Debt Rattle, July 7 2008: A monkey with an abacus

Dorothe Lange Granville County July 1939
Tenant farmers and tobacco barn in Granville County, North Carolina

Ilargi: Economists are monkeys with an abacus. Reporters are apes with a typewriter. G8 leaders are dung beetles with their fingers on the trigger. So what’s new? The level of incompetence amongst experts, analysts and politicians is rivaled only by the lack of intelligence, compassion and self-knowledge prevalent in the general public. If you ask me, that’s a pretty perfect fit. You get what you deserve.

If we were to stop listening to the most accomplished liars in our midst, we might be forced to stop lying to ourselves. And if there’s one thing I’m sure off, it’s that we can’t face the truth. We are not capable of anything more than buying a different light-bulb or a greener car.

No matter that, if we were to have a chance in hell of minimizing the suffering we have created with our own bare hands, we’d have to cut our consumption of every single product that shapes our lives, by 90%. We will not do that. And we’ll come up with a reason not to. We’re good at that.

Against all rational odds, we’ll convince ourselves that buying a lightbulb is a step towards saving the planet (every bit counts), that a 10% decrease in consumption is quite a daring step, that there is still time left, that we need 90% of what we have, that others need to do more, that the economy will rise again, as it’s always done, after a "cyclical" downturn, that the economy needs to grow, or else.

And we’ll bitch about a 10-cent rise in gas prices on our 100-mile commute, about not being able to buy our home in the burbs, about our chosen leaders having an 8-course meal while discussing millions of starving children. That way, we don’t have to face up to the fact that we’re using, each and everyone of us, 100 or 1000 times more of everything than we should be.

We are a lost species, because our main talents are lying and killing, not kindness and intelligence. It’s just that we are good at lying about that too.


It hasn't gotten cleared up at all

Twenty years ago, Ted Forstmann contributed a scathing – and prescient – op-ed to this newspaper warning that the junk-bond craze was about to end badly: "Today's financial age has become a period of unbridled excess with accepted risk soaring out of proportion to possible reward," he wrote in October 1988.

"Every week, with ever-increasing levels of irresponsibility, many billions of dollars in American assets are being saddled with debt that has virtually no chance of being repaid." Within a year, the junk-bond market had collapsed, and within 18 months Drexel Burnham Lambert, the leading firm of the junk-bond world, was bankrupt. Mr. Forstmann sees even worse trouble coming today.

"We are in a credit crisis the likes of which I've never seen in my lifetime," Mr. Forstmann warns. He adds: "The credit problems in this country are considerably worse than people have said or know. I didn't even know subprime mortgages existed and I was worried about the credit crisis."

Mr. Forstmann denies being an expert in the capital markets. But he does have some experience with them. He was present at the creation of the private-equity business. The firm he co-founded, Forstmann Little, rode the original private-equity boom in the 1980s while skirting the excesses of the junk-bond craze in the later years. It was for a time the most successful private-equity firm in the world, renowned for both its outsize returns and its caution.

For two years after Mr. Forstmann wrote his 1988 op-ed, Forstmann Little sat on $2 billion in uninvested funds, waiting for the right opportunities. Savvy investments in Dr. Pepper and Gulfstream, among others over the years, helped make Mr. Forstmann a billionaire. These days, he devotes most of his professional attention to IMG, the sports and entertainment agency. But the economy has him worried.

Mr. Forstmann's argument about the present crisis starts with the money supply. After Sept. 11, 2001, the Federal Reserve pumped so much money into the financial system that it distorted the incentives and the decision making of everyone in finance. He illustrates this with what he calls his "little children's story": Once upon a time, when credit conditions and the costs of borrowing money were normal, the bank opened at 9:00 a.m. and closed at 5:00 p.m.

For eight hours a day, bankers made loans and took deposits, and then they went home. But after 9/11, the Fed opened the spigot. Short-term interest rates went to zero in real terms and then into negative territory. When real interest rates are negative, borrowing money is effectively free – the debt loses value faster than the interest adds up. This led to a series of distortions in the financial sector that are only now coming to light.

The children's story continues: "Now they [the banks] have all this excess money. And they open at nine, and from nine to noon or so, they're doing all the same kind of basically legitimate things with it that they did before." So far, so good. "But at noon, they have tons of money left. They have all this supply, and the, what I would call 'legitimate' demand – it's probably not a good word – but where risk and reward are still in balance, has been satisfied.

But they're still open until five. And around 3:30 in the afternoon they get to such things as subprime mortgages, OK? And what you guys haven't seen yet is what happened between noon and 3:30." Straightforward economics tells us that when you print too much money, it loses value and prices go up. That's been happening too. But Mr. Forstmann is most concerned with a different, more subtle effect of the oversupply of money.

When it becomes too plentiful, bankers and other financial intermediaries end up taking on more and more risk for less return. The incentive to be conservative under normal credit conditions is driven in part by what economists call opportunity cost – if you put money to use in one place, it leaves you with less money to invest or lend in another place. So you pick your spots carefully.

But if you've got too much money, and that money is declining in value faster than you can earn interest on it, your incentives change. "Something that's free isn't worth much," as Mr. Forstmann puts it. So the normal rules of caution get attenuated. "They could not find enough appropriate uses for the money," Mr. Forstmann says. "That's why my little bank story for the kids is a fun way to put it.

The money just kept coming and coming and coming and coming. What are you going to do with it? IBM only needs so much. The guy who can really pay his mortgage only needs so much." So you start thinking about new ways to lend the money, which inevitably means riskier ways. "I don't know when money was ever this inexpensive in the history of this country. But not in modern times, that's for sure."

Mr. Forstmann has been around a long time, so he's seen a lot. But is it possible that he's simply fallen behind the times? By his own description, he's a bit of a figure from another age – "a bit like Wyatt Earp in 1910." But it would be a mistake to dismiss Mr. Forstmann's pessimism too quickly. After all, he knows something about both credit and crises.

"You've got Paulson saying 'Oh, you see the good news is it's over.'" The problem, according to Mr. Forstmann, is that it's far from over. "I think we're in about the second inning of this." And of course, the credit crisis wasn't even supposed to last this long. "This all started in August [of 2007], and it was going to get cleared up by October. It hasn't gotten cleared up at all."

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Ilargi: Mr. Mortgage predicts IndyMac wlll fall today. That is $10s of billions in one day. That should shake a few heads.

IndyMac: Is This the End? Finally!

Note: At this point in time this story is RUMOR as is has not been made official by IndyMac or regulators. I am reporting it from what I have been personally told by people familiar with the matter. And I am not short this stock or trying to start rumors to drive down the price. How much further can it drop! Its at 67 cents. Just remember that when stories like this have come out in the past, there is a flurry of positive spin and in the end, 99.9% are true.

My sources put regulators at IndyMac this weekend doing the deed. I am being told an announcement will come tomorrow first thing, that IndyMac is no more and at least their wholesale operation is gone effective immediately. I would make sense that retail would be included as well, but I wholesale was the only operation referred to.

Apparently wholesale sales and operations will get pink slips, no new loans will be locked and all existing loans in the pipe must be closed by the end of July. I can’t imagine a ‘buyer’ would step up to the plate at this point in time, as in the case of Countrywide, because there is not another Gov’t shill as large as BofA to take her over.

IndyMac sits atop 10s of billions in the most toxic of all loans, Pay Option ARMs, HELOCs and subprime. Much of these are on lines or have been borrowed against from the likes of the Federal Home Loan Bank of Atlanta, which in a fit of generosity and stupidity in Q3/Q4 2007 took Pay Option ARMs as collateral before Schumer made a stink. They got suckered into the Pay Option ARMs ‘investment grade’ ratings as well.

