Friday, January 28, 2005

The time has finally come for General Glut and his platoon to make their way across the pond. I'm flying to London on Monday and so the Globblog will be on a brief hiatus -- hopefully back to blogging on Wednesday.
The Muses, still with freedom found,
Shall to thy happy coast repair:
Blest isle! with matchless beauty crowned,
And manly hearts to guard the fair.

Rule, Britannia!

Yes, boys and girls, it's once again time to play America's favorite macroeconomic quiz game: Guess That Current Account Deficit!

You may remember that the US current account deficit as a percentage of GDP hit -5.6% in 2004:III. With the 2004:IV GDP data in plus some quick back-of-the-envelope work by your truly on estimating the CA balance for the fourth quarter, we can see whether stable global rebalancing has even a whisker of a chance in 2005.

The advance numbers for US GDP in the fourth quarter of 2004 are an annualized $11,967.0bn in current dollars. We already know that the balance on goods and services for October and November was a combined -$116bn, which included November's blowout of -$60bn. Let's estimate a conservative -$55bn for December, based on spot oil prices for the month being 11% lower than November and 19% lower than October. That gives us a pretty conservative estimate of the balance on goods and services on the quarter being -$171bn.

Balance on income is notoriously unpredictable, but I'll wade in and predict a very safe +5.0bn. The income balance has been roughly +$5bn for the previous two quarters. With the US net international investment position nearing -30% of GDP, this figures has to go negative eventually, but for now lets be conservative.

Finally, I'll estimate unilateral transfers at -$18bn. This is right in the middle of the range this figure fluctuated in over the six quarters prior to 2004:III when big flows of insurance funds from Europe to the US due to the hurricanes shrank the number to just -$14bn.

With some pretty conservative guesswork, I estimate the 2004:IV CA balance will come in at -$184bn -- some $20bn lower than in 2004:II or 2004:III.

A quick flick of the computer keypad, and we get an estimate for the fourth quarter current account balance as a percentage of GDP to be:

That is a true monster of a number.

Thursday, January 27, 2005

American Bubble Fuel TM continues to fly off store shelves and find its way into a home near you.
Freddie Mac (NYSE:FRE) today released the results of its Primary Mortgage Market Survey in which the 30-year fixed-rate mortgage (FRM) averaged 5.66 percent, with an average 0.6 points, for the week ending January 27, 2005, down slightly from last week when it averaged 5.67 percent. Last year at this time, the 30-year FRM averaged 5.68 percent.

The average for the 15-year FRM this week is 5.14 percent, with an average 0.6 points, down from last week when it averaged 5.15 percent. A year ago, the 15-year FRM averaged 4.97 percent.

Five-Year Treasury-indexed hybrid adjustable-rate mortgages (ARMs) averaged 5.02 percent this week, with an average 0.6 points, down from 5.05 last week. There is no historical information for last year since Freddie Mac began tracking this mortgage rate at the start of this year.

One-year Treasury-indexed adjustable-rate mortgages (ARMs) averaged 4.18 percent this week, with an average 0.6 points, up from last week when it averaged 4.11 percent. At this time last year, the one-year ARM averaged 3.59 percent.
The 30-year FRM is down 11 basis points on the year and the 15-year FRM is down 7 points. However, the one-year ARM seems to be lacking in bubble fuel, now up 8 basis points on the year. Put this together with the marked rise in rates on all US treasuries with maturity at three years or less -- the kind of notes John Snow loves to issue best -- and one might be tempted to say that the Asian central banks' interest in short-term US securities is, at these low returns, waning a bit. A big sign will be if the one-year ARM jumps above 4.2%, something it has done just once since late 2002.

Following the deflating (bursting?) London housing bubble.
Fears of A housing market crash rose yesterday after the Bank of England issued an unexpected warning of an asset price correction and new figures revealed the first rise in mortgage arrears for six years.

Economists on the Bank's Monetary Policy Committee are worried that investors' increasingly desperate search for profit in a low inflation environment was forcing them to take on more risk.

"The committee judged that there might be some downside risk of an asset price correction," the minutes of their January meeting showed. . . .

Short-term arrears of between three and six months rose from 49,720 in the first half of last year to 53,960 in the second half - an 8 per cent increase.

The CML said the numbers were "extremely low" by historic standards - there were 190,000 in the first half of 1994 - but admitted it pointed to problems ahead.

"With short-term arrears increasing, we are bound to see a rise in longer-term arrears and repossessions following behind," Michael Coogan, its director general, said.
Of course, it is markedly unfair to compare the beginning of a bubble deflation to its nadir, which is what CML is doing here. The trend, of course, is what matters. Back in the late 1980s, the declining arrears trend bottomed out in the second half of 1988 and began rising in the first half of 1989; the housing price bubble peaked in mid-1989.

To bolster the turnaround case, Hometrack is reporting that national UK home prices fell yet again in January. Asking prices are now down nationally to �162,800, -2.9% since June. The actual fall may be more steep in that Hometrack data also shows that the price achieved as a percentage of the asking price is down as well, from 96% at the peak of the bubble to just under 93% in December (Hometrack won't put their January data up on their website yet -- only to paying newspapers for now).

Regarding the arrears data, it is always important to say, "one month (or in this case, one six-month observation) does not a trend make". The lesson is, however, keep your eyes peeled.

Does China need the dollar peg to ensure domestic financial stability? This has long been a cornerstone argument of the Chinese government, but the IMF thinks otherwise.
We argue that with existing capital controls in place -- even if these are somewhat porous -- the banking system is unlikely to be subject to substantial stress simply as a result of greater exchange rate flexibility. Domestic banks do not have a large net exposure to currency risk, and exchange rate flexibility by itself is unlikely to create strong incentives (or channels) to take deposits out of the Chinese banking system. . . .

The current overall exposure of the corporate sector and banks in China to foreign exchange risks appears to be low . . . indicators seem relatively innocuous when compared with those of other countries. Their recent evolution, however, points to a trend that bears watching closely: during 2001-03, banks' foreign currency loans to domestic residents have increased by over 60 percent, net foreign currency liabilities are up by nearly 50 percent, and total short-term external debt (which is denominated in foreign currencies) has risen by over 50 percent.
Unfortunately, the IMF report doesn't say much more than this on the issue of domestic financial stability and the peg.

The relative and absolute values of the Chinese banking system's foreign currency exposure seems a slightly different issue from what The Economist, for example, repeatedly calls the "weak" or even "fragile" Chinese banks. Something that is weak and fragile, of course, cannot absorb the same blow which something robust and resilient can. The question isn't merely exposure to foreign exchange instability, but also the large volume of nonperforming loans in the system overall, a matter the IMF report does not deal with at all. If many of these nonperforming loans are both in foreign currencies and in politically sensitive sectors, all the more reason to fear a move off the peg.

Thus I continue to believe that the expenses of the dollar peg are simply the price of the stability the Chinese leadership so dearly desires. This doesn't mean, of course, that China won't demand higher interest rates on US treasuries . . .

UPDATE: More good discussion on this matter from Sean Corrigan, aka Obiter Dicta at Sage Capital AG.

Wednesday, January 26, 2005

After binging in November, foreign central banks are pushing away from the table today.

Shorter-dated US Treasury notes were weaker on Wednesday after disappointing demand at an auction of $24bn in two-year notes.

Bids reached 2 times the amount on offer, less than the recent average of 2.21 times. Indirect bidders, which include foreign central banks, took only 29.8 per cent, below 34 per cent at a December sale, and a recent average nearer 50 per cent.

Traders said expectations of interest rate rises in the months ahead weighed on appetite for the rate-sensitive paper.
This is consistent with foreign central banks' understandable dissatisfaction at the low rates they're earning on US treasuries. One strategy they've been pursuing of late is to move into higher-yielding dollar assets such as agency bonds and corporate bonds. Total foreign purchases of agency bonds rose 34% last year, and official purchases of corporate bonds doubled.

Another related move is to demand higher rates on T-bills. At 3.26%, the 2-year is now at its highest point since May 2002.

That which the East Asians want, stays cheap. That which they don't want, becomes dear.

