"Col. Roscoe Turner, winner of speed trophies in the air, dropped down to Washington Airport today with a red high-wing monoplane which he presented to the friends of New China, represented by Miss Hilda Yen, Chinese Aviatrix. The plane, 'Spirit of New China.' was built by the Porterfield factory."
Ilargi: Jim Rogers is right. There is no recovery in the American economy. Things have only gotten worse, and a lot too. Still, Rogers can’t help seeing the world through his own subjective eyes either, distorted by his age and his professional views. He makes money as an investor, and can’t imagine a world in which investors like him are not part of the landscape.
And that’s the big blind spot for most analysts, publications and websites that occupy themselves with finance and the economy. They're written by people who make a living because the economy is organized a certain way, and they see a situation in which that will mostly continue to be so, with some more or less minor tweaking. Rogers understands a lot of what’s coming, but he stops short of pondering himself as a victim. This may be completely natural and logical, but it does potentially cloud his vision. For him, the question is where to invest, not whether to invest at all.
But, again, he's right. There's no recovery. A Bloomberg piece this morning illustrates why. It says that China's Q3 output was up 19.2%, with exports down 1.3%, and imports up 26.7%.
China’s growth accelerated to 8.9 percent in the third quarter on the record lending and a $586 billion, two-year stimulus package, helping Asia to lead the recovery from the global economic slump.
The Chinese government injects a comparatively gigantic amount of money into the economy, which the banks use to hand out record loans. And that, all by itself, says Bloomberg, makes Asia (re: China) lead the recovery from the slump. This is the gospel according to Washington, the gospel of Barack Obama and George W. Bush. The first is on record claiming that the US can "spend its way out of the recession", the second became famous for encouraging people to go shopping in the face of economic hardship. In other words, as Jim Rogers phrases it:
"The idea you can solve a problem of too much debt and too much consumption with more consumption and more debt defies belief. I cannot believe that grown-ups would stand there and say that."
Well, Jim, grown-ups in governments ranging throughout history and across the globe have stood there, and today stand there, saying exactly that. By the way, if I were you, I would, but that's just me, in the light of the Chinese embrace of the Washington "spend and borrow your way out of debt" gospel, perhaps take another look at your own embrace of the Chinese economic model.
It would feel more consistent, since China of course has no genuine recovery either. Its exports are still falling, but its output rose 19.2%. In other words, the Chinese will have to buy their own products. Problem is, they don't feel like doing it. According to Michael Pettis, Chinese household consumption is 35% of its economy, vs 55-65% in Europe and 70-72% in the US. And its consumption isn't rising fast, if at all, either. What is rising are savings, presently at 26%, vs a negative savings rate in the US until recently. Pettis asks an intriguing question about China:
"Crises seem to drive the household consumption rate down, even though bull markets don’t seem to drive it back up. Is that because crises cause households to worry about risk (although if that were true they wouldn’t go permanently down, would they)? Or is it because the government responds to crises by increasing the amount of misallocated investment, the consequence of which is to reduce future consumption?"
So what would it take to drive Chinese consumption upwards towards levels that might sustain at least part of its economy if and when American and European export markets don’t rise from their ashes? Pettis says:
Just to return consumption to 40% of GDP over the next five years (and even that level is widely considered to be way too low, and probably unprecedented in the world excluding recent Chinese history), 8% average annual growth rates in GDP would require a tad under 11% annual growth in consumption. [..]
To bring Chinese consumption in 20 years up to 50% of GDP, which is the low end for other high saving Asian countries, and far lower than any other large economy in Asia (and remember that large economies are less able to rely on exports to fuel growth than small countries), 7% annual GDP growth would require average annual consumption growth of just under 9% for twenty years.
In other words while GDP growth slows significantly from its 12-13% rate of the past several years, consumption will nonetheless have to surge at rates far in excess of the 8-9% growth rates of recent years in order for even a small, partial rebalancing to take place.
One thing should become clear now: China won’t be able to run its economy on domestic demand for many years to come. Until then, it will rely on western consumers, who are broke, and on government subsidies, i.e. consumption of its own flesh. Whatever the choice may be, a 19.2% increase in Q3 2009 output looks a lot like despair. Who will buy all that extra output? There are no extra clients anywhere on the horizon.
Just as is the case in the US, people like the Bloomberg reporter quoted above confuse government funding with credit. Of course, if you ask no questions, both may look pretty much the same. But that doesn’t mean they are. You can't be both the seller and the buyer of your own products and still claim you’re making a profit.
The Chinese are trying to kick-start economy with their own reserves. But once the engine runs, if it does, it’ll need somewhere to go, someone to purchase its products. That someone will have to have a trade surplus, i.e. money to spare. The Americans don’t have any. They are trying to kick-start their economy with borrowed money, which means they are increasing their already sky-high debt levels. Which is why Jim Rogers is dead-on when he says that there is no recovery, and things have only gotten worse in the past year.
You wouldn't know it from looking at the stock markets yet, but if you imagine the economy as a closed system, which in the thermodynamics definition can exchange heat and work (energy), but not matter, with its surroundings, it becomes clear that whatever happens inside the system doesn’t solve any problems, but merely transfers wealth (heat) from one part of the system to the other. That is, while banks and investors have been making money over the past 6-month rally, someone else has been losing out.
To figure out who, you need look no further than the record numbers of American citizens who are unemployed, homeless and/or living on foodstamps. The system as a whole shows no recovery, just parts of it do due to increased misery in other parts. Moreover, what does enter the system from outside is borrowed money that needs to be repaid. This should also make clear why printing money cannot solve any of the existing problems. For one thing, America's largest creditor is China, which has its currency pegged to the dollar. No gains there.
In more general terms, much, if not most, of what is seen as wealth consists of nothing but leveraged bets. Which is how a home that cost $100,000 to build comes to sell for $500,000. This wealth will have to be deleveraged, until things are worth what they are, i.e. they have a price someone is willing and able to pay for them. In the absence of cheap and abundant credit, that is.
All countries are chasing the same remaining pieces of the pie, which can only be obtained by increasing one’s exports, or, more correctly and comprehensively, one’s trade balance. And since the world economy as a whole can also be considered a closed system, the only possible turn of events in this case too is wealth transfer. Which can be achieved, as noted, by an increase in exports, or possibly through warfare. It cannot be achieved by printing one’s own currency. That could function (temporarily, until hyperinflation sets in) only if the system were what thermodynamics defines as an isolated system, i.e. no exchange whatsoever with the outside world.
Since the US depends on the money it borrows from outside its borders, it is as yet far from being an isolated system. It can try to devalue its currency, but so can any other country. The US has an added disadvantage in the fact that the US dollar is the world reserve currency, which means people will flee to it in times of global stress and uncertainty. Which in turn will push up the dollar’s exchange rate.
Once the US is cut off from the rest of the global economy, either forcibly or voluntarily, it may or may not go the way of Weimar and Zimbabwe, both more or less isolated systems in an economical sense. That moment, though, is years away.
Until then, to quote Jim Rogers once more, things will only get worse if the present "spend your way out of misery" gospel continues to rule our ways. Just look at how much more debt, most of which is owed to foreigners, the US has compared to a year ago. It runs in the trillions. In just one year.
Rogers is right again when he notes that Obama was merely a community organizer just 6 years ago, doesn't understand economics, and relies entirely on the people he nominated in his economic team. But that is not a valid excuse.
A headline in French weekly Le Point yesterday said : "Warlord Obama receives his Nobel Peace Prize". Being the President of the United States means you can't wreck the nation's economy and plead innocence or ignorance. Neither does it mean you can send 30,000 extra young Americans into battle and pick up a Peace Prize one week later. He could have refused the prize. And probably should have. Or, as someone suggested, sent an unmanned drone to pick it up for him.
Jim Rogers is buying American dollars. You?
Ilargi: In case it might have slipped your mind, perhaps I should mention we still accept donations (time to start the Christmas Drive), and our advertisers still appreciate your visits.
Beware the Hin-DEBT-burg
by Christopher G. Galakoutis
A blinding affliction can be seen with the gold bugs. Make reference to a strong dollar and falling gold, and you must be a supporter of the central banks, as well as the powerful families with cross-border tentacles that stand behind them. In our case, nothing could be further from the truth. We must put politics and other biases aside if we are to understand the big picture, in order to avoid, and not be ruined by, what’s around the corner.
Let’s not forget that many of the rabid free-marketers and doomsday hyper-inflationists, many of whom were completely invested in gold & silver stocks, oil and foreign assets, would have been ruined and their clients bankrupt, were it not for Ben Bernanke and the central bankers of the world who bailed them out, in effect, by way of this year’s liquidity rally that has elevated all risky assets. Those risky assets plummeted late in 2008 as the US dollar rallied during the initial deflationary decline.
"Deleveraging" is what the inflationists call what happened during the crash of 2008, and continue to call it. What the inflation side fails to see is that deleveraging is a necessary consequence of deflation, and that, despite a short-term reprieve that is just about over, the Fed is powerless to stop it. By repositioning themselves and their clients back into inflation plays, and going ‘all-in’ of late it seems, they are headed smack into the next leg down of deflation, and the next deflationary wave won’t care if it takes many well-intentioned folks down with it.
Uncontrolled credit growth spreads like fire across an economy, spawning bubbles based on a flimsy debt foundation. Cheap credit ultimately ends up in the markets, pushing up asset values. But the problem is that cheap credit does not only propel higher the asset values in portfolio’s of those who access the cheap credit, but all stocks and bonds his demand pushed higher, making everyone think they are richer. The last trade of the day, even if conducted by one motivated buyer using credit, and one seller, affects the value of all holders of that asset. If that asset’s value is propelled higher, then every holder of that asset appears to be wealthier.
Others then use this newfound "wealth" to leverage up and purchase more assets on credit. This action multiplies across an economy the further the credit bubble expands. It isn’t difficult to understand and envision the destruction on the other side of this when debt bubbles break and futile efforts to re-inflate them fail. That’s what has been happening since last year, and is nowhere near an end.
Many in the inflation camp concede there will be no new credit bubble inflated. Yet they argue for a continued inflation run. Since the blowing of an epic credit bubble this decade gave us the credit inflation that catapulted gold and other assets to dizzying heights, and if that bubble is now deflating, why would these assets continue higher? The Hin-DEBT-burg is burning and heading for a crash landing. Ben Bernanke’s printing press cannot, and will not, stop it. The debt bubble was the elephant. The Fed is the mouse. Forewarned is forearmed.
What Recovery? America's Problems "Getting Worse, Not Better," Jim Rogers Says
"It's getting worse, not better." That's how Jim Rogers responds to the recent talk of improvement from President Obama, Treasury Secretary Geithner and Fed Chairman Bernanke, among others. "Papering over the problem is not going to solve America's problem," Rogers says. "The idea you can solve a problem of too much debt and too much consumption with more consumption and more debt defies belief. I cannot believe that grownups would stand there and say that."
History shows the only way to solve a financial crisis is "when people go bankrupt, you let them go bankrupt," Rogers say. "Then, competent people come in, take over the assets, reorganize and you start over." But rather than "take the pain and reorganize and start over," as Sweden, South Korea and others have done, Rogers says America is "doing the Japanese model." Keeping zombie banks alive and bailing out their creditors will only prolong the pain, the famed financier predicts. "What has been happening is the government has been printing and spending a lot of money," he says. "The problem is not solved - they're making the problem worse."
Adding insult to injury, Rogers fears the "unintended consequences" of new regulations that inevitably come from politicians seeking someone to blame for the crisis. "The problems in last two years came from industries that are heavily regulated: banking, insurance, mortgage," he notes. "Now what? You're going to make the regulations tougher? It's not the regulations, it's the regulators."
Joyce's Armageddon warning
Tony Abbott's new finance spokesman, Barnaby Joyce, believes the American Government may default on its debt, triggering an "economic Armageddon" that will make the recent global financial crisis pale into insignificance. He has also proposed that the Federal Government should introduce laws allowing it to break up the assets of the four main banks - and use them to force banks to hold down interest rates.
"You don't even have to break them apart," he said. "But you have to suggest to them that those powers could be in place to do that if they aren't more diligent in how they respect the Australian community." Senator Joyce came under attack from several ministers, including Treasurer Wayne Swan, who said he had been elevated "straight from the reactionary fringe of our economic debate to the second most senior economic policy-making job in the alternative government".
In an interview with The Age, Senator Joyce said he did not want to alarm the public, but there needed to be a debate about Australia's "contingency plan" for a sovereign debt default by the US or even by an Australian state government. "A default by the US means complete economic collapse around the world and the question we have got to ask ourselves is where are we in that?" he said. He said the chances of a US debt default were distant but real, and politicians were not doing the electorate a favour by refusing to acknowledge the risk.
Senator Joyce first warned of America defaulting at a Senate estimates hearing in October where he asked Treasury secretary Ken Henry for his views. Dr Henry warned then that public figures had to be careful about discussing "hypotheticals that are that extreme" because such discussions could be misinterpreted in the community. Rather than tempering his language since his promotion, Senator Joyce has stepped up the rhetoric, saying he also had concerns that some states would have trouble repaying their borrowings.
"The first thing you tell a new client is exactly where they are. We have to tell the Australian people precisely where they are," said the former accountant from the Queensland town of St George. "The Federal Government has $115.7 billion in debt, Australian government securities, notes and bonds on issue, and the states have another $170 billion in debt," Senator Joyce said. "We have to ask whether the states have the capacity to repay that. I would say in some instances they do not - particularly Queensland."
Senator Joyce said that if the US recovered, global funds would flow back into North America. He said the only way Australia could keep capital flowing into the country would be to increase interest rates. "That is the first scenario, which is extremely bad for Australia.
"The worse scenario is where the United States doesn't repay their debt - the $US2 trillion in debt they owe to the Chinese, the $US1 trillion in debt they have to the Japanese and the $US1 trillion in debt to others - and then we are really nailed." That would result in a shift from the US dollar to the yuan, "and China becomes an immensely powerful player overnight".
"If America collapses there will be no more sale of Chinese products to America and therefore very little purchase of Australian resources by China." "The whole pulse of trade is compromised because people say, 'Why would I trade with the US when it might not pay its debt back?' " He said this "real financial crisis will mean this preamble we have just had pales into insignificance". Asked what sort of contingency plan he would advocate, Senator Joyce said it was like trying to prepare for a tidal wave, but the local economy should have more self-reliance.
"Things you look for in that economic Armageddon are the capacity to feed ourselves, the capacity to provide the fundamentals in medicines and basic fundamental requirements for our nation." His comments about the banks were made later in the day on Sky TV. He said the Government had stood back and watched the centralisation of the sector, resulting in interest rates being hiked "under the cover of darkness".
Initial jobless claims rise; Total claims, including extended benefits, top 10 million
The number of people filing claims for state unemployment benefits rose by 17,000 to a seasonally adjusted 474,000 in the week ending Dec. 5, while the total number of people claiming benefits of any kind topped 10 million, a sign of very sluggish hiring, the Labor Department reported Thursday. First-time claims -- which measure new layoffs -- rose for the first time in six weeks in the week after Thanksgiving. Economists surveyed by MarketWatch had expected initial claims to fall to about 450,000. First-time claims in the previous week were unrevised at 457,000.
The four-week average of new filings -- which smoothes out distortions caused by one-time events such as holidays, bad weather or strikes -- fell for the 14th straight week to a seasonally adjusted 473,750, the lowest in 14 months. The number of people collecting state benefits fell by 303,000 to a seasonally adjusted 5.16 million in the week ending Nov. 28. It's the fewest continuing claims since February. Compared with a year ago, initial claims are down 11%, while state continuing claims are up 31%.
Over the past several months, the claims data have flashed two somewhat contradictory messages: Fewer people are losing their jobs than were six months ago, but once a job is lost, it's very hard to find another one. "New layoffs are slowing significantly, but those who lost their jobs during the recession are still finding it very difficult to get work," wrote Stephen Stanley, chief economist for RBS Securities. "In short, as the November payroll figure suggested, the labor market is starting to stabilize, but the level of unemployment is (and will remain for the time being) very high."
On a not-seasonally adjusted basis, the number of people claiming unemployment benefits of any kind in the week ending Nov. 21 rose by 417,000 to 10 million. The number collecting federal benefits rose by 126,000 to record 4.65 million. In response to the recession, the federal government is offering extended benefits to many of those who exhaust their state eligibility, typically after 26 weeks. For the first time on record, more than half of those who file an initial claim for benefits exhaust their eligibility before finding work.
This is the beginning of the period of the year with the largest number of people collecting benefits, due to large numbers of seasonal layoffs in construction and other outdoors occupations. The regular state data are adjusted for this seasonal expansion in benefits, but the extended federal benefits are not seasonally adjusted. Federal benefits are now available for up to 99 weeks in some parts of the country. As of November, about 5.9 million people -- 38% of the 15 million people officially classified as unemployed -- had been actively looking for work longer than six months, the Labor Department reported last week. In a separate report, the Commerce Department said the U.S. trade gap narrowed to $32.9 billion in October as exports expanded by 2.6% and imports increased 0.4%.
