Highlights:
| China GDP growth to ease to 10.5 percent |
Yes, but…
| Property prices in major Chinese cities up 10.5% in December |
| Yuan Gains for the Sixth Week, Its Longest Rising Streak in Seven Months |
| Local authorities urged to make interim price control plans |
| Banks show record figures |
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Dollar weak enough to support exports:
NYC hits tourism record
by Samantha Gross
NEW YORK (AP) – With a falling dollar sweetening the deal for international travelers, a record-setting number of tourists visited
the city last year, spending an estimated $28 billion, tourism officials said Sunday.
With a final count still pending, the city’s tourism office said an estimated 46 million people had visited the city in 2007 — up 5
percent from 2006. The jump was largely due to visitors from other countries, who numbered an estimated 8.5 million — a growth of 17 percent.
George Fertitta, chief executive of city tourism office NYC & Company, said the visitors were drawn by more than a favorable exchange rate and the city’s international marketing efforts.
“The city is more vibrant, cleaner and safer — and it’s just more exciting than ever before,” he said.
The portion of the city’s tourists who were from other countries had dwindled since the Sept. 11 attacks, and last year’s growth returned the ratio to pre-2001 levels.
The city has been working to draw such international visitors, who stay longer and spend more money. NYC & Company has launched an overseas television, print and billboard campaign, and in 2007 it more than doubled its marketing offices overseas, targeting countries including China, Brazil and Canada.
New York is one of only a few U.S. urban centers that did not see a drop in the number of overseas visitors between 2000 and 2006.
Mayor Michael Bloomberg has said he wants the city to attract 50 million travelers each year by 2015. Last year, visitors to New York spent $4 billion more than they had the year before.
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U.S. Trade Deficit Hits 14-Month High on Oil Imports
by Reed Saxon
The U.S. trade deficit in November surged to the highest level in 14 months, reflecting record imports of foreign oil. The deficit with China declined slightly while the weak dollar boosted exports to another record high.
The Commerce Department reported that the trade deficit, the gap between imports and exports, jumped by 9.3 percent, to $63.1 billion. The imbalance was much larger than the $60 billion that had been expected.
The increase was driven by a 16.3 percent surge in America’s foreign oil bill, which climbed to an all-time high of $34.4 billion as the per barrel price of imported crude reached new records. With oil prices last week touching $100 per barrel, analysts are forecasting higher oil bills in future months.
The big surge in oil pushed total imports of goods and services up by 3 percent to a record $205.4 billion. Exports also set another record, rising by a smaller 0.4 percent to $142.3 billion. Export demand has been growing significantly over the past two years as U.S. manufacturers and farmers have gotten a boost from a weaker dollar against many other currencies. That makes U.S. goods cheaper on overseas markets.
Exports still moving up.
Through the first 11 months of 2007, the deficit is running at an annual rate of $709.1 billion, down 6.5 percent from last year’s all-time high of $758.5 billion. Analysts believe that the export boom will finally result in a drop in the trade deficit in 2007 after it set consecutive records for five years.
Agreed. Ultimately, the only way the foreign sector can slow their accumulation of $US, as the falling $ indicates they are in the process of doing, is to spend it here.
The growth in exports has been a major factor cushioning the blow to the economy from the slump in housing and a severe credit crunch. However, with oil pushing imports up sharply, analysts believe the help from trade in the final three months of last year will be shown to have been significantly smaller.
Could be. December numbers will not be out for another month.
By country, the deficit with Canada, America’s largest trading partner, dropped by 12.1 percent to $4.7 billion in November while the imbalance with Mexico rose by 1.4 percent to $7.6 billion. The imbalance with the European Union fell by 12.6 percent to $10.4 billion.
Might explain some weakness in Canada and Eurozone.
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It makes political sense to use export taxes as a form of a domestic subsidy for basic necessities, and from a macro economic
point of view, it a good way to express the political desire as well.
A negative is this will give domestic producers an incentive to ‘cheat’ to avoid the tax. Enforcement costs depend on they type of borders, etc.
It also puts downward pressure on the currency, though very modestly in this case, as it now takes more fx to buy the same products.
China – Passing higher food prices to Asia
Barclays Capital Research
by Wai Ho Leong
Tax on food grain exports comes shortly after subsidies removed.
In a further attempt to rein in food price inflation, China will introduce a one-year tax on grain exports beginning in January 2008. This will require exporters of 57 types of food grains to pay temporary taxes of 5-25%. Exporters of wheat, rye, barley and oats will be required to pay a 20% tax, while exporters of corn, rice and soy beans will have to pay 5%. Soaring food prices (+18% Y/Y in November), which have a 33% weight in the CPI, drove inflation to an 11-year high of 6.9% in November. The tax applies only to basic food grains. Other agricultural and processed products are not included, reflecting the government’s continued emphasis on promoting higher-value-added agricultural exports.
This latest administrative measure comes less than two weeks after China scrapped a 13% rebate on 84 types of exported food grains on 18 December. Prices have been rising, even though government reserves of corn and wheat were opened up earlier this year to meet domestic demand. The administrative measures taken in China will compound these pressures further, particularly in North Asian countries.