George W. Bush, conquering his own little Iwo Jima.
the fundamental question is: Can we advance that history? And that's what my inauguration speech said. It said, yes, we can. I firmly planted the flag of liberty, for all to see that the United States of America hears their concerns and believes in their aspirations.
Another golden moment from today's press conference was when Bush once again demonstrated that he doesn't read anything, even major public statements from his own top foreign policy advisors in the most prominent and influential foreign relations publication in the country.
Q Mr. President, Dr. Rice again -- quoting your future Secretary of State, wrote in "Foreign Affairs Magazine" in 2000, outlining what a potential Bush administration foreign policy would be, talked about things like security interests, free trade pacts, confronting rogue nations, dealing with great powers like China and Russia -- but promotion of democracy and liberty around the world was not a signature element of that prescription. I'm wondering what's changed since 2000 that has made this such an important element of your foreign policy.

THE PRESIDENT: I'm the President; I set the course of this administration. I believe freedom is necessary in order to promote peace, Peter. I haven't seen the article you're referring to. I can assure you that Condi Rice agrees with me that it's necessary to promote democracy. I haven't seen the article, I didn't read the article. Obviously, it wasn't part of her job interview. (Laughter.)
When did wanton ignorance become an attractive personality trait? It should be no time before one of my students tries the "I haven't seen the article, I didn't read the article" line out on me. I mean, how can anyone look their students in the eye and tell them that they must do the readings, after they see the president of the United States say things like this to the entire nation on television? Mr. President, what will we tell the children?

I respect immensely the work of Nouriel Roubini and Brad Setser and am honored to hash out ideas with them concerning the US current account deficit, the dollar and the fate of the global political economy. After a very long posting yesterday about why I think Nouriel and Brad overstate the case for the world going off its dollar asset diet, let me throw a note of discord into my own argument.

The big players in supporting the dollar -- Asian central banks -- have been doing so for two main reasons: [1] maintain access to the US export market; and [2] maintain access to the Chinese export market. Thanks to the Chinese peg, [1] and [2] go together like Mary-Kate and Ashley. The Chinese have their own [2], namely to promote domestic financial stability. All told, a pretty heady mix of interests aligned to support the dollar.

Yet the biggest players -- Japan, China, Taiwan, Korea -- move in a bloc. They support the dollar together, and they could also defect together with the potential of sending a giant financial tsunami across the Pacific. What prevents them from doing so has long been their dependence upon the US market for their exports. If that changes, the days of a dollar asset diet are surely numbered. Now of course we all know these days are numbered, and as a non-believer in Bretton Woods II, I think the fall will be a hard one rather than a calm and orderly adjustment. Those days may be slightly fewer than I thought.
China overtook the US to become Japan's biggest trading partner in 2004, according to numbers released by Japan's Finance Ministry on Wednesday.

China accounted for 20.1% of Japan's trade in 2004, compared with 18.6% for the US. In 2003, the US was ahead with 20.5% and China came second with 19.2%.

The change highlights China's growing importance as an economic powerhouse.

In 2004, Japan's imports from and exports to China (and Hong Kong) added up to 22,201bn yen ($214.6bn;�114.5bn).

This is the highest figure for Japanese trade with China since records began in 1947. It compares with 20,479.5bn yen in trade with the US.

Trade with the US during 2004 was hurt by one-off factors, including a 13-month ban on US beef imports following the discovery of a cow infected with mad cow disease (BSE) in the US.

However, economists predict China will become an even more important Japanese trading partner in the coming years. On Tuesday, figures showed China's economy grew by 9.5% in 2004 and experts say the overall growth picture remains strong.
The high-end consumer power of China is growing remarkably. Bloomberg reports
``If you look at household income, as opposed to individuals, by 2020, there will be 100 million households with disposable incomes equivalent to western Europe today,'' said Yuwa Hedrick-Wong, economic adviser to MasterCard International Inc., the world's second-biggest credit-card network by number of cards.``That's how powerful the demand side driver is.''
So this is where the rubber meets the road. When does Japan, Korea, Taiwan and the south-east Asian NICs decide they can cut loose from the US market and turn to China instead? The answer has to be coordinated with China's answer to the question of when it feels its banks are strong enough to live without the peg. China's favorable access to the US export market won't be affected much by a revaluation of the renminbi since it's costs of production are so low that a 10-20% rise in the currency won't perceptibly change matters.

There are dicy political-military issues in the mix as well, not the least of which being that most everybody in East Asia is scared to death of China even as it cozies up to the country economically. Strangely enough, Bush's best bet for forcing East Asia to eat more and more US debt is to cultivate China, and secondarily North Korea, as existential threats to Japan, Taiwan and Korea. China's best bet to end US power in East Asia would thus be to make nice with Taiwan while pressuring North Korea to behave "or else".

Strange brew . . .

He forgot Poland!
The White House has scrapped its list of Iraq allies known as the 45-member "coalition of the willing," which Washington used to back its argument that the 2003 invasion was a multilateral action, an official said on Friday.

The senior administration official, who spoke on condition of anonymity, said the White House replaced the coalition list with a smaller roster of 28 countries with troops in Iraq sometime after the June transfer of power to an interim Iraqi government.

The official could not say when or why the administration did away with the list of the coalition of the willing.
Thanks to JackNYC for the tip.

Tuesday, January 25, 2005

In the game of chicken that the US is playing with its creditors/dependent trade partners, this move by the Bush administration has to be chalked up as a giant "F*** you".
The federal budget deficit is expected to reach $368 billion this fiscal year, the non-partisan Congressional Budget Office projected today . . .

If the deficit reached $368 billion this year, it would be the third highest deficit on record, in dollar terms, topped only by last year's $412 billion and the $377 billion gap in 2003. Add another $80 billion [to fund the wars in Iraq and Afghanistan] and close to $1 billion in promised relief for the Asian tsunami and the deficit could reach a record $449 billion.
Well, at least Bush will continue issuing mountains of T-bills so as to float a dozen more $60bn monthly trade deficits.

With these kinds of numbers, the Bush administration is flat out daring the Asian central banks to not buy US debt. One could even see it as an incredibly reckless attempt to throw China off its dollar peg. With the US federal government issuing more and more debt, our best customers need to consumer more and more of it to keep the dollar up and thus their exports flowing (and in China's case, their banks afloat). If China refuses to keep buying, the pressure on the dollar to fall will grow incredibly, venting first on the yen and the euro, and then Japan and the EU venting politically on China. Hot money would presumably start flooding China and Hong Kong, stepping up the pressure on the People's Bank of China to adjust the peg.

Would Japan and Europe let it go this far? Can China resist this pressure on their 8.28 ft. dike? Would the Bushies really hope to provoke the chaos that would ensue?

For my $0.02, China keeps on eating US debt, and eating, and eating . . . but as we know from Monty Python, if you eat enough, even a wafer thin mint can cause you to explode.

UPDATE: If you like a lot of game theory jargon, Nouriel Roubini has a good post on the same topic today. Suffice to say that Nouriel thinks China is much closer to being fed up with the US than do I. Why? Certainly not because I'm a believer in Bretton Woods II. It's because I have real reservations concerning the key reasons for China calling the US bluff.
China may tire of financing the US for lots of reasons: eventual capital losses on holding of forex reserves are massive; partially sterilized intervention causes dangerous credit and asset bubble, excessive real investment and even larger NPLs with risk of China hard landing down the line; it also causes higher inflation as if you repress fundamental real appreciation driven by relative productivity growth by avoiding nominal appreciation, you will get that real appreciation via higher and socially dangerous higher inflation; and everyone in Asia is free riding on China that is thus overfinancing the US deficit.
Let's take these one at a time.

First, massive losses on forex reserves. China is already eating real losses due to open market operations as I mentioned yesterday. 15-20bn renminbi is hardly peanuts, but even these losses have not yet caused the PBOC to shy away from dollar assets. Massive losses, moreover, only result if dollars are exchanged for renminbi. China can avoid all losses by keeping their financial assets in dollars and then buying real US assets down the line -- natural resources, real estate, IBM, whatever.

Second, excessive real investment. Well, so far China is convinced that administrative controls and higher interest rates will keep the lid on investment. Fourth quarter GDP figures suggest that they're having real success on this score: industrial production rose at the slowest pace in more than a year in December and Chinese officials say there will be no let-up on administrative restrictions plus there will be higher interest rates as 2005 progresses.

Third, higher inflation. But China is keeping inflation under control so far, with consumer prices up 2.4% in December, the smallest gain in 10 months.

Certainly China will tire of consuming an ever-increasing amount of dollar denominated financial assets, but in the short term at least, this just seems to be an unpleasant cost of maintaining the peg which is clearly delivering a lot of valuable services to the Chinese leadership.

