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June 03, 2010

One of you sent me a market letter warning that the credit crisis indicators that had correctly forewarned of the 2008 stock market meltdown were flashing red once again :

    · the two year fixed -to-floating swap rate had exploded from 9.6 bps last March to a 13-months’ high of 64 bps - indicative of less confidence in the quality of souvereign credits;

    · three months dollar-based LIBOR rates had more than doubled from 25 bps last December to 54 bps – suggesting that banks are having less faith in each other’s creditworthiness); and

    · credit default swap rates have surged - in other words, the cost of insuring against the risk of default generally has risen sharply

Reems has been written about the Gaza flotilla incident, some of it by people smarter and/or better informed than I (such as Nicholas Kristof in the article summarized below). So I will limit my comments. 

Israel was clearly “set up”, but walked into a trap of its own making that was due to it overplaying its hand & once again not properly evaluating the potential risks inherent in its contemplated actions (thus in this case the IDF apparently operated on the assumption its soldiers would not meet resistance. What is now likely to happen is that it is going to face wave after wave of Gaza flotillas until it has to fold, or at least moderate, its embargo tents (which will be interpreted by its detractors as indicative of it having become a ‘Paper Tiger” (reinforcing the impression created about the IDF by the outcome of the Lebanon War & that the IDF is only good at is beating up the vulnerable). 

When the Gaza flotilla incident occurred Netanyahu was in Ottawa & scheduled to go on to Washington to meet with Obama pursuant an invitation conveyed to him unexpectedly on May 20th by White House Chief of Staff Rahm Emanuel when the latter was in Israel on a family visit for his son’s Bar Mitzvah. While the reason given for his cancelling the Washington leg of his journey was that he was needed at home ‘to take charge of the situation’, the more likely reason was that he didn’t want to have his ears boxed in private by Obama. Unfortunately this has been a key problem in Obama’s policy vis a vis Israel, an assumption that the Netanyahu crowd is amenable to reason & can be prevailed upon to do ‘the right thing’ by cajoling them in private. But it has become increasingly evident that Netanyahu c.s. interpret this approach as giving them license to become ever more intransigent. So, unfortunately for Obama, the time has come, & likely is long overdue, for Tough Love, dealing harshly with Israel like a parent would with a wayward teenager who thinks he/she has the world by the tail & can get away with everything, for the sake of the individual involved

Thomas Friedman in his latest column quotes an old friend & Israeli university professor as noting that “It’s time we start using our wits (something the Jewish people historically were very good at). If we had used even a tiny fraction of the brain power and resources we put into ‘defence’ into finding a way forward in terms of living with the Palestinians, we would have solved the problem long ago. The Arabs are scared of the Iranians, the Saudi peace plan is still on the table and the Palestinians are beginning to act rationally. But we lack the leadership to make real change.” (perhaps he is onto something : the Israelis could always count of the Palestinians to act irrationally & now that this assumption may no longer bevalid, they are at a loss as to what to do, except to become irrational themselves).



No. 363 - June 3rd, 2010 

IS GREECE JAPAN’S FUTURE? (Project Syndicate, Heizo Takenaka) 

    · The problem of excessive government debt is not confined to the EU. Japan’s Debt-to-GDP ratio stands at 170% (vs. Greece’s 110%). But Japan’s government isn’t taking the problem seriously. In fact the Hatoyama government is focused on boosting spending to meet its grandiose election promises; so the ratio of tax revenue to spending has fallen below 50% for the first time since WW II, & next year’s budget deficit likely will exceed this year’s.

    · But Japanese government bonds (JGBs) have historically been purchased mostly by domestic institutions & households, thereby avoiding the risk of the capital flight that brought Greece to its knees. But there are two reasons why this is about to change. In three years the volume of JGBs outstanding will exceed total household monetary assets (currently 1,100TR yen, i.e. US$12TR, 85% of the US national debt, with 40% of its population). And with Japan aging fast, household savings will decline, & fiscal pressures from higher pension & healthcare costs rise, dramatically. This too will start to bite in three years.

    · Between 2001 & 2006, Prime Minister Koizumi aggressively tackled Japan’s fiscal problem  by advocating smaller government & setting numerical targets for fiscal consolidation, incl. a primary budget balance in ten years. And he almost succeeded : the latter declined from 28TR yen in 2002 to 6TR yen by 2007. But since then Japan has had three Prime Ministers in three years (& now, with Hatoyama’s resignation after eight months in office, supposedly to atone for his failure to keep his promise to have a US base on Okinawa moved off the island but in reality, due to his slumping popularity, more likely to give his party a better chance in the Upper Chamber elections a few weeks away, that has made it four in less than four years), giving rise to a populist spending bias in fiscal policy.

    · And, compared to the current European problem, the effect of a fiscal crisis in Japan will be huge, not just on neighbouring countries but on the world economy; for Japan still is the world’s second-largest economy, accounting for one-third of Asia’s GDP & 8% of global GDP, whereas Greece’s share of the EU’s GDP was just 3% (i.e. <0.1% of global GDP). 

And when that happens, people will ask again : “How come we didn’t see this coming?” 


    · Europe’s woes are only one of many risks still facing the US economy. And they are made only worse by an increasingly incoherent response by Congress (the Senate left town on May 28th for a week’s break without passing the bill to extend unemployment benefits the House had passed - albeit after deleting  provisions for health insurance subsidies for