Global growth: American exceptionalism

American exceptionalism

Jul 1st 2011, 17:41 by R.A. | WASHINGTON; Courtesy, The Economist

AMERICA’S economic prospects seem to be improving, but it’s very nearly alone in that respect. The latest data from purchasing managers’ indexes around the world provide a snapshot of a global slowdown. While American manufacturing activity grew at a faster pace in June relative to May, most countries saw slowdowns and a few dipped back into contractionary territory. (See this useful interactive at Real Time Economics for an easy comparison.)

Slowing growth in China has grabbed attention, given recent headlines about debt loads and unrest there. China’s PMI dipped from 52 to 50.9, barely in expansionary territory, in June. That’s not entirely a bad thing, however. Chinese inflation has been running uncomfortably high, and the government has been working to slow the economy’s growth. The story is the same in India, where activity also slowed, and in Brazil, where production actually fell in June.

As the chart at right indicates, the Indian and Brazilian economies have been running especially hot. (You can see an interactive chart of the factors that make-up the index here.) Depending on the pace of the slowdown over the next few months, there are sure to be worries about hard landings. Emerging market governments have little choice but to combat destabilising inflation.

The good news for the rich world is that slowing emerging market growth will keep commodity prices. That, in turn, will dampen inflationary pressures and free central banks to respond more appropriately to domestic economic conditions. In Europe, those conditions are weak and getting weaker. Manufacturing activity for the euro zone decelerated sharply in June. The big core economies, Germany and France, weren’t spared. But matters are worse around the periphery.

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Irish opposition claims historic poll victory

By Padraic Halpin and Kate Holton
Reuters

DUBLIN — Ireland’s main opposition party claimed a historic election victory on Saturday and looked set to form a coalition government after voters, incensed at a financial collapse and bailout, routed the government.

Early results showed Fianna Fail was facing the biggest collapse in support for any Irish party since independence from Britain in 1921, and its defeat would make it the first euro zone government to be brought down by the debt crisis.

“Good riddance to them,” said Simon McGrath, a 23-year-old student. “I don’t think they’ll be missed.”

Having to go cap in hand to the European Union and the International Monetary Fund last year was the killer blow for the ruling party and will make for uncomfortable reading in Lisbon, seen as next in line for a bailout.

Kenny said he expected to form the next government, but his celebrations were understated as he vowed to fulfill an election pledge to renegotiate the terms of the 85 billion euro bailout.

“We don’t have any time to lose. The country can’t borrow money, the banks can’t borrow money, we are up to our necks here,” he told national broadcaster RTE.

A host of high-profile independents — ranging from a shaggy-haired builder to a tailored former stockbroker — swept out parties and candidates who had ruled for generations.

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How the Irish Can Save Civilization (Again)

In three weeks’ time, Ireland will, for a moment, hold the fate of Europe in its hands. Through a quirk of Irish constitutional procedure, on Oct. 2 the Republic of Ireland will be the only European Union nation to hold a referendum on a treaty to revamp how the EU, home to half a billion people, does business. The Lisbon Treaty, therefore, will stand or fall on the votes of perhaps one and a half million Irishmen and women.

From the perspective of Brussels, this is grossly unfair—a miscarriage of democracy masquerading as democracy. The Irish have stymied the denizens of Brussels’ European Quarter before, most recently the first time they voted against the Lisbon Treaty last year.

Back then, the establishment in Brussels blamed one man above all for the defeat. His name is Declan Ganley. He was one of the driving forces behind the No campaign the last time around, and he’s back to do it again. Your correspondent recently sat down with him to find out what he’s fighting for in trying to see to it that Ireland once again votes No to Lisbon—and in the process, he hopes, forces the EU to choose a different path.

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Ismael Roldan

I put it to Mr. Ganley, an impeccably dressed, balding Irishman of 42, that from Brussels, this whole referendum looks profoundly unjust. Why should 1.5 million Irish voters get the opportunity to hold back the progress of 500 million citizens of Europe?

“I would look at it a very different way,” he shoots back. “It’s profoundly undemocratic to walk all over democracy. . . The Irish people had a vote on the Lisbon Treaty. They voted no. A higher percentage of the electorate voted no than voted for Barack Obama in the United States of America. No one’s suggesting he should run for re-election next month. But—hey, presto!—15 months later we’re being told to vote again on exactly the same treaty.” He taps the table for emphasis: “Not one comma has changed in the document.”

But the insult to democracy is more egregious, in his view, than simply asking the Irish to vote twice—that was already done to Ireland with the Nice Treaty in 2002. In this case, it is not just the Irish whose democratic prerogatives are being trampled, but the French and the Dutch, among others, as well.

In 2005, France and the Netherlands each rejected the proposed EU Constitution in referendums. Lisbon, Mr. Ganley contends, “is the same treaty.” What is the evidence for that? “Well, first of all, the people who drafted the European Constitution say it is. Like [former French President Valéry] Giscard d’Estaing. He called it the same document in a different envelope. And having chaired the presidium that drafted the Constitution, he would know.” There’s more. “He also said in respect of the Lisbon Treaty that public opinion would be led to adopt, without knowing it, policies that we would never dare to present to them directly. All of the earlier proposals for the new Constitution will be in the new text, the Lisbon Treaty, but will be hidden or disguised in some way. That’s what he said. And he’s absolutely right. There is no law that could be made under the European Constitution that cannot be made under the Lisbon Treaty. None.”

So in trying to ram the Lisbon Treaty through, the EU is also undoing the democratic choice of the French and Dutch electorates. “Millions of people in France, a majority, voted No to this European Constitution. In the Netherlands, millions of people did exactly the same thing. When the Irish were asked the same question, they voted no also. Those three times that it was presented to an electorate, the people voted no.” Far from thwarting the will of those hundreds of millions of fellow Europeans, then, the way Mr. Ganley sees it, Ireland has a duty to them to uphold the results of those earlier votes. Approving the treaty would be a betrayal of those in France and the Netherlands—not to mention the millions of others who were never offered a vote on the Constitution or Lisbon.