Moreover, don't forget the Bank of Japan or the European Central Bank. I've said many times that as long as Japan is in deflation, it's ability to consume US debt is practically infinite. It's willingness to do so over the past three years seems to match its ability. The Europeans have not yet moved into supporting the dollar, but could be forced to if the euro sails above $1.40. This is particularly the case in light of the ever-fading export-dependent German economy.

The world is addicted to cheap money, and addicts aren't usually known for the prudence, planning and foresight.

When the Bush administration starts bombing Iran, they'll have to do it this time without British political cover.
JACK STRAW has drawn up a dossier putting the case against a military attack on Iran amid fears that President George W Bush�s administration may seek Britain�s backing for a new conflict. . . .

He will press home the point at a meeting with Condoleezza Rice, the incoming secretary of state, at a meeting in Washington tomorrow.

The document says a peaceful solution led by Britain, France and Germany is �in the best interests of Iran and the international community�. It refers to �safeguarding Iran�s right to the peaceful use of nuclear technology�.

The dossier, entitled Iran�s Nuclear Programme, was quietly issued in the Commons on the eve of Bush�s inauguration last week for fear of provoking a public rift with Washington � although privately tensions are running high between the two nations.

The approach contrasts with the government�s two Iraq dossiers, which were trumpeted to make the case for war. . . .

A cabinet minister said: �Jack is making clear, as is Tony, that we are not getting involved in American sabre-rattling to make Iran comply with its international obligations.�
Blair was so publicly and profoundly cuckolded by Bush over the Iraq war that it seems the PM has finally admitted the truth about Bush. It turns out Georgie wasn't working late at the office all those nights, but lining up tawdry trysts with not one but multiple street-walking neoconservatives. Time for this marriage to head to divorce court. One wonders if we can petition the court to grant sole custody of us to Tony -- with no visitation.

From Agence France Presse, 19 September 2002:
White House budget chief Mitch Daniels Wednesday questioned a colleagues estimates that a possible war with Iraq could cost as much as 100 billion to 200 billion dollars.

That estimate is "likely very, very high, if it's meant to apply to the cost to taxpayers," Daniels said.
If $100-200bn is "very, very high", one wonders what the Bush administration would call $300bn?
Congress started to digest a new Bush administration request of $80 billion to bankroll wars in Iraq and Afghanistan . . .

Congress approved $25 billion for the wars last summer. Using figures compiled by the Congressional Research Service, which prepares reports for lawmakers, the newest request would push the totals provided for the conflicts and worldwide efforts against terrorism past $300 billion.
There really should be a Congressional budget line titled "Wars". It would really help us out in tracking down just how much these imperialist adventures are costing us.

Monday, January 24, 2005

Just because Alan Greenspan says it�s time to go home doesn�t mean the crowd is going to obey.

In Thursday's FT, Samuel Brittain digs up some interesting numbers crunched by the big British bank HSBC.
As the HSBC bank has just reminded us, a 10 per cent revaluation of the renminbi would only reduce the Fed's trade-weighted dollar exchange rate by 1 per cent, compared with the 20 per cent fall that has already taken place. Even if all other Asian currencies were to follow suit, the reduction would still only be 3.7 per cent, but with the risk of a speculative upheaval.
Even if renminbi revaluation comes this year, it is virtually unimaginable that it would be by more than 10%. Unless US personal savings picks itself up off the sticky floor, we could be headed for a current account deficit of 7% of GDP in 2005.

The FT tried to scare us all today with their headline: "Central banks shift reserves away from US". But another headline could be "Best Laid Plans of Mice and Men".
70 per cent of central bank reserve managers said they had increased their exposure to the euro over the past two years. . . .

In a further worrying sign for the greenback, 47 per cent of reserve managers surveyed said they expected the growth of official reserves to slow to less than 20 per cent over the next four years. Between the end of 2000 and mid-2004, official reserves had increased by 66 per cent. . . .

More than 90 per cent of central bank reserve managers said that the income from reserve management was "important" or "very important".
We already knew that Russia among some others was increasing their holdings of euros, but Brad Setser estimates some one-third of all reserve accumulation in 2004 went into non-dollar assets. Sounds like a lot. Moreover, even a slowing of global reserve accumulation could spell danger for an ever-growing US CA deficit.

All that being said, take a step back and consider a few things. First, note that part of this survey was conducted during a month in which net foreign central bank purchases of US long-term securities hit $27.9bn.

Second, central bank quests for higher yielding assets has not yet meant moving out of the dollar. Instead central banks have been buying US agency bonds and even equities with all the salutary effects on US mortgage rates and the stock market.

Third, in 2004 the US is set to run a CA deficit of around $650bn, a gargantuan figure indeed yet easily financed in the midst of net long-term securities flows and net FDI of around $750bn.

A run on the dollar in 2005? No way. The Fed is trying to raise interest rates, but foreign capital has such a hunger for US assets that mortgage rates aren't budging, keeping the housing bubble aloft and wealth-effect consumption chugging along. Without renminbi revaluation, China seems set to keep amassing reserves, too, and income from reserve management doesn't seem "very important" to the People's Bank of China managers: in 2004 it is estimated that the PBOC lost at least 15-20bn renminbi in open market operations.

Which leads me to: fourth, the survey cited by the FT covered only
65 central banks that participated [which] control 45 per cent of global official reserves. Individually, they had up to $250bn under management.
With levels that small, we can rest assured that neither the Bank of Japan nor the People's Bank of China -- i.e. the ones whose opinions really matter re the dollar -- were among those questioned.

Saturday, January 22, 2005

John Quiggin discovers that Thomas Friedman is an idiot.
Iranians are stocking up on candy and flowers with which to bestrew invading US troops, according to Thomas Friedman who says "many young people apparently hunger for Mr. Bush to remove their despotic leaders, the way he did in Iraq.". His evidence for this proposition is the following

An Oxford student who had just returned from research in Iran told me that young Iranians were �loving anything their government hates,� such as Mr. Bush, �and hating anything their government loves.� Tehran is festooned in �Down With America� graffiti, the student said, but when he tried to take pictures of it, the Iranian students he was with urged him not to. They said it was just put there by their government and was not how most Iranians felt. Iran, he said, is the ultimate �red state.�
It's too bad John stopped at that. He could have included the even more ridiculous paragraph which preceded the one above:
Funnily enough, the one country on this side of the ocean that would have elected Mr. Bush is not in Europe, but the Middle East: it's Iran, where many young people apparently hunger for Mr. Bush to remove their despotic leaders, the way he did in Iraq.
How does Tom Friedman know anything about anywhere? Well, he hung out for a day or two with some upper-middle class liberal Westernized locals that he found on the internet and asked them what they thought about their leaders, their countries, the world, and Tom Friedman, of course! Except in this instance, he asked somebody else who hung out with the types of people Friedman is sure will, with the aid of Almighty America, soon be running the Middle East (and will be in love with Israel to boot!).

If you, too, want to be as facile a columnist as our august Mr. Friedman, just try Michael Ward's "Create your own Thomas Friedman op-ed column" and start bombarding the New York Times with your submissions. The operative formula for the matter at hand goes like this:
When I was in [country in question] last [week/month/August], I was amazed by the [people's basic desire for a stable life/level of Westernization for such a closed society/variety of the local cuisine], and that tells me two things. It tells me that the citizens of [country in question] have no shortage of [courage/potential entrepreneurs/root vegetables], and that is a good beginning to grow from. Second, it tells me that people in [country in question] are just like people anywhere else on this great globe of ours.
Can't wait until Friedman-the-Neocon-Fellow-Traveler starts recycling his 2002 columns urging on the Iraq War. It will give him so much more time to finally work out that "Post-Hapsburg Lichtenstein-Morocco Theory of Conflict Prevention" he stopped pursuing after 9/11 changed everything.

Friday, January 21, 2005

Gosh, it seems like just yesterday that people actually worried about $50/barrel oil. Now it just seems to roll right off the black kangaroo boots decorated with a white star and embroidery, together with a smart and sexy aqua-colored mink wrap, that all the fashionable Republicans are sporting this season.

Here is today's triple whammy:
Temperatures in the U.S. Northeast, the world's largest heating oil market, will stay much below normal through the weekend with cold locked in longer than previous expected by heavy snowfall, forecasters said. . . .

customs data released on Friday showed China's crude imports hit a record 12.1 million tonnes in December, sending total 2004 imports to 122.7 million tonnes, a rise of almost 35 percent from last year. . . .

