Overall executive compensation was little changed last year, despite generally poor stock performance, research firm says.
NEW YORK (CNNMoney.com) -- Compensation for top executives at many of the nation's largest publicly traded firms was essentially unchanged last year, even as the stock market plummeted, according to a study released Thursday.
The Corporate Library, a corporate governance research firm that focuses on executive compensation, said the median change in total compensation for chief executives was a decline of less than 0.1%.
The drop was small considering the dramatic declines in the stock market last year, and suggests "that the link between CEO pay and firm performance remains very weak," the report said.
Nevertheless, it was the first time CEO pay declined since the group began tracking such data in 2002, and came after a 4% increase in 2007.
The results also indicated that 75% of CEOs received an increase in their base salary. That's up from 73% the year before.
The survey was based on data from 2008 proxy statements issued by more than 2,000 publicly traded companies.
Executive compensation has been in the spotlight recently after a number of big financial firms gave employees huge bonuses last year despite spectacular losses on Wall Street.
However, the report showed that chief executives did not escape last year's market collapse unscathed.
The median change in total realized compensation, which includes the value of vested and exercised stock awards, was down 6.4% last year, compared with a gain of 7.5% in 2007.
Stephen Schwarzman, chief executive of Blackstone Group (BX), was the highest paid CEO in 2008, taking home $702.4 million in salary and stock options. The report notes that the figure was affected by a large stock award Schwarzman received when Blackstone went public in 2007.
A Blackstone spokesman said Schwarzman's compensation was only $350,000 last year and called the report "totally misleading."
Schwarzman was the only CEO from a financial services company to make the top 10 highest paid executives after Wall Street executives dominated the list in previous years.
Oracle Chief Executive Lawrence Ellison, 2007's highest paid CEO, was second on the list, pocketing nearly $557 million.
The bulk of Ellison's compensation came from exercised stock options, which totaled $543 million from a whopping 36 million options. That's despite a 21% drop in Oracle's (ORCL, Fortune 500) share price over 2008.
The next seven CEOs on the list all oversee energy companies, with a median payday of $114 million. Among the energy barons on the list: Ray Irani of Occidental Petroleum (OXY, Fortune 500), John Hess of Hess Corp. (HES, Fortune 500) and Michael Watford of Ultra Petroleum. (UPL)
In a separate report released earlier this week, the Corporate Library identified five CEOs who received compensation packages they deemed unusually large compared with the relatively poor performance of the company's stock.
Michael Jeffries, chief executive of retail apparel maker Abercrombie & Fitch, was one of the "highest paid worst performing" CEOs, according to the report. Jeffries was also No. 9 on the list of the 10 highest-paid CEOs.
A call requesting comment from Abercrombie & Fitch was not immediately returned.
Earlier this week, after a handful of major corporations announced plans to change the way they pay their employees based on guiding principles set forth by The Conference Board, a business research firm.
AT&T (T, Fortune 500), Cisco Systems (CSCO, Fortune 500) and Hewlett-Packard (HPQ, Fortune 500) were among the companies that agreed to adopt the principles, which include efforts to clearly link pay to performance, provide fair and "affordable" compensation, eliminate excessive golden parachutes, ensure board oversight and increase transparency with shareholders.
Meanwhile, the Federal Reserve is said to be preparing a proposal that would give the central bank the power to oversee pay practices at some of the biggest financial institutions.
Friday, September 25, 2009
Thursday, September 24, 2009
Darling says party over for banks
Chancellor of the Exchequer Alistair Darling has warned bankers that the party is over and they must realise that the world has changed.
He made the comments in a BBC interview before leaving for the G20 summit.
He wants a limit on bonuses and rules to allow banks to be able to get them back if bankers make losses later.
He said there was a limit to how much could be achieved by regulation and that bankers must realise that they have to change their behaviour.
He wants to use regulations to force banks to limit the proportion of their profits that they can give out in bonuses and make sure there are no rewards for failure.
The UK's financial regulator, the Financial Services Authority (FSA), is preparing to put such regulations in place.
"The key thing to get across to bankers is that for them the party has got to be over," he said.
"We've got to get into a situation where they behave sensibly.
"After all, there are very few bankers in the world who would still be standing if it hadn't been for the fact that taxpayers all over the world had to step in and save them last year."
'Almighty car crash'
He said that he agreed with the thrust of a speech by Lord Turner, the head of the FSA, who said on Tuesday that "radical change" was needed in the regulation of the banks that had "cooked up" the crisis.
"What's the origin of this crisis? It's frankly that banks started buying and selling products that they didn't understand," Mr Darling said.
"It's hardly surprising then that there's this almighty car crash. The tragedy is that it wasn't them [the bankers] that suffered, it was everybody else because the world economy plunged into a recession."
The chancellor has also unveiled a new policy that he wants to introduce at the meeting in Pittsburgh with a view to having it agreed at the G20 finance ministers' summit in November.
At the summit in London it was agreed that there would be a blacklist of countries that were operating as tax havens.
Mr Darling's idea is to also have a blacklist of countries that are regulatory havens where the rules and regulations companies have to follow are less onerous.
"People can set up in the Caribbean or South America, the regulators here can't get the sort of information they want and that sort of secrecy leads to instability," he said.
"I think we can get an agreement this weekend to outlaw that sort of activity."
The rules he wants to introduce would allow sanctions to be taken against countries that do not have strong enough regulatory regimes.
The other part of the plan would be that there could be sanctions taken against UK-based companies that did business in blacklisted countries.
So, for example, if a British bank invested in an investment fund based in a blacklisted country, the regulator could penalise it by saying that it has to keep more of its cash in reserve.
Monday, September 21, 2009
Moral hazard is back
n a controversial case a good 16 years ago this month, Singapore's much-vaunted legal system ruled on administering a punishment of caning for a 18-year old American student by the name Michael Fay. After much protests from United States president Bill Clinton and 24 assorted Senators among a series of legal and government nominees, Singapore agreed to reduce the sentence from six lashes to four. Fay's Asian compatriots in the crimes of vandalism were less lucky, each getting a few months in prison and more lashes of the cane.
Four years later, in 1998, Michael Fay shot back to prominence, accused of possessing drugs in Florida; he was set free on a technicality involving arrest procedures. No further crime reports were ever received for the Asian compatriots of Michael Fay who didn't receive the leniency that he did.
The above isn't to suggest that this author supports corporal punishment; rather that the idea of people receiving the full penalty of applicable laws is the functioning basis for any society. Whenever that aspect of implementing laws breaks down; or where special favors are granted for any number of reasons, it is likely that results prove counter-productive.
In the above example, the US government intervened in the laws of a democracy that had a history of applying its stern disciplinarian measures on all of its citizens; in an attempt to protect the narrow interests of one individual. It is possible that the individual felt "good" enough about his government's intervention to feel special; which then translated into behavioral problems later on. In contrast, the boys who got the full punishment under Singapore law never did return to the world of crime, petty or otherwise.
We can see the same examples everywhere. In both of the world's largest countries, China and India, there is clearly a class of people who do not face the full force of the law because of who they happen to be. In other words, political or economic superiority protects some people from laws designed to be applied across society. The net result is stunning levels of corruption (see my article "The wages of corruption, Asia Times Online, August 19, 2006) as well as, perhaps more importantly, rising criminality. China's ruling classes are the very epitome of corruption and petty theft from government coffers; while in India the selective application of laws has resulted in politics becoming the archetypal dirty profession.
When looking at the political classes of both China and India today, I am reminded of Mark Twain's eternal quote, "There is no native criminal class in America, except Congress". Interestingly, almost 100 years after he made the statement, events of the last year have contrived to create a new criminal class across Western society, and that is the world's bankers.
It wouldn't be an idle speculation in my mind at least to compare the politicians of India and China today to the bankers of America and Europe tomorrow.
How did we get to this point? What can be done about it?
The Lehman boondoggle
Over the past few days, newspapers around the world have dredged up their one-year calendar observance special - ie on the aftermath of Lehman Brothers and what it meant for the global financial system. Comments have veered around the following poles:
# Groups of inevitably "liberal" commentators whose refrain has been a steady "Lehman should have never been allowed to fail" which then explains their follow-up assessment of how the right-wing views on financial system integrity were reversed and therefore benefited the world. This group has an altogether rosy view of the world economy, certifying that bailouts have worked and so on.
# The conservative, right-wing view is of course the opposite, namely that the failure of Lehman Brothers was a good thing for the world economy and the wider financial system; this group also holds that bailouts of the financial system that followed would create resource misallocation, inflationary panic and the like.
No prizes for guessing which group I belong to.
This article isn't about the merits and otherwise of the Lehman rescue; but rather about the moral hazard construct that is integral to these situations. In particular, I will seek to examine the behavioral aspects of the past year's government efforts on a new generation of bankers and financiers, broadly continuing the themes first suggested in past articles such as The New Brahmins [Asia Times Online, March 29, 2008] and Easy bets with other people's money [Asia Times Online, May 23, 2009].
In previous articles, I have pointed out time and again that creative destruction is an integral part of capitalism much as bureaucratic sloth is integral to communism; disallowing failures of private companies while also preventing necessary reforms will essentially create the worst of both worlds.
This is broadly where we are today:
1. Governments have spent hundreds of billions of dollars and euros on the rescue of banks around the world, guaranteeing all manner of senior and junior debt obligations in addition to deposits at the banks (actually, according to the International Monetary Fund the total bill thus far is a staggering US$12 trillion; as in $12,000 billion or $12 million million).
2. Governments' slivers of equity, instead of giving them management control, have provided adverse incentives to pushing through real (structural) reforms. Politicians have spent inordinate amounts of time discussing what to do with their shares in the banking system, rather than what to do with the banking system itself.
3. All manners of public securities have been purchased directly under the programs initiated by the European Central Bank (ECB), the Federal Reserve (Fed) and US Treasury. Further in this article, I will specifically discuss the game theory aspects of the US mortgage market securities (RMBS); resulting from the fact that governments are the largest owners of privately issued securities.
4. Bank balance sheets have actually expanded because of the adverse incentives pushed through by the largest shareholder (governments) and easy refinancing available at the "discount" window.
I am no mastermind like Federal Reserve Chairman Ben Bernanke, but it does appear to me that the simple implications for each of the above can be or more importantly, should be the following:
1. The wide use of monetary stimulus in dealing with the current crisis is roughly equivalent to 40% of the combined GDP of the United States and Europe, this means that today's asset values are vastly inflated. In addition, the apparent illusion of wealth so created by seemingly higher stock and property values also engenders inflationary trends on key commodities (why oil prices have risen), over-optimism on the part of suppliers (emerging market countries have seen stunning rebounds) and a failure to reduce leverage (while savings rates are up in the US and Europe, these are more than dwarfed by rising government debt). None of this though is nearly as important as the increase in volatility implied for the future: at some point, all this money has to be removed from the system one way or another (ie, either through withdrawal of quantitative easing or through inflation of asset and retail prices). Oh and did I mention - in conjunction with all that, governments around the world but particularly in the US and Europe will need to raise taxes or cut public services?
2. Controlling the banks hasn't made governments in the US and Europe any smarter. If anything, incentives to restrain the financial system and put institutions on a self-sustaining course have actually gone in the opposite direction, with a new generation of "value maximize initiatives" in each government being tasked with making sure that banks produce more profits. That has immediately led banks to increase their balance sheets, which given poor economic data, also means that the quality of balance sheets has become worse not better under government tutelage. You don't hear much about banks being forced to become smaller, because they aren't being told to become smaller. So let's see now: we have financial institutions with significant exposure to high-risk assets. Gee, what a refreshing change from 2007.
3. The US government, through the Treasury and the Fed holds hundreds of billions of securities in basically, itself. Let me explain: the Treasury bought some $700 billion of "troubled assets" from US and European banks. In addition, the Fed is authorized to purchase $1.25 Trillion (that's $1.25 million million) of conforming mortgages that are backed by Federal agencies (Fannie Mae, Ginnie Mae, and Freddie Mac), $300 billion of long-term US Treasury bonds and $200 billion of the debt issued by (the now nationalized) Federal agencies.
4. This self-ownership of debt raises important questions on the market reaction: Chinese government sources have released details of the country's concerns at the Fed essentially printing money to purchase US debt, but it doesn't appear that a wider acceptance of this position has been found with other Asian central banks or indeed, global bond investors. As with the stunning rise of the stock market, I am left dumbfounded by the complete avoidance of risk discussions in the middle of this mess by the investors most exposed to downside risks of the strategy: namely Asian investors.
5. Then again perhaps I have been blindsided in the past, too: the part of the program detailing the purchases from US Federal agencies was clearly an attempt to mollify the Chinese government which had the biggest exposure to such MBS and Federal agency debt. In other words, the US government may have bailed out the Chinese government directly, in return for the latter to continue buying other US government debt. Indeed, there have been a number of articles on the Internet suggesting that Fed purchases have been directly linked to asset disposals by Chinese government entities. This raises a very interesting game theory argument, which I explore later in the article.
6. Amid all this liquidity sloshing around, the world's bankers have been quietly having a nice party in the back. Banks still making markets in securities - a fancy way of saying that they can both buy and sell these securities - have reaped the benefits of extremely wide spreads between the buying and selling prices ('bid-ask spreads' in the jargon). Additionally, they have managed to refinance the most illiquid stuff on their balance sheets with the respective central banks, and used the borrowed money to buy very toxic assets (As I wrote in previous articles including Easy bets with other people's money, Asia Times Online, May 23).