Mr. Ganley speaks in a low, measured tone, even when, as he occasionally does, he slips into rhetorical bomb-throwing mode. “Why,” he asks, “when the French voted no, the Dutch voted no and the Irish voted no, are we still being force-fed the same formula? You don’t have to scratch your head and wonder about democracy in some intellectualized, distant way and wonder, is there some obscure threat to it.” He adds, without raising his voice, “This is manifest contempt for democracy. It is a democracy-hating act. . . . This is so bold a power grab as to be almost literally unbelievable.”

The nature of the power grab that Mr. Ganley refers to deserves some elaboration. What, exactly, is wrong with the Lisbon Treaty itself? “The treaty is a product and indeed enshrines a set of principles and a way of governing the European Union that clearly shows no will or intent for democracy,” Mr. Ganley says. “You will hear it discussed quietly across the dinner tables in certain sections of Brussels and elsewhere that we’re entering into this post-democratic era, that democracy is not the perfect mechanism or tool with which to deal with the challenges of global this-that-or-the-other. This idea of entering into some form of post-democracy is dangerous. It’s ill-advised. It’s naïve.”

The Lisbon Treaty, like the EU Constitution would have, puts this idea of post-democracy into practice in a number of concrete ways. The most striking is Article 48, universally known by its French nickname, the passerelle clause. It says that “with just intergovernmental agreement, with no need of going back to the citizens anywhere, they can make any change to this constitutional document, adding any new powers, without having to revisit an electorate anywhere,” Mr. Ganley explains. “Do you think they want to revisit an electorate anywhere? Of course they don’t.” If the Irish vote yes, in other words, Oct. 2 would mark the last time that Brussels would ever have to bother giving voters a say on what the EU does and how it does it. Ireland would have, in effect, voted away the last vestige of European direct democracy not just for itself, but for the entire continent.

The passerelle clause is not the only evidence in the treaty of a post-democratic mindset. “The other thing it does,” Mr. Ganley says, “is it creates its own president—the president of the European Council, commonly referred to as the president of the European Union.” This EU president, Mr. Ganley notes, “will represent the European Union on the global stage. This will be one of the two people that Henry Kissiner would call, in answer to his famous question, when I want to speak to Europe, who do I call? He’s now going to have a telephone number, a voice that speaks for Europe, because that voice will have half a billion citizens, legally.”

The other person who would speak for Europe is the “grandly named” High Representative for Foreign and Security Affairs, the EU’s foreign minister, in effect. Mr. Ganley is, as he puts it, “cool with that.” But there is this: “Presumably they’re going to be speaking for me, right, because I’m a citizen,” he says. “But I don’t get to vote for or against these people. So, who mandates them, if not me, as a citizen, or you? Oh, so somebody who is how many places removed from me selects from within one of their own. They never have to debate with a competitor. I’m never given a choice of, do you want Tom, Joe or Anne. I’m presented with my president. Do I walk backward out of the room now?” Just as a yes vote in Ireland would mean that future expansions of the powers of the EU would never have to be put to a popular vote, it would also mean that Europeans would never get the opportunity to elect its highest officials.

It’s easy to see why Mr. Ganley has made himself unpopular in Brussels. And yet, he avows, “I am a committed European. I am not a euroskeptic, not in any way, shape or form. I believe that Europe’s future as united is the only sensible way forward.” It’s just that he fears that Europe, as it is presently constituted, is setting itself up for a fall. “I’m very sure about one thing,” he says. “Which is, if it is not built on a solid foundation of democracy and accountability and transparency in governance, then it will fail. And it’s too valuable a project, and it has cost too much in terms of blood and treasure, to create an environment where this could happen.”

The whole political dynamic in the European Union, he argues, is outmoded. To talk of only euroskeptics and europhiles actually serves the interests of the mandarins in Brussels because it doesn’t allow for the existence of a loyal opposition or constructive dissent. But a loyal opposition is precisely what Mr. Ganley hopes to create. “What I’ve been saying since the beginning of the last Lisbon campaign, it blows fuses in Brussels,” he says. “They just can’t process it. The system crashes. They have to reboot every time because I don’t fit into the euroskeptic box.” Their mentality, he says, is “friend-enemy. Uh, no.” And he points to himself: “Friend—a real friend, because I’m telling you the truth. I’m telling you, you’ve got a problem and we’ve got to fix it.”

He adds, referring to the European establishment in Brussels: “I’ve got news for them. This little European citizen, along with millions of others in France, the Netherlands and Ireland, have now said something to them. And they can either carry on the way that they’re going, and fail, or they can listen to the people, engage them, and bring them along with them.”

Instead of a dense, almost unreadable treaty that shuffles the deck chairs of the Berlaymont building in Brussels, the Commission’s headquarters, Mr. Ganley would like to see a readable, 25-page document that provides for the direct election of an EU president, greater transparency in decision-making and a bigger voice for the people of Europe. “We have to ask more of people,” he says. But equally, “we have to trust people. They talk about the democratic deficit. The deficit of trust is a yawning gap right now in Europe. And the biggest loss of trust has been between those that govern and the people, not the other way around. What was it Bertolt Brecht said? ‘That the people have lost the confidence of their government?’ This is the identical mentality.”

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Still, for all this talk about democracy and higher principles, the people of Ireland have their own parochial concerns to consider as well. There’s been a lot of talk about how a No vote could hurt the Irish economy in some way. And a number of big multinationals in Ireland have called on the Irish to ratify the treaty and let it go forward. Is Mr. Ganley putting his country at risk by calling for a No vote?

He emphatically denies it. “The only people at risk in the Lisbon Treaty are these elites in Brussels,” he scoffs. “Somebody said last time that Ireland would be the laughing stock of Europe if we voted no. Well, we voted no, and actually these elites in Brussels became the laughing stock of the people of Europe. That’s what I saw in the weeks that came afterwards.” He goes on: “The only people we risk annoying are a bunch of unelected bureaucrats and what I call this tyranny of mediocrity that we have across Europe.” What’s more, he says, “the Irish have never been afraid throughout history of asking the tough questions and standing up for freedom and what was right against much, much bigger opponents. In fact, we seem to revel in it.”

