March 30 2009 1: Don't be misled

Harris & Ewing Don't be misled 1925
F.W. Grand store.Washington, D.C.

Ilargi: I’m going to try and shake up things a little around here. It's all getting clogged up too much in my view with too many articles in one go. Today, I’ll do two posts, a lunch and a dinner version, so one around 12.30 pm and another around 5.30 pm. I’m hoping it’ll make TAE more accessible, and if I think it works, it stays. Both posts will be on the frontpage for the duration of the day.

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Ilargi: So Obama, Larry Summers and Tim Geithner have kicked Rick Wagoner out of GM. Can we see the severance package please? Does it matter? I doubt it. Let the president explain in plain terms to the people why Wagoner was guillotined while Lloyd Blankfein, Vikram Pandit and Edward Liddy and all those chaps are still in their plush seats. If he doesn't, his troubles will keep growing. People have an inalienable right to know what their trillions are being spent on, and why. Increasingly, they'll demand to know. What's happening in Detroit lacks any and all transparency, which leaves one impression only: nothing has changed. Washington wants Chrysler to merge with Fiat, but it doesn't yet like the terms, since Fiat would profit too much when a turnaround happens. Don't worry, guys, there won't be any. And Fiat is nuts if it agrees to any merger, but I guess there's far too many short term dollar signs in the Italian eyes to see clearly.

It'll all end in tragedy and bankruptcy regardless, just 10 years and hundreds of billions of dollars too late. In their present state, US carmakers need 12 million vehicle sales per year in the American market. They’ll be lucky if 5 million are sold in 2009. Not that anyone would publicly admit it, not the industry nor the government. That 5 million number will mean additional losses up to the carmakers, and the taxpayers', eyeballs. When the first Detroit bail-outs happened last year, it was estimated that a 50% cut in production capacity in the industry would lead to as much as 2 million job losses in the overall economy. Well, that 50% will have to be cut, and probably more. That won't look good on Obama's rap sheet, losing 2 million more jobs. Too little and too late. And no, "green cars" won’t make any difference. that's like the nutty notions behind the weekend's Earth Hour. Tickling the ego's of the clueless.

Internationally, the president risks losing a lot of political capital as well. I don't for a moment believe that the US is prepared for the erosion of its clout and power that it will be confronted with; it prefers the hold on to the illusion. Europe will not follow the American banking rescue plans, which add up to more than $11 trillion to date. The status of the greenback as a global reserve currency has become so unstable that it's merely a matter of time before it's cut down from its pedestal. Talk about turnarounds and recovery at this point in time is hollow inflated lukewarm air. Economic growth as a foundation for the world's markets is gone forever, yet nobody is willing to even consider it. There's one reaction in case the plans fail: more of the same. As Geithner said again over the weekend: the biggest risk is not doing enough. Which is nonsense, the biggest risk simply remains doing the wrong things. All this turns the entire multi-trillion dollar operation into one huge gamble with no plan B. And no seat at the table for the ultimate victims.

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Global markets dive as Obama rejects carmakers' plea

Global stock markets dived today after the White House denied General Motors (GM) and Chrysler multi-billion dollar bailouts and threatened to push the ailing carmakers into bankruptcy if they do not implement aggressive restructuring plans. The Obama Administration effectively seized control of the companies – ousting General Motors’ chairman and chief executive and pushed Chrysler toward a merger – after finding that the carmakers’ own restructuring plans “did not establish a credible path to viability”. The Dow Jones industrial average tumbled 215.37 points to 7,560.81 within minutes of opening while in London, the FTSE 100 index of leading companies fell 104.59 points to 3,794.26. In Germany, the DAX declined 145.88 points and in France, the CAC fell 89 points to 4,057.67.

In a document released at midnight last night, the White House set out its key findings on the two companies after more than a month of intensive talks between the President's auto taskforce, GM and Chrysler's managements and other stakeholders. GM last December received a $13.4 billion bailout and had asked for a further $16.4 billion, while Chrysler got $4 billion and wanted up to $6 billion more. However, the President refused to grant the full loans based on the companies’ current restructuring plans, which the White House document said were insufficient to justify a substantial new investment by taxpayers. Instead, the Government will provide GM with funding for 60 days to give it time to develop a more aggressive plan and a strategy to implement the plan.

In return, the White House demanded that Rick Wagoner, the chief executive and chairman who has led the company since 2000 and overseen an $82 billion loss over the past five years, step down. Mr Wagoner was replaced by Fritz Henderson, its current president and chief operating officer. Long-time board member Kent Kresa will step in as interim chairman. The Government also said that the majority of the board would be replaced over the coming months. “The Administration does believe that there is a path to a viable GM and is confident that the company can emerge from this crisis as a strong, competitive business,” the Government said. But it took a swipe at Mr Wagoner, saying in a more detailed document on GM that the automaker's turnaround over the past few years had been far too slow, which allowed it to “lag the best-in-class competitors.