7. Then there is the whole mark-to-myth malarkey that has been egged on by central bankers and regulators - thanks to their ownership of the banks as highlighted two points above - which means there is no longer any reason to take accounting losses on problem assets. Let me be clear - banks haven't stopped having loan losses; they have simply stopped accounting for them. Lastly, with low deposit rates and high lending rates, their basic businesses have made substantial profits this year. Out of all this, readers should expect that banks will set aside bumper bonuses for their executives, and do these out of stock grants to mollify critics; but don't for a moment forget where the money for those equity gains comes from.
Game theory: Why Americans should default on mortgages
There is also an interesting point about the circularity of US mortgages that bears close monitoring. At a very simplistic level, Americans borrow money from their banks, which sell (conforming) mortgages to Federal agencies, which then issue securities that are bought by Chinese banks that are then repurchased by the US Fed. What happens when some people start repaying their mortgages? The ultimate losers would be the US Fed in the above scheme. This is handled either through money made available by the US Congress (new taxes) or interest rates being raised (more expensive mortgages). Either way, the average US homeowner will find his costs of living going up.
If you were an American taxpayer and homeowner, what would be the most optimal course of action? Think of it this way - if the government owns all the housing debt effectively, and there are a number of defaults every year, everyone who defaults will be better off (financially) than those that continue to pay. If you were one of a 1,000 people getting a mortgage and say 100 people defaulted, then you would in effect (one way or another) be paying for those 100 people who default. As the number rises, you would be pushed towards greater financial pressure as both taxes and mortgage servicing costs rise. Meanwhile, for the people who default, the scheme of arrangement for their debts will mean lower fixed mortgaging costs and other benefits such as tax holidays. For self-employed people who tend to receive cash for their work, defaulting on mortgages could easily become the route to prosperity with low taxes and little debt repayment.
So the logical course of action for a hardworking taxpayer holding a mortgage would be to default right away. This becomes more compelling when you consider the general tightening of credit across the US and Europe, where other forms of credit that used to be easily available previously (credit cards, personal loans) are more difficult to come by now. In typical game theory perspective that means the "penalty" of defaulting on mortgages in the form of reduced credit availability isn't really applicable because that is the case for everyone now.
Add the bit about all that money basically enabling the Chinese to sell their risky assets to the US government in return for US government liabilities, then something far worse looms. At best, this means China executed a perfect portfolio switch, going to better quality assets with lower durations; at worst it means that their direct leverage over the US government has increased substantially. This means that a "buyers' strike" from China will inevitably lead to higher interest rates; which could further increase the pain for US mortgage borrowers. The persistence of that risk on the horizon simply makes the need for Americans to default on their mortgages that much more likely.
Learning from hedge funds
The performance and risks of the banking system wouldn't be so bad if we didn't have anything to compare them with. Unfortunately for the banks, that isn't the case really. Look at hedge funds, those much derided vehicles of capitalists that had been billed as the most destructive forces in the world barely a year ago:
1. A vast number of hedge funds have closed down since the middle of 2008, a trend that continues till today. This bout of creative destruction has meant that strategies that were wrong have been shut down; only hedge fund strategies (and managers) that worked well through the volatile period of 2008 and the more benign conditions of 2009 have survived. Contrast this to the banks, where good and the bad bankers not only co-exist, but bad bankers actually appear to be thriving.
2. While some smaller hedge funds have opened shop, by and large capital hasn't been made available; and certainly nowhere to the degree of stating 'business as usual'. Contrast this with the hundreds of billions in largely public funds that have been pumped into the banking system, as previously highlighted.
3. Consolidation has increased, with the largest hedge funds attracting a greater amount of new capital than smaller entities. This effectively means that the average risk of hedge funds as a financial asset group has declined in the past year; again to be contrasted with the rising risks of the banking system.
4. Overall leverage in the sector has declined, as hedge funds trimmed their overall asset size relative to their capital bases. For example, credit hedge funds have on average cut their leverage by over 25% with the median around 50%; these are interesting statistics because credit hedge funds approximate the basic qualities of banks (that have certainly not cut leverage and indeed may have increased the same).
5. So far, there has been one major scandal involving a hedge fund (Bernie Madoff's $50 billion caper). Compare that to the multiple number of scandals plaguing banks across the world, that are virtually too numerous to highlight.
In effect, hedge funds prove that capitalism does work. By imposing significant penalties on failures combined with rewards for success, it has been relatively easy to align the interests of all parties concerned. Risks have declined for investors, and returns have increased.
Over the horizon
The inevitable conclusion from all this is that capitalism provides a readymade whipping tool, ie bankruptcy, that keeps errant capitalists in check. Confuse that picture, be it for a delinquent teenager or an overextended banker, and the results are fairly predictable: ie a repeat of previous behavior. This then is the true legacy of Lehman Brothers: the aftermath that virtually ensures that eventually there will have to be more such bankruptcies.
Four years later, in 1998, Michael Fay shot back to prominence, accused of possessing drugs in Florida; he was set free on a technicality involving arrest procedures. No further crime reports were ever received for the Asian compatriots of Michael Fay who didn't receive the leniency that he did.
The above isn't to suggest that this author supports corporal punishment; rather that the idea of people receiving the full penalty of applicable laws is the functioning basis for any society. Whenever that aspect of implementing laws breaks down; or where special favors are granted for any number of reasons, it is likely that results prove counter-productive.
In the above example, the US government intervened in the laws of a democracy that had a history of applying its stern disciplinarian measures on all of its citizens; in an attempt to protect the narrow interests of one individual. It is possible that the individual felt "good" enough about his government's intervention to feel special; which then translated into behavioral problems later on. In contrast, the boys who got the full punishment under Singapore law never did return to the world of crime, petty or otherwise.
We can see the same examples everywhere. In both of the world's largest countries, China and India, there is clearly a class of people who do not face the full force of the law because of who they happen to be. In other words, political or economic superiority protects some people from laws designed to be applied across society. The net result is stunning levels of corruption (see my article "The wages of corruption, Asia Times Online, August 19, 2006) as well as, perhaps more importantly, rising criminality. China's ruling classes are the very epitome of corruption and petty theft from government coffers; while in India the selective application of laws has resulted in politics becoming the archetypal dirty profession.
When looking at the political classes of both China and India today, I am reminded of Mark Twain's eternal quote, "There is no native criminal class in America, except Congress". Interestingly, almost 100 years after he made the statement, events of the last year have contrived to create a new criminal class across Western society, and that is the world's bankers.
It wouldn't be an idle speculation in my mind at least to compare the politicians of India and China today to the bankers of America and Europe tomorrow.
How did we get to this point? What can be done about it?
The Lehman boondoggle
Over the past few days, newspapers around the world have dredged up their one-year calendar observance special - ie on the aftermath of Lehman Brothers and what it meant for the global financial system. Comments have veered around the following poles:
# Groups of inevitably "liberal" commentators whose refrain has been a steady "Lehman should have never been allowed to fail" which then explains their follow-up assessment of how the right-wing views on financial system integrity were reversed and therefore benefited the world. This group has an altogether rosy view of the world economy, certifying that bailouts have worked and so on.
# The conservative, right-wing view is of course the opposite, namely that the failure of Lehman Brothers was a good thing for the world economy and the wider financial system; this group also holds that bailouts of the financial system that followed would create resource misallocation, inflationary panic and the like.
No prizes for guessing which group I belong to.
This article isn't about the merits and otherwise of the Lehman rescue; but rather about the moral hazard construct that is integral to these situations. In particular, I will seek to examine the behavioral aspects of the past year's government efforts on a new generation of bankers and financiers, broadly continuing the themes first suggested in past articles such as The New Brahmins [Asia Times Online, March 29, 2008] and Easy bets with other people's money [Asia Times Online, May 23, 2009].
In previous articles, I have pointed out time and again that creative destruction is an integral part of capitalism much as bureaucratic sloth is integral to communism; disallowing failures of private companies while also preventing necessary reforms will essentially create the worst of both worlds.
This is broadly where we are today:
1. Governments have spent hundreds of billions of dollars and euros on the rescue of banks around the world, guaranteeing all manner of senior and junior debt obligations in addition to deposits at the banks (actually, according to the International Monetary Fund the total bill thus far is a staggering US$12 trillion; as in $12,000 billion or $12 million million).
2. Governments' slivers of equity, instead of giving them management control, have provided adverse incentives to pushing through real (structural) reforms. Politicians have spent inordinate amounts of time discussing what to do with their shares in the banking system, rather than what to do with the banking system itself.
3. All manners of public securities have been purchased directly under the programs initiated by the European Central Bank (ECB), the Federal Reserve (Fed) and US Treasury. Further in this article, I will specifically discuss the game theory aspects of the US mortgage market securities (RMBS); resulting from the fact that governments are the largest owners of privately issued securities.
4. Bank balance sheets have actually expanded because of the adverse incentives pushed through by the largest shareholder (governments) and easy refinancing available at the "discount" window.
I am no mastermind like Federal Reserve Chairman Ben Bernanke, but it does appear to me that the simple implications for each of the above can be or more importantly, should be the following:
1. The wide use of monetary stimulus in dealing with the current crisis is roughly equivalent to 40% of the combined GDP of the United States and Europe, this means that today's asset values are vastly inflated. In addition, the apparent illusion of wealth so created by seemingly higher stock and property values also engenders inflationary trends on key commodities (why oil prices have risen), over-optimism on the part of suppliers (emerging market countries have seen stunning rebounds) and a failure to reduce leverage (while savings rates are up in the US and Europe, these are more than dwarfed by rising government debt). None of this though is nearly as important as the increase in volatility implied for the future: at some point, all this money has to be removed from the system one way or another (ie, either through withdrawal of quantitative easing or through inflation of asset and retail prices). Oh and did I mention - in conjunction with all that, governments around the world but particularly in the US and Europe will need to raise taxes or cut public services?
2. Controlling the banks hasn't made governments in the US and Europe any smarter. If anything, incentives to restrain the financial system and put institutions on a self-sustaining course have actually gone in the opposite direction, with a new generation of "value maximize initiatives" in each government being tasked with making sure that banks produce more profits. That has immediately led banks to increase their balance sheets, which given poor economic data, also means that the quality of balance sheets has become worse not better under government tutelage. You don't hear much about banks being forced to become smaller, because they aren't being told to become smaller. So let's see now: we have financial institutions with significant exposure to high-risk assets. Gee, what a refreshing change from 2007.
3. The US government, through the Treasury and the Fed holds hundreds of billions of securities in basically, itself. Let me explain: the Treasury bought some $700 billion of "troubled assets" from US and European banks. In addition, the Fed is authorized to purchase $1.25 Trillion (that's $1.25 million million) of conforming mortgages that are backed by Federal agencies (Fannie Mae, Ginnie Mae, and Freddie Mac), $300 billion of long-term US Treasury bonds and $200 billion of the debt issued by (the now nationalized) Federal agencies.
4. This self-ownership of debt raises important questions on the market reaction: Chinese government sources have released details of the country's concerns at the Fed essentially printing money to purchase US debt, but it doesn't appear that a wider acceptance of this position has been found with other Asian central banks or indeed, global bond investors. As with the stunning rise of the stock market, I am left dumbfounded by the complete avoidance of risk discussions in the middle of this mess by the investors most exposed to downside risks of the strategy: namely Asian investors.
5. Then again perhaps I have been blindsided in the past, too: the part of the program detailing the purchases from US Federal agencies was clearly an attempt to mollify the Chinese government which had the biggest exposure to such MBS and Federal agency debt. In other words, the US government may have bailed out the Chinese government directly, in return for the latter to continue buying other US government debt. Indeed, there have been a number of articles on the Internet suggesting that Fed purchases have been directly linked to asset disposals by Chinese government entities. This raises a very interesting game theory argument, which I explore later in the article.
6. Amid all this liquidity sloshing around, the world's bankers have been quietly having a nice party in the back. Banks still making markets in securities - a fancy way of saying that they can both buy and sell these securities - have reaped the benefits of extremely wide spreads between the buying and selling prices ('bid-ask spreads' in the jargon). Additionally, they have managed to refinance the most illiquid stuff on their balance sheets with the respective central banks, and used the borrowed money to buy very toxic assets (As I wrote in previous articles including Easy bets with other people's money, Asia Times Online, May 23).
7. Then there is the whole mark-to-myth malarkey that has been egged on by central bankers and regulators - thanks to their ownership of the banks as highlighted two points above - which means there is no longer any reason to take accounting losses on problem assets. Let me be clear - banks haven't stopped having loan losses; they have simply stopped accounting for them. Lastly, with low deposit rates and high lending rates, their basic businesses have made substantial profits this year. Out of all this, readers should expect that banks will set aside bumper bonuses for their executives, and do these out of stock grants to mollify critics; but don't for a moment forget where the money for those equity gains comes from.
Game theory: Why Americans should default on mortgages
There is also an interesting point about the circularity of US mortgages that bears close monitoring. At a very simplistic level, Americans borrow money from their banks, which sell (conforming) mortgages to Federal agencies, which then issue securities that are bought by Chinese banks that are then repurchased by the US Fed. What happens when some people start repaying their mortgages? The ultimate losers would be the US Fed in the above scheme. This is handled either through money made available by the US Congress (new taxes) or interest rates being raised (more expensive mortgages). Either way, the average US homeowner will find his costs of living going up.
If you were an American taxpayer and homeowner, what would be the most optimal course of action? Think of it this way - if the government owns all the housing debt effectively, and there are a number of defaults every year, everyone who defaults will be better off (financially) than those that continue to pay. If you were one of a 1,000 people getting a mortgage and say 100 people defaulted, then you would in effect (one way or another) be paying for those 100 people who default. As the number rises, you would be pushed towards greater financial pressure as both taxes and mortgage servicing costs rise. Meanwhile, for the people who default, the scheme of arrangement for their debts will mean lower fixed mortgaging costs and other benefits such as tax holidays. For self-employed people who tend to receive cash for their work, defaulting on mortgages could easily become the route to prosperity with low taxes and little debt repayment.
