May 2011: MONTHLY MARKET COMMENTARY - (Subscription Service I - 21 Pages)
For nearly 30 years we have had two Global Strategies working in a symbiotic manner that created a virtuous economic growth spiral. Unfortunately, the economic underpinnings were flawed and as a consequence, the virtuous cycle has ended. It is in the process of reversing and becoming a potential vicious downward economic spiral. These two strategies have worked in harmony because they fed off each other, each reinforcing the other. However, today the realities of excess debt have brought the virtuous spiral to an end. One strategy is the "Asian Mercantile Strategy". The other is the" US Dollar Reserve Currency Strategy".. MORE>>
June 2011: GLOBAL MACRO TIPPING POINTS - (Subscription Service II - 89 Pages)
The Sovereign Debt Crisis in Europe continues to worsen. The bailouts are not working and Greece now borders on default. Elections across Europe are showing that the electorate is distraught about the size and scope of the bailouts and the austerity programs being enacted. The social unrest in North Africa and the Middle East continues as does the fighting in Libya. Geo-Political conflicts in Iran, Syria and Israel are now beginning to raise their destabilizing heads. MORE>>
May 2011: MARKET ANALYTICS & TECHNICAL ANALYSIS - (Subscription Service III - 83 Pages)
The market action since March 2009 is a bear market counter rally that is presently nearing a final end in a classic ending diagonal pattern. The Bear Market which started in 2000 will resume in full force by late spring of 2011. We presently have the early beginnings of a 'rolling top'. We are seeing broad based weakening analytics and cascading warning signals. This behavior is typically seen near major tops. This is all part of a final topping formation and a long term right shoulder technical construction pattern. MORE>>
CURRENCY WARS: EU: A FLAWED FOUNDATION, BUT A BRILLIANT STRATEGY Released May 31st, 2011
It was the perception of getting something of value without any meaningful sacrifice that initially fostered the EU Monetary Union. Though the countries of Europe were fiercely nationalistic they were willing to surrender minor sovereign powers only if it was going to prove advantageous to them. They were certainly unwilling to relinquish sufficient sovereignty to create the requisite political union required for its success. After a decade long trial period it is now time to pay the price for Monetary Union. I suspect that the EU membership is unwilling to do so. Though they likely will see the price as too high to do so, the price to not do so has become even greater. They have unwittingly been trapped by a well crafted strategy. MORE>>
CURRENCY WARS: The Economic Death Spiral Has Been Triggered Released May 27th, 2011
For nearly 30 years we have had two Global Strategies working in a symbiotic fashion that has created a virtuous economic growth spiral. Unfortunately, the economic underpinnings were flawed and as a consequence, the virtuous cycle has ended. It is now in the process of reversing and becoming a vicious downward economic spiral. One of the strategies is the Asian Mercantile Strategy. The other is the US Dollar Reserve Currency Strategy. These two strategies have worked in harmony because they fed off each other, each reinforcing the other. However, today the realities of debt saturation have brought the virtuous spiral to an end. MORE>>
CURRENCY WARS: Debt Saturation & Money Illusion Released April 27th, 2011
Most of the clearly evident financial problems that surround us today stem from one cause - Debt Saturation. Most, intuitively, sense this to be a correct assessment but few can either prove it or articulate it to the less sophisticated. Let me arm you to be the "Nostradamus" amongst your friends and colleagues in explaining the problem and what the future therefore foretells. However, let me make it very clear, this will not make you popular. Smart maybe, but highly likely to make you unwanted at the social gatherings of the genteel. MORE>>
06/02/2011 3:58 AM
Postings begin at 5:30am EST
and updated throughout the day
Global economy: A high price to pay - The 44-year-old Vietnam father of two is working harder than ever because of a triple hit from inflation, which accelerated to 19.8 per cent year-on-year in May, one of the highest rates in the world. Petrol prices are up 30 per cent since February;
increases in government-regulated taxi fares have driven away customers; and
family living costs have jumped in the past year, with some food prices doubling. “Life is tough and I have to work 12 hours a day, seven days a week, to keep putting rice and noodles on the table,” says Mr Pham.
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"The moment of critical mass, the threshold, the boiling point"
The tipping point is the critical point in an evolving situation that leads to a new and irreversible development. The term is said to have originated in the field of epidemiology when an infectious disease reaches a point beyond any local ability to control it from spreading more widely. A tipping point is often considered to be a turning point. The term is now used in many fields. Journalists apply it to social phenomena, demographic data, and almost any change that is likely to lead to additional consequences. Marketers see it as a threshold that, once reached, will result in additional sales. In some usage, a tipping point is simply an addition or increment that in itself might not seem extraordinary but that unexpectedly is just the amount of additional change that will lead to a big effect. In the butterfly effect of chaos theory , for example, the small flap of the butterfly's wings that in time leads to unexpected and unpredictable results could be considered a tipping point. However, more often, the effects of reaching a tipping point are more immediately evident. A tipping point may simply occur because a critical mass has been reached.
The Tipping Point: How Little Things Can Make a Big Difference is a book by Malcolm Gladwell, first published by Little Brown in 2000. Gladwell defines a tipping point as "the moment of critical mass, the threshold, the boiling point." The book seeks to explain and describe the "mysterious" sociological changes that mark everyday life. As Gladwell states, "Ideas and products and messages and behaviors spread like viruses do."
The three rules of epidemics
Gladwell describes the "three rules of epidemics" (or the three "agents of change") in the tipping points of epidemics.
