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Friday, March 14, 2003

US Consumer Confidence Falls Again

This is becoming unrelenting, and there seems no end in sight. I'm worried. I really can smell recession. And look at the PPI, strip out food and energy and prices are still falling. Oh, oh!

The University of Michigan's preliminary March index of consumer sentiment fell for a third straight month, to 75.0, its lowest since October 1992, from 79.9 in February, market sources told Reuters on Friday. That was below expectations for a dip to 77.6. The slide in the index was due primarily to the current conditions index, which suffered an even bigger drop than after the Sept. 11 attacks. It fell to a preliminary reading of 87.1 in March from 95.4 in February, and economists blamed fears about war with Iraq.

The bad news has been relentless recently for households: the labor market shed 308,000 jobs in February while retail sales last month plunged 1.6 percent. Stocks fell close to their October lows before rallying in the past two days. Meanwhile, surging gasoline and other energy prices have pinched incomes. In a sign of consumer spending pull-back, anecdotal reports suggest auto sales may fall for a third straight month in March even as Detroit's automakers leave generous incentives in place. Ford Motor Co. said Thursday it was slashing production 17 percent this year because war worries have cut sales.
Source: Yahoo News

Prices paid to U.S. producers climbed more than expected in February, pushed up by soaring fuel costs, the government said on Friday in a report showing little sign of inflation outside the energy sector. Overall producer prices climbed 1.0 percent, the Labor Department (news - web sites) said, higher than analyst forecasts for a 0.7 percent rise. The number followed a 1.6 percent increase the previous month. But stripping out volatile food and energy costs, prices dropped 0.5 percent, pulled down by falling car, truck and computer prices. Analysts were expecting the so-called core inflation to be unchanged. "No price increases means no inflation and clearly this is a no-inflation report when excluding food and energy," said Timothy Ghriskey, money manager with Ghriskey Capital Partners LLC.
Source: Yahoo News

Schroder Unveils German Reform Package

The Financial Times views this package as bold. I'm not so sure. It's a stick, but where's the carrot? Remember German's are saving and not consuming sufficiently. Promises to cut pensions, while they may be inevitable, are hardly going to change this tendency. It is really time for some imaginative thinking. Perhaps the most revealing part of his speech was the declaration that: "either we modernise, or we will be modernised by the unremitting force of the markets". I need time to think about this. I'll try and blog something more over the weekend.

Gerhard Schröder, the German chancellor, committed his government to a bold programme of reforms in a landmark speech to parliament that went beyond the measures leaked widely in the past week. Mr Schröder told a packed Bundestag that Germany had to adjust its social welfare and health system to straightened circumstances, while the stretched state pensions cover would require further changes to meet the challenges of an ageing population and falling birthrate.

All three areas are currently subject to thorough review procedures. The health ministry is due to produce wide ranging suggestions in May, while a special commission on social welfare and pensions should report by early summer. But it was the chancellor's comments on the labour market that went beyond the cautious steps expected and provoked unease among traditionalists in his Social Democratic party and their trade union backers.

Mr Schröder, as expected, said the government would propose legislation to soften Germany's rigid rules on job protection in an attempt to raise incentives for smaller companies to hire new labour. Compensation procedures for job losses will also be simplified to try to avoid the complex court actions that often accompany dismissals. The chancellor also met expectations of some cuts in unemployment benefit, with a simplification of the current system governing payments to the longer term out of work. Where he surprised observers was in also announcing a significant reduction in the duration of the main unemployment benefit, to 12 or 18 months, depending on the age of the recipient, from a maximum 32 months at present.Mr Schröder also went significantly further than expected in telling workers and employers they should consider ways around Germany's inflexible national pay bargaining system in favour of one-off local level arrangements in special circumstances.
Source: Financial Times

The Economist Backs Fed Rate Cut

There is nothing I suppose unusual in this. What is more interesting is that they cite the Fed's own paper to prod the Fed. Equally you could cite the Economist's own euro arguments (see two posts down) to say that dropping the dollar another 5% could give a lot more stimulus. Alan Greenspan's job is to play poker, and at the level of to cut, or not to cut another quarter point I guess he's better placed than I am. There is no clear 'good' decision available here. My feeling is that the closer we get to zero the more people will get nervous and that this factor can offset any beneficial effect. One rather worrying detail here is the way everyone is quoting the 'Ahearne et al' Fed paper, as if the mantra would itself ward-off any looming deflation. (Really the arguments in this paper have received very little critical examination, which is, in-itself, quite disturbing). Anyway, it's your call Alan.

America's Federal Reserve has to make its decision when its open-market committee meets next week. Some economists argue that, since the present weakness in American confidence and spending is largely due to uncertainty about the consequences of a war with Iraq, it might be better to hold fire for now and see what the economy looks like once the conflict is over. If the war goes well and the economy rebounds afterwards, an interest-rate cut may be unnecessary. Even if the economy remains weak, they argue, a rate cut then will be more effective than it would be now, when it is likely to be swamped by dismal headlines about war. With interest rates already as low as 1.25%, the Fed should save its ammunition.

This argument is wrong, for two reasons. First, at a time of heightened uncertainty, it is wiser to take out an insurance policy against a future deep downturn. If a rate cut proves unnecessary, the cost of reversing it would be small. On the other hand, if the American economy remains weak, valuable time will have been gained in giving it an extra boost. When the world economy is groaning with spare capacity, there is little risk that any excessive easing of policy might send prices soaring. A greater risk is of deflation, not inflation. The lesson of Japan's failure to arrest deflation after its bubble burst in the early 1990s is that, as interest rates approach zero and the risk of deflation rises, a central bank should cut rather sooner than it might otherwise. Once deflation sets in, monetary policy can do little to pull an economy out of a slump. A second argument is that today's weak demand is not entirely due to worries about war with Iraq in any case. A large part of it reflects the fact that households and companies are only halfway through purging the excesses of the bubble years. Even without any fallout from a war, the economy is in need of some help.
Source: The Economist

Is the Bubble Finally Purged

For the Economist at least, it seems that it isn't. Far from it, and once the war issue is resolved there will still be plenty to think about. Including having a US centric global economy in which the US itself is light on saving, and where the US consumer lives thanks to a continuing inflow of foreign funds to pay the deficit and from the rising value of their homes.

To a large extent the fate of the rich economies rests on America. Stephen Roach, chief economist at Morgan Stanley, reckons that America accounted for two-thirds of total global growth since 1995. If the American economy now stumbles again, neither Europe nor Japan look ready to take over as an engine of growth. The biggest is that the economic excesses created by the greatest financial bubble in history have still not been fully purged. Ed McKelvey, an economist at Goldman Sachs, argues that the main reason why private-sector spending is weak is that households and companies are still trying to correct the huge deficits that they ran up during the stockmarket bubble.