It was easier to revel, however, when Ireland was still enjoying a boom of historic proportions. Will the Irish decide, this time around, that it is safer to keep their heads down, and go along with the program? In Mr. Ganley’s view, this would be totally self-defeating. If Ireland votes Yes, he says, “We’re getting nothing in return except to be patted on the head by some mandarins and told we’re good Europeans. Would we be acting as good Europeans if we said yes to this?” He thinks not. “If this question was asked of the people of Europe, whether they wanted this constitution, we know almost for sure that en masse they would vote no.” And yet, “We’re almost literally being held hostage, with a gun pointed to our head, and being told, if you don’t sign this thing, unspecified bad things will happen. But what they’re asking us to do is to sell out the rest of the people of Europe.”

And the whole European project—which he supports—”has to be about ‘We, the people,’” Mr. Ganley says. “It’s not top-down, it’s got to be bottom-up. And the European Union right now is top-down. It does not have the support of the mass of its people. It does not have their engagement. They don’t even know what’s going on. And it literally conducts its business behind closed doors, and that has to stop and it has to stop now.” If Mr. Ganley has anything to say about it, it will stop in three weeks, in a little country called Ireland on the Atlantic periphery of Europe.

Mr. Carney, the editorial page editor of The Wall Street Journal Europe, is the co-author of “Freedom, Inc.,” due out in October.

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Durability of global recovery in doubt

WASHINGTON – Turnabouts in European and Asian economies, along with recent gains in the U.S., are raising hopes that the worldwide recession is drawing to a close. That’s not to say the coast is clear.

The brightening outlook in Europe and Asia and the improvement in U.S. credit markets and indicators reflect heavy government stimulus spending. Many analysts question whether the top economies can sustain recoveries after stimulus measures and easy-credit policies have run their course — and in the absence of significant new consumer spending, especially among Americans.

“It’s not clear that these economies can continue to move forward without stimulus,” said Mark Zandi, chief economist for Moody’s Economy.com. “And that’s in part why stock markets across the globe are nervous.”

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23 Singapore Business Times Investment round table – Equities: what’s on the horizon

OVERVIEW

STOCK prices around the world recently hit their highest levels for this year, buoyed by a wave of optimism about prospects for a global economic recovery – only to fall back to a three-month low this week on fresh doubts about the sustainability of that recovery. So, is it ‘for real’ or is it destined to run out of steam? The Business Times empanelled a team of key experts to answer this critical question, and to tell us whether the world faces a threat of inflation, deflation or stagflation in the coming months. There were mixed views on the prospects for equity markets, but interestingly, everyone on the panel was bullish about gold.

Panellists

Mark Mobius, executive chairman, Templeton Asset Management

Eisuke Sakakibara, former vice finance minister for international affairs, Japan, and now Professor at Waseda University, Tokyo

Jesper Koll, president and CEO, Tantallon Research, Japan

The Hon Robert Lloyd-George, chairman of Lloyd George Management, Hong Kong

Ernest Kepper, former senior official of the International Finance Corporation (IFC) and Wall Street investment banker who now heads an Asian financial consultancy

William Thomson, chairman, Private Capital Ltd, Hong Kong and senior adviser to Axiom Funds, London and formerly a Vice President of the Asian Development Bank

Christopher Wood, managing director and equity strategist, CLSA Asia-Pacific Markets, Hong Kong

Moderator: Anthony Rowley, Tokyo correspondent, The Business Times

Anthony Rowley: Let me start by asking: is the apparent recovery in the global economy for real, or a ‘phony’ one? And, are stock markets justified in behaving the way they have been doing lately?

Eisuke Sakakibara: I don’t understand why equity prices are so high – in Japan the US and elsewhere. In China’s case, there is obviously a very major bubble in the equity market. Also, I don’t see any reason why the US Dow Average should be more than 9,000 (as it is now)or why the Japanese Nikkei average is more than 10,000. I just cannot understand it.

Ernest Kepper: This is a phony recovery. A turn-up in the economy is not the same as the economy recovering all lost ground. To keep rising in the future, markets need a sign of real economic recovery, and that requires a surge in consumer spending, business investment and home buying, combined with a reduction in government spending.

I fully expect to see the markets rise for a while longer, even as high as Dow 10,000 or S&P 1,100. After that, I think that we are going to see another leg down when the current rally ends, just as the powerful rally following the initial crash in 1929, ended up dealing out severe losses to those who held onto their shares.

William Thomson: In the wake of Lehman’s failure the global financial system was staring into the abyss of a systemic meltdown. Governments then junked their economic philosophies and threw fiscal and monetary assistance at the problems on an unimaginable scale, just to keep things afloat. It has worked to the extent the system limps on and there has been a rally in the markets. But there has been no recovery in the real economy yet in the West. The pace of decline has slowed and the second half of 2009 could be modestly positive. But modest is the operative word since unemployment is likely to continue to grow well into 2010, reaching double digits even on the official count.

With housing foreclosures likely to keep climbing in the wake of extended unemployment, the consumer is likely to keep his wallet shut and try and repair his balance sheet. Modest economic recovery should continue as long as neither fiscal or monetary conditions become restrictive too quickly. But markets need a period of consolidation whilst they assess future prospects, so a broad trading range may be possible for the rest of the year. Dips can bought and rallies sold.

Anthony: Are any of you gentlemen more optimistic about the global outlook?

Robert Lloyd-George: This is not a ‘phony’ recovery. It may be slower and weaker than usual because of the debt super-cycle. But it is a real recovery – in trade, auto sales, consumer spending, corporate capital spending and so on.

We are ‘climbing a wall of worry’ because many economists (and hedge fund managers) do not believe in the recovery and still have 50 per cent cash, awaiting a correction, which may never come. Earnings, and GDP, figures will slowly improve and equity markets will strengthen well into spring of 2010.