Globe "Overdue for a Currency Crisis"; Why Jim Rogers Is Buying Dollars
"It wouldn't surprise me at all to see a nice rally in the dollar,” says Jim Rogers. The legendary investor tells Tech Ticker he has started to accumulate more greenbacks as of late. Rogers is still negative on the long-term fundamentals for the dollar, noting "the U.S. is the largest debtor nation in the history of the world." But "when everybody is on one side of the boat, invariably you should run over to the other side, for awhile," he tells Aaron in the accompanying video.
At least for the time being, the U.S. remains the world's reserve currency. And, as St. Louis Fed President Jim Bullard reminded us in our recent interview, the dollar has rallied, not fallen, when things have looked especially worrisome during recent bouts of financial crisis. Rogers says it's nothing more than short covering, not an endorsement of the dollar or U.S. policy. In fact, Rogers believes we're "overdue for a currency crisis" which will likely come "in the next year or two."
That may give the dollar a boost for technical reasons, but he recommends investors protect themselves by buying "good currencies" from creditor nations -- namely China, South Korea, Taiwan, Singapore and Japan -- or "hard assets." Gold, of course, being one of those hard assets he owns. Rogers still stands by his previous prediction that gold will be at least "a couple of thousands of dollars an ounce" in the next decade, even if the metal stalls a bit in the near term.
US Food Stamps Go to a Record 37.2 Million
A record 37.2 million people, or about one out of every eight Americans, received food stamps in September, as the recession drove a surging jobless rate, according to a government report. Recipients of the subsidy for retail-food purchases climbed 18 percent from a year earlier, according to a statement posted today on the U.S. Department of Agriculture’s Web site. Participation has set records for 10 straight months. The government boosted food aid as unemployment soared, heading to a 26-year high of 10.2 percent in October. The jobless rate cooled to 10 percent last month, the Labor Department said on Dec. 4.
"We’ve been working to get that money out the door" to families that need assistance, Deputy Agriculture Secretary Kathleen Merrigan said last week in an interview. Nevada had the biggest increase in food-stamp participation rates from a year earlier, surging 54 percent, followed by a 46.5 percent jump in Utah, according to the USDA. Texas had the most recipients at 3.1 million, followed by California with 2.9 million and New York with 2.6 million. Recipients increased in every state and the District of Columbia, except Louisiana. Because of a sharp rise after Hurricanes Ike and Gustav in 2008, the number of people in Louisiana getting food stamps fell 65 percent in September from a year earlier. Gains of more than 30 percent from 2008 were reported in 18 states.
About 35 million people are expected to receive food stamps each month through the Supplemental Nutrition Assistance Program in the fiscal year that began Oct. 1, according to the budget that President Barack Obama sent to Congress in May. "In this economic time, SNAP has been essential," Merrigan said. The participation rate of state residents who are eligible for food stamps varies widely, the USDA said last month in a report based on 2007 data.
In Missouri, about 100 percent who were eligible that year took advantage of the program, the highest rate in the nation, followed by residents of Maine and Michigan, at 91 percent and 89 percent, respectively, the USDA said. Wyoming’s participation rate of 47 percent was the lowest in fiscal 2007, followed by California and Idaho at 48 percent and 50 percent, according to the study. Nationwide, participation in the food-stamp program was 66 percent of those eligible for the aid in 2007, the USDA said. The department has budgeted for a rate of 68 percent in the current 2010 fiscal year. "We know of a lot of people who are SNAP-eligible who are not participating in the program," Merrigan said. "We are working with states to improve participation."
Banking System "a Long Way from Healthy," Ken Rogoff Says
The Obama Administration is going to extend the TARP program into 2010, Treasury Secretary Tim Geithner told Congress Wednesday. But the focus is going to be on aiding consumers vs. financial institutions, amid a sense the banking system is back on its feet after its near-death experience in 2008. "We didn't have a [second] Great Depression, we could have. You have to give them a lot of points for averting that," says Harvard professor Kenneth Rogoff, co-author of This Time Is Different.
But that doesn't mean the danger is over. The system is "a long way from healthy," Rogoff says, noting the banks have only profited this year thanks to various and sundry government programs and the Fed's easy money policies. "If I told you, you could borrow almost 30 times what your house is worth at almost zero percent and lend around to anyone you wanted, I'd bet you'd make money too," he says. The big reason banks aren't lending aggressively is they're bracing for a lot more write-downs in the years ahead, as defaults in consumer loans and commercial real estate mount, Rogoff says. In that regard the banks are acting rationally.
But Rogoff fears onerous regulations will be the ultimate payment for the massive taxpayer subsidized bailouts the banks received in 2008 - and the moral hazard they engendered. "If bondholders think they can lend to financial institutions at no risk we're going to get into trouble in another 10 years or less if we don't do something," he says. Unfortunately, that "something" probably means tighter regulations, which could contribute to slower growth going forward, he says.
Small Business Cash Crunch Fears Getting Worse And Worse
There's been a lot of discussion about the carnage at the small business level, where credit is not so freely available. Without credit, small businesses die on the vine, and without small businesses, job creation is impossible.
Today's chart comes from data from DiscoverCard Small Business Watch. Each month they ask their clients how fearful they are of cash flow issues. While the number is a bit jumpy, you can see it's been on a clear uptrend all year, with November right near the worst of it.
Treasury Yield Curve Widens to Most Since 1992 Before $13 Billion Auction
Treasuries fell, with the gap in yields between 2- and 30-year securities near the widest margin in 17 years, before today’s $13 billion bond auction. The so-called yield curve touched 368 basis points, one basis point below the 369 level it reached in 1992, with the Federal Reserve’s target rate anchored at a record-low range of zero to 0.25 percent and the Treasury extending the average maturity of government debt being sold. The shift to longer- maturity debt has raised concern that investors will demand higher yields to offset the risk of inflation as government spending drives the deficit to a record $1.4 trillion.
"The market is continuing to worry about the massive amount of Treasury issuance that’s going to hit the market well into next year," said Ian Lyngen, senior government bond strategist at CRT Capital Group LLC in Stamford, Connecticut. "In the very short term, part of it is going to be supply accommodation." Thirty-year bond yields rose four basis points to 4.46 percent at 10:50 a.m. in New York, according to BGCantor Market Data. The bond to be sold today yielded 4.50 percent in pre- auction trading. Yields on two-year notes gained four basis points to 0.79 percent. The spread between 2- and 30-year debt was at 191 basis points at the end of 2008, and has averaged 132 basis points over the last five years.
The "historically wide slope" between 2- and 30-year debt "should help entice investors and arbitrageurs to consider bidding for today’s supply against shorter issues on the curve," Chris Ahrens, head of interest-rate strategy in Stamford, Connecticut at UBS AG, wrote in a note to clients. UBS is one of the Fed’s 18 primary dealers, which are required to bid at Treasury auctions. The previous sale of 30-year bonds, a record $16 billion offering on Nov. 12, drew a yield of 4.47 percent and attracted bids for 2.26 times the amount offered, the lowest level since May. Indirect bidders bought 44 percent of the securities. The 30-year bond to be sold today yielded 4.44 percent in pre- auction trading.
"The problem is that domestic fund inflows into 30-years have waned in recent months and unless they’re waiting in the weeds for today’s auction, it’s hard for our desk to spot where the demand will come from," wrote William O’Donnell, U.S. government bond strategist at primary dealer Royal Bank of Scotland Plc in Stamford, Connecticut, in a note to clients. U.S. government debt lost investors about 2 percent this year, according to Bank of America Merrill Lynch’s Treasury Master Index, as President Barack Obama borrowed record amounts to fund spending programs. U.S. marketable debt rose to a record $7.17 trillion in November. The federal budget deficit in the last fiscal year was a record $1.4 trillion and is forecast to be about the same size this fiscal year.
The average number of Americans filing first-time claims for unemployment benefits over the past four weeks dropped to a one-year low. The four-week moving average of initial claims declined to 473,750 last week from 481,500, Labor Department figures showed today in Washington. The trade deficit in the U.S. unexpectedly narrowed in October as rebounding economies overseas and a weaker dollar pushed exports up for a sixth consecutive month. The gap shrank 7.6 percent to $32.9 billion from a revised $35.7 billion in September, Commerce Department data showed today in Washington. Exports were up 2.6 percent, reaching the highest level since November 2008. A plunge in demand for petroleum checked the gain in imports.
U.S. government securities declined yesterday after an investor class that includes foreign central banks bought the least amount of 10-year notes since June at the government’s auction. The $21 billion offering drew a yield of 3.448 percent, compared with an average forecast of 3.421 percent in a Bloomberg survey. The bid-to-cover ratio, which gauges demand, was 2.62, less than an average of 2.63 at the past 10 auctions. Indirect bidders, which include foreign central banks, purchased 34.9 percent of the 10-year debt on offer, compared with an average of 45.6 percent since the Treasury made changes in June on how bids are classified. The previous day’s sale of three-year notes drew a yield of 1.223 percent, compared with a forecast for 1.229 percent.
UK Pre-Budget report hurts bonds: "Government's plan is still in the credibility-free zone"
UK government bond prices fell sharply in London on Thursday as the pre-Budget report failed to allay concerns over the state of Britain's public finances. The yield on the 10-year benchmark government bond, or gilt, was up almost 10 basis points to 3.76pc by lunchtime, its highest level in a month. The sell-off comes a day after Alistair Darling revealed that he will borrow a record 178bn this year and another 176bn next as the recession depletes the Treasury's coffers. "24 hours after the pre-Budget report and nothing has changed," said Marc Ostwald, a bond analyst at Monument Securities. "The Government's plan is still in the credibility-free zone."
Governments around the world are shouldering ever more debt as the downturn erodes what they take in tax from companies and households. Some countries, including Britain, are also continued to spend more. A day before the pre-Budget report, the ratings agency Moody's delivered a public warning that the UK's prized 'AAA' rating is more vulnerable than that of Germany and France. In what was generally recognised as a highly political pre-Budget, Mr Darling sought to depict the Conservatives as the party that would rush to cut the deficit and choke off a still fragile recovery. The Chancellor insisted that tackling the deficit too quickly would torpedo the economy back into recession.
The prospect of that strategy helping to narrow the lead the Conservatives enjoy in the opinion polls is also unsettling markets, said Mr Ostwald. "If you assess it in political terms it's worrying," said Ostwald. "It could lead us to a hung parliament and that creates great political uncertainty which markets hate." The increasing risk now attached to owning gilts is underlined by the fact that investors are demanding a much smaller yield to own debt sold by Germany. The spread between the yields on the countries 10-year debt is 60 basis points, the widest in a year. A chrous of voices, including Mervyn King, the governor of the Bank of England, have called on the Government to take a more aggressive approach to reducing the deficit, which is projected to reach 12.6pc of gross domestic product this year. Although Mr Darling announced an array of tax rises yesterday, he also planned to increase spending by 1.2bn next year.
Michael Saunders, an economist at Citigroup, sounded a warning today that Labour's plan to reduce the deficit to 5.5pc of gross domestic product by 2013-14 may not be enough. "The UK's fiscal route will, if followed, probably also lead to the UK losing its top-notch status for the first time," Mr Saunders wrote to clients. "We suspect that as this budget is digested, gilts and sterling will react badly." The headache for gilt investors is deepened by the prospect of the Bank of England winding down its radical policy of printing money, which has seen it buy billions and billions of pounds of gilts. According to some estimates, the Bank now owns about 30pc of the outstanding market. The Bank today held interest rates at 0.5pc and choose not to expand its policy of printing money beyond 200bn.
Another (sobering) slice of the jobsdata
Here's a pretty depressing picture, courtesy of the Bureau of Labor Statistics:
This means that, as of November, 19.4% of American men in their prime working years didn't have jobs. By this measure, the current job situation (for men, at least) is much, much worse than in any downturn since the BLS started measuring this stuff in 1948. Either that or there are just a lot more stay-at-home dads, grad students, and men who voluntarily spend their days playing golf or pinochle. But I think it's mostly the former.
We’re Not Done With The Jobs Report
Amid all the wailing about sovereign debt downgrades and such, you may have missed yesterday’s jobless numbers from the Bureau of Labor Statistics. No, you didn’t miss the monthly jobs report, or even the weekly initial claims. What you missed (if you did miss it,) was the Job Openings and Labor Turnover Survey. Or, the JOLTS report.
The BLS reported there were 2.5 million job openings in October, with the opening rate at 1.9%, a level that has held steady since March. That means hiring has not picked up at any pace since the stock-market rally - and the purported recovery - began, and the ratio of more than six unemployed for every job opening remains steady.
So even if you buy into Friday’s jobs report, the fact remains that hiring has not picked up, which is confirmed by the fact that long-term unemployment continues to rise.
And if you don’t buy into Friday’s report, well, you’re not alone. Like I wrote Friday, I’m skeptical. And certainly Fed Chairman Ben Bernanke didn’t think it was strong enough to get him to even hint that he might lift interest rates off the floor. And other folks are still deconstructing it.
East Shore Partners’ Frank Veneroso, who initially called the November jobs report “super strong,” is rethinking that position today. He was initially impressed by the increase in the work week and the upward revisions to prior months. But “after thinking about this for several days, I realize I may have overstated the implications for recovery strength.”
“My concern today that I was premature in heralding significant employment improvement last Friday is fed by some of the recent concurrent economic data.” He cites several competing reports, the NFIB report, the ISM services report, the JOLTS report, and withholding tax data, which all paint a weaker picture than the BLS report.
“The withholding income tax data does not lie because tax withholding is automatic. The payroll survey lies because the birth/death model contribution is a ‘plug number’ based on a past employment picture that looks nothing like employment in this recession, which is the worst in three generations.”
Gluskin Sheff’s David Rosenberg takes note of a little known (I’d never heard of it) calculation the BLS does, the “adjusted” household survey, which tries to reconcile the establishment and household surveys. According to that figure, the nation lost 109,000 jobs in November.
“This may well be the nugget that everyone missed because the Household Survey does a much better job at picking up what is happening in the small business sector,” Rosenberg wrote.
And the error may come from the bureau’s calculations about new business creation, which results in the relatively notorious “birth/death adjustment.”Jeffrey Miller at A Dash of Insight explores the methodology behind the monthly jobs report, and comes to this conclusion: the methodology missed some important trends.
The BLS, essentially, guesses at job creation, extrapolating from job destruction. The “residual,” as Miller calls it, is the birth/death adjustment. “For many years this residual was stable,” he writes. “The most recent test against the state data indicated a significant error, showing that the BLS estimates have been wrong for nearly a year, especially since 1Q09.”
“Something important happened at the start of the year - probably the loss of credit available to new businesses,” he says. “The strong historical relationship used by the BLS finally broke down. Without a good estimate of job creation, the BLS monthly change is suspect.”
Jim Rogers: Audit the Fed, Then Abolish It
Count famed investor Jim Rogers as an ardent support of Congressman Ron Paul's effort to audit the Fed. The Fed is "the only institution in the world I know of that doesn't expect to be audited," Rogers says in the accompanying video. "It's incomprehensible to me these people are saying they have no reason to be audited -- they must have done something wrong, must have something to hide." A longtime critic of Ben Bernanke and his predecessor, Rogers goes a (big) step further than merely auditing the Fed, suggesting we get rid of the central bank altogether.
"We don't need the Fed. The Fed is making our lives miserable," the famed financier says. "The Fed is printing huge amounts of money, which we'll have to pay for sometime. The Fed is borrowing gigantic amounts of money on their balance sheet...the numbers are so staggering that this is going to have ramifications before too much longer." With an eye on history, Rogers notes the current Fed is America's third central bank: the First Bank of the U.S. was created in 1791 with a 20-year charter. The Second Bank was created in 1816 with the same term. The current Fed was chartered in 1913. Arguably, the current Fed is the nation's fourth central bank if you count the National Banking Act of 1863-64, but Rogers' point remains the same: America survived and prospered without a central bank for long periods and can do so again.
If Rogers is right, this won't be an academic discussion for much longer. "The Fed is going to abolish itself," he predicts. "Between Bernanke and Greenspan they've made so many mistakes [that] within the next few years the Fed will disappear." I didn't get the sense Rogers was joking or speaking metaphorically, so I asked what the practical ramifications of abolishing the Fed would be: "Yes it would be complicated and painful for a while," Rogers responded. "But I'd rather find out they're bankrupt today than to find out in five or 10 years -- when they've had another 10 years of this madness where they're printing even more money [and] taking out even more debts in our name."
Goldman Sachs Top Execs Get No Cash Bonus For 2009
Goldman Sachs Group Inc. on Thursday said its top 30 executives won't receive a cash bonus for 2009 as the Wall Street bank bows to public pressure about runaway compensation packages. The move approved by Goldman's board is an attempt to quell public criticism about multimillion-dollar bonus packages expected to be doled out this year. The firm's 31,000 employees are on track to earn an average of more than $700,000 apiece this year, the most in its 140-year history.