America's private sector was a net saver for 40 years until 1997: the total income of households and firms always exceeded their spending, with average net saving of 2.6% of GDP. But the irrational exuberance of the late 1990s encouraged a massive boom in spending and borrowing, pushing the private sector into a deficit of 5.2% of GDP by 2000. In the year to the third quarter (the latest period for which data are available), the private sector was still in deficit, to the tune of 1.4% of GDP. In other words, says Mr McKelvey, the private sector is only halfway back to its long-term average rate of net saving of 2.6% of GDP.

Firms have done much to cut costs and restore the health of their balance sheets, but they have further to go. In the early stages of a recovery, the corporate sector usually runs a small financial surplus, investing less than cashflow. But America's companies continue to run a deficit. Worse still, profits have remained feeble. Ian Harwood, chief economist of Dresdner Kleinwort Wasserstein, estimates that profits across the whole economy, as measured in the national accounts, fell again in the fourth quarter of last year—the third quarter in a row of decline after a brief recovery. This may explain why firms are still cutting jobs.

American households have done even less to repair their balance sheets. Personal savings rose from 2% of disposable income in 2000 to 4% in the fourth quarter of 2002. But Mr McKelvey reckons that the appropriate saving rate, given the decline in households' total net worth as share prices have fallen, is somewhere in the 6-10% range. The main reason why households have been able to postpone their adjustment is their ability to borrow—and so spend—against the rising value of their homes. But that extra cash could soon run out: even if property prices stay high and mortgage rates stay low, the scope for home-equity withdrawal will decline. Households will then have to tighten their belts. This, in turn, implies that America's growth rate could remain below potential for some time, regardless of what happens in Iraq.
Source: The Economist

Euro Zone Monetary Conditions Have in Fact Tightened

This unusual point is made by the economist. The rise in the trade weighted value of the euro is in fact equivalent to a 0.5% rate increase.

Since the ECB cut interest rates in December, the euro's trade-weighted value has risen by 6%, equivalent in terms of its impact on inflation to a rise in interest rates of more than half a point. Policy has, in effect, tightened this year, even though the economic outlook has deteriorated; and the euro area's core inflation rate (excluding food, energy and tobacco) has dropped below 2%. Fiscal policy has also tightened slightly because of the straitjacket imposed by the stability pact, which is forcing Germany to increase taxes in the midst of recession. Tighter fiscal policy increases the case for monetary easing.
Source: The Economist

Unless We Slide into Japan Style Deflation....

I'm afraid my thoughts coudn't be more distant from those expressed by Paul Krugman this week. Of course I find the way the US deficit is ballooning scary, and of course I think the Bush administration isn't thinking clearly about the future, but I can't buy the 'inflation scare' argument. Of course, Paul is intelligent and he adds the 'caveat emptor' get-out clause, "unless we slide into a Japan style deflation". But that's just the point, that seems to be exactly where we are heading. And, unless I got something badly wrong, isn't he suggesting inflation targeting as a protection from Japan's malaise? And Paul is far too good an economist not to know that if you stoke up 4% inflation, then you don't know where this will take you. Our 'fine tuning' isn't that fine you know.

Running out of base points is not the same thing as running out of ideas. One swallow doesn't make a summer, and one Fed paper - even a good one - doesn't mean we've understood Japan. The real lesson from Japan is that thinking economics exclusively in terms of monetary/fiscal mix, like love in a time of cholera, simply isn't enough. Fortunately we do have science, but only if we are willing to climb out of the box, learn to think critically and try to understand what is happening. My feeling is that institutional and structural factors need more attention than they are getting. We could also put some historical time (rather than abstract state space) back into economics. Be that as it may, this is neither the time nor the place to develop such points.

Unfortunately fiscal bankruptcy does not necessarily imply inflation. Recourse to text books doesn't help here, since they all carry those 'ceteris paribus', 'buyer beware' stickers. Because if other things are not equal.........

And they aren't. For the trillionth time, when were we last looking at these demographics? National Income it will be remembered is commonly assumed to be a function of capital and labour, and capital formation stands in some relation to the saving habits of those who are working. So if the proportion of people working in any society goes down (and of course the proportion of those who are dependent goes up), shouldn't we expect that fact in itself to produce changes in things like national productivity and national income. Lets put this another way: isn't it probable that there will be some unpleasant consequences associated with the unwinding of that most beneficial of beneficial phenomena, the ninetees 'participation squeeze'. How far this goes all depends on what kind of vicious circle we manage to get ourselves backed into.

For what it's worth my hunch is that inflation has something to do with forward-looking growth expectations and liquidity constraints. What does this mean? Take growth in Japan and the US 1960 to 1985. GDP went up at the rates of 5.2% and 2.5% per annum respectively. Under these conditions a 25 year old Japanese citizen could expect to be 12.5 times richer (in terms of lifetime earnings) than his or her 75 year old grandparent, while a 25 year old American would only expect to be 2.8 times richer than the grandparent. Small differences in growth expectations create big differences in lifetime earnings expectations. Obviously these differences can then be reflected in differing capacities for bringing forward future earnings for consumption now (read borrowing, read liquidity constraints). Our societies are evidently facing a future where the screws of liquidity constraints are definately going to be turned. On the most optimistic expectations growth will slow. But this reduction in growth can then feed back into diminished borrowing and hence even slower consumption (this is one part of what I mean by vicious circle). Then look at the age demographics of consumption. A society with a lot of young people is 'front loaded' in the sense of having many people whose future earnings are multiples higher than their current income stream. An aging society does not have that priviledge, future earnings for a growing part of the population are pretty near to what they are now, or less. Conclusion: where's the inflation push? ( This may seem hopelessly simplistic right now, but just give me time.....)

On the other hand the US and Japan are not Argentina (and even there inflation has been remarkably restrained of late, given everything). In fact Japan's enormous saving's surplus means that the government can benefit from remarkably low interest rates into the indefinite future (the 30 year yield curve is, in fact, flattening out). It would be a rise in interest rates which would precipitate national bankrupcy, that's why no-one in Japan expects inflation any time soon. I don't see in principle why it should be any different in the US. When push comes to shove interest rates are, after all, determined by the supply-of and demand-for savings.

My feeling is that Paul Krugman might well live to regret his fixed interest mortgage decision. (A better decision, as the economist seemed to be recommending, might have been to sell now, pocket the money and rent, but it's just a thought. If deflation really sets in the only asset with a rising value might just be: cash. Certainly the uncertainty level suggests that the smart money now is liquid, but of course isn't that why so many people are meticulously going in the opposite direction and evacuating their bank accounts to sink their hard earned savings in concrete. This puts me in mind of another Paul Krugman, the one sitting in the cheap Pizza diner, watching all those truckers busily following CNN Money). Still, this all goes to show that even the best of economists can make the same mistakes as everyone else. Meanwhile developing a bit of theory to help explain what's going on could prove to be the most useful investment of all.

With war looming, it's time to be prepared. So last week I switched to a fixed-rate mortgage. It means higher monthly payments, but I'm terrified about what will happen to interest rates once financial markets wake up to the implications of skyrocketing budget deficits.