It also slammed GM’s current restructuring plan as too optimistic on its assumptions of market share, pricing, brands and other issues. The White House had previously told GM to cut its unsecured debt of about $28 billion by two-thirds but some bondholders have held out against a deal. The White House threatened last night to put GM into a “court-supervised process to extinguish unsustainable liabilities” if the company cannot get agreement from its creditors. Chrysler had proposed a partnership with Italy’s Fiat, in which the US company would manufacture fuel-efficient vehicles using Fiat’s technology. But the original deal would have handed Fiat a 35 per cent stake in Chrysler, which the Government complained gave the Italians first dibs on the benefit from a turnaround at the company.

The White House made clear that Chrysler cannot stand alone, criticising its current restructuring plan as containing a “number of assumptions that are unrealistic or overly optimistic. “The Administration does not believe that on its own Chrysler can achieve the scale or debt of product mix necessary to compete in the twenty-first century global auto market,” last night’s findings read. Instead, the Government will give Chrysler 30 days worth of capital in which to strike a deal with Fiat and other stakeholders. The Italian and US companies have already agreed with the Government to protect taxpayers’ investment in the venture. Chrysler must also hit a number of other targets – getting rid of all of its unsecurity debt and most of its outstanding secured debt, agree greater concessions with auto workers’ unions, come up with better financing options for its dealers and customers and with Fiat put together an operating plan that shows meaningful profits.
Failure to meet these demands will end in almost certain collapse for the company.

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White House questions viability of GM, Chrysler

President Barack Obama is sending a blunt message to Detroit automakers: To survive -and win more government help- they must remake themselves top to bottom. Driving home the point, the White House ousted the General Motors chairman as it rejected GM and Chrysler's restructuring plans. Obama is set to elaborate on that message Monday when he announces what his White House told reporters over the weekend: Neither GM nor Chrysler submitted acceptable plans to receive additional federal bailout money. GM chairman Rick Wagoner became the most conspicuous casualty of that decision, forced out Sunday as the White House indicated Detroit must make management and other changes if it hopes to survive and that the Obama administration will have a hands-on role in those changes.

Michigan Gov. Governor Jennifer Granholm said Wagoner "clearly is a sacrificial lamb" who stepped aside "for the future of the company and for the future of jobs." She spoke on NBC's "Today" show Monday. Obama said the companies must do more to receive additional financial aid from the government. "We think we can have a successful U.S. auto industry. But it's got to be one that's realistically designed to weather this storm and to emerge -at the other end- much more lean, mean and competitive than it currently is," Obama said on CBS' "Face the Nation" broadcast Sunday. Frustrated administration officials, speaking on condition of anonymity ahead of Obama's announcement, said Chrysler has been given a 30-day window to complete a proposed partnership with Italian automaker Fiat SpA. The government will offer up to $6 billion to the companies if they can negotiate a deal before time runs out. If a Chrysler-Fiat union cannot be completed, Washington plans to walk away, leaving Chrysler destined for a complete sell-off.

For GM, the administration offered 60 days of operating money to restructure. Officials say they believe GM can put together a plan that will keep production lines moving in the coming years. New directors will now make up the majority of GM's board. Fritz Henderson, GM's president and chief operating officer, became the new CEO. Board member Kent Kresa, the former chairman and CEO of defense contractor Northrop Grumman Corp., was named interim chairman of the GM board.
"The board has recognized for some time that the company's restructuring will likely cause a significant change in the stockholders of the company and create the need for new directors with additional skills and experience," Kresa said in a written statement. The Obama administration move comes amid public outrage over bonuses paid to business leaders and American International Group executives - set against a severely ailing economy.

GM failed to make good on promises made in exchange for $13.4 billion in government loans. Chrysler, meanwhile, has survived on $4 billion in federal aid during this economic downturn and the worst decline in auto sales in 27 years. In progress reports filed with the government in February, GM asked for $16.6 billion more and Chrysler wanted $5 billion more. The White House balked and instead started a countdown clock. Two people familiar with the plan said bankruptcy would still be possible if the automakers failed to restructure. Those officials spoke on condition of anonymity because they were not authorized to make details public.

An exasperated administration official noted that the companies had not done enough to reduce debt; in some cases, it actually increased during this restructuring and review process. GM owes roughly $28 billion to bondholders. Chrysler owes about $7 billion in first- and second-term debt, mainly to banks. GM owes about $20 billion to its retiree health care trust, while Chrysler owes $10.6 billion. GM and Chrysler employ about 140,000 workers in the U.S. In February, GM said it intended to cut 47,000 jobs around the globe, or almost 20 percent of its work force, close hundreds of dealerships and focus on four core brands: Chevrolet, Cadillac, GMC and Buick.