"The Law of the Few", or, as Gladwell states, "The success of any kind of social epidemic is heavily dependent on the involvement of people with a particular and rare set of social gifts."According to Gladwell, economists call this the "80/20 Principle, which is the idea that in any situation roughly 80 percent of the 'work' will be done by 20 percent of the participants."(see Pareto Principle) These people are described in the following ways:
Connectors are the people who "link us up with the world ... people with a special gift for bringing the world together." They are "a handful of people with a truly extraordinary knack [... for] making friends and acquaintances". He characterizes these individuals as having social networks of over one hundred people. To illustrate, Gladwell cites the following examples: the midnight ride of Paul Revere, Milgram's experiments in the small world problem, the "Six Degrees of Kevin Bacon" trivia game, Dallas businessman Roger Horchow, and ChicagoanLois Weisberg, a person who understands the concept of the weak tie. Gladwell attributes the social success of Connectors to "their ability to span many different worlds [... as] a function of something intrinsic to their personality, some combination of curiosity, self-confidence, sociability, and energy."
Mavens are "information specialists", or "people we rely upon to connect us with new information." They accumulate knowledge, especially about the marketplace, and know how to share it with others. Gladwell cites Mark Alpert as a prototypical Maven who is "almost pathologically helpful", further adding, "he can't help himself". In this vein, Alpert himself concedes, "A Maven is someone who wants to solve other people's problems, generally by solving his own". According to Gladwell, Mavens start "word-of-mouth epidemics" due to their knowledge, social skills, and ability to communicate. As Gladwell states, "Mavens are really information brokers, sharing and trading what they know".
Salesmen are "persuaders", charismatic people with powerful negotiation skills. They tend to have an indefinable trait that goes beyond what they say, which makes others want to agree with them. Gladwell's examples include California businessman Tom Gau and news anchorPeter Jennings, and he cites several studies about the persuasive implications of non-verbal cues, including a headphone nod study (conducted by Gary Wells of the University of Alberta and Richard Petty of the University of Missouri) and William Condon's cultural microrhythms study.
The Stickiness Factor, the specific content of a message that renders its impact memorable. Popular children's television programs such as Sesame Street and Blue's Clues pioneered the properties of the stickiness factor, thus enhancing the effective retention of the educational content in tandem with its entertainment value.
The Power of Context: Human behavior is sensitive to and strongly influenced by its environment. As Gladwell says, "Epidemics are sensitive to the conditions and circumstances of the times and places in which they occur." For example, "zero tolerance" efforts to combat minor crimes such as fare-beating and vandalism on the New York subway led to a decline in more violent crimes city-wide. Gladwell describes the bystander effect, and explains how Dunbar's number plays into the tipping point, using Rebecca Wells' novel Divine Secrets of the Ya-Ya Sisterhood, evangelistJohn Wesley, and the high-tech firm W. L. Gore and Associates. Gladwell also discusses what he dubs the rule of 150, which states that the optimal number of individuals in a society that someone can have real social relationships with is 150.
PROCESS OF ABSTRACTION
SOVEREIGN DEBT & CREDIT CRISIS
Inverted chart of 30-year Treasury yields courtesy of Doug Short and Chris Kimble. As you can see, yields are at a "support" area that's held for 17 years.
If it breaks down (i.e., yields break out) watch out!
The state budget crisis will continue next year, and it could be worse than ever. That's part of what's freaking out muni investors, who last week dumped them like they haven't in ages.
States face a $112.3 billion gap for next year, according to the Center on Budget and Policy Priorities. If the shortfall grows during the year -- as it does in most years -- FY2012 will approach the record $191 billion gap of 2010. Remember, with each successive shortfall state budgets have become more bare.
Things could be especially bad if House Republicans push through a plan to cut off non-security discretionary funding for states, opening an additional $32 billion gap.
MUNI BOND OUTFLOWS
RESIDENTIAL REAL ESTATE - PHASE II
COMMERCIAL REAL ESTATE
2011 will see the largest magnitude of US bank commercial real estate mortgage maturities on record.
2012 should be a top tick record setter for bank CRE maturities looking both backward and forward over the half decade ahead at least.
Will this be an issue for an industry that has been supporting reported earnings growth in part by reduced loan loss reserves over the recent past? In 2010, approximately $250 billion in commercial real estate mortgage maturities occurred. In the next three years we have four times that much paper coming due.
Will CRE woes, (published or unpublished) further restrain private sector credit creation ahead via the commercial banking conduit?
Wiil the regulators force the large banks to show any increase in loan impairment. Again, given the incredible political clout of the financial sector, I doubt it.
We have experienced one of the most robust corporate profit recoveries on record over the last half century. We know reported financial sector earnings are questionable at best, but the regulators will do absolutely nothing to change that.
So once again we find ourselves in a period of Fed sponsored asset appreciation. The thought, of course, being that if stock prices levitate so will consumer confidence. Which, according to Mr. Bernanke will lead to increased spending and a virtuous circle of economic growth. Oh really? The final chart below tells us consumer confidence is not driven by higher stock prices, but by job growth.
9 - CHRONIC UNEMPLOYMENT
There are 3 major inflationary drivers underway.
1- Negative Real Interest Rates Worldwide - with policy makers' reluctant to let their currencies appreciate to market levels. If no-one can devalue against competing currencies then they must devalue against something else. That something is goods, services and assets.
2- Structural Shift by China- to a) Hike Real Wages, b) Slowly appreciate the Currency and c) Increase Interest Rates.
3- Ongoing Corporate Restructuring and Consolidation - placing pricing power increasingly back in the hands of companies as opposed to the consumer.