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A Rescue Plan for the Dollar
By Ronald McKinnon and Steve H. Hanke
The Wall Street Journal, December 27, 2007
Central banks ended the year with a spectacular injection of liquidity to lubricate the economy. On Dec. 18, the European Central Bank alone pumped $502 billion — 130% of Switzerland’s annual GDP — into the credit markets.
Misleading. It’s about price, not quantity. For all practical purposes, no net euros are involved.
I have yet to read anything by anyone in the financial press that shows a working knowledge of monetary operations and reserve accounting.
The central bankers also signaled that they will continue pumping “as long as necessary.” This delivered plenty of seasonal cheer to bankers who will be able to sweep dud loans and related impaired assets under the rug — temporarily.
Nor does this sweep anything under any rug. Banks continue to own the same assets and have the same risks of default on their loans. And, as always, the central bank, as monopoly supplier of net reserves, sets the cost of funds for the banking system.
The causation is ‘loans create deposits’, and lending is not reserve constrained. The CB sets the interest rate – the price of funding – but quantity of loans advanced grows endogenously as a function of demand at the given interest rate by credit worthy borrowers.
But the injection of all this liquidity coincided with a spat of troubling inflation news.
At least he didn’t say ’caused’.
On a year-over-year basis, the consumer-price and producer-price indexes for November jumped to 4.3% and 7.2%, respectively. Even the Federal Reserve’s favorite backward-looking inflation gauge — the so-called core price index for personal consumption expenditures — has increased by 2.2% over the year, piercing the Fed’s 2% inflation ceiling.
Yes!
Contrary to what the inflation doves have been telling us, inflation and inflation expectations are not well contained. The dollar’s sinking exchange value signaled long ago that monetary policy was too loose, and that inflation would eventually rear its ugly head.
The fed either does not agree or does not care. Hard to say which.
This, of course, hasn’t bothered the mercantilists in Washington, who have rejoiced as the dollar has shed almost 30% of its value against the euro over the past five years. For them, a maxi-revaluation of the Chinese renminbi against the dollar, and an unpegging of other currencies linked to the dollar, would be the ultimate prize.
Mercantilism is a fixed fx policy/notion, designed to build fx reserves. Under the gold standard it was a policy designed to accumulate gold, for example. With the current floating fx policy, it is inapplicable.
As the mercantilists see it, a decimated dollar would work wonders for the U.S. trade deficit. This is bad economics and even worse politics. In open economies, ongoing trade imbalances are all about net saving propensities,
Yes!!!
not changes in exchange rates. Large trade deficits have been around since the 1980s without being discernibly affected by fluctuations in the dollar’s exchange rate.
So what should be done? It’s time for the Bush administration to put some teeth in its “strong” dollar rhetoric by encouraging a coordinated, joint intervention by leading central banks to strengthen and put a floor under the U.S. dollar — as they have in the past during occasional bouts of undue dollar weakness. A stronger, more stable dollar will ensure that it retains its pre-eminent position as the world’s reserve, intervention and invoicing currency.
Why do we care about that?
It will also provide an anchor for inflation expectations, something the Fed is anxiously searching for.
Ah yes, the all important inflation expectations.
Mainstream models are relative value stories. The ‘price’ is only a numeraire; so, there is nothing to explain why any one particular ‘price level’ comes from or goes to, apart from expectations theory.
They don’t recognize the currency itself is a public monopoly and that ultimately the price level is a function of prices paid by the government when it spends. (See ‘Soft Currency Economics‘)
The current weakness in the dollar is cyclical. The housing downturn prompted the Fed to cut interest rates on dollar assets by a full percentage point since August — perhaps too much. Normally, the dollar would recover when growth picks up again and monetary policy tightens. But foreign-exchange markets — like those for common stocks and house prices — can suffer from irrational exuberance and bandwagon effects that lead to overshooting. This is precisely why the dollar has been under siege.
Seems to me it is portfolio shifts away from the $US. While these are limited, today’s portfolios are larger than ever and can take quite a while to run their course.
If the U.S. government truly believes that a strong stable dollar is sustainable in the long run, it should intervene in the near term to strengthen the dollar.
Borrow euros and spend them on $US??? Not my first choice!
But there’s a catch. Under the normal operation of the world dollar standard which has prevailed since 1945, the U.S. government maintains open capital markets and generally remains passive in foreign-exchange markets, while other governments intervene more or less often to influence their exchange rates.
True, though I would not call that a ‘catch’.
Today, outside of a few countries in Eastern Europe linked to the euro, countries in Asia, Latin America, and much of Africa and the Middle East use the dollar as their common intervention or “key” currency. Thus they avoid targeting their exchange rates at cross purposes and minimize political acrimony. For example, if the Korean central bank dampened its currency’s appreciation by buying yen and selling won, the higher yen would greatly upset the Japanese who are already on the cusp of deflation — and they would be even more upset if China also intervened in yen.
True.