From a fiscal point of view the impending war is a lose-lose proposition. If it goes badly, the resulting mess will be a disaster for the budget. If it goes well, administration officials have made it clear that they will use any bump in the polls to ram through more big tax cuts, which will also be a disaster for the budget. Either way, the tide of red ink will keep on rising.
How will the train wreck play itself out? Maybe a future administration will use butterfly ballots to disenfranchise retirees, making it possible to slash Social Security and Medicare. Or maybe a repentant Rush Limbaugh will lead the drive to raise taxes on the rich. But my prediction is that politicians will eventually be tempted to resolve the crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt.

And as that temptation becomes obvious, interest rates will soar. It won't happen right away. With the economy stalling and the stock market plunging, short-term rates are probably headed down, not up, in the next few months, and mortgage rates may not have hit bottom yet. But unless we slide into Japanese-style deflation, there are much higher interest rates in our future.

I think that the main thing keeping long-term interest rates low right now is cognitive dissonance. Even though the business community is starting to get scared — the ultra-establishment Committee for Economic Development now warns that "a fiscal crisis threatens our future standard of living" — investors still can't believe that the leaders of the United States are acting like the rulers of a banana republic. But I've done the math, and reached my own conclusions — and I've locked in my rate.
Source: New York Times

Thursday, March 13, 2003

Why All the Fuss About Deflation

Deflation is a generalised and sustained fall in prices, with the emphasis on generalised and sustained. At any given time, especially in a low-inflation economy like that of our recent times, prices of some goods and services will be falling. Price declines in a specific sector may occur because productivity is rising and costs are falling more quickly in that sector than elsewhere or because the demand for the output of that sector is weak relative to the demand for other goods and services. Sector-specific price declines, uncomfortable as they may be for producers in that sector, are generally not a problem for the economy as a whole and do not constitute deflation. Deflation per se occurs only when price declines are so widespread that broad-based indexes of prices, such as the consumer price index, register ongoing declines.

The above more-or-less is the now commonly accepted definition of deflation. However worrying about deflation is one thing (all thinking economists are now worried about it). Knowing why it is happening, and having something useful to say about what to do about it is another. We can all get interest rates down to the zero limit, and then start dropping our currencies 1930's style - but will it work, or will we only succeed in going round in circles?

Even while there is a growing consensus that the problem of deflation is real, my feeling is we are quite short on analysis. This was also my initial impression when I read the writings of two deflation stalwarts: Paul Krugman and Steven Roach . Importantissimo as their work is in drawing attention to the problem, too much weight in my view has been placed on the debt deflationary dynamics of the burst bubble, and not enough attention has been paid to getting to grips with why this impact has been so deep, and why it is happening now?

Why, for example, is Japan so ill? Certainly we have the boom-bust cycle story (and thanks a lot to Stephen Roach and Larry Summers for this), but are things really so unstable that you cross over a little white line and bingo, you're stuck. This, incidentally, cuts across all those arguments to the effect that we've actually got better at handling economic and financial problems.And why is today's Japan deflation of the chronic, slow-burn variety, which is very different from the dramatic and acute deflation of the 1930's. Again what is the significance for policy of this difference?

My question then is, is there something more important going off? I personally think so: I tend to use the expression 'phase transition' - or regime switch - to describe this move from an inflationary to a deflationary environment, but it's only a metaphor.

So far, I've come up with three candidates:

Firstly the secular decline in the unit price of INFORMATION (ie not just IT equipment, but eg human genome string etc, for more on this see Kurzweil's exponential over exponential, or law of accelerating returns - another thing some people just don't seem to get).

Secondly the changing demography of the developed countries: aging, changing support ratios, changing patterns of saving and consumption etc. Jeffrey Williamson and Angus Deaton, for example, have some interesting material on the growth of the so called Asian tigers that makes very interesting reading here.

Thirdly the changing structure of international production through globalisation, and in particular the entry of China into the WTO. Again Williamson and O'Rourke show how the opening of the New World changed structurally the European economies and facilitated industrial growth. It is only reasonable to expect that the take-off of China and then India will have similarly dramatic consequences in the twenty first century. These three pointers are only a start, my point of departure for an ongoing investigation. I have set up a page on my website and it is my attention to use this page to take this analysis further, and to continue digging until in Wittgenstein's famous phrase, my spade is turned. Anyone else who's interested is welcome to join me there, and mail me if you have anything interesting to contribute.

Commodity Currencies Up or Down?

This one is for Chris in Australia, who tells me that over there they got of the back of the sheep at the end of the 19th century - but you're still a commodities dependent economy, right. Or do they have it wrong at the FT. And for John in Canada, thanks.

Risk aversion appears to be sapping the strength of the "commodity currencies", which have been among the best-performing of the year. The Australian dollar, which reached a 49-month high of US$0.617 this month, was at US$0.594 on Wednesday while its New Zealand counterpart was at US$0.548, down from a 46-month high at US$0.566. With interest rates at 4.75 per cent in Australia and 5.75 per cent in New Zealand, the currencies had benefited from investor appetite for higher yields but, said Michael Metcalfe at State Street Bank, that is waning. "Our risk appetite indicator has been in risk-neutral territory for seven consecutive days and the correlation between currency performance and yield has turned negative for the first time since September," said Mr Metcalfe, who added that a further rise in risk aversion could send the pair lower still."Judging by their correlation with risk appetite in the past 12 months, the Australian and New Zealand dollars would be the most vulnerable major currencies." Liquidity is also an issue, said HSBC's Marc Chandler. "Some players are apparently concerned that as the prospects of war draw closer, the liquidity in these currencies is likely to suffer and have been inclined to book some substantial profits," he said. "Some of these longs were so extended we'd already have had a pull-back if it wasn't for the war jitters," added Meg Browne, his colleague.The Canadian dollar, also nominally a "commodity currency", tracked the move lower, but analysts believed strong economic fundamentals and expectations of further rate rises would continue to support it.
Source: Financial Times

German Dax Decline now equals that of 1929

The news from global stock markets gets grimmer every day. It is probably going to get worse before it gets better. Which leaves us with the question: how much permanent damage is all this likely to cause?

Another bout of turbulence on world markets Wednesday sent share prices tumbling, at one stage pushing Germany's Dax index down to a level 73 per cent below its peak - a scale of decline last seen in the 1929 crash. War jitters, bad corporate news and rumours surrounding the future of Tony Blair, British prime minister, drove a sell-off across Europe. Some analysts speculated that markets are now approaching the point of "capitulation" - the final stage of a bear market characterised by rapid selling.In London indiscriminate selling sent the FTSE 100 on its seventh biggest daily fall - down 5 per cent to 3,287, its lowest level since April 1995. The dividend yield on the UK equity market has also risen above the yield on benchmark government bonds for the first time since 1957. Frankfurt's Dax index fell 4.9 per cent to 2,192 in early evening trade - its lowest point for seven years. It closed at 2,202.96. In Paris, the CAC index slid 3.6 per cent to another six-year low.
Source: Financial Times

Wednesday, March 12, 2003

Kohler Doing His Best to Talk Up the World Economy

The head of the IMF is trying to talk up the world economy, and I think that's just fine, because I think that's what he is paid for. I mean, imagine if he tried to talk it down. Responsible economists are in a difficult trap between a rock and a hard place. Difficult question: how much reality to they need to inject into their 'promo'?. Well, I simply want to flag the fact now that I don't agree. Yes, I am convinced that the financial markets now are too pessimistic, and, yes, I am convinced that we can see a rebound. But when this is all over, what will we have: a US centric world economy. And as Steven Roach keeps reminding us, it's difficult to see a global economy which is firing on only one cylinder pushing forward a sustained expansion. I'm afraid we're back with Christine Keeler and: he would say that wouldn't he.