FOOD PRICE PRESSURES
RICE: Abdolreza Abbassian, at the FAO in Rome, says the price of rice, one of the two most critical staples for global food security, remains below the peaks of 2007-08, providing breathing space for 3bn people in poor countries. Rice prices hit $1,050 a tonne in May 2008, but now trade at about $550 a tonne.
WHEAT: The cost of wheat, the other staple critical for global food security, is rising, but has not yet surpassed the highs of 2007-08. US wheat prices peaked at about $450 a tonne in early 2008. They are now trading just under $300 a tonne.
The surge in the FAO food index is principally on the back of rising costs for corn, sugar, vegetable oil and meat, which are less important than rice and wheat for food-insecure countries such as Ethiopia, Bangladesh and Haiti. At the same time, local prices in poor countries have been subdued by good harvests in Africa and Asia.
- In India, January food prices reflected a year-on-year increase of 18%t.
- Buyers must now pay 80%t more in global markets for wheat, a key commodity in the world's food supply, than they did last summer. The poor are especially hard-hit. "We will be dealing with the issue of food inflation for quite a while," analysts with Frankfurt investment firm Lupus Alpha predict.
- Within a year, the price of sugar on the world market has gone up by 25%.
US STOCK MARKET VALUATIONS
WORLD ECONOMIC FORUM
Potential credit demand to meet forecast economic growth to 2020
The study forecast the global stock of loans outstanding from 2010 to 2020, assuming a consensus projection of global
economic growth at 6.3% (nominal) per annum. Three scenarios of credit growth for 2009-2020 were modelled:
• Global leverage decrease. Global credit stock would grow at 5.5% per annum, reaching US$ 196 trillion in 2020. To
meet consensus economic growth under this scenario, equity would need to grow almost twice as fast as GDP.
• Global leverage increase. Global credit stock would grow at 6.6% per annum, reaching US$ 220 trillion in 2020.
Likely deleveraging in currently overheated segments militates against this scenario.
• Flat global leverage. Global credit stock would grow at 6.3% per annum to 2020, tracking GDP growth and reaching
US$ 213 trillion in 2020 – almost double the total in 2009. This scenario, which assumes that modest
deleveraging in developed markets will be offset by credit growth in developing markets, provides the primary credit
growth forecast used in this report.
Will credit growth be sufficient to meet demand?
Rapid growth of both capital markets and bank lending will be required to meet the increased demand for credit – and it is
not assured that either has the required capacity. There are four main challenges.
Low levels of financial development in countries with rapid credit demand growth. Future coldspots may result from the
fact that the highest expected credit demand growth is among countries with relatively low levels of financial access. In
many of these countries, a high proportion of the population is unbanked, and capital markets are relatively undeveloped.
Challenges in meeting new demand for bank lending. By 2020, some US$ 28 trillion of new bank lending will be
required in Asia, excluding Japan (a 265% increase from 2009 lending volumes) – nearly US$ 19 trillion of it in China
alone. The 27 EU countries will require US$ 13 trillion in new bank lending over this period, and the US close to US$
10 trillion. Increased bank lending will grow banks’ balance sheets, and regulators are likely to impose additional capital
requirements on both new and existing assets, creating an additional global capital requirement of around US$ 9 trillion
(Exhibit vi). While large parts of this additional requirement can be satisfied by retained earnings, a significant capital gap in
the system will remain, particularly in Europe.
The need to revitalize securitization markets. Without a revitalization of securitization markets in key markets, it is doubtful
that forecast credit growth is realizable. There is potential for securitization to recover: market participants surveyed by
McKinsey in 2009 expected the securitization market to return to around 50% of its pre-crisis volume within three years.
But to rebuild investor confidence, there will need to be increased price transparency, better data on collateral pools, and
better quality ratings.
The importance of cross-border financing. Asian savers will continue to fund Western consumers and governments:
China and Japan will have large net funding surpluses in 2020 (of US$ 8.5 trillion and US$ 5.7 trillion respectively), while
the US and other Western countries will have significant funding gaps. The implication is that financial systems must
remain global for economies to obtain the required refinancing; “financial protectionism” would lock up liquidity and stifle
US$ RESERVE CURRENCY
SocGen crafts strategy for China hard-landing
Société Générale fears China has lost control over its red-hot economy and risks lurching from boom to bust over the next year, with major ramifications for the rest of the world.
Société Générale said China's overheating may reach 'peak frenzy' in mid-2011
- The French bank has told clients to hedge against the danger of a blow-off spike in Chinese growth over coming months that will push commodity prices much higher, followed by a sudden reversal as China slams on the brakes. In a report entitled The Dragon which played with Fire, the bank's global team said China had carried out its own version of "quantitative easing", cranking up credit by 20 trillion (£1.9 trillion) or 50pc of GDP over the past two years.
- It has waited too long to drain excess stimulus. "Policy makers are already behind the curve. According to our Taylor Rule analysis, the tightening needed is about 250 basis points," said the report, by Alain Bokobza, Glenn Maguire and Wei Yao.
- The Politiburo may be tempted to put off hard decisions until the leadership transition in 2012 is safe. "The skew of risks is very much for an extended period of overheating, and therefore uncontained inflation," it said. Under the bank's "risk scenario" - a 30pc probability - inflation will hit 10pc by the summer. "This would cause tremendous pain and fuel widespread social discontent," and risks a "pernicious wage-price spiral".
- The bank said overheating may reach "peak frenzy" in mid-2011. Markets will then start to anticipate a hard-landing, which would see non-perfoming loans rise to 20pc (as in early 1990s) and a fall in bank shares of 50pc to 75pc over the following 12 months. "We think growth could slow to 5pc by early 2012, which would be a drama for China. It would be the first hard-landing since 1994 and would destabilise the global economy. It is not our central scenario, but if it happens: commodities won't like it; Asian equities won't like it; and emerging markets won't like it," said Mr Bokobza, head of global asset allocation. However, it may bring down bond yields and lead to better growth in Europe and the US, a mirror image of the recent outperformance by the BRICs (Brazil, Russia, India and China).