So the logical course of action for a hardworking taxpayer holding a mortgage would be to default right away. This becomes more compelling when you consider the general tightening of credit across the US and Europe, where other forms of credit that used to be easily available previously (credit cards, personal loans) are more difficult to come by now. In typical game theory perspective that means the "penalty" of defaulting on mortgages in the form of reduced credit availability isn't really applicable because that is the case for everyone now.
Add the bit about all that money basically enabling the Chinese to sell their risky assets to the US government in return for US government liabilities, then something far worse looms. At best, this means China executed a perfect portfolio switch, going to better quality assets with lower durations; at worst it means that their direct leverage over the US government has increased substantially. This means that a "buyers' strike" from China will inevitably lead to higher interest rates; which could further increase the pain for US mortgage borrowers. The persistence of that risk on the horizon simply makes the need for Americans to default on their mortgages that much more likely.
Learning from hedge funds
The performance and risks of the banking system wouldn't be so bad if we didn't have anything to compare them with. Unfortunately for the banks, that isn't the case really. Look at hedge funds, those much derided vehicles of capitalists that had been billed as the most destructive forces in the world barely a year ago:
1. A vast number of hedge funds have closed down since the middle of 2008, a trend that continues till today. This bout of creative destruction has meant that strategies that were wrong have been shut down; only hedge fund strategies (and managers) that worked well through the volatile period of 2008 and the more benign conditions of 2009 have survived. Contrast this to the banks, where good and the bad bankers not only co-exist, but bad bankers actually appear to be thriving.
2. While some smaller hedge funds have opened shop, by and large capital hasn't been made available; and certainly nowhere to the degree of stating 'business as usual'. Contrast this with the hundreds of billions in largely public funds that have been pumped into the banking system, as previously highlighted.
3. Consolidation has increased, with the largest hedge funds attracting a greater amount of new capital than smaller entities. This effectively means that the average risk of hedge funds as a financial asset group has declined in the past year; again to be contrasted with the rising risks of the banking system.
4. Overall leverage in the sector has declined, as hedge funds trimmed their overall asset size relative to their capital bases. For example, credit hedge funds have on average cut their leverage by over 25% with the median around 50%; these are interesting statistics because credit hedge funds approximate the basic qualities of banks (that have certainly not cut leverage and indeed may have increased the same).
5. So far, there has been one major scandal involving a hedge fund (Bernie Madoff's $50 billion caper). Compare that to the multiple number of scandals plaguing banks across the world, that are virtually too numerous to highlight.
In effect, hedge funds prove that capitalism does work. By imposing significant penalties on failures combined with rewards for success, it has been relatively easy to align the interests of all parties concerned. Risks have declined for investors, and returns have increased.
Over the horizon
The inevitable conclusion from all this is that capitalism provides a readymade whipping tool, ie bankruptcy, that keeps errant capitalists in check. Confuse that picture, be it for a delinquent teenager or an overextended banker, and the results are fairly predictable: ie a repeat of previous behavior. This then is the true legacy of Lehman Brothers: the aftermath that virtually ensures that eventually there will have to be more such bankruptcies.
Sunday, September 20, 2009
China’s regulator warns on loan spree
China’s top banking regulator on Friday warned of growing risks to the country’s financial system as a result of an unprecedented expansion in new loans and urged the country’s lenders to improve their internal management.
The statement by Liu Mingkang, chairman of the China Banking Regulatory Commission, may signal a more assertive stance from the body in the build-up to a top-level Communist party meeting scheduled for November that will set the country’s economic agenda for the coming year.
Chinese financial institutions extended Rmb8,185bn ($1,199bn) in local currency loans in the first eight months of this year, an increase of 164 per cent from the same period in 2008, a credit binge analysts say has been facilitated by a serious relaxation in lending standards.
“This year, all kinds of risks have arisen in the banking sector along with the rapid credit expansion,” said Mr Liu in a written statement. “Banking institutions should always stick to the bottom line of compliance management, to lay a solid foundation for risk management.”
For most of this year, the CBRC has been an almost lone voice within the government urging caution over the rapid loan growth and the potential for a future shock to the system.
China’s economic recovery has been largely fuelled by the flood of credit from the state-controlled banks but this has prompted fears of fresh bubbles forming in the property and equities markets and raised the prospect that growth could falter as lending returns to a more sustainable level.
“This is a high-risk strategy, since in prior eras, massive Chinese loan growth eventually led to massive Chinese non-performing loans and a banking sector that had to be recapitalised,” Michael Cembalest, chief investment officer at JPMorgan Global Wealth Management, said in a recent report.
“The removal of loan quota limits once the global recession hit may have unleashed a torrent of relaxed underwriting standards that will not be visible until the next downturn.”
The CBRC has introduced tightening measures in recent months, demanding that banks increase the money they hold in reserve to cover bad loans and monitor whether their loans are being diverted into speculative investments in stocks and property.
Chinese banks are required to maintain a minimum capital adequacy ratio of 8 per cent, but the CBRC has ordered most banks to raise their reserve funds to 10 per cent.
The statement by Liu Mingkang, chairman of the China Banking Regulatory Commission, may signal a more assertive stance from the body in the build-up to a top-level Communist party meeting scheduled for November that will set the country’s economic agenda for the coming year.
Chinese financial institutions extended Rmb8,185bn ($1,199bn) in local currency loans in the first eight months of this year, an increase of 164 per cent from the same period in 2008, a credit binge analysts say has been facilitated by a serious relaxation in lending standards.
“This year, all kinds of risks have arisen in the banking sector along with the rapid credit expansion,” said Mr Liu in a written statement. “Banking institutions should always stick to the bottom line of compliance management, to lay a solid foundation for risk management.”
For most of this year, the CBRC has been an almost lone voice within the government urging caution over the rapid loan growth and the potential for a future shock to the system.
China’s economic recovery has been largely fuelled by the flood of credit from the state-controlled banks but this has prompted fears of fresh bubbles forming in the property and equities markets and raised the prospect that growth could falter as lending returns to a more sustainable level.
“This is a high-risk strategy, since in prior eras, massive Chinese loan growth eventually led to massive Chinese non-performing loans and a banking sector that had to be recapitalised,” Michael Cembalest, chief investment officer at JPMorgan Global Wealth Management, said in a recent report.
“The removal of loan quota limits once the global recession hit may have unleashed a torrent of relaxed underwriting standards that will not be visible until the next downturn.”
The CBRC has introduced tightening measures in recent months, demanding that banks increase the money they hold in reserve to cover bad loans and monitor whether their loans are being diverted into speculative investments in stocks and property.
Chinese banks are required to maintain a minimum capital adequacy ratio of 8 per cent, but the CBRC has ordered most banks to raise their reserve funds to 10 per cent.
Saturday, September 19, 2009
Why people are so dissatisfied with today's economy
by Lee Price
In recent weeks, incumbent politicians have bragged about growth in gross domestic product, jobs, and pay and touted declines in unemployment. Yet a January 12 Gallup poll found that 55% of Americans rate the economy as only "fair" or "poor," and that 52% believe the economy is getting worse. It will not come as a surprise to these Americans that the Commerce Department reported today that, in the fourth quarter of 2005, GDP grew by a tepid 1.1% and the wage and salary growth rate was 1.7%.
The following set of questions and answers provides insight into the public's dissatisfaction with the economy despite the seemingly positive numbers that often get the most attention.
Jobs
President Bush has noted that 2 million jobs were created over the course of 2005 and that we have added 4.6 million jobs since the decline in jobs ended in May 2003. Doesn't that mean the labor market is getting back to normal?
Recent job gains lag far behind historical norms. Last year's 2 million new jobs represented a gain of 1.5%, a sluggish growth rate by historical standards (Figure A). In fact, it is less than half of the average growth rate of 3.5% for the same stage of previous business cycles that lasted as long. At that pace, we would have created 4.6 million jobs last year. If jobs had grown last year at the pace of even the slowest of the prior cycles2.1% in the 1980swe would have added 2.8 million jobs. Over the last half century, the only 12-month spans with job growth as low as 1.5% were those that actually included recession months, occurred just before a recession, or were during the "jobless recovery" of 1992 and early 1993.
Unemployment
According to President Bush, today's 4.9% unemployment rate is below the average rate of the 1970s, 1980s, and 1990s. Doesn't that mean we have a tight labor market?
Unfortunately, no, because the unemployment rate under today's circumstances is misleading as a gauge of tightness in the labor market. The unprecedented 26-month decline in jobs (from March 2001 to May 2003) followed by sluggish job growth ever since has caused many people simply to withdraw from the labor force. Only those who are actively looking for work are included in the calculations of the unemployment rate. However, the employment rate (i.e., the ratio of employed workers to the country's working-age population) provides a better gauge of tightness in the labor market for the 227 million people now of working age. The employment rate has declined from 64.3% in March 2001 to 62.8% in December 2005. If the employment rate had recovered to its March 2001 level, an additional 3.4 million people would be employed today. What's more, if the rate had increased by the average 0.6 point gain of previous cycles, 4.7 million more people would have jobs today (Figure B).
Wages
Last month, Treasury Secretary John Snow noted that real (inflation-adjusted) wages had risen 1.1% since March 2001 in contrast to the 2.1% decline in wages over a comparable period of the 1990s business cycle. Aren't wages doing pretty well?
The slack in the labor market has taken a toll on pay gains. While the Treasury data are accurate, they give the misleading impression that wages are doing well in this cycle. In fact, real wages fell by 0.5% over the last 12 months after falling 0.7% the previous 12 months. Because of the momentum of real wage growth from the tight labor market of the late 1990s, real wages actually continued to grow during the recession that began in March and ended in November 2001. Since then, however, they have fallen slightly (Figure C).
The decline in inflation-adjusted pay has been the largest for lower and middle-income employees. For example, workers at the 20th percentile of the income scale suffered a 0.8% decline in real pay. Only the highest wage employees enjoyed pay gains that outpaced inflation—those in the 95th percentile of wages had gains last year of 0.8% (Figure D).
Tax cuts and jobs
Haven't the tax cuts passed since 2001 been vital to job creation?
No. Federal spending, not tax cuts, are responsible for the jobs that have been created.
If tax cuts have created jobs at all since 2001, it will have happened in the private sector. Assuming that job growth in 2006 matches the Bush Administration's projections, the economy will have added about 2.0 million jobs to the private sector from FY2001 through FY2006. But how many of these two million jobs actually can be attributed to tax cuts and how many to increased government spending—particularly increased defense spending—in this period?
Based on Defense Department estimates of the number of private-sector jobs created by its own spending, we project that additional defense spending will account for a 1.495 million gain in private sector jobs between FY2001 and FY2006. Furthermore, increases in non-defense discretionary spending since 2001 will have added yet another 1.325 million jobs in the private sector, for a total of 2.82 million jobs created by increased government spending. Increased mandatory government spending—which is not even included in these estimates or Figure E—would account for even more job creation. The mere fact that the projected job growth resulting from increased defense and other government spending exceeds the actual number of jobs projected to be added to the economy through 2006 clearly indicates that the tax cuts hardly seem plausible as the engine of the modest job growth in the economy since 2001.
Declining wage gains
Don't rising health care costs explain why wages have not done well?
No, labor market slack has caused both pay and employer benefit costs to rise more slowly. Data on employers wage and benefit costs show that over the last year, wage and salary income per hour rose by 2.3%, the slowest year-over-year rate on record. That compares to a gain of 2.9% two years earlier. Over the most recent year, benefit costs (including employer-paid health insurance) rose 5.1%, down from 6.5% two years earlier (Figure F). As a result, growth in total compensation slowed from 3.9% to 3.1%. Because of the acceleration in inflation over that period, inflation-adjusted compensation declined by 1.5% over the last year in contrast to a 1.5% gain two years earlier. That fact, plus the fact that increases in profits are running multiple times the increase in employer health care costs, makes clear that the squeeze on wages is coming from profits and not from health care costs.
Research assistance by David Ratner.
by Lee Price
In recent weeks, incumbent politicians have bragged about growth in gross domestic product, jobs, and pay and touted declines in unemployment. Yet a January 12 Gallup poll found that 55% of Americans rate the economy as only "fair" or "poor," and that 52% believe the economy is getting worse. It will not come as a surprise to these Americans that the Commerce Department reported today that, in the fourth quarter of 2005, GDP grew by a tepid 1.1% and the wage and salary growth rate was 1.7%.
The following set of questions and answers provides insight into the public's dissatisfaction with the economy despite the seemingly positive numbers that often get the most attention.
Jobs
President Bush has noted that 2 million jobs were created over the course of 2005 and that we have added 4.6 million jobs since the decline in jobs ended in May 2003. Doesn't that mean the labor market is getting back to normal?
Recent job gains lag far behind historical norms. Last year's 2 million new jobs represented a gain of 1.5%, a sluggish growth rate by historical standards (Figure A). In fact, it is less than half of the average growth rate of 3.5% for the same stage of previous business cycles that lasted as long. At that pace, we would have created 4.6 million jobs last year. If jobs had grown last year at the pace of even the slowest of the prior cycles2.1% in the 1980swe would have added 2.8 million jobs. Over the last half century, the only 12-month spans with job growth as low as 1.5% were those that actually included recession months, occurred just before a recession, or were during the "jobless recovery" of 1992 and early 1993.
Unemployment
According to President Bush, today's 4.9% unemployment rate is below the average rate of the 1970s, 1980s, and 1990s. Doesn't that mean we have a tight labor market?