The global economic recovery should accelerate once tension over the Middle East has dissipated, the head of the International Monetary Fund said on Tuesday. In one of the IMF's first public comments on the economy since the start of the build-up to war with Iraq, Horst Köhler, the fund's managing director, said that global growth this year should slightly outstrip 2002's 3 per cent rate. Such a projection would be substantially lower than the 3.7 per cent in the IMF's last official forecast in September. But Mr Köhler said the underlying conditions existed for a recovery, including rapid technological progress. "Although we know that full confidence is unlikely to return until the geopolitical tensions have subsided, we must avoid undue pessimism," Mr Köhler told a conference in Madrid. "Despite the series of large shocks in recent years, the global economy and the international financial system have proven remarkably resilient." Financial markets should "bounce back" from their current travails, he said.
Source: Financial Times

US Equities: On the Mend?

Well I think John Snow really should get a Laureate for this one. Since when is it advisable for the US Treasury secretary to call stocks. If he wants the world to believe he really 'supports' a high dollar, then he'd better cut back on the 'I'm sorry they only just showed me my lines' stuff. No self-respecting professional actor would come out with this. I mean, he's seen a number of private sector estimates, doesn't the US Treasury have any competent economists to give him data? And this ignoring the fact that he's probably got the story wrong. Hadn't he better watch out for Eliot Spitzer here. Peter, Paul and Mary had it right a long time ago: when will they ever learn?

U.S. Treasury Secretary John Snow said on Tuesday stock prices could get a significant boost from the Bush administration proposals to stimulate economic activity, especially by eliminating taxes on dividends. Speaking to America's Community Bankers, a banking lobby group, Snow portrayed the proposal to end dividend taxes as a potential major benefit of the $695 billion stimulus program. "It will clearly make our corporations worth more because as the after-tax distribution of the corporations rise, the market will be able to capitalize it," Snow said, adding "I've seen a number of private sector estimates indicating increases from this proposal ... in market equity of 10, 12, 15, 17, as much as 20 percent," Snow said. Snow said the economy is recovering in a halting fashion and needs help to stay on track. "There is some concern now ... that the recovery could weaken and we need an insurance policy against it," Snow said.
Source: Yahoo News

German Pensions Warning

Well the bad news from Germany continues, as it will, I'm afraid, continue. This time it's pensions. When will we learn 1980 - 2000 we were on the virtuous circle. Now we're on the other one, the vicious kind. All the pension numbers go out of the window if economic growth drops near zero. This fall in pensions expectations produces a fall in consumption as people try to save more (the so called Ricardian effect). The decrease in consumption causes a fall in profitability, which causes equity (and hence pension fund values) to fall. All of which reduces economic growth expectations, which reduces pensions expectations, which........

Meantime house prices start to fall, and then we really are mired in it. No, I know it's not that simple. But why, oh why doesn't someone older and wiser than me try to examine this process a bit more rigourously (I think this is a kinda unveiled hint for Paul Krugman). Well everybody: did you enjoy the ride up?

German economic reform efforts will face a further setback on Thursday when its leading pensions association warns that statutory contributions will have to increase sharply to cover a looming gap caused by feeble growth in Europe's biggest economy.The VDR association of statutory pension funds, an advisory body that influences government policy, will say increasing contributions to the state-run pay-as-you-go pension system from 19.5 to 19.9 per cent of gross wages may be unavoidable given the weak economy and high unemployment.

The warning comes as a bruising blow to Gerhardt Schröder, the German chancellor, who will deliver a keynote parliamentary speech on Friday aimed at reducing the non-wage labour costs borne by employers. An increase in pension contributions, shared by employers and employees, would further push up costs, increasing the competitive pressures on the economy. An increase of 0.4 percentage points is equivalent to €3.5bn. Any increase in pension costs will also fuel tensions between Mr Schröder's Social Democrats and the Greens, the junior coalition partners. Green opposition to the increase to 19.5 per cent last year was overruled. The forecast of higher costs came as the opposition Christian Democrats threatened to withhold crucial support for Mr Schröder's reforms unless he used Friday's speech to present a far-reaching "master plan" for recovery. Mr Schröder has promised a package of labour market and social security reforms. He said last night the measures would involve "sacrifices by many people".
Source: Financial Times

Tuesday, March 11, 2003

Housing: On Bubble Business Bound

Does the current housing market constitute another case of bubbleitis. This week it's the turn of the Economist to worry. They look at all sides of the argument, and as usual these days stay firmly on the fence. Certainly the evidence for the existence of a bubble is unclear. Three cases, however, do stand out: the UK, Spain and Australia. Others like the US, Italy, Sweden and France are less obvious, really we will only know with hindsight. But the connection with the peak in stock market values is evident. With the equity collapse and low interest rates all round, second homes or more expensive first homes have become for many a safe haven source of saving or investment. True in the past house prices have not fallen subsequently as much as equity prices. But in the past housing was not converted so feverishly into a financial instrument. It's important to note that it's a lot quicker to get your money quickly out of the bank than it is out of concrete.

Many argue that the increased values only reflect the reduced repayments. This is also true, but a lot depends on the future direction of general prices. If we are making a transition from an inflationary to a deflationary envirnoment then this will have importance for the way these increased repayments may or may not be sweat off. If there is no inflation to reduce the real capital value of the debt, and wages and prices are sticky but downward bound, then those increased premium payments are going to weigh heavy on all those newly indebted young people, who will it should be remembered be paying for all those extra pensions coming on line. A sticky situation all round.

America's boom is already slowing: the average price of a home rose by 7% in the year to December, compared with an 11% gain during 2001. In the fourth quarter prices rose at an annual rate of only 3.3%, the slowest since 1997. However, according to The Economist's global house-price indicators, markets in many other countries continue to bubble merrily. (We launched these indices a year ago, and plan to update them every six months.)

Australia, Britain, Ireland and Spain all saw double-digit increases in house prices in 2002. House-price inflation rose in eight of the 13 countries covered in the year to the fourth quarter, but fell in five. Prices fell in Germany and Japan, which have yet to recover from the bursting of property bubbles in the 1990s. In both countries prices are lower than in 1995.

Britain, Ireland and the Netherlands have seen average annual price rises of more than 10% since 1995 (chart 2). But the Dutch bubble is now bursting: prices fell late last year. House prices are also falling in London, if not yet in the rest of Britain. The Irish housing market, which saw a brief fall in prices in 2001, has taken off again. The average Irish home now costs three times as much as in 1995.