Mark Mobius: The financial crisis was real in the banking system but not in the industrial economy. It impacted the economy because the banking system froze. However, markets are leading indicators and they are telling us the recovery is on the way now.

Jesper: I agree. There is nothing ‘phony’ about the recovery; globally, the policy response was swift and massive and very correct. Since the start of 2009, slowly but surely, global money and credit have started to flow again.

Markets have, of course, been pulled by the massive liquidity creation; the tell-tale sign was the US banks raising massive amounts of private capital this spring without much problem; and beyond financial companies, corporations in general have been very fast in cutting costs and slashing inventories. Many CEOs used the crisis as an opportunity to do all the harsh and hard things they had been wanting to do for years, but could not ; corporations are now mean and lean. Corporate profits for many companies are poised to explode in the coming two years; global stock markets are – right now – transitioning from a ‘liquidity market’ to an ‘earnings market’ ; in this phase, stock selection will become increasingly important.

Anthony: What is driving recovery in the markets – emerging markets especially?

Mark: In a word, money is what is driving the recovery. The money supply in most countries is rising at a very rapid pace. This money is finding its way into the economic system and is driving prices and economic activity. Added to this are the US$600 trillion in financial derivatives which amplifies money supply.

Jesper: In a word – growth. There is no question that the structural growth potential of ‘Chindonesia’ – China, India and Indonesia – is easily about two times, if not three times higher than that of the US, Europe or Japan. Even so, it will be interesting to see how long emerging markets sustain their growth premium. Valuations are now very stretched and if the US and Japanese recovery continues to gain visibility, these two markets could well start to outperform the emerging world for a couple of quarters.

Robert: Emerging Markets – Brazil, India and China anyhow – have clearly risen faster and stronger from the crisis, for good fundamental reasons – young consumers in hundreds of millions, and governments following ambitious infrastructure plans (in turn), driving demand for commodities.

Christopher Wood: Recovery is partly driven by the hope of a US restocking cycle and partly by the fact that Asia and emerging markets in general are becoming more domestic-demand driven.

William: We are in the midst of a historic shifting of economic power globally from a worn-out, complacent, over-leveraged, demographically challenged and decrepit West to a youthful, striving, high savings and increasingly well educated and confident Asia eager to take its place at the top table internationally.

Emerging markets cannot decouple completely in a globally integrated world but they do have greater flexibility to develop their own internal markets – as we have seen with the Chinese stimulus programme. This growth of emerging markets at the expense of the West is the story of the next 50 years.

Anthony: Let’s focus on China especially for a moment since that is where most of the action continues to be. How do you see prospects in the China market?

Mark: Excellent. Chinese stocks have already gone up a lot and they will correct downwards but that will be temporary.

Robert: I remain bullish on China. Their macro-economic planning and management during the crisis continues to defy the Western pundits. They have plenty of cash (US$2 trillion reserves) and plenty of confidence. The younger generation will consume and borrow more. Economic relations with Taiwan improve. Overseas trade will recover. The renminbi is internationalising.

Jesper: China is one of the countries most exposed to rising cost pressures. Profit margins are already very thin, competition keeps intensifying across most sectors, and skilled labour is scarce. The key to success in the Chinese equity market will be an intense focus on stock selection – the gap between winners and losers is poised to widen sharply.

We will see the rise of true multinationals from China, true global players who do not just manufacture, but actually control the distribution channels and branding across the globe. These will be the real winners emerging from China over the next couple of years.

Ernest: China took aggressive measures to increase bank lending which in turn supported a strengthening of the stock market and is producing what looks like the start of a bubble, which the authorities are now trying to contain.

The Chinese government’s stepping up bank lending was necessary but it’s time for the excessive lending to be scaled back now. China’s stimulus adds its own risk, including those of asset bubbles, overcapacity and non-performing loans.

Christopher: It is possible that the Chinese economy will grow by around 9 per cent in the second half of this year, after 7.1 per cent (year on year) growth in the first half of the year, due to surging public-sector and private-sector fixed-asset investment and resilient consumption. This assumes no real recovery in the West and a negative contribution to growth in terms of net exports. I am still overweight on China equities.

Eisuke: China will continue to grow at a fairly high rate of 7 or 8 per cent for some years to come and next year I think that China will be number two in terms of GDP.

That is only natural (because) China is a big country with a big population. China will need to emerge as a major economic power in the world.

William: The Chinese stimulus programme has been successful but the question is whether it is sustainable. It has involved a rapid expansion of bank balance sheets that could result in substantial losses a few years from now. As long as China’s export markets stabilise then China’s growth rate can be maintained at levels well above the West’s rates. China recognises the old reliance on exports must change and it will. The real question is how fast that transformation can occur. Chinese equities have had a great run and are overdue for a breather but they have a core position in any long-term growth portfolio.

Anthony: Let’s turn to wider issues. Is the world facing a risk of inflation as a consequence of all the liquidity that has been injected into economies, or deflation because of the global recession?

Eisuke: The global inflation threat is almost zero but there are some asset bubbles. If you think in terms of prices of goods, inflation fear is groundless but in terms of the prices of assets, there is a danger of bubbles in China, and even in Japan and the US. I don’t think there will be hyper-inflation.

Robert: I expect inflation to rise within 12 months. Deflation is politically unacceptable in Western democracies and monetising debt is the only way out. This is very bearish for government bonds but mildly bullish for equities, property, and commodities, provided that inflation remains below 10 per cent.

William: We have been printing money like never before: the Fed’s monetary base more than doubled in three months in late 2008. However, this has been going to fill up the black holes in balance sheets created by the credit implosion and velocity has dropped sharply. As a consequence it has yet to create inflation.

As things stand, we still need more quantitative easing and ultimately we need some inflation to reduce the real burden of our excessive debts. Renewed inflation would most likely come from currency depreciation especially the dollar which looks very weak at present and headed further south, possibly disastrously. I believe US government bonds are unattractive under such circumstances, selected equities are relatively more attractive, especially emerging markets on pull backs, as well as some commodities, including gold, silver and oil. Income producing property should also be attractive after the falls of the last two years.

