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September 03, 2009

I have long since learnt that it is often better to be lucky than smart (although it helps to be both). This was proven again late last night when my computer for some reason I have yet to fathom ‘ate’ part of this week’s Gleanings including what was the most valuable part thereof, an article by David Cho in the Washington Post entitled Rapid Bank Growth Alarms Regulators that, despite my best efforts I was unable to retrieve from anywhere, including my own files (at which point I gave up & went to bed). Then this morning in a telephone conversation with one of you I was told about Beijing’s warning about unauthorized hedges entered into by Chinese SOEs (State-Owned Enterprises) that let me to build some of its salient points into the following three paragraphs from memory.  

Earlier this year three Chinese airlines took a US$2BN hit on jet fuel hedges that went against them. So recently Beijing issued a warning to a handful of major banks that it was reserving the right to unilaterally terminate all commodity & other hedges they had entered into with a couple of dozen Chinese companies not on its list of those authorized to do such transactions. In doing so, Beijing may actually be doing the system a favour (while enhancing its own position in the global financial system). For these banks obviously had bet that Beijing wouldn’t let these companies, whether they were on the list or not, default if these hedges went against them. So if Beijing were to disillusion of that notion, that it will put a whole new complexion on the ‘moral hazard’ issue (i.e. the expectation, and now in the US the knowledge, that certain financial intermediaries are ‘too big to fail’ and hence will be bailed out if they are at risk of going TU due to bad and/or stupid financial decisions - turns capitalism into a ‘heads I win, tails you lose’ affair).  

This is potentially a lose-lose situation for the banks; for Beijing obviously only would do so if these hedges were underwater. And the banks have no leverage; for China’s importance in the system has now grown to the point where they can play hardball with banks to their heart’s content with  the latter having little choice but to dance to Beijing’s tune & ‘suck it up & take it’ since they cannot risk being excluded from any business Beijing may generate now, or more importantly, in the future. But the news is not all bad for them; for they now know that, if push came to shove, Washington would have but one option : bail them out some more, since the potential implications of not doing so for the multi-trillion dollar global derivatives market,  that in notional value terms dwarfs the US economic & financial system, & for the US economic & financial system itself, would be deemed too horrendous to even contemplate. 

For as a result of Washington’s past bailouts & orchestrated shotgun marriages among major US financial institutions, the ‘moral hazard’ risk (that brought on the recent crisis) in the US financial system has actually increased. This is due to the fact that in the past year the asset base of Wells Fargo has grown rose 40+% from its merger with Wachovia, that of JPMorganChase’s by 50+% from its takeovers of Bear Stearns & Washington Mutual & that of BankAmerica by a whopping 130+% due to its absorption of Countrywide & Merrill. So now these companies & Citigroup, all of them beneficiaries of dollops of bailout money, each account for one-tenth, or more, of the nation’s deposits & between them control half of the mortgages, & two-thirds of the credit cards, in the US; this means that, if they were once deemed ‘too big to fail’, they now are even more so. 

The increases in the unemployment rates in both the US & Canada may actually be good news. For the way these rates are calculated does not include those who have become sufficiently disheartened to quit looking for a job. By all accounts the rise in the rates is in both cases due to at least some of those people rejoining the legions of job-seekers, with the optimists’ interpretation being that they now believe doing so would not be totally futile & the pessimists that they were driven to do so by sheer desperation. 


No. 328 - September 3rd, 2009 

CRISIS ISN’T OVER : BANKER (EJ, Business Browser) 

    ∙ Ewald Nowotny, the Governor of Austria’s central bank & a member of the ECB’s Governing Council, on August 31st warned an economic conference in Alpbach, Austria against believing the financial crisis is over, saying “We did manage to prevent a collapse, but I must strongly warn against the end of difficult economic times.”  

This came on the heels of similar warnings by the Head of the ECB, the President of the German central bank &  Russia’s Deputy Minister of Economic Development, and ahead of those by the Prime Ministers of the UK & Germany, and France’s President, Nicolas Sarkozy, prior to this weekend’s meeting of G-20 policy makers on London. And it is also consistent with earlier warnings from the IMF that the world’s banking system is still be covering up half, or more, of its losses. And while the central bankers may not know where all the bodies are buried, they certainly have a better knowledge of the whereabouts of many than the ‘talking heads’ who are talking up the end of the troubles. 


    ∙ Many business economists doubt the Fed will be able to prevent the trillions in stimulus spending pumped into the US economy from stoking inflation over the next decade. A National Association for Business Economics’ poll  found their median estimate of consumer price inflation to be 3% p.a. for the 2014-2018 period. This confirms consumer surveys that expect the Fed to have its work cut out for it dampening inflationary expectations.  