The commonest argument for why house prices are not overvalued is that low interest rates allow people to borrow more, so they are willing to pay more for their homes. But is it possible to work out some sort of fundamental value of a home? Edward Leamer, an economist at the University of California in Los Angeles, argues that the price of a house, like that of any other asset, should reflect its future income stream. Just as analysts and investors seemed to believe during the dotcom boom that the link between share prices and profits was irrelevant, people today may have forgotten the link between house prices and the rental income that can be earned if homes are let.
Mr Leamer argues that a price/earnings (p/e) ratio can be calculated for houses, as for shares, by dividing average house prices by average rents. John Krainer, an economist at the Federal Reserve Bank of San Francisco, has calculated this ratio for America's housing market, covering the past two decades. He uses an index of average house prices and the imputed rent paid by owner-occupiers that goes into the consumer-price index. As home prices have outpaced rents, the p/e ratio has soared

Mr Krainer estimates that house prices would have to fall by 11% to bring the ratio back to its long-run average. In contrast, the p/e ratio for America's S&P 500 stockmarket index suggested in early 2000 that share prices needed to fall by more than 50%. Alternatively, if house prices instead remain constant and rents grow at their average pace of 4% a year, the ratio would revert to its long-term average by the end of 2005, with no need for a price decline. Mr Krainer concludes that, nationally, American house prices are not dramatically out of line with rental values. But there are two caveats. First, after a boom the housing p/e ratio usually undershoots. That implies either a bigger fall in prices or a longer period of stagnation. Second, it may be too optimistic to assume that rents will rise by 4% a year.
Source: The Economist

Possible Fed Cut on the Horizon?

Rumourology is at work again. Does last Friday's disappointing US employment data, and the rapidly deteriorating global economic and geopolitical environment mean the Fed might just contemplate another cut this week? Your guess is as good as mine, but Roach has been emphasising that the Fed has assimilated the cut early and cut often lesson from the Japanese experience. So maybe they just might. After all, things are getting to look pretty dark out there.

The Federal Reserve (news - web sites) may soon be forced to cut interest rates again, driving them to the lowest level since Dwight Eisenhower was president, amid fears that the shaky economy is about to fall back into recession. Concerns about the anemic recovery from the 2001 downturn were heightened with last week's report that unemployment had risen to 5.8 percent in February, with a big loss of 308,000 jobs. "Prior to the unemployment report, we thought the Fed would stay on hold for some months to come and the next move would be a rate hike, not a rate cut," Louis Crandall, chief economist at Wrightson ICAP, a bond market research firm, said Monday. Now, Crandall said, he is forecasting a quarter-point rate cut at the March 18 Fed meeting.
Source: Yahoo News

Can China Learn From Japan's Mistakes?

This is the timely question being asked today by Stanford's Ronald McKinnon. Along with Stephen Roach, Andy Xie and the rest of the Morgan Stanley set McKinnon has one clear message: hold out against Rinban Revaluation.

These days, even the most casual shopper must be impressed by the number of made-in-China labels on clothes, bicycles, toys and electronic gadgets. China is the only truly booming part of the world economy. But this surge in exports has provoked complaints in the older industrial economies that Chinese goods are too cheap.

China's burgeoning trade surpluses have been linked to its fixed exchange rate. The renminbi has been stable at 8.3 to the dollar since 1994. Many economists and commentators have suggested that the Chinese currency should now be allowed to strengthen; then, once China cleans up its banks, liberalises its financial markets and scraps its exchange controls on capital movements, the renminbi should be allowed to float - presumably upwards.

One has only to look at the history of the postwar Japanese economy to realise that this is bad advice.From the 1960s to the mid-1990s, the rapid expansion of Japanese exports of steel, cars, machine tools and semi- conductors - culminating in large net trade surpluses - upset European and US industrialists. The angst was even greater among western trade unionists. Trade disputes were usually resolved by Japan's formally agreeing to "voluntary" restraints on the export of such goods and an implicit agreement to let the yen appreciate. Indeed, until Robert Rubin announced America's strong dollar policy in April 1995, US Treasury secretaries and influential pundits used to hector the Japanese to let the yen strengthen. And the yen rose - albeit erratically - from 360 to the dollar in 1971 to about 116 today.

This massive appreciation failed to eliminate Japan's trade surpluses, which simply reflect its higher propensity to save. In 2002, Japan and China both had "surplus saving" of 2 to 3 per cent of their gross national product, while the US has a current account deficit of 5 per cent of GNP. In open economies, the ongoing current account surplus is determined by a nation's net saving propensity, not by exchange rate changes. The exchange rate eventually determines domestic inflation or deflation. Thus the strengthening of the yen during the 1980s and 1990s imposed deflationary pressure on Japan's slumping economy, while forcing nominal interest rates towards zero.
Source: Financial Times

Multi Year Lows All round

The equity market carnage continues, with no apparent respite in sight. If this continues any length of time watch out for the German banks and other financial institutions:

World markets took fright on Monday as investors realised that the countdown to a war in Iraq had begun. European equities tumbled to levels not seen since the mid-1990s and bond yields slipped to their lowest point for 50 years as investors sought the haven of government debt.Wall Street was under pressure on the third anniversary of the Nasdaq composite’s peak during the dotcom boom. The Nasdaq market has lost 75 per cent of its value since the internet bubble days and closed 2 per cent lower on Monday.

The Dow Jones Industrial Average closed down 2.2 per cent to a five-month low. While war fears are driving the market lower, investors are also concerned about the prospects for economic growth and poor US unemployment figures last week continue to weigh on sentiment. Economic concerns put pressure on the dollar, which was close to a four-year low against the euro. Oil prices continued their recent rise, with April Brent crude at its highest point since the 1991 Gulf war - $34.33 a barrel. Oil futures on Nymex reached $38 a barrel. In Japan, the Nikkei 225 average fell to its lowest point for 20 years as the yen strengthened to a six-month high of Y116 to the dollar. Japanese retail investors have been buying precious metals as a haven and on Monday pushed the platinum price to a 23-year high of $707 per ounce.Two-year German government bond yields fell to a record low of 2.2 per cent and two-year US Treasury yields again touched the record lows set last week of 1.36 per cent. In global equity markets, investors either sat on their hands or piled into bonds. London’s FTSE100 index fell to 3,436 its lowest level since June 1995. Germany’s Dax index fell to a seven-year low as record losses by Deutsche Telekom forced the market down further.
Source: Financial Times

More Fuel for the Pensions Fire

We all know it's coming, but we try not to think about it. The 'it' in question this time: the looming pensions crisis.This week it's the turn of the European Financial Services Round Table, an entity which represents such institutional lynchpins as Deutsche Bank, ABN-Amro, Axa and Barclays, to enter the fray by writing to European leaders urging them to speed up the creation of a single market in financial services to try to help solve the European pensions problem. Of course whether these estimates are in any way realistic, and whether private pension plans, depending as they normally do on equity values, offer any security or solution, this is another matter. (See my arguments: eg here).