- Diana Choyleva from Lombard Street Research said the drop in headline inflation from 5.1pc to 4.6pc in December is meaningless because the regime has resorted to price controls on energy, water, food and other essentials. The regulators pick off those goods rising fastest. The index itself is rejigged, without disclosure. She said inflation is running at 7.6pc on a six-month annualised basis, and the sheer force of money creation will push it higher. "Until China engineers a more substantial tightening, core inflation is set to accelerate.
- The longer growth stays above trend, the worse the necessary downswing. China's violent cycle could be highly destabilising for the world." Charles Dumas, Lombard's global strategist, said the Chinese and emerging market boom may end the same way as the bubble in the 1990s. "The basic strategy of the go-go funds is wrong: they risk losing half their money like last time."
- Société Générale said runaway inflation in China will push gold higher yet, but "take profits before year end".
- The picture is more nuanced for food and industrial commodities. China accounts for 35pc of global use of base metals, 21pc of grains, and 10pc of crude oil. Prices will keep climbing under a soft-landing, a 70pc probability. A hard-landing will set off a "substantial reversal". Copper is "particularly exposed", and might slump from $9,600 a tonne to its average production cost near $4,000. Chinese real estate and energy equities will prosper under a soft-landing,
- The bank likes regional exposure through the Tokyo bourse, which is undervalued but poised to recover as Japan comes out of its deflation trap. If you fear a hard landing, avoid the whole gamut of Chinese equities. It will be clear enough by June which of these two outcomes is baked in the pie.
PIMCO'S NEW NORMAL: According to PIMCO, the coiners of the term, the new normal is also explained as an environment wherein “the snapshot for ‘consensus expectations’ has shifted: from traditional bell-shaped curves – with a high likelihood mean and thin tails (indicating most economists have similar expectations) – to a much flatter distribution of outcomes with fatter tails (where opinion is divided and expectations vary considerably).” That is to say, the distribution of forecasts has become more uniform (as per Exhibit 1).
Federal Reserve Chairman Ben Bernanke gave his predictions on a House Republican plan to cut $60 billion dollars from the FY 2011 budget, saying it would eliminate 200, 000 jobs and only slightly lower economic growth.
He instead endorsed a Congressional federal deficit reduction plan that would take effect over a five to 10 year period, saying that markets look more towards Congressional action than the actual state of the economy. His remarks came during a House Financial Services Committee hearing in which he delivered his agency's semi-annual monetary report.
Despite Bernanke’s observations, several Republican lawmakers expressed doubt based on past efforts by the Fed and Congress to prompt economic growth through large stimulus packages.
Yesterday, the Fed Chair told the Senate Banking Committee that the U.S. economy will continue to grow this year despite rising oil prices, a high employment rate and weak housing market.
The 1978 Humphrey-Hawkins Act requires the Federal Reserve Board of Governors to deliver a report to Congress twice a year on its past economic policy decisions and discuss recent financial and economic developments.
In his 20 years as a Hanoi taxi driver, Pham Van Vinh has learnt to negotiate the chaotic streets of Vietnam’s capital and the demands of its avaricious traffic police.
But the 44-year-old father of two is working harder than ever because of a triple hit from inflation, which accelerated to 19.8 per cent year-on-year in May, one of the highest rates in the world.
Petrol prices are up 30 per cent since February;
increases in government-regulated taxi fares have driven away customers; and
family living costs have jumped in the past year, with some food prices doubling.
“Life is tough and I have to work 12 hours a day, seven days a week, to keep putting rice and noodles on the table,” says Mr Pham.
His is a familiar story across the emerging world. Year-to-year figures for the latest months available show inflation in fast-growing BRIC nations of
6.5 per cent in Brazil,
8.7 per cent in India,
9.6 per cent in Russia and
5.3 per cent in China.
The International Monetary Fund predicts this year’s emerging market average rate will be 6.9 per cent, compared with just 2.2 per cent for the developed world.
The question is how much this poses a threat to global economic growth. After all, emerging economies have come out of the 2008-09 crisis growing much faster than the developed world.
The IMF forecasts 6 per cent gross domestic product growth rate for 2011 for emerging economies – three times higher than in the developed world.
Surely, inflation of 6-7 per cent is a price worth paying for the big boost to the global economy from emerging markets?
Perhaps – if it remains at moderate levels. But emerging market policymakers are battling a range of inflationary challenges including
higher energy prices,
skilled labour shortages,
huge waves of liquidity generated by central banks in the US, Europe, China and elsewhere to pull the world economy out of the crisis.
As Wen Jiabao, Chinese prime minister, says: “Inflation is like a tiger: once set free it is very difficult to get back into its cage.”
While countries face common dangers, much will depend on how they respond individually.
Some states have learnt from history and tamed inflation through consistent anti-inflationary policies, including tight fiscal management and bank supervision. The Czech Republic is an example, with inflation of just 1.6 per cent.
But nations where fiscal, monetary and banking policies are chronically lax are close to inflationary crisis.
In Argentina, for instance, economists reckon inflation is running at 25 per cent – making a mockery of the official figure of 10 per cent.
For policymakers, it is more than a question of economics. The doubling of food prices in many emerging economies in the past year hits the poor hardest, fuelling
In recent weeks, there have been anti-inflation protests in
China, where Shanghai truck drivers staged strikes
The main driver of inflation in the past 18 months has been the soaring rise in
raw materials prices, powered by growing demand from China, India and other emerging countries.