Instead, the dollar should be kept as the common intervention currency by other countries, and it would be unwise and perhaps futile for the U.S. to intervene unilaterally against one or more foreign currencies to support the dollar. This would run counter to the accepted modus operandi of the post-World War II dollar standard, a standard that has been a great boon to the U.S. and world economies.
‘Should’??? I like my reason better – borrow fx to sell more often than not sets you up for a serious blow up down the road.
The timing for joint intervention couldn’t be better. America’s most important trading partners have expressed angst over the dollar’s decline. The president of the European Central Bank (ECB), Jean Claude Trichet, has expressed concern about the “brutal” movements in the dollar-euro exchange rate.
Yes, but the ECB is categorically against buying $US, as building $US reserves would be taken as the $US ‘backing’ the euro. This is ideologically unacceptable. The euro is conceived to be a ‘stand alone’ currency to ultimately serve as the world’s currency, not the other way around.
Japan’s new Prime Minister, Yasuo Fukuda, has worried in public about the rising yen pushing Japan back into deflation.
Yes, but it is still relatively weak and in the middle of its multi-year range verses the $US.
The surge in the Canadian “petro dollar” is upsetting manufacturers in Ontario and Quebec. OPEC is studying the possibility of invoicing oil in something other than the dollar.
In a market economy, the currency you ‘invoice’ in is of no consequence. What counts are portfolio choices.
And China’s premier, Wen Jiabao, recently complained that the falling dollar was inflicting big losses on the massive credits China has extended to the U.S.
Propaganda. Its inflation that evidences real losses.
If the ECB, the Bank of Japan, the Bank of Canada, the Bank of England and so on, were to take the initiative, the U.S. would be wise to cooperate. Joint intervention on this scale would avoid intervening at cross-purposes. Also, official interventions are much more effective when all the relevant central banks are involved because markets receive a much stronger signal that national governments have made a credible commitment.
And this all assumes the fed cares about inflation. It might not. It might be a ‘beggar thy neighbor’ policy where the fed is trying to steal aggregate demand from abroad and help the financial sector inflate its way out of debt.
That is what the markets are assuming when they price in another 75 in Fed Funds cuts over the next few quarters. The January fed meeting will be telling.
While they probably do ultimately care about inflation, they have yet to take any action to show it. And markets will not believe talk, just action.
This brings us to China, and all the misplaced concern over its exchange rate. Given the need to make a strong-dollar policy credible, it is perverse to bash the one country that has done the most to prevent a dollar free fall. China’s massive interventions to buy dollars have curbed a sharp dollar depreciation against the renminbi;
Yes, as part of their plan to be the world’s slaves – they work and produce, and we consume.
they have also filled America’s savings deficiency and financed its trade deficit.
That statement has the causation backwards.
It is US domestic credit expansion that funds China’s desires to accumulate $US financial assets and thereby support their exporters.
As the renminbi’s exchange rate is the linchpin for a raft of other Asian currencies, a sharp appreciation of the renminbi would put tremendous upward pressure on all the others — including Korea, Japan, Thailand and even India. Forcing China into a major renminbi appreciation would usher in another bout of dollar weakness and further unhinge inflation expectations in the U.S. It would also send a deflationary impulse abroad and destabilize the international financial system.
Yes, that’s a possibility.
Most of the world’s government reaction functions are everything but sustaining domestic demand.
China, with its huge foreign-exchange reserves (over $1.4 trillion), has another important role to play. Once the major industrial countries with convertible currencies — led by the ECB — agree to put a floor under the dollar, emerging markets with the largest dollar holdings — China and Saudi Arabia — must agree not to “diversify” into other convertible currencies such as the euro. Absent this agreement, the required interventions by, say, the ECB would be massive, throwing the strategy into question.
Politically, this is a non starter. The ECB has ideological issues, and the largest oil producers are ideologically at war with the US.
Cooperation is a win-win situation: The gross overvaluations of European currencies would be mitigated, large holders of dollar assets would be spared capital losses, and the U.S. would escape an inflationary conflagration associated with general dollar devaluation.
Not if the Saudis/Russians continue to hike prices, with biofuels causing food to follow as well. Inflation will continue to climb until crude prices subside for a considerable period of time.
For China to agree to all of this, however, the U.S. (and EU) must support a true strong-dollar policy — by ending counterproductive China bashing.
Mr. McKinnon is professor emeritus of economics at Stanford University and a senior fellow at the Stanford Institute for Economic Policy Research. Mr. Hanke is a professor of applied economics at Johns Hopkins University and a senior fellow at the Cato Institute.
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Perspective
by Steve Hanke
US Mercantilist Machismo, China replaces Japan
The United States has recorded a trade deficit in each year since 1975.
That is a good thing – exports are real costs, imports benefits.
This is not surprising because savings in the US have been less than investment.
This is a tautology from the above misconceived notion and of no casual consequence.
The trade deficit can be reduced by some combination of lower government consumption, lower private consumption
Yes, if we get less net goods and services from non residents, our trade deficit goes down, as does our real terms of trade and our standard of living.
Real terms of trade are the real goods and services you export versus the real goods and services you import.