Unfortunately, no, because the unemployment rate under today's circumstances is misleading as a gauge of tightness in the labor market. The unprecedented 26-month decline in jobs (from March 2001 to May 2003) followed by sluggish job growth ever since has caused many people simply to withdraw from the labor force. Only those who are actively looking for work are included in the calculations of the unemployment rate. However, the employment rate (i.e., the ratio of employed workers to the country's working-age population) provides a better gauge of tightness in the labor market for the 227 million people now of working age. The employment rate has declined from 64.3% in March 2001 to 62.8% in December 2005. If the employment rate had recovered to its March 2001 level, an additional 3.4 million people would be employed today. What's more, if the rate had increased by the average 0.6 point gain of previous cycles, 4.7 million more people would have jobs today (Figure B).
Wages
Last month, Treasury Secretary John Snow noted that real (inflation-adjusted) wages had risen 1.1% since March 2001 in contrast to the 2.1% decline in wages over a comparable period of the 1990s business cycle. Aren't wages doing pretty well?
The slack in the labor market has taken a toll on pay gains. While the Treasury data are accurate, they give the misleading impression that wages are doing well in this cycle. In fact, real wages fell by 0.5% over the last 12 months after falling 0.7% the previous 12 months. Because of the momentum of real wage growth from the tight labor market of the late 1990s, real wages actually continued to grow during the recession that began in March and ended in November 2001. Since then, however, they have fallen slightly (Figure C).
The decline in inflation-adjusted pay has been the largest for lower and middle-income employees. For example, workers at the 20th percentile of the income scale suffered a 0.8% decline in real pay. Only the highest wage employees enjoyed pay gains that outpaced inflation—those in the 95th percentile of wages had gains last year of 0.8% (Figure D).
Tax cuts and jobs
Haven't the tax cuts passed since 2001 been vital to job creation?
No. Federal spending, not tax cuts, are responsible for the jobs that have been created.
If tax cuts have created jobs at all since 2001, it will have happened in the private sector. Assuming that job growth in 2006 matches the Bush Administration's projections, the economy will have added about 2.0 million jobs to the private sector from FY2001 through FY2006. But how many of these two million jobs actually can be attributed to tax cuts and how many to increased government spending—particularly increased defense spending—in this period?
Based on Defense Department estimates of the number of private-sector jobs created by its own spending, we project that additional defense spending will account for a 1.495 million gain in private sector jobs between FY2001 and FY2006. Furthermore, increases in non-defense discretionary spending since 2001 will have added yet another 1.325 million jobs in the private sector, for a total of 2.82 million jobs created by increased government spending. Increased mandatory government spending—which is not even included in these estimates or Figure E—would account for even more job creation. The mere fact that the projected job growth resulting from increased defense and other government spending exceeds the actual number of jobs projected to be added to the economy through 2006 clearly indicates that the tax cuts hardly seem plausible as the engine of the modest job growth in the economy since 2001.
Declining wage gains
Don't rising health care costs explain why wages have not done well?
No, labor market slack has caused both pay and employer benefit costs to rise more slowly. Data on employers wage and benefit costs show that over the last year, wage and salary income per hour rose by 2.3%, the slowest year-over-year rate on record. That compares to a gain of 2.9% two years earlier. Over the most recent year, benefit costs (including employer-paid health insurance) rose 5.1%, down from 6.5% two years earlier (Figure F). As a result, growth in total compensation slowed from 3.9% to 3.1%. Because of the acceleration in inflation over that period, inflation-adjusted compensation declined by 1.5% over the last year in contrast to a 1.5% gain two years earlier. That fact, plus the fact that increases in profits are running multiple times the increase in employer health care costs, makes clear that the squeeze on wages is coming from profits and not from health care costs.
Research assistance by David Ratner.
Friday, September 18, 2009
Banks in the US
As financiers of the largest economy in the world, it is little wonder that banks in the United States have gained substantial importance in the global financial market. They offer the widest range of products and services globally, ranging from personal to small business, corporate and institutional banking. With the most advanced online services available, US banks are easily accessible from any part of the world.
Personal Banking Services of Banks in USA
The personal banking solutions of US banks are designed to cater to the day-to-day banking requirements of consumers. Checking products are easy to operate and come with a host of added benefits like free internet banking, ATM/debit card facilities, online bill payment, monthly statement with image, low opening deposits, and many more.
American banks’ loan products are offered in the forms of home equity loans, car loans, and personal loans. Certificates of deposit and passbook savings are the two most preferred forms of savings products.
Mortgage Services of US Banks
US banks offer an array of mortgage services. These services are designed to take care of the diverse mortgage requirements of customers. Besides providing standard mortgage services, the US banks also offer mortgage calculators to help clients calculate their payment schedules, monthly payments, maximum mortgage amounts, extra payments, and more.
Online mortgage services in the US help clients select the best deals. They also make the process of mortgage procurement quite simple and hassle-free.
Business Banking Services of Banks in the USA
The business banking services of US banks support active corporate clients. The business checking accounts take care of the financial requirements of all types of businesses. The common loan products under the business banking include commercial loans and construction loans. Commercial loans are offered for business operation, equipment, and commercial real estate purchases.
Other Products and Services of Banks in USA
Among the other banking products and services, agricultural loan products and checking accounts of the US banks are worth mentioning. Agricultural loans help to purchase machinery, livestock, and real estate. Agricultural checking accounts are cheap and easy to operate.
Internet Banking Solutions of Banks in the USA
The internet banking solutions of the banks in the USA come with a number of facilities like checking balance, funds transfer, and bill payment at any point of time.
The Largest Banks in the US
The largest banks in the US ranked by deposits, according to FDIC, are:
* Bank of America
* JP Morgan Chase Bank
* Wachovia Bank
* Citibank
* Washington Mutual Bank
* SunTrust Bank
* US Bank
* Regions Bank
* Branch Banking and Trust Company
* National City Bank
* HSBC Bank USA
* World Savings Banks, FSB
* Countrywide Bank
* PNC Bank
* Keybank
* ING Bank, FSB
* Merrill Lynch Bank USA
* Sovereign Bank
* Comerica Bank
* Union Bank of California
Personal Banking Services of Banks in USA
The personal banking solutions of US banks are designed to cater to the day-to-day banking requirements of consumers. Checking products are easy to operate and come with a host of added benefits like free internet banking, ATM/debit card facilities, online bill payment, monthly statement with image, low opening deposits, and many more.
American banks’ loan products are offered in the forms of home equity loans, car loans, and personal loans. Certificates of deposit and passbook savings are the two most preferred forms of savings products.
Mortgage Services of US Banks
US banks offer an array of mortgage services. These services are designed to take care of the diverse mortgage requirements of customers. Besides providing standard mortgage services, the US banks also offer mortgage calculators to help clients calculate their payment schedules, monthly payments, maximum mortgage amounts, extra payments, and more.
Online mortgage services in the US help clients select the best deals. They also make the process of mortgage procurement quite simple and hassle-free.
Business Banking Services of Banks in the USA
The business banking services of US banks support active corporate clients. The business checking accounts take care of the financial requirements of all types of businesses. The common loan products under the business banking include commercial loans and construction loans. Commercial loans are offered for business operation, equipment, and commercial real estate purchases.
Other Products and Services of Banks in USA
Among the other banking products and services, agricultural loan products and checking accounts of the US banks are worth mentioning. Agricultural loans help to purchase machinery, livestock, and real estate. Agricultural checking accounts are cheap and easy to operate.
Internet Banking Solutions of Banks in the USA
The internet banking solutions of the banks in the USA come with a number of facilities like checking balance, funds transfer, and bill payment at any point of time.
The Largest Banks in the US
The largest banks in the US ranked by deposits, according to FDIC, are:
* Bank of America
* JP Morgan Chase Bank
* Wachovia Bank
* Citibank
* Washington Mutual Bank
* SunTrust Bank
* US Bank
* Regions Bank
* Branch Banking and Trust Company
* National City Bank
* HSBC Bank USA
* World Savings Banks, FSB
* Countrywide Bank
* PNC Bank
* Keybank
* ING Bank, FSB
* Merrill Lynch Bank USA
* Sovereign Bank
* Comerica Bank
* Union Bank of California
Thursday, September 17, 2009
'Tire war' strains US-China relations
United States President Barack Obama's decision last week to impose tariffs on Chinese tire imports has sparked a war of words with Beijing, which could lead to retaliatory tariffs and a possible World Trade Organization (WTO) investigation into the US's use of emergency tariffs against one of its biggest trading partners.
Late on Friday evening, Obama authorized a 35% emergency tariff on Chinese tire imports in order to curb a "surge" of Chinese tires which, according to US trade unions, have cost 7,000 US factory workers their jobs.
Beijing responded quickly to condemn the US tariffs and threatened its own tariffs against US products.
Chen Deming, China's minister of commerce, condemned the US tariffs, saying that it "sends the wrong signal to the world" and, "[n]ot only does it violate WTO rules, it contravenes commitments the US government made at the [April] G20 financial summit".
On Sunday, Beijing took steps to initiate retaliatory tariffs against US poultry and automobile imports. Chinese and overseas reports also referred variously to chicken products and auto parts. It also suggested that it might ask the WTO to investigate the US use of emergency tariffs.
Obama's decision to come down hard on Chinese imports was defended by the White House as a reasonable response to offer relief to US tire manufacturers and hold China to the promises they made upon ascension to the WTO in 2001.
"When China came in to the [WTO], the US negotiated the ability to impose remedies in situations just like this one," said US Trade Representative Ron Kirk on Friday. "This administration is doing what is necessary to enforce trade agreements on behalf of American workers and manufacturers. Enforcing trade laws is key to maintaining an open and free trading system."
Indeed the "safeguard" measure to which Kirk was referring was written specifically to permit the US to impose tariffs on Chinese goods if imports are growing rapidly and hurting US manufacturers.
The measure was a condition of China's membership in the WTO and lasts until 2013, but Beijing has suggested it may use the WTO's review and dispute resolution mechanisms to challenge Obama's tire tariffs.
Since its ascension to the WTO eight years ago, China has shown both a capability and willingness to use sophisticated legal tactics within the WTO to protect its interests in disputes with trading partners.
Some analysts have expressed concern that the White House's harsh response to growing Chinese tire imports could spark a trade war of retaliatory tariffs and spur a protectionist trend in US trade policy.
"The good news is that we now have clarity about where the president stands on trade. The bad news is that his stance reflects his isolationist primary election campaign rhetoric and not the post-election messages of avoiding protectionism and repairing the damage done to America's international credibility by unilateralist [George W] Bush administration policies," wrote Daniel J Ikenson, associate director of the Center for Trade Studies at the pro-free trade Cato Institute, last week on the Cato website.
"Short of armed hostilities or political subversion, no state action is more provocative than banning another's products from entering your market," he said.
However, other analysts have said that recent history has shown China to err toward measured responses in trade disputes and an increasing tendency to resolve disputes through the WTO.
Obama's support of trade union's and the US tire industry may reflect the Democratic party's close ties to organized labor, a vital ally for any Democratic politician seeking election.
"For far too long, workers across this country have been victimized by bad trade policies and government inaction," said United Steelworkers president Leo W Gerard on Monday. "Today, President Obama made clear that he will enforce America's trade laws and stand with American workers. The president sent the message that we expect others to live by the rules, just as we do."
Beijing hasn't overlooked the US domestic political dimension in its decision to target poultry farmers and auto manufacturers for retaliatory sanctions. Both agriculture and the auto industry are politically sensitive industries in the US, and automobile manufacturers recently underwent a controversial multibillion dollar bailout.
At the root of the situation may be Obama's desire to show the US manufacturing sector that he will stand up to Beijing, enforce existing trade agreements and reduce a trade deficit with China that reached $268 billion 2008.
For its part, Beijing must deal with increasing Chinese nationalism, which has pressured the government to address US criticism in more aggressive and outspoken ways.
The trade dispute between Beijing and Washington will be hard to overlook at next week's G-20 summit in Pittsburgh, where an ambitious agenda will push member countries to make progress in a disparate array of issues, including North Korea, Iranian nuclear ambitions, financial market reforms, numerous proposed reforms of the global financial system and forming a roadmap to conclude the stalled Doha round of trade talks.
Most if not all of the initiatives will require the cooperation of the US and China - the world's first and third largest economies.
"I think it's in China's interests and our interests and the world's interests to avoid protectionism, particularly just as world trade is starting to bounce back from the huge declines that we've seen in the last year," Obama told CNBC.
He said he understood China's displeasure with the US decision to impose tariffs, "But keep in mind, we have a huge economic relationship with China. We have cultivated a strong strategic relationship with China."
Late on Friday evening, Obama authorized a 35% emergency tariff on Chinese tire imports in order to curb a "surge" of Chinese tires which, according to US trade unions, have cost 7,000 US factory workers their jobs.
Beijing responded quickly to condemn the US tariffs and threatened its own tariffs against US products.
Chen Deming, China's minister of commerce, condemned the US tariffs, saying that it "sends the wrong signal to the world" and, "[n]ot only does it violate WTO rules, it contravenes commitments the US government made at the [April] G20 financial summit".
On Sunday, Beijing took steps to initiate retaliatory tariffs against US poultry and automobile imports. Chinese and overseas reports also referred variously to chicken products and auto parts. It also suggested that it might ask the WTO to investigate the US use of emergency tariffs.
Obama's decision to come down hard on Chinese imports was defended by the White House as a reasonable response to offer relief to US tire manufacturers and hold China to the promises they made upon ascension to the WTO in 2001.
"When China came in to the [WTO], the US negotiated the ability to impose remedies in situations just like this one," said US Trade Representative Ron Kirk on Friday. "This administration is doing what is necessary to enforce trade agreements on behalf of American workers and manufacturers. Enforcing trade laws is key to maintaining an open and free trading system."