Investors will also get a say on pay: Goldman said shareholders will get an advisory vote on the company's compensation policies. The firm has been in private discussions with major investors during the past several weeks in an effort to ward off backlash over its record compensation pool. Lloyd Blankfein, Goldman's chairman and chief executive, has given a number of speeches about compensation since the company's annual meeting earlier this year. The changes to compensation of its 30-person management committee are part of his plan to better align payouts with long-term performance and the interests of the firm.
The investment bank, considered to be the most profitable in Wall Street history, saw its third-quarter profit soar as rallying equity markets led to trading gains and strong investment performance. The firm also set aside $5.35 billion for benefits and compensation during the quarter, putting bonuses on track to set a record this year. Still, Wall Street has come under severe criticism in the wake of last year's meltdown, with many saying that the Street's compensation regime led its players to focus excessively on short-term gains.
Responding to those calls, Goldman's board voted to make all discretionary compensation for the committee, which comprises all global divisional and regional leadership, in the form of shares at risk, which must be held for five years. On top of that, the holding period includes a stronger provision to allow Goldman to take back the shares in cases where the employee failed to properly account for risk. "The measures that we are announcing today reflect the compensation principles that we articulated at our shareholders' meeting in May. We believe our compensation policies are the strongest in our industry and ensure that compensation accurately reflects the firm's performance and incentivize behavior that is in the public's and our shareholders' best interests," Blankfein said.
Bernanke Low Rates 'Poison' to U.S. Economy, Xie Says
Federal Reserve Chairman Ben S. Bernanke is prescribing "poison" to the U.S. economy by keeping interest rates near zero and fueling a wave of speculative capital that may cause the next global crisis, former Morgan Stanley chief Asian economist Andy Xie said. Bernanke is making decisions based on "marginal considerations" that will help short-term growth and employment, instead of focusing on the "soundness of the system," Xie wrote in an e-mailed note today. The next worldwide crisis will probably strike in 2012, driven by inflation as the low cost of borrowing spurs increases in asset prices, he said.
"There is a Chinese saying that one could quench the thirst by drinking poison," said Xie, who predicted in September 2006 that the U.S. economy would fall into a recession in 2008. "Bernanke seems to be prescribing exactly this to the U.S. economy. The slower Bernanke raises interest rates, the bigger the next crisis." Bernanke, a scholar of the Great Depression, has overseen a record injection of liquidity into the world’s largest economy, pledging not to make the mistake of the 1930s, when officials tightened policy. The Fed chairman yesterday said that the U.S. economy faces "formidable headwinds" including a weak labor market and tight credit that are likely to produce a "moderate" pace of expansion.
"We’ve got to figure out a way to get out of these post- bubble emergency actions a lot more effectively," Morgan Stanley Asia Chairman Stephen Roach said in an interview with Bloomberg Television in Hong Kong today. "I worry that Ben Bernanke, while he says one thing, will do another." Inflation in the U.S. remained "subdued" and interest rates are likely to remain low for an "extended period," Bernanke told the Economic Club of Washington. Policy makers around the world cut interest rates and boosted government spending by more than $2 trillion as part of emergency steps to counter the global recession. The Japanese government today unveiled a 7.2 trillion yen ($81 billion) economic stimulus package amid signs the recovery and Prime Minister Yukio Hatoyama’s popularity are waning.
Fiscal stimulus worldwide restored stability "temporarily" and may be inflationary, said Xie, now an independent economist. Asset-price increases are also making a "significant contribution" to global growth, mostly in emerging economies, and industries such as property, automobiles and commodities, he said. "The policy consensus to prop up the global economy with stimulus will continue until inflation takes off or governments are broke," Xie said. "This strategy is too expensive to last." Inflation will likely become apparent in 2011, and a "vicious wage-price spiral" could take place the year after, Xie said. He said the lag between money creation, which happened last year, and inflation may take more than 18 months.
Asian policy makers are already studying capital controls to limit "hot money" inflows that may stoke asset bubbles and force their currencies to appreciate. "Inflation would scare central banks into tightening dramatically in 2012, which would pop the current asset bubble," Xie wrote. "By then the global problem would be more serious than now. In addition to the leverage problem in the household and financial sectors, the government sector would also be hugely levered then." The trillions of dollars that governments are spending is "buying some time," Xie said. One of the risks is that governments may not have enough money to "cushion the pain during the coming economic restructuring," the economist wrote. "The whole world is drinking poison to quench the thirst," Xie said. "It may feel like relief now. The sickness will strike in 2012."
Geithner Says Treasury Faces Huge Losses From Carmakers, AIG
Treasury Secretary Timothy Geithner said today the government is unlikely to recoup its investments in insurer American International Group Inc. or the automakers General Motors Co. and Chrysler Group LLC. Geithner also said he chose to extend the $700 billion Troubled Asset Relief Program to give the Obama administration more time to unwind its bank-rescue efforts. The economy still faces "significant headwinds," and housing markets remain dependent on government support even as they are stabilizing, he said.
U.S. financial and economic conditions have improved, Geithner said in prepared testimony for the Congressional Oversight Panel. The Treasury now expects to make money on its banking investments, if not on its efforts to stabilize the automobile and insurance industries. "There is a significant likelihood we will not be repaid from our investments in AIG, GM and Chrysler," Geithner said. The Government Accountability Office yesterday said that U.S. taxpayers will lose $30.4 billion from the auto-industry bailout, down from a prior estimate of $43.7 billion. The GAO report predicted a similar loss of $30.4 billion in AIG, down from a previous estimate of $31.5 billion.
Stocks rose today after government reports showed fewer Americans on average filed claims for jobless benefits over the past four weeks and the trade deficit unexpectedly narrowed in October. The Standard & Poor’s 500 Index was up 0.6 percent to 1,102.89 at 10:46 p.m. in New York. The index has jumped 63 percent from its low for the year on March 9. The world’s largest economy expanded at a 2.8 percent annual rate in the fourth quarter after shrinking for a year. The economy will expand 2.6 percent in 2010, according to the median forecast of 58 economists surveyed by Bloomberg News this month. The jobless rate will average 10 percent next year. "The economy would not be growing again without TARP," Geithner told the panel in response to a question.
The Treasury predicts a $19 billion profit on its banking investments, Geithner said. Long-term TARP costs will be no higher than $140 billion, Treasury forecasts. Geithner said the ultimate return will depend on how the economy fares. Geithner appears before the panel, led by Harvard law professor Elizabeth Warren, as it prepares for a personnel shift. Representative Jeb Hensarling, a Texas Republican, yesterday resigned, Warren said in an interview with Bloomberg Television. "He said he wanted to concentrate his efforts elsewhere here in Congress," Warren said. Hensarling has been a vocal critic of TARP.
Geithner told the panel that the Treasury can’t force small banks to participate in initiatives aimed at stimulating small- business lending. He said these programs have been less successful than hoped because banks have been wary of submitting to the extra regulation that comes with taking TARP aid. Geithner said parts of the securitization markets are "still impaired," especially for securities backed by commercial mortgages. He also hailed improvements in the markets for asset-backed securities, which he said are no longer as dependent on publicly supported markets like the Federal Reserve’s Term Asset-Backed Securities Lending Facility.
What’s behind mixed signals from Obama and Geithner on TARP?
President Obama and Treasury Secretary Timothy Geithner appeared to contradict each other this week on whether the TARP program would be extended. The mixed signals reflect the political unpopularity of the bank bailouts.
President Obama said Tuesday that the TARP bailout program has served its purpose and is being wound down. Treasury Secretary Timothy Geithner sent a different signal Wednesday, with the gist of his message being this: Not any time soon.
In a letter to Congress, Mr. Geithner said he is authorizing the Troubled Asset Relief Program (TARP) to continue through Oct. 3 next year, and that as much as $550 billion of the $700 in potential funds could be deployed. So the TARP, after having served its purpose over the past year, is going to keep on serving.
What do these seemingly mixed signals mean? They’re a sign of how the politically-unpopular TARP remains a hot potato – something Washington wants to get rid of but can’t. The financial system is still too shaky for the emergency support to be pulled away, though the rescues are proving less costly than expected, experts say.
An independent panel waded into these complicated issues with its own report Wednesday. The Congressional Oversight Panel, headed by Elizabeth Warren, came to some pointed but nuanced conclusions: The TARP, along with other strong government actions, “can be credited with stopping an economic panic,” but big problems in the financial system remain, the report said.
The maneuvering over TARP comes at an important moment for three reasons:
• The economy is trying to emerge from recession, and the strength of the rebound depends in part on how the TARP program is managed.
• The Obama administration and Congress are making the case that TARP “savings” – as the program comes in with lower-than-expected costs – free up about $200 billion that could be spent for a jobs program.
• Congress is considering regulatory reform of the financial sector, and much of the effort boils down to the fundamental question of how to avoid TARP-style bailouts in the future.
The president and his Treasury secretary weren’t quite talking past each other in their statements this week. Mr. Obama didn’t say the program would end immediately but would “wind down” since the program “has served its original purpose.” And Geithner framed his extension of the program as an “exit strategy.”
Still, the Treasury’s move to maintain the program into next year is a reminder that the financial bailouts are still unfinished, and that uncertainties remain. Some banks have repaid TARP funds, while others have been unable to even pay the dividends they owe to taxpayers on Treasury money invested. In addition, the bailout funds are being used to support automakers, the insurer AIG, and the mortgage giants Fannie Mae and Freddie Mac.
The fact that firms such as Bank of America have been able to repay the TARP money is a good sign. It means that many banks are able to raise capital from private investors. With help from low Federal Reserve borrowing costs, many banks are earning enough money to cover losses on mortgage and other loan defaults.
And the repayment trend has led the Treasury to dial down its estimates of what TARP will cost taxpayers, by about $200 billion. In his letter Wednesday, Geithner told congressional leaders that he expects “up to $175 billion in repayments by the end of next year, and substantial additional repayments thereafter.” Republicans argue that TARP repayments should be used to reduce federal deficits, not used for other spending.
Companies have a strong incentive to exit the TARP if they can, says Brian Bethune, an economist at IHS Global Insight in Lexington, Mass. In addition to getting out from government caps on pay for top executives – a condition of bailouts – paying back the Treasury may signal to investors that the firm is healthier than bailed-out rivals, he says.
But overall, the financial sector is hardly back to normal, despite the support from TARP and Federal Reserve over the past year.
“Not enough capital is being generated yet in overall banking system to get us back to a normal situation with the flow of credit,” Mr. Bethune says.
The oversight panel headed by Ms. Warren reached similar conclusions. Banks remain reluctant to lend and have many “toxic assets” still on their books. Foreclosures continue to rise. And many firms or credit markets continue to rely on government support.
“It is unclear whether the market can yet withstand the removal of this support,” the report said.
Market jitters as Spain joins Dubai on danger list
Fears about corporate and sovereign debt continue to loom over markets as Standard and Poor's revises Spain's outlook to 'negative'. Worries about corporate and sovereign debt continued to overshadow world markets as Spain became the latest country to come under the spotlight and there was more evidence of Dubai's troubles.
A day after Greece's credit rating was cut amid rising concern about the state of its finances, the ratings agency Standard & Poor's revised its outlook on Spain to negative and warned that the country faced a risk of a debt downgrade in two years if the government did not take tough action. Spanish bank shares fell on the news adding to existing market nervousness about the ability of Greece to pay its debts.
As Greek financial markets took a pounding Greece's prime minister George Papandreou vowed to do whatever it took to check the country's huge deficit. "We must close the credibility gap to survive as a sovereign and cohesive nation," he told a televised cabinet meeting. In Dubai, Nakheel, the property developer behind the palm-shaped islands that have come to symbolise the country's excess, reported a 13.43bn dirham (£2.25bn) loss for the first half of the year. Dubai markets fell sharply for the third successive day on the news.
The business, part of Dubai World, which is attempting to restructure $26bn (£15.9bn) of debt, wrote down the value of its assets during the first half, from 155.5bn dirhams to 147bn dirhams, reflecting the deep fall in property values over the past year. Property prices have plunged by about 50% since the global economy started to slip into recession. The company said it would pare back further capital expenditure by scaling down or mothballing some developments that had been planned for after 2012. It said the impairment charge "relates to the writedown in the value of land to current fair market levels and the writedown of certain properties under construction relating to projects that have been delayed or scaled back".
The cost of insuring Dubai's debt against restructuring or default rose again as investors grew steadily more anxious about the ability of Dubai World to cope with its debts. The state-owned company stunned world markets two weeks ago when it said it would seek a six-month standstill on debt repayments, while it attempted to restructure the business. The government later prompted fury by refusing to stand behind the company and assume responsibility for the debts, despite its being a state-owned entity.
Dubai's finance chief on Tuesday admitted that it would now probably need more than six months. Credit rating agency Moody's this week downgraded six Dubai government-related companies because of the perceived lack of support from the state. Investors, including British banks Royal Bank of Scotland and Lloyds, are still assessing potential losses. As well as the property assets, Dubai World owns the former P&O – part of a wider ports business. The Dubai financial market's benchmark index fell by 6%, with the declines of the past three days wiping out a year's worth of gains. One of the biggest fallers was Emaar Properties, the company behind the world's tallest tower, which is yet to be completed, and in which the government holds a roughly one-third stake. The bourse in Abu Dhabi, the oil-rich state and the home of the United Arab Emirates federal government, fell by over 2.7%.
Dubai World is shouldering total debts of about $60bn (£36.9bn), but has indicated that it intends to ringfence the profitable parts of the conglomerate, including the ports business and its private equity arm, Istithmar World. In a sign that Dubai World may struggle to hold on to its prized assets, Istithmar lost its W Hotel in Manhattan in a foreclosure auction for $2m (£1.23m) on Tuesday, after buying the property for $282m (£173.6m) in 2006. Analysts at Barclays Capital have warned that Dubai Holding, an investment company directly controlled by Dubai's ruler could be "next in line" with credit problems.
Bond jitters as Japan launches yet another stimulus plan
Japan has launched its fourth fiscal rescue package since the economic crisis began last year, spraying a further $81bn (£50bn) into the regions and on subsidies for "eco-cars" and refrigerators. The spending blitz will lift debt issuance to a record $835bn this year and comes despite warnings by finance minister Hirohisa Fujii that Japan risks exhausting the patience of bond vigilantes. "Japan's fiscal situation is serious. If we over-issue government bonds, there will be a loss of confidence," he said. There were already signs of investor fatigue at an auction for bonds yesterday, with yields rising as high as 2.23pc.
Mr Fujii said Tokyo must raise a further $112bn through an extra budget to pay for the stimulus measures. Junko Nikiosha from RBS said markets are looking beyond the spending plan, fretting whether the Democrat-led coalition will be able to meet deficit targets in 2010 fiscal year. "If the government fails to keep these promises, it will bring worries about government bond supply back to the market, calling for a fiscal risk premium," he said. The package comes days after the Bank of Japan reversed plans for withdrawal of monetary stimulus, agreeing to extend emergency lending to firms by $115bn. Japan's economy bounced back over summer as companies rebuilt stocks but there are signs of fading momentum. Julian Jessop from Capital Economics said that growth may have stalled in the fourth quarter, citing a fall in Japan's Economy Watchers Survey to 33.9 in November.
The strong yen – though weaker over recent days – has left export giants such as Sony struggling to break even on foreign shipments. While Japan can still raise debt cheaply in nominal terms, the cost is rising in real terms as deflation tightens its grip. Core inflation was minus 2.2pc in October. The country must service a rapidly growing debt with a shrinking workforce and an economy that has contracted 10pc in yen terms since early last year. While the state pension fund has been a captive buyer of government bonds in the past – holding 20pc of the total stock – it became a net seller this year to meet payout obligations.
The International Monetary Fund has warned Japan that it risks a sudden jump in debt funding costs. Gross public debt is expected to reach 227pc of GDP next year. Tax revenues collapsed 24pc in the first half. Corporate tax payments have since turned negative as firms claim rebates on losses. Economists are watching events in Japan with macabre interest. The country has blazed the path of extreme Keynesian fiscal stimulus over the last two decades – with poor results – making it a laboratory case for how much debt a mature economy can take on before it suffocates.
UK Taxpayers face £2 trillion ($3.26 trillion) unfunded pensions liability
Taxpayers are facing a £2 trillion unfunded pensions liability, equivalent to more than £80,000 for every household in Britain, according to figures quietly released by the Government yesterday. In a document released on its website only a few hours before the Chancellor's pre-Budget report (PBR) statement, the Office for National Statistics (ONS) laid out the definitive cost taxpayers will have to bear for both the state old age pension and public sector pensions.
The document reveals:
- The total public sector pensions bill is now £810bn, a figure confirmed later in the day in the pre-Budget report. The majority of the state employees are on generous final salary schemes unattainable elsewhere in the UK.
- This bill for key public sector workers' pensions has rocketed by 20pc between 2006 and 2008.
- The Government Actuary's Department's estimate of the cost of the state pension due to all workers is £1,350bn as of 2005 – equivalent to almost 100pc of Britain's annual economic output.