OPEC oil to be shipped in the four weeks ending Feb. 5 sank by 650,000 bpd, marking the biggest drop since April, a shipping analyst said on Thursday.
WTI spot prices averaged $43.15/barrel in December, the lowest monthly level since July. Yet they've been rising precipitously all January and today settled at over $48 after rising as high as $48.95; they may be set to close above $50 next week for the first time since the election.

Stephen Roach's rule of thumb for an energy "shock" has long been an extended period of >$50/barrel. So far the US has only seen one month of such action, but prices have remained above $40/barrel consistently since mid-July. Maybe that doesn't rank up there with shoving a screwdriver into a wall socket, but six months of this has to at least qualify as grabbing hold of an electric fence.

Today's WSJ (sub. only) suggests the late 2004 optimism over impending renminbi revaluation has definitely burned itself out.
After feverish expectations that China would let its currency appreciate, a few market signals suggest that some speculators no longer see a revaluation of the yuan, at least for now.

A widely used proxy for assets denominated in Chinese yuan, Hong Kong stocks are down almost 5% so far this year, after rising 13% in 2004, as measured by the benchmark Hang Seng Index. The premium quoted for the yuan on a lightly traded forward market has declined 25% since the start of the year, a sign that traders are more confident the currency, also known as the renminbi, will stay put. And the Shanghai property market, another magnet for speculative cash, appears to be coming off the boil.

Investors are becoming more skeptical that the yuan is likely to come unshackled anytime soon, said Cheah Cheng Hye, managing director of Value Partners, which operates a $550 million fund investing mainly in China-related stocks. "The story is looking very shaky," he said.

Economists at HSBC, Hong Kong's biggest lender, don't see an appreciation in the yuan this year. "I don't think there's any question that the appetite for positioning for renminbi appreciation has diminished," said Richard Yetsenga, Asia currency strategist with HSBC.
It's not just the Hang Seng that folks are looking at for tracking hot money into China. The Shanghai property market has cooled markedly in the last six months, too. That being said, investment banks haven't pulled back from their predictions. J.P. Morgan Chase looks into its crystal ball and sees a remarkable 7% rise in the renminbi against the dollar this year, and Goldman Sachs divines a 5% uptick.

China has the US over one hell of a barrel. If the Bush administration threatens tariffs on Chinese textiles, for example, China can threaten to cut back on its purchases of US debt. In this game of chicken, I say Bush swerves first, especially if he thinks he can seriously push through a $2 trillion Social Security borrowing scheme through Congress this year. Dubya will gladly sacrifice US manufacturing on the altar of his historical legacy.

Look for a lot of heat but precious little light at the London G7 meeting next month.

Thursday, January 20, 2005

All the biggel balls have been tallied and the Audio-Telly-o-Tally-o-Count is finally in: 34 mentions of the word "free" or "freedom", 16 mentions of the word "liberty" or "liberating", and 3 mentions of the word "democracy" or "democratic" making for a combined total of 53 in the President's 31-paragraph address today.

He said "America" or "American(s)" just 30 times, paling in comparison to the freedom/liberty/democracy juggernaut.

The speech was a true homage to the American God, or as Bush calls him, "the Author of Liberty" after the usage in Samuel Francis Smith's popular nationalist hymn "America". It is funny how Bush tries to deny a belief in this American God by saying
We go forward with complete confidence in the eventual triumph of freedom. Not because history runs on the wheels of inevitability; it is human choices that move events. Not because we consider ourselves a chosen nation; God moves and chooses as He wills.
yet at the same time claims
history also has a visible direction, set by liberty and the Author of Liberty
and identifies the United States as his/its ever-faithful servant,
mov[ing] forward in every generation by reaffirming all that is good and true that came before � ideals of justice and conduct that are the same yesterday, today, and forever
with the special mission which
proclaims liberty throughout all the world, and to all the inhabitants thereof.
America the New Israel, and George Bush its Isaiah.

While inflation is bubbling up here and there across the US economy, firms selling electronics aren't anywhere near the Land of the Rising Price.
Sony sent another shock wave through markets on Thursday after warning profits for its current business year would be significantly lower than previously forecast.

The consumer electronics and entertainment group said operating profits in the year ending March 31 would be 31 per cent lower than it had expected at the end of the first half due to plunging consumer electronics prices and changing market trends in its core TV and audio segments.

The profit warning highlights the severe impact sharp price falls are having on consumer electronics manufacturers and raises concerns about Sony�s recovery prospects in particular.

�Prices are falling at a speed that could not have been imagined in the past,� said Katsumi Ihara, chief financial officer. Although Sony has increased market share in many of its main product areas, it was unable to cut costs in line with the fall in market prices, he said.
The BLS data shows that the "video and audio" group (including equipment, media and services) has seen steadily falling prices since April, since then at a -1.1% annualized clip. The story is, of course, much much worse in "information technology, hardware and services" where in 2004 the inflation rate ran at -8.1% and dropped off especially at the end of the year; in the last quarter of 2004 the sector saw an annualized inflation rate of -13.6%.

Deflation still rules his own kingdoms, although he has been beaten back substantially since late 2003.

Wednesday, January 19, 2005

The December CPI report shows "stay the course" is this economy's motto on prices. Overall consumer prices fell 0.1% while core (non-food, non-energy) prices rose 0.2%. Consumer inflation now stands at an annual 3.3% although much of that number is due to energy inflation running at 16.6% annually. Core annual CPI is a much more tame 2.2%, and over the last three months an even lower annualized 2.0%.

That being said, inflation is actually starting to invade my favorite deflationary sector, core commodities. Core commodity prices dropped a dramatic 0.6% in December, but on the year core commodity inflation is +0.6%. For three months running now there has been core commodity inflation in the US, after 34 straight months of annual deflation. 2005 may see the first year of core commodity price inflation since 2001.

The falling dollar may finally be starting to have its price effect even if it has completely failed to have its trade deficit effect. The non-fuel import price index is up 3.0% on the year -- not nearly as much as the dollar is down (-4.9% for the year per the broad dollar index) but nonetheless a notable figure.

Inflation is even seeping into housing. We all know the story of runaway housing price inflation, but the standard story to explain it all away has been that, thanks to ultra-low mortgage rates, monthly payments have not been rising much. The December CPI report tells us that owners' equivalent of rent (OER) is up 2.3% on the year after bottoming out in January-February 2004 at 1.9%. In bubbly Los Angeles-Riverside-Orange County the OER inflation rate is a much steeper 5.6%, the highest level in nearly three years. More telling for the fate of housing markets are payments for new mortgages. DataQuick tells us that from December 2003 to December 2004 the average new mortgage payment in Southern California rose a steep 21%.

How are Americans affording to chase after all these goods and services? It surely isn't their rising wages and salaries. Real average hourly earnings in private industry stand at $8.23 in December, up $0.01 from October and November but down from a recent high of $8.32/hr. in November 2003. Real hourly wages changed -0.7% from December 2003, and for all of 2004 real hourly wages changed -0.4% -- the first year real hourly wages fell for since 1993!

One way to make more money to chase more goods and services is to work longer hours, and Americans were certainly doing that in 2004. Aggregate weekly hours (SA) in December rose to their highest level since September 2001, and for the year stood at the highest level since 2001.

Another tried and true measure is through debt. The December numbers on consumer credit aren't in yet, but we do know that from November 2003 to November 2004 revolving credit grew by $37.6bn or 5.1%. In nominal terms, over the same period wages and salaries were up 4.6% while consumption rose 6.1% -- so a little extra debt helped grease the consumers' skids.

The "fundamentals" all say "deflation", but consumer power and inflation continues to be created through ultra-loose monetary policy in every corner of the globe. Stephen Roach thinks this just can't last. But ever since the mid-1990s the US economy has been all about inflating asset prices, debt- and wealth-effect consumption. Somebody is going to have to stop us, because we aren't about to stop ourselves.

If you liked Iraq, you're going to love Iran.

How else to sum up Sy Hersh's latest New Yorker piece? Here are a few choice excerpts:
The Europeans have been urging the Bush Administration to join in these negotiations. The Administration has refused to do so. The civilian leadership in the Pentagon has argued that no diplomatic progress on the Iranian nuclear threat will take place unless there is a credible threat of military action. �The neocons say negotiations are a bad deal,� a senior official of the International Atomic Energy Agency (I.A.E.A.) told me. �And the only thing the Iranians understand is pressure. And that they also need to be whacked.� . . .