Indeed the "safeguard" measure to which Kirk was referring was written specifically to permit the US to impose tariffs on Chinese goods if imports are growing rapidly and hurting US manufacturers.
The measure was a condition of China's membership in the WTO and lasts until 2013, but Beijing has suggested it may use the WTO's review and dispute resolution mechanisms to challenge Obama's tire tariffs.
Since its ascension to the WTO eight years ago, China has shown both a capability and willingness to use sophisticated legal tactics within the WTO to protect its interests in disputes with trading partners.
Some analysts have expressed concern that the White House's harsh response to growing Chinese tire imports could spark a trade war of retaliatory tariffs and spur a protectionist trend in US trade policy.
"The good news is that we now have clarity about where the president stands on trade. The bad news is that his stance reflects his isolationist primary election campaign rhetoric and not the post-election messages of avoiding protectionism and repairing the damage done to America's international credibility by unilateralist [George W] Bush administration policies," wrote Daniel J Ikenson, associate director of the Center for Trade Studies at the pro-free trade Cato Institute, last week on the Cato website.
"Short of armed hostilities or political subversion, no state action is more provocative than banning another's products from entering your market," he said.
However, other analysts have said that recent history has shown China to err toward measured responses in trade disputes and an increasing tendency to resolve disputes through the WTO.
Obama's support of trade union's and the US tire industry may reflect the Democratic party's close ties to organized labor, a vital ally for any Democratic politician seeking election.
"For far too long, workers across this country have been victimized by bad trade policies and government inaction," said United Steelworkers president Leo W Gerard on Monday. "Today, President Obama made clear that he will enforce America's trade laws and stand with American workers. The president sent the message that we expect others to live by the rules, just as we do."
Beijing hasn't overlooked the US domestic political dimension in its decision to target poultry farmers and auto manufacturers for retaliatory sanctions. Both agriculture and the auto industry are politically sensitive industries in the US, and automobile manufacturers recently underwent a controversial multibillion dollar bailout.
At the root of the situation may be Obama's desire to show the US manufacturing sector that he will stand up to Beijing, enforce existing trade agreements and reduce a trade deficit with China that reached $268 billion 2008.
For its part, Beijing must deal with increasing Chinese nationalism, which has pressured the government to address US criticism in more aggressive and outspoken ways.
The trade dispute between Beijing and Washington will be hard to overlook at next week's G-20 summit in Pittsburgh, where an ambitious agenda will push member countries to make progress in a disparate array of issues, including North Korea, Iranian nuclear ambitions, financial market reforms, numerous proposed reforms of the global financial system and forming a roadmap to conclude the stalled Doha round of trade talks.
Most if not all of the initiatives will require the cooperation of the US and China - the world's first and third largest economies.
"I think it's in China's interests and our interests and the world's interests to avoid protectionism, particularly just as world trade is starting to bounce back from the huge declines that we've seen in the last year," Obama told CNBC.
He said he understood China's displeasure with the US decision to impose tariffs, "But keep in mind, we have a huge economic relationship with China. We have cultivated a strong strategic relationship with China."
Wednesday, September 16, 2009
UK Economic Profile, British Economy, United Kingdom Economy
During the days of the British Empire the UK economy was the largest in the world and the first to industrialise (or industrialize, ushering in the Industrial Revolution). Although it has declined in significance since, the UK is still the sixth largest economy in the world by purchasing power parity.
It is a member of the G7 (now expanding to the G8 and G20), the European Union (although not the European Economic and Monetary Union -EMU - or Euro) and the OECD (Organisation for Economic Cooperation and Development). It is also the founding member of the Commonwealth, the association formed by former British Empire states.
The British Economy is one of the most globalised (or globalized) economies in the world, thanks in no small part to the City of London, considered to be the largest financial center in the world.
The economy of the United Kingdom of Great Britain includes the economies of England, Scotland, Wales and Northern Ireland. The Isle of Man and the Channel Isles are part of the British Isles and have offshore banking status.
The Bank of England had cut interest rates to 1.0 per cent by the end of 2008, and that is expected to drop to 0.5 per cent for most of 2009 and 2010.
UK budget deficit stood at 5.3 per cent of GDP in 2008. With economic stimulus packages and bank bailouts being worked on, that is expected to balloon to 11.3 per cent of GDP in 2009 and 13 per cent of GDP in 2010.
In 2008, the UK had the 43rd largest relative national public debt, at 47.2 per cent of GDP. This figure could rise to 58.5 per cent of GDP by 2009 and 70 per cent of GDP in 2010, thanks to the projected budget deficits of 2009-2010.
Inflation had ramped up to 3.6 per cent in 2008, but has dropped back with the economic collapse and is expected to be 0.4 per cent in 2009 and 0.8 per cent in 2010. It had the 58th lowest inflation rate in the world at end 2008.
The 3-month Treasury rate has similarly dropped, from 5.5 per cent in 2008 to an expected 1.3 per cent in 2009 and 2010.
The unemployment rate had reached 6.3 per cent in the UK by the end of 2008 according to the Office of National Statistics, reaching close to 2 million unemployed. This figure is likely to grow to the 2.5 million – 3 million figures, or 8-10 per cent.
The UK has the third highest current account deficit in the world of US$186 billion. It has a large trade deficit in manufacturing and has become a net importer of energy and North Sea extraction declines. It runs $468.7 billion of exports (9th in the world export rankings) and $654.7 billion of imports (6th in the world).
It was the 2nd largest recipient of foreign direct investment (FDI) in 2007 (although the figure has dropped since), and one of the most competitive in Europe for business and tax.
UK GDP Data
The UK economy is the 5th largest in the world and 2nd largest in Europe with GDP of US$2.279 trillion (6th largest by PPP GDP).
GDP growth was 1.1 per cent in 2008 but it is expected to contract in coming years, with GDP growth forecasts of -3.2 per cent in 2009 and -1.1 per cent in 2010.
The UK has a population of 61m and a GDP per capita is US$37.4k, which makes it the 30th richest country in the world, above the European Union average of US$33.8k.
UK GDP by industrial sector:
* Services Sector - 76.2 per cent of UK GDP
* Industry & Manufacturing - 22.8 per cent of UK GDP
* Agriculture - 0.9 per cent of UK GDP
UK Economic History
The UK was once the largest economy in the world. At its peak during the nineteenth century it ran the British Empire – and one quarter of the world. Its global mercantile system transported people, resources and capital, generating vast profits for the Empire.
Since the end of World War II the UK has been weakened by the costs of war, the end of the Empire and the Republic of Ireland leaving the United Kingdom.
In recent times, there have been two periods of strong economic performance. The first resulted from the Prime Ministership of Margaret Thatcher, who famously broke the unions and ushered in free market reforms that helped the UK to shed its ‘Sick Man of Europe’ mantle.
The second came about when the ‘New Labour’ government came to power in 1997, with Gordon Brown serving as both Chancellor of the Exchequer Gordon Brown and later Prime Minister, inheriting and expanding a period of continuous economic growth from 1992 to 2007.
UK Economy 2001-2007
The UK experienced a double bubble in both housing and the stock markets from 2001 - 2007.
Credit was cheap and easy, regulation lax and rules broken. Fuelled by mortgages of up to 125 per cent, house prices tripled in some areas during that period and the London Stock Exchange (LSE) reached record highs.
Home prices peaked in the third quarter of 2007 and the long decline set in. Unable to get wholesale funding UK bank Northern Rock was forced to turn to the Bank of England as lender of last resort in September 2007. This led to the first run on a British bank in generations, and forced the government eventually to nationalise the bank.
UK Economy 2008
Northern Rock did not mark the end of the British government’s involvement in the financial sector.
It was forced to nationalise Bradford & Bingley, help Alliance & Leicester and HBOS get bought, and provide capital, funding and underwriting worth more than 400 billion GBP to both over-leveraged giants like RBS and Lloyds TSB, and relatively stronger groups like Barclays, HSBC and Standard Chartered.
By Q2 2008 the UK was officially in recession and Sterling had dropped more than 30 per cent against the other main currencies.
With consumer confidence dropping and unemployment rising, the auto and retail sector were the next victims of recession. Household names in the High St including Woolworths, Zavvi (the former Virgin Megastores), MFI, Adams and Waterfords Wedgewood went into receivership by Christmas 2008.
UK Economy 2009
The British economy in 2009 was declining at an even quicker rate than originally suspected.
All sectors of the UK economy seem to be struggling, with consumer confidence, the housing market, employment and manufacturing either at the lowest point, or dropping faster than ever previously recorded.
Seeking to overcome blame for the recession and the fall out from his previous statements that he had tamed the ‘Boom and Bust’ cycle, Prime Minster Gordon Brown announced a major economic stimulus package. It will add to already high debt levels above 40 per cent of GDP, leading to speculation that Britain’s sovereign debt ratings would be downgraded and to further slides int eh value of sterling.
By the end of 2009, the UK economy is expected to have contracted 3.2 per cent (although some economists are revising that figure further downwards), with UK public debt rising to a staggering 70 per cent.
UK Economy 2010 Forecast
Forecasting in the midst of such economic uncertainty and financial upheaval is, to put it mildly, a challenge.
The consensus for 2010 has now shifted to flat to negative growth. Forecasts range from 0 per cent to – 5 per cent growth, with the median in the -1 to -2 per cent range, although most economists state that major downside risks remain.
The Bank of England Interest Rate, Inflation and the three month Treasury rate are expected to stay low at under 1 per cent, under 1 per cent and 1.3 per cent respectively.
The budget balance is forecast to grow dangerously to -13 per cent of GDP, which would take UK national public debt above 70 per cent of GDP.
UK Monetary and Fiscal Policy
As of Q1 2009, the Bank of England has already cut Interest Rates to a historic low of 1.0 per cent, with a drop to 0.5 per cent or even 0 likely.
Further measures are probably needed, and this will include quantative easing, in other words printing more money.
During Gordon Brown’s stint as Chancellor, the Labour Party officially adopted the Golden Rule and the Sustainable Investment Rule in fiscal policy, which state that deficit over an economic cycle should only be used for future investment, and only up to a national debt of 40 per cent of GDP.
By the end of 2008 estimated public debt had already risen to 42 per cent, and could rise to 70 per cent of GDP by 2010, meaning that the rules have gone out of the window as fighting the recession takes priority. Keynesian economics says this is the right thing to do, but it leaves the British government finances dangerously over leveraged – and over leverage was, after all, what got us into this mess in the first place.
UK Real Estate, UK Property Market
The UK real estate or property market has been growing for most of the years since 1992. Between 2000 and 2007 alone, some areas saw median prices trebling in value. Since the third quarter of 2007, prices have fallen every month, reaching record levels of price drops and record lows in terms of new sales.
Speculators were a big part of the growth of that market, with Buy-To-Let buyers making up as much as 50 per cent of house purchases in London before the crash. This effectively priced new home buyers out of the market.
Although prices have now dropped back to affordable levels, fears of further falls, rising unemployment and reluctance among beleaguered banks to lend continue to restrict the market.
UK Tax
The UK taxation system involves taxes applied by both the central government and local government. Central government collects tax through Her Majesties Revenue and Customs (HM Revenue & Customs) department, in the form of income tax, national insurance, VAT (value added tax), corporation tax and fuel duty.
Local government receives grants from central government, and additionally collects revenue from business rates, council tax and fees such as on-street parking.
Tax as a percentage of GDP reached a percentage of GDP reached 46 per cent as of 2005-2006, according to HM Treasury.
It is a member of the G7 (now expanding to the G8 and G20), the European Union (although not the European Economic and Monetary Union -EMU - or Euro) and the OECD (Organisation for Economic Cooperation and Development). It is also the founding member of the Commonwealth, the association formed by former British Empire states.
The British Economy is one of the most globalised (or globalized) economies in the world, thanks in no small part to the City of London, considered to be the largest financial center in the world.
The economy of the United Kingdom of Great Britain includes the economies of England, Scotland, Wales and Northern Ireland. The Isle of Man and the Channel Isles are part of the British Isles and have offshore banking status.
The Bank of England had cut interest rates to 1.0 per cent by the end of 2008, and that is expected to drop to 0.5 per cent for most of 2009 and 2010.
UK budget deficit stood at 5.3 per cent of GDP in 2008. With economic stimulus packages and bank bailouts being worked on, that is expected to balloon to 11.3 per cent of GDP in 2009 and 13 per cent of GDP in 2010.
In 2008, the UK had the 43rd largest relative national public debt, at 47.2 per cent of GDP. This figure could rise to 58.5 per cent of GDP by 2009 and 70 per cent of GDP in 2010, thanks to the projected budget deficits of 2009-2010.
Inflation had ramped up to 3.6 per cent in 2008, but has dropped back with the economic collapse and is expected to be 0.4 per cent in 2009 and 0.8 per cent in 2010. It had the 58th lowest inflation rate in the world at end 2008.
The 3-month Treasury rate has similarly dropped, from 5.5 per cent in 2008 to an expected 1.3 per cent in 2009 and 2010.
The unemployment rate had reached 6.3 per cent in the UK by the end of 2008 according to the Office of National Statistics, reaching close to 2 million unemployed. This figure is likely to grow to the 2.5 million – 3 million figures, or 8-10 per cent.
The UK has the third highest current account deficit in the world of US$186 billion. It has a large trade deficit in manufacturing and has become a net importer of energy and North Sea extraction declines. It runs $468.7 billion of exports (9th in the world export rankings) and $654.7 billion of imports (6th in the world).
It was the 2nd largest recipient of foreign direct investment (FDI) in 2007 (although the figure has dropped since), and one of the most competitive in Europe for business and tax.