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Wagoner Is Ousted to Maintain GM's Lifeline

General Motors' longtime CEO falls on his sword to appease unions, bondholders, and the Obama Administration in a bid to keep the automaker afloat. He's out. General Motors (GM) Chairman and CEO G. Richard Wagoner Jr. has been asked by President Barack Obama's Administration to step down in advance of GM's getting any further funds from the federal government. Treasury officials said Wagoner was asked to leave and agreed to quit. Wagoner's ouster will be the first in a series of moves that Treasury will make as it forces GM and Chrysler to restructure. Without a change in the way they do business, Treasury officials say, those companies aren't viable and won't get more funds to avoid bankruptcy.

Wagoner's ouster won't surprise many, and plenty of critics have been calling for his head. True, he was dealt a tough hand when he became CEO in June 2000, inheriting a raft of management missteps that included lavish worker contracts and retiree benefits the company had accepted in fat times. But Wagoner never made the tough decisions to reduce union labor costs, cull GM's bloated family of brands, or get the company to make money on anything but a handful of trucks and SUVs that guzzled fuel. Wagoner was pushing slowly to change GM, but the company wasn't prepared for the fuel-price spikes that started in 2005 or the recession that hit the auto industry like a hurricane in 2008. "He deserves it," says longtime industry watcher Maryann N. Keller. "Obama doesn't want to be seen giving money to someone who has had so many bad years."

Wagoner began to push harder to remake GM over the past several years. And the company has been putting out better passenger cars. The Chevrolet Volt electric car, due to hit the market in 2010, shows that GM understands how important fuel economy has become. Wagoner also scored a union contract in 2007 that cut wages in half for new hires and would have given the union $36 billion in cash to set up a health-care trust, extricating GM from high employee medical costs. But all of that happened much too late. GM was thrown into crisis in 2005, when the company lost $10.5 billion. Oil jumped above $50 a barrel and sales of GM's money makers—full-size SUVs like the Chevy Tahoe—tanked. GM, bleeding cash, bought out thousands of union workers and cut health-care costs.

Wagoner's restructuring moves got the company to roughly break even on an operating basis in 2006 and 2007, but GM lost $31.5 billion in 2008 amid a deep recession and financial crisis. Altogether, since Wagoner took over in 2001, GM has lost $72.8 billion, if you include a $38.7 billion paper loss in 2007 due to lost tax credits. To his credit, Wagoner has shrunk GM's payroll by nearly 70,000 jobs since 2005. He has restructured the company to the point where analysts estimate it could break even in a market of about 12 million annual car sales. (Americans buy 15 million or more vehicles in a typical year.) And he did drop the Oldsmobile brand in 2001. But Wagoner still tried to make eight brands work when health-care and retiree costs claimed too much cash to support them all.

The outgoing Bush Administration agreed to extend a $17.4 billion lifeline to GM and Chrysler in December, with a Mar. 31 deadline for the companies to meet cost-cutting and debt-reduction goals. Before the new Obama Administration was willing to extend that help beyond Tuesday, however, it needed a scalp to show the American public that the government wasn't throwing public funds to the same executives that failed. "He's being tarred as the architect of a strategy that didn't succeed," says Edmunds.com President Jeremy Anwyl. Wagoner's ouster is more than just public relations, however. One of President Obama's Auto Task Force advisors, former United Steelworkers negotiator Ron Bloom, often used to push companies to change management if the USW was agreeing to make big concessions, notes Leo Gerard, the union's president and a close friend of Bloom.

Says Gerard: "We always had the philosophy that the people who got a company into the mess won't get you out." While GM moved methodically to address its legacy costs, Japanese rivals such as Toyota, Honda, and Nissan were blitzing consumers with new vehicles and marketing them hard. As a result, GM's market share on Wagoner's watch plummeted from the 28.1% it held in 2000 under retiring Chairman Jack Smith to less than 20% so far this year. "He was incrementally moving the company forward," says Anwyl. "He just ran out of time."

Wagoner made other big mistakes. GM was paying $1 billion a year in shareholder dividends until 2006, even as the company needed to borrow $14 billion to shore up its pension fund and cut new-product spending. Wagoner also got GM into a deal with Italy's Fiat Auto that ultimately cost $4.5 billion. While he was chief operating officer, GM bought Hummer, which now needs to be divested. The Obama Administration Obama will turn GM over to Wagoner's groomed successor, GM COO Frederick A. "Fritz" Henderson, who will be CEO, and GM board member and former Northrop Grumman CEO Kent Kresa, who becomes interim chairman. GM will be rocked hard. Wagoner is out just as Vice-Chairman Bob Lutz is set to retire at the end of April, when he becomes an adviser. Both leaders were liked and their departures will usher in an era with new management, deep cuts, and strong government oversight. However GM emerges from this crisis, it will be a very different company.

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G20 unity spells end of Brown’s 'New Deal’

Gordon Brown’s plans for a $2 trillion (£1.4 trillion) “New Deal” to revive the global economy have been quietly dropped to preserve the facade of unity as world leaders gather in London for the G20 summit. The US and Britain have both backed away from spending proposals worth 2pc of global GDP, accepting that each country must find its own way. White House officials confess that there is no chance of a deal that entails further public debt. “Nobody is coming to London to commit to do more right now. No single number is sacrosanct,” said Michael Froman, the US deputy national security advisor. British Foreign Secretary David Miliband disowned a leaked draft retaining talk of a $2 trillion boost, insisting that it was an old document that merely lists spending packages already under way across the world. “This G20 summit was never about writing national budgets.