It’s truly unbelievable how Pay Option ARMs fooled the smartest guys in the room for the longest period of time. The easiest trade in the entire mortgage implosion universe was to short the Pay Option lenders when the subprimes were initially collapsing. They included but are not limited to: AHM, IMB, CFC, WM, WB, DSL, BKUNA and FED. Look at the 12-month charts.

Pay Options were hoarded by banks trying to drive profits due to the fact that borrowers with better than average credit score had an effective rate as high as 10% when the underlying indices surged and remained elevated until recent quarter. Then as these loans became virtually worthless in the marketplace mid 2007, lenders were stuck with unusually large percentages of these vs other loan types on the books.

The big sucker punch with these loans is that approx 80% of borrowers make the minimum monthly payment of 1% to 3.95% depending on the lender. The difference between the real interest rate and the minimum payment rate is called ‘negative amortization’, which the lender gets to book as revenue. So, for example the lender is booking the fully indexed payment of $5k per month but 80% of borrowers only make a payment of $2500 per month.

This phantom income (called deferred interest, CINA etc) is booked as revenue because in theory banks get it back when they foreclose and sell the property. NOT! This was fine and dandy until property values in the bubble states where these loans are most prevalent crashed 30% in the past 12 months. Now, lender can’t get it back so eventually there will be massive earnings restatements for income booked that was never received and will never be received.

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Ilargi: The Resolution Trust Corporation (RTC) gets a mention; what happens when the FDIC "guarantees" become laughably inadequate?

Wiki: According to Joseph E. Stiglitz in his book, Towards a New Paradigm in Monetary Economics, the real reason behind the need [for RTC] was to allow the United States government to subsidize the US banking sector in a way that was not very transparent and therefore avoid possible resistance from people opposed to the plan. This is supported by the fact that the banks had better information relating to the loans than the RTC.

Men in Black at IndyMac?

New York Senator Chuck Schumer caught some flack last week for leaking his concerns about IndyMac to the press. Perhaps imprudent, but probably prescient. The FDIC is certainly looking very closely at the bank’s books after a mini bank-run last week.

At $16.5 billion, IndyMac’s insured deposit base is far larger than the combined total of other failed banks rescued by the FDIC so far this year. And the FDIC’s total liquid assets were only $51 billion at year end, of which only $4.2 billion was cash. (for details, see the balance sheet on page 63 of their 2007 annual report). As banks drop like flies this year and next, its likely the FDIC will quickly run out of funds to pay depositor losses. The RTC may get an encore…

IndyMac’s insured deposits grew 91%(!) in the year ending March 31st. As their equity has been hit by massive losses, and as “other” sources of financing have dried up, IndyMac has plugged the holes with new consumer deposits. They are attracting these deposits despite their questionable financial condition by offering interest rates among the highest in the nation. [Incidentally, much of the increase in IndyMac's deposits are of the controversial "brokered" variety. These have more than tripled over the last year to $6.9 billion.]

Take a look at that list of banks offering the highest CD rates. Many are effectively insolvent, surviving only because they can sell risk-free U.S. government obligations. What is a federally insured deposit, after all, but an obligation of the U.S. government? Taken together, the insured deposits of all distressed deposit-taking institutions dwarf the FDIC’s available capital. Taxpayers will have to pick up the slack.

Other troubled banks besides IndyMac include Downey Financial, BankUnited, and Corus. These four have $37.4 billion of insured deposits between them. They do have assets that can be sold to pay back depositors, but most are adjustable rate mortgages ($28 billion between Downey, BankUnited and IndyMac) or loans to build condos ($7 billion at Corus).

BusinessWeek last week reported that default rates on Option ARMs may reach 50%. Loss rates on these will be very large, leaving little capital left to pay back depositors. Corus’s condo loans, most of which are in hard-hit states like California and Florida, will be worth even less. Most threatening to the FDIC, and by extension to American taxpayers, would be the failure of Washington Mutual.

WaMu has $144 billion of insured deposits alone. And $100 billion of adjustable rate mortgages. It’s not a stretch to think WaMu, concentrated as it is in California and Florida, could fail. If the FDIC can’t find someone to rescue WaMu the way BofA rescued Countrywide—and in this environment who would?—taxpayers will have a hefty tab to pick up.

Twain was right: history rhymes. The S&L scandal snowballed into a far larger bailout than it ever had to be because failing institutions continued to accumulate federally insured deposits for years after regulators recognized they were insolvent. Most of the S&L’s investments failed utterly, providing no cash to pay depositors’ interest.

Like any Ponzi scheme, the S&L’s often used funds raised from new deposits to pay the interest owed previous depositors. And, as author Martin Mayer pointed out in a 1982 NYT Op-Ed: “the weakest institutions offer[ed] the highest rates.” The same is true today.

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GM Weighs More Layoffs, Sale of Brands

Bruised by a deep sales slump and a half-century-low in its stock price, General Motors Corp. is preparing to cut thousands more white-collar jobs and is considering whether it should sell or shutter more of its brands, people familiar with the matter said.

Both moves are part of a broader re-evaluation of GM's strategy and of its ability to meet an internal projection of returning to profitability in 2010, these people said. The job cuts are likely to be approved when GM's board of directors meets in early August, these people said. Management may also present the board with options for raising additional cash to help GM make it through the downturn, they said.

The board will probably also hear management's latest thoughts on whether GM should trim the number of brands it offers in the U.S. The company currently sells vehicles under eight different brands, but most, including Buick, Saturn and Saab, struggle to attract buyers despite offering new models that cost GM billions of dollars to develop. The company has already decided to put its Hummer division up for sale.



Discussions among top executives about the number of brands have intensified in recent weeks, and signal a potential major shift in thinking by the company -- especially by Chief Executive Rick Wagoner. As top executives review future cars and trucks earmarked for various brands, "nothing is off the table," several people said. All but Cadillac and Chevrolet, which GM considers core to its business, are undergoing close scrutiny, other people said.

A restructuring marks not just another humbling of the nation's largest auto maker, but offers competitors a chance to steal market share. For decades, GM has believed a key to making money in North America was maintaining market share. Most GM executives have countered that having different brands helps the company reach more potential customers and gives it more tools in fighting the likes of Toyota Motor Corp.

They point to the company's closure of its Oldsmobile division earlier this decade, which left many of that brand's customers defecting to brands other than GM's. Critics have said keeping so many brands is a drain on resources and leaves many of its divisions competing with each other. Like GM, rivals Chrysler LLC and Ford Motor Co. have also hit hard times, but they have both concluded they need to become significantly smaller companies in order to generate healthy profits.

Ford, for example, has sold its Land Rover, Jaguar and Aston Martin brands and is considering putting Volvo on the market. Chrysler is cutting the number of models it offers by a third to a half, and acknowledges its U.S. market share is likely to shrink.

In the past few years, as GM has run up massive losses, some board members and some executives have on occasion raised questions about its plethora of brands, only to be rebuffed by Mr. Wagoner, people familiar with the matter said. As recently as February, Mr. Wagoner was publicly dismissing the idea of killing brands as "not a thoughtful discussion."

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The buck doesn't stop here; it just keeps falling

Things in the U.S. sure are tough. Brother, can you spare a euro? Signs saying "We accept euros" are cropping up in the windows of some Manhattan retailers. A Belgium company is trying to gobble up St. Louis-based Anheuser-Busch, the nation's largest brewer and iconic Super Bowl advertiser.