In economics, it is better to receive (real goods and services) than to give.
or lower private domestic investment.
We could (and would if ‘profitable’) ‘borrow to invest’ domestically (loans ‘create’ deposits, not applicable/no such thing as ‘borrowing from abroad’ etc.)
But said, domestic borrowing decreases ‘savings’ equal to the increased domestic investment (accounting identity). So, the trade gap would remain the same if we invested more or less via domestic funding.
So, his above statement is a tautology of no casual interest.
But you wouldn’t know it from listening to the rhetoric of Washington’s politicians and special interest groups. Many of them are intent on displaying their mercantilist machismo. This is unfortunate. A reduction of the trade deficit should not even be a primary objective of federal policy. Never mind. Washington seems to thrive on counter-productive trade “wars” that damage both the US and its trading partners.
Almost sounds like he gets it! But don’t get your hopes up..
From the early 1970s until 1995, Japan was an enemy. The mercantilists in Washington asserted that unfair Japanese trading practices caused the US trade deficit and that the US bilateral trade deficit with Japan could be reduced if the yen appreciated against the dollar.
Washington even tried to convince Tokyo that an ever-appreciating yen would be good for Japan. Unfortunately, the Japanese
complied and the yen appreciated, moving from 360 to the greenback in 1971 to 80 in 1995. In April 1995, Secretary of the Treasury Robert Rubin belatedly realized that the yen’s great appreciation was causing the Japanese economy to sink into a deflationary quagmire.
Actually, it was the fiscal surplus they allowed from 1987-1992 that drained net yen income and financial assets that removed support for the yen credit structure and ended the expansion.
In consequence, the US stopped arm-twisting the Japanese government about the value of the yen and Secretary Rubin began to evoke his now-famous strong-dollar mantra. But while this policy switch was welcomed, it was too late. Even today, Japan continues to suffer from the mess created by the yen’s appreciation.
The mess was created by the surplus and repeated attempts to reduce the following countercyclical deficits. Only when the deficit was left alone and grew to 7% of GDP a few years ago did the economy finally get the net income and financial assets it needed to recover. Only to be undermined recently by a political blunder regarding building codes. Japan should do better in 2008, as that obstacle is overcome.
As Japan’s economy stagnated, its contribution to the increasing US trade deficit declined, falling from its 1991 peak of almost 60% to about 11%.
Sad to see that happens. Now Americans have to build the cars here as their new factories are now in the US.
While Japan’s contribution declined, China’s surged from slightly more than 9% in 1990 to almost 28% last year.
Yes, they have workers willing to consume fewer calories than those in Japan.
With these trends, the Chinese yuan replaced the Japanese yen as the mercantilists’ whipping boy. Interestingly, the combined Japanese–Chinese contribution has actually declined from its 1991 peak of over 70% to only 39% last year. This hasn’t stopped the mercantilists from claiming that the Chinese yuan is grossly undervalued, and that this creates unfair Chinese competition and a US bilateral trade deficit with China.
The unfair part is their workers are willing to work for a lot less real consumption and become the world’s slaves via net exports.
And we don’t know how to sustain our own domestic demand via internal policy; so, our politicians blame the foreigners.
I was introduced to the Chinese currency controversy five years ago when I appeared as a witness before the US Senate Banking Committee on May 1, 2002. The purpose of those hearings was to determine, among other things, whether China was manipulating its exchange rate.
All state currencies are public monopolies, and value is a function of various fiscal/monetary policies. So in that sense, all currencies are necessarily ‘manipulated’ as all monopolists are inherently ‘price setters’.
So, this entire point is moot, though far from mute.
United States law requires the US Treasury Department, in consultation with the International Monetary Fund, to report biyearly as to whether countries – like China – are gaining an “unfair” competitive advantage in international trade by
manipulating their currencies.
Clearly no understanding that exports are real costs, and imports are real benefits. The entire worlds seems backwards on this.
The US Treasury failed to name China a currency manipulator back in May 2002, and it hasn’t done so since then. This isn’t too surprising since the term “currency manipulation” is hard to define and, therefore, is not an operational concept that can be used for economic analysis. The US Treasury acknowledged this fact in reports to the US Congress in 2005. But this fact has not stopped politicians and special interest groups in the United States, and elsewhere, from asserting that China manipulates the yuan.
Yes, to keep their wages low so they can produce, and we can consume.
Protectionists from both political parties in the US have threatened to impose tariffs on imported Chinese goods if Beijing does not dramatically appreciate the yuan. These protectionists even claim that China would be much better off if it allowed the yuan to become stronger vis-à-vis the US dollar.
They would – it would lower their net exports, a real benefit at the macro level.
Percenta
This is not the first time US special interests have made assertions in the name of helping China. During his first term, Franklin D. Roosevelt delivered on a promise to do something to help silver producers. Using the authority granted by the Thomas Amendment of 1933 and the Silver Purchase Act of 1934, the Roosevelt Administration bought silver.
Can’t think of a better way to help a producer!
This, in addition to bullish rumors about US silver policies, helped push the price of silver up by 128% (calculated as
an annual average) in the 1932-35 period.