Let us not hear that somehow the Anglo-Saxons are for fiscal policy and the other Europeans are somehow for regulation – you have got to do both,” he said. The text reiterates the traditional pieties, calling for an “an open world economy based on market principles” and a determined effort to “resist protectionism”. It comes as the World Trade Organisation predicts a 9pc fall in global shipments this year following a violent plunge in the last quarter of 2008. The pledge to uphold free trade has already been cast into doubt by China, which announced a raft of export tax rebates on Friday to shore up exports. The protectionist move is likely to irk Washington. There is grumbling on Capitol Hill that the US stimulus is leaking out to surplus states in east Asia and northern Europe which seem to be counting on American demand to rescue the world again. But the two sides are so far apart in their diagnosis of this crisis that no real agreement seems possible.

German Chancellor Angela Merkel said over the weekend that the “German economy is very reliant on exports, and this is not something you can change in two years. It is not something we even want to change”. Czech premier Mirek Topolanek, holder of the EU presidency, attacked the US fiscal plan last week as the “road to Hell”. Europe’s leaders insist the region is already doing enough since generous unemployment payments – starting at 80pc of earnings in Germany – act as an automatic stabiliser. The problem is that job losses lag the downturn by several months. By the time the stimulus kicks in, it may be too late. Washington believes that this emergency calls for a radically different approach.

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A new plan needed as the cycle grows vicious
by Wolfgang Münchau

So you think you can see the green shoots of recovery? You draw comfort from the recent stabilisation of forward-looking indicators such as new home sales in the US? Or you think the stock market rally marks the end of the crisis? Of course, economic growth rates are bound to improve soon for technical reasons. Otherwise, not much would be left of the global economy by the end of the year. Even if a recovery were to start early in 2010, as some optimistic forecasters believe, most of the pain of the recession is still ahead of us: unemployment and default rates will rise sharply everywhere. Most of the pain in the financial sector is also still ahead of us. This will feel like a depression long after it has ceased to be one.

I am more worried now than I was a month ago. The main problem is that the feedback loops between the real economy and the banking sector are truly scary. Remember that all the public and private sector forecasters are still busy adjusting their 2009 economic projections downwards. The latest downward revision for Germany came from Commerzbank last week, which now projects 2009 growth at a negative 6-7 per cent for this year. At this rate of contraction, the number of private and corporate defaults is likely to increase massively beyond some of the stress-test assumptions made by the banks themselves. After the crisis caused by toxic securitised assets, the financial industry is now hit by another crisis of potentially similar magnitude. This looks to be one of the worst credit cycles in living memory.

Economists and policymakers who wonder how much it will take to recapitalise the banking sector are discovering that rescuing the banks is a much more dynamic exercise than they thought. Whatever you think it costs – and there have been widely different estimates – it is likely to end up costing you a lot more for that precise reason. The economy is trapped in a vicious circle where credit crunch and recession mutually reinforce each other. By the end of December, global banks had written off about $1,000bn (€752bn, £699bn) in bad assets, approximately half of that in the US. Since the onset of the crisis, the writedown of assets in the US has exceeded the provision of new capital. Even the Geithner public-private partnership plan is not going to reverse the expected deterioration of capital ratios at sufficient speed and on sufficient scale.

In Europe, new capital exceeded writedowns by a small amount, but on the recent projections I have seen, this trend could reverse sharply this year, unless governments introduce new recapitalisation plans. In the absence of such plans, the banking sector will continue to contract its balance sheet by cutting lending. This is a totally rational response by the banks. To unfreeze the global financial market therefore requires significant increases in bank capitalisation, not just to the status quo ante, and not just to account for the toxic securitised assets themselves, but to adjust for the stuff that is getting toxic right now and tomorrow. The estimate by Alan Greenspan, the former chairman of the Federal Reserve, that one needs to push the ratio of banks’ equity capital to assets from 10 per cent to 13 or 14 per cent seems plausible to me. After a long period of undercapitalisation, you need a period of overcapitalisation just to get back to normal.

In other words, you have to do quite a bit more than you think you need to do, rather than quite a bit less. This is the main reason why the Geithner plan is not an optimal policy response. It is a very smart plan in terms of the way it is constructed. It provides no-brainer incentives for private investors to buy toxic assets. But it will not produce sufficient recapitalisation, let alone sort out the problem to such an extent that banks start lending again. For all its technical ingenuity, this plan is at best insufficient – and more likely an expensive distraction that delays the inevitable policy response of a government-led recapitalisation programme. Europeans think they have less of a problem because they already put bank rescue packages in place last October. This is one of the many misjudgments of European officials in respect of this crisis.