The entire bill of around £2.2 trillion would more than triple the size of the national debt overnight. It is entirely unfunded, so will have to be paid directly by future generations of taxpayers, rather than out of a pot contributed to by the pensioners themselves. The revelations, contained in the ONS's Pensions Trends document, underline the scale of the long-term fiscal crisis facing this and future governments – even before the added costs of the economic and financial crisis are taken into account. The Treasury itself has never published its own comprehensive calculation of the size of Britain's unfunded pensions liabilities.
A range of institutions, including the International Monetary Fund, the Organisation for Economic Co-operation and Development and ratings agencies such as Standard and Poor's, have warned Britain that unless it takes drastic action over a long period of time, these pensions costs could trigger fiscal crises in the future. The National Institute of Economic and Social Research has said that in order to fight the rising deficit and combat the added costs of the financial crisis, the Government ought to raise the retirement age for both men and women to 70, or increase the basic rate of income tax by as much as 15p.
Independent pensions consultant John Ralfe said: "The real worry here are the figures on the public sector pensions. The old age pension age could be changed relatively quickly, so the liabilities there could be tackled almost overnight. You can't do that with the public sector pension, which is contractually agreed." The Treasury has always been reluctant to release details of the size of the public sector pensions liability, but in a supplementary document produced alongside the PBR on long-term fiscal projections it said that the bill for public sector pensions had crept up to £810bn. A recent study from the Institute for Fiscal Studies showed that the final salary schemes offered to public sector employees are even more generous than those given to private sector workers with equivalent pension schemes.
U.S. Foreclosures to Reach 3.9 Million in Second Record Year
Foreclosure filings in the U.S. will reach a record for the second consecutive year with 3.9 million notices sent to homeowners in default, RealtyTrac Inc. said. This year’s filings will surpass 2008’s total of 3.2 million as record unemployment and price erosion batter the housing market, the Irvine, California-based company said. "We are a long way from a recovery," John Quigley, economics professor at the University of California, Berkeley, said in an interview. "You can’t start to see improvement in the housing market until after unemployment peaks."
Foreclosure filings exceeded 300,000 for the ninth straight month in November, RealtyTrac said today. A weak labor market and tight credit are "formidable headwinds" for the economy, Federal Reserve Chairman Ben S. Bernanke said in a Dec. 7 speech in Washington. The 7.2 million jobs lost since the recession began in December 2007 are the most of any postwar economic slump, Labor Department data show. Unemployment, at 10 percent last month, won’t peak until the first quarter, Quigley said.
Loan-modification programs and an expanded government tax credit for first-time homebuyers are helping slow the monthly pace of filings and "keeping a lid" on further foreclosures, James Saccacio, RealtyTrac’s chief executive officer, said in the statement. November filings fell 15 percent from the July peak and dropped 8 percent from October, the seller of default data said. That was the fourth straight monthly drop.
A total of 306,627 properties received a default or auction notice or were seized by banks last month, or one in 417 U.S. households, and a similar number are expected for December, RealtyTrac said. There have been 3.6 million filings from January through November, the most in RealtyTrac records dating to January 2005. Three loans went bad for every one that improved in the first 10 months of this year, according to a Dec. 2 report from Lender Processing Services Inc.
The combined delinquency and foreclosure rate for all loans increased to 12.6 percent through October, the Jacksonville, Florida-based loan servicing and mortgage data company said. Still, fewer than 1.5 million homeowners -- or less than half of those targeted -- were eligible as of last month for President Barack Obama’s Home Affordable Modification Program, Herb Allison, Treasury assistant secretary for financial stability, said in Dec. 8 congressional testimony.
"Federal programs have not been successful and have done little about declining asset values," Quigley said. "The probability that a renegotiated mortgage goes into subsequent default is substantially high." Nevada had the highest foreclosure rate for the 35th consecutive month, with one in 119 households receiving a filing in November. Total filings dropped 33 percent from both a year earlier and the previous month, to 9,295.
Florida ranked second, with filings for one in every 165 households. California was third, at one in 180, RealtyTrac said. Arizona, Idaho, Michigan, Illinois, Utah, Maryland and New Jersey rounded out the 10 highest foreclosure rates. California had the most filings with 73,995, up 22 percent from a year earlier. Foreclosure notices in the most populous state have fallen on a monthly basis since peaking in July, according to RealtyTrac. Florida had 52,935 filings, up 8 percent from November 2008 and 2 percent from the previous month.
Illinois was third with 16,422 filings, more than double a year earlier. They fell 18 percent from a record high in October. Michigan ranked fourth with 15,988, up 10 percent from a year earlier. Arizona, Texas, Ohio, Georgia, Nevada and New Jersey completed the 10 states with the most filings, RealtyTrac said. Filings rose 65 percent from a year earlier to 9,227 in New Jersey. They dropped 3.7 percent to 2,114 in Connecticut, and jumped 69 percent to 4,401 in New York.
US Lending Squeeze Drags On
Consumer lending shrank 1.7% in October, the ninth consecutive drop, extending the dramatic decline of financing available to help fuel the U.S. economy. The $3.5 billion decline, calculated by the Federal Reserve, caps a 4% drop in consumer lending from its July 2008 peak. Before then, borrowing by U.S. consumers -- including credit-card debt and auto loans, but excluding mortgages -- had been growing for more than a half-century. Consumer activity accounts for about two-thirds of U.S. economic growth. Curtailed lending to consumers could hurt the chances for a strong recovery.
Federal Reserve Chairman Ben Bernanke emphasized Monday that the economy is unlikely to experience a "vigorous" recovery. Even though unemployment for November was better than expected, he said, the picture for U.S. job growth remains unclear. It's not just consumers having trouble borrowing. For all the talk of a revival in financial markets and a perception that the economy is on path to recovery, many companies lack easy access to borrowing. "Despite the general improvement in financial conditions, credit remains tight for many borrowers," Mr. Bernanke said in a Monday speech, "particularly bank-dependent borrowers such as households and small businesses."
In the process of adapting to post-crisis realities, the nation's lending markets have changed significantly. In particular, markets where the U.S. government is either a big borrower or a de facto guarantor are ballooning, while some corporate-lending and consumer-finance markets have shriveled. A Wall Street Journal analysis of data from the Federal Reserve and private research firms shows that these corporate- and consumer-credit markets have shrunk in size by 7%, or $1.5 trillion, in the two years through early November. The financial markets that support credit-card lending, auto loans and home mortgages not backed by the government are between 10% and 40% smaller than they were in the second half of 2007.
On the other hand, Treasury debt outstanding has jumped about 40% as the government races to finance its deficits and investors seek the safety of U.S.-backed debt. The market for securities backed by mortgages that are effectively guaranteed by the government has expanded by 21%. Credit markets have healed considerably, after having nearly shut down more than a year ago at the height of the global financial crisis. In the process, prices of almost every type of bond have bounced back from their historic crisis-era lows. But the rally in prices doesn't mean borrowers have more money available. "Most of the money that's going into the markets is not flowing through into the economy yet," says Thomas Priore of ICP Capital, a small investment firm in New York.
One measure of the retreat in consumer lending: In 2005, over six billion credit-card offers flooded consumers' mailboxes. This year just 1.4 billion have been sent out, according to Synovate, a market-research firm. Earlier this year, Visa reported that people for the first time were using their debit cards (which draw cash out of a bank account) more than credit cards (which use borrowed money). The result of tighter lending: Consumers spend less and businesses are more reluctant to hire and invest. The changed credit markets, says Mohamed El-Erian, chief executive of bond-investing giant Pacific Investment Management Co., will mean the economy grows only 1.5% to 2% a year, a slow pace compared with the 3% that typically defines healthy expansion in the U.S.
"The idea that we will reset to where we came from is false," Mr. El-Erian says. "It is a bumpy journey to a new destination with significant long-term effects." Some of the decline in lending is also due to lower demand as borrowers focus on paying off the debt they already have.
In the past 25 years, household debt has exploded. It now stands at 122% of total disposable income, up from just over 60% a quarter-century ago. At the end of last year's third quarter, household debt started to decline as Americans began belt-tightening. The hardest-hit markets since the crisis were ones at the heart of the financial problem -- the "securitization" markets where loans for everything from mortgages to credit-card debt get sliced up and repackaged into complex securities.
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The size of the market for securities backed by loans tied to homeowners' equity has shrunk more than 40% since the second half of 2007. The market for securities backed by auto loans has shrunk 33%. For securities backed by riskier mortgages, the decline is about 35% since the end of 2007, according to the Federal Reserve and data provided by FTN Financial. These securitization markets provided as much as 50% of consumer lending in the years leading up to the crisis, says Tim Ryan of the Securities Industry and Financial Markets Association, a financial-industry trade group. "Without [the securitization markets], it's very difficult to replicate the amount of money moving into the economy," he says.
Classic short-term credit markets serving businesses have also withered. Commercial paper sold by businesses to finance payroll and other short-term cash needs has slumped by 35%. The shrunken markets for short-term debt are also complicating life for investors in money-market funds. These funds invest in short-term debt and have a reputation as being safe places to park cash. Worried investors (both individuals and corporations) have piled money into these funds. Money-market funds still have nearly $1 trillion more in assets than they did in mid-2007 before the credit crisis kicked off, according to iMoneyNet.
But the shrinking market for corporate short-term debt has limited the funds' investment options and forced them to funnel cash into government-issued Treasury bills that mature in three months or less. This heavy demand helped drive yields on some Treasury bills into negative territory last month. In the corporate-credit markets, a strong rebound has created haves and have-nots. The market for investment-grade bonds, including debt sold by banks and backed by the Federal Deposit Insurance Corp., expanded by about 13% from November 2007 until November this year, while the junk-bond market receded about 7%.
Even companies that are able to borrow are being hurt because their suppliers are struggling. To help, Wal-Mart Stores Inc. is telling lenders it is standing behind its suppliers and encouraging lenders to let the suppliers use Wal-Mart purchase orders to obtain cash advances if needed.
No Credit. No Economy.
by Eric Fry
"The great American consumer deleveraging continues," our colleagues at The 5-Minute Forecast observed yesterday. "The Fed announced that consumer credit shrank for a record ninth month in a row in October."
Consumer credit, as we all know, drives a big chunk of consumer spending, which drives a big chunk of the American economy. Ergo, no credit; no economy.
But consumers are not the only borrowers between the Atlantic and the Pacific who contribute to economic activity. Commercial and industrial (C&I) borrowers also play a large role. The dots are pretty easy to connect here: When C&I lending is growing, businesses are expanding. And that means rising profitability and employment. When C&I lending is falling, however, businesses are contracting.
This is the unfortunate condition that now prevails.
The combined total of C&I and consumer loans outstanding contracted by nearly $300 billion during the first nine months of this year. And this dismal trend shows absolutely no sign of reversing itself, as Douglas French, explains in his column, The Credit Crunch Continues.
The Credit Crunch Continues
by Douglas French
The credit crunch continues, with businesses large and small finding that their bankers remain exceedingly stingy in the wake of the 2008 financial debacle.
"We need to see banks making more loans to their business customers," Federal Deposit Insurance Corporation (FDIC) Chairwoman, Sheila Bair, told reporters recently after the FDIC released figures showing that the amount of loans outstanding in the nation’s banks fell $210.4 billion in the third quarter of 2009. That is the largest quarterly decline since the FDIC began tracking loans in 1984.
If we dig inside these data, we see that business lending has contracted at a much faster pace than consumer lending. This trend is not merely a function of contracting economic activity, it is also a function of the fact that banks have been deemphasizing business lending for many, many years.
Numbers from the FDIC reflect this shift over the past decade. At the end of the third quarter of 1999, the assets of the nation’s banks totaled $5.5 trillion. As of September 30 of this year, bank assets had grown to $13.2 trillion. But commercial and industrial loans outstanding barely budged, only growing from $947 billion a decade ago to $1.27 trillion by September 30 this year. Meanwhile, loans secured by real estate increased from $1.43 trillion in the fall of 1999 to $4.5 trillion this fall. And investment in securities doubled, rising from $1.03 trillion to $2.4 trillion.
This secular shift away from "productive" lending to businesses toward "nonproductive" lending to consumers creates a new kind of structural weakness for the American economy.
Robert Prechter makes the point in the November edition of the Elliott Wave Theorist that banks have lent sparingly to businesses for the past 35 years. Businesses report that since 1974, ease of borrowing was either worse or the same as it was the prior quarter, meaning that – at least according to business owners – loans have been increasingly hard to get the entire time.
Unfortunately, from a macroeconomic perspective, lending to consumers rather businesses is a suboptimal emphasis/counterproductive exercise.
Prechter writes in his book Conquer the Crash that the lending process for businesses "adds value to the economy," while consumer loans are counterproductive, adding costs but no value. The consumer may call his borrowing "productive," but it surely does not create capital, i.e., build shops or factories or manufacture tools and dies that enhance the productivity of human labor. The banking system, with its focus on consumer loans, has shifted capital from the productive part of the economy, people who have demonstrated a superior ability to invest or produce (creditors) to those who have demonstrated primarily a superior ability to consume (debtors).
Total household debt peaked in 2008 at $13.8 trillion, with $10.5 trillion of that being mortgage debt. And as Sean Corrigan explained, "Houses are nonproductive assets, financed with a great deal of leverage." And while homeowners reap the services provided by homes slowly over time, houses "deliver a large dollop of uncompensated purchasing power up front to their builders or to those cashing out of the market," making housing "the ultimate engines of created credit on the upswing, and…among the more dangerous deflators on the way down."
In the last decade, the US system of fractional-reserve banking has created what Frank Shostak calls "empty money," which masquerades as genuine money when in fact "nothing has been saved." This explosion of money was created through the banking system, as consumers gorged themselves on nonproductive assets like houses, autos, and big-screen TVs. These purchases gave the illusion of economic growth and good times, but in reality weakened the process of wealth formation; instead of building capital, this system wasted it.
Meanwhile, businesses that create wealth-producing jobs have stagnated. The workforce was induced into working for enterprises that represent malinvestment: home and commercial construction, as well as other real-estate-related jobs, and businesses dependent on consumer consumption.
Unfortunately, the federal and state governments constantly enact legislation that makes the employment of workers more costly and in turn makes business expansion riskier. So wealth-producing businesses, like metal fabrication and the like, have every incentive not to borrow money from a bank to expand their operations and not to wander into a wider thicket of onerous employment rules by hiring more workers. Instead, the entrepreneur puts energy into obtaining a low-interest mortgage and buying a big house, or dabbling in real-estate development and speculation. Besides, up until this current meltdown the entrepreneur could obtain a real-estate loan much more easily than a business loan.
Those in Washington are doing all they can to promote the continued destruction of capital and wealth. Policies like "cash for clunkers"; tax credits for home buyers; the bailing out of the big banks, Fannie, Freddie, and the auto companies; and keeping interest rates near zero only serve to promote speculation and consumer consumption. Instead, Washington should be lowering taxes and the costs of hiring employees, especially in industries that produce capital and wealth.
Christina Romer Says Spending Our Way Out of Recession Is "Sensible Policy"
Hoping to garner support for his latest jobs plan, the President is set to meet with a group of lawmakers at the White House later today to discuss job creation. It's the follow-up to the plan he unveiled on Tuesday focusing on infrastructure spending, small business tax breaks and credits, and tax incentives to create more energy efficient homes. With unemployment at 10%, Mr. Obama caught a lot of heat from Republicans on Tuesday for saying he'll "spend our way out of" the economic doldrums if that's what it takes to get Americans back to work. His plan is estimated to cost anywhere from $75 billion to $150 billion. Infrastructure spending alone could reach $50 billion.
Where will the money come from?
Christina Romer, chair of the White House Council of Economic Advisers, says some of it could come from the $200 billion the government plans to get back in TARP funds. "Obviously you don't use that directly on any of these programs but it does tell you we have made some progress in the fiscal space," she tells Tech Ticker. "And we think [this] frees up some resources that can be used to for this incredibly important priority which is putting people back to work."
Only in Washington could someone get away with this kind of fuzzy math. Let's not forget that $200 billion she refers to isn't a gain we booked on our TARP investment, it's simply $200 billion we didn't lose. It's like spending $2000 on a PC, returning the PC and then calling the refunded money a profit. Republicans, including House Minority leader John Boehner from Ohio, calls the move, "repulsive" arguing the TARP funds should go back to the government to pay down the debt.
The administration argues paying down the debt is also a main priority of this plan. But that shouldn't exclude them from spending on jobs creation. "It's just sensible policy to get people back to work," Romer claims. "It's not only good for people, it's good for the budget because they then are earning and are paying taxes."
Albert Edwards: Here Comes The Next Leg Of The Bear-Market
With the dollar surging, and with correlation momos no longer having a clue what to do courtesy of all correlations having recently broken down, here comes Albert Edwards to pour even more cold water on the rally, prophecying that the next leg of the bear market is just around the corner.