Christopher: The risk in America and the West remains deflation. There remains almost zero evidence of re-leveraging in America.

Mark: Inflation is good for equities but not for bonds because bond rates must go up. Depending on how fast the money supply brakes are applied then the impact on equities could be positive or negative.

Anthony: While we’re talking about inflation, the gold price continues its upward climb. Where is it headed and why?

Mark: Gold has probably already discounted a lot of inflation expectations but when hyperinflation hits then gold could move much higher.

Robert: Gold is going to a minimum of US$2,000 an ounce by 2011, in my view, for all the reasons above. World money supply has doubled in the last two years. No new gold supply, plus dwindling faith in ‘fiat’ currencies all around the world. Neither the dollar, nor the yen, nor the Euro will fill the bill.

Christopher: I maintain a long-term bullish view on gold bullion, with my long-term target price set at US$3,360 an ounce.

William: Gold has been tracing out a huge consolidation pattern since it first crossed the US$1,000 mark in March 2008. The demand for physical gold has been huge during this period of financial crisis as gold performs its familiar role of asset of last resort as governments around the world have engaged in unprecedented levels of quantitative easing. I am looking for a significant breakout to higher prices in the coming months: US$1,200 by the end of the year is not impossible with higher prices next year.

Jesper: Gold is the best hedge we have to the principal risk, which is inflation; so I like gold and also inflation linked bonds as a hedge.

Ernest: Psychology is the driving force behind the price of gold. Unless you have a clear idea who is going to come and rescue your portfolio of paper investments, owning gold and silver is important. Gold is still the only asset class which has risen in price every year since 2001. In fact, it is a bargain for gold to be selling for less than US$1,000 per ounce!

Anthony: In conclusion, what could go wrong to derail the present recovery?

Mark: Money supply has had fed the markets. Excess money supply begets inflation and that is what could go wrong but that is something we don’t have to worry about for probably another year.

Robert: The only real problem I see is the high level of European government debt, which should not affect Asian markets.

Christopher: What can go wrong, and will go wrong, is that Western growth will remain anaemic in 2010 as a result of continuing de-leveraging.

Jesper: The biggest threat is inflation; if we get a new round of cost-push inflation we would be forced to call for a negative earnings cycle coming as soon as 2011. Another big threat is protectionism. Personally, I am hopeful this threat is low; I am very encouraged by the well coordinated response we have had to the global financial crisis, which suggests that global policy makers actually act rationally.

William: Many problems have been swept under the carpet and so a sustainable recovery to former growth rates does not seem to be on the cards for the US, the EU and Japan. The de-leveraging process still has a way to go and consumers, especially, have to continue to rebuild their balance sheets. Governments will have to restrain their expenditures and increase taxes, which will be neither easy nor popular.

Central banks also have to walk a fine line between taking away the punchbowl of quantitative easing and creating the fuel for future large scale inflation.

Ernest: There are two major things that could go wrong – the commercial property mortgage market and stimulus spending which could cause a bubble. Years of loose monetary policy has fuelled a dangerous credit bubble, leaving the global economy more vulnerable to another 1930s-style slump than generally understood.

Throwing billions of stimulus dollars at the banks is unlikely to produce a healthy economy because households are broke. At best, it may only lead to a temporary pickup in growth. Stimulus packages around the world are ultimately going to cause more damage than they prevent. These packages have simply delayed the coming downturn, and by adding significant numbers to the massive debt bubbles of the world’s nations, will ultimately make the downturn worse than had governments not injected massive amounts of money into the economy.

When the (current) debt bubble bursts, the world will enter a serious downturn. The bailout is much bigger than the dot-com and real estate bubbles which hit speculators, investors and financiers the hardest. When the ‘Bailout Bubble’ explodes, the system goes with it because neither the US President nor the Federal Reserve will have the fiscal fixes or monetary policies available to inflate another bubble.

European Economic Recovery – The ECB May Have Got It Right

I have read a number of articles and research report which throw darts at the European Central bank for not being more aggressive with ‘quantitative easing’ and stimulus efforts. These latest reports indicate to me that the ECB may have played it ‘just right’. I know it won’t be clear sailing from here, and that the European recovery will still have some bumps, but the ECB left some powder dry and will be able to step in again if needed. And if the recovery sticks in Europe, the ECB won’t have near as much manufactured liquidity to pull in from the markets.

And I’m sure some readers will question how I can trumpet the recovery in Europe while at the same time believing the recovery here in the US won’t have legs. The main difference is what is fueling these recoveries. While many, including your current Pfennig writer, are in the opinion that the nascent recovery here in the US has mainly been driven by government stimulus; you can’t say the recovery in Germany and France is being driven by government intervention. Digging into the recent positive data here in the US shows the government is responsible for most of the spending; the private sector has largely stayed on the sidelines. The recovery in Europe, on the other hand, is being fueled by increased consumer confidence and internal private sector demand. In fact, many of the dollar bulls have continually chastised the European governments for not taking a more aggressive role in providing stimulus to their economies.

England and the US have yet to feel the inflationary impact of their budget busting ‘quantitative easing’ programs; but believe me, inflation is lurking just around the corner. While the US’s Bernanke and UK’s Darling have chosen to ignore the future consequences of these programs, Trichet and the ECB always kept a hawkish eye looking toward the future.

Chris Gaffney, CFA
Vice President
EverBank World Markets

Fall of the West

Fall of the West

Neville Bennett

Is the West in long time decline relative to the rest of the world? I believe it is, and will indicate some sources bearing that out. It is not a new question for me as in my youth I enjoyed reading Toynbee, Spengler and others.

Many of my generation received a broad liberal education at a state grammar school. Science was very strong at my school, where many friends later became engineers, but we were all taught to love literature, art, music (you had to play an instrument), history and 5 years of at least two languages. At school we debated the rise and fall of Rome, plus the British and other Empires.