UK GDP Data
The UK economy is the 5th largest in the world and 2nd largest in Europe with GDP of US$2.279 trillion (6th largest by PPP GDP).
GDP growth was 1.1 per cent in 2008 but it is expected to contract in coming years, with GDP growth forecasts of -3.2 per cent in 2009 and -1.1 per cent in 2010.
The UK has a population of 61m and a GDP per capita is US$37.4k, which makes it the 30th richest country in the world, above the European Union average of US$33.8k.
UK GDP by industrial sector:
* Services Sector - 76.2 per cent of UK GDP
* Industry & Manufacturing - 22.8 per cent of UK GDP
* Agriculture - 0.9 per cent of UK GDP
UK Economic History
The UK was once the largest economy in the world. At its peak during the nineteenth century it ran the British Empire – and one quarter of the world. Its global mercantile system transported people, resources and capital, generating vast profits for the Empire.
Since the end of World War II the UK has been weakened by the costs of war, the end of the Empire and the Republic of Ireland leaving the United Kingdom.
In recent times, there have been two periods of strong economic performance. The first resulted from the Prime Ministership of Margaret Thatcher, who famously broke the unions and ushered in free market reforms that helped the UK to shed its ‘Sick Man of Europe’ mantle.
The second came about when the ‘New Labour’ government came to power in 1997, with Gordon Brown serving as both Chancellor of the Exchequer Gordon Brown and later Prime Minister, inheriting and expanding a period of continuous economic growth from 1992 to 2007.
UK Economy 2001-2007
The UK experienced a double bubble in both housing and the stock markets from 2001 - 2007.
Credit was cheap and easy, regulation lax and rules broken. Fuelled by mortgages of up to 125 per cent, house prices tripled in some areas during that period and the London Stock Exchange (LSE) reached record highs.
Home prices peaked in the third quarter of 2007 and the long decline set in. Unable to get wholesale funding UK bank Northern Rock was forced to turn to the Bank of England as lender of last resort in September 2007. This led to the first run on a British bank in generations, and forced the government eventually to nationalise the bank.
UK Economy 2008
Northern Rock did not mark the end of the British government’s involvement in the financial sector.
It was forced to nationalise Bradford & Bingley, help Alliance & Leicester and HBOS get bought, and provide capital, funding and underwriting worth more than 400 billion GBP to both over-leveraged giants like RBS and Lloyds TSB, and relatively stronger groups like Barclays, HSBC and Standard Chartered.
By Q2 2008 the UK was officially in recession and Sterling had dropped more than 30 per cent against the other main currencies.
With consumer confidence dropping and unemployment rising, the auto and retail sector were the next victims of recession. Household names in the High St including Woolworths, Zavvi (the former Virgin Megastores), MFI, Adams and Waterfords Wedgewood went into receivership by Christmas 2008.
UK Economy 2009
The British economy in 2009 was declining at an even quicker rate than originally suspected.
All sectors of the UK economy seem to be struggling, with consumer confidence, the housing market, employment and manufacturing either at the lowest point, or dropping faster than ever previously recorded.
Seeking to overcome blame for the recession and the fall out from his previous statements that he had tamed the ‘Boom and Bust’ cycle, Prime Minster Gordon Brown announced a major economic stimulus package. It will add to already high debt levels above 40 per cent of GDP, leading to speculation that Britain’s sovereign debt ratings would be downgraded and to further slides int eh value of sterling.
By the end of 2009, the UK economy is expected to have contracted 3.2 per cent (although some economists are revising that figure further downwards), with UK public debt rising to a staggering 70 per cent.
UK Economy 2010 Forecast
Forecasting in the midst of such economic uncertainty and financial upheaval is, to put it mildly, a challenge.
The consensus for 2010 has now shifted to flat to negative growth. Forecasts range from 0 per cent to – 5 per cent growth, with the median in the -1 to -2 per cent range, although most economists state that major downside risks remain.
The Bank of England Interest Rate, Inflation and the three month Treasury rate are expected to stay low at under 1 per cent, under 1 per cent and 1.3 per cent respectively.
The budget balance is forecast to grow dangerously to -13 per cent of GDP, which would take UK national public debt above 70 per cent of GDP.
UK Monetary and Fiscal Policy
As of Q1 2009, the Bank of England has already cut Interest Rates to a historic low of 1.0 per cent, with a drop to 0.5 per cent or even 0 likely.
Further measures are probably needed, and this will include quantative easing, in other words printing more money.
During Gordon Brown’s stint as Chancellor, the Labour Party officially adopted the Golden Rule and the Sustainable Investment Rule in fiscal policy, which state that deficit over an economic cycle should only be used for future investment, and only up to a national debt of 40 per cent of GDP.
By the end of 2008 estimated public debt had already risen to 42 per cent, and could rise to 70 per cent of GDP by 2010, meaning that the rules have gone out of the window as fighting the recession takes priority. Keynesian economics says this is the right thing to do, but it leaves the British government finances dangerously over leveraged – and over leverage was, after all, what got us into this mess in the first place.
UK Real Estate, UK Property Market
The UK real estate or property market has been growing for most of the years since 1992. Between 2000 and 2007 alone, some areas saw median prices trebling in value. Since the third quarter of 2007, prices have fallen every month, reaching record levels of price drops and record lows in terms of new sales.
Speculators were a big part of the growth of that market, with Buy-To-Let buyers making up as much as 50 per cent of house purchases in London before the crash. This effectively priced new home buyers out of the market.
Although prices have now dropped back to affordable levels, fears of further falls, rising unemployment and reluctance among beleaguered banks to lend continue to restrict the market.
UK Tax
The UK taxation system involves taxes applied by both the central government and local government. Central government collects tax through Her Majesties Revenue and Customs (HM Revenue & Customs) department, in the form of income tax, national insurance, VAT (value added tax), corporation tax and fuel duty.
Local government receives grants from central government, and additionally collects revenue from business rates, council tax and fees such as on-street parking.
Tax as a percentage of GDP reached a percentage of GDP reached 46 per cent as of 2005-2006, according to HM Treasury.
Tuesday, September 15, 2009
The Economy in 2009
What are the prospects for the economy in 2009? Frankly, they suck.
At the start of the year there vague hopes that the world might pull out of recession by the end of 2009, but they have been dashed.
The pricking of the housing and stock bubbles, and the re-adjustment of the global inbalances between consumption in the US and other advanced economies, and saving in China and other developing nations, has been rapid and painful.
In December 2008, the World Bank projected slight global growth of 0.9 per cent. Just 3 months later, in their 30 March update, they had revised that figure down to a 1.7 per cent decline. Others say it could be a 2 per cent plus decline.
This is a massive change at a global level, and would represent the first drop in global economic growth since the end of World War II.
World trade is expected to drop a massive 6.1 per cent this year, again unheard of in the post-war economy.
Governments and central bankers have taken drastic measures to try to counteract the sudden slump, but those measures will help only partially in developed nations, which still have trillions of dollars of de-leveraging to complete.
Developing nations are in a somewhat better position. China's stimulus package is already having some impact, and growth will continue in China and across the BRIc countries, although at a slower rate than previous years.
None of this will stop unemployment rising. The US is likely to pass the 10 per cent unemployment rate this year, together with many European countries.
Although the unemployment rate in developing nations will be less, the sheer size and relative poverty of the population in countries like China, India, Brazil and Indonesia mean that social unrest will growth, possibly leading to recruitment by extremists and terrorists.
Whatever the case, volatility will increase and no country is safe from the economic and financial shocks, and their unforseen consequences.
Asia marks further gains
MONTREAL - Asian equity markets by and large marked another week of solid gains. Every national stock market exchange average reviewed here chalked up a gain. With only two exceptions, these gains were over 2%, often well over. The MSCI Asia Pacific Index ended at up 3.9% to 117.18, with the ex-Japan version up 3.7% to 380.71.
The three main Greater China indexes upheld their reputation for volatility. They were this week in fact the three most volatile. The South/Southeast Asian group of India and Singapore were tied after them for the next most volatile, while the Northeast group (Japan, South Korea) and the Australasian group (Australia, New Zealand) were all generally not only quantitatively but alsoqualitatively less volatile than the others.
The Hang Seng Index was the largest gainer, up about 4.5% through early afternoon Friday at 21,161. There is great skepticism that it can follow through successfully, given the fact that seven times in the last two-and-a-half months it has popped through 21,000 only to fall back in the next day or two. Nevertheless, short-term technical indicators for the Hang Seng are moderately strong, with the significant exception being a decline in turnover. I have previously pointed to the 20,000-21,500 level as an interval of resistance for the Hong Kong average. Beneath that is a support just below 19,000.
The Taiwan Stock Exchange Composite (TSEC) powered forward 2.6% on the week, tied for fourth greatest gain, and closing at 7,337, breaking through its resistance in the high 7,200s from August of last year but not yet the one in the low 7,500s from January last year. The latter coincides with the lower bound of a still unfilled gap-down in late June 2008. The upper bound of the gap is in the 7,800s.
The conviction on Friday, after the market close, of former Taiwan president Chen Shui-bian for graft and his sentencing to life in prison is likely to have a limited, if any, impact on the Taiwan market. This is not the crisis of a whole political structure and it does not reflect on the island's current rulers, who are drawn from another political party. The market also has a whole weekend to digest the news, during which other news may well be deemed more important.
In the near term, Taiwan's market will draw as likely to draw investors through its strong earnings outlook and rising demand in China and other Asian countries.
The most volatile was again the Shanghai Stock Exchange Composite (SSEC), which closed however with the relatively small gain of 1.4%, the second worst of the week, at 2,990, which is the top of the range that it "should" have respected over the summer but did not, breaking out up to 3,500 in July.
Yet impressive production statistics and firm governmental statements that the stimulus will not be rolled back continue to push the averages higher, and are credited even this week with lifting them up. It must be said, however, that the short-term technical indicators are not as strong as they might be, and they do not by and large justify significant further advances at the moment.
In the Australasian group, the only interesting exchange was Sydney, where the Australian All Ordinaries Index scored the second-largest advance of the week (unless Mumbai recovers in late afternoon local time), up 3.4% to 4,596 as the Australian dollar also continued to rise.
The Australian advance, unexpected in some quarters, comes on the back of the recent near-term commodities run-up. Short-term technical indicators for the Australian market therefore tend to be favorable, although they do suggest the need for a brief consolidation as the index has hit a potential resistance level inherited from October-November 2005. If it succeeds in breaching the resistance, however, the chart gives it a clear run up to the 4,800-5,000 range, barring unforeseen extrinsic circumstances.
The Indian market is falling back in Friday trade to under 16,200 after having gapped up to over 16,400 at the Thursday open. It still remains the region's third-biggest gainer on the week, up 3.2%. Short-term technical indicators are slightly ambivalent but more positive than negative. The low 16,000s are an important resistance level that it has already twice unsuccessfully attempted to break through to the upside since the beginning of summer. The third time may well be the charm.
The Straits Times Index in Singapore is finishing the week in the low 2,680s, up 2.2% on the week. It was at this level in early August but was unable to continue its advance, confirming the resistance there inherited from a local maximum occurring in early May 2006. Short-term technical indicators do not show the strength that would give confidence to a prediction of a definite conquest over this level.
I end with mention of the Northeast Asian indices. There is not much to add to my recent, somewhat more detailed discussion of the South Korean situation (see South Korea shows recovery skills, Asia Times Online, September 11, 2009). It is sufficient to add that Seoul's KOSPI was little changed on Friday, closing at 1,651 with moderately strong but not overwhelmingly favorable short-term technical indicators, suggesting that a consolidation may be in order before further advances are traced out.
Finally the Nikkei 225 in Tokyo was up 2.7% on the week to 10,444 and still in the midst of a wide interval from 10,000 to the high 11,800s that may well constitute a trading range for some time into the future.
Dr Robert M Cutler (http://www.robertcutler.org), educated at the Massachusetts Institute of Technology and the University of Michigan, has researched and taught at universities in the United States, Canada, France, Switzerland, and Russia. Now senior research fellow in the Institute of European, Russian and Eurasian Studies, Carleton University, Canada, he also consults privately in a variety of fields.
The three main Greater China indexes upheld their reputation for volatility. They were this week in fact the three most volatile. The South/Southeast Asian group of India and Singapore were tied after them for the next most volatile, while the Northeast group (Japan, South Korea) and the Australasian group (Australia, New Zealand) were all generally not only quantitatively but alsoqualitatively less volatile than the others.
The Hang Seng Index was the largest gainer, up about 4.5% through early afternoon Friday at 21,161. There is great skepticism that it can follow through successfully, given the fact that seven times in the last two-and-a-half months it has popped through 21,000 only to fall back in the next day or two. Nevertheless, short-term technical indicators for the Hang Seng are moderately strong, with the significant exception being a decline in turnover. I have previously pointed to the 20,000-21,500 level as an interval of resistance for the Hong Kong average. Beneath that is a support just below 19,000.
The Taiwan Stock Exchange Composite (TSEC) powered forward 2.6% on the week, tied for fourth greatest gain, and closing at 7,337, breaking through its resistance in the high 7,200s from August of last year but not yet the one in the low 7,500s from January last year. The latter coincides with the lower bound of a still unfilled gap-down in late June 2008. The upper bound of the gap is in the 7,800s.
The conviction on Friday, after the market close, of former Taiwan president Chen Shui-bian for graft and his sentencing to life in prison is likely to have a limited, if any, impact on the Taiwan market. This is not the crisis of a whole political structure and it does not reflect on the island's current rulers, who are drawn from another political party. The market also has a whole weekend to digest the news, during which other news may well be deemed more important.
In the near term, Taiwan's market will draw as likely to draw investors through its strong earnings outlook and rising demand in China and other Asian countries.
