Greenspan had "to some degree" instilled in the Fed his deep command of data. "Nevertheless, Greenspan's own expertise will be hard to match."
Poole said the Fed had made large strides toward policymaking transparency under Greenspan, contributing greatly to the central bank's success and the economy's health.
However, Poole's remarks showed he remains uncomfortable with the Fed's recently adopted practice of providing forward guidance on its expected monetary policy path.
He said the "measured pace" language introduced by the Greenspan Fed to characterize its current monetary tightening cycle was an example of this untested "significant departure" that may eventually need to be reassessed.
"Experience to date with forward guidance has been successful but in my opinion it is too early to tell whether this departure will be successful in the long run," Poole said. "The matter will be tested when changed circumstances require policy action that differs from forward guidance."
As he has in the past, Poole argued that markets should properly reflect the likely direction of interest-rate policy as long as they had a thorough understanding of what would drive the central bank's decisions.
"In the years ahead, maintaining and extending improved predictability of policy will be a major challenge for Federal Reserve chairmen," he said.

See also this post "AP Boils Down Greenspan Succession to 3 Names"

Fed Issues Revised Edition Of Standard Textbook

The Federal Reserve has published it's ninth revision of the standard textbook "The Federal Reserve System - Purposes & Functions." For a download of the complete 146-page book in pdf-format click here or go here for single-chapter downloads. The book was last revised in December 1994.
While most of the book focuses on a systematic description of the technicals of the US central bank, the chapter "How monetary policy affects the economy" on page 16 is as good a read as the following chapter "Limitations of monetary policy" on page 19. For an explanation of the "Taylor rule" leaf to page 23.
The conclusion can be found on page 25 or here.
All of the guides to monetary policy discussed here have something to do with the transmission of monetary policy to the economy. All have certain advantages; however, none has shown so consistently close a relationship with the ultimate goals of monetary policy that it can be relied on alone. Consequently, monetary policy makers have tended to use a broad range of indicators - those mentioned above along with many others, including the actual behavior of output and prices-to judge trends in the economy and to assess the stance of monetary policy.
Such an eclectic approach enables the Federal Reserve and other central banks to use all the available information in conducting monetary policy. This tack may be especially important as market structures and economic processes change in ways that reduce the utility of any single indictor. However, a downside to such an approach is the difficulty it poses in communicating the central bank's intentions to the public; the lack of a relatively simple set of procedures may make it difficult for the public to understand the actions of the Federal Reserve and to judge whether those actions are consistent with achieving its statutory goals. This downside risk can be mitigated if the central bank develops a track record of achieving favorable policy outcomes when no single guide to policy has proven reliable.

Fed Funds 1955-2004

CHART: A history of the Fed Funds Rate. Source: "The Federal Reserve System - Purposes & Functions."