(It has gone up more here in the last three years without the government buying any.)
Bizarre arguments contributed mightily to the agitation for high silver prices. One centered on China and the fact that it was on the silver standard. Silver interests asserted that higher silver pricesâ€â€Âwhich would bring with them an appreciation in the yuanâ€â€Âwould benefit the Chinese by increasing their purchasing power.
Yes – whoever is long silver wins when the price goes up.
As a special committee of the US Senate reported in 1932, “silver is the measure of their wealth and purchasing power; it serves as a reserve, their bank account. This is wealth that enables such peoples to purchase our exports.”
Things didn’t work according to Washington’s scenario. As the dollar price of silver and of the yuan shot up, China was thrown into the jaws of depression and deflation. In the 1932-34 period, gross domestic product fell by 26% and wholesale prices in the capital city, Nanjing, fell by 20%.
In an attempt to secure relief from the economic hardships imposed by US silver policies, China sought modifications in the US
Treasury’s silver purchase program.
They didn’t know how to sustain domestic demand. They needed to float the currency, offer a public service job at a non disruptive wage to anyone willing and able to work, and leave the overnight risk free rate at 0%. (See ‘Full Employment and Price Stability‘.)
But its pleas fell on deaf ears.
Maybe ears with different special interests?
After many evasive replies, the Roosevelt Administration finally indicated on October 12, 1934 that it was merely carrying out a policy mandated by the US Congress. Realizing that all hope was lost, China was forced to effectively abandon the silver standard on October 14, 1934, though an official statement was postponed until November 3, 1935.
About the same time the US abandoned the gold standard domestically for much the same reason.
This spelled the beginning of the end for Chiang Kaishek’s Nationalist government.
He let unemployment go too high out of ignorance of how to sustain domestic demand. A common story throughout history.
History doesn’t have to repeat itself. Foreign politicians should stop bashing the Chinese about the yuan’s exchange rate. This would allow the Chinese to focus on important currency and trade issues: making the yuan fully convertible, respecting intellectual property rights and meeting accepted health and safety standards for their exports.
Why do we want to encourage anything that reduces their net exports???
(rhetorical question)
Steve H. Hanke is a Professor of Applied Economics at The Johns Hopkins University in Baltimore and a Senior Fellow at the Cato Institute in Washington, D.C.
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Higher oil prices mean lower rates from the Fed, and higher inflation rates induced by shortages mean stronger currencies abroad.
Why do I have so much trouble getting aboard this paradigm, and instead keep looking for reversals? Feels a lot like watching the NASDAQ go from 3500 to 5000 a few years ago.
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Calories, Capital, Climate Spur Asian Anxiety
2007-12-26 17:51 (New York)
by Andy Mukherjee
(Bloomberg) — The new year may be a challenging one for Asian policy makers.
Year-end U.S. closing stocks for wheat are the lowest in six decades; soybeans in Chicago touched a 34-year peak this week. Palm oil in Malaysia climbed to a record yesterday.
The steeply rising cost of calories may be more than just cyclical, notes Rob Subbaraman, Lehman Brothers Holdings Inc. economist in Hong Kong. Growing use of food crops in biofuels and increasing demand for a protein-rich diet in developing countries may have pushed up prices more permanently.
The wholesale price of pork in China has surged 53 percent in the past year.
“Consumer inflationary expectations may soon rise, feeding into wage growth and core inflation, but we expect Asian central banks to be slow to react, initially due to slowing growth and later because of strong capital inflows,” Subbaraman says.
If the U.S. Federal Reserve continues easing interest rates to combat a housing-led economic slowdown, a surge in capital inflows into Asia may indeed become a stumbling block in managing the inflationary impact of higher commodity prices.
Food and energy account for more than two-fifths of the Chinese consumer-price index, compared with 17 percent for countries such as the U.K., U.S. and Canada, and 25 percent in the euro area, according to UBS AG economist Paul Donovan in London.
As Asian central banks raise interest rates — when the Fed is cutting them — they will invite even more foreign capital into the region. That will cause Asian currencies to appreciate, leading to a loss of competitiveness for the region’s exports.
Carbon Emissions
On the other hand, paring the domestic cost of money prematurely may worsen the inflation challenge.
That isn’t all.
Higher oil prices will also boost the attractiveness of coal as an energy source, delaying any meaningful reduction in carbon emissions in fast-growing Asian nations such as China and India.
As Daniel Gros, director of the Centre for European Policy Studies in Brussels, noted in recent research, the price of coal — relative to crude oil — has been halved since the end of 1999. And per unit of energy produced, coal is a much bigger pollutant than oil or gas.
This doesn’t augur well for the environment.
“Given that China is likely to install over the next decade more new power generation capacity than already exists in all of Europe, this implies that the current level of high oil prices provides incentive to make the Chinese economy even more intensive in carbon than it would otherwise be,” Gros said.