The almighty dollar is mighty no more. It has been declining steadily for six years against other major currencies, undercutting its role as the leading international banking currency. The long slide is fanning inflation at home and playing a major role in the run-up of oil and gasoline prices everywhere.

Vacationing Europeans are finding bargains in the U.S., while Americans in Paris and other world capitals are being clobbered by sky-high tabs for hotels, travel and even sidewalk cafes. Northern border-city Americans who once flocked into Canada for shopping deals are staying home; it's the Canadians flocking here now.

Everything made in America — from goods to entire companies — is near dirt cheap to many foreigners. Meanwhile, American consumers, both those who travel and those who stay at home, are seeing big price increases in energy, food and imported goods. The dollar has lost roughly a quarter of its purchasing power against the currencies of major U.S. trading partners from its peak in 2002.

Since oil is bought and sold in dollars worldwide, the devalued dollar has made the recent surge in energy prices even worse for Americans, leading to $4 gasoline in the United States. Analysts suggest that of the $140 a barrel that oil fetches globally, some $25 may be due to the devalued dollar. Further declines in the dollar will add to oil's appeal as a commodity to be traded. Oil, suggests influential energy consultant Daniel Yergin, is "the new gold."

The limp greenback has had one big benefit to the U.S. economy: Since it makes American goods cheaper overseas, it has helped manufacturers who export and other U.S. based companies with international reach. Exports have been one of the few bright spots in an otherwise darkening U.S. economy. Franklin Vargo, vice president of international economic affairs at the National Association of Manufacturers, welcomes the dollar slide, as do members of his organization.

"We can see that, when the dollar's not overpriced, that people around the world want American goods and our exports are going gangbusters now," he said. He doesn't see the dollar as undervalued. He sees it as having being overpriced in the 1990s — and what's happened since as something along the lines of a correction.

Still, Vargo acknowledges the dollar's decline has brought a measure of pain to some consumers. "As the dollar has gone down in value, that has added to the dollar cost of oil. No question. So having the dollar decline is not unambiguously a plus. That's why we say there's got to be a balance there somewhere. What we want is a Goldilocks dollar. Not too strong, not too weak. But just right. And only the market can determine that," Vargo said.

Mark Zandi, chief economist at Moody's Economy.com, said expanding exports due to a weak dollar are "an important source of growth, but it doesn't add a lot to jobs, it doesn't mean very much for the average American household. For the average American, for the average consumer, these are pretty tough times."

The loss of the dollar's purchasing power and international respect has some experts worrying that the euro might one day replace the dollar as the so-called primary reserve currency. And that could trigger a dollar rout as foreign governments and international investors flee from U.S. Treasury bonds and other dollar-denominated investments.

Making matters worse: The gaping U.S. current-account deficit — the amount by which the value of goods, services and investments bought in the U.S. from overseas exceeds the amount the U.S. sells abroad — and the low levels of domestic savings means that foreigners must purchase more than $3 billion every business day to fund the imbalance.

Since roughly half of the nation's nearly $10 trillion national debt is held by foreigners, mostly in Treasury bills and bonds, such a withdrawal could have enormous consequences. Yet Washington finds its options limited. President Bush asserts longtime support for a "strong" dollar, and made that point again Sunday in a news conference in Japan with Prime Minister Yasuo Fukuda.

"In terms of the dollar, the United States strongly believes — believes in a strong dollar policy and believes that the strength of our economy will be reflected in the dollar." But not once in his presidency has the U.S bought dollars on foreign exchange markets — called intervention — to help prop up the greenback.

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Commodities Regulator Under Fire

With oil at more than $140 a barrel, the real fireworks in Washington resume this week on one of the hottest issues in the global economy: whether speculation is contributing to the past year's doubling of crude-oil prices and should be curbed.

The House Agriculture Committee will host hearings examining whether the Commodity Futures Trading Commission has a strong-enough grip on the fast-growing, $5 trillion futures market for oil and other commodities or needs other tools. It also will examine how that market is affected by the $9 trillion "over-the-counter" market that has mushroomed outside CFTC regulation.

The committee has asked lawmakers to outline competing bills that could significantly reshape the commodities markets. In addition to calling for the collection of more-detailed trading data, some measures seek to ban pension funds from commodities; sharply increase the collateral required to make a trade; or limit the size of some investors' trades.

Meanwhile, the CFTC is scrambling to collect data from Wall Street firms by mid-July to rethink the question of whether a speculative rush into commodities is causing a bubble. It plans a report by September. The CFTC has maintained for years that an influx of investor cash into commodities has not distorted prices but instead provided liquidity, or greater numbers of buyers and sellers.

The acting chairman of the CFTC, Walter Lukken, a Republican, says supply-and-demand fundamentals still are driving prices, but in recent weeks, has taken a more-aggressive stance on oversight at an agency known for a free-market culture. The CFTC is overhauling its information-reporting requirements, increasing regulation of electronic energy trading and using its "special call" authority to require new data about over-the-counter trading.

The CFTC says it will significantly expand international surveillance by requiring more information sharing from the London oil-trading arm of Atlanta's IntercontinentalExchange Inc. It also announced it will condition access by U.S. traders to London markets on limits to the size of their positions. But the CFTC is not moving fast enough for Congress, whose members do not want to tell voters furious about gas prices that there is nothing Washington can do.

Late last month, the House voted to force the CFTC to use emergency powers to curb "excessive" speculation. The Senate will take up the measure this summer. Prices have been on a steady march, the Democrat said, and "you have been idly sitting by twiddling your thumbs." A CFTC representative says "the futures markets are continually evolving, and a smart regulator should evolve with change. That's exactly what this agency has been and is doing."

Still, as Wall Street lobbying interests hit the Hill to decry the potential chaos that could result from too-drastic measures, some lawmakers have started to grow uneasy about major overhauls to the market. Some congressional aides say it is looking harder to push through and pass the tougher steps, such as the pension-fund ban. Then again, if oil hits $150 a barrel, anything is possible.

Until recently, a lightly equipped regulator appeared to be what Congress, the White House and Wall Street wanted. Last year, the CFTC had a staff of 437, 12% fewer than it employed in 1976, shortly after it began operating. Its fiscal 2007 budget was $98 million, about a quarter less than President Bush had requested and roughly one-tenth of what Congress gave to the Securities and Exchange Commission. The CFTC's budget has since risen, but not by much.

Yet the CFTC must oversee and referee U.S. futures exchanges that now handle contracts valued at $4.78 trillion a year, more than 1,000 times the value traded in the mid-1970s.

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Deutsche, UBS Fight History Forecasting Best S&P 500 Since 1982

Deutsche Bank AG, Lehman Brothers Holdings Inc. and UBS AG say the Standard & Poor's 500 Index will gain the most in 26 years during this year's second half. That isn't going to happen, if history is any guide.

The S&P 500 will rise 18 percent by January, according to the consensus projection of 10 U.S. strategists surveyed by Bloomberg. The forecasts are based partly on estimates that profits will jump 50 percent in the fourth quarter after falling for the past year. Even if that happens, it may not be enough. In 2001, the last time profits fell as much, they then had to climb for three straight quarters before stocks rebounded.

Analysts' earnings estimates for this year still represent a decline from 2006 levels, making the strategists' optimism harder to justify, investors say. "If they're accurate, I'll give them a big kiss," said Randy Bateman, who oversees $15 billion as chief investment officer at Huntington Bancshares Inc. in Columbus, Ohio. "I don't think those are very realistic figures."