At turning points, like the 2009-2013 period, change occurs in leaps & bounds, not the  forecasters’ smooth paths. And unless the Fed can pull a rabbit out of the hat, fighting inflation will involve less liquidity, higher interest rates & fiscal tightening, all of them inimical to economic growth.  


    ∙ In nominating him for another term as Fed Chairman President Obama compared his recent efforts to FDR’s “bold, persistent experimentation” to get the country out of the Great Depression. For on his watch to date the Fed has taken on unprecedented risk by taking on a trillion dollars of toxic assets (more than doubling the size of its balance sheet in just  three months), slashed interest rates, bailed out financial industry titans & launched more than a dozen costly lending programs.  According to Lyle Gramley, a former Fed governor from the 80's era when Paul Volcker ‘wrestled inflation to the ground’, “The problem with all of the risk is that it created an unhappiness with Congress ... It’s going to create problems for Bernanke in his confirmation (especially now that the crisis is considered by many as abating), but these things had to be done to prevent an absolute meltdown in the economy.”

    ∙ Gramley believes Bernanke is the best man for the job if only because he created the situation (which is not entirely true : Greenspan created it & Bernanke was left to deal with the consequences just as Obama inherited a whole bunch of Bush-created problematic situations, although he has since added some of his own), saying that “Obama’s nomination is not just a reward for Bernanke’s past performance ... He is the most well-qualified person to deal with the problems that the Fed has created for itself by doing what it had to do...”. But he added a proviso : “What we need now is a lot of prayer.” Lakshman Achutan, Managing Director of the Economic Cycle Research Institute, on the other hand, is less sure, saying “it’s about when they exit from this : If they leave too early, we get deep deflation, and we get spiraling inflation if they leave too late ... It’s a high-wire act ... (and while ) Bernanke has demonstrated that he is skilled at high-drama, emergency surgery ... it’s not at all clear ... he is good at preventative medicine to avoid the need to visit the ER ... We are all hopeful that they get the timing right, but I wouldn’t bet on that heavily.” 

The timing of the onset of the doubling of the Fed’s balance sheet & the launch of the flood of new lending programs that monetized banks’ toxic  assets is noteworthy; for it coincided with ill-fated September 15th decision to let Lehman Brothers go TU. 

U.S.NUMBERS UPBEAT (EJ, Business Browser) 

    ∙ In August the ISM (Institute for Supply Management) Index of National Factory Activity rose to 52.9, up from 48.9 in July, well in excess of the 50.5 expected. This was the highest level since June 2007 & the first time since January 2008 that it has been above the 50.0 reading  indicative of expansion. And the National Association of Realtors reported that its Pending Home Sales Index, based on contracts signed in July, rose 3.2% to 97.6, its highest level since June 2007, and has now risen for a record six months in a row. 

On the other hand, August retail sales were down 2.9% YoY.  


    ∙ Obama should have been better prepared for the hyperbolic claims & heated invective emanating from the opponents of meaningful healthcare reform. For 74 years ago similar denunciations were used to try & kill Social Security, now the nation’s most cherished social program. Then too critics claimed it would bankrupt future generations, and warned it would “destroy” private pension plans & unfairly compete with insurance companies (as is now claimed of the public option). But FDR was prepared for the charges of “fascism”, “socialism”  & “communism” & before these ‘got legs’ had framed Social Security as a matter of “fairness”& of giving Americans the security in their old age they deserved. Unfortunately Obama failed to define the terms for the national debate on healthcare & now is on the defensive to the point where it may be “too late” for a really positive outcome.  

Harsh, but not entirely undeserved. On the other hand, FDR through his ‘fireside chats’ on radio had a national communications monopoly that is no longer feasible in the age of TV, Internet chat rooms, cell phones, Blackberries & text messaging (although, given the way he utilized these media during his run for the Presidency, Obama ought to have been able to turn them to his advantage). 


(CanWest, Sheldon Alberts) 

    ∙ He will address a rare joint session of both houses of Congress on September 9th to outline his priorities for reform in detail in an attempt to regain control of the debate. For August witnessed such an awful decline in support for both the President & healthcare reform, that his liberal critics charge his hands-off approach had enabled opponents to gain the upper hand & saw lawmakers, instead of negotiating a bilateral approach, come up with no fewer than five different proposals, none of them with any measure of Republican support. 

Obama’s challenge now is to rescue what he can by getting the conservatives in his own party too fall in line (which is going to be an extreme exercise in leadership & political arm-twisting). 