The current rescue packages are not doing the job. They were emergency measures only. But we have moved beyond the immediate emergency, and need a strategic response. Europe, too, will have to start to address the problem, by forcing banks to write down their assets in exchange for new capital. And not all the banks should survive. We must allow the sector to shrink while we recapitalise. This means many painful and unpopular decisions have yet to be taken. I have no hope that this week’s Group of 20 summit will provide a solution to this problem. In fact, the old Group of Seven would be a much more appropriate group to discuss a co-ordinated approach about crisis resolution, as most of the world’s most important financial centres are located in these countries. But it matters less who does it than what is being done. The Europeans need a new plan. And the US needs a better plan.

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New Task Seen for Fannie, Freddie

The regulator of Fannie Mae and Freddie Mac is considering giving the government-backed mortgage companies another role: helping to finance small mortgage banks. A spokeswoman for the regulator, the Federal Housing Finance Agency, said it is looking at ways that the two companies might help revive the market for so-called warehouse loans, which are loans made to mortgage banks. This possible role for Fannie and Freddie is the latest sign of how they are being used increasingly as instruments of government policy rather than corporations focused on shareholder returns.

Demand for mortgages is surging as low interest rates prompt millions of Americans to refinance. New U.S. first-lien home-mortgage loans granted this year will surge to $2.78 trillion, up 72% from 2008's depressed level, the Mortgage Bankers Association predicts. But mortgage banks have been hobbled in recent months by a dearth of credit, making it hard for them to respond to that demand. Partly as a result of this credit crunch, giant full-service banks like Bank of America Corp. and Wells Fargo & Co., which don't need warehouse funding, are increasing their dominance of the mortgage market. Consumers will face higher interest rates and slower service if mortgage banks can't get enough credit to compete with the giants, mortgage bankers argue.

The regulator has asked representatives of mortgage banks, including the Mortgage Bankers Association, to come up with a detailed plan for Fannie and Freddie to help mortgage banks get credit. John Courson, chief executive officer of the association, said in an interview that the plan should be ready to be presented to the regulator within about a week. One possibility is that Fannie and Freddie will guarantee debt issued by warehouse lenders, making it easier for them to provide financing to mortgage banks. When mortgage bankers complained about the lack of warehouse funding, officials in the Treasury and Federal Reserve urged them to seek help from the regulator of Fannie and Freddie.

Last September, the regulator took over management control of the two shareholder-owned companies as surging defaults depleted their thin layers of capital. They are now being propped up by funds from the Treasury. Under regulatory control, they have shifted their focus to the prevention of foreclosures, even though that may delay their return to profitability. The Treasury also has said that Fannie and Freddie may play a role in supporting state housing-finance agencies. Mortgage banks typically are small, family-owned companies. Unlike commercial banks or thrifts, they aren't licensed to take deposits and so don't have that source of money for their loans. Instead, they borrow money from warehouse lenders, which often are units of larger banking companies. The mortgage banks use the short-term credit to provide loans to their customers and then pay back the warehouse lenders after selling the loans to bigger banks or to investors such as Fannie or Freddie.

Until credit markets froze up in 2007, Wall Street investment banks and many large mortgage lenders were eager to provide these warehouse lines of credit. Now, many of those big institutions have stopped making warehouse loans or have cut back on that business. Warehouse Lending Project, a group of mortgage bankers seeking to revive the market, estimates overall money available for warehouse loans has dropped nearly 90% since 2006, to about $25 billion Mr. Courson said he believes the regulator can give Fannie and Freddie temporary authority to help fund warehouse loans and that it won't be necessary to seek congressional approval for this expansion of the two companies' role. "We just don't have the luxury of time for going through the legislative meat grinder," he said.

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Ilargi: Alan Wheatley is China Economics Editor for Reuters. Reading him, however, you'd think he's on intimate terms with Hu Jintao. Wen Jiabao and the rest of the party crowd. Wheatley tries hard to create the impression that he happens to know exactly what China wants.

"On the chess board of currency politics, China has disclosed its endgame..." "Beijing's ultimate goal is to replace the globally dominant dollar with a beefed-up Special Drawing Right..."

Of course, he's simply guessing, which makes this article a piece of crap reporting. We can all take guesses at what China’s goals are. For now, if you ask me, they're throwing some trial balloons into the ether, and enjoying the confused effects these have in the west. Undoubtedly, China is in a position to make more demands now than it has been in centuries, and it will make them. That will mean the end of the US dollar's hegemony sometime down the line. To suggest that China has "disclosed" its endgame is rubbish. It makes way more sense to suggest that China holds a lot of trump cards and plays them close to its chest.

Pundits invariably claim that China will not use its dollar reserves to sink the dollar, since that would hurt China itself. As I’ve said before, I think that is a narrow and potentially dead wrong view. A boxer volunteers to go into the ring, even though he knows he’ll take a few hits, because he's confident he’ll get hit less than his opponent. If China feels dumping dollar reserves will hurt the US more than Beijing, it might see it as a very viable move. The US is vulnerable, and it shouldn't expect any pity, if only because it hasn't shown any. China may see its reserves not as a financial, but as a power tool.