The S&P 500 dropped 1.2 percent last week to 1,262.90, coming within a percentage point of a "bear market," defined as a 20 percent plummet from its peak in October. Based on the index's closing price of 1,280 on June 30, the average strategist forecast of 1,515 by year-end calls for the biggest rally of any second half for the S&P 500 since Ronald Reagan was in the White House in 1982.

Strategists at Deutsche Bank, Lehman Brothers and UBS are the most bullish and expect the benchmark for American equities to climb to a record in the second half. Binky Chadha, Deutsche Bank's New York-based chief strategist, says the S&P 500 will end the year at 1,650, up 29 percent from June 30. Ian Scott, Lehman's global strategist, is predicting an advance of 27 percent to 1,630, while David Bianco at UBS says the index will increase at least 25 percent.

The S&P 500's rebound "is going to be one of the greatest roars we've seen," Bianco said. "The market has way too many fears baked into the valuation right now. The fear out there is the earnings are about to collapse and interest rates are about to surge on inflationary fears. Neither is going to happen."

Strategists' annual forecasts have been off by an average of 14 percentage points since 2000, according to data compiled by Bloomberg. They haven't projected an annual decline in at least eight years. At the start of the year, strategists told clients to expect an average 11 percent advance in the S&P 500 in 2008 to 1,634, Bloomberg data show. The measure has dropped 14 percent so far.

"A monkey with an abacus is probably better at the end of the day," said Peter Sorrentino, a Cincinnati-based senior money manager at Huntington Asset Advisors, which oversees $16.7 billion. "To read the strategists' input is intriguing and thought-provoking, but at the end of the day, you'd better have your own tools. We're nowhere near as optimistic as some of the forecasts."

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U.S. Stocks Now Worth Less Than Rest of G-8

As President George W. Bush meets with counterparts from the Group of Eight nations, he faces a new deficit: U.S.-traded stocks have declined to less than the combined value of those from the rest of the G-8, according to data compiled by Bloomberg. The combined value of companies traded on equities exchanges in Japan, the U.K., France, Canada, Germany, Italy and Russia was $15.16 trillion at the end of trading on July 4.

Market value in the U.S. totaled $14.95 trillion, the data show. "A sharp reversal began in early June," Goldman Sachs Group Inc. said in a report from Tokyo. "Housing prices continue to decline rapidly, the credit crunch is becoming increasingly evident in lending data, oil is marking new highs, and -- last but not least -- the labor market is unraveling," the report said.

The market capitalization of the rest of the G-8 nations first exceeded the U.S.'s on Nov. 7, 2007, when Washington Mutual Inc., the largest savings and loan, plunged the most in 20 years. The dollar also fell to the lowest in 30 years against a basket of six major currencies that day. The value of U.S.- traded shares then regained the top position most of the time through March, show the data, which date back five years.

Leaders of the U.S., Japan, Germany, the U.K., France, Italy, Russia and Canada are meeting from today to July 9 in Toyako, Japan. It will be Bush's final G-8 summit as president. "The U.S. believes in a strong dollar policy," Bush said at a news conference with Japanese Prime Minister Yasuo Fukuda yesterday. The economy of the U.S. remains fundamentally strong even as growth has slowed, he said.

DBS Group Holdings Ltd. said in a report today to "expect lots of comments regarding the world's growing concern about the weakness of the U.S. dollar, especially its link in driving up oil prices and fanning global inflation."

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Merrill Close To Selling Bloomberg, BlackRock Stakes

Merrill Lynch & Co. is moving closer to selling stakes in financial firm BlackRock Inc. and information provider Bloomberg LP, as the Wall Street firm scrambles to raise cash to make up for $6 billion in coming write-downs, say people familiar with the matter.

Merrill is likely to seek about $5 billion for its 20% stake in Bloomberg, the namesake company of New York Mayor Michael Bloomberg, a price lower than it might fetch in the open market. Bloomberg has the right of first refusal over the stake sale, which means it could be difficult to attract rival buyers.

Merrill, which bought the stake in Bloomberg years ago, will make billions off the sale, but whatever it fetches will be subject to taxes. A Merrill spokeswoman declined to comment on the firm's options. A Bloomberg spokeswoman declined to comment. Merrill also is expected this week to sit down with top officials from BlackRock, the money manager in which it owns a 49% stake. The asset is valued at more than $12 billion.

If Merrill does proceed with a sale, it is likely that it will sell only part of its interest and try to maintain a strategic alliance with the firm. Merrill can't sell its BlackRock stake before 2009 without the agreement of BlackRock's board, a condition ironed out when Merrill bought the stake in 2006 for $9.8 billion. One issue Merrill will need to hash out with BlackRock if a sale proceeds is whether the shares sold will be released to the public or sold privately.

Merrill is facing write-downs in the second quarter of almost $6 billion, and the expected quarterly loss when the firm reports next week will be its fourth in a row. Still, one person close to the firm said that while Merrill needs to explore its options this week, it doesn't need to have the sale of the stakes wrapped up by earnings day as long as it can deliver on them in a timely manner.

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US Abandoned Retail Space Amount Highest in 28 Years

Vacancies at U.S. neighborhood and community shopping centers rose in the second quarter to a 13- year high, while vacancies at larger, regional malls were at their highest level since 2002, research firm Reis Inc. said.

The average vacancy rate at neighborhood and community malls rose to 8.2 percent, up from 7.3 percent a year earlier and the highest level since 1995, the New York-based real-estate researcher said. At regional and super-regional malls, vacancies increased to 6.3 percent, up from 5.6 percent a year earlier and the highest since the first quarter of 2002, Reis said.

Retail sales and demand for shopping-center space are being hurt by rising unemployment, increasing food and gasoline costs, and declining home values. U.S. employers cut jobs in June for a sixth straight month, and the jobless rate remained at 5.5 percent after jumping in May by the most in two decades, the Labor Department said last week.

The amount of retail space being abandoned, "consistent with store closures, is at its highest level in almost 28 years," or as long as Reis has been collecting data, Sam Chandan, the firm's chief economist, said in an e-mail message. Retailers Linens 'n Things Inc., Sharper Image Corp., Lillian Vernon Corp., Bombay Co. and Levitz Furniture Inc. have all filed for bankruptcy protection as credit has become harder to obtain and consumers have cut back on purchases.

Asking-rent growth at neighborhood and community shopping centers dropped to 0.4 percent in the second quarter from 0.5 percent in the first quarter and 0.8 percent a year earlier, Reis said. Neighborhood shopping centers typically have 30,000 to 150,000 square feet (2,800 to 14,000 square meters) of retail space and are anchored by a supermarket, according to the International Council of Shopping Centers.

Community centers usually have 100,000 to 350,000 square feet of space, are open- air, and are anchored by two or more discount department, drug, grocery, or home-improvement stores. Reis tracks data for about 1.97 billion square feet of neighborhood and community shopping center space across the U.S.

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TIPS Flunk Inflation Test as Fuel, Food Overtake CPI

Treasury Inflation Protected Securities aren't living up to their name for bond investors who say they can't trust the way the U.S. government calculates the rising cost of consumer goods.

Morgan Stanley, the second-biggest securities firm, and FTN Financial, a unit of Tennessee's largest bank, are telling clients to pare holdings of TIPS, whose principal amount rises with the Labor Department's consumer price index. Morgan Stanley says derivatives tied to inflation expectations are a better bet, while FTN recommends corporate and agency bonds because the index doesn't reflect the actual rate of U.S. inflation.