One Western diplomat told me that the Europeans believed they were in what he called a �lose-lose position� as long as the United States refuses to get involved. �France, Germany, and the U.K. cannot succeed alone, and everybody knows it,� the diplomat said. �If the U.S. stays outside, we don�t have enough leverage, and our effort will collapse.� The alternative would be to go to the Security Council, but any resolution imposing sanctions would likely be vetoed by China or Russia, and then �the United Nations will be blamed and the Americans will say, �The only solution is to bomb.�� . . .

Silvan Shalom, the [Israeli] Foreign Minister, said in an interview last week in Jerusalem . . . �If they can�t comply, Israel cannot live with Iran having a nuclear bomb.� . . .

The goal is to identify and isolate three dozen, and perhaps more, such targets that could be destroyed by precision strikes and short-term commando raids. �The civilians in the Pentagon want to go into Iran and destroy as much of the military infrastructure as possible,� the government consultant with close ties to the Pentagon told me. . . .

The hawks in the Administration believe that it will soon become clear that the Europeans� negotiated approach cannot succeed, and that at that time the Administration will act. �We�re not dealing with a set of National Security Council option papers here,� the former high-level intelligence official told me. �They�ve already passed that wicket. It�s not if we�re going to do anything against Iran. They�re doing it.�
You get the picture.

We've already seen the US Congress begin flirting with a resolution targeting Iran for "regime change," frighteningly reminiscent of a similar resolution against Iraq in 1998. The neocon propaganda machine has already been cranking out the vitriol against Iran as well as sunny predictions of "cake walk" regime change in Tehran. Maybe a nice bombing campaign against Iran will take our minds off of what Bush wants to do to Social Security?

About six weeks ago I posted the following, and I repost it here today in the hopes that we can draw some conclusions from a similar situation back in the early 1960s.


In light of the increasingly palbable concern over the Iranian nuclear program, it might be of considerable benefit to look back on the growing menace of the Chinese nuclear program in the early 1960s and extant US plans to "strangle it in its crib".

The bases for direct action against Chinese Communist nuclear facilities were explored in April 1964 in a paper by Robert Johnson of the Department of State Policy Planning Council, which paper it was apparently decided should form the basis for any subsequent consideration of the subject. . . .

The major conclusion of the paper is to the following effect:

"It is evident . . . that the significance of a [Chicom nuclear] capability is not such as to justify the undertaking of actions which would involve great political costs or high military risks."
This conclusion appears to be based on the observations summarized above regarding technical feasibility, impermanence of effect, and political difficulty, and, very importantly, on arguments to the effect that the near and medium term consequences in Asia of a Chinese nuclear capability will be small, and that direct threat to the US will be very small.
The government document from which these quotes are taken, written by Arms Control and Disarmament Agency official George Rathjens, feels the Johnson paper (which is still classified) is all wet. Yet history has indeed vindicated Robert Johnson, and evaluations of pre-emptive strikes on foreign nuclear facilities forty years ago should be used to help observers think seriously about the present day.


Let me be more blunt today than I was back in November. Despite the radical nature of the regime in Beijing under Mao in the 1950s and 1960s, the US realized the incredible recklessness of an attack on Chinese nuclear facilities, and decided it could learn to live with a nuclear China. If the US is faced with the same dilemma in 2005 regarding Iran -- certainly no more radical and probably less so than was China forty years ago -- we can and should learn to do the same.

UPDATE: From Fred Kaplan's review of the Condi Rice hearing:
In a similar exchange, Biden raised Seymour Hersh's claim, in the latest New Yorker, that Pentagon civilians are pushing for an airstrike against Iran, as a means of toppling its fundamentalist regime. Biden emphasized he wasn't asking Rice to confirm the report. He just wanted to know if she believes it's possible to topple the Iranian regime through military action�and whether regime change in Iran is the administration's goal.

Rice replied that the administration's goal is to have a regime in Iran that's responsive to U.S. concerns. She then noted that the current regime stands "180 degrees" in opposition to those concerns�on nuclear weapons, relations with al-Qaida, and support of Hezbollah. She added, "The Iranian people, who are among some of the most worldly that we know�in a good sense�do suffer under a regime that has been completely unwilling to deal with their aspirations."

Once again, Biden gave Rice a chance to dismiss the hottest rumor of the moment. And, again, she demurred.
From a normal administration I'd say that this is nothing more than good diplomacy -- you can't remove the stick from the negotiating table even if you accept that it is tremendously profoundly unlikely to be used. But with this bunch, we know the stick -- or rather, the bomb -- is the first, last and only desired option.

Tuesday, January 18, 2005

The central banks of the world have spoken: the dollar will not falter.

This has to be the interpretation of the November Treasury International Capital (TIC) report from the US Treasury released today. In November, official net purchases of US long-term securities jumped to $27.9bn after averaging just $16.1bn/mo. over the previous three months. Their purchase of treasuries shot up to $21bn (avg. $14bn in Aug-Oct) and of agency bonds up to $3.5bn (avg. $1.3bn in Aug-Oct). They even stepped into buying US equities to the tune of $1.5bn, the largest monthly purchase in nearly ten years.

But that's not all. Private capital (and central banks disguising their purchases) also gobbled up US securities in November. Overall net private purchases soared from $50.5bn in October to $71.8bn in November. The biggest gainer was equities; foreign capital bought $13.0bn of them in November, the biggest monthly purchase since January. No wonder the US stock market has been booming!

American capital continued fleeing the country, with net purchases of foreign securities hitting $18.7bn, continuing the ominous trend begun in October. However, because of the massive inflows, the net long-term flows figure for the month skyrocketed to $81.0bn. With figures like this, now a $60.3bn trade deficit for November looks like small potatoes. The US could have financed a deficit one-third higher!

For the twelve months through November, net long-term capital flows into the US stand at $827.8bn. The trade deficit over the same period is a "mere" $561.3bn. At this rate, the US could have "afforded" a current account deficit of 7% of GDP for 2004.

I say let's go for it in 2005! Don't let nothin' hold us back!

At the end of a long serious engagement with a recent speech by New York Federal Reserve President Tim Geithner, Brad Setser wrestles with the global economy's $64,000 question.
Geithner -- like most -- recognizes that current account deficits of 5-6% of GDP cannot be sustained indefinitely: the real debate right now is over how long those deficits can be sustained. Geithner, though, argues the flexibility of the US economy may allow a relatively painless adjustment (a Greenspan theme).

I am a bit less sanguine. The US has a fair bit of experience shifting resources (capital, labor) out of the production of tradable goods; much less experience shifting resources back into the production of tradable goods. Yet it is pretty clear that at some point, the US either has to export more, or it will have to import less -- and the required change is large in relation to the United States small export base (a key point made by Rogoff and Obstfeld, among others). . . .

I don't think there is much evidence that current low interest rates are spurring a wave of investment in US export industries, or in industries that compete with imports . . .

the current pattern of investment is, in part, a byproduct of the distortions created by the Bretton Woods two system of central bank financing for US deficits. The implicit interest rate subsidy from Asian central banks spurs interest sensitive sectors, but Asia's undervalued exchange rates discourages investment in sectors that currently compete with Asia, or will do so in the future. The result: plenty of investment in hard-to-export residential housing ...
Indeed every 'soft landing' scenario is predicated upon a massive wave of new US exports which are less and less likely to occur as the US and the rest of the world is hell-bent on destroying the US export base of manufacturing and agriculture. The small and shrinking US services surplus doesn't put more than a dent in the overall current account deficit.

Yet this doesn't mean that the system is teetering. Brad winds up his missive by stating "The result: plenty of investment in hard-to-export residential housing ...", but in fact housing has become rather easy to export thanks to the mortgage-backed security and US government agencies like Fannie Mae and Freddie Mac which create and sell them. In fact, exporting our houses is precisely part of the US strategy for financing the trade deficit.

In the 12 months ending October 2004, net US agency bond sales to foreigners hit $218.5bn, a 36% increase over calendar year 2003's $161bn. In addition, selling commercial real estate, industrial facilities and the infrastructure for wholesale/retail trade is part of the strategy. Over the last four quarters (2003:IV to 2004:III), foreign direct investment into the US stood at $96.6bn, a whopping 224% higher than calendar year 2003's mere $29.8bn.

The goal seesm to be to create or provide the context for the creation of expensive new assets with which the US can trade for goods and services. Thus the US sells the means of production and the means of reproduction to foreign capital for current consumption.

A profoundly short-sighted strategy, indeed, almost a form of voluntary colonization. It is also a strategy which only delays the pain. Yet it's also a strategy which I think can still work for a while still. The US has clearly been getting out of the production of goods for over twenty years, and it will take an experience as humbling as was Britain's 1976 IMF crisis to begin a turnaround.