The most volatile was again the Shanghai Stock Exchange Composite (SSEC), which closed however with the relatively small gain of 1.4%, the second worst of the week, at 2,990, which is the top of the range that it "should" have respected over the summer but did not, breaking out up to 3,500 in July.
Yet impressive production statistics and firm governmental statements that the stimulus will not be rolled back continue to push the averages higher, and are credited even this week with lifting them up. It must be said, however, that the short-term technical indicators are not as strong as they might be, and they do not by and large justify significant further advances at the moment.
In the Australasian group, the only interesting exchange was Sydney, where the Australian All Ordinaries Index scored the second-largest advance of the week (unless Mumbai recovers in late afternoon local time), up 3.4% to 4,596 as the Australian dollar also continued to rise.
The Australian advance, unexpected in some quarters, comes on the back of the recent near-term commodities run-up. Short-term technical indicators for the Australian market therefore tend to be favorable, although they do suggest the need for a brief consolidation as the index has hit a potential resistance level inherited from October-November 2005. If it succeeds in breaching the resistance, however, the chart gives it a clear run up to the 4,800-5,000 range, barring unforeseen extrinsic circumstances.
The Indian market is falling back in Friday trade to under 16,200 after having gapped up to over 16,400 at the Thursday open. It still remains the region's third-biggest gainer on the week, up 3.2%. Short-term technical indicators are slightly ambivalent but more positive than negative. The low 16,000s are an important resistance level that it has already twice unsuccessfully attempted to break through to the upside since the beginning of summer. The third time may well be the charm.
The Straits Times Index in Singapore is finishing the week in the low 2,680s, up 2.2% on the week. It was at this level in early August but was unable to continue its advance, confirming the resistance there inherited from a local maximum occurring in early May 2006. Short-term technical indicators do not show the strength that would give confidence to a prediction of a definite conquest over this level.
I end with mention of the Northeast Asian indices. There is not much to add to my recent, somewhat more detailed discussion of the South Korean situation (see South Korea shows recovery skills, Asia Times Online, September 11, 2009). It is sufficient to add that Seoul's KOSPI was little changed on Friday, closing at 1,651 with moderately strong but not overwhelmingly favorable short-term technical indicators, suggesting that a consolidation may be in order before further advances are traced out.
Finally the Nikkei 225 in Tokyo was up 2.7% on the week to 10,444 and still in the midst of a wide interval from 10,000 to the high 11,800s that may well constitute a trading range for some time into the future.
Dr Robert M Cutler (http://www.robertcutler.org), educated at the Massachusetts Institute of Technology and the University of Michigan, has researched and taught at universities in the United States, Canada, France, Switzerland, and Russia. Now senior research fellow in the Institute of European, Russian and Eurasian Studies, Carleton University, Canada, he also consults privately in a variety of fields.
The Surreal Symphony
Asia Times Online recently received an unexpected package recently, sent from the future. It details a story, The Surreal Symphony, that is evidently popular some 40 years from now; thankfully, we also have some of the reading notes attached to the tale that help us to make some sense of the story ...
.... Gather around kids, for I am going to tell you a tale.
There was once a country called Stoneland, which had some of the most intelligent, innovative, charming, personable people in the world. The dark side of Stoneland was that it was also a country where pretty much all denizens were constantly drugged out of their brains. Over the years, Stoneland had gone from being a country happy to make cool products to one that didn't know
how to make anything; even all its drugs were bought from a country called Drugland.
Now, Drugland was ruled by a tyrant, albeit one considered benevolent by most people, barring, of course, the ones who crossed him - they soon lost their liberty, or worse, their lives. The sole moneymaking business of Drugland was to make drugs that were consumed by the people of Stoneland.
At one point, Drugland had sold all the drugs it could to the denizens of Stoneland who could pay with cash. This reduced any chance of further growth in Drugland. That's when someone in Stoneland came up with the idea of Stone-backed-securities (SBS), which depended on the future cash flow from stoned people. Immediately, the tyrant of Drugland noticed the potential for selling more drugs to the people of Stoneland by expanding the target market to people who couldn't pay today but possibly could in a few years.
There was a problem of course - who would buy these SBS issued on the stoners' income? Drugland could buy some, but not all of these "assets". That's when Oldland stepped in - these were old people who lived in a place between Drugland and Stoneland (if the crow flew west) both physically and semantically. Oldland had a lot of savings and very little use for those savings in their own country. They were too scared to invest in Drugland because of the tyrant, but the idea of buying SBS seemed very appealing - after all, the stoners were living in Stoneland, not in Drugland.
This radical idea immediately helped to increase sales of drugs in Stoneland, and of course benefited Drugland. Initially at least, the people of Oldland were quite happy because they were getting some money back on the SBS; this encouraged them to buy more SBS, which of course made Drugland even more happy.
Slowly though, the denizens of Stoneland started getting worried about both their drug habits and the rapidly escalating amounts of money they now owed to Drugland and Oldland. So one day they started not paying their debt; leading to falling prices of SBS. They also decided to cut back on their drug purchases, hurting Drugland.
# This was termed the "Global Sobriety Crisis", and very soon there was panic all around the world. There were a number of conferences arranged urgently in the capitals of Stoneland, Oldland and Drugland, all of which asked the same basic questions: Could the Stonelanders simply have lost all sense, or was the latent demand for sobriety actually something worth thinking about?
# Did they not know that stopping their use of mind-altering drugs could actually cause them to behave responsibly in future?
# What would happen to the citizens of Drugland who would be rendered unemployed by this new eagerness for Stonelanders to become sober?
# What about the Oldlanders - how would they ever get their money on the SBS back?
# Lastly, how would drug peddlers - the biggest part of the Stoneland economy - bounce back to their billion-dollar bonuses?
In the initial phase of the sobriety crisis, the government of Stoneland adopted the tactic of allowing the country's drug peddlers simply to go bankrupt. However, there was a big hue and cry after one of the five biggest drug peddlers went bust, which led to everyone around the world questioning the financial soundness of all drug peddlers everywhere.
This was clearly a problem in the world where drug peddlers had risen to great prominence and taken over the reins of politics in any country not directly ruled by a tyrant. So the great and the good determined that, rather than allow the risks of sobriety from spreading responsibility and good behavior, the world's governments resolved the following:
1. That all drug peddlers in Stoneland, Oldland and Drugland would be guaranteed by their respective governments in order to ensure that their vital functions would continue uninterrupted;
2. That the government of Stoneland would start borrowing money from Oldland and Drugland to then compensate the buyers of SBS in those two countries;
3. That the government of Stoneland would simply start putting drugs into its own water supply and specifically ensure that younger people would grow up with both high amounts of debt and low sobriety.
Within a few weeks of this decision, the citizens of Stoneland went back to borrowing money and spending it all on drugs. Thus it was that the great sobriety crisis was defeated by the courageous action of the governments of these countries.
Here endeth the tale.
Reading notes on the tale, 2050 edition
The Surreal Symphony is often considered a work of fiction that has been disguised as a news item, in the style of "blog" columns that were popular on the first and second versions of the Internet circa 40 years ago.
Many authors and historians have debated The Surreal Symphony, alleging that the countries named are based on real countries; the general consensus is that Stoneland refers to the United States of America, Drugland to China and Oldland to Germany. There are many other theories for what were the real countries; or indeed if more than one country fits into the description.
What is clear for latter-day students is that the events described in The Surreal Symphony led directly caused the Trade Wars that racked the world between 2012 and 2025, which itself culminated in World War III in 2025. The deaths of two-thirds of humanity in that war, and the wide use of nuclear weapons resulted in today's climate of dust.
Similarly, the "sobriety crisis" is believed to refer to the Great Financial Crisis of 2007, which history shows only ended in 2020 with the worldwide destruction of financial institutions. Many authors therefore believe that The Surreal Symphony was written a good 10 years before the end of the financial institutions known as "banks".
These "banks" are of course the "drug peddlers" referred to in the tale, although many modern authors believe that it would have been impossible for such a small group of people to have acquired and then misused all that power.
.... Gather around kids, for I am going to tell you a tale.
There was once a country called Stoneland, which had some of the most intelligent, innovative, charming, personable people in the world. The dark side of Stoneland was that it was also a country where pretty much all denizens were constantly drugged out of their brains. Over the years, Stoneland had gone from being a country happy to make cool products to one that didn't know
how to make anything; even all its drugs were bought from a country called Drugland.
Now, Drugland was ruled by a tyrant, albeit one considered benevolent by most people, barring, of course, the ones who crossed him - they soon lost their liberty, or worse, their lives. The sole moneymaking business of Drugland was to make drugs that were consumed by the people of Stoneland.
At one point, Drugland had sold all the drugs it could to the denizens of Stoneland who could pay with cash. This reduced any chance of further growth in Drugland. That's when someone in Stoneland came up with the idea of Stone-backed-securities (SBS), which depended on the future cash flow from stoned people. Immediately, the tyrant of Drugland noticed the potential for selling more drugs to the people of Stoneland by expanding the target market to people who couldn't pay today but possibly could in a few years.
There was a problem of course - who would buy these SBS issued on the stoners' income? Drugland could buy some, but not all of these "assets". That's when Oldland stepped in - these were old people who lived in a place between Drugland and Stoneland (if the crow flew west) both physically and semantically. Oldland had a lot of savings and very little use for those savings in their own country. They were too scared to invest in Drugland because of the tyrant, but the idea of buying SBS seemed very appealing - after all, the stoners were living in Stoneland, not in Drugland.
This radical idea immediately helped to increase sales of drugs in Stoneland, and of course benefited Drugland. Initially at least, the people of Oldland were quite happy because they were getting some money back on the SBS; this encouraged them to buy more SBS, which of course made Drugland even more happy.
Slowly though, the denizens of Stoneland started getting worried about both their drug habits and the rapidly escalating amounts of money they now owed to Drugland and Oldland. So one day they started not paying their debt; leading to falling prices of SBS. They also decided to cut back on their drug purchases, hurting Drugland.
# This was termed the "Global Sobriety Crisis", and very soon there was panic all around the world. There were a number of conferences arranged urgently in the capitals of Stoneland, Oldland and Drugland, all of which asked the same basic questions: Could the Stonelanders simply have lost all sense, or was the latent demand for sobriety actually something worth thinking about?
# Did they not know that stopping their use of mind-altering drugs could actually cause them to behave responsibly in future?
# What would happen to the citizens of Drugland who would be rendered unemployed by this new eagerness for Stonelanders to become sober?
# What about the Oldlanders - how would they ever get their money on the SBS back?
# Lastly, how would drug peddlers - the biggest part of the Stoneland economy - bounce back to their billion-dollar bonuses?
In the initial phase of the sobriety crisis, the government of Stoneland adopted the tactic of allowing the country's drug peddlers simply to go bankrupt. However, there was a big hue and cry after one of the five biggest drug peddlers went bust, which led to everyone around the world questioning the financial soundness of all drug peddlers everywhere.
This was clearly a problem in the world where drug peddlers had risen to great prominence and taken over the reins of politics in any country not directly ruled by a tyrant. So the great and the good determined that, rather than allow the risks of sobriety from spreading responsibility and good behavior, the world's governments resolved the following:
1. That all drug peddlers in Stoneland, Oldland and Drugland would be guaranteed by their respective governments in order to ensure that their vital functions would continue uninterrupted;
2. That the government of Stoneland would start borrowing money from Oldland and Drugland to then compensate the buyers of SBS in those two countries;
3. That the government of Stoneland would simply start putting drugs into its own water supply and specifically ensure that younger people would grow up with both high amounts of debt and low sobriety.
Within a few weeks of this decision, the citizens of Stoneland went back to borrowing money and spending it all on drugs. Thus it was that the great sobriety crisis was defeated by the courageous action of the governments of these countries.
Here endeth the tale.
Reading notes on the tale, 2050 edition
The Surreal Symphony is often considered a work of fiction that has been disguised as a news item, in the style of "blog" columns that were popular on the first and second versions of the Internet circa 40 years ago.
Many authors and historians have debated The Surreal Symphony, alleging that the countries named are based on real countries; the general consensus is that Stoneland refers to the United States of America, Drugland to China and Oldland to Germany. There are many other theories for what were the real countries; or indeed if more than one country fits into the description.
What is clear for latter-day students is that the events described in The Surreal Symphony led directly caused the Trade Wars that racked the world between 2012 and 2025, which itself culminated in World War III in 2025. The deaths of two-thirds of humanity in that war, and the wide use of nuclear weapons resulted in today's climate of dust.
Similarly, the "sobriety crisis" is believed to refer to the Great Financial Crisis of 2007, which history shows only ended in 2020 with the worldwide destruction of financial institutions. Many authors therefore believe that The Surreal Symphony was written a good 10 years before the end of the financial institutions known as "banks".
These "banks" are of course the "drug peddlers" referred to in the tale, although many modern authors believe that it would have been impossible for such a small group of people to have acquired and then misused all that power.
Gold a hedge and no more - yet
Even a rather wobbly reserve currency is a better asset than gold, whose price again crossed the US$1,000 mark last week. Gold is far less liquid than US Treasury securities, costly to store and insure, and above all far more volatile in price.
Gold's price volatility since January 2000 (the standard deviation of the daily price divided by the average) is 45%, almost triple that of the US dollar-euro exchange rate. In a functioning world financial system, in which investors trust governments to control extreme instability, even an indifferently managed reserve
currency with a broad capital market behind it is better than gold.
US$ price volatility, January 2000 to August 2009
Gold Euro Yen
Standard Deviation/Average 45% 17% 8%
Strictly speaking, gold isn't an investment but an insurance policy against a breakdown of the functioning of the world financial system. In particular, it represents insurance against the breakdown of the political understandings that make possible a world financial system. That is why gold reached its all-time peak (in inflation-adjusted) terms at the end of 1979, when the Soviet Union invaded Afghanistan.