The $500 billion TIPS market's 5 percent returns this year have beat a 2.2 percent gain for Treasuries, according to Merrill Lynch & Co. indexes. TIPS should pay more, because the consumer price index downplays the 39 percent increase in gasoline and a 133 percent rise in corn in the past year, investors say. Yields on TIPS relative to Treasury debt, a gauge of traders' inflation bets, barely changed over the past 18 months even as consumer expectations for prices climbed to 3.4 percent, the highest since 1995.

"The consumer price index underestimates inflation," said Jeremy Wolfson, who oversees $8.5 billion as chief investment officer at the City of Los Angeles Department of Water and Power Pension Fund. "Whether TIPS are adding a true inflation hedge, that's arguable based on the CPI component of it." TIPS pay a lower coupon than Treasuries because investors expect the inflation adjustment on the principal to make up the difference.

Traders who expect inflation to increase bet that the gap, or spread, between yields on TIPS and Treasuries will widen. The bigger the so-called breakeven rate, the greater traders' expectations that prices will go up. TIPS "haven't paid off" because the breakeven rate has "barely budged" over the past 18 months, said George Goncalves, chief Treasury and agency bond strategist with Morgan Stanley in New York.

TIPS due in two or more years show traders see inflation slowing from its current level. In contrast, U.S. consumers expect it to climb to 5.1 percent a year from now, a monthly survey by the University of Michigan showed. Consumer prices rose at a 4.2 percent annual pace through May, more than double the rate as recently as August, according to the Labor Department.

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Finance Group Questions Bond-Rating Proposals

A key financial-industry investment group said U.S. regulatory proposals to improve the credibility of bond ratings may not go far enough.

The CFA Institute, which represents 96,000 investors, brokers, analysts and others in finance-related professions, said in a poll to be released this week that many of its members want a new regulatory organization to police rating firms and a different set of rating symbols for structured products such as mortgage-backed securities and collateralized debt obligations.

Credit-rating firms "have more than just a perception problem about their processes and integrity," said James Allen, a director at the CFA Institute Centre for Financial Market Integrity. Officials from the CFA organization, which awards the chartered-financial-analyst designation, have met with officials of large ratings firms, such as Standard & Poor's and Moody's, in recent months to discuss their concerns about ratings being influenced too much by bond issuers that pay for the ratings and have a financial interest in higher ratings for their bonds.

The CFA's concern was spurred last year by the downgrades of thousands of mortgage-related bonds, and grew with the survey's finding that 11% of the 1,940 respondents globally said they had "witnessed" a ratings firm "change a rating as a consequence of pressure or influence" from an outside party such as a bond underwriter.

Kurt Schacht, managing director of the CFA Institute Centre, called that finding "the most troubling" in the poll because it suggests ratings firms aren't following their own procedures, which bar ratings officials from being influenced by outside pressure. The affirmative answers represent only about 0.2% of the CFA's total membership. Mr. Schacht said they could reflect behavior witnessed years ago.

The poll, completed last week, also showed that 55% said ratings firms should form an international self-regulatory organization to enforce rules about conflicts of interest and disclosure. The U.S. Securities and Exchange Commission took more-formal oversight of ratings firms last year, a step European regulators may follow. Overall, the survey indicated a preference for adding more outside monitoring of ratings firms' practices.

About 47% of respondents said regulators should compel ratings firms to use symbols for structured-finance products that differ from those used for ordinary corporate debt, while 42% said they shouldn't. Wall Street firms have said changing from the triple-A scale would be costly and potentially disruptive to already-battered parts of the market.

The SEC proposed a new rule in June that would give ratings firms the choice between using new symbols for structured products or publishing more research about the products' risks. "Given the level of confusion, we felt there should be a more overt requirement" to use different symbols, said Mr. Schacht.

Ratings firms have taken several of their own steps to restore credibility, including conducting internal surveys, reviewing ratings issued by analysts who have left for Wall Street firms, adding more internal oversight and providing more educational materials about ratings for investors.

S&P President Deven Sharma said in a statement that the company's "reputation for independence is our most valuable asset" and that it maintains policies "to support the objectivity of our ratings."

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Britain is riddled with debt... but the cure is a killer

Gordon Brown has campaigned forcefully for a 100 per cent write-off for Third World debt. Yet, while cancelling foreign loans, he has presided over an unprecedented 10-year explosion in domestic debt. In Britain, personal, household and company debt has risen to extraordinary levels, while public-sector borrowing is now approaching the historic highs of the 1980s.

Total UK personal debt (including secured and unsecured lending) at the end of May stood at £1,443bn, 8 per cent up on the previous 12 months. Every five minutes, UK personal debt grows by £1m, a daily increase of £288m. That this is unsustainable is evinced by the rise in court action by creditors against indebted individuals.

The number of county court judgments is at a 10-year high, with a total of 247,187 consumer debt-related CCJs being issued in the first three months of this year. Litigation over mortgage debt is similarly up. During the first quarter of 2008, there were 38,688 mortgage possession claims issued on a seasonally adjusted basis, 16 per cent higher than in the first quarter of 2007. These difficulties extend to the rented sector, where 37,221 landlord possession claims were issued and 28,503 landlord possession orders made.

The UK's overall household debt sits at 109 per cent of GDP – the highest of the big five Western European countries and the highest in the G7. What this means is that, as a country, we borrow more than we earn. This line was crossed last year when, for the first time, our debt burden exceeded our GDP. In 2007, it took us until 5 January 2008 to pay off the debt we had accrued during the year.

In 1997, "debt freedom day" fell on 23 August in the same year. This year, it is likely to extend well into 2009. Recent levels of the household debt-service ratio (interest payments plus repayments of mortgage principal) are, in the first quarter of 2008, up to 13.5 per cent, the highest since 1991.

And it is not as if people have much to fall back on. Shockingly, figures released last month by the Office for National Statistics show that the household savings ratio – a measure of the take-home pay we save – has dropped to 3.1, so low that we have to go back to 1959 (which had a rate of 1.5) to find a worse situation. Even more worrying, the first quarter of 2008 saw the rate drop even further to 1.1.

And this development is not just restricted to households: the UK's overall national savings rate (that of companies, households and the Government) is the second lowest in the G7 and has fallen by more than any other G7 country in the past five years.

The corporate sector is, if anything, more financially extended than the domestic. Ordinary British non-finance companies have a debt-GDP ratio of 123 per cent, the highest among the "big five" in Western Europe. What is more, their ratio of interest payments to profits, at 28 per cent, is approaching the 1990s peak of 31 per cent. Perhaps unsurprisingly, the most extended companies are financial firms other than banks (hedge funds, private equity, wholesale mortgage lenders, etc).

As Michael Saunders, an economist at Citigroup, remarks: "There has been an even more eye-popping rise in debt among non-bank financial companies." Mr Saunders points out that aggregate debt for these companies has risen from £580bn (68 per cent of GDP) 10 years ago to £2,427bn (171 per cent of GDP) at the end of the first quarter of 2008. The comparable average for the euro area was only 32 per cent at the end of 2006. Clearly, this cannot last. As Mr Saunders says: "The debt pyramid has begun to unwind, as has the belief that leverage is the route to prosperity."

And there is not much point looking to the Government for assistance, as public finances are not exactly in a healthy state either. Public-sector debt is climbing steadily – and with a current deficit of 2.8 per cent might even breach the 3 per cent Maastricht limit. At the end of December 2007, general government debt had risen to £618.8bn, equivalent to 43.8 per cent of GDP, whereas public-sector net debt, expressed as a percentage of GDP, was 37.2 per cent at the end of May 2008, compared with its most recent low of 29 per cent in March 2002.