West below 50% world GDP

“The Greater Depression (NBR 12 June ) has accelerated the decline of Western GDP of 60% to 64% of global GDP over 1995-2004. A British think-tank, CEBR, had earlier forecast 2015 as the date when the West’s GDP would go below 50% of world GDP, but the credit crunch and changes in foreign exchange has brought the date forward from 2015 to 2009. Defined as US, Canada and Europe, the West’s share of global GDP is predicted to decline further to 45% by 2012.

The report identifies an inventory-led recovery conforming to my bullish attitude to oil and metals (NBR May 29). They predict some bounce in 2009, but in 2010 recovery will be held back by fiscal retrenchment and the impact of structural deleveraging. They conclude, the West “has to get to grips with the fact that we are no longer dominant and cannot expect to have things our own way”. China’s recovery is having a marked effect on oil and commodities.

Oil as an indicator

Crude oil prices have increased by 120% since February, at a time when the IMF confirms a recession in the world economy. Normally, falling crude prices would be expected. Actually, the price is about $72 p.b. and the futures market is predicting $88. So the prices defy “demand destruction”, or the idea that price rises lower demand. BP’s statistical review has shown that for the first time in history, emerging market demand has outstripped the West’s. This is significant in our oil-based civilization.

Until now traders have tended to look at US conditions for oil market leads. Henceforth, Western demand can slump while overall consumption is rising. Perhaps this is one reason why oil prices are strong now. 2008 oil consumption fell in the US by 6.4%; in the BRICs consumption grew y-o-y by 3.3% in China, 4.8% in India, 5.3% in Brazil, and 3.1% in Russia.

The BRICs

The BRICs now muster 20% of global GDP, about the same as the USA. These are rapidly changing societies with a large propensity to consume oil and commodities. Presumably their oil demand will burgeon, as industrialization proceeds at pace. One tends to think of them as financially undeveloped, but they have at least one huge advantage: they save.

Collectively their currency reserves are half of the global total. A recent Telegraph article said G7’s reserves’ (excluding Japan) has only 6% of world reserves. This makes it a little odd that the US dominates the IMF, World Bank etc. How can that last?

The BRIC’s are holding their first formal summit this week in Yekaterinburg, Russia. Curious that it gets little reported because the BRICs could stop lending the West money and deepen the recession. Their agenda includes ways to reshape the financial system and perhaps produce a new reserve currency. The Brazilian President wants the BRICs “change the political and trade geography of the world”.

The Chinese premier arrived as I went to press. I imagine that China will be much less confrontational than Brazil and Russia. China holds the most US Treasuries and does not want to undermine the dollar. It merely wants to supplant the USA as the world’s biggest economy, as it may do in 20 years.

World Economic Forum

Readers may recall an earlier article in which I outlined the briefing for the upcoming Davos meeting. The article specifically questioned the western model of development, and adopted the spirit of Asian capitalism with stronger central direction, saving and heavy capital investment. The report went beyond extending current trends and explicitly discussed “critical uncertainties”, and “potential discontinuities”. It also stressed rapidly shifting geo-economic power. (NBR Jan 23). Changing demography is a factor: “western” populations are shrinking, but emerging country populations are not.

Philosophers: Oswald Spengler

Spengler insisted in the 1920’s, when he was extremely influential, that we were living in the winter time of the Faustian civilization. His description of the Faustian civilization is where the populace constantly strives for the unattainable—making the western man a proud but tragic figure, for while he strives and creates he secretly knows the actual goal will never be reached. His “unattainable” is materialism.

Spengler asserted that democracy is simply the political weapon of money, and the media is the means through which money operates a democratic political system. Politics becomes an unprincipled struggle for executive power. Instead of conversations between men, the press and the “electrical news-service keep the waking-consciousness of whole people and continents under a deafening drum-fire of theses, catchwords, standpoints, scenes, feelings, day by day and year by year.”

Philosopher: Arnold Toynbee

Toynbee wrote magnificent Annual reports during the 1930’s are which I often set as required reading for graduate students. I had the joy once of meeting him. He dropped into Hong Kong University and asked if he could help. I took him to a tutorial, where unforgettably he raged against the state but lauded the polis (city).

Toynbee predicted the decline of the west. All civilizations are surrounded by peripheral countries of greater resources. Once the periphery absorbs the civilizations superior technology, especially military technology, it conquers.

Conclusion

Two centuries of western dominance has passed. The emerging world has caught up in terms of development. The West still has cutting-edge technology and military power, but it is being challenged on every front.

Treasury Bonds – Private Buyers Pulling Out, Leaving Foreign Powers as Buyers of Last Resort.

By Ambrose Evans-Pritchard
The Telegraph, London
Sunday, May 24, 2009

The U.S. Treasury is facing an ordeal by fire this week as it tries to sell $100 billion of bonds to a deeply sceptical market amid growing fears of a sovereign bond crisis in the Anglo-Saxon world.

The interest yield on 10-year U.S. Treasuries — the benchmark price of long-term credit for the global system — jumped 33 basis points last week to 3.45 percent on contagion effects after Standard & Poor’s issued a warning on Britain’s “AAA” credit rating.

The yield has risen over 90 basis points since March when the U.S. Federal Reserve first announced its controversial plan to buy Treasury bonds directly, a move designed to force down the borrowing costs and help stabilise the housing market.

The yield spike may be nearing the point where it threatens to short-circuit economic recovery. While lower spreads on mortgage rates have kept a lid on home loan costs so far, mortgage rates have nevertheless crept back up to 5 percent.

The Obama administration needs to raise $2 trillion this year to cover the fiscal stimulus plan and the bank bail-outs. It has to fund $900 billion by September.

“The dynamic is just getting overwhelming,” said RBC Capital Markets.

The U.S. Treasury is selling $40 billion of two-year notes on Tuesday, $35 billion of five-year bonds on Wednesday, and $25 billion of seven-year debt on Thursday. While the U.S. has not yet suffered the indignity of a failed auction — unlike Britain and Germany — traders are watching closely to see what share is being purchased by U.S. government itself in pure “monetisation” of the deficit.