Food accounts for just 8 per cent of consumer spending in the US. In China, the figure is 30 per cent; in India, 45 per cent.
The May sell-off in commodities has eased concerns, with oil falling back from about $125 a barrel for Brent crude to about $110; and raw materials prices dropping 10 per cent from their April peaks.
The IMF forecasts emerging markets inflation will fall next year to 5.3 per cent.
Some economists see this as panic over. As developed states struggle with sluggish growth and huge debt, the real threat in emerging markets, they argue, is an output slowdown, not an inflation take-off. “I don’t see the levels of inflation that have been destructive in the past,” says Bill O’Neill of Merrill Lynch BofA. But others remain worried.
John-Paul Smith of Deutsche Bank says: “Investors are underestimating the extent to which inflation across many emerging markets is a structural as opposed to a cyclical phenomenon.”
Even after the recent sell-off, the CRB commodity futures index remains about 72 per cent above its 2009 lows and 14 per cent higher than its average since 2006.
Forecasting commodity prices is difficult, given the speculative flows – boosted by loose monetary policies – pouring through the markets. But little can be taken for granted given the potential impact on oil markets of further Middle East turmoil and the weather on food supplies.
As Renaissance Capital notes, the next few months are crucial. “The food price threat for 2011-12 is very significant, but may disappear in August [when northern hemisphere harvests come in].”
Higher commodity prices are having knock-on effects in domestic economies, especially those where supply and demand are tight, and labour costs are rising – including Brazil, India and China.
With the rapid recovery of the past two years, many companies are running at full stretch.
HSBC says the output gap – the difference between actual output and maximum capacity – has disappeared in most east Asian economies, including China, and in Brazil.
Workers are winning pay increases and employers are passing on the costs.
The UK bank says: “This creates the risk that in emerging economies inflation shocks turn into self-perpetuating inflation processes.” The examples are multiplying.
In China, where officials have supported wage increases to help rebalance the economy, pay has risen by 20-40 per cent in some companies.
In India, hotel managers’ salaries are forecast to rise 50 per cent this year.
In Brazil, construction workers this month secured rises of almost 10 per cent. This year, the country’s indexing formula has set the minimum wage increase at 6 per cent. Next year it could be 14 per cent. “The biggest danger facing Brazil is a return of indexation,” says Abram Szajman, head of Fecomércio, a retailers’ and wholesalers’ association. “That’s one evil we don’t want again, or we will have salaries going up every year, then every six months, then every three, then every month – and we’ve seen that all before.”
Hon Hai, a Taiwanese electronics assembler that last year increased pay by 30 per cent after strikes at its Chinese plants, last week revealed operating expenses rose 80 per cent in 2011’s first quarter. Operating margins halved to 1.1 per cent. Higher costs are squeezing industry’s margins.
Infrastructure, too, is under pressure, notably in India, where construction lags behind that of the other Brics. Roads, airports and power supplies cannot keep pace with demand.
“We have to address the bottlenecks on the supply side,” says Rajiv Kumar, director-general of Ficci, the Indian employers’ body.
The IMF says core inflation – excluding commodities – has risen from 2 per cent to 3.75 per cent “suggesting that inflation is broadening” beyond commodities-linked increases.
Central banks in most emerging economies have responded by raising interest rates and imposing quantitative controls on bank lending.
In Vietnam, official rates have doubled in six months to 14 per cent.
In India, among the first to take action last year, rates have risen nine times to 6.75 per cent.
In China, following four increases, they are at 6.31 per cent. But it is not enough to hold back a wave of credit creation – and red-hot property investment.
In its World Economic Outlook last month the IMF said: “The issue is whether [leading emerging markets including China, India and Brazil] are experiencing the kind of credit boom that inevitably ends with a bust.
Evidence is not reassuring in this regard.” In the four largest emerging markets, the Brics,
credit is still growing at 17-20 per cent annually, with only China experiencing a serious slowing in the past six months.
Officials, notably in Beijing, who boosted credit to counter recession remain cautious in applying the brakes for fear of hitting growth. After allowing for inflation, interest rates are negative in Russia and India, and barely positive in China. So borrowers pay little or nothing, in real terms, for money.
Only in Brazil are rates strongly positive. Admittedly, credit in emerging economies is growing from low levels.
It is just 46 per cent of GDP in Brazil and 60 per cent in India.
But in China, it is already at 140 per cent.
All are well short of America’s 360 per cent for 2010 – but the gap is closing.
Evidence of credit-fuelled property booms is visible in luxury homes in Mumbai, Rio de Janeiro and Chinese cities.
As the IMF report says: “Credit and asset price behaviour is disconcerting in China and Hong Kong, showing boom-like dimensions ... and there are mounting concerns about the potential for steep corrections in property prices and their implications.”
Emerging markets as a whole do not face a property bust. The world’s urban population will grow by 1.4bn in the next two decades, taking the total to 5bn. So most homes will find buyers – but not overpriced prime accommodation.
Complicating life for emerging market policymakers is the flow of cheap funds generated by the developed world’s easy money policies.
The US Federal Reserve ends quantitative easing in summer but serious tightening is not expected until later this year or in 2012.
Emerging market governments were loath to let their currencies rise last year, sparking fears of currency wars. But this year they have allowed limited appreciation to counter the rising cost of imported commodities.
However, officials have capped the gains for fear of hurting exports.
The renminbi has climbed nearly 5 per cent against the dollar since last summer’s liberalisation. But on a trade-weighted basis, it fell 1.8 per cent in January to April 2011, according to Bank for International Settlements.