So where will it all end? Well, for many, in very real financial disaster. Likewise, many companies will face increasing difficulties, and the number of those going into administration (up 54 per cent in the first quarter of 2008) and receivership (up 85 per cent, ditto) will rise. Given that 72.8 per cent of British companies are sole traders, their difficulties soon translate into serious issues for households. And it is people's housing that is most at risk, which in turn most imperils the British economy.

Last year, 27,100 properties were repossessed; the latest estimates for 2008 have already reached 45,000. Other indications are that it could get much worse. The Council of Mortgage Lenders estimates that there will be 170,000 mortgages with arrears greater than three months by the end of the year. According to the charity Shelter, 400,000 households are already falling behind with mortgage or rent.

Before this slow-moving consumer car wreck, New Labour has thrown its hands in the air, repeated its arcane faith in markets, and done precisely nothing. Indeed, the Bank of England, determined to fight the next war with the tactics of the last one, has bizarrely decided inflation is the primary issue and that it will be able to control international commodity price increases by suppressing domestic demand. The trouble is that if the Bank succeeds in restricting our domestic spend, it risks plunging Britain into outright economic meltdown. Why? Because the real risk is not inflation, but deflation.

And deflation is worse – much worse – than inflation. In a deflationary economy, prices are constantly falling. If prices fall, profit falls; if profit falls, then growth drops and unemployment rises. This produces a vicious circle of increasing productive capacity, falling demand, falling prices, lay-offs and negative growth. And this is a possible mid-term scenario for the UK.

The highly respected Bank for International Settlements has already denounced the Anglo-Saxon credit economies and explicitly warned of the dangers of long-term deflation brought about by unpayable debt. Indeed, the Great Depression of 1929 was, in part, caused by the tightening of monetary policy intended to prick the speculative bubble of the "Roaring Twenties". Likewise, Japan in the 1990s tried to stem a property and asset boom by raising interest rates, which again were too high for too long; the result has been 18 years of deflationary stagnation.

Thus, the credit crunch, allied with the demand to reduce wages and raise interest rates, could tip the UK into a deflationary debt spiral. Quite simply, if the tightening continues, people won't be able to pay their bills. Given the levels of debt that the credit boom of the past 10 years has produced, any widespread default could bring down the entire financial edifice.

After all, this is exactly what happened in the US sub-prime disaster, when interest rates on the mortgages of low-income households were suddenly jacked up to levels they simply couldn't afford to pay. Our own housing sector is now poised on a similar cliff edge.

In short, we need a reversal of policy. Instead of looking on glumly as the disaster unfolds, we should be enabling households to meet their obligations. We need to construct a more radical version of the anti-foreclosure legislation currently before the US Congress – and prevent mortgage lenders from repossessing properties and, in any subsequent sell-off, driving asset prices still lower.

Likewise, help is needed for the millions of indebted and credit-impaired Britons. Since they are, like the Third World, enslaved by unpayable debt, an extensive programme of debt forgiveness and freezing of interest is required. On a macroeconomic level, it is a matter of choosing the least-worst option. Loosening fiscal policy until international price inflation bleeds out of the system at least keeps the whole ship afloat.

Focusing on inflation now risks sending us all to the bottom. Domestic inflation is a danger that can be tackled later – now we have to lessen the debt burden (currently at 173 per cent of household income) and help people pay their bills.

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England may not be able to afford an independent central bank

You don't have to be an economist to know that the UK is edging ever closer to a recession. A profit warning from Marks & Spencer and the prospect of the construction company Taylor Wimpey heading for default were two of the more dramatic headlines in another grim week for Gordon Brown.

It will only get worse, because the Bank of England is reacting dogmatically to the unprece-dented energy and food price shock, and ignoring a collapse of the housing market. Followers of the oil industry have been warning for years that the world has used up much of the easy and cheap supply of crude.

Global production peaked way back in May 2005 and supply problems may send prices still higher as the world heads into recession. Saudi Arabia does not have the reserves it claims and the world's largest producer, Russia, has seen its production peak too. Aside from Iraq, few other countries are able to step in and fill the void; in many, such as Norway, the US, Mexico and the UK, output continues to fall rapidly.

A further surge in crude will put more pressure on food prices, as corn is siphoned off into ethanol to keep US cars on the road. As corn prices soar, so the effect ricochets around the global food chain. Headline inflation may indeed accelerate. We are witnessing the inevitable consequence of a blinkered, short-termist energy policy – namely a failure to develop alternatives to fossil fuels.

But the Bank of England is compounding this folly by threatening to drive the UK economy deep into recession. More banks will share the fate of Northern Rock if the Bank does not abandon its threat to raise interest rates. With the honourable exception of David Blanchflower, the Monetary Policy Committee seems oblivious to the risks.

Mortgage demand collapsed in May when approvals fell from 58,000 to 42,000, a record decline of 27.6 per cent. As the turmoil of recent weeks shows, the markets are turning against the banks, and the tough monetary stance of the MPC isn't helping. It is becoming difficult for banks to raise fresh capital, and they will be forced to push mortgage rates even higher to increase their loan- loss reserves, so driving down demand for home loans and sending house prices tumbling faster.

It is the ultimate vicious circle. Before long, the banks will be coming back to the markets cap in hand, searching for yet more capital. Next time, the markets may say no. Any central banker who believes the current surge in en-ergy costs will become "embedded" clearly does not understand the way globalisation has destroyed the bargaining power of ordinary workers.

Wages are not going up, not in the UK, the US or even euroland. Last week, the analysts IDS reported a fall in wage settlements even as headline inflation rose. Many workers cannot afford to go on strike and are fearful of losing their homes should they get behind with their repayments. Real incomes are being squeezed hard.

And that is already having an impact on inflationary pressures. The retail sales deflator is still falling, down 0.3 per cent year-on-year in May. It is a different measure of inflation on the high street – one that takes into account changing shopping patterns. Marks & Spencer's sales collapsed because shoppers are heading for discount stores – food being a good example. The consumer price index shows food prices rose 8.7 per cent year-on-year in May. But the retail sales deflator was up less than half that, by 4.1 per cent year-on-year.

So inflation may well continue to rise. But with wages dormant, the "second-round" effects will be constrained. There is plenty of room to cut interest rates. And unless rates fall now, the slide in house prices will accelerate. But the Bank of England is digging in. It may even hike the cost of borrowing, following the European Central Bank's perverse action last week in pushing rates up from 4.0 to 4.25 per cent.

Unemployment in Spain has risen by a quarter of a million in three months as a result of the downturn in its housing market. Retail spending has collapsed. But the ECB ploughed on regardless. The Government needs to decide whether an independent central bank is worth the political price – the loss of perhaps 200 or more Labour MPs at the next election.

If the Bank of England refuses to cut interest rates, the Treasury should assume control of monetary policy. Otherwise, the collapse of Northern Rock may become a template for more banks

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Ilargi: Evans-Pritchard, always good for interesting facts, though often wanting in interpretation, misses the boat painfully completely on energy: "Call it Peak Oil, or just Peak Non-Cooperation by the dictatorships that control most of the world's remaining 5 or 6 trillion barrels (Mankind has used one trillion so far)."Ambrose, time to do some research! It’s not that hard to get this one right, you know.

Oil price shock means China is at risk of blowing up

The great oil shock of 2008 is bad enough for us. It poses a mortal threat to the whole economic strategy of emerging Asia. The manufacturing revolution of China and her satellites has been built on cheap transport over the past decade. At a stroke, the trade model looks obsolete.