    ∙ The state requires everyone to have health insurance through private insurance, employer plans or subsidization for low income individuals (from a fund partially financed by the US$1,000 annual fines on those who don’t get insurance), but has no ‘public option’. As a result, the state now has the least uninsured, 2.6% vs. a 15% national average.

    ∙ Costs have been far exceeded forecasts, in part, but only in part, since the higher numbers of unemployed has made more people eligible for subsidization. To eliminate the fund’s resultant US$9BN shortfall by next June, its board eliminated dental coverage, and the state cut payments to hospitals & boosted cigarette taxes by US$1/ pack, but nevertheless will have less money available for other programs such as education & public safety.

    ∙ But the program hasn’t been able to address the problem of rising healthcare costs; for ‘one person’s cost is another’s income’. And the expectation that, once poor people had coverage, they would use emergency rooms less failed to materialize; in fact they now use them more, which has made the cuts in hospitals’ reimbursement more of an issue.

    ∙ The Massachusetts experiment demonstrates the political & logistical difficulty of  fixing a  healthcare system, even in a state with a high percentage of already insured residents & above-average personal incomes. Polls now suggest that only 26% of residents deem it a success with the remaining 74% evenly divided between those who call it “a failure” & those who aren’t sure (with those who describe themselves as conservatives calling it “a flop” by a 55-18,  & ‘liberals’ calling it a success by a smaller 37-17, margin). 

Nobody should have ever expected such a ‘download’ of healthcare costs from the private- onto the public sector to be easy or achievable without the ‘money following the user’, i.e. higher taxes. Otherwise it would have entailed a major crypto tax cut. 

DUCKING THE DEFICIT (NW, Robert J. Samuelson) 

    ∙ The problem of the burgeoning national debt is political, but the fallout, if any, will be economic. But since no one knows what that might be, when it might show up, if it does, & even whether it will occur at all, politicians from both parties recoil from doing anything unpopular that could bring the budget back into balance over the next, say, six or seven years : they are not in the business of anticipating, or preempting, future problems.

    ∙ While the size of the current deficit is due to the savage recession (which is only partially true), it’s real cause is political. For deficits enable liberal & conservative politicians alike to hang on to their self-serving positions. So we have had deficits in 43 of the last 48 years, although none as large relative to GDP as they are now & are predicted to be as far as the eye can see in the absence of drastic changes in spending and/or taxation policies. The liberals preach we can have more of everything while taxing only “the rich” and the conservatives that taxes can be cut & yet leave everybody with all, or even more of, the government services & benefits they enjoy now, & take for granted.  But neither claim is even remotely believable; for over time all government benefits must be paid for by taxes 

One way to explain a deficit in a way that all but the intentionally deaf can understand is by describing it as the gap between what tax payers want & what they are prepared to pay for. 


    ∙ On Sunday August 30th her bid for a second term in the September 27th elections suffered a possible setback when her right-of-centre Christian Democrat party lost support in regional elections in three states. But her ‘Grand Coalition’ partner, the left-of-centre SPD, didn’t emerge as a big winner, despite the claim by her SPD Foreign Minister/aspiring Chancellor-in-waiting that “Whoever wrote off the SPD in the last few weeks is in for a surprise”, although the head of the Berlin-based Psephos polling firm opined that as a consequence of these results ”alarm bells should be ringing at CDU headquarters.” 

For almost nine months the polls have given Merkel’s CDU & her preferred ally, the Free Democrat  Party, a clear majority, which would enable her to drive the SPD, her current coalition partner, into opposition & like reduce the time for her to form a government from the months it did last time. 


    ∙ It plans to buy a 60% working interest in two undeveloped oilsands properties owned by Athabasca Oil Sands Corp. that hold an estimated 5BN of bitumen reserves in Northeastern Alberta. The company has already filed for provincial approval to develop them, at an estimated cost of as much as $20BN, with the first oil flowing by 2014. 

This alarmed Washington. Carolyn Bartholemew, Chair of the US-China Economic and Security Review Commission, a Congress watchdog, said Petrochina is a vehicle of Beijing’s Communist government & urged Ottawa to subject the deal to a thorough review, incl. ‘sensitive national security issues’. The question, of course, is whose national security she’s talking about; for it’s in Canada’s national interest to have its exports flow into global markets rather than those where ‘transfer prices’ are determined by corporate interests (these have long been an issue for both the US & Canadian tax authorities). Moreover, this involves a Canadian company, not Unocal.  