Beijing Olympics
Climate-related issues will be in the spotlight in Asia next year. China’s eagerness to use the Beijing Olympic Games to showcase solutions to its huge environmental challenges will be one of the “big things to watch for” in Asia in 2008, Spire Research and Consulting, a Singapore-based advisory firm, said last week.
Even if China succeeds in reducing air pollution during the Olympics, the improvements may not endure after the sporting event ends on Aug. 24, especially since the underlying economics continue to favor higher coal usage.
A drop in hydrocarbon prices might help check emissions and global warming, Gros noted last week on the Web site of VoxEu.org.
In fact, lower oil prices may also make food costs more stable by lessening the craze for biofuels.
That will leave capital flows as Asia’s No. 1 challenge in 2008. And it won’t be an easy one for policy makers to tackle.
Capital Inflows
Take India’s example.
The $900 billion economy has attracted $100 billion in capital in the 12 months through October, with a third of the money entering the country as overseas borrowings, according to Morgan Stanley economist Chetan Ahya in Singapore.
This has caused the rupee to appreciate more than 12 percent against the dollar this year, knocking off more than three percentage points from India’s inflation index, says Lombard Street Research economist Maya Bhandari in London.
Naturally, exporters are complaining.
So why doesn’t India cut domestic interest rates? It can’t do that without the risk of stoking inflation.
Money supply is growing at an annual pace of more than 21 percent in India, compared with the central bank’s target of between 17 percent and 17.5 percent. Inflation has held well below the central bank’s estimate of 5 percent for five straight months partly because of the government’s insistence on not passing the full cost of imported fuel to local consumers. It isn’t yet time for monetary easing in India.
China has it worse. Monetary conditions there remain dangerously loose. And China may be reluctant to do much about the undervalued yuan — the root cause of its record trade surpluses and the attendant liquidity glut — until the Olympics are out of the way.
Asian economies may, to a large extent, be insulated from the subprime mess. Still, 2008 won’t be all fun and games.
(Andy Mukherjee is a Bloomberg News columnist. The opinions expressed are his own.)
–Editors: James Greiff, Ron Rhodes.
To contact the writer of this column:
Andy Mukherjee in Singapore at +65-6212-1591 or
amukherjee@bloomberg.net
To contact the editor responsible for this column:
James Greiff at +1-212-617-5801 or jgreiff@bloomberg.net
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Ben Bernanke will save the world, but first we bleed
Posted by Ambrose Evans-Pritchard on 14 Dec 2007 at 12:48
The Bernanke ‘Put’ has expired.
Are Bernanke’s academic doctrines blurring his vision?
The Fed cuts a quarter point, and what happens? Wall Street’s ungrateful wretches knock 294 off the Dow 294 in an hour and half; the home builders index dives 10pc; Japanese bond surge; Euribor spreads rise to an all-time high of 99 basis points.
Have the markets begun to digest the awful possibility that central banks cannot cut rates fast enough to prevent a profits crunch because they are caught between the Scylla of the credit crunch and the Charybdis of inflation, a new deviant form of stagflation?
Nor is there any evidence or credible theory that interest rate cuts would help. For example, fed economists say that 1% rates didn’t do much – it was the fiscal impulse of 03 that added aggregate demand and turned the economy.
US headline CPI is stuck at around 3.5pc to 4pc, German CPI is 3pc (and wholesale inflation 5.7pc), China is 6.9pc, and Russia is skidding out of control at 10pc.
Note ‘out of control’. Mainstream theory says inflation will accelerate once it gets going.
As for the Fed, it now has to fret about the dollar – Banquo’s ghost at every FOMC meeting these days. A little beggar-thy-neighbour devaluation is welcome in Washington: a disorderly rout is another matter. No Fed chairman can sit idly by if half Asia and the Mid-East break their dollar pegs, threatening to end a century of US dollar primacy.
They are more worried about ‘imported inflation’ than ‘primacy’.
Yes, inflation is a snapshot of the past, not the future. It lags the cycle. After the dotcom bust, US prices kept rising for ten months. Alan Greenspan blithely ignored it as background noise, though regional Fed hawks put up a fight.
He had a deflationary global context, as he said publicly and in his book. That has changed, and now import prices are instead rising substantially.
Ben Bernanke has not yet acquired the Maestro’s licence to dispense with the Fed staff model when it suits him.
As above, different global context.
In any case, his academic doctrines may now be blurring his vision.
Not sure why they are, but all evidence is they are based on fixed exchange rate/gold standard theory.
So, in case you thought that every little sell-off on Wall Street was a God-given chance to load up further on equities, let me pass on a few words of caution from the High Priests of finance.
A deluge of pre-Christmas predictions have been flooding into my E-mail box, some accompanied by lavish City lunches. The broad chorus-by now well known – is that the US will hit a brick wall in 2008.
Yes, originally scheduled for 07. Not saying we won’t, but I am saying those forecasting it hae a poor record and suspect models.
Less understood is that Europe, Asia, and emerging markets will also flounder to varying degrees, knocking away yet another prop for US equities – held aloft until now by non-US global earnings.
Yes, that is a risk.