No surprise that Shanghai's bourse is down 56pc since October, one of the world's most spectacular bear markets in half a century. Asia's intra-trade model is a Ricardian network where goods are shipped in a criss-cross pattern to exploit comparative advantage. Profit margins are wafer-thin.

Products are sent to China for final assembly, then shipped again to Western markets. The snag is obvious. The cost of a 40ft container from Shanghai to Rotterdam has risen threefold since the price of oil exploded.
"The monumental energy price increases will be a 'game-changer' for Asia," said Stephen Jen, currency chief at Morgan Stanley. The region's trade model is about to be "stress-tested".

Energy subsidies have disguised the damage. China has held down electricity prices, though global coal costs have tripled since early 2007. Loss-making industries are being propped up. This merely delays trouble. "The true impact of the shock will only be revealed over time, as subsidies are gradually rolled back," he said. Last week, China raised internal rail freight rates by 17pc.

BP 's Statistical Review says China's use of energy per unit of gross domestic product is three times that of the US, five times Japan's, and eight times Britain's. China's factories "were not built with current energy levels in mind", said Mr Jen. The outcome will be "non-linear". My translation: China is at risk of blowing up.

Any low-tech product shipped in bulk - furniture, say, or shoes - is facing the ever-rising tariff of high freight costs. The Asian outsourcing game is over, says CIBC World Markets. "It's not just about labour costs any more: distance costs money," says chief economist Jeff Rubin. Xinhua says that 2,331 shoe factories in Guangdong have shut down this year, half the total.

North Carolina's furniture industry is coming back from the dead as companies shut plant in China. "We're getting hit with increases up and down the system. It's changing the whole equation of where we produce," said Craftsmaster Furniture. China is being crunched by the triple effects of commodity costs, 20pc wage inflation, and sagging import demand in the US, Canada, Britain, Spain, Italy, and France.

Critics warn that Beijing has repeated the errors of Tokyo in the 1980s by over-investing in marginal plant. A Communist Party banking system has let rip with cheap credit - steeply negative real interest rates - to buy political time for the regime. Whether or not this is fair, it is clear that Beijing's mercantilist policy of holding down the yuan to boost exports share has now hit the buffers.

Foreign reserves have reached $1.8 trillion, playing havoc with the money supply. Declared inflation is just 7.7pc, but that does not begin to capture the scale of repressed prices, from fuel to fertilisers. "There is a lot more bottled-up inflation in this economy than meets they eye," says Stephen Green, from Standard Chartered.

Inflation merely steals growth from the future. It defers monetary tightening until matters get out of hand, which is where we are now. Vietnam has already blown up at 30pc. India is on the cusp at 11pc, so is Indonesia (11pc), the Philippines (11pc), Thailand (9pc) - leaving aside the double-digit Gulf.

Of course, oil prices may fall again. They plunged to $50 a barrel in early 2007 after the Saudis raised production. The scissor effect of slowing global growth and extra crude later this year from Brazil, Azerbaijan, Africa, and the Gulf of Mexico may chill the super-boom. The US Commodities Futures Trading Commission is on an "emergency" footing, under orders from the Democrats on Capitol Hill to smash speculators. If it is really true that investment funds have run amok, we will soon find out.

I suspect that the energy markets have fallen prey to their own version of the "shadow banking system" that so astonished regulators when the credit bubble burst. I also suspect that Hank Paulson and his EU colleagues have a surprise up their sleeve for the late-cycle über-bulls. Those who claim that derivatives (crude futures) cannot drive spot prices have overlooked a key point. The Saudis and others use the IPE Brent Weighted Average of futures contracts as their pricing mechanism. Futures now set the spot price.

But even if oil comes down for a year or two, the mid-term outlook of the International Energy Agency warns that crude markets will be tighter than ever by 2012. Call it Peak Oil, or just Peak Non-Cooperation by the dictatorships that control most of the world's remaining 5 or 6 trillion barrels (Mankind has used one trillion so far).

Come what may, globalisation has passed its high-water mark. The pendulum will now swing back from China to America. The mercantilists will have to reinvent themselves.

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Asia's exporters suffering as global demand weakens

Cliff Sun is hurting. The 54-year-old chief executive of Kin Hip Metal Plastics had spent much of the past year grappling with rising labor and material costs in China and a strengthening yuan. Now that the U.S. consumer juggernaut is slowing, he's throwing in the towel and relocating inland from coastal southern China.

"If we don't cut margins or even take small losses these days, we're just not able to get the same level of orders," said the former chairman of the Hong Kong Exporters' Association. "We're facing a bitter, cold winter ahead."

Sun and others that collectively make up Asia's mighty export engine face a difficult second half with Asia's central banks now ready to sacrifice growth to combat food- and oil-based inflation and with Europe no longer taking up the slack amid downward-spiraling U.S. consumption.

The worst is yet to come. Exports make up 10 percent of China's gross domestic product and up to 30 percent for externally vulnerable economies like Hong Kong and Singapore. Asia -- much of which had remained resilient in the face of the U.S. downturn -- and China are expected to decelerate with interest rates on the rise, inflation mounting and oil at $145 a barrel.

Toyota Motor, the world's top carmaker, said it could fall short of its U.S. sales target this year as high gasoline prices and a sluggish economy cut into demand. Deutsche Bank estimates some 20 percent of China's low-end exporters will go belly-up this year.

And Japanese exports to the United States fell for a ninth straight month in May, while shipments to the European Union -- which had been holding up well -- recorded their first annual drop in more than two years. "The Euro area and Japan are decelerating and that's really bad news for Asian exporters," said David Fernandez, Head of Economic and Sovereign Research at JP Morgan.

Hong Kong's exports to the United States -- much of which originates in China, the world's workshop -- fell 1.5 percent year on year in the first 5 months. Exports to the United States from South Korea shrank 0.3 percent in January to May.

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Ilargi: I have asked before how motivated James Hansen can still be in the face of his data, which paint a fast worsening climate picture, and in the face of the reactions to these data. The "time to act" gets shorter all the time, and still nobody acts. Recently, he shortened his estimate of our time to act to one year only.

This report is not even close to being his best; maybe he’s given up on trying to communicate with G8 leaders. That would be a wise move.

James Hansen to the G8: We've passed safe C02 levels

On the eve the annual G8 Summit where NASA's Dr. James Hansen will announce that we've passed safe C02 levels (safe being maximum 350 ppm; we're now at 385 ppm), Hansen has penned a comprehensive letter (PDF) to Japanese Prime Minister Yasuo Fukuda, host of the G8 Summit, requesting his leadership in addressing his findings:

Dear Prime Minister [Yasuo Fukuda],

Your leadership, and continued leadership by Japan, is needed on the matter of climate change, a matter with ramifications for life on our planet, including all species. Prospects for today’s children, and especially the world’s poor, hinge upon success in stabilizing climate. ~snip~

Japan has been a strong supporter of actions to mitigate dangerous climate change, including the Kyoto Protocol. It is not Japan’s fault that international action has failed so far to slow emission of dangerous gases. But as the host for the upcoming G8 meeting, you can initiate discussion of an approach that could meet the challenge humanity faces.

The past approach, and extensions now under discussion, are fatally flawed and would doom our children and grandchildren to an increasingly impoverished life on a more desolate planet. Clear thinking and bold leadership of the international community are essential in the next 1-2 years to change the course of human history.