India’s rupee slipped 2.6 per cent and the Turkish lira 5.9 per cent.
The real and the rouble were higher – by 3.7 per cent and 3.4 per cent.
Overall, emerging nations’ rapid recovery from the global crisis is a historic achievement that has helped prevent prolonged worldwide recession. Their economies are resilient and their companies compete with best anywhere. For most, the cost in terms of increased inflation is so far justified by the GDP growth generated.
What comes next matters, however. Another surge in commodity prices would create dangers for nations facing inflationary challenges, including the Brics. And there are countries already in danger: not least Vietnam. Mr Pham will have to be as careful with the family budget as he is in the Hanoi traffic.
Hanoi leadership is at risk of undermining an impressive growth record. As in Ukraine and Argentina, so in Vietnam.
The emerging nation is the latest in which surging inflation threatens to undermine an impressive record of economic growth, writes Ben Bland.
Hanoi’s Communist leadership has steadily opened the country to global trade in the past 25 years, a shift that intensified ahead of the country joining the World Trade Organisation in 2007.
However, while gross domestic product has been growing at an average of 7 per cent a year in the past decade, rapid credit growth and large investments in wasteful state-owned companies have brought the economy to the brink of crisis.
Battling wide trade and budget deficits, Vietnam’s foreign exchange reserves have shrunk to cover less than two months of imports, according to the Asian Development Bank; the central bank has been forced to devalue the currency, which is pegged to the dollar, four times in the past 18 months; and annual inflation accelerated to 19.8 per cent in May, a 29-month peak and the highest rate in Asia.
The government was reluctant to cool the overheating economy in the run-up to key Communist party elections in January. But in February it finally sprang into action, unveiling a package of fiscal and monetary tightening measures – known as Resolution 11 – aimed at shifting the focus of policy from growth at all costs to stability.
It also deployed administrative measures, introducing price controls and tightening restrictions on the buoyant black market trade in gold and dollars – a trusty store of value for many inflation-battered Vietnamese.
While economists have praised the government’s moves, some question whether it is willing and able to deliver. Although the central bank has increased interbank interest rates to as much as 14 per cent and vowed to restrict credit growth to less than 20 per cent this year, there are few signs yet of economic activity slowing.
In a note to clients, Santitarn Sathirathai of Credit Suisse wrote of the difficulty in determining whether “this is simply due to the fact that monetary policy works with a lag, or that the government has not been effective in enforcing these measures”.
Matt Hildebrandt, an economist at JPMorgan Chase in Singapore, believes the central bank’s ability to fight inflation is limited by the nation’s exposure to rising global commodity prices.
Food, fuel and raw materials for construction account for about 60 per cent of the consumer price index basket.
“Small, open economies like Vietnam tend to be dictated by global trends,” he says.
However other economists argue that the country’s problems are mostly self-inflicted. According to Jonathan Pincus of Harvard University’s economics teaching programme in Ho Chi Minh City: “Vietnam printed money for a couple of years so now there’s inflation.
• China consumes 53% of the world's cement... and 48% of the world's iron ore... and 47% of the world's coal... and the majority of just about every major commodity.
•China's economy grew 7 times as fast as America's over the past decade (316% growth vs. 43%)
• China's GDP per capita is the 91st-lowest in the world, below Bosnia & Herzegovina
• 85 percent of artificial Christmas trees are made in China. So are 80 percent of toys
• If he spent his ENTIRE YEARLY INCOME on housing, the average Beijing resident could buy 10 square feet of residential property
• China has more pigs than the next 43 pork producing countries combined
• Chinese consume 50,000 cigarettes every second
• America's fastest "high speed" train goes less than half as fast as the new train between Shanghai and Beijing (150 mph vs 302 mph)
• China's enormous Gobi Desert is the size of Peru and expanding 1,400 square miles per year due to water source depletion, over-foresting, and over-grazing
• China has 64 million vacant homes, including entire cities that are empty
• The world's biggest mall is in China... but it has been 99% empty since 2005
• Nearly 10,000 Chinese citizens each year are sucked into unsanctioned 'black jails'
• "By 2025, 40 billion square meters of floor space will be built -- in five million buildings. 50,000 of these buildings could be skyscrapers -- the equivalent of ten New York Cities."
• “By 2030 China's cities will have added 350 million people—more than the entire population of the United States today.”
• There are already more Christians in China than Italy
• An impressive 74 percent of Chinese believe in evolution, better than Mexico (69%), Argentina (68%) and Great Britain (68%). Only Russia (48%), USA (42%), South Africa (41%) and Egypt (25%) remain skeptical about Darwin's theory.
• China executes three times as many people as the rest of the world COMBINED... and uses mobile execution vans for efficiency.
• When you buy Chinese stocks, you are basically financing the Chinese government. Eight of Shanghai's top ten stocks are government owned. Eight of the ten largest stocks on the Shanghai Stock Exchange are nothing but state-controlled companies:
• Industrial and Commercial Bank of China
• Bank of China
• China Shenhua Energy Company
• China Life Insurance Company
• Bank of Communications
• Chinese GDP could overtake the U.S. in less than 15 years.
1. "China's growth will be underpinned by a rapid expansion in emerging market economies, which will account for about 70% of global GDP growth in the coming decade, Deutsche Bank's Chief Economist for Greater China, Jun Ma, told an investment conference in Hong Kong,"
2. "By the early 2020s, China will over[take] the U.S. in terms of GDP, Ma said, noting the forecast is dramatically stepped-up from his views two years earlier."
3. '"China's nominal GDP growth could surpass that of the United States within ten years, a period which will likely be accompanied by a gradual appreciation of the yuan," Ma said.'
