Unscrupulous Hucksterism

Commenting on the recent golbal settlement between Wall Street regulators and analysts, the New york Times, in an editorial, muses the adequacy of the agreed punishment to the acknowledged crime. Irrespective of your verdict on this one, it's impossible not to be struck by their conclusion that prosecutor Spitzer's determined efforts have at least served an educational purpose since "investors are now on notice that unscrupulous hucksterism is a part of any frenetic bull market". Unfortunately this, I fear, is to miss the point. During any bear market the "unscrupulous hucksterism" of the bull market is all too apparent, but it's during the bull market itself that it's hard to see. Any bull market bubble will have its attendent "irrational exuberance", that's what defines it as a bubble. The analysts were, after all, only telling the people what they wanted to hear, and if they had offered a different message it probably wouldn't have been heeded. Bottom line: any agreed regulations will work perfectly during the bear, but will be surprisingly ineffective next time we go up. Anyone who doesn't believe this should try asking house buyers in the UK, or here in Spain, what they think of the research reports which say property is currently greatly overvalued and warn that a correction is in the pipeline.

The cleanup crew showed up at the New York Stock Exchange yesterday to tackle the debris left over from Wall Street's dot-com binge — the tainted research, the rigged initial public offerings and all the rest of it. Marshaled by Eliot Spitzer, New York State's attorney general, a raft of regulators announced a global settlement with 10 major Wall Street firms that stand accused of duping investors. The firms will pay close to $1 billion in fines, and have agreed to alter their behavior.

The settlement should prove beneficial to investors. The firms agreed to insulate their research analysts from their investment-banking operations. No longer will analysts be permitted to help land underwriting deals, or to have their compensation tied to these efforts. Greater disclosure will be required of analysts' past performance, and firms will pay hundreds of millions of dollars, beyond their fines, to subsidize independent, third-party research that will be shared with their retail clients. Firms are also barred now from allocating I.P.O. shares to executives of client companies.

Critics who feel such sums are paltry compared with the billions that banks made peddling overvalued stocks can take comfort in the fact that a record of findings to be released next month as part of the settlement could prove valuable to the dozens of class-action lawsuits the banks still face.
Source: New York Times
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German Doldrums

Two pieces of news from Germany this morning which may be more related than they appear at first sight. The first is the decision of the country's highest court to strike down the new landmark immigration law after procedural objections by the opposition.The ruling by the federal constitutional court means the law, simplifying and modernising Germany's complex immigration rules to allow greater access for well qualified candidates from outside the European Union, will not come into effect on January 1 as planned. The second is the fact that German business confidence deteriorated for the seventh month running in December (although it did show signs it might start to pick up again soon). The Ifo economic institute on Wednesday said that its business climate index fell to 87.1 this month from 87.3 in November. Now while these two items are clearly not related in the sense that there is any evident causal mechanism which links them, German business men and women do have good reason to lack confidence in a population which is now in natural decline (ie live births are now less than deaths) and which repeatedly demonstrates its inability to open itself to the world:

The constitutional court upheld the argument of six opposition-governed states that last March's controversial Bundesrat immigration vote was invalid. The case stemmed from differences between the government and opposition regarding the treatment of the decisive vote cast by Brandenburg, a state run by a "grand coalition" of the CDU and the Social Democratic party (SPD).The ruling came against a background of wage strikes by public-sector workers and followed the government's embarrassing need this week to offer the CDU extensive concessions to ensure support for its ambitious job placement and labour market reforms
Mr Schröder's difficulties were further underlined on Wednesday with the latest Ifo index of business confidence, showing its seventh consecutive monthly fall. Separately, a new opinion poll revealed that Mr Schröder's SPD was trailing the opposition by 21 percentage points.
Source: Financial TimesLINK

A Future Without McDonalds, The Food Your Father Ate

In yet another illustration of the fact that everything that lives was born to die, McDonalds turned-in its first loss in history yesterday. McDonald's Corp. informed the world of its first-ever quarterly loss after a package of cutting jobs and closing outlets failed to bring the numbers back into line, while sales at the world's largest restaurant deteriorated in the saturated U.S. fast-food market. The hamburger maker's shares fell 8 percent to close at $15.99 on the New York Stock Exchange, down $1.39. In fact yesterday the stock was the most actively traded issue on the NYSE, touching at one stage $15.59, its lowest level in nearly eight years. The background to all this is a change in the U.S. fast-food market which has become increasingly competitive as McDonald's hamburger rivals Burger King Corp. and Wendy's International struggle to maintain market share while consumer tastes change and other fast-food options - such as sandwich chain Panera Bread - emerge. All this goes to show that in a world of dynamic competition, nothing lasts forever. With other big name outfits like Disney also hit this year, it is clear that something of a cultural sea change is taking place. How long should we give Levi's and Coca Cola?