The letter, which includes extensive supporting data, opens with current climate status: the loss of sea ice, the approaching tipping points, the effects on people and wildlife, the unstoppable sea level rise, shifting of climate zones, species extinctions, loss of glaciers, water supply for hundreds of millions, droughts and forest fires, rains and floods, intensified thunderstorms, tornadoes and tropical storms.

My address tomorrow to the United Nations University G8 Symposium summarizes scientific data revealing that the safe level of atmospheric carbon dioxide (CO2) is no more than 350 ppm (parts per million), and is likely less than that. Implications for energy policy are profound, as atmospheric CO2 is already 385 ppm.

Dr. Hansen goes on to write that "basic fossil fuel facts must be acknowledged" to minimize the impact of climate change.

Dr. Hansen's full letter is here (PDF)

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G8 leaders feast on 13 courses after discussing world food shortages

Organisers of the G8 summit have proudly displayed the menu for a sumptuous eight-course banquet enjoyed by world leaders meeting to discuss international food shortages. Only 24 hours after Gordon Brown urged people not to waste food, and with the summit dominated by fears of global shortages, leading statesmen were treated to smoked salmon and kyoto beef - hours after enjoying a five-course lunch.

Several African leaders were at the table as the need for their continent to double its food production ranked highly at the summit. The lunch began with truffle soup and rare crab while the evening feast, involving 19 separate dishes, even had its own theme - grandly entitled "Hokkaido, Blessings of the Earth and the Sea".

Organisers proudly boasted the chef's team "know everything that there is to know about food". They proclaimed: "The three specialists will make the best of Hokkaido's natural blessings, supported by higher quality ingredients, more natural ingredients and the soil with which to enjoy them."

The dishes were prepared by the first Japanese to win the famed one star of the Michelin guide Katsuhiro Nakamura. He was hired as the "grand chef" by the Windsor Hotel where the leaders are staying. 30 miles away from the general public and cut off by 20,000 special police officers keeping crowds at bay, its Presidential Suite costs a staggering £7,000-a-night.

The Japanese air force was flying regular patrols overhead and even the coastguard was on standby on the island of Hokkaido.
Aides insist Mr Brown's warning to householders was not aimed at hectoring people, but he insisted ending food waste could save families £8 per week. The G8 summit has cost £283million, which could have bought 100million mosquito nets to save Africans from catching malaria.

Shadow International Development Secretary Andrew Mitchell said: “The G8 have made a bad start to their Summit, with excessive cost and lavish consumption. “Surely it is not unreasonable for each leader to give a guarantee that they will stand by their solemn pledges of three years ago at Gleneagles to help the world’s poor. “All of us are watching, waiting and listening."

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Ilargi: The rest of this essay by Roubini is behind a wall, and I ain’t gonna pay for scaling it. But the point he makes is interesting, and its consequences potentially far-reaching. In the end, it’s about the USD as the reserve currency.

The Coming End Game of Bretton Woods2

Will the Bretton Wood 2 Regime of fixed and/or heavily managed exchange rates in many emerging market economies collapse in the same way as the Bretton Woods 1 regime (the “dollar standard” regime that ruled after 1945 in the global economy) collapsed in the early 1970s?

What are the similarities and differences between those two regimes? It is interesting to note that the same factors – U.S twin deficit, U.S. loose monetary policies and fixed pegs to the U.S. in the dollar standard regime of Bretton Woods (1945-1971) - that led to the commodity inflation and goods inflation in the early 1970s and thus to the demise of the Bretton Woods 1 regime (in the 1971-73 period) are also partially the same factors that are leading now to the rise in commodity and goods inflation in emerging markets that are pegging to the U.S. dollar and/or heavily managing their exchange rates.

Thus, like the rise of commodity and goods inflation led to the demise of BW1 the current rise in commodity and goods inflation in emerging market economies may be the trigger that will lead – as argued in my 2005 BW2 paper with Brad Setser and a more recent 2007 paper of mine – to the demise of BW2.

It is true that BW2 is still alive as the massive ongoing reserve accumulation by BRICs, GCC and other emerging markets suggests. But the rise in inflation that these exchange rate policies are causing may soon lead to its demise: abandoning pegs and/or letting currencies appreciate at a faster rate will be the necessary step to control inflation in such emerging market economies.

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Recession is not the worst possible outcome

If this had been a mere financial crisis, it would be over by now. The fact that we are suffering its fourth wave tells us there might be something at work other than merely financial euphoria and bad regulation. Maybe this is not a Minsky moment after all.

Hyman Minsky, the 20th century US economist, formulated the long forgotten, and recently rediscovered, financial instability hypothesis, according to which capitalist economies, after a long period of prosperity, end up in a vicious circle of financial speculation. The Minsky moment is the point when what economists call this “Ponzi game” collapses. But there might be better explanations.

As the Bank of International Settlements said in its latest annual report, subprime might have been the trigger for this crisis, but not the cause. We do not have a full understanding yet of what happened but the BIS suggested that fast expansion of money and credit must have played a role. I would go further and say this is not primarily a crisis of financial speculation, but one of economic policy. Its principal villains are therefore not bankers, but economists – not in their role as teachers and researchers, but as policy advisers and policymakers.

So who are they? I recall a wonderful episode told by Jagdish Bhagwati in his book In Defense of Globalization when he quoted John Kenneth Galbraith as saying: “Milton’s [Friedman’s] misfortune is that his policies have been tried.” In fact, this is not the worst that could happen. The worst is for economists to try out their own theories themselves. This happened to several highly respected academics who have since become central bankers or finance ministers.

If, or rather when, they turn out to be wrong, they risk a double reputational blow – as policymakers and as academics. So do not count on them to change their mind when the facts change. Several of them have been leading proponents of an economic theory known as New Keynesianism. It is, in fact, probably the most influential macroeconomic theory of our time.

At the heart of the New Keynesian doctrine stands the so-called dynamic stochastic general equilibrium model, nowadays the main analytical tool of central banks all over the world. In this model, money and credit play no direct role. Nor does a financial market. The model’s technical features ensure that financial markets have no economic consequences in the long run.

This model has significant policy implications. One of them is that central banks can safely ignore monetary aggregates and credit. They should also ignore asset prices and deal only with the economic consequences of an asset price bust. They should also ignore headline inflation. An important aspect of these models is the concept of staggered prices – which says that most goods prices do not adjust continuously but at discrete intervals.

This idea lies at the heart of some central bankers’ focus on core inflation – an inflation index that excludes volatile items such as food and oil. There is now a lively debate – to put it mildly – about whether an economic model in denial of a financial market can still be useful in the 21st century.

So when economists tell us that we need to keep real interest rates negative, just as we did for long periods in the past 15 years, or that we now need to bail out homeowners and banks and raise our national debt in the process, or ignore any considerations of moral hazard while the crisis is raging, we might want to question whether the recipes that got us into this mess are also most suited to get us out again.

If we believe, as the BIS does, that a rapid expansion of money and credit has either caused, or significantly contributed to, the build-up of asset price bubbles and higher inflation, the opposite policy conclusions might be more appropriate. Under this setting, the priority might be not to impede the fall in asset prices. Real house prices in the US, the UK and several other economies might end up falling by some 40-50 per cent, peak-to-trough, in the downward phase of this cycle.

Let this happen and do not implement policies to prevent this fall – such policies might alleviate some pain in the short run for some people but will make the adjustment last a lot longer. Second, monetary policy should be geared towards price stability first and foremost. When inflation expectations rise, real interest rates should be positive. This would necessitate a large interest rate increase in the US and further interest rate increases in the eurozone as well. Third, allow some defaulting banks to go bust.

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