Watch China's FX swaps, not just super-currency plan

On the chess board of currency politics, China has disclosed its endgame in a striking show of confidence ahead of this week's Group of 20 summit in London. Just as significant, it is already advancing its pawns. Beijing's ultimate goal is to replace the globally dominant dollar with a beefed-up Special Drawing Right, the International Monetary Fund's in-house unit of account, which would become a "super-sovereign reserve currency". The plan, laid out a week ago by central bank governor Zhou Xiaochuan, is bold, thoughtful and visionary. It is also magnificently unrealistic.

The political intent of Zhou's message could not be clearer: as the crisis of capitalism erodes U.S. influence, China is losing faith in the dollar and sees the time ripening for the yuan to assume its rightful role as a major world currency. "It has the potential to lead to one of the most profound reforms of the global monetary system in the coming decades," Jun Ma, Deutsche Bank's chief China economist, said of Zhou's blueprint. However, with 5,000 years of history behind it, Beijing is ready for a long game. Zhou knew his trial balloon would immediately be shot down, save for backing from Russia. Hence his acknowledgement that creating a new international monetary order would require "extraordinary political vision and courage".

Translation: Beijing realizes that a currency does not lose its global domination overnight. Even after the United States overtook Britain in economic size in the late 19th century, it took two world wars that drained Britain's Treasury and its military might before the dollar supplanted sterling. The American grandmaster will not surrender his title lightly. "It's not a feasible or workable monetary measure," Zhong Wei, an economics professor at Beijing Normal University, said of Zhou's proposal. Rather, he said, the central bank chief was simply rueing the unfairness of today's global financial order.

"The paper should be read as a complaint from Chinese officials -- and that's all," Zhong said. Perhaps. But Zhou's essay takes on a different complexion if read in the context of a flurry of moves by China in the usually dull arena of trade finance. Since mid-December, China has sealed currency swap accords totaling 650 billion yuan ($95 billion) with the central banks of South Korea, Malaysia, Indonesia, Hong Kong, Belarus and, in a deal announced on Monday, Argentina. These are pawns that are not being moved at random, and financial diplomats say more agreements are in the pipeline. The proximate purpose is to grease the wheels of trade, which have been gummed up by the global credit crunch. Importers in the six countries will be able to pay for Chinese goods in yuan instead of in dollars, the principal export-import currency.

But the potential repercussions for global currency politics are more far-reaching: if Asia got accustomed to the practice, the yuan could evolve into a regional currency, giving Beijing the status and influence that goes with it. A former senior international monetary official said the pacts were in keeping with what he said was China's greater assertiveness in global forums over the past two years or so. "They want to play a stronger role, and these small steps such as giving bilateral swaps to Indonesia, Malaysia and Korea are a lot more important than the SDR proposal," said the official, who declined to be named as the issues are sensitive.

Getting comfortable with the internationalization of the yuan for trade should, in turn and in time, make Beijing more willing to move toward capital account convertibility -- a precondition for the yuan to become part of a revamped SDR. Now, there is no sign China wants to speed up the opening of its capital account -- even though the yuan, if it could be bought and sold for non-trade purposes, would be more attractive for central banks as an alternative reserve asset to the dollar. But, as some economists see it, pricing and settling trade in yuan will inevitably lead to greater use of the Chinese currency offshore for financial and investment purposes. "The swaps should be seen as a political statement with the intention of turning the yuan into a regional reserve currency," said Ben Simpfendorfer with Royal Bank of Scotland in Hong Kong.

Take the scheme, due to be launched soon, that will allow trade between Hong Kong and the mainland province of Guangdong to be settled in yuan rather than in U.S. or Hong Kong dollars. The 200 billion yuan swap that Beijing signed with Hong Kong in January will provide an initial pool of Chinese currency needed for paying export and import invoices in yuan. But imagine if the experiment takes off: banks would eventually need access to the mainland interbank market for funding, according to a financial diplomat in Beijing. And should banks in Hong Kong -- and other centers -- be allowed to adjust their positions with each other? If so, an offshore interbank market in yuan would sprout. "We must understand that it is an inevitable trend that an overseas yuan investment market will grow after foreign trade settlement in yuan becomes widely accepted," Ye Xiang, a co-founder of VisionGain Capital, a Hong Kong investment management firm, wrote in Caijing magazine.

Hong Kong is already a test bed for liberalization of the yuan. In the past few years Beijing has permitted the issuance of yuan-denominated bonds in the city, as well as the establishment of Chinese currency accounts for Hong Kong residents. Many pieces will need to be moved around the board before China is in a position to force a draw with the dollar, let alone declare checkmate. But Beijing, thinking strategically, is unlikely to be too perturbed if Zhou's gambit founders in London. "Whether or not the reserve currency question progresses beyond an intellectual debate, it is clear that China has decided the time is ripe to become proactive in the debate," Stephen Green and David Mann, economists at Standard Chartered Bank, said in a report. "The crisis which started in the West is helping to accelerate the ascendancy of economic superpowers in the East."