At this time of year I normally get requests for year-end forecasts. My erstwhile colleague, James Montier, always used to tell me never to offer pin-point forecasts as they are a hostage to fortune (in addition, he felt passionately that investing should not be based on what he termed the folly of forecasting).
But when I do give forecasts in a moment of weakness, often they appear extreme. Some clients have taken such umbrage that they try and get me fired! With that pressure not to stray too far from consensus, most sell-side analysts? forecasts end up as consensus mush ? and if they do deviate from consensus it is almost always on the bullish side. The industry quickly forgives a bull who is wrong whereas an erring bear must be hunted down, hung, drawn and quartered. Hence the industry gets what it deserves: economic and market forecasts that either call for mean reversion or which stick close by the current spot rate (with their usual bullish bias). But in reality the world is seldom ever like that.
Regular readers will know that many of my more extreme predictions have had an annoying habit of eventually coming true, albeit with the usual heavy dose of poor timing. Certainly when I see the current extremely low number of equity bears (the lowest since the market top of 2007 - see chart below), the likelihood is that the next leg of the long-term structural valuation bear market is closer than people might realise.
Next on plate: poor technicals and an H2 rally that has been running almost exclusively on fumes and liquidity rebate seekers.
The very weak German new orders and production data for October has certainly put a dent in the cyclical optimism that has abounded for most of this year. My own view is that the markets will march to a very different drumbeat next year. Chartwise, the S&P seems to be stuck close to its 50% retracement level from the October 2007 peak. In addition, many technical analysts are noting the poor volume and the divergence of the Relative Strength Index (RSI) which has made lower highs through the rally in the second half of this year (see chart below). This is seen as the H2 rally lacking strong technical underpinnings.
And even as the secular trend is ever lower (think Japan), the likelihood of such bear market rallies is always present (again, think Japan).Our structural bearishness has never precluded participation in cyclical rallies. We have regularly observed that in Japan, the Nikkei used to enjoy strong cyclically led rallies of 40-50% (see chart below). But with the market still some 75% below its peak, investors tend to forget these rallies and only remember the gloom. A long-only equity investor could have made good money in Japan since the bubble burst.
Here is why leading indicators themselves are leading indicators of a major leg down:
The secret to making money in Japan was to remember to exit just as most investors had become convinced of a self-sustaining recovery. Investors should have sold as the leading indicators began to turn down (see chart below). They needed to sell despite protestations from economists that we were set for a mid-cycle pause and strategists telling us that the market was much cheaper than had been seen in recent years. In each case the sanguine voices were proved appallingly wrong. Even moderate fiscal tightening would pitch Japan?s economy back into recession and the Nikkei made new lows. At the stock level, my Quant colleague, Andrew Lapthorne, has demonstrated that in Japan value/momentum strategies needed to be replaced by reversal strategies (buying the losers/selling the winners) ? link. The buy and hold era was crushed by the reality of economic and market volatility.
And even as investors should have had years of practice with the Japanese model, they have yet to apply it to America. The problem is complacency rules, courtesy of Bernanke's Moral Hazard doctrine. Which is why the rude awakening is coming with a bang not a whimper.
For Japanese investors, it took some time to learn the new metrics of investing. Today, investors have no such excuse. After all, Ben Bernanke tells us we should learn the lessons of Japan and so we must. Though many commentators want to complicate the investment business, we try and keep our advice as simple as possible. The leading indicators have begun to turn down in the US (see charts below) and so risk assets are therefore dangerous. Almost no-one will be willing to predict renewed global recession and no-one will predict new lows in equities. And with the market so bullish (cover chart) a cyclical failure will come as a crushing blow to sentiment. It is time for caution. It is time to sell.
Will momos and quants embrace the impending downward slide with the same enthusiasm they rode the wave higher? Time will tell, but if the answer is yes, expect a major overshoot to the recent low of 666 on the S&P.
Sovereign Debt Defaults Likely Over Next Several Years, Says Rogoff
Global markets tumbled overnight amid fresh concerns about the global economy, and more specifically, the prospect of sovereign debt defaults. Standard & Poor’s lowered its outlook for Spain's debt grade as the country's finances worsened. A day earlier, Fitch cut Greece's long-term debt to BBB+ from A minus, marking the first time in a decade the country has seen its rating pushed below an A grade.
The news doesn't come as a surprise to our guest Ken Rogoff, professor of economics and public policy at Harvard University. As Dubai's recent debt crisis shows, more sovereign debt defaults will be likely over the next several years, he says. The International Monetary Fund will try to prevent any global economic crisis in the near term says Rogoff, a former IMF chief economist. But, longer-term, difficult decisions remain about how to tackle mounting debt among G8 nations. "We can barely have the political will to raise taxes to pay our own debts," which means less money to pay for bailouts of other creditors, he predicts.
"In a couple of years as U.S. debt explodes, as German debt explodes, and they're all going to be pushing difficult levels, they're really going to start thinking. 'Hmm. Do we really want to cast this safety net?' We've got to scale back," says Rogoff, also co-author of a new book, "This Time Is Different: Eight Centuries of Financial Folly." The book outlines how periods of boom and bust are marked by bouts of overspending and mounting debt, whether by consumers, banks or governments -- just like the current crisis.
Should American taxpayers be worried? Financial crises in Asia during the late 1990s and in Latin America during the '80s largely were regional affairs but higher U.S. inflation is almost a certainty. Rogoff, however, is more certain about the future of California, a state strapped by rising expenses and falling tax revenues. They'll be on the brink of default repeatedly, Rogoff says.
France, Britain Implement 50% Tax on Bonuses, Propose Global Version
French President Nicolas Sarkozy and British Prime Minister Gordon Brown have proposed a one-off tax on excessive bonuses this year. The idea has not been well received in Germany, but banks here have already instituted new bonus rules. The problem, as British Prime Minister Gordon Brown and French President Nicolas Sarkozy see it, is that while bankers reap the profits from their at-times highly risky investments, taxpayers are forced to foot the bill when those investments go sour.
How to solve the problem? The pair of European leaders proposed one measure in an editorial for Thursday's Wall Street Journal: tax bank bonuses. "We agree that a one-off tax in relation to bonuses should be considered a priority, due to the fact that bonuses for 2009 have arisen partly because of government support for the banking system," the pair wrote. In other words, without government help, banks wouldn't be doing as well as they are today. And the bankers need to hand some of their newly earned money back to the state. On Wednesday, the United Kingdom already began implementing the idea, with head of the Treasury Alistair Darling announcing a 50 percent tax on all discretionary bonuses over £25,000 ($40,800 or €28,000).
He advertised the move as a way to exact a measure of revenge for the financial crisis that sent the British economy into a downward spiral this year. "There are some banks who still believe their priority is to pay substantial bonuses to some already high-paid staff," Darling said. "If they insist on paying substantial rewards, I am determined to claw money back for the taxpayer." Darling was blasted at home for the plan, with many saying it was merely a stunt to gain support for his lagging Labour Party ahead of elections to be held by next June. Many say the £550 million the measure might raise would do virtually nothing against the £178 billion the British government will have borrowed by the end of the year -- in part to prop up the economy reeling from the financial crisis.
Brown and Sarkozy on Thursday seemed to indicate they thought it was a plan that should be extended across the globe. "There is an urgent need for a new compact between global banks and the society they serve," they wrote. The idea of a one-off tax on bonuses is not likely to be one implemented in Germany. Chancellor Angela Merkel's governing coalition includes the business-friendly Free Democrats, and on Friday, FDP financial spokesman Frank Schäffler told the Berliner Zeitung that he is opposed to such a "penal tax."
Merkel's conservative Christian Democrats likewise came out against "special taxes for specific professions." Still, the Germans are not just sitting out the debate. According to the business daily Handelsblatt on Thursday, large German banks have decided to follow the new G-20 bonus regulations voluntarily in 2009, though they won't officially go into effect in Germany until next year. The rules call for bonuses to be linked to long-term success rather than short-term profits. Bonuses are to be paid out over a three-year term instead of immediately. Should a deal go sour during those three years, the bonus payments will drop or disappear entirely.
Bankers fail to clear bonus clouds
by Gillian Tett
Bin The Bashing. That was the central message of a 220-page report that thudded out from Washington’s Institution of International Finance on Wednesday. For as British bankers reel from hefty new bonus taxes and Washington’s politicians debate a new round of regulatory controls, the IIF is frantically fighting back by wielding a list of bullet points that appear intended to overwhelm (or bore) its opponents into submission.
In exhaustive detail, Wednesday’s report described all the global banking sector had done "voluntarily" to clean up its act in the last year. While the details were complex, the moral was clear: if only national politicians would stop meddling so erratically, the financial sector would become healthy again – for the good of all concerned. Will this political pleading work? I doubt it. If any non-banker has the appetite to wade through the IIF’s report – and its endless appendices – they will certainly find plenty of sensible ideas and encouraging news. The sections on risk management and liquidity systems, for example, include laudable and welcome details (albeit many which have arrived two years too late).
But the big political cloud, both in the UK and elsewhere, is pay. On Wednesday, Josef Ackermann, head of Deutsche Bank, appealed to bankers to show restraint in the current bonus round, noting that "it would be useful for all of us to recognise that the recent rise in profitability at many firms is attributable in part to exceptional support from governments and central banks". He probably means it. After all, Mr Ackermann has often remarked to friends in recent years that it is bizarre that his brother (a Swiss doctor) has been taking home so much less pay than bankers (such as Mr Ackermann himself).
But Mr Ackerman has also muttered for years that it would be corporate suicide for any bank to pay its top employees less than its competitors. Thus, not even the IIF seems to believe restraint alone can solve the issue: its report yesterday also called for globally co-ordinated guidelines to be issued in a level-headed, co-ordinated way. Yet, in a piece of political theatre – or irony – that it would be hard to invent, that worthy plea came just as the British announced its unilateral bonus tax. And that is unlikely to be the end of the controversy.
After all, in the coming weeks, details of this year’s bonus round will inevitably leak. More news will come about future cuts to public finances too, echoing what Alistair Darling, the UK chancellor, told the British parliament on Wednesday. And if that combination were not already bad enough, next spring the G20 will issue a scorecard on the progress that its members have – or have not – made in implementing joint commitments to curb pay.
Some bankers hope this G20 initiative will just be rhetorical mush, or something that groups such as the IIF will help to shape. Hence the IIF’s call on Wednesday for "co-ordinated" measures on pay – as opposed to the unilateral move that the British have unveiled. However, the G20 pay report may yet turn out to be more forceful and controversial than it currently seems. After all, those running the project know the report will be the first test of whether the G20 can produce tangible, post-crisis reforms, and if nothing else, this will put the bonus issue back in the news.
So the IIF has its work cut out. Perhaps 2010 will turn out to be the year that politicians become so wildly unpopular that the public will finally be distracted enough to stop bashing the bankers. After all, it will be a year of budget cuts and elections. But in a world where bankers continue to be convenient, distracting targets, politicians will undoubtedly keep trying to shift the focus; just as Mr Darling did, in fact, yesterday. Meanwhile, I rather suspect that the worthy 220-page IIF report now looks destined to become a more effective paperweight than political weapon. Perhaps it is time for the IIF – or any financier wanting to make a point – to master the art of Twitter.
GE chief attacks executive ‘greed’
Jeffrey Immelt, General Electric’s chief executive, said on Wednesday his generation of business leaders had succumbed to "meanness and greed" that had harmed the US economy and increased the gap between the rich and the poor. Mr Immelt’s attack on his fellow corporate chiefs – made in a speech at the West Point military academy – is one of the strongest criticisms by a top executive of the compensation and business practices that prevailed before the financial crisis.
"We are at the end of a difficult generation of business leadership ... tough-mindedness, a good trait, was replaced by meanness and greed, both terrible traits," said Mr Immelt, who succeeded Jack Welch, one of the toughest leaders of his generation, at the helm of the US conglomerate. "Rewards became perverted. The richest people made the most mistakes with the least accountability." Several executives, especially in financial services, have apologised for their companies’ role in the crisis but Mr Immelt’s remarks went further, linking bad leadership to growing inequality. "The bottom 25 per cent of the American population is poorer than they were 25 years ago. That is just wrong," he said. "Ethically, leaders do share a common responsibility to narrow the gap between the weak and the strong."
GE wants to win a large slice of the infrastructure projects funded by governments around the world in an effort to kick-start their economies. Mr Immelt said business should welcome government as "a catalyst for leadership and change". Mr Immelt also issued a mea culpa over his inabilty to foresee the financial turmoil, which slashed GE’s profits and put its financial arm, GE Capital, under pressure, saying he should have been a better listener. "I felt like I should have done more to anticipate the radical changes that occurred," he said. The GE chief now gathers GE’s top 25 executives to twice-monthly Saturday sessions to talk about the company and its future.
In the speech, Mr Immelt indicated GE would continue to shrink GE Capital, which accounted for around half of the company’s profits as reently as two years ago. He said it was wrong for the US economy to have "tilted toward the quicker profits of financial services" at the expense of the manufacturing industry and research and technology investments.
Jeff Immelt tires of associating with bankers
The attack by Jeff Immelt, General Electric’s chief executive, on "meanness and greed" among business leaders is an interesting straw in the wind. His speech at West Point coincided with the decision by Alistair Darling, the UK chancellor of the exchequer, to levy a 50 per cent windfall tax on the bonus pools of banks operating in Britain. In his speech, Mr Immelt said:"We are at the end of a difficult generation of business leadership … tough-mindedness, a good trait, was replaced by meanness and greed, both terrible traits. Rewards became perverted. The richest people made the most mistakes with the least accountability."
He added that it was wrong for the US economy to have "tilted toward the quicker profits of financial services" and away from manufacturing industry and research investment.
Taken together, the implication of these points is clear. There is something distorted about an economy in which extremely high rewards go to relatively few people in financial services.
Mr Immelt’s remarks are the latest - perhaps the strongest - among business and financial leaders calling for self-restraint and a change in attitude. Such appeals have fallen on deaf ears. As the FT reports, many bankers in the City were not only furious at the windfall tax but also threatened to move overseas in protest. Whether or not that is plausible - since the tax is a one-off levy, it is unlikely too many people will move home permanently - it indicates a yawning gulf in attitudes.
Many people - probably most - believe that bankers’ bonuses are profoundly unfair, especially since they were not curtailed in the wake of the financial crisis. Meanwhile, bankers regard themselves as victims of populism kindled by politicians and the media. The significance of Mr Immelt’s speech, I think, is that the leader of one of the biggest companies in the US is willing to say publicly what many non-business people feel. Leaders in non-financial industries have worried since last year about being tainted by the behaviour of bankers. Now, it seems, they are running out of patience
Gold may fall toward $1000 by year end, says Investec Australia
Spot gold could fall toward $US1000 an ounce by year end as investors rush to take profits and wait for a new influx of monies in the New Year, Investec Australia said today. Gold's decline from highs earlier this month has been intensified by many fund and institutional players unwinding positions ahead of the year's end.
"We feel that given the usual thin liquidity at this time of year, it is possible that gold could see a sell-off taking it closer to $US1000 by year end," it said in a daily note. Investec was commenting after a rebound in the US dollar, sovereign debt worries and easing inflation saw gold record a sharp fall for a fourth straight session in New York to hit its lowest level in more than three weeks at $US1116.80 from this month's record high of $US1226.30.
Gold bubble worries lead to significant sell-off in top gold ETF
The world's largest gold-backed exchange-traded fund, SPDR Gold Trust (GLD), noted that its holdings fell to 1,116.247 tonnes, worth over $41 billion at the current gold price, as of December 8th. This represented a fall of 1.2 percent or more than 13 tonnes in a day and was the largest one-day drop in around five months according to a Reuters report. The SPDR Gold Trust ETF hit a record high of 1,134.03 tonnes on June 1, and up until recently had been climbing back towards this level again.
Further falls were expected to be announced today as the gold market is going through a period of uncertainty and some investors are liquidating some or all of their holdings, and taking some hefty profits, in case the recent gold price falls are because a gold price ‘bubble' has burst. The SPDR Gold Trust gold holdings are larger than those of most nations' Central Banks, and there has always been a worry that this overhang of gold, effectively in fickle investors' hands, could in itself prompt a catastrophic fall in the gold price if sentiment moved sufficiently to generate a major sell-off, leading to a downwards price spiral.
So far this has not happened, and with the weaker dollar this morning seeing the gold price pick up, and continuing economic uncertainty, there is evidence of buyers coming back into the gold market seeing the earlier falls as a good buying opportunity, and ignoring the ‘bubble' talk. There is no doubt that the recent sharp movements in the gold price that have seen it fluctuate up and back down by nearly $100 in the past weeks make this a market for those with nerves of steel.
Several observers have warned of excessive volatility ahead and these warnings are definitely coming into play. The fundamentals which have been driving the gold price upwards are still in play, but as we have warned before on Mineweb, markets are often driven by investor sentiment and if the force is no longer seen to be with gold there could be even more volatility ahead for the price until some stability sets in. Movements up or down in the SPDR gold ETF holdings will thus be watched with particular interest over the next few days as this will be a good indicator of where gold investment sentiment is trending.