Monday, January 17, 2005

As we Americans celebrate today the 20th Martin Luther King Jr. holiday nationally and prepare (for those having iron stomachs) to listen to the President himself praise King at the Kennedy Center, we must remember King for the man he was rather than simply the icon he has become.

To be more specific, we should not simply remember the �cuddly� King of the 1964 �I Have a Dream� speech. This is the pleasant King whom we have beatified into our official registery of national saints, the King who said things that � at least now, forty years later � we all want to hear and believe. This is the King who, in the recent words of Agence France Presse, is still "a figurehead in the American fight against racial discrimination", who dreamed of being judged not by the color of our skin but by the content of our character. And well we should remember this King.

But there is more.

I realize Paul O'Neill has become a sort of hero among some centrist Democrats simply because he is a Republican who is not simultaneously a Bush toady. However, this kind of argument should most definitely not be taken up by Dems when the Social Security fight starts getting nasty.
The problem with the current arrangement is that our contributions are a tax, not savings. So we should begin by agreeing that we are going to require all Americans to save, individually, to provide for their financial security in old age. After all, if we don't save on our own for our retirement needs, who will do it for us? Our neighbors? Our children? In a civilized society we have a responsibility to take care of our own needs so as not to be a burden on others.
When you start talking about human beings who aren't earning an income in the market as "a burden on others," you've already lost the "civilized society" argument.

I've said before that the Dems need a strong moral argument in favor of Social Security. That moral argument rests upon social solidarity across the generations. For God's sake, that even a conservative argument -- at least it was back when there were such people in the United States before "conservative" became the label for nut-job libertarians, yahoo imperialists and money-grubbing ladder-climbers. Put the argument in the context of what we owe one another as members of the same society. We don't owe the aged an "opportunity," we owe them a safety net and a minimum guaranteed standard of living -- period.

The Los Angeles Times and now the Washington Post are getting in on a big story of the last thirty years -- the massive transfer of economic risk from capital to labor. Why can't the Dems use this stuff?? The vast majority of people don't want more risk for more "opportunity" -- the research shows it.

Here's my one-two punch: hit 'em with the conservative moral argument about generational solidarity, and then scare the hell out of everybody with Bush's plans to destroy Social Security ("if you liked what Bush did to Iraq, you'll love what he'll do to your retirement . . .").

In 2002 the US textile workers' union UNITE issued a report on factories in six countries around the world -- Lesotho, El Salvador, Bangladesh, Indonesia, Mexico and Cambodia -- producing clothing for The Gap. The union found: below subsistence level wages, systematic verbal and physical abuse of workers, rampant health and safety violations, routine union-busting, and regular violations of local minimum wage laws. And now these workers have Chinese textile exports facilitated by the demise of the Multi-Fibre Agreement dangling like a Sword of Damocles over their factories.

But thankfully, these workers have free traders like Dean Spinanger, senior researcher at the Kiel Institute for World Economics in Germany and "an expert on the quota system" telling them that they've been taking it too easy too long. In fact, Spinanger says,
"it will make them aware that they have to shape up."
It appears the "shape up" message is indeed getting out.
Already, gains in wage levels and working conditions are starting to unravel. In Lesotho, the government has agreed to give apparel and textile factory owners an exemption from paying a mandatory cost-of-living increase. Business leaders in El Salvador want to reduce the nation's $5.04-a-day maquiladora minimum wage in rural areas to stay competitive with China and its lower-cost neighbors in Central America.

Halfway around the world in the Philippines, a panel of business and government officials has proposed exempting garment makers from paying the minimum daily wage, which ranges from about $3.75 to $5.
Clearly when free traders say "shape up," they mean that $5/day has become an extravagant coddling of labor -- but fear not, little ones! Apparently Jerusalem will be builded here / Among these dark Satanic mills.

Asian currency round-up: Taiwan dollar up, yen up, won up, renminbi down.
Taiwan's dollar had its biggest gain in almost seven weeks, leading a rally in Asian currencies, on speculation investors abroad are increasing share purchases. . . .

South Korea's won rose on speculation the yen's gain to a five-year high versus the dollar Jan. 14 reduces the need for the Bank of Korea to sell its currency to keep exporters competitive with Japanese rivals. . . .

Other Asian currencies also strengthened after the yen's advance. The appreciation in regional currencies today extended weekly gains from last week. . . .

The Singapore dollar rose 0.2 percent to S$1.6351, Thailand's baht climbed as much as 0.4 percent to 38.57, the highest since May 11, 2000. The Indonesian rupiah rose 0.2 percent to 9,140. The Philippine peso gained as much as 0.4 percent to 55.46, its strongest since May 6.
Everyone seems to be taking their signals from Japan. If the Bank of Japan is willing to let the yen rise vis-a-vis the renminbi (oh, and against that other currency, too -- the US dollar or something like that), then so will all the Asian small fry. The name of the game in Asia seems to be for Japan, Korea and Taiwan to compete against one another for the same export markets -- to the US, to China and to one another -- while using their stronger currencies to invest in China so as to compete against one another for the same exports markets, etc. etc. etc.

The Chinese Ministry of Commerce reported last week that FDI into the country hit a record $60.6bn in 2004 while contracted investment -- "a sign of future plans" as they say -- leaped up to $153.5bn. According to Bloomberg,
Companies are rushing to invest in China ahead of an anticipated revaluation of the nation's currency, the yuan, this year. Economists including Yiping Huang at Citigroup Inc. say they expect China's leaders to let the yuan appreciate against the U.S. dollar in 2005, easing a decade-old peg that U.S. politicians partly blame for a ballooning trade deficit with China.
There are a lot of speculators out there, as well as speculative direct investments, putting a lot of pressure on the renminbi to rise. China did pretty well in 2004 in cooling the economy down, and I must say I'm fairly skeptical that the world is in store for any meaningful change to the renminbi peg. More administrative control and higher interest rates, yes, but when you've got the world -- and especially the US -- by the family jewels, why let go?

Friday, January 14, 2005

If we took a holiday / Took some time to celebrate / Just one day out of life / It would be, it would be so nice.
US multinational companies will be barred from using a one-year tax break for repatriated foreign earnings, passed by Congress last year, to finance stock buybacks or dividend payments, the Treasury Department said on Thursday.

Analysts said the rules did little otherwise to restrict how companies could spend the money released by the tax break, estimated at more than $300bn. . . .

Publication of the regulations is expected to trigger a big inflow of capital under the one-time tax break, part of the $137bn corporate tax bill approved by Congress in October. Companies will pay 5.25 per cent tax on repatriated retained foreign earnings rather than the usual 35 per cent. The concession came after lobbying by a coalition of US multinationals eager for a tax holiday to free overseas earnings that have accumulated offshore to avoid corporate taxes.
There's nothing quite like a tax holiday to make a capitalist's weekend, is there? What is most interesting about this provision is that it is projected to bring tens of billions of dollars in capital to the US. In 2004:III the US balance on capital income was +$5.3bn and on private remittances and other transfers, -$8.3bn. With tens of billions promising to flow into the country in 2005, these figures could rise markedly -- and that would mean yet more room to run yet larger trade deficits! Anyone game for $70bn a month?

With more gimmicks like this, the US may be able to go on consuming indefinately . . .

Wednesday, January 12, 2005

I stumbled across this great chart by Robert Scott of the Economic Policy Institute showing the relationship between the US dollar and the US trade deficit since 1980. Everything seems in order per standard economic theory, until it all begins to go haywire beginning in 2002. The data only goes through 2004:II -- simply draw out the red line futher up and the black line further down for an update.

Tell me again how the falling dollar acts to reduce the trade deficit . . . ?

Boy are the sparks gonna fly at the February G7 meeting!
Otmar Issing, the European Central Bank�s chief economist said the euro strength against the dollar had gone too far and Asia should share the burden of dollar weakness.

�On the question of foreign exchange rates, the adjustment at the European level is complete and has also gone too far. The key to solving this... is in Asia and principally China,� Mr Issing said.

�Issing�s comments suggest a step up in the pressure for revaluation of Asian currencies, possibly setting the tone for the February 4-5 G7 meeting in London,� Adam Cole of RBC Capital Markets said.

The yen was taking the strain of dollar selling because though Mr Issing is targeting China rather than Japan, effectively urging revaluation of the renminbi, it is a case of �those [currencies] that can [move] rather than those that should,� according to Mark Austin, chief currency strategist at HSBC. The renminbi is pegged to the dollar while the Japanese currency is free floating.