Divided by the US Consumer Price Index (CPI), the price of gold trades at half its 1979 peak, when the world had cause to believe that America would lose the Cold War. American diplomats still were hostage to the Iranian Revolutionary Guards Corps in Tehran; a rescue operation had failed ignominiously; the overall state of America's military was weaker than at any time since World War II; and the European consensus held that the North Atlantic Treaty Organization would break up. Russia's move into Afghanistan seemed like the penultimate blow to American power. If America ceased to be the leader of the free world, the dollar also would cease to be the world's reserve currency. The cost of options on America's funeral - for that is what the gold price was - went through the ceiling.
America's position in the world today is far less subject to challenge than it was in those dark days at the end of the Jimmy Carter administration. The US has stuck its hand into the meatgrinder in every venue it visits, but unlike 1979, no hostile power lurks along the road to exploit American weakness.
On the contrary: most of the world (China and India in particular) would prefer that America enhance rather than diminish its world role. The last thing China wants to do, for example, is to have to suppress Islamist insurgencies inspired by Washington's newfound interest in engaging the Muslim world. The last thing India wants to do is to sort out a Pakistan dominated by the Taliban, whose prospects for victory have risen with American stumbling in Afghanistan.
Thirty years after the dollar's nadir, and the near-collapse of America's strategic position, the world's largest nations look at America like an obnoxious, arrogant, but useful partner who has taken to drink and needs to be picked up out of the gutter from time to time. As annoying as it was to live with America, it would be difficult in the extreme to live without it.
The scurrilous fringe of financial journalism likes to speculate as to when China will dump the dollar, without asking the obvious question: what would China do in the absence of the dollar? The billion people who inhabit China's interior are no substitute for the 300 million in the American market. They have a fraction of the purchasing power, they have little access to financial services, they have no credit bureaus to calculate their capacity to carry debt, and they have no means to make liquid their limited assets through mortgage markets. Perhaps over a dozen years of Herculean efforts, the situation might be changed - but that is then, and this is now.
It is commonplace that China would be happy to exchange its $2 trillion of US Treasury securities for the same amount of assets producing food, energy and raw materials. But in a world in which corporate control over raw materials is a highly political matter, it will take many years for China to diversify its portfolio enough to make a difference.
The world not only is stuck with the United States for the time being, but wants to be stuck with the United States. But the Barack Obama administration's attempt to substitute government spending for collapsing consumer spending makes US assets less attractive, while its attempt to diminish America power on dubious ideological grounds forces other countries to act as rivals, unsuited and unwilling as they might be to do so.
That is why options on the end of the US are trading well in the form of the gold price. Gold will have no official role unless America's international role really does collapse, and the world is reduced from a system of trust (or imperial dictates, which amounts to the same thing) to a kind of barter at the international level. That would be a situation much to be abhorred, but it is not to be excluded. The world may need an alternative to the dollar if Obama persists in his present course.
The same characteristic, namely volatility, that makes gold undesirable as a central bank reserve asset makes it a very desirable hedge. What investors seek in a hedge is volatility, that is, very large price movements with respect to the assets to be hedged.
Gold, euro and yen priced in US dollars (Jan 2000 = 100%)
The euro has risen about 40% since January 2000, while gold is up three and a half times. There is no reason for this pattern to reverse. Everyone owns too many dollars; by definition, a problem in the reserve currency means that the whole world is long an asset they no longer want.
But the dollar is so large that nothing can substitute for it. When the pound sterling collapsed under the weight of Britain's debt from two world wars, the huge American economy was there to offer the dollar as a substitute. Professor Robert Mundell, the great economist who won the 1999 Nobel Prize for inventing modern international economics, was the father of the euro. He now is proposing to substitute a basket of currencies for the dollar. But that implies a degree of monetary and political cooperation across countries that post-war Europe was able to achieve but the present world will not. Much as I revere Mundell, I do not think his present plan is practical.
Unfortunately, the world will gyrate between the dollar, the reserve currency everyone has but doesn't want, and options on the end of the world. It is quite possible that gold will continue to rise, even if the price level in the US falls as measured by the CPI.
We are in the first deflation since the Great Depression, albeit a mild one. In fact, raw materials prices have fallen just as far, but our consumption basket has shifted to items whose prices are slower to deflate.
Note that the great deflation of 1929-1933 was followed by a brief increase in inflation (to a 5% year-on-year CPI gain) before falling back into negative numbers. This was the result of president Franklin D Roosevelt's devaluation of the dollar against gold, from $20.67 to $35 an ounce (a level that held until August 1971 when president Richard Nixon again devalued the dollar). That the effects of the dollar devaluation were quite temporary is evident from the chart.
Year-on-year change in US CPI, 1929-1939
The dollar may fall further against other currencies, but it cannot fall too much further. At one euro buying 1.42 US dollars, or one Australian dollar to 0.85 US cents, or one US dollar to 1.08 Canadian dollars, the weak US currency creates painful strains on other economies. But the price of an option on an eventual replacement for the dollar has no natural ceiling. The gold price can go as high as it wants to without provoking economic disruptions of any kind.
Gold, moreover, can keep rising even while the dollar stabilizes against other currencies, or the price level falls. In a service-based economy, most of the measured price level depends on the price of labor. Americans are likely to work more cheaply than ever before. To begin with, the cost of living has fallen dramatically for American workers because the cost of owning a home has fallen. In many parts of the country, the combination of lower home prices and lower mortgage rates has reduced the single-largest item in the household budget by more than half.
To have actual inflation, someone has to take cash and buy goods rather than (for example) securities. If everyone hypothetically wanted to buy securities rather than goods, prices of goods would crash. China will be exchanging securities for goods to the extent it can, but Americans will eschew goods in favor of securities.
An aging population increases its purchases of securities and decreases its purchases of goods as it saves for retirement. Americans have saved nothing for the past 10 years, and the capital gains that they considered savings-substitutes have vanished. That means that an enormous savings deficit accumulated over more than a decade has been exposed, and that Americans must attempt to correct it quickly and under the worst of circumstances. Americans will work more, spend less, and save more. America may have the worst of both worlds: currency devaluation and price deflation, as in the 1930s.
The rate of return on American assets will continue to grind lower under this scenario. If the deterioration of the dollar's attractiveness is matched by additional strategic blunders, it is possible to envision a collapse of the dollar's reserve role within a five- or 10-year horizon. I recommended gold in my "Inner Workings" blog on July 3, and continue to believe that it offers a useful hedge against the worst prospective consequences of the Obama administration's mistakes.
Gold's price volatility since January 2000 (the standard deviation of the daily price divided by the average) is 45%, almost triple that of the US dollar-euro exchange rate. In a functioning world financial system, in which investors trust governments to control extreme instability, even an indifferently managed reserve
currency with a broad capital market behind it is better than gold.
US$ price volatility, January 2000 to August 2009
Gold Euro Yen
Standard Deviation/Average 45% 17% 8%
Strictly speaking, gold isn't an investment but an insurance policy against a breakdown of the functioning of the world financial system. In particular, it represents insurance against the breakdown of the political understandings that make possible a world financial system. That is why gold reached its all-time peak (in inflation-adjusted) terms at the end of 1979, when the Soviet Union invaded Afghanistan.
Divided by the US Consumer Price Index (CPI), the price of gold trades at half its 1979 peak, when the world had cause to believe that America would lose the Cold War. American diplomats still were hostage to the Iranian Revolutionary Guards Corps in Tehran; a rescue operation had failed ignominiously; the overall state of America's military was weaker than at any time since World War II; and the European consensus held that the North Atlantic Treaty Organization would break up. Russia's move into Afghanistan seemed like the penultimate blow to American power. If America ceased to be the leader of the free world, the dollar also would cease to be the world's reserve currency. The cost of options on America's funeral - for that is what the gold price was - went through the ceiling.
America's position in the world today is far less subject to challenge than it was in those dark days at the end of the Jimmy Carter administration. The US has stuck its hand into the meatgrinder in every venue it visits, but unlike 1979, no hostile power lurks along the road to exploit American weakness.
On the contrary: most of the world (China and India in particular) would prefer that America enhance rather than diminish its world role. The last thing China wants to do, for example, is to have to suppress Islamist insurgencies inspired by Washington's newfound interest in engaging the Muslim world. The last thing India wants to do is to sort out a Pakistan dominated by the Taliban, whose prospects for victory have risen with American stumbling in Afghanistan.
Thirty years after the dollar's nadir, and the near-collapse of America's strategic position, the world's largest nations look at America like an obnoxious, arrogant, but useful partner who has taken to drink and needs to be picked up out of the gutter from time to time. As annoying as it was to live with America, it would be difficult in the extreme to live without it.
The scurrilous fringe of financial journalism likes to speculate as to when China will dump the dollar, without asking the obvious question: what would China do in the absence of the dollar? The billion people who inhabit China's interior are no substitute for the 300 million in the American market. They have a fraction of the purchasing power, they have little access to financial services, they have no credit bureaus to calculate their capacity to carry debt, and they have no means to make liquid their limited assets through mortgage markets. Perhaps over a dozen years of Herculean efforts, the situation might be changed - but that is then, and this is now.
It is commonplace that China would be happy to exchange its $2 trillion of US Treasury securities for the same amount of assets producing food, energy and raw materials. But in a world in which corporate control over raw materials is a highly political matter, it will take many years for China to diversify its portfolio enough to make a difference.
The world not only is stuck with the United States for the time being, but wants to be stuck with the United States. But the Barack Obama administration's attempt to substitute government spending for collapsing consumer spending makes US assets less attractive, while its attempt to diminish America power on dubious ideological grounds forces other countries to act as rivals, unsuited and unwilling as they might be to do so.
That is why options on the end of the US are trading well in the form of the gold price. Gold will have no official role unless America's international role really does collapse, and the world is reduced from a system of trust (or imperial dictates, which amounts to the same thing) to a kind of barter at the international level. That would be a situation much to be abhorred, but it is not to be excluded. The world may need an alternative to the dollar if Obama persists in his present course.
The same characteristic, namely volatility, that makes gold undesirable as a central bank reserve asset makes it a very desirable hedge. What investors seek in a hedge is volatility, that is, very large price movements with respect to the assets to be hedged.
Gold, euro and yen priced in US dollars (Jan 2000 = 100%)
The euro has risen about 40% since January 2000, while gold is up three and a half times. There is no reason for this pattern to reverse. Everyone owns too many dollars; by definition, a problem in the reserve currency means that the whole world is long an asset they no longer want.
But the dollar is so large that nothing can substitute for it. When the pound sterling collapsed under the weight of Britain's debt from two world wars, the huge American economy was there to offer the dollar as a substitute. Professor Robert Mundell, the great economist who won the 1999 Nobel Prize for inventing modern international economics, was the father of the euro. He now is proposing to substitute a basket of currencies for the dollar. But that implies a degree of monetary and political cooperation across countries that post-war Europe was able to achieve but the present world will not. Much as I revere Mundell, I do not think his present plan is practical.
Unfortunately, the world will gyrate between the dollar, the reserve currency everyone has but doesn't want, and options on the end of the world. It is quite possible that gold will continue to rise, even if the price level in the US falls as measured by the CPI.
We are in the first deflation since the Great Depression, albeit a mild one. In fact, raw materials prices have fallen just as far, but our consumption basket has shifted to items whose prices are slower to deflate.
Note that the great deflation of 1929-1933 was followed by a brief increase in inflation (to a 5% year-on-year CPI gain) before falling back into negative numbers. This was the result of president Franklin D Roosevelt's devaluation of the dollar against gold, from $20.67 to $35 an ounce (a level that held until August 1971 when president Richard Nixon again devalued the dollar). That the effects of the dollar devaluation were quite temporary is evident from the chart.
Year-on-year change in US CPI, 1929-1939
The dollar may fall further against other currencies, but it cannot fall too much further. At one euro buying 1.42 US dollars, or one Australian dollar to 0.85 US cents, or one US dollar to 1.08 Canadian dollars, the weak US currency creates painful strains on other economies. But the price of an option on an eventual replacement for the dollar has no natural ceiling. The gold price can go as high as it wants to without provoking economic disruptions of any kind.
Gold, moreover, can keep rising even while the dollar stabilizes against other currencies, or the price level falls. In a service-based economy, most of the measured price level depends on the price of labor. Americans are likely to work more cheaply than ever before. To begin with, the cost of living has fallen dramatically for American workers because the cost of owning a home has fallen. In many parts of the country, the combination of lower home prices and lower mortgage rates has reduced the single-largest item in the household budget by more than half.
To have actual inflation, someone has to take cash and buy goods rather than (for example) securities. If everyone hypothetically wanted to buy securities rather than goods, prices of goods would crash. China will be exchanging securities for goods to the extent it can, but Americans will eschew goods in favor of securities.
An aging population increases its purchases of securities and decreases its purchases of goods as it saves for retirement. Americans have saved nothing for the past 10 years, and the capital gains that they considered savings-substitutes have vanished. That means that an enormous savings deficit accumulated over more than a decade has been exposed, and that Americans must attempt to correct it quickly and under the worst of circumstances. Americans will work more, spend less, and save more. America may have the worst of both worlds: currency devaluation and price deflation, as in the 1930s.
The rate of return on American assets will continue to grind lower under this scenario. If the deterioration of the dollar's attractiveness is matched by additional strategic blunders, it is possible to envision a collapse of the dollar's reserve role within a five- or 10-year horizon. I recommended gold in my "Inner Workings" blog on July 3, and continue to believe that it offers a useful hedge against the worst prospective consequences of the Obama administration's mistakes.
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