Fed Publishes Background On FOMC Statements

The Federal Reserve has published a "Background on FOMC Statements" (pdf) in its spring bulletin. Most of the five page document focuses on the history of FOMC releases, but the last two pages contain worthwhile information for every Fed watcher, and if it is only for the purpose to recheck one's interpretation mode of the sometimes cryptic statements. Read on for the most important clues on Fed-speak. Also note that the scrutiny and the multiple person efforts involved in the creation of a FOMC statement leave no room for such a mistake as the initial omission of the expectations on long-term inflation in the May FOMC statement.
From the Fed's spring bulletin:
Conventions of Language
The minutes try to convey clearly the content of the meeting through commonly used language. At times, the minutes use specific terms in the interest of precision. For example, the minutes distinguish among the terms "members," "meeting participants," and "staff." "Members" refers only to the twelve members of the FOMC - namely, the individuals eligible to vote at that meeting - whereas "meeting participants" includes both the members and the seven nonvoting Reserve Bank presidents (or those attending in their stead). The views of all meeting participants are included in the discussion of current economic conditions and the outlook. When it comes to the description of the policy discussion (usually the final few paragraphs of the minutes), however, the views of the twelve members are the focus. This focus reflects the intention of this section, which is to provide the specific reasons underlying the policy action decided upon by those voting at the meeting. Comments by other meeting participants may be mentioned by way of background in this section when it is felt that they provide important context for the policy discussion, but such comments would not be attributed to members.
To give an indication of how widely expressed a particular view is at a meeting, the minutes use common quantitative wording: "all," "most," "many," "several," "few," or "one," in descending order. Often, other similar words are used for stylistic purposes, and care should be used by readers to avoid over-interpreting specific wording. Moreover, tracking expressions of support for particular viewpoints in the give-and-take of a meeting tends to be an imprecise science. For example, a meeting participant speaking relatively late in a meeting may choose not to repeat views expressed earlier by others, or speakers may alter or amend their views in the course of the meeting. Therefore, these quantitative words should be read as indicative rather than definitive.
Document Structure
The minutes follow a structure that is fairly consistent from one meeting to the next. The initial section includes a list of attendees and any noteworthy organizational or procedural items. For the FOMC's annual organizational meeting, this initial section is appreciably longer because it also includes the election of Committee officers and the approval of various Committee documents.
The second section of the minutes follows a more or less standard format in presenting an overview of the economic and financial information provided to the Committee. This section ends with a summary of the staff forecast at the time of the meeting. In the case of the two-day meetings, during which the Committee discusses a special topic, the opening paragraphs of this section typically summarize the staff presentation and the Committee discussion of the special topic.
The third section covers meeting participants' perspectives on current economic developments and the outlook. The structure of this section is less standard because it depends upon the focus of the discussion. Nevertheless, the section typically includes paragraphs on such topics as business investment, consumer spending, the labor market, the external sector, and inflation. For the two-day meetings, the third section tends to be longer, in part because the minutes cover participants' projections for the economy.
The fourth section of the minutes focuses directly on the policy decision. It includes a few paragraphs covering members' views on policy and any discussion of the post-meeting statement. It also records the vote, including the language that the Committee voted on and the vote of each member by name. The minutes then conclude with confirmation of the date for the FOMC's next scheduled meeting.
A record of any notation votes that occurred during the period between regularly scheduled meetings would be included at the end of the minutes of the later meeting, as would the minutes of any unscheduled FOMC meetings, such as conference calls, that occurred during that period.
Process
The minutes of each FOMC meeting are now prepared on an accelerated timetable in order for the document to be approved by the Committee and published on time, twenty-one days after the end of the meeting. An internal experiment covering most of the 2004 FOMC meetings preceded the decision to expedite the release, and that experiment was an essential element in providing the Committee with the necessary confidence that the shortened schedule could be met reliably.
Staff Draft
The minutes are drafted by staff members of the Board of Governors who attend the FOMC meeting. But the process of producing the minutes begins even before the meeting, as the standard staff summaries of the economic and financial situation (for example, the Greenbook and the Bluebook) prepared for each meeting become available a few days ahead of the meeting. A Board staff member uses those summaries, along with the staff presentations prepared for the FOMC meeting and other input, to draft the section of the minutes that reviews the information provided to the Committee. Shortly after the meeting, a draft of this section is completed, and several senior staff members review it for accuracy and pass it on to be incorporated with the other sections.
The writing of the third and fourth sections of the minutes, which cover the discussion of the economic outlook and the policy decision, begins as soon as the
meeting ends. Several senior staff members gather and discuss major themes from the meeting and the way they will be covered in the minutes. The author of these sections, an officer from the Board’s Division of Monetary Affairs serving on a rotating basis, begins a draft based initially on notes taken at the meeting. By the day after the meeting, however, a rough transcript of the meeting has been prepared, and the author typically relies on the transcript to complete the draft. By the end of the week of the meeting, a draft that includes all sections of the minutes is circulated among the officers in the Division of Monetary Affairs for review.
Policymaker Review
A series of several rounds of policymaker review of the draft minutes begins during the week after the meeting. After the minutes have been reviewed by the Chairman, the Secretary of the FOMC sends the draft to the meeting participants for comments late in the week after the FOMC meeting (typically on Thursday of that week, or nine days after a Tuesday meeting). Early in the subsequent week, the Secretary sends out a revised draft that incorporates input received from meeting participants. By the end of the second week after the meeting, a final version is produced and provided to the Committee for approval by a notation vote. The notation voting period lasts about four calendar days and closes at noon on the day before publication. After the processes of preparation and coordination for the release of the minutes are completed, the approved minutes are published at 2:00 p.m., twenty-one days after the policy decision was made.
This shortened schedule for release has required the Federal Reserve to devote additional resources to produce the minutes. A wider circle of drafters is engaged to ensure that the deadline is met, and logistics are closely coordinated to ensure that policymakers are available for timely review and approval of the minutes. The Committee believed that the costs and risks associated with the new schedule were outweighed by the benefits of additional policy transparency and openness. As such, the earlier release of the minutes was viewed as consistent with the evolution of the FOMC’s communication strategy over the years.

This article was prepared by Deborah J. Danker and Matthew M. Luecke, of the FRB's Division of Monetary Affairs.
The next opportunity to test your Fed-speak skills is on July 21, when the Minutes of last week's FOMC meeting will be released.

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