�I don�t see any movement from China for quite some time. Asia has more important concerns at the moment. China will be waiting to take stock of the repercussions of the tsunami,� Chris Towner of HIFX said.
While China is not a member of the G7, its representatives attended the G7 finance ministers meeting for the first time ever in October. UK Chancellor of the Exchequer Gordon Brown has invited senior Chinese officials to an enterprise forum in London the day before the February G7 meeting in London, assuming they will stay on for the big show itself under a 'special invitation'. Assuming they show up, man are they going to get an earful.

I'm really starting to run out of superlatives to describe the US trade deficit. When you hit $60bn a month, and that in the midst of falling oil prices (WTI spot price avg.: $53.28/barrel in October, $48.47/barrel in November), you've flown right out of the damned thesaurus.
The U.S. Census Bureau and the U.S. Bureau of Economic Analysis, through the Department of Commerce, announced today that total November exports of $95.6 billion and imports of $155.8 billion resulted in a goods and services deficit of $60.3 billion, $4.3 billion more than the $56.0 billion in October, revised. November exports were $2.2 billion less than October exports of $97.8 billion. November imports were $2.0 billion more than October imports of $153.8 billion.
This report is ugly 1000 ways till Sunday. Where to begin? Even though the dollar fell steadily in November and had been falling since early October, US exports were actually down $2.2bn from October to their lowest level in five months. Goods exports really plummeted, -$2.6bn although the much smaller services export number did rise $0.4bn. Lest we be comforted by the robust US services sector, note that the US services surplus for Jan.-Nov. is $44bn -- down from $46.5bn in Jan.-Nov. 2003 and $56.4bn in 2002.

Imports, of course, raced further on, up $2.0bn for the month thanks to the country's unquenchable thirst for imported petroleum. Non-petroleum goods imports actually shrank in November, -$0.7bn, but petroleum raced up +$2.0bn. Again, these are seasonally adjusted figures and oil prices in November fell over 9%. The November data on oil imports in volume terms isn't out yet, but one has to assume that October's figure of 10.3 mbd was shattered.

Surprisingly, US monthly goods imports from OPEC shrank in November by $0.5bn. Of course, the US gets less than half of its oil imports from OPEC, so perhaps we shouldn't be all that surprised. Perhaps all that oil was coming from Canada, the country's #1 foreign petroleum source.

The 2004:IV trade deficit is thus far 12.3% larger than in 2004:III and 15.5% larger than in 2004:II. On the first 11 months of the year the overall US trade balance stands at -$561.3bn. Suddenly Brad Setser's estimate of -$606bn for the year seems conservative -- even downright prudish.

More wine! More women! More song! Eat and drink, for tomorrow we die.

Tuesday, January 11, 2005

Andy Xie of Morgan Stanley thinks renminbi revaluation in 2005 is about as likely as Brad and Jennifer living happily ever after.
Under either international political pressure or internal inflationary pressure, China may revalue the currency in line with market expectations (say, by 15�25%). Such an approach is likely to lead to a hard landing as the massive amount of hot money flows out to realize profits. Commodity prices would fall sharply as a result, and the dollar would strengthen. China would immediately suffer deflation as falling commodity prices and excess capacity cause prices to decline. Since this scenario makes little sense for China overall, I give it a 10% probability.
China is the largest contributor to the US trade deficit (-$131.1bn in goods so far in 2004, or net 25% of the overall goods deficit), so don't expect much in the way of trade deficit reduction this year. In light of a new report by the EPI's Robert Scott for the US-China Economic and Security Review Commission, we shouldn't be expecting much in the way of job growth, either.
Between 1989 and 2003, the growth in US exports to China created demand that supported 199,000 additional US jobs. In the same period, the growth in imports displaced production that could have supported an additional 1,659,000 jobs . . . As a result, growth in the US trade with China eliminated a net 1,460,000 domestic job opportunities in this period. These estimates include both the direct and the indirect effects of changes in trade flows on employment. . . .

. . . the economy has operated well below potential output since 2001 because total employment growth has failed to keep up with growth in the working-age population. In this environment, the persistence of large and growing trade deficits has had a depressing effect on the overall level of employment, as well as its distribution across major sectors of the economy.
So what does 2005 promise? Asset bubbles, lackluster job growth, and the continued erosion of any US export base with which to address the trade deficit. At least we can all rest easy because the National Review informs us that neoclassical economic theory is God-given.
the U.S.�s trade deficit with China . . . has occurred alongside a trading relationship that continues to grow, and which by definition continues to enrich both parties.
Funny how those Ricardian assumptions about balanced trade and money as a veil become accurate descriptions of the "real world" a few hundred years later.

The latest national UK housing price data from Halifax came out on Friday. While there was a surprising 1.1% rise in the seasonally-adjusted national index, there is no mistaking the downward trend. As Halifax reports,
House prices rose by 1.1% (seasonally adjusted) in December and, on a quarterly basis, by 0.1% in Quarter 4. This was the smallest quarterly gain since 2000 Quarter 2, providing further evidence that house price inflation is slowing.

House prices increased by 15.1% in 2004, but by only 2.8% in the second half, with the annual rise last year the smallest since 2001 when prices rose by 11.7%. (2002: 26.4% and 2003: 15.4%.)
More important are the figures for London. I've been following the bursting London housing bubble for a while now, and the end of the year now provides us with a better perspective. Prices in Greater London changed -0.5% in 2004:IV and that follows a -0.6% adjustment in 2004:III. From their peak, Greater London home prices are now -1.1%.

The last time London had two consecutive quarters of falling home prices was in 1995 at the uneasy end of the early 1990s bubble shakeout. The likelihood of a third quarter of falling prices is very high; the last time that happened was 1992-93, the depths of the last popping bubble.

Most economists are quite sanguine over the London market's ability to hold up under pressure. As Halifax itself says,
Housing market fundamentals remain sound � a strong labour market, historically low interest rates and a shortage of housing supply � which should curb the extent of the downturn in the housing market and result in only a 2% fall in house prices this year.
Perhaps. The 1980s run-up in prices was steeper than in the 2000s, and the drop-off more abrupt.

That being said, much depends upon the persistence of these "fundamentals" into 2005. The Independent tells us today that
High street has suffered its worst Christmas for more than a decade, according to a survey published today that confirms retailers' worst fears.

The value of sales through stores' tills in December fell 0.4 per cent compared with Christmas 2003, the British Retail Consortium said. The survey, based on sales at stores that were open a year ago, comes in the wake of profits warnings from some of Britain's best known chains.

It was the steepest fall since March 2003, when Britons were glued to their television screens during the Iraqi war, and the worst December since the BRC's records began in 1993.

The BRC said it was probably not as bad as the slumps during the recessions of the 1980s and 1990s, when sales fell up to 2 per cent. Kevin Hawkins, its director general, said: "These figures represent the worst Christmas for retailers in the last decade." He said it was a reflection of faltering consumer confidence in the face of worries over the housing market and urged the Bank of England to cut interest rates.
Watch for central bank policy to continue to be driven by the need to support asset bubbles, both in the UK and in the US.

Saturday, January 08, 2005

Apologies to all, especially the regulars, for the light blogging this week. With the book manuscript due on the 15th and the General's entire platoon deploying to London at the end of the month, it's been a little hectic.

But don't forget: old soldiers never die, so stay the course, a thousand points of light . . . stay the course.

Thursday, January 06, 2005

I finally got around last night to reading Peter Gosselin's excellent series on income instability in the Los Angeles Times. If you haven't read it, get to the Times web site and read it pronto.

The articles are chock full of very interesting facts and figures concerning the offloading of risk from capital and the state onto labor, at the same time that capital and the state have increased socio-economic risk in general through globalization. One tidbit of data jumped out at me and is especially important in light of today's jobless claims numbers and tomorrow's December employment numbers.
Government used to provide substantial help in coping with joblessness. In the mid-1970s, jobless workers could collect up to 15 months of unemployment compensation. By last December, Congress had pared the program to just six months. Additionally, federal legislation in 1978 and 1986 effectively reduced the value of benefits by making them taxable. And state eligibility restrictions imposed in the late 1970s and early '80s shrank the fraction of the workforce entitled to collect benefits from about one-half to a little more than one-third. Of the 8 million people who were unemployed last month, only 2.9 million were collecting benefits.
Now consider that information in light of news today that first-time unemployment insurance claims surged to an unexpected 364,000 last week.
First-time claims for U.S. unemployment benefits jumped by 43,000 to 364,000 last week, the highest since September, the Labor Department reported Thursday.