    ∙ On July 28th a gang executed Iraq’s bloodiest bank robbery ever, absconding with US$3.8MM & killing eight police guards. The cash was since recovered & two former guards of Iraqi Vice-President Adel Abdel Mahdi implicated. On September 2nd four of the gang were sentenced to hang, incl. two who were bank guards themselves who claimed to have told the authorities about the planned heist in advance, but not to have taken part in it. Meanwhile, four others, incl. a captain & a lieutenant in the Presidential Guard, who supposedly masterminded, & participated in, the robbery, and another army officer, are nowhere to be found (& according to the judge will be dealt with at a later date), and the fifth man on trial, a guard at Mahdi-owned newspaper, was released due to ’insufficient evidence’. The Supreme Iraqi Islamic Council, the Iran-oriented party to which Mahdi belongs and that, along with Mustaqa al-Sadr’s party, recently withdrew its support from Prime Minister Nouri al, Maliki ahead of next January’s general election, has accused its political opponents of blowing this matter ‘out of proportion’ to harm its election prospects. 

At least some of those sentenced to death may be ‘targets of convenience’.  


    ∙ In August consumer prices in the 16-member Eurozone fell for the third month in a row (by 0.2% YoY, slightly less than expected, and compared to 0.7% in July & 0.1% in June), but economists are expecting them to start growing again in the months to come. 

So, inflation-paranoid as it may be, ECB won’t change interest rates at its September  3rd meeting.  


    ∙ Russia’s Black Sea fleet on August 27th barred Ukrainian bailiffs from seizing navigation equipment at the two century-old Russian Navy base near the Crimean city of Sevastopol that the Ukranian government has told Moscow it must vacate in 2017 upon the expiry of the current 20-year lease negotiated following the meltdown of the Soviet Union.  

The relationship between the Ukraine & Russia is tricky. The former’s hope to join NATO doesn’t fit Putin’s dream of restoring for Russia the Soviet Union’s sphere of influence. The Ukraine’s  population is a mix of ethnic non-Russians in the West of the country & a larger number of ethnic Russians in the East (who Putin uses as leverage over the Ukraine’s government). And the Ukraine sometimes gets behind in its payments for its natural gas purchases from Russia which twice in the past few years has led to Moscow halting the flow of all gas through the pipelines across the Ukraine to Central & Western Europe (although this  problem may have been alleviated, if not eliminated, by Moscow’s September 1st decision to allow the Ukraine to pay only for whatever gas it consumes, rather than what it is contractually obligated to take down - this will reduce the financial pressure on the Ukraine since its domestic gas consumption has declined by 50%).  

KENYAN INFLATION HITS 18.4% IN JULY (EJ, Business Browser) 

    ∙ This compares to June’s 17.8% annual rate. Much of the increase is due to higher prices for food stuffs & non-alcoholic drinks. 

While no doubt due in part to drought conditions in large swaths of it’s more productive regions (four-fifths of the country is rated ‘semi-arid’ or ‘desert& has little or no food-production potential), this is by no means an isolated case in the Third World. Thus inflation in Ghana is running at a similar 18+% annual rate & in Vietnam at 27%. These rates of inflation, especially when driven by rising food prices, are a recipe for social unrest in countries in which at the best of times many people’s lives already are only marginally, if at all, above subsistence levels.  


    ∙ On August 31st, two weeks after a government $2.6BN bank bailout of five Nigerian banks,  a number of their senior executive were paraded in a federal court in Lagos, charged with  offenses ranging from recklessly granting loans without adequate security or approval to conspiring to drive their banks’ shares higher. 

The optimistic view is that there must be hope for this notoriously corrupt country if it can set an example for those with far more sophisticated & transparent financial & judiciary systems & the cynical view that they simply failed to pay off the right people.   


    ∙ The US Cash for Clunkers program resulted in 690,000 gas guzzlers heading for the scrap yard with their engines seized. This contributed to new car sales in August topping a 14MM annual rate, Ford’s sales of cars & light trucks being up an impressive 58% YoY & GM’s inventory levels hitting an all-time low of 379,000. 

This obviously was a very fast-acting stimulus move. Initially, Congress earmarked US1BN for this program for a ten week period ending September 30th but quickly raised that to US$3BN. But it was all gone before the end of August, i.e. within six weeks. The question now is to what extent these sales were ”stolen” from future months and/or how they will ll affect the car-buying public.      

    ∙ A total of 416 regional banks with a total of US$300BN assets was recently reported to have flunked the regulators’ tests for liquidity & asset quality. 

While in macro terms this is as significant as a speck of fly shit on a window, at the micro level the well-being of banks lower down the banking food chain is critical to that of the communities in which they operate & to consumer confidence.  

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