“This month’s report is marked by the confirmation of a double-dip in home prices across much of the nation. The National Index, the 20-City Composite and 12 MSAs all hit new lows with data reported through March 2011. The National Index fell 4.2% over the first quarter alone, and is down 5.1% compared to its year-ago level. Home prices continue on their downward spiral with no relief in sight.” says David M. Blitzer, Chairman of the Index Committee at S&P Indices.
See the dotted line here to see that markets have now fallen to fresh lows, below the previous dip.
The central government in Beijing is about to shift 2-3 TRILLION yuan ($308-$463 billion) in local debt to the Federal books.
Basically, local governments have borrowed like crazy, and there's been a fear of a massive wave of defaults, especially as revenue from real estate dries up.
Also there's no local bond market, so these are debts owed to banks, meaning that this bailout of localities is also a bank bailout (surprise!).
The expert on this issue is Northwestern poli-sci professor Victor Shih, who points out that China has been able to maintain the illusion of growth without government debt precisely through these local authorities. Others have likened local governments to the infamous SIVs from the US financial crisis -- pockets of leverage hidden from public view.
That this is happening now is potentially a big moment. Remember, throughout the US crisis, there were a series of bailouts that, at first blush, would have appeared to put a halt to things. If history is any guide, this kind of big bailout is closer to the beginning of the story.
China's regulators plan to shift 2-3 trillion yuan ($308-463 billion) of debt off local governments, sources said, reducing the risk of a wave of defaults that would threaten the stability of the world's second-biggest economy.
As part of Beijing's overhaul of the finances of heavily-indebted local governments, the central government will pay off some of their loans and state banks including some of the "Big Four" will be forced to take some losses on the bad debt, said the sources, both of whom have direct knowledge of the plans.
Part of the debt will also be shifted to newly created companies, while private investors would be welcomed in projects previously off-limits to them, sources said.
Beijing will also lift a ban on provincial and municipal governments selling bonds, a step aimed at bolstering their finances with more transparent sources of funding.
Many analysts see China's pile of local government bad debt as a major risk to the economy, especially as the economy slows, but few see widespread banking fallout as they believe cash-rich Beijing can step in to soak up losses.
The clean-up plan could boost investor confidence in Chinese banks, which have provided many of their loans as part of the massive economic stimulus program launched by Beijing in late 2008 to counter the global financial crisis. The program resulted in unfettered lending to local government financing vehicles, hybrid government-company bodies that governments used to get around official borrowing restrictions.
After a months'-long investigation into local government liabilities, Beijing has determined that local governments have borrowed around 10 trillion yuan, said one of the sources. Chinese media have reported that the governments may default on around 2 trillion yuan worth of those loans.
The source said that three government bodies -- the bank regulator, the Finance Ministry and the National Development and Reform Commission, China's state economic planner -- plan to start cleaning up the debt in June and finish in September. The second source said the program may take longer. "It's to rescue local government finances, not banks. It's different in nature from the bailout of the four big (state) banks in the late 1990s before they listed (on stock markets)," the first source told Reuters, requesting anonymity because he is not authorized to talk to reporters.
In 1999, China set up asset management companies to clear 1.4 trillion yuan in bad loans off the books of the large state-owned banks, which were saddled with piles of debt after decades of politically motivated lending. The Big Four are Industrial and Commercial Bank of China (601398.SS) (1398.HK), Bank of China (3988.HK) (601988.SS), China Construction Bank (0939.HK) (601939.SS) and Agricultural Bank of China (1288.HK) (601288.SS).
The banking regulator, the Finance Ministry and the state planner declined immediate comment when reached by telephone.
UP Planners are still ironing out details about how the sour loans would be written off, the source said. "The central government will swallow some of it," he said, and "some local governments will be allowed to issue bonds." "The government hopes to resolve this problem before the 18th Congress next year," the second source said, referring to the Communist Party's key conclave where a leadership reshuffle is expected.
Details on the firms that will be created to manage the debt were not immediately known, but the first source said they may receive funds from private investors.
State-owned China Development Bank accounts for about one-third of all local government loans, said one of the sources, with the rest being extended by big state-owned banks and city commercial banks.
Worried these loans could strain China's public finances if they sour, China's cabinet has instructed banks to clamp down on lending to local governments, an order which Chinese banks say they are abiding by.
State media previously reported that as part of Beijing's clean up of the local government debt mess, it will consolidate about 3,800 local government financing vehicles.
Guo Tianyong, an economist at the Central University of Finance and Economics, said that while the debt overhauling exercise might take the bad debt off the local governments' books, it wouldn't necessarily resolve the question of who would ultimately pay.
"I feel it won't fundamentally solve the problem by hiving off and selling the debt to other investors," Guo said.
Underscoring worries that China's public finances may be strained by bad debt, Fitch last month cut the outlook for China's local currency rating to "negative."
Standard & Poor's said this month the non-performing loan ratio among Chinese banks could reach 5-10 percent in the next three years.
Some analysts also believe China's central bank is wary of raising interest rates too forcefully for fear of burdening local governments with growing interest payments.
The stash of local government debt is still growing, however. The Economic Observer newspaper said it may hit 12 trillion yuan by the end of 2011, citing unnamed experts.