Europeans need to save an extra €456bn (£315bn) a year to preserve the level of retirement benefits while holding down the cost of public pensions, Europe’s leading financial services companies claim. Pehr Gyllenhammar, chairman of the Round Table and of Aviva, the UK’s largest insurer, said: “This is a call for very urgent action. If European governments deliberately want to erode the livelihood of 377m and more people because they dare not touch the pensions bomb, that is not responsible behaviour.” European Union government figures show that if policies remain unchanged, the cost of state pensions in the EU is expected to rise from 10.4 per cent of gross domestic product in 2000 to 13.6 per cent by 2040.

For its estimate, the Round Table supposed that the cost to the state in each EU country were capped at its 2000 share of GDP, but pensioners were still to receive the same level of benefits. Based on the current best projections, private savings for the next four decades would have to be 456bn a year higher - about 5 per cent of the EU’s GDP in 2002. The greatest need for increased savings is in France, which according to the Round Table needs an extra €137bn a year. Mr Gyllenhammar said making personal pensions portable within the EU, opening national markets to competition and allowing greater economies of scale were essential to encourage private saving. The Round Table calculates that the European fund management industry could save 10bn a year in administration if the average EU fund was were as large as the average US fund. The attempt to create a single market in financial services has been seen as one of the relatively successful elements of the economic reform programme that the EU committed itself to at the Lisbon summit in 2000. Of the 42 measures in the financial services action plan, 32 have so far been signed off. But Mr Gyllenhammar said progress had been slow, with the directives only rarely translated into genuinely open markets.
Source: Financial Times

Monday, March 10, 2003

To Monetise or Not to Monetise, That is not the Question

Curious how almost everyone who's anyone in New York or Washington thinks that the Japanese problem has a monetary solution, while almost everyone who's anyone in Tokyo disagrees. This time it's the turn of Morgan Stanley's Robert Alan Feldman.

Is it too late for Japan? The monetization is now complete along the yield curve. European investors ....worry that Germany might be the next Japan, or that somewhere else might be the next Japan. In particular, criticism has been targeted at the Fed and ECB for not moving aggressively enough in the face of deflation potential. Japan is cited as the example of what not to do, for example, in a paper by the Federal Reserve (“Preventing Deflation: Lessons from Japan’s Experience in the 1990s,” by Ahearne et al., June 2002). Although I agree that Japan has provided some examples of what other countries should not do (just as have European and North American economies at times), the contention that monetary policy was the key failure is, in my view, absurd. Rather, the key omission was an aggressive approach to structural reform in both financial and industrial sectors.

So we get back to the debate on what monetary policy should do. For those who think that ending deflation simply means lowering rates a lot and/or printing a lot of money, Japan’s experience should toll a warning bell. Base money is up by 80% since 1997, while deflation has continued. Even monetarists in Japan now agree that the collapse of money velocity cannot stop without structural reform. Moreover, the Weimar experience suggests that rapid money printing will not end the troubles of the Japanese economy. Even in less dramatic contexts, no one has ever argued that high inflation improves resource allocation -- even if it removes bank debt at the expense of creditors. On the contrary, capital flight is the natural result of such an approach, in the wake of which both confidence and real investment collapse.

I agree with my colleagues that it is necessary for the ECB and the Fed to move aggressively, in order to prevent deflation. Where my approach differs is on the question of whether monetary aggressiveness is sufficient. Easy money was NOT sufficient for Japan to avoid deflation. Structural policies were necessary too. In my view, the real lesson from Japan will be learned only when both Europe and the United States focus on the heavy, political issues of dealing with structural impediments to resource re-allocation in their own economies.
Source: Morgan Stanley Global Economic Forum

A Dismal Science for a Dismal World: Into the Twilight Zone

Phew, difficult stuff to stomach this, definitely adult reading: but I wish I could fault the reasoning:

As the world moves on a slow-motion collision course with war, the wheels of commerce are grinding to a standstill. Financial markets sense the angst and are hunkering down for the duration. Of course, we’re all trained to look beyond the shock -- to focus more on upside of the postwar climate than on the downside of a prewar paralysis. Yet it seems tougher than ever to make that leap of faith. That’s because this war could either end the uncertainty or compound it. It’s as if we’re caught in the twilight zone between two worlds -- hopeful of a return to a familiar equilibrium but fearful of the pitfalls of a new disequilibrium. That lingering uncertainty is not exactly a comforting outcome for financial markets.
Source: Morgan Stanley Global Economic Forum

China's Impact Felt Across Asia

A good piece of journalism this from Alan Wheatley, Reuters Asian economics correspondant. Strong on fact and analysis. All the main points are covered, China is not just about China, but is about global impacts. First and most deeply affected are the Asian economies. China is not responsible for deflation and rinban revaluation is not the answer, China is importing as much as it is exporting, so China is as important as a source of demand as well as supply. The main lesson is that Asia ex-China needs a new identity strategy. And after Asia the rest of the developing world.

A few days into the new year, the workers of local electronics maker Unico learned the hard way about the brute force of China's industrial revolution. The Malaysian firm had been providing computer motherboards to chip giant Intel Corp, which runs a big assembly plant just down the road, when a Chinese rival grabbed the contract by offering to do the job for about half the price. At a stroke, half of Unico's 1,600 work force was laid off. "We make very good products -- high quality, fast delivery. Unfortunately, China's running a lot cheaper than us. That's the name of the game," said Alex Soon, Unico's chief financial officer. It's a game that's being played at breakneck speed across Asia. Hardly a day goes by without a company announcing plans to open a plant in China to tap into the country's unbeatably low labor costs and fast-growing market of 1.3 billion consumers. For all the dislocations that China's emergence as the workshop of the world is causing, people in Penang at least show remarkably little bitterness toward their neighbor to the North. "We were in the same position in the '70s as China is today," said K. Veeriah, the Penang secretary of the Malaysian Trades Union Congress. "We've come full circle. A lot of people don't understand the impact that China is going to have over the next five years, but I don't think there's any resentment."

Indeed, if China's rivals respond nimbly by developing new skills, they should be able to carve out niches in higher-margin industries where China cannot compete and take advantage of rising Chinese demand for tourism, health and education services. Last week, U.S.-based computer hard disk drive maker Maxtor Corp flagged job losses among its Singapore work force of 8,000 once a $115 million plant it plans to build in the Chinese city of Suzhou comes on stream in 2005. But a day earlier Mandarin Oriental Hotel Group said it planned a second upscale hotel in Hong Kong to cater to the growing number of visitors from mainland China. China already has a voracious appetite for energy, commodities, raw materials and equipment to feed its industrial machine, leading Jim Walker, chief economist at CLSA Emerging Markets, to call it the golden goose of the global economy.