How To Kill OTC Derivatives Reform in Two Sentences
by Mike Konczal
Have lobbyists snuck another major loophole into the OTC Derivatives bill? This week the final touches are being put on Barney Frank’s financial regulation bill – H.R. 4173 – “Wall Street Reform and Consumer Protection Act of 2009.” One of the centerpieces of this reform is Title III: Over-the-Counter Derivatives Markets Act. And one of the goals of this reform would be to get as many derivatives as possible to trade on exchanges.
An initial hurdle for Barney Frank was what to do with an “end-user exemption.” This would exempt certain types of derivative buyers who use derivatives, say corporations hedging interest rate risk without speculating, from the extra scrutiny and regulation that comes with the exchange/clearing system. One of the narratives of financial reform so far has been that this initial end-user exemption was too large a loophole at first, and instead of just handling 10-20% of the market, it would let a large majority of the market sneak through, but ultimately Barney Frank was convinced by consumer groups and people pushing for stronger financial regulation and fixed this issue. See Noah Scheiber here in “Could Wall Street Actually Lose in Congress?” for this story, and it shows up as well in a recent profile of Barney Frank in Newsweek.
I thought it was a little too early to declare victory, and sure enough instead of attacking and weakening how people will have to use the exchanges, lobbyists have re-focused their attack on the idea of the exchange itself. For a while, reformers have been worried about an “alternative swap execution facility.” This would be a way of essentially allowing the current way things are done to be allowed to count as an exchange. Fighting off this loophole was a battle from a month ago, and it had appeared to be won. Now many are worried that this language appears to have snuck back into the final bill now.
Colin Peterson (D-MN), Chairman of the House Committee on Agriculture, along with Barney Frank, has added an amendment to the OTC Bill (opens large pdf). There are two relevant sentences for reformers from the long document. The first is on page 32:
(49) SWAP EXECUTION FACILITY.—The term ‘swap execution facility’ means a person or entity that facilitates the execution or trading of swaps between two persons through any means of interstate commerce, but which is not a designated contract market, including any electronic trade execution or voice brokerage facility.
This replaces other language in the original bill (opens even larger pdf), on page 546:SEC. 5h. SWAP EXECUTION FACILITIES.
(A) No person may operate a swap execution facility unless the facility is registered under this section.
(B) The term ‘swap execution facility’ means an entity that facilitates the execution of swaps between two persons through any means of interstate commerce but which is not a designated contract market.
So notice any differences? First the definition of a swap execution facility has been expanded to include “a person” (different from the “or entity”). It’s also expanded to an “or trading” definition, and includes voice brokerage firms. So now we are moving from the definition of something that is a platform for swaps to be traded on to instead something that simply helps swaps get traded. This could, quite simply, be a telephone over which two people trade a derivative (with one person declaring himself to be the exchange?). Instead of changing the way business is done for reform it looks like it redefines reform as the way things are currently done, and just calls it a victory.
Now on page 89 of the amendment:(2) RULES FOR TRADING THROUGH THE FACILITY.—Not later than 1 year after the date of the enactment of the Derivative Markets transparency and Accountability Act of 2009, the Commission shall adopt rules to allow a swap to be traded through the facilities of a designated contract market or a swap execution facility. Such rules shall permit an intermediary, acting as principal or agent, to enter into or execute a swap, notwithstanding section 2(k), if the swap is executed, reported, recorded, or confirmed in accordance with the rules of the designated contract market or swap execution facility.
The second sentence here allows an intermediary to execute a swap, ignoring the section 2(k) which is the meat of the reform, as long as the swap is recorded somewhere. Now we already have, from above, that a swap execution facility can be something other than the exchange. This is a rule that guts the regulation right out the door, and for no apparent benefit to reform. Many of these alternative swap facilities will be owned by the banks, so it won’t necessarily force the price transparency that has been promised. To trust regulators to simply do the right thing is naive at best when the ability to follow fixed rules is available.
From what I’m hearing, it is possible Frank doesn’t even know that this language, once in the bill as an amendment but removed, has snuck back into his reform legislation. Things are moving very quickly on the hill right now, and this is scheduled to be wrapped up by tomorrow. However this new language runs counter to the reforms Frank has promised to deliver to the American people. Either this language needs to be clarified before the bill is complete, or removed entirely.
India Seeks to Ban Over-The-Counter Derivatives
The Reserve Bank of India may ban over-the-counter oil swaps and options trading in an attempt to prevent losses that could bankrupt companies. Reliance Industries Ltd., India’s most valuable company, and state-owned Indian Oil Corp., the country’s largest refiner, are among those that may only deal in derivatives through bourses like the New York Mercantile Exchange or ICE Futures Europe, the central bank said in draft guidelines issued Nov. 12. They also won’t be allowed to sell options on these exchanges. "This could impact the banks because they lose the captive audience for their exotics," said Jonathan Kornafel, a director for Asia at options traders Hudson Capital Energy in Singapore. "Moving from the bilateral model to the exchange cleared does entail putting up some margin or some premium to trade but you do get something in return."
Indian regulators want to prevent losses at airlines and refiners akin to the $675 million that Ceylon Petroleum Ltd. suffered in 2008 on adverse OTC options trading. JPMorgan Chase & Co. and Deutsche Bank AG, among the biggest banks dealing in energy risk derivatives, could lose out on income from offering complex swaps and options to processors and consumers in a country that may become the fourth largest oil importer by 2025. A clearinghouse eliminates some of the risks of over-the- counter trading as it acts as the counterparty for the swap or option that is bought through the exchange. Participants put up funds, or margin, as collateral in the event of a default. An over-the-counter deal depends on credit agreements worked out directly between the two sides.
India’s proposed changes reflect moves in the U.S. and Europe to increase regulation of the $600 trillion derivatives market amid allegations that speculation in swaps and options drove crude oil prices to a record $147.27 a barrel in 2008. Commodity Futures Trading Commission Chairman Gary Gensler has asked lawmakers to require more transactions go through clearinghouses which underwrites such deals. The margin requirement may increase costs "but you get thousands of counterparties to work with and you don’t have to worry about counterparty risk," said Hudson’s Kornafel. A move to exchanges could mean a loss in profits for the banks that are active in this market.
An analyst at Sanford C. Bernstein & Co. calculated in a Dec. 2 report that JPMorgan Chase & Co., the second-largest U.S. bank, may lose as much as $3 billion should most derivatives trades, including such deals as interest-rate swaps and energy options, be moved to exchanges. That loss will come as a result of a narrowing in the difference in the buy and sell price of a swap, known as the bid-ask spread, said Anthony Nunan, an assistant general manager for risk management at Mitsubishi Corp. in Tokyo. "Banks could charge a greater margin on the bilateral deals that were done," said Nunan. "Their profit margin will be reduced. Moving to exchanges will increase the transparency so it should reduce the bid-offer spreads."
Requiring companies to trade on exchanges may restrict the ability of energy end-users to enter into some types of hedges as they are limited to the products offered. "The niche stuff, I just don’t know how people will do that," said Mitsubishi’s Nunan. "If you have a huge volume or a multiyear hedge you could hit a liquidity problem." The Reserve Bank’s proposed rules would limit the amount of anticipated imports a refiner could hedge to 50 percent of the average imports over the past three years. Central bank officials declined to respond to calls for comment. Reliance Industries also didn’t respond to calls while a spokesman for Indian Oil said it has studied the guidelines and given feedback to the central bank.
The draft also bans the use of zero-cost products where the purchase of an option to protect upside risk is offset by collecting a premium from the sale of a derivative. For example, a company would buy a call, or the right to purchase crude at a specific price, and at the same time sell a put, or the right to deliver a commodity. Companies that structured such deals got caught after prices started to drop from the July 2008 peak. China Eastern Airlines Corp. posted a loss of 916 million yuan ($134 million) on hedges in the first quarter of this year. Singapore Airlines Ltd. had a fuel-hedging loss of S$287 million ($200 million) in the quarter ended June. Other oil companies and airlines have lost money as well.
"A large portion of the recent losses from airlines came from putting on collars and leveraged exotics when the jet fuel price was near its high," said Hudson’s Kornafel. "Simple exchange-cleared structures like collars often get caught up in the negativity that OTC exotics can produce." Indian companies haven’t reported losses of similar scale to that seen in Asian airlines and refiners. Ceylon Petroleum Corp., neighboring Sri Lanka’s government-run oil company, suffered one of the largest losses related to wrong-way bets on oil prices.
Ceypetco, as it is known, purchased OTC derivatives from Deutsche Bank, Standard Chartered Plc and Citigroup Inc. priced at between $100 and $130 a barrel in 2008. The Sri Lankan government ordered payments on the contracts be suspended and the sides are now in the midst of arbitration proceedings. Comments on the draft proposal, which is also looking at amending foreign exchange, freight and other commodity derivative trading, are due to the Reserve Bank by Dec. 15. "Trading exchange-cleared swaps, buying calls and buying puts is a very safe way to hedge but it does limit the effectiveness of a hedging program," Hudson’s Kornafel said.
Barclays Halts Sale of India Exchange-Traded Notes Amid Derivatives Ban
Barclays Bank Plc suspended sales of its exchange-traded notes linked to Indian stocks after the country’s capital markets regulator ordered the bank’s local unit to stop selling or trading offshore derivatives. Barclays discontinued sales of its iPath MSCI India Index Exchange Traded Notes, the London-based bank said today in a statement. The iPath notes are the second largest exchange- traded product linked to Indian equities, with assets of $1.1 billion, according to data compiled by Bloomberg.
The regulator yesterday accused Barclays of providing incorrect and false information, including the identity of counterparties, about offshore derivatives. The London-based bank demonstrated "blatant disregard" for the rules and must show adequate controls are in place before it resumes selling the instruments, the agency said. Barclays, which has until Dec. 18 to respond, said it’s cooperating with the regulator. "We do not believe that use of notes will dwindle because of this suspension," said Akil Hirani, managing partner at Majmudar & Co., an Indian law firm. "The know-your-client norms have been in place since some time now, and the onus is on the foreign institutional investors to follow them."
Barclays said today that suspending sales of the iPath notes, which are traded on the NYSE Arca stock exchange, may cause fluctuations in trading value. Daily redemptions at the option of the holders won’t be affected, the bank said. Barclays said last month it planned to double its investment banking team in India, where the benchmark stock index has surged 78 percent this year and sales of equity-linked derivatives totaled 1.25 trillion rupees ($26.8 billion) at the end of October. The bank confirmed that it had received a show cause notice from the Securities and Exchange Board of India, known as SEBI. "We have been and will continue to cooperate fully with SEBI as it examines certain offshore derivative transactions," Barclays said in an e-mailed statement late yesterday.
Derivatives are securities whose value is derived from an underlying asset such as stocks, bonds, commodities or currencies. The regulator lifted curbs on overseas investors in October last year in a bid to stem record sales of assets by offshore funds that triggered a 52 percent slide in the benchmark Sensex Index in 2008. The agency has been tightening rules, requiring brokers to disclose information about the terms of derivative instruments and the investors to whom they are sold.
Barclays provided incorrect and false information when issuing offshore derivatives, the regulator said in a statement late yesterday. The bank sold instruments linked to the shares of Reliance Communications Ltd. to Hythe Securities Ltd., and incorrectly reported that they were issued to UBS AG, the regulator said. Hythe then sold the notes to Pluri Emerging Companies PCC Cell E Emerging Markets Growth Fund, while Barclays reported they weren’t reissued, the regulator said. "This shows the blatant disregard by Barclays in complying with the provisions of the Foreign Institutional Investor regulations," the regulator said in its statement.
Tough words and and hard budgets for eurozone
Greece has been warned by a top European Central Bank policymaker that it has a year to bring public finances back under control or risk having its bonds disqualified for use as collateral by banks borrowing ECB liquidity. The comments by Axel Weber, Germany’s Bundesbank president, intensify the pressure on the new Socialist government in Athens following revelations that its budget is in a far worse shape than previously feared.
This further blow to the eurozone country came as some of its currency bloc partners, both large and small, felt the full force of the recession. Ireland unveiled its harshest budget in years to try and bring spending under control. Spain, one of the largest economies in the eurozone, had its ratings outlook changed to negative by Standard & Poor’s. On Tuesday, Fitch cut its rating on Greek debt to BBB plus – the first time in 10 years that a leading ratings agency has rated Greece below the A grade. Standard & Poor’s has also warned that a downgrade is possible.
Prior to the global economic crisis an A minus grade was the minimum requirement for assets put up by eurozone banks when taking part in ECB liquidity boosting operations. The threshold was reduced to BBB minus after the collapse of Lehman Brothers last year threatened to paralyse financial markets, but so far the ECB has only said that the lower standard will apply until the end of 2010. Speaking to the international club of business journalists in Frankfurt, Mr Weber noted the temporary arrangements "will run out" and added that "the Greek government and those who hold responsibility see the clear need to implement now concrete [fiscal] consolidation steps".
Mr Weber, an ECB governing council member, was unclear, however, whether the ECB would ever make good any threat to exclude bonds from a eurozone government in its liquidity operations – a step which would be seen as highly-political. Mr Weber assumed Greece would act in response to the pressures being imposed by financial markets and ratings agencies. "The ball lies in Greece’s court," he said. European Union authorities are keen to keep up the pressure on Athens to step up efforts to reduce its deficit, which is expected to reach almost 13 per cent of gross domestic product this year.
In February, Germany’s finance ministry hinted that in the worst case, help could be made available to struggling eurozone countries. But that reassurance has not been repeated more recently, fuelling speculation that if Greece eventually faced the threat of default, it would be forced into the hands of the International Monetary Fund. However, Mr Weber expressed confidence that the EU had the means to force the Greek government to bring its deficit back in line with the region’s "stability and growth pact" – which is supposed to compensate for the lack of a single fiscal authority in the 16-country eurozone. The pact sets a limit of a three percent for public sector deficits. "Within the stability and growth pact there is no role for the IMF – rightly," said Mr Weber.
European finance ministers have started proceedings that could eventually result in Greece facing sanctions for repeatedly flouting the stability and growth pact. Frustration with Greece escalated because of the unreliably of its statistics. Earlier this year, the European Commission expected a deficit for 2009 that was above the 3 per cent limit but in November, it had to revise its projections to show a deficit of 12.7 per cent. Greek government debt is expected this year to exceed 112 per cent of GDP. Meanwhile, its current account deficit reached almost 15 per cent of GDP last year, although it is expected to fall below 9 per cent in 2009.
Robust German exports calm recovery fears
Robust German exports have helped calm fears that the economic recovery in Europe’s largest economy is losing momentum. Exports rose by 2.5 per cent in October, extending a 3.6 per cent rise in the previous month, according to official statistics that suggested the Germany’s economy had started the fourth quarter on a positive note. The data came as a relief after news earlier this week that industrial orders and production had fallen in October – which had led to worries that the pace of growth might have slowed.
Germany escaped recession in the second quarter of this year – ahead of the UK and US – helped by a pick-up in global demand for its industrial products. In the third quarter, growth accelerated, with gross domestic product increasing 0.7 per cent. Axel Weber, Bundesbank president, told business journalists in Frankfurt late on Tuesday that Germany’s reliance on exports to power growth mean it was doing better than rival European economies. "Germany has a certain function as a pioneer".
Revised Bundesbank forecasts last week showed the economy would expand 1.6 per cent in 2010, after a contraction of almost 5 per cent this year. A remarkable feature of Germany’s slowdown has been the modest impact on unemployment, which the Bundesbank estimates will rise from 3.4 million this year to 3.8 million in 2010. One explanation has been the widespread use of government-funded short-time working schemes, which have allowed companies to avoid making large numbers of staff redundant. But Mr Weber argued that the increased internal flexibility of German companies was "not sufficiently appreciated by commentators".
However, Mr Weber warned that the recovery process would also see setbacks, and economic activity remains well below pre-crisis levels. Since the low point in April, German exports have risen more than 12 per cent. But the steep falls late last year and earlier in 2009 meant that October’s exports were still almost 16 per cent lower than in the same month a year before.
Unemployment at 3.7 percent - a Dutch miracle?
At first glance, the numbers seem to speak for themselves. The number of unemployed people in the Netherlands grew by 110,000 last year and currently totals 400,000. Compared to almost all other countries however, the Netherlands is doing just fine with unemployment at just 3.7 percent.
Consider the United States, where 10 percent of the workforce is unemployed. Or the European Union as a whole, where unemployment has reached a similar level, leaving 15.5 million people without work, according to data collected by the European statistical agency Eurostat.
Latvia and Spain are leading the pack, with unemployment rates running close to 20 percent. Austria and the Netherlands are doing the best, with 4.7 and 3.7 percent respectively. (Note that the figure cited by Eurostat is slightly lower than the 5 percent rate estimated by the Dutch statistics office CBS.)