Don Kohn, the Fed’s vice-chair, said over the weekend that Fed actions would add $1 trillion of stimulus to the US economy over time and had already prevented “fire sales” of assets.

“The preliminary evidence suggest that our programme has worked,” he said.

The U.S. is not alone in facing a deficit crisis. Governments worldwide have to raise some $6 trillion in debt this year, with huge demands in Japan and Europe. Kyle Bass from the U.S. fund Hayman Advisors said the markets were choking on debt.

“There isn’t enough capital in the world to buy the new sovereign issuance required to finance the giant fiscal deficits that countries are so intent on running. There is simply not enough money out there,” he said. “If the U.S. loses control of long rates, they will not be able to arrest asset price declines. If they print too much money, they will debase the dollar and cause stagflation.

“The bottom line is that there is no global ‘get out of jail free’ card for anyone,” he said.

The U.S. is acutely vulnerable because it relies heavily on foreign goodwill. China and Japan alone hold 23 percent of America’s $6,369 billion federal debt. Suspicions that Washington is trying to engineer a stealth default by letting the dollar slide could cause patience to snap, even if Asian exporters would themselves suffer if they harmed their chief market.

The dollar has fallen 11 percent against a basket of currencies since early March. Mutterings of a “dollar crisis” may now constrain the Fed as it tries to shore up the bond market. It has so far bought $116 billion of Treasuries as part of its “credit easing” blitz, out of a $300 billion pool.

When the Fed first said it was going to buy Treasuries in March the 10-year yield to dropped instantly from 3 percent to near 2.5 percent, but the shock effect has since worn off. Any effort to step up purchases might backfire in the current jittery mood.

In the late 1940s the Fed was able to cap the 10-year yield at around 2 percent, but that was a different world. The US commanded half global GDP and had a colossal trade surplus. The Fed could carry out its experiment without worrying about foreign dissent.

Fed chair Ben Bernanke has long argued that central banks can bring down long-term borrowing rates by purchasing bonds “at essentially no cost.” His frequent writings rarely ask whether foreign investors — from a different cultural universe — will tolerate such conduct.

Mr Bernanke is betting that under a floating currency regime there is no risk of repeating the disaster of October 1931, when the Fed had to raise rates twice to stem foreign gold withdrawals, with catastrophic consequences. This assumption may be tested.

It is not clear where the capital will come from to cover global bond issues. Asian central banks and Mid-East oil exporters have cut back on their purchases of US and European bonds as reserve accumulation slows. Russia has slashed its holding by a third to support growth at home. Even Japan’s state pension fund has become a net seller of bonds for the first time this year as the country’s population ages.

Japan’s public debt will reach 200 percent of GDP next year. Warnings by the Japan’s DPJ opposition party that, if elected this autumn, it would not purchase any more U.S. debt unless issued in yen is a sign that the political mood in Asia is turning hostile to U.S. policy.

There is no evidence yet that foreigners are in the process of dumping U.S. Treasuries. Brad Setser from the U.S. Council on Foreign Relations said global central banks added $60 billion to their U.S. holdings in the first three weeks of May.

This is bittersweet for Washington. It suggests that private buyers are pulling out, leaving foreign powers as buyers of last resort.

We just have to hope that G20 creditors agree to put a clothes peg on their nose and keep buying Western debt until the crisis passes, for the sake of the world.

Inflation… Deflation… Gold

By Ambrose Evans-Pritchard
The Telegraph, London
Saturday, May 23, 2009

The world’s top hedge fund manager, John Paulson, has built a gold position of at least $5.5billion, the biggest such move since George Soros and Sir James Goldsmith bet on Newmont Mining in 1993.

Britain has become the first of the Anglo-Saxon “AAA” club to face a downgrade. As feared, the cancer of bank leverage is spreading to sovereign cores.

Gold prices tend to slide in late May and languish through the summer, because of the seasonal ups and downs of jewellery demand. The trader reflex would be to short gold at this stage after its $90 vault to $959 an ounce over the past month. They may think again this year.

Paulson & Co. has bought $2.9 billion in SPDR Gold Trust, the biggest of the gold exchange-traded funds (ETFs), which now holds 1,106 tonnes — three times the Brown-gutted reserves of the United Kingdom.

Mr Paulson has also built up a $2.3 billion holding of Anglo Ashanti, Goldfields, Kinross Gold, and Market Vectors Gold Miners. The fact that he is launching a “Paulson Real Estate Recovery Fund,” reversing the bet against sub-prime securities that made him rich, tells us all we need to know about his thinking. This is a liquidity-reflation play.

He may be wrong, of course. In his early 50s, he belongs to the baby-boom cohort most psychologically vulnerable to the 1970s “paradigm error.” And perhaps he has never lived in Japan.

It is striking how many of those most alert to the deflation danger are either veterans of Japan’s Lost Decade or close students of it: Albert Edwards at Societe Generale, Russell Jones at RBC Capital, Nobel laureate Paul Krugman, the Fed’s Ben Bernanke, and Athanasios Orphanides, who helped draft the Fed’s study on the Japan trap.

“People always thought Japan’s bond yields had to rise, but they kept falling and Japan is still not really out of deflation,” said Mr. Edwards. Indeed, 20 years after the Nikkei peaked at over 39,000 it stands today at 9,280. Interest rates are 0.01 percent. The yield on two-year state bonds is 0.34 percent. Still there is not a whiff of inflation.

A number of readers have written to me in tones of polite reproach asking why I fret about deflation when governments everywhere are spending and printing as if there was no tomorrow. I admit to being tortured by self-doubt, like others grappling with this extraordinary situation.

What we know is that inflation is already negative in Ireland (-3.5 percent), China (-1.5 percent), Thailand (-0.9 percent), Korea (-0.5 percent), U.S. (-0.7), Japan (-0.3), Switzerland (-0.3), Spain (-0.2). The eurozone may be negative by July. Alistair Darling said Britain’s retail RPI inflation used to set wage deals will be minus 3 percent by September.