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World Bank warns of social discontent in Russia

The World Bank has given warning of serious social discontent in Russia after delivering a bleak assessment of the country's economy. Scotching optimism that the world's largest country may already be in recovery, the bank predicted that Russia's economy is contracting far more sharply than the Kremlin has acknowledged. According to revised government forecasts, the Russian economy will shrink by 2.2pc this year. But it its latest economic report on Russia, the World Bank predicts that Gross Domestic Product will actually contract by 4.5pc. The assessment comes as foreign investors focussed on emerging markets again start to flirt with Russia after months of record capital flight in the wake of last August's war with Georgia and a collapse in the price of oil. The Russian stock exchange's benchmark RTS index has gained over 30pc this year alone, outpacing most emerging markets, after a modest recovery in oil and metal prices.

But Zeljko Bogetic, the World Bank's lead Russia economist, cautioned against such optimism. "As the crisis continues to spread to the real economy around the world, initial expectations that Russia and other countries will recover fast are no longer likely," he said. Mr Bogetic also warned the Kremlin that it faced popular discontent, especially among Russia's large working class, if social spending was not dramatically increased. "The social situation has worsened so rapidly and so unexpectedly that it is important to shift the focus of the anti-crisis policy to the population," he said. "Since there is a threat of significant social pressure, it would have been clever to pay attention and assign funds for social protection." With the World Bank predicting a rise of unemployment to 12pc, Mr Bogetic called on Russia to raise unemployment subsidies by 70pc and child welfare benefits by 220pc.

Russia's fiscally conservative finance ministry has so far been reluctant to raise social spending so dramatically, fearing inflationary pressure. Even so, Russia's budget is expected to run a deficit of over 7.0pc this year, against a 4.1pc surplus in 2008, thanks to falling oil revenues, an ambitious stimulus package and a reluctance to cut back on planned infrastructure spending. Despite the size of the deficit, Russia should have little difficulty financing the budget thanks to substantial foreign currency reserves and a healthy oil windfall fund. While the World Bank's forecast is gloomy, it remains more optimistic than the predictions of some government officials who have privately warned that the economy could shrink by as much as 10pc in 2009. The World Bank's assessment is predicated on oil prices of $45 a barrel. Russia's Urals blend of crude is hovering at about $50, up from a low of $35 last year. Some strategists predict oil could continue to recover over the next few months thanks to greater discipline in enforcing production cuts by the Organization of Petroleum Countries, of which Russia is not a member.

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Russia backs return to Gold Standard to solve financial crisis

Russia has become the first major country to call for a partial restoration of the Gold Standard to uphold discipline in the world financial system. Arkady Dvorkevich, the Kremlin's chief economic adviser, said Russia would favour the inclusion of gold bullion in the basket-weighting of a new world currency based on Special Drawing Rights issued by the International Monetary Fund. Chinese and Russian leaders both plan to open debate on an SDR-based reserve currency as an alternative to the US dollar at the G20 summit in London this week, although the world may not yet be ready for such a radical proposal.

Mr Dvorkevich said it was "logical" that the new currency should include the rouble and the yuan, adding that "we could also think about more effective use of gold in this system". The Gold Standard was the anchor of world finance in the 19th Century but began breaking down during the First World War as governments engaged in unprecedented spending. It collapsed in the 1930s when the British Empire, the US, and France all abandoned their parities. It was revived as part of fixed dollar system until US inflation caused by the Vietnam War and "Great Society" social spending forced President Richard Nixon to close the gold window in 1971.

The world's fiat paper currencies have lacked any external anchor ever since. It is widely argued that the financial excesses and extreme debt leverage of the last quarter century would have been impossible - or less likely - under the discipline of gold. Russia is a major gold producer with large untapped reserves of ore so it has a clear interest in promoting the idea. The Kremlin has already instructed the central bank of gradually raise the gold share of foreign reserves to 10pc. China's government has floated a variant of this idea, suggesting a currency based on 30 commodities along the lines of the "Bancor" proposed by John Maynard Keynes in 1944.

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Ilargi: Reading Robert Reich, I have an urge to just give up. Anyone who uses terms like "sustained economic growth" and "sustainable growth " in a serious fashion needs to take a vow of silence and go back to the books, since he hasn't gotten the picture at all. As long as the people in high places don't figure out that "sustainable growth" is an oxymoron and an empty feel-good propaganda slogan, we will as societies keep on making the same mistakes, all the way until the moment when one ultimate inevitable disaster or another of our own ignorant making will finish off the mess that our impaired brains have created.