Many explanations for Dutch success
Granted, Dutch unemployment will grow in the year to come in the wake of the recession, perhaps reaching 600,000 by the end of 2010, but even then the Netherlands will remain well below the European average.The fact that 35,000 people are currently in "partial unemployment," a Dutch system which allows for people to remain partially employed while supplementing their income with benefits, is not the only thing propping up Dutch employment rates. Nor are the 30,000 young people who are staying in school or college longer because they want to delay entering a dismal job market.
To explain the huge difference in numbers, "one has to consider the past," says Erik de Gier, a professor who teaches comparative job market research in Nijmegen. "We were in great shape when the crisis hit home. Our job market was incredibly tight. Unemployment was at an historic low and businesses were having a very hard time finding new staff. Now that times are hard, they are hesitant to fire the staff that they have worked so hard to find in the first place. Particularly because they will need these people even more when the baby boomers start to retire en masse.
"This psychological effect might be temporary, De Gier warns. "No one can predict how the economy will recover. We might have left the recession behind us officially, but if growth slows down, or if a second recession follows, the job market will experience further fallout. Even if only because of government cutbacks coming up in the next few years.”
According to De Gier, the firmly entrenched Dutch part-time job culture also explains why unemployment rates run so low. Nowhere is part-time employment as popular as it is in the Netherlands, De Gier says. "That has a huge effect on unemployment, simply because we need more people to do the same amount of work."
In combination with the relatively high number of temp workers, this also makes for a very flexible job market, says Michiel Vergeer, an economist for the Dutch statistical office CBS. "Flexibility is key here, because it enables us to match supply with demand."According to Professor Jan van Ours, who teaches labour economy in Tilburg, the large number of part-time workers is a left-over from the 80s."Back then, unemployment was skyrocketing and politicians called for a better division of the few jobs that remained," he says.
The unions initially opposed part-time jobs, which they saw as second rate employment. Van Ours: "Only later, when unemployment rates really got out of control did they change their stance on the issue. Since then, part-time work has rapidly gained in popularity. But in the countries surrounding us, the unions still oppose part-time work, mostly because it pays very little. There, a lot of part-time jobs consist of poorly paid unskilled labour. Here we have full-fledged part-time employment. People can do fulfilling and rewarding work for three or four days a week. In most other nations that is out of the question."
The Dutch lack of a large industrial base offers another explanation for low unemployment rates. "Industry is always hit the hardest in a recession," says Ruud Muffels, a professor of labour markets and social security in Tilburg. "Ours is mostly a service economy, with a lot of jobs in health care, education and government, sectors that are generally less prone to cyclical effects."Van Ours also points to the Dutch social security system, which has seen drastic reform since the 70s and 80s, further expanding the workforce.
"Unemployment benefits have been reduced and qualifying for them has become harder," Ours says. "While our social security system still pays a fair amount, especially compared to other countries, you can only draw on it for a limited time. The unemployed are also required to actively seek new jobs. If they don't apply for jobs, or refuse work they are offered, they are penalised and receive less money. Other countries have less effective stimuli or none at all," Van Ours said.
Still, Muffels predicts that unemployment in the Netherlands will slowly continue to rise to 8 percent."The job market is always slow to respond to economic shifts because Dutch law makes it hard for employers to lay people off," he warns. "We shouldn't count our chickens before they hatch."
Greece stirs to Fitch’s wake-up call
Greece finally seems to be waking up to the gravity of its economic situation. Fitch’s downgrade of Greek sovereign debt on December 8 rattled markets but prompted only a paltry initial response from the government. A day later, Prime Minister George Papandreou was talking about taking urgent action. Hopefully he has realised that if he does not use this opportunity to tackle Greece’s colossal deficit, it could soon be too late to restore market confidence. The official line in the aftermath of the downgrade was far from reassuring. Greece, investors were told, was sheltered by the umbrella of the euro zone. The authorities stressed that the European Central Bank was still accepting Greek debt as collateral and that the country's banks had access to multiple sources of liquidity.
Papandreou’s new sense of urgency is hugely welcome. But it is not clear precisely what action he has in mind - although it is easy to see where he should start. Greece’s pension system is paying a rapidly ageing population too generously. The country’s public sector remains unproductive, uncompetitive, overblown and hostile to reform. Savage cuts are required across the board. The good news is that Fitch believes that concerted government action could narrow the fiscal deficit by 3.6 percentage points of GDP to 9.1pc during 2010. The government has said that its January budget will seek to cut spending by 10pc. But there are still doubts as to how that target will be achieved – and whether the government really has the guts to go ahead with painful policies that are likely to provoke tremendous public anger.
The rating agencies themselves appear to be applying pressure so that the government finds the required resolve. For example, Fitch’s downgrade came well in advance of the expected budget announcement. And Standard & Poor’s gave Greece 60 days to respond to its decision to place it on negative watch, instead of the usual 90. Meanwhile, the clamour from European peers suggesting that Greece needs to get its act together is getting louder. Greece has to roll over a portion of its debt early next year. Papandreou is running out of time to show he means business.
Mexico Has Hedged Oil for 2010 at $57 a Barrel
Mexico spent $1.172 billion to buy oil hedges for 2010, covering a possible revenue shortfall if production falls for the sixth straight year and prices don’t recover from about a five-year low. Mexico purchased put options that give it the option, not the obligation, to sell its oil for $57 a barrel next year, the Finance Ministry said in an e-mail statement today. "We want this as an insurance policy," Finance Minister Agustin Carstens said in New York today. "If we don’t collect any resources from this transaction it’s OK because that means oil would have been above $57 a barrel."
Mexico lost out on 300 billion pesos ($23.3 billion) of oil revenue this year as production at state-owned Petroleos Mexicanos fell at the fastest rate since 1942 and crude prices fell about half since a record $147.27 a barrel in July 2008.. Pemex, the sole producer of oil in Mexico, pumped 2.602 million barrels of oil a day in October, 5.7 percent less than a year earlier. A six-year drop in output has reached a "floor" and will gradually recover during the next three years, Carstens said. Mexico is the second-largest supplier of oil to the U.S.
Fitch Ratings last month cut Mexico’s rating to BBB, the second-lowest investment grade level, as falling oil revenue and tax collection swell the government’s budget deficit to the largest in about 20 years. Pemex provides about 40 percent of federal government revenue. Mexico hedged oil exports for 2009 at $70 per barrel and received $5.1 billion from the hedges this week, the Finance Ministry said today. Goldman Sachs Group Inc., Morgan Stanley, Deutsche Bank AG and Barclays Plc were counterparties in the hedges, Carstens said.
Oilsands pollution far exceeds official estimates
An independent study suggests pollution from Alberta's oilsands is nearly five times greater and twice as widespread as industry figures say. The study says toxic emissions from the controversial industry are equal to a major oil spill occurring every year. Government and industry officials say contamination in area soils and rivers is natural, but the report links it firmly to oilsands mining.
"We found rather massive inputs of toxic organic compounds by the oilsands industry to the Athabasca River and its tributaries," said David Schindler, a co-author of the study. "The major contribution to the river was from industry." The study, published Monday in the U.S.-based Proceedings of National Academy of Science, also takes direct aim at Alberta's monitoring program. "Our study confirms the serious defects of the (regional aquatic monitoring program)," it says. "More than 10 years of inconsistent sampling design, inadequate statistical power and monitoring-insensitive responses have missed major sources of (contamination) to the Athabasca watershed."
Government officials questioned the report's conclusions. Contaminants are more concentrated near oilsands facilities because that's where the bitumen deposits are most concentrated, said Alberta Environment scientist Preston McEachern. "The mines are located where they are because they're the richest part of the bitumen deposits," he said. As well, he added, the monitoring program in question is only intended to provide broad, regional information. Alberta relies on specifics from industry, audited by provincial inspectors, for more detailed data.
The report is the latest to question official figures and point out the industry's environmental costs -- from acid rain to reduced songbird populations. In the summer of 2008, Schindler's team set up monitoring stations on the Athabasca and several of its tributaries. Some stations were upstream of both the oilsands and facilities, others were in the middle of the bitumen deposits but upstream of industry and still others were downstream of both. It found petrochemical concentrations did not increase until the streams flowed past oilsands facilities, especially when they flowed past new construction. "We always found that the major contribution to the river was from industry," Schindler said.
Researchers also took snow samples from similar locations earlier that spring. They found deposits of bitumen particulates within a 50-kilometre radius around Suncor and Syncrude's upgraders -- twice the previous distance estimate. The deposits were "substantial" and enough to form an oily slick on the snow when it was melted. "The close association of deposition with proximity to the upgrading facilities suggests they are the primary source," says the report.
In all, the study estimates about 34,000 tonnes of particulates are falling every year near Suncor's and Syncrude's facilities, which were designated as the centre of development. Company figures total just over 6,000 tonnes. The study calculates those particles carry 3.5 tonnes of raw bitumen and carcinogenic polycyclic aromatic compounds (PAC). "This amount of bitumen released in a pulse would be equivalent to a major oil spill, repeated annually," the report says.
McEachern said the province is aware that some contamination comes from airborne particles. But he suggested little of it finds its way into rivers and most of it breaks down in the soil. "It is not directly entering surface waters. You're getting some of this into soil and it sits there -- a lot of (it) does degrade." McEachern said comparing airborne contamination to an annual oil spill is an exaggeration. Schindler said the total concentration of pollutants, measured in parts per trillion, remains low in both soil and water, although there's already enough to be toxic to some fish embryos. He pointed out many of the compounds don't break down and gradually accumulate wherever they land.
Health implications for downstream communities are uncertain, Schindler said. Researchers weren't able to learn what happened as far downstream as Fort Chipewyan, where residents have long complained of high cancer rates. However, the report's main conclusion is clear. "The oilsands industry is a far greater source of regional PAC contamination than previously realized ... The existing (regional aquatic monitoring program) must be redesigned with more scientific and technical oversight."
The report is the latest to criticize environmental monitoring in the oilsands. Other studies suggest that greenhouse gas emissions from the oilsands are being underestimated by nearly a quarter. One paper blamed blamed increased soil acidification on the industry. U.S. researchers have said oilsands mines, roads and other facilities in the area are destroying so much bird habitat that up to 166 million fewer songbirds could be flying North American skies within 50 years.
Americans Are Furious at Wall Street
A new Bloomberg National Poll shows them angry at banks and brokers—and furious about bonuses. Wall Street firms are recovering—but their standing with the American public is not. The public rage directed at Wall Street banks and brokerages remains at high levels, according to a Bloomberg National Poll of 1,000 U.S. adults conducted on Dec. 3-7 by the Des Moines firm Selzer & Co. Two-thirds of Americans say they have an unfavorable view of financial executives. More than half say big financial companies, which are expected to pay record yearend bonuses, are out only to enrich themselves and also should not have received government aid.
Banks that got taxpayer help through the Troubled Asset Relief Program—the $700 billion financial rescue plan passed by Congress last year—shouldn't pay any bonuses, according to 75% of those polled. And this includes 39% of respondents who say they disapprove of bonuses even when the banks have paid the government back. "The fact that they're even in existence should be bonus enough," says Cassie Swihart, a 58-year-old retired registered nurse from Warsaw, Ind. Adds Elijah Brown, 42, an unemployed union contractor from California: "Why would you want to give somebody a bonus who put us into this situation?" Brown is among the 64% of people who said bailing out banks was a bad idea.
Many large banks have roared back to profitability as the financial markets and broader economy have recovered this year. Goldman Sachs, Morgan Stanley, and JPMorgan Chase's investment banking unit will hand out a combined $29.7 billion in bonuses, according to analysts' estimates. That's a record, beating the $26.8 billion in 2007—and up 60% from last year, when all three banks took billions in support from the Treasury to weather the financial crisis. The Bloomberg poll also questioned Americans about the Obama Administration's performance, the challenges confronting the economy heading into 2010, and the war in Afghanistan. Go here for the full poll data.
American Dream 2: Default, Then Rent
Schoolteacher Shana Richey misses the playroom she decorated with Glamour Girl decals for her daughters. Fireman Jay Fernandez misses the custom putting green he installed in his backyard. But ever since they quit paying their mortgages and walked away from their homes, they've discovered that giving up on the American dream has its benefits. Both now live on the 3100 block of Club Rancho Drive in Palmdale, where a terrible housing market lets them rent luxurious homes -- one with a pool for the kids, the other with a golf-course view -- for a fraction of their former monthly payments.
"It's just a better life. It really is," says Ms. Richey. Before defaulting on her mortgage, she owed about $230,000 more than the home was worth. People's increasing willingness to abandon their own piece of America illustrates a paradoxical change wrought by the housing bust: Even as it tarnishes the near-sacred image of home ownership, it might be clearing the way for an economic recovery. Thanks to a rare confluence of factors -- mortgages that far exceed home values and bargain-basement rents -- a growing number of families are concluding that the new American dream home is a rental.
Some are leaving behind their homes and mortgages right away, while others are simply halting payments until the bank kicks them out. That's freeing up cash to use in other ways. Ms. Richey's family of five used some of the money to buy season tickets to Disneyland, and plans to take a Carnival cruise to Mexico in March. Mr. Fernandez takes his girlfriend out to dinner more frequently. "We're saving lots of money," Ms. Richey says.
The U.S home-ownership rate has charted its biggest decline in more than two decades, falling to 67.6% as of September from a peak of 69.2% in 2004. And more renters are on the way: Credit firm Experian and consulting firm Oliver Wyman forecast that "strategic defaults" by homeowners who can afford to pay are likely to exceed one million in 2009, more than four times 2007's level. Stiffing the bank is bad for peoples' credit, and bad for banks. Swelling defaults could also mean more losses for taxpayers through bank bailouts.
Analysts at Deutsche Bank Securities expect 21 million U.S. households to end up owing more on their mortgages than their homes are worth by the end of 2010. If one in five of those households defaults, the losses to banks and investors could exceed $400 billion. As a proportion of the economy, that's roughly equivalent to the losses suffered in the savings-and-loan debacle of the late 1980s and early 1990s. The flip side of those losses, though, is massive debt relief that can help offset the pain of rising unemployment and put cash in consumers' pockets.
For the 4.8 million U.S. households that data provider LPS Applied Analytics estimates haven't paid their mortgages in at least three months, the added cash flow could amount to about $5 billion a month -- an injection that in the long term could be worth more than the tax breaks in the Obama administration's economic-stimulus package. "It's a stealth stimulus," says Christopher Thornberg of Beacon Economics, a consulting firm specializing in real estate and the California economy. "The quicker these people shed their debts, the faster the economy is going to heal and move forward again."
As the stigma of abandoning a mortgage wanes, the Obama administration could face an uphill battle in its effort to keep people in their homes by pressuring banks to cut their mortgage payments. Some analysts argue that's not always the right approach, particularly if it prevents people from shedding onerous debts and starting afresh. "The effect of these programs is often to lead homeowners to make decisions that are not in their economic best interests," says Brent White, a law professor at the University of Arizona who has studied mortgage defaults.
Few places in the U.S. were better suited to attract true believers in home ownership than Palmdale. A farming community that expanded in the 1950s to accommodate the aerospace industry around nearby Edwards Air Force Base, the city more than doubled its population from 1990 to the present as it became the final frontier for Los Angeles-area workers looking to buy. About half of Palmdale's 147,000 residents endure a daily commute that can extend to two hours or more one way. In return, they get a homestead in a high-desert locale of haunting beauty, with Joshua trees dotting the landscape, and real-estate developments locked into a master grid of streets with anonymous names such as Avenue O-8 or Avenue M-4.
The 3100 block of Club Rancho Drive, built by Beazer Homes mostly in 2002, captures the essence of Palmdale's appeal. Winding along the southern edge of the Rancho Vista golf course just south of Avenue N-8, its spacious homes, verdant lawns and imported birch and sycamore trees exude a sense of middle-class tranquility. Club Rancho became a solid community of owner-occupiers, many of whom stretched their finances to the limit. As of the end of 2007, total mortgage debt attached to the 13 houses on the block for which records are available had reached $4.5 million.
Fast-forward to the end of 2009, and the picture changes radically. Thanks to a 50% drop in home prices, at least two owners on the block now owe between $60,000 and $160,000 more on their mortgages than their houses are worth. Four more homes have already passed through foreclosure into the hands of new owners. In the process, the block's total mortgage debt has fallen 37%, to $2.7 million. Much of Club Rancho also has converted to rentals, a shift mirrored across Palmdale. Five homes on the 3100 block are now occupied by renters, up from only two in 2007. In the past six months, at least three families have moved into those rentals after walking away from other homes.
Ms. Richey, the teacher, arrived in Palmdale in 1999. In 2004, she and her husband, Timothy, bought a two-story home on Caspian Drive, near Avenue O-8, with a no-down-payment loan. They took pride in the amenities they installed: a powder room with granite countertops, a backyard pool and play area, and the purple-and-turquoise fantasy playroom upstairs for their three daughters. But the value of the house plunged to less than $200,000 in 2009. Their $430,000 mortgage, with its $3,700 monthly payment, began to look more like an unwanted burden. By May, amid troubles getting tenants for two rental properties she also owned, Ms. Richey decided the time had come to cut a deal with America's Servicing Co., a unit of Wells Fargo & Co. servicing the mortgage on the house.