Does this constitute deflation in a meaningful sense? Not yet, perhaps. But it is moving too close for comfort in a world stretched by extreme leverage. The economies of the U.S., Japan, the eurozone, and Britain have been contracting in “nominal” as well as “real” terms — which smacks of the 1930s.

The “yen GDP” of Japan has shrunk by 10 percent in one year; the “euro GDP” of Germany has shrunk 6.2 percent, and Italy’s by 4.7 percent; the “dollar GDP” of the U.S. has shrunk 3.3 percent. Debts are not shrinking, however.

GMO’s Jeremy Grantham says in his latest note, “Last Hurrah And Seven Lean Years,” that the market value of equities, houses, and commercial property in the US reached $50 trillion in the boom. This “perceived wealth” sustained $25 trillion of debt.

The crash has cut this wealth to $30 trillion, but the debts are still there. America’s debt-gearing has exploded, as it has in the U.K. and Europe. This looks awfully like Irving Fisher’s “debt deflation” trap of 1933. It will be a long slog for households to bring their debt-to-wealth ratios down to manageable levels.

You can argue — as do UBS, Merrill Lynch, ING, and Capital Economics, to name a few — that massive global stimulus is merely struggling to offset a massive deflationary shock.

So how will gold fare in a “Japanese” stalemate world where neither inflation nor deflation gets the upper hand? The eight-year rally that has lifted gold from $254 to $959 may lose momentum for a while.

“The air is getting thin up here,” said John Reade, precious metals guru at UBS. “Rich investors are no longer rushing out to buy gold bars as they did after the Lehman collapse. Still, we think it is highly significant that both China and Russia — two of the biggest holders of foreign reserves — are both buying gold,” he said.

Personally, I remain a gold bug out of fear that the most corrosive phase of this crisis lies ahead. There are two more boils to lance: Europe and China. As the International Monetary Fund keeps telling us, Europe’s banks are still covering up their vast toxic debts. Nor has the G20 begun to address the root cause of the global crisis, which lies in excess exports from East (aided by currency manipulation) to an overspending West. China is putting off the day of reckoning with its crisis response, which is to build yet more plant to flood the world with yet more overcapacity.

For “political bears” the risk is that the EU polity fragments under strain and that governments restrict basic markets to defend themselves — whether by imposing exchange controls to stop bond flight, or shutting derivatives markets used as hedges, or putting up trade barriers. We will find out if and when unemployment hits 10 percent in America, 12 percent in Germany, and 20 percent in Spain, or if migrant workers rampage in Shenzhen.

Some call this the “Armageddon case” for gold. That is going too far. However, gold has outperformed Wall Street’s S&P 500 index by 500 percent so far this century, as if able sniff out trouble in advance. Such runs tend to finish with a “parabolic” blow-off before they die. Mr Paulson may yet make another fortune, whatever his reason.

Duke/CFO Global Business Outlook Survey Results

I just participated in the latest Duke University CFO Magazine Global Business Outlook Survey, and received advance notification of the results.

Following is an extract of key survey results:

CFOs express record or near-record pessimism. On a scale of 0 to 100, U.S. CFOs rate the economic outlook at an all-time low of 40. European and Asian CFOs are similarly pessimistic, rating their economies at 43 and 47, respectively, on a scale of 0 to 100.

Only 35 percent of CFOs say the U.S. economic recovery will begin in 2009, with most CFOs expecting recovery to begin in 14 months. European (16 months) and Asian CFOs (13 months) also expect the recession to last well into 2010.

Domestic employment is expected to fall in the U.S. (5.6 percent reduction), Europe (7.6 percent reduction), and Asia (3.2 percent reduction) over the next year. In addition to layoffs, a majority of firms report wage freezes or cuts, as well as reductions in hours worked.  

Nearly 60 percent of U.S. companies indicate they will institute a hiring freeze for the next year. In addition, 57 percent will enforce a wage freeze or reduction, with one in five companies expecting to reduce wages over the next year. Even for those employees who keep their jobs, 39 percent will work fewer hours per week.

Nearly two-thirds of European companies indicate they will institute a hiring freeze over the next year, and 57 percent will freeze or reduce wages. Almost one-third of companies say they will reduce work hours for remaining employees. More than 60 percent will reduce their workforce, with the average reduction among those firms being 9 percent.

More than two-thirds of Asian firms plan a hiring freeze for the next 12 months. Sixty-three percent plan a wage freeze or wage reduction. In addition, 30 percent of Asian CFOs say their firms will reduce the hours worked by employees who retain their jobs.

More than two-thirds of Chinese companies will impose a hiring freeze this year, and 30 percent will reduce wages. One-third will reduce the hours worked by retained employees.

Weak consumer demand and financial market woes are major external concerns for CFOs around the world. Working capital management is a primary internal concern, as is maintaining employee productivity and morale.

Credit market turmoil is still buffeting the corporate sector, with the effects much worse on companies with poor credit ratings. About 40 percent of companies rated AAA or AA indicate credit market conditions are hurting their firms. Among companies rated B or lower, 77 percent say they have been hurt.

U.S. Companies rated B or lower have nearly maxed out credit lines, drawing on average 70 percent of the maximum. AAA and AA rated firms, in contrast, have drawn only 27 percent of the maximum. Among Chinese companies with bank lines of credit, the average firm has drawn 56 percent of the maximum allowed.

Fifty-eight percent of European CFOs report problems with suppliers, ranging from 40 percent of suppliers being unable to obtain trade credit or bank financing to 21 percent of companies having a supplier go out of business.

Fifty-five percent of Asian CFOs report problems with suppliers, with many not receiving enough order volume to be viable. This has led to a consolidation of orders with stronger suppliers at nearly half of Asian firms.

Forty-six percent of Asian CFOs expect their own country’s economy to begin to recover in 2009, and another 29 percent expect the recovery to begin in the first half of 2010.

Al Walsh, Owner/Founder

Walsh Enterprises, Business Advisors

Huntington Beach, Ca

http://www.awalsh.us