Morgan Stanley has just added a “mild recession” alert for Japan (Buckle Up) on top of its “manufacturing recession risk” for the eurozone. It’s US call (`Recession Coming’), it is no longer hedged about with many ifs or buts. Americans face a “perfect storm” and CAPEX is buckling. Demand will shrink by 1pc a quarter for nine months.
The bank has cut its target MSCI emerging market equities by 6pc next year. I suspect that this will be cut a lot further as the plot thickens, but you have to start somewhere.
They have been bearish all year.
Merrill Lynch has much the same overall view. “The US consumer is on the precipice of its first recessionary phase since 1991. The earnings recession has already arrived.”
Maybe, but no evidence yet. Employment remains sufficient for the consumer to muddle through, and exports are picking up the slack.
“Real estate deflations are unique and have never ended well for the consumer, the credit market, or the economy. Maybe it will be different this time, but we fail to see why.”
The subtraction to aggregate demand due to real estate is maybe a year behind us and rising exports have filled the gap.
And this from a Goldman Sachs note entitled “Quantifying the Stock Market Impact of a Possible Recession.”
“Our team believes that there is about a 40pc to 45pc chance that the US will enter recession over the next six months. If a recession does occur, it has the potential to feed on itself,” said bank’s global markets strategist Peter Berezin.
Goldman just upped their Q4 GDP foregast by 1.5%, and it’s now at 1.8%.
“We expect home prices to decline 7% in 2007 and a further 7% in 2008. But if the US does fall into a recession, home prices could decline by as much 30% nationwide, which would make it the worst housing bust since at least the Great Depression.
“If global growth slows next year as we expect, cyclical stocks that so far have held up quite well may feel more pressure. It seems unlikely that the elevated earnings estimates for next year can be sustained,” he said.
Lots of ‘if’ and ‘we expect’ language, but no actual ‘channels’ to that end. No one seems to have any. Best I can determine if exports hold up, we muddle through.
Now, stocks can do well in a soft-landing (which Goldman Sachs still expects, on balance), since falling interest rates offset lost earnings. But if this does tip over into outright contraction, History is not kind.
Stocks are likely to adjust PE’s to higher interest rates now that expectations are moving toward lower odds of rate cutting due to inflation.
The average fall in S&P 500 over the last 9 recessions is 13pc from peak to trough. These include 1969 (18pc), 1981 (23pc) and 2001 (52pc).
Still up 5% for the year. And it has been an OK leading indicator as well for quite a while.
As for the canard that stocks are currently cheap at a projected P/E ratio of 15.3, this is based on an illusion. US profit margins are currently inflated by 250 basis points above their ten-year average.
Inflated? Seems a byproduct of productivity and related efficiencies. No telling how long that continues. And products changes so fast there is no time for ‘competitive forces’ to drive down prices to marginal revenue with many products; so, margins remain high.
While Goldman Sachs does not use the term, this is obviously a profits bubble. Super-cheap credit in early 2007 – the lowest spreads ever seen – flattered earnings.
Not sure it’s related to ‘cheap credit’ as much as productivity.
I would add too that free global capital flows have allowed corporations to engage in labour arbitrage, playing off cheap Asian wages against the US and European wages. This game is surely played out. Chinese wages are shooting up.
Yes, as above, and this is the global context Bernanke faces – import prices rising rather than falling.
Voters in industrial democracies will not allow capitalists to continue take an ever larger share of the pie. Hence Sarkozy, Hillary Clinton, and the Labour victory in Australia.
Not sure both sides are pro profits. That’s where the campaign funding is coming from and most voters are shareholders or otherwise profit directly and indirectly from corporate profits. Wage earners are a shrinking constituency with diminishing political influence.
Once you strip out this profits anomaly, Goldman Sachs says the P/E ratio is currently 26. This compares with a post-war average of 18, and a pre-recession average of 17.
As above. PE’s are more likely to adjust down near term due to valuation issues – rising interest rates and perception of risk.
“It is clear that if the US enters a recession, there is significant scope for both earnings and stock prices to decline beyond what the market has already priced. The average lag between peak and nadir in stock prices is only 4 months. This implies a swift correction in equity prices.”
Sure, but that’s a big ‘if’.
The spill-over would be a 20pc fall in the DAX (Frankfurt) and the CAC (Paris), 19pc fall on London’s FTSE 250, 13pc on the IBEX (Madrid), and 10pc on the MIB (Milan).
Doesn’t sound catastrophic.
Be advised, this is not a Goldman Sachs prediction: it is merely a warning, should the economy tip over.
Yes, but without a direct reason for a recession, nor a definition of a recession, for that matter.
Now, whatever happens to US, British, French, Spanish, Italian, and Greek house prices, and whatever happens to the Shanghai stock bubble or to Latin American bonds, the Fed and fellow central banks can – and ultimately will – come to the rescue with full-throttle reflation.
Wrong, the fed doesn’t have that button. Lower interest rates maybe, if they dare to do that with the current inflation risks of the triple supply shock of crude, food, and the lower $US.
But as shown with Japan, low rates do not add aggregate demand as assumed.