Japan believes China has an unfair advantage by artificially holding down its yuan currency, which is pegged at around 8.28 per dollar, and wants a revaluation that would curb its exports and thus boost Japan's own sluggish, export-dependent economy. But Walker argues that would kill the China goose: cutting China's export income would reduce its demand for imports. "What we would all rather have -- a moribund but competitive Japan or a competitive and dynamic China? The question is rhetorical because the answer is so obvious," Walker said. "China is on the move and it is a massive benefit for everyone in the global economy," he said in a note to clients. Jun Ma of Deutsche Bank agreed. He calculates that China accounted for 65 percent of total world import growth in 2002. By 2006 Ma expects China to be consuming more than 20 percent of the world's production of steel, copper and aluminum on its way to becoming the world's second-largest economy -- it is now No. 6 -- by 2017.

Another fear stoked by the competitive pricing that cost Unico its Intel contract is that China is exporting deflation. Most economists take the view that a generalized fall in prices is caused by inadequate demand in an economy and say it is a fallacy that China is driving down prices across the globe. Yes, the price of manufactured goods is dropping, but the prices of palm oil and many industrial commodities are soaring. "China contributes both inflation and deflation to the world market, depending on the labor intensity of the sectors in question," Ma said in a report. "The net China impact on aggregate world prices is very mild." That's cold comfort for businessmen in Penang, who say a growing array of imported Chinese consumer goods sell in the shops for less than it costs to make similar products locally. "How are we going to compete with that? It's a dangerous trend," said Cheah See Kian, who runs a business manufacturing traditional Chinese medicines. Textbooks say Penang should respond by abandoning low-margin manufacturing and move into more sophisticated and lucrative sectors such as design and development. This is in fact already happening, but given a local skills shortage and China's own ambitions to clamber up the value-added ladder, officials know the transition will be tough. Foreign direct investment into Malaysia is being lured away by China, fanning fears that the broad industrial base that Penang has built over the past generation will be hollowed out. "All the textiles, the plastics, the commodity stuff will all leave, just like they did from the U.S. 20-30 years ago and from Singapore in the last 10 years. So Malaysia is facing it 30 years later -- it's not a surprise," Soon, the Unico executive, said.

Indeed, rather than taking China head-on in manufacturing, some economists think Southeast Asian countries should play to their strengths and focus on natural resources and tourism. "That's a more realistic option, if you ask me, than to keep saying we are going to compete with China in manufacturing at the high end, because China is moving fast into the high end as well," said Toh Kin Woon, the Penang state executive councilor for economic planning. But Daniel Lian, an economist with Morgan Stanley in Singapore, has his doubts. In 2002, manufactured exports from Malaysia, Singapore, Thailand, Indonesia and the Philippines accounted for 54 percent of the five countries' combined gross domestic product of $566 billion. Lian estimates that $90 billion of these exports, or 30 percent of the total, will be lost to China within a decade, while annual receipts from a Chinese-fueled tourism boom cannot realistically exceed $20 billion to $25 billion. "Tourism cannot replace manufacturing," he said in a report. Maintaining -- let alone raising -- living standards during what Morgan Stanley calls "The Chinese Decade" will thus tax policy makers in the rest of Asia to the limit. Reforms to clean up failed banks, improve education and allocate capital better will become more important than ever. "The wave has been and gone. The manufacturing boom is over, for Southeast Asia at least," said Boonler Somchit, executive director of the Penang Skills Development Center. "China can only grow. We grow old. We are no longer the courted maidens."
Source: reuters News

Another Monster Turns in a Monster Loss

This time it is the turn of Deutsche Telekom to go breaking all the numbers records. This is one European Champions league no-one is especially keen on winning.

Deutsche Telekom, Germany's leading telecommunications operator, on Monday reported Europe's biggest ever annual corporate loss but reported that business had improved in the fourth quarter. For 2002 the company posted a net loss of €24.6bn ($27.1bn), in-line with analysts expectations, largely due to write-downs on assets bought during the telecom and dot.com booms and charges totalling €19.3bn. It is the third time in just a week that the European loss-making title has changed hands, after France Telecom and Vivendi both unveiled 2002 losses of more than €20bn.
Source: Financial Times

Japan: Let the Fiddler Play On

More on divining the entrails in Japan. Much recent western comment has been mildly optimistic on the possibility of serious change and reform in Japan. Japanese commentators meanwhile, when not actually banging their heads against the wall, seem to spend most of their time tearing their hair out. This piece from the Asahi Shinbun's Senior Staff writer is pretty typical. If they're even halway right it looks like the best we can hope for is more fudge. It seems Duisenberg isn't the only one to be busy fiddling while the empire burns.

British writer Thomas Carlyle, who lived in the same period as Karl Marx, called economics ``dismal science.'' The epithet may well apply to the current economic debate on deflation in Japan. One gets the impression that the nation's economy is going nowhere. The underlying problem seems to be a policy stasis that stems from the inability of policy-makers to draw up a unified blueprint for action. The sense of paralysis was evident at the symposium held last month at the Finance Ministry under the theme: Challenges for Japan's Economy-Deflation and Economic Policy. Symbolic of the policy paralysis is the standoff between the government and the Bank of Japan over ways of beating deflation. Government officials feel this way: ``We are taking steps such as tax cuts. Now it's the BOJ's turn to follow up.'' But central bank officials are deeply suspicious of the government. Their feeling is: ``We could be left holding the bag trying to generate inflation.''The discord came to a head at the symposium, creating acrimony among the participants. Academic panelists demanded that the BOJ change its monetary policy, but some in the audience-politicians and BOJ people-reacted sharply, saying it is wrong to blame only the central bank for inaction. A truce of sorts was called when University of Tokyo professor Hiroshi Yoshikawa, a panelist and a member of the government's Council on Economic and Fiscal Policy, said, ``The important thing is for the government and the Bank of Japan to put together a unified package of measures to remove uncertainties over the future.''

The question is specifically what kind of anti-deflation program should be worked out. If it turns out to be a hodgepodge of halfway measures, the economic situation will become gloomier still. For example, a mere increase in public works investment-a prime example of distorted resources allocation and wasteful spending-would only make things worse. On the other hand, aggressive measures focused on generating inflation could end up creating ``stagflation''-a combination of recession and inflation. What is needed is a bold plan of action-namely, a forward-looking, reform-oriented program to fix deflation. Reform means dismantling the ``construction state''-the bloated system of public works projects-and increasing investment in other areas such as environment, welfare and education. Along these lines, utmost efforts should be made to foster industries of high growth potential and create new jobs.
Source: Asahi Shinbun

Japan: Which Side Are You ON?

I'm posting this piece from Morgan Stanley's Takehiro Sato since, apart from anything else, it is a hoot. Trying to make sense of what happens in Japan is difficult at the best of times, but when a market oriented party starts to socialise the economy, and the ex-communists begin to demand market based measures, well, I think we move from the world of the sublime to that of the ridiculous. Sato - to steal a phrase from Brad Delong - certainly seems to be 'banging his head against the wall' here. I hope it isn't too painful.