Obamanomics Isn't About Big Government

Twenty-eight years ago, Ronald Reagan used the severe economic downturn of 1980-82 to implement an economic philosophy that not only gave force and meaning to a wide range of initiatives but also offered a way back to sustained economic growth. Is there a similarly powerful animating idea behind Obamanomics? I believe there is -- and it's not a return to big government. The expansive and expensive forays of the Treasury and the Federal Reserve Board into Wall Street notwithstanding, President Barack Obama's 10-year budget (whose projections may prove wildly optimistic if the economy fails to rebound by early next year) presents a remarkably conservative picture. In 10 years, taxes are expected to fall to around 19% of GDP, a lower level than the late 1990s. Spending is expected to drop to around 22.5% of GDP, about where it was under Ronald Reagan -- including nondefense discretionary spending at about 3.6% of GDP, its lowest since data on this were first collected in 1962.

The real distinction between Obamanomics and Reaganomics involves government's role in achieving growth and broad-based prosperity. The animating idea of Reaganomics was that the economy grows best from the top down. Lower taxes on the wealthy prompts them to work harder and invest more. When they do so, everyone benefits. Neither Reagan nor the apostles of supply-side economics explicitly promised that such benefits would "trickle down" to everyone else but this was broadly understood to be the justification. Reaganomics surely marked the beginning of one of the longest bull markets in American history and generated enormous gains at the top. But its benefits were not widely shared. After the Reagan tax cuts, growth in the median wage slowed, adjusted for inflation.

After George W. Bush's tax cuts in 2001 and 2003, the median wage dropped. Meanwhile, an increasing share of total income went to the top 1% of income earners. In 1980, before Reagan took office, the highest-paid 1% took home 9% of total national income. By 2007, before the economy melted down, the richest 1% was taking home 22%. Obamanomics, by contrast, holds that an economy grows best from the bottom up. The president proposes to increase taxes on the highest 2% of income earners starting in 2011. Those tax increases will fund more Pell grants allowing lower-income children to attend college, better pay for teachers that show they're worth it, broader access to health care, improved infrastructure, and more basic research. These and related expenditures are designed to help Americans become more productive. You might think of it as "trickle up" economics.

The key is public investment. Reaganomics did not view any public spending as an investment in the future except when it came to spending on the military. Hence, since 1980, federal spending on education, job training, infrastructure and basic research and development (apart from defense-related R&D) have all shrunk as a proportion of GDP. And apart from a modest expansion of health insurance available to poor children, there has been no significant attempt to make health insurance broadly affordable to Americans. Obamanomics is premised on the central importance of public investments in the productivity of Americans. The logic is straightforward. Capital no longer remains within the borders of a nation where it is saved. It moves to wherever around the globe it can get the best return. Some of it flows as highly liquid investments that slosh across borders at the slightest provocation, as we're witnessing in the current financial crisis. But much takes the form of direct investments in new plants and equipment, telecommunications systems, laboratories, offices and -- most important of all -- jobs.

Such capital goes to nations that can deliver high returns either because labor is cheap and taxes and regulations low or because labor is highly productive: well educated, healthy and supported by modern infrastructure. In this way, every nation faces an implicit choice of whether its strategic advantage will lie in low costs or high productivity. For the better part of the last three decades America's job strategy has tended toward the former. But this inevitably exerts downward pressure on the real wages of a larger and larger portion of our population. Only those Americans whose parents can afford to give them a high-quality private education and health care, and who can situate themselves in locations with excellent infrastructures of telecommunication, transportation, public health and safety, have been able to link up with global capital on more positive terms. But not even they are entirely secure economically, because they face growing shortages of talented people they can rely on within easy reach, and can't entirely avoid the disadvantages of a deteriorating public infrastructure, such as ever more congested roads and airports.

Obamanomics recognizes that the only resource uniquely rooted in a national economy is its people -- their skills, insights, capacities to collaborate, and the transportation and communication systems that link them together. Public investment is the key to attracting long-term private investment so that a nation's people can prosper. Bill Clinton understood this but failed to do much about America's deteriorating public investments because he came to office during an economic expansion, when the major worry was excessive government spending leading to inflation. Mr. Obama comes to office during the biggest downturn since the Great Depression, and his plan represents the largest commitment to public investment in 30 years. Regulation, done correctly, is also a form of public investment because it enables consumers and investors to be confident about what they're receiving, and ensures that the side-effects of trades don't harm the public.

Reaganomics assumed that deregulated markets always function better. They do in many respects. But when they don't, all hell can break loose, retarding economic growth. Energy markets were deregulated and we wound up with Enron. Food and drug safety has been neglected, resulting in contaminated products that have endangered consumers and threatened whole industries. Financial markets were deregulated and we now have a global meltdown. Obamanomics, by contrast, views appropriate regulation as an essential precondition for sustainable growth. Under Reaganomics, government was the problem. It can still be a problem. But a central tenet of Obamanomics is that there are even bigger problems out there which cannot be solved without government. By building the economy from the bottom up, enhancing public investment, and instituting reasonable regulation, Obamanomics marks a reversal of the economic philosophy that has dominated America since 1981.

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