McDonald's, based in Oak Brook, Illinois, has been testing other concepts, including pizza and Mexican-food chains, while Wendy's has relied on its Canadian doughnut chain to help drive growth. Yum has been pushing aggressively into overseas markets such as China. So far in the fourth quarter, McDonald's sales at stores open at least 13 months are down 1.6 percent before the effects of foreign exchange, the company said in an updated earnings outlook. Same-store sales in the United States, McDonald's largest market, fell 1.3 percent in October and November and 1.5 percent through the first 11 months of the year, a sign that the company's new discounting strategy is not meeting expectations, analysts said. "It's clear that the discounting program is not working," said Bear Stearns analyst Joe Buckley, referring to the "Dollar Menu" McDonald's recently launched to drive up sales. "To improve service is very important for them, I think that's kind of the short-term key." Incoming CEO Jim Cantalupo, former vice chairman and president, is in the process of "aggressively reviewing" all aspects of the restaurant company's operations with an eye on improving financial performance.
Source: Reuters News
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Some Thoughts on Stephen Roach and Paul Krugman

While it's 'full marks' to both Krugman and Roach for having focused all our attention on the complex problems attendant on the collapse of the internet boom and the bursting of the stock market bubble, I still can't convince myself that the analysis isn't missing something. Both of them have, correctly in my view, stressed heavily the point that bubble-unwinding takes us into territory which is outside the pattern of the 'normal' business cycle as we have come to know it since the 1970's. In particular this is a result of the negative credit dynamics which follow the unwinding, a dynamic process which makes investment much more expensive for the corporate sector and hence, as a consequence, growth much slower. It is this 'sluggish' growth which brings the danger of deflation nearer as rapid productivity improvement puts downward pressure on prices. Hence our economies as they say 'are subject to downside risks'.

The latest piece of evidence Roach cites to back his thesis are the just-released minutes of the early-November Federal Open Markets Committee meeting. For him there is little question about what the Fed is really up to: they are preparing the fire brigade ready for action. In the Fed's own words : "…a faltering economic performance would increase the odds of a cumulatively weakening economy and possibly even attendant deflation. An effort to offset such a development, should it appear to be materializing, would present difficult policy implementation problems."

However I cannot help feeling that there is something missing in this story. As I have said before, it is rather like staging Hamlet without the Prince. In the present case offering a projection of our current problems and future prospects absent the principal actor: the demographic transition.

I’ve been bearish for so long, they’ve removed the "plus key" from my laptop. I am still of the view that the risks to this US-centric global economy remain decidedly on the downside of consensus expectations. I also believe that there’s more to come on the deflation watch. But this once heretical view has now caught the attention of policy makers around the world. They have jumped on the anti-deflation bandwagon as never before.

America’s Federal Reserve has led the way. The Fed has clearly gotten religion on the deflation watch. The first inklings of this conversion were evident in the form of a seemingly obscure staff research paper published by the Federal Reserve Board last June (see A. Ahearne, et. al., "Preventing Deflation: Lessons from Japan’s Experience in the 1990s," International Finance Discussion Papers, No. 729, June 2002).

I have long felt that the Fed was laying the groundwork at the time for an anti-deflationary assault in the United States (see my 15 July 2002 dispatch, "Asymmetrical Risks" in the Global Economic Forum). And that’s exactly what has happened. The Fed threw down the gauntlet, with its larger than expected 50-basis-point monetary easing on 6 November. The ink was barely dry on the policy statement of that action, when Chairman Alan Greenspan went public on the deflation debate in front of the US Congress. That was followed by a seminal speech by newly installed Governor Ben Bernanke, which dispelled any lingering doubts over the Fed’s concerns over deflation (see his 21 November remarks before the National Economists Club, "Deflation: Make Sure ‘It’ Doesn’t Happen Here").
Source: Morgan Stanley Golbal Economic Forum
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The problem is that as we empty all our conventional armoury of ammunition - interest rates steadily draw nearer to zero, and fiscal policy looks increasingly problematic as outstanding obligations to ageing populations make debt-related spending a non-starter for any protracted period - the only remedy which seems to be left is exchange rate policy (unless your're in the Euro zone that is, because there even that is a non-starter). But even a mathematical non-genius can see that if we all try to come down at once it won't work. And, hey, doesn't this smell awfully like those 1930's style competitive devaluations which seemed to do so much harm, and which all the post 1945 financial and monetary architecture was supposed to stop. Well guess what, we're back in the land of Keynes, a land where looming indebtedness seems to be about to throw an enormous brake switch on our collective growth capacity, and we haven't even realised it's happening, yet. Well Keynes was always unorthodox, so I've got one 'New Keynesian' proposal which might help start the ball rolling. How about an international 'Bretton Woods' style conference on population and international migration?