It was the biggest increase in nearly three years.

However, a Labor Department official once again encouraged users of the data to look at the less-volatile, more-informative four-week moving average of new claims, which rose by 750 to 333,000. . . .

Meanwhile, the number of ex-workers collecting unemployment checks rose by 61,000 to 2.84 million in the week ending Dec. 25, the highest since September.

The four-week average of continuing claims increased by 13,500 to 2.77 million, a six-week high.
Unemployment insurance claims are only the tip of the unemployment iceberg in the United States. Consider especially the use of temporary workers -- especially around Christmas -- who are not entitled to unemployment benefits. Consider also that
Long-term unemployment has been particularly insidious during this business cycle. In November, 1.74 million, or 21.7 percent, of the 8 million workers classified as unemployed had been out of work longer than six months. The average duration of unemployment remained high at 19.9 weeks.

About 40 percent of workers who collect benefits exhaust them before finding a new job.
For the past four Decembers there has been net job destruction, something that seasonal adjustment cleverly hides from our eyes. Moreover, ever since 1990 at least 2 million non-farm jobs have been eliminated in January, and since 1996, the minimum has been 2.5 million. Seasonal adjustment will sweep away the awful truth, but there are going to be a lot more real seasonally unadjusted unemployed workers in America in the weeks to come.

And if 364,000 seasonally-adjusted workers filed for unemployment benefits last week, rest assured that nearly 600,000 more are out there pounding the pavement with no check coming in the mail.

Like any strung out addict, US retailers need more and more drug to get the same high.
Aggressive discounts after a slow start to the holiday shopping season helped most US retailers reach sales that were slightly above conservative expectations.

Last-minute shoppers and gift-card redemptions after Christmas also helped US retailers post solid sales gains in December.

However, promotions may have hurt profits at some retailers. Discount retailer Target said US same-store sales - sales at stores open longer than a year - rose 5.1 per cent in December but warned that fourth quarter profits would fall short of expectations because increased store discounts cut into profits.

Ken Perkins, analyst with retail research firm RetailMetrics, said: "By all accounts this was a more promotional holiday season than in December 2003. And of course there is a direct correlation between promotion and margins."
Sales are rising, but thanks to discounting more than anything else. The malady of US auto makers is spreading. And are these figures adjusted for inflation?

At the end of the day capital wants profits, not sales. With no pricing leverage, however, increased sales is about all capital can hope for. Rising sales at lower prices means a hell of a lot of throughput if the high profit margins that Wall Street demands are going to be realized. And you know what that means. More imports, higher trade deficits, and a global imbalance that is nowhere close to beginning a steady correction.

Wednesday, January 05, 2005

The US stock markets sold off sharply yesterday amidst fears that inflation is bubbling to the surface. Price data didn't spook them. Instead it was the Fed's analysis of price data which send them scurrying back to their holes.
U.S. financial markets sold off late Tuesday after the Federal Open Market Committee revealed it is seriously divided over the prospects for inflation.

The FOMC was roughly split into two camps on the outlook for inflation at their closed-door meeting on Dec. 14, according a summary of the meeting released Tuesday.

Although the faction that insists that inflation is under control won out at the December meeting, the minutes showed a number of the U.S. central bankers on the committee were growing worried that the weaker dollar, higher energy prices and a slowdown in productivity growth could lead to higher prices.

They saw signs that the prolonged period of low interest rates was leading to bubble-style behavior and "excessive risk-taking," such as "quite narrow credit spreads, a pickup in initial public offerings, an upturn in mergers and acquisition activity and anecdotal reports that speculative demands were becoming apparent in the markets for single-family homes and condominiums."
Two-speed inflation is the name of the game these days. The combination of globalization and loose monetary policy from the major players (esp. US and Japan) means:
  1. outright deflation in most tradable goods and services -- for example, nominal durable goods prices (PCE index) in the US are -19% since early 1995, and clothing and shoes are -13% over the same period;

  2. runaway inflation in assets, especially housing.
It seems the Federal Reserve is today more or less where the Bank of England was a year ago. Back in January 2004 the BoE repo rate stood at 3.75%, just beginning its steady climb to today's 4.75%. UK consumer inflation was and has been well under control, running consistently below 2.0%. However, asset prices -- especially housing -- were spiralling out of control. So the BoE upped rates with an eye to deflating the housing bubble.

The inflation "hawks" at the Fed are staring at much larger housing bubbles across much of the US, particularly California, Nevada, Florida and the Northeast. The inflation "doves" on the other hand are looking at low job growth and consumer prices and see nothing to worry about.

This dichotomy is precisely what one expects to see under conditions of commodity and financial globalization, particularly in a country like the US which can attract capital under almost any condition (stress on almost). The real question is whether the Fed thinks asset inflation is growing out of control and is likely to crash abruptly -- and whether a Fed tightening might burst the bubble itself.

Interest rates are one hell of a blunt hammer to use when attempting to work on a myriad of economic fixer-upper projects. But as the old saying goes, when all you've got is a hammer, suddenly all problems start looking like nails.

I think we can stop calling it "partial" privatization now.
President Bush is expected to unveil his plan for a Social Security overhaul in late February, with administration officials eyeing investment accounts that would hold two-thirds of workers' annual payroll taxes.

. . . the administration is leaning toward letting workers divert 4 percentage points of their 6.2 percent in payroll taxes � almost two-thirds � into investment accounts, up to $1,000-$1,300 a year, the official said. The remainder of the workers' payroll taxes would continue going into the system.

Tuesday, January 04, 2005

The smell of consumer price deflation once again begins to waft through the air.
Fearing the mediocre sales that so many had predicted, department stores and specialty shops sharply marked down merchandise - particularly clothes - in the week before and after Christmas. The strategy brought a surge in traffic for many stores, but analysts said yesterday in reports and interviews that they were concerned that so many markdowns might hurt profits.

"We saw some of the most excessive markdowns at stores, including Ann Taylor, the Gap and the Limited's Express division," said Mark A. Friedman, a first vice president at Merrill Lynch, who covers retail stocks. Asked if he was concerned about the level of markdowns, he said, "Yes, we think there will be more earnings pressure," which may mean lower earnings.

Good news on the Social Security front: House Republicans are not impervious to public pressure.

It is well known that elections to the US Congress -- and particularly to the US House of Representatives -- have become less and less competitive as the decades have worn on. In fact, today House districts are so gerrymandered and the American public is so segregated economically and culturally that House elections are more like elections to the USSR's old Supreme Soviet than anything else. In 2004, 210 House seats were won by landslide (>20% margin), a mere 37 House members won with less than 55% of the vote (a commonly used line to measure vulnerability in the next election), and but 7 incumbents lost -- 4 of those because of Tom DeLay's Texas redistricting.

I have long been afraid that because of the incredibly uncompetitive nature of US congressional elections, House Republicans in particular were immune to voter opinion. Destroying Social Security sure isn't a popular idea, but in this system popularity seems to be the least important characteristic of a member of Congress.

However, this has at least marginally restored my flagging faith in American democracy and the future of Social Security.
Stung by criticism that they were lowering ethical standards, House Republicans on Monday night reversed a rule change that would have allowed a party leader to retain his position even if indicted. . . .

When they rewrote party rules in November, Republicans said they feared that Mr. DeLay could be subjected to a politically motivated indictment as part of a campaign finance investigation in Texas that has resulted in charges against three of his associates. The decision, coupled with other Republican proposals to rewrite the ethics rules, drew fierce criticism from Democrats and watchdogs outside the government, who said the Republican majority was subverting ethics enforcement.

Lawmakers said the party had also abandoned a proposed ethics change that would have effectively eliminated the broad standard that lawmakers not engage in conduct that brings discredit on the House, a provision that has been the basis for many ethics findings against lawmakers. . . .

. . . Republicans unanimously agreed to restore the old rule after Mr. DeLay told them that the move would clear the air and deny Democrats a potent political issue.
Put this alongside the Republicans' capitulation on the intelligence bill last month and you've got a least a sliver of a reson to believe that serious pressure on House Republicans in the Northeast, Midwest and maybe even Appalachia could doom the Boy King's Social Security deform program.

So, the General has a book manuscript due in less than two weeks, and he'd really like a two-week extension from his publisher. What do you think the odds are?