Looming Problem of Local Debt in China-- 1.6 Trillion Dollar and Rising
Did China accomplish the impossible? Did it generate almost 9% growth and maintain low debt to GDP ratio even as its export plummeted by 20%? What about claims that the torrent of investment in China has come without too much leveraging? After spending half a year looking into the debt level of local government investment entities-- some 8000 of them-- my conclusion is no. As in the past, the Chinese government just ordered banks to lend to investment companies set up by both central and local governments. Local governments have fully taken advantage of the green light in late 2008 and borrowed an enormous sums from banks and bond investors starting in late 2008 (well, a large amount even before that). In an editorial in the Asian Wall Street Journal yesterday, I outline some problems with this massive amount of borrowing:
Beijing is no longer sure how much money local investment entities have borrowed from banks and raised from bond and equity investors. The amount, however, must be large. In September, the Chinese press, citing government sources, suggested that these entities have borrowed $880 billion (6 trillion yuan). In a January interview with the Twentieth Century Business Herald, a Chinese newspaper, the vice chairman of the Finance and Economic Committee of the National People's Congress, Yi Zhongliu, revealed that local investment entities borrowed some $735 billion in 2009 alone.
These are mere guesses, however. A National Audit Agency audit conducted late last year uncovered so many problems with the data that Premier Wen Jiabao ordered another large-scale audit of local investment entities. Until a thorough audit is completed and the results announced to the public, no one really knows the total scale of local borrowing.
Given the information vacuum surrounding this issue, I spent half a year collecting data that would allow me to provide an estimate of total local debt (and also for each of China's provinces). Again, in the WSJ piece, I briefly outline my methodology and the results in the piece.
To obtain an independent estimate, I collected data from thousands of sources, including regulatory filings, bond-rating reports and press releases of government-bank cooperative agreements. I estimate local investment entities' borrowing between 2004 and the end of 2009 totals some $1.6 trillion. The data are far from perfect because borrowing by low-level government entities and lending by small banks are difficult to track. Nonetheless, my evidence suggests that the scale of the problem is much larger than previous government estimates. At $1.6 trillion, the size of local debt is roughly one-third of China's 2009 GDP and 70% of its foreign-exchange reserves.
So basically, in addition to the 20% of official debt-to-GDP ratio, one has to add an additional 30%. We also have to add other debt that the central government guarantees, such as the nearly 1 trillion RMB in Ministry of Railway bonds and bonds issued by the asset management companies. All of this gives China a high debt to GDP ratio. Also, there are some disturbing implications of this high debt. For one, local governments would have to sell lots and lots of land every year for many years to come to pay interest payment on this debt. Thus, to the extent that there is a real estate bubble today, it must continue for local governments to remain solvent. Regardless of what you believe about Chinese real estate, you have to think that this growth in real estate and land prices must slow or reverse at some point.
I think that the best course of action for the Chinese government is to credibly stop leveraging by local investment companies. Instead of the half measures in place today, a public and stern order should be given to banks to stop lending to all new projects undertaken by these local entities. Other measures should follow:
Since county governments are in the poorest fiscal shape and have the least ability to repay banks, the central government should take over the debt of almost all of the county-level investment vehicles. Although this will increase China's debt-to-GDP ratio significantly, the total would still be low by international standards.
A sudden contraction of lending to local investment vehicles will generate a wave of nonperforming loans, but a greater reliance on market mechanisms can easily solve this problem over the next few years. First, banks will fully recover the debt of the healthiest local entities, which may account for half of total local debt. For the remainder, the government needs to allow banks to directly sell subprime or distressed loans to both foreign and domestic investors. Beijing need not fear that China's listed banks will sell their nonperforming loans at below-market prices, as these banks report to shareholders. Banks, in conjunction with investment banks and distressed-asset investors, should also explore ways to securitize local debt for sale to both domestic and international investors. The latter in particular would have a healthy appetite for yuan-denominated security, anticipating a currency revaluation soon.
Basically, I think the Chinese government can turn this into a great opportunity for market reform in the financial system and the internationalization of the RMB. However, it has to act soon before local debt gets too large to handle
For awhile now we've been telling you about the work of professor Victor Shih who is warning about the $1trillion+ debts incurred by Chinese state governments.
A new report from research from Independent Strategy has a very nice characterization of these local governments, and their analogue to the US crisis: they're the SIVs, the vehicles that allowed Citigroup (C) et. al. to mask the true state of their rot.
According to Shih, the rot is located in the so-called Local Government
Financing Vehicles (LGFVs) belonging to one of China’s many levels of
local government ranging from towns and counties to cities and provinces.
LGFVs are conduits, like the Special investment Vehicles (SIVs) were
for western banks, used by local government to borrow and spend on
infrastructure and other projects (like real estate).
Local governments inject land banks, SOEs and cash into a LGFV to give
it assets and a capital base for borrowing. Guarantees of LGFV debt by
local governments are also common (as are guarantees of one LGFV’s
debts by another). The usefulness of the LGFV is that it allows local
government to borrow and spend way in excess of its own budget, where
normally tax revenues cover only about half expenditure (with the rest
coming from Beijing). Local government deficit spending is not allowed.
There are over 8,000 LGFVs in China with only paltry information avail-
able for all but 100 of them and even for those the information is incom-
plete. Local authorities have used LGFVs to divert funds borrowed for
authorised projects to other ends (e.g. loans for infrastructure spending
channeled into real estate speculation by local cadres) or to borrow and
feed back the proceeds to local government. LGFVs are predominantly
unprofitable, with the debt service on existing debts being funded by
further cash subsidies from local government and additional borrowings.
And they have been financed by asset injections at inflated prices (e.g.
local government land banks) to dress up their balance sheets and facili-
tate borrowing, despite often being insolvent.
It's these SIVs that allow for this:
In conclusion, these local entities -- which get at least half of their revenue from real estate, and not taxes -- have one solution: keep praying for a bubble (oh, and hope that the export sector never slows down).