Merrill says the Fed may cut rates to 2pc. (rates were 1pc in 2003 and 2004). Let me go a step further. It would not surprise me if debt deflation in the Anglo-Saxon countries proves so serious that we reach Japanese extremes – perhaps zero rates, with a dollop of ‘quantitative easing’ for good measure.
Right, and with the same consequences – those moves have nothing to do with aggregate demand.
The Club Med states may need the same, but they will not get it because they no longer control their monetary policy. So Heaven help them and their democracies.
True, the systemic risk is in the Eurozone. Not sure he knows why.
The central banks are not magicians, of course. We forget now that Keynes and his allies in the early 1930s knew that monetary policy ‘a l’outrance’ could be used to flood the system by buying bonds. They concluded that such a policy might backfire – possibly causing panic – since investors were not ready for revolutionary methods.
Keynes was right but was talking in the context of the gold standard of the time. Not directly applicable today without ‘adjustments’ to current floating fx regimes.
This at least has changed. The markets expect a bail-out, demand it, and believe religiously in its benign effects.
Ben Bernanke said in his 2002 ‘helicopter’ speech that there was practically no limit to what sorts of assets the Fed could buy in order to inject money.
No limits, but big differences to aggregate demand. Buying securities has no effect on demand, while buying real goods and services has an immediate effect, also as Keynes and others have pointed out many times.
The bank’s current mandate does not allow it to buy equities, but that could be changed easily enough.
Yes. Won’t support demand, but will support equity prices.
So yes, in the end, the Fed can always stop a deflationary spiral.
Yes, but more precisely, the tsy, as they can buy goods and services without nominal limit and support demand at any level they desire. The ‘risks’ are ‘inflation’ not solvency. (See ‘Soft Currency Economics‘.)
As Bernanke said to Milton Freidman on his 90th birthday, the Fed will not repeat the monetary crunch it allowed to happen 1930-32.
That was in the context of the gold standard of the day. Not applicable currently.
“Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”
Thanks to floating the $, it hasn’t happened since.
Bernanke is undoubtedly right. The Fed won’t do it again. But before the United States can embark on an economic course that radically transforms the nature of capitalism, speculative markets may have to take a beating – for appearances sake, at least.
♥
(Reuters article)
Big Banks Lower Outlook, Overshadowing Fed Plan
Three major U.S. banks said they expect more write-downs and loan losses in the fourth quarter, eroding investor enthusiam over a Federal Reserve plan to ease the global credit crunch.
The warnings from the three banks, Bank of America, Wachovia and PNC Financial Services Group, triggered a selloff in financial stocks and reversed a huge rally in the markets.
Nell Redmond / AP
Executives of all three spoke at a Goldman Sachs conference in New York.
Lewis said Bank of America is likely to be profitable in the quarter but expects to set aside $3.3 billion for losses and write-downs.
Loss less than ¼’s earnings.
“While we do not make a practice of forecasting quarterly earnings, I think you certainly can assume results will again be quite disappointing,” Lewis said.
Wachovia’s Thompson told the conference his bank was facing “as tough an environment as I’ve ever seen” and did not know when the credit crunch would be over.
Thompson said Charlotte, North Carolina-based Wachovia had boosted its loan loss provision for the fourth quarter to about $1 billion from a previous $500 million to $600 million.
He said fourth-quarter losses from commercial and consumer mortgages, leveraged finance and structured products, including subprime-backed mortgage securities, had reached about $1.4 billion, similar to the
level seen in the third quarter.
Pittsburgh-based PNC now expects to report earnings of 60 to 75 cents a share for the quarter, or between $1.00 and $1.15 excluding items. Analysts on average had expected PNC to report earnings of $1.33 a
share before items.
Still profitable as well.
The changes reflect a write-down of $1.5 billion in commercial mortgage loans, weak trading results amid market volatility and a higher provision for credit losses stemming from residential real estate development, it said.
Bank of America’s Lewis said he had hoped that the Federal Reserve would cut rates by half a point rather than the quarter point cut it made Tuesday “because the capital markets are still so fragile.”
Can’t blame him for trying!
Lewis said in response to analysts’ questions that the bank hopes to sell off some of its 9 percent stake in China Construction Bank starting in 2008 and is “talking to the Chinese to see what level they would be comfortable with us holding.”
Wachovia’s Thompson said despite the difficult environment, he expected to grow earnings in 2008. He added that the bank might consider raising capital next year in a “relatively inexpensive form,”
such as a preferred stock offering.
Seems to me these losses are ‘well contained’ and not threatening to interrupt business or aggregate demand.
♥
Checked with our China economist, it appears that China’s export price has been rising since early 06. Compared to the price by end of 06, export prices are already 7.4% higher (See charts attached)-an interoffice email
While headlines focus on China’s internal inflation issues, more relevant to the fed are China’s export prices, which become our import prices.
And it is not wrong to view import prices as functionally equivalent to unit labor costs, due to outsourcing of labor investment inputs.
And a weaker $ vs Yuan will add to our ‘import inflation’.
Fed hawks know this and probably sense a ripping inflation in the pipeline.