Japan About to Try to Lower the Yen

Signals coming out of Japan, difficult as they are to read at times, seem to indicate that a change in exchange rate policy may be imminent. On Mondayprime minister Junichiro Koizumi added his voice to a growing body of evidence that his government, which regards the yen's rise as reflecting external weaknesses rather than any significant improvement in its own economy, would welcome a currency depreciation. He said the new governor of the Bank of Japan should support an aggressive anti-deflation policy. Mr Koizumi must choose a new BoJ governor by March. Since Japan has all but exhausted the possibilities of fiscal and monetary policy a substantial depreciation of the yen remains one of the few policy options open to the government.

A senior official warned on Monday that Japan would take decisive action against rapid fluctuations of the yen, reflecting growing concern that economic recovery is being stifled by a strengthening of the currency. The signal from Toshiro Muto, vice-finance minister, of possible intervention came on the same day that the Nikkei average notched up its longest losing streak in 11 years, with yen-sensitive exporters particularly heavy casualties. On Friday, the yen rose to a one-month high against the dollar at ¥120.3, and was hovering around ¥120.6 on Monday, prompting investors to unload shares of Japan's biggest exporters, including Sony and Canon. The Nikkei average lost 0.8 per cent to 8,450.94, its first nine-day losing streak since September 1991.
Source: Financial Times
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Europe Groping for an Identity?

Last week's EU enlargement agreement has been hailed as historic by some, and as a lost opportunity by others. Whatever decision is finally passed by history one thing seems sure, this is an important turning point. Among other changes, the Euro zone countries will now be a minority within the EU. In redrawing the map of Europe, the 15 men whose countries represent one of the world's most important and exclusive clubs tore down one border only to build another. The summit formally invited 10 new members, most with dysfunctional economies, to join the European Union by 2004, thereby expanding eastward into territories whose future economic and political development is far from clear. At the same time they rejected Turkey's demand that its candidacy be given more urgency, erecting a wall that is sure to be seen by the mostly Muslim country of 67 million people — and by the rest of the Muslim world — as a division between the Christian West and the Islamic East. The Europeans rejected a plea from Turkey to set a date for starting talks on its eventual admission. The response from within Turkey itself was predictable. The front page of one Turkish newspaper - Hurriyet - was illustrated with da Vinci's "Last Supper". Below figured the question, "Will the E.U., like Christ's last supper, be purely for Christians or will there be a Muslim at the table?"

My feeling on these decisions is that on the one hand the enlargement programme is far more problematic than is normally recognised, while on the other a great opportunity has been missed. But the Europeans are getting old, and old is not normally synonymous with bold. The newly admitted countries are not a re-run of the Spain, Portugal, Greece expansion of an earlier era. The new countries do not have the demographic 'gift' that lay before the mediterranean countries at the time of their entry. They are mainly economies which have barely survived the transition shock from the old centrally-planned type. They are ageing societies whose birth rates have long been among Europe's lowest, where women - of all ages - have long since been out of the home working. If they do not face the negative debt dynamics of the other EU countries, then this is only because they have assumed only minimal responsibility for the welfare of their aged, and thus the anticipated costs of ageing are lower. But this is not exactly good news. It means, among other things, that we are extremely unlikely to see an expansion of internal consumption 'mediterranean-style', but rather an increase in decrepitude, misery and dispair.

Turkey's stuation could not be more different. Turkey is going through a 'demographic transition' and birth rates are steadily falling towards that magic number: 2.1 live births per woman of childbearing age. But they have not got there yet, and Turkey's young population - nearly 30% of the 70 million population are under 15, compared to an average of only 15 % in the new entrants - could give EU consumption growth a much needed boost. But while the economic arguments for an early accession date for Turkey are compelling, the political and cultural ones should be decisive. Turkey has a human rights problem, sure. But there is an internal battle inside Turkey over this, and bringing the Turks into dialogue with the Union would give important aid to the pro-democratic, pro-human rights forces that exist there. In addition, moving Turkey's dossier forward would give the world another, and even more imporant, message about Europe's cultural identity. It would give a message about diversity and openness, a message of hope for that enormous majority among the islamic populations of the world who have no more sympathy for the Bin Laden's of this world than we do.

European politicians wave away talk of a clash of religions or of blocking Turkey to control immigration and insist that their decision was based on standards of democracy and human rights, and on controlling immigration and terrorism. With the decisions here, the European Union has given itself the thankless task of defining Europe, a task that has baffled scholars and politicians for centuries. "Geographical Europe," wrote Norman Davies in "Europe: A History," "has always had to compete with notions of Europe as a cultural community, and in the absence of common political structures, European civilization could only be determined by cultural criteria." Jean Monnet, the visionary advocate not just of economic union but of an eventual United States of Europe, took the extreme position in the immediate years after World War II, writing, "Europe has never existed; one has genuinely to create Europe." His way of doing so was to bring together that part of geographical Europe that was democratic into a common unit by knitting its economies together. The aim was that politics would follow. Now, the European Union is embarked on the task of adapting that vision to a very different political landscape. Even as it struggles to create political, economic, social and even military institutions to serve its current members, it has been challenged by events to enlarge itself — and is faced with the question of what other societies might fit in.
Source: New York Times
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