Let’s look at recent remarks by an opposition party official regarding the Industrial Revitalization Corporation of Japan (IRCJ): “The plan put forward by the government calls for dividing bank lending that has concern for recoverability into two categories, with the genuinely bad loan going to the RCC and other watch list loan being handled by the IRCJ. Yet banks should be responsible for the job of lending. In this plan, however, the government-owned corporation will be assuming the responsibility of banks and shouldering the credit risk and then using public capital to cover losses if companies fail, instead of the banks. Rather, banks should be doing the job of industrial revitalization. It does not seem appropriate for such a special public corporation to take on this role.”

Before proceeding, it should be noted that I personally am not a supporter of this party and have no intention of giving it a boost. The party’s core principles call for liberation from the exploitation of capitalism and construction of a planned economy through socializing the means of production. What is stated here, however, is mostly correct regardless of the party’s ideology.

It is rather confusing in Japan that the right-wing “conservative” party is pressing for revision of the national constitution, while the left-wing “reformist” party wants to leave the current constitution intact, for example. We find a similarly ironic contradiction in the party that stands for “liberalism” relying on government control in both macro and micro policy, while the socialist party fights for market principles and resists the takeover of excessively indebted companies by such a government-owned entity. Currently, a conservative to center-right coalition cabinet backs a socialistic economy despite the prime minister’s resolution, while left-wing opposition parties criticize these policies, therefore calling for a market mechanism. Such a distorted situation came to be a normal state of affairs, and the PM has aptly acknowledged that Japan has a socialistic economy along the lines of the former Soviet Union and East Germany.

The IRCJ runs the risk of being transformed into a holding ground for excessively indebted companies and classic example of socialistic policy, if political interference were to be allowed. Likewise, policymakers seek to prevent as much as possible an expansion of social inequalities from a hard-landing scenario. Furthermore, the core capitalistic concept of “profit-making” is seen to be nearly rejected, perhaps from some manifestation of Confucian mentality, which makes the groundwork for oriental ethics.

The most obvious example is banks. There have been policies that effectively reject profit-making by this sector through the Revitalization program which was aimed for the increase of lending to comparatively risky borrowers such as small and medium enterprises. Also, public opinion takes an extremely harsh view of bank profiting. In this sense, I have asserted that Japan’s banking business has been converted into a non-profit organization (NPO).
Source: Morgan Stanley Global Economic Forum

Fitch Twitchy on EU banks and Derivatives

I can hardly believe it, but for once I seem to find myself on the same side of the ball park as Warren Buffet, and on the opposite side to Alan Greenspan. Buffet is worried about financial derivatives, Greenspan says that the use of derivatives, obligations derived from debt and equity securities, commodities and currencies, is a positive factor which has "significantly improved the flexibility of economies," Just to put the issue in perspective, the market for derivatives traded outside exchanges ( measured by the value of underlying assets) grew 15 percent, to a record 128 trillion dollars in the first half of 2002 according to the latest figures from the Bank for International Settlements. That is more than 10 times the value of the United States gross domestic product. So we are not talking small beer here. The big preoccupation is the way the value of derivatives can fluctuate more than the value of the underlying asset to which they are attached. Buffet, as is his way, is theatrical with his 'financail weapons of mass destructions' comment. Still, I think one this one needs watching just in case something does happen, and so do Fitch.

European regional banks have taken on a lot more risk than their public accounts show because of heavy exposure to credit derivatives, according to new research. Three-quarters of the European banks surveyed in a report by Fitch, the credit rating agency, have sold about €50bn of credit protection to other parties.Half of these banks were German, with the state-owned Landesbanken being particularly active. They have increased their exposure to high-yielding derivatives to offset flagging profits in traditional lending businesses. Fitch says it may cut the credit rating on banks with large exposures to credit derivatives. The Fitch report follows last week's warning from Warren Buffett, the influential US investor, that derivatives represented "financial weapons of mass destruction" and are "potentially lethal" to the economic system. Fitch said the European banks' exposure to credit derivatives was surprising because banks typically buy credit protection to reduce risk. Institutions that sell protection on a bond or loan using a credit derivative assume the underlying credit risk of the security. Although European banks are net buyers of protection, with about €65bn purchased, the bulk of the buying has been undertaken by a few large institutions. Only 30 per cent of European banks active in the credit derivatives market are protection buyers. Fitch has spent three months trying to quantify financial institutions' exposure to credit derivatives but has been only partially successful. Some institutions have refused to disclose information about their derivative activities."We need more financial transparency," said Roger Merritt, Fitch analyst and co-author of the report, to be released today.
Source: Financial Times

Sunday, March 09, 2003

Nikkei Heading on Down?

If there is one thing I have learnt in following the Japanese economy closely over the last couple of years it is that, as far as Japan is concerned, you should take everything with a big pinch of salt. Still, the Nikkei is at a twenty year low, that is real and that is a fact. This week Forbes suggests it could fall below the 8,000 level, and that with year-end book-balancing in sight. They also mention a figure, 7,500, below which the capital adequacy ratios of the Japanese banks would be threatened. I remember it was just six months ago we were talking of going below 10,000 as being critical, but it wasn't. In all of this one thing is clear. The numbers, except for those relating to bad loans and government debt, continue to get smaller. One day a critical point will be reached and we'll have blow out. When exactly that day will finally come neither I nor any other commentator can tell you. The big danger is that the yawn, yawn, plus ça change effect in Japan might mean that when it actually does come we won't be expecting it. In all of this just be sure that, absent a major and unforeseeable change of trajectory, that day will come, and that the consequences for the global economy will be enormous.

Tokyo stocks could plumb new 20-year lows this week as war worries and a host of domestic factors discourage buyers. Analysts said the Nikkei average could drop below 8,000, a key support level, after falling 2.62 percent last week to 8,144.12 -- its lowest close since March 1983. "Investor appetite has dried up, so I won't be surprised if the Nikkei falls below the 8,000 mark," said Reiko Nakayama, head of the investment strategy division at Marusan Securities. Some investors may look for bargains early in the week, but the market's longer-term prospects are clouded by the prospect of a trade-disrupting war on Iraq, worries about North Korea's missile and nuclear programmes, and a weak economic outlook......Analysts said the Nikkei is likely to move between 7,800 and 8,350 this week. The further prices fall, the more Japanese banks and private pension funds are expected to dump shares in the run-up to the end of the fiscal year on March 31.

With only three weeks to go before year-end book-closings for most Japanese companies, the drop in share prices is bad news for banks, which are saddled with mountains of bad loans, as lower valuations on their stock holdings will erode their capital.

Analysts say many banks' capital adequacy ratios -- a key gauge of financial health -- could fall below the eight percent global requirement if the Nikkei approaches 7,500. At Friday's close, combined unrealised stock losses at the top seven banking groups stood at around 5.84 trillion yen ($50 billion), according to Daiwa Institute of Research. Investors are also concerned about the ability of Prime Minister Junichiro Koizumi to deal with any financial crisis.Friday's arrest of Takanori Sakai, a member of the ruling Liberal Democratic Party, was the latest of a series of political scandals to embarrass reformist Koizumi, whose popularity is fading ahead of nationwide local elections in April. Sakai is alleged to have breached political funding laws.
Source: Forbes