After three months of wrangling, she says she finally received a modification approval. The new monthly payment: about $3,300, far more than she had hoped. A Wells Fargo spokesman confirmed the bank offered Ms. Richey a modification under the Obama administration's Making Home Affordable program, and said, "The Richeys turned down the lowest payment we could offer." Ms. Richey and her husband had already been working on Plan B -- exploring the neighborhood's "For Rent" signs.
On one trip, they drove by the house at 3152 Club Rancho Drive. It was bigger than their house on Caspian, had a pool with three waterfalls, and boasted a cascading staircase that Ms. Richey says she could picture her daughters descending on prom night. The rent was $2,195 a month. The situation presented Ms. Richey with a quandary now facing more than 10 million U.S. homeowners who owe more on their mortgages than their houses are worth. On one hand, walking away from her home would be easy. California is one of 10 states that largely prevent mortgage lenders from going after the other assets of borrowers who default. But she also had to consider the negatives. Her credit could be tarnished for years and, perhaps most importantly, she feared her friends and neighbors might ostracize her. "It was scary," she says, noting that people tended to keep such decisions to themselves for fear of being stigmatized. "It's still very hush-hush."
Tom Sobelman, whose family of four lives across the street from Ms. Richey, at 3127 Club Rancho Drive, sees mortgages as a moral as well as financial obligation. He's still paying the mortgage on an investment property he owns nearby, despite the fact that the rent is about $1,000 a month short of covering his costs. Mr. Sobelman, 37, argues that people who choose to default are unfairly benefiting at the expense of taxpayers, who have put trillions of dollars at risk to bail out struggling banks. "All these people are gaming the system, and I'm paying for it," he says. "My kids are going to be paying it off."
Mr. Sobelman has plenty of company. In a recent study of people who owe more on their mortgages than their houses are worth, economists Luigi Guiso, Paola Sapienza and Luigi Zingales found that about four out of five believe defaulting on a mortgage is morally wrong if one can afford to pay it. But they also found that the people become 82% more likely to say they'll default if they know someone else who defaulted. Moral or not, the individuals who want to shed their mortgage debts are quickly transforming the Palmdale real-estate market.
Adam Robbins, who runs the local Realty World franchise and manages about 80 properties, says about 90% of his prospective tenants are people in Ms. Richey's situation. So he and other rental managers are loosening rules to accept people who have been through foreclosures. "Those are all good people," he says. "They just got bad loans or bought at the wrong time." Ms. Richey and her family made the move to Club Rancho Drive in August, when she was already several months behind on the mortgage. With Mr. Robbins's help, she recently sold the house on Caspian Drive for $195,000, money that the bank will accept to settle the $430,000 mortgage debt. She's also considering walking away from the mortgages on her two rental properties.
Showing a visitor the personal touches in her new home, including a $1,800 dining set she bought with some of her newly available income, she notes the advantages of being a renter rather than an owner. "You take a risk for the American dream," she says. "I don't have to worry about paying property tax, homeowners' insurance, the landscaping, cleaning the pool or any repairs." Others on Ms. Richey's block have made similar moves. Mr. Fernandez, the firefighter, moved into 3139 in July, after stopping the $4,800 monthly payments on the home he owned around the corner on Champion Way. Mr. Fernandez says he made four attempts to modify the larger of the two mortgages on his home, which add up to $423,000. Ultimately, he was offered a monthly payment that, together with back taxes, was higher than what he had been paying. Today he's working to partially reimburse his lenders, IndyMac Bank (now OneWest Bank) and American First Credit Union, by selling the home, which he expects to fetch about $300,000.
A spokeswoman for OneWest Bank said the bank "offered Mr. Fernandez the lowest payment possible under the [Federal Deposit Insurance Corp.] loan modification guidelines." A spokesman for American First said the company always seeks to help clients stay in their homes. With an income of about $8,300 a month and a rent of $2,200, Mr. Fernandez says he now has the wherewithal to do things he couldn't when he was stretching to pay the mortgage. He recently went to concerts by Rob Thomas and Mat Kearney. He also kept his black BMW 6 Series coupe, which has payments of about $700 a month. "I don't know if I'll buy another house again, because it's such a huge headache," he says.
New underground economy
Key indicator: Avoidance of bank accounts
The underground or "black" economy is rapidly rising, and the fault is mainly due to government policies. Here is the evidence. The Federal Deposit Insurance Corp. (FDIC) released a report last week concluding that 7.7 percent of U.S. households, containing at least 17 million adults, are unbanked (i.e. those who do not have bank accounts), and an "estimated 17.9 percent of U.S. households, roughly 21 million, are underbanked" (i.e., those who rely heavily on nonbank institutions, such as check cashing and money transmitting services). As an economy becomes richer and incomes rise, the normal expectation is that the proportion of the unbanked population falls and does not rise as is now happening in the United States.
Tax revenues are falling far more rapidly at the federal, state and local level than would be expected by the small drop in real gross domestic product (GDP) and changes in tax law that have occurred since the recession began. The currency in circulation outside the U.S. Treasury, Federal Reserve banks and the vaults of depository institutions - that is, the currency held by individuals and businesses - has grown by 13.3 percent in the last two years, while real nominal (not inflation-adjusted) GDP has not grown at all, and real (inflation-adjusted) GDP incomes have fallen by more than 3 percent. With the growth of electronic means of payment and financial service providers, it would be expected that the currency component of GDP would fall, not rise.
The underground economy refers to both legal activities, such as often found in construction and services industries where taxes are not withheld and paid, and illegal activities, such as drug dealing and prostitution. Countries such as the United States, Switzerland and Japan historically have had relatively small, nonreporting and/or illegal sectors, a typical estimate being 13 percent of GDP. Most European countries have had somewhat larger underground sectors (typically 20 percent or so) in part because of the desire to escape higher tax rates. Italy and some of the other Southern European countries are believed to have underground sectors that account for 30 percent or more of all economic activity.
I recall an Italian finance minister telling a few of us at a meeting a couple of decades ago that, for policy purposes, he assumed that "the economy was 40 percent larger than what was reported." In some developing countries and/or highly corrupt countries, underground or "off the books" activities are estimated to be as high as 70 percent of all economic activity. The FDIC report about the size of the unbanked or underbanked sector in the U.S. should be of concern because those who do not use the banking system often have to pay higher fees to cash checks, pay bills (e.g., money orders, etc.), or transmit funds.
People who keep their savings in cash at home rather than in banks make themselves easier prey for criminals and are more likely to lose their money to fire, flood, or just neglect. Not surprisingly, a majority (71 percent) of the unbanked have household incomes of less than $30,000 per year. There are many reasons people do not have bank accounts. Banks, because of the "know your customer" and other anti-money laundering regulations, make it difficult for nonestablished people, such as the young and transient, as well as legal and illegal immigrants, to open bank accounts.
Also, many of these same regulations are responsible for the rise in bank fees, which are a particular burden for low-income people. You can be sure that every time Congress passes some new law or the IRS implements some new regulation to "get tax cheats," much of the real burden of these compliance costs will fall on those least able to afford it, while those intent on finding their way around it will do so. People also avoid having bank accounts because they are vulnerable to asset seizure, judgments, levies, etc. Increasingly, bankers and others who provide financial services are forced by governments to spy and snitch on their own customers, and this is a real turnoff for many people, which causes them to find other ways of maintaining financial privacy.
Many studies have shown that when people believe the taxes they are required to pay are reasonable and the political leaders tend to spend their tax dollars wisely, tax compliance rises, and vice versa. In the United States, there is increased evidence that many tax dollars are not being spent wisely and are often used to pay off political cronies. Over the past year in particular, the public has become aware that many in Washington who advocate higher taxes and argue that everyone has a responsibility to pay taxes are themselves not complying with the tax laws and regulations.
When you have a secretary of the Treasury and the chairman of the House Ways and Means Committee (the tax writing committee) accused of cheating on their taxes, it greatly undermines the moral authority of the tax collectors, making the common citizens feel like chumps and, hence, much more willing to try to legally avoid or illegally evade taxes themselves. The evidence is unambiguous; governments cannot increase tax compliance and decrease the size of the underground economy by ever increasing and more onerous regulations.
It is no accident that those governments that allow their citizens a high degree of personal and financial liberty, including financial privacy, and spend taxpayer dollars wisely, honestly and competently, have much smaller underground sectors than corrupt and oppressive governments. Washington, take note.
The difficult arithmetic of Chinese consumption
by Michael Pettis
How fast does consumption need to grow in China in order for a meaningful rebalancing to take place? Probably a lot more than you think. This is arithmetically the case because China is starting from such a low base.
At roughly $1.2 trillion in 2008, total Chinese private consumption is only a little more than that of France (around $1.0 trillion) and still less than that of Germany (about $1.3 trillion, not to mention the UK’s $1.4 trillion and Japan’s $3.2 trillion). This fact alone should cause us to be extremely skeptical of feverish claims about the role Chinese consumers can play in making up for any contraction in US consumption – which at roughly $9.4 trillion last year is nearly eight times the size of China’s – without even taking into account that Europe and Japan are likely to exacerbate, rather than help absorb, the contraction in US net demand.
Chinese private consumption has dropped dramatically as a share of GDP in the past two decades. McKinsey put out a much-discussed report on consumption in August, which like many McKinsey reports is thoughtful and thorough, and generally does a good job of summarizing the informed consensus – for example the claim that a major reason for high savings is the lack of a social safety net, for which I think there is much less than meets the eye.
Unfortunately, the report tends explain the sources of low consumption too often by referring to consequences of the underlying dynamics, rather than the underlying dynamics themselves, making its proposed solutions either impractical or irrelevant. For example, the report complains that "China’s investment- and industry-intensive model crowds out consumption."
In fact the main reason for overinvestment, and the fact that much of it is misallocated, thus widening the future gap between production and consumption, is probably too-low interest rates and a distorted credit allocation system, so it is not a question of reorienting growth away from a capital-intensive model. It requires first of all a fundamental reform of interest rate management and banking governance.
One can also easily argue that the fact that "China’s consumers make limited use of credit", as the report claims, reflects the underlying industrial strategy more than just a technical failure to develop consumer credit. A burgeoning consumer credit market – big enough to matter – will undermine the growth model by changing the direction of implicit subsidies. This is a pretty big reform.
But that is an aside. Like most McKinsey reports it has lots of great data. For example it shows that the Chinese were not always so reluctant to consume. According to the McKinsey (and the National Bureau of Statistics) data, in 1990 consumption represented just a little over 50% of GDP. Around the time of the inflationary crisis of 1993-94 it dropped to around 45% of GDP and stayed at that level until shortly after the 1997-98 Asian crisis, when it began a fairly steep decline, hitting 40% in 2003-04 and around 35% currently.
Crises seem to drive the household consumption rate down, even though bull markets don’t seem to drive it back up. Is that because crises cause households to worry about risk (although if that were true they wouldn’t go permanently down, would they)? Or is it because the government responds to crises by increasing the amount of misallocated investment, the consequence of which is to reduce future consumption? Government consumption, by the way, has stayed pretty steady, at around 15% of GDP, during that period.
Compared to non-Asian countries Chinese consumption rates are astonishingly low. Consumption for most European countries lies in the 55-65% range. Consumption for other developing countries can easily fall in the 65-70% range – where much of Latin America falls. US consumption has been around 70-72% in recent years.
Even by Asian standards Chinese consumption is off the charts. South Korean and Malaysian consumption is around 50% of GDP (although during and after the Asian crisis Malaysian consumption did drop to around 45% of GDP, before recovering). Other major Asian economies, like India, Japan, Taiwan and Thailand, show consumption in the 55-60% of GDP range. Compared to those numbers China’s 35% is astonishing, even if, as some claim it may be somewhat understated (which by the way may be true of other developing countries).
The flip side of the decline in consumption has been the rise in household savings. After bouncing around erratically between 10% and 20% of disposable income in the 1980s, around 20 years ago Chinese household savings equaled 12-15% of disposable income. Around 1992 they began rising steadily until 1998, and then stabilized at around 24-25% until very recently, when they rose slightly to about 26% of disposable income. The report correctly notes that the real increase in national savings in recent years was caused by the sharp increase in corporate savings, although as I have often mentioned before, I think corporate savings are themselves caused by the transfer from household savings via low interest rates.
During that same period China ran small surpluses or deficits on the trade account until 1996, when it booked its last trade deficit, beginning a steady upward march of its trade surplus until 2003, when the trade surplus was around 5% of GDP, after which time it surged to over 10% of GDP in 2007-2008. Investment, too, rose steadily during this period as a share of GDP. In 1990 it was around 23% of GDP. It rose sharply in 1992-94 to around 31% of GDP, stabilized at that level, and then began climbing inexorably around 1997-98 to reach around 40% in 2008.
Rising investment and rising trade surpluses are inextricably linked in China’s case. Strategies that explicitly or implicitly boosted Asian savings rates and constrained consumption, I have argued many times before, were viable strategies as long as the resulting trade surpluses, which were an almost automatic account of these policies, could be absorbed by trade deficit countries. Of course the US has played this role for the past thirty years, but there is good reason to believe that it might not be able or willing to do so much longer.
These growth strategies basically forced households to subsidize investment and production, thus generating rapid economic and employment growth at the expense of household income growth, and as I have argued many times before it is the growth in household income that has primarily constrained household consumption growth.
This is borne out by the numbers. From 1990 to 2002, according to the McKinsey numbers, household income ranged from 64% of GDP to 72% of GDP. It peaked in 1992 and then began a slow, erratic descent to 66% in 2002, after which time it plunged to 55%. I suspect that if there were a way to measure changes in wealth – for example the value of the deteriorating social safety nets and the environment, the present value of savings as interest rates are changed for policy reasons, etc.—and household income were adjusted by these changes, the decline would have been greater.
The report goes on to discuss McKinsey’s projections and expectations for consumption growth over the next few years. I read it with interest but frankly I find these kinds of exercises not terribly useful because of the tremendous difficult in ascertaining the various feedback loops – of which there are many in China – which inevitably force reality far away from expectations. But I did try to do some quick arithmetic, in order to determine what kinds of numbers we are going to need to get anything resembling a rebalancing.
Rebalancing is the key word here. Many analysts think that what we need is for consumption in China to grow quickly, and this will resolve China’s (and the world’s) problem with contracting net demand in the US.
Actually, no. What we need is an expansion in Chinese net demand – rebalancing in other words – so that China can adjust to contracting net demand from the US in a way that doesn’t harm trade partners and competitors and rebounds on itself with escalating trade tensions. The way to rebalance is not for consumption to grow, but rather for consumption to grow as a share of GDP. Even if consumption declines, and GDP decline more quickly – a horrible outcome to be sure – rebalancing will occur. The best way of course is for GDP to grow quickly and for consumption to grow even more quickly.
But this is I think what most people miss. Just growth in Chinese consumption alone does not help if it grows in line with GDP, and less so if it grows slower than GDP. In that case the imbalances will get worse, and while the impact on the trade account can be temporarily disguised if investment continues to surge, ultimately it just postpones the needed adjustment (and increases the cost if the investment surge is misallocated).
What kind of consumption growth will we need for the country to rebalance? The numbers are a little worrying. If China grows by 8% a year, consumption would have to grow by a little over 11% to raise the consumption share of GDP from 35% to 36% in one year. It would have to grow by a little over 9 1/2% annually to do it in two years. Consumption, in other words, must grow substantially faster than GDP for the rebalancing even to begin to take place. This is arithmetically true because China begins the process with such a low consumption ratio.
Look at it over the longer term. Just to return consumption to 40% of GDP over the next five years (and even that level is widely considered to be way too low, and probably unprecedented in the world excluding recent Chinese history), 8% average annual growth rates in GDP would require a tad under 11% annual growth in consumption. Similarly, 7% average annual GDP growth rates would require that consumption grow annually over the next five years by nearly 10%. To bring Chinese consumption in 20 years up to 50% of GDP, which is the low end for other high saving Asian countries, and far lower than any other large economy in Asia (and remember that large economies are less able to rely on exports to fuel growth than small countries), 7% annual GDP growth would require average annual consumption growth of just under 9% for twenty years.
In other words while GDP growth slows significantly from its 12-13% rate of the past several years, consumption will nonetheless have to surge at rates far in excess of the 8-9% growth rates of recent years in order for even a small, partial rebalancing to take place. I don’t think I have ever seen a case in which consumption has grown at nearly that rate for any length of time. I believe if China pulled it off it would be unprecedented.
Of course this will not be easy, and I think too many commentators underestimate the magnitude of the problem. China’s rebalancing process will even in the most optimistic of cases take many years before it can even reach the lowest consumption levels reached by other Asian countries that pursued investment-driven policies accompanied by too-low interest rates and undervalued currencies. This will be a long haul, and if I am right – if we need to see a transfer of income back for the state sector to the household sector really to get it going – we should expect much lower GDP growth rates over the next decade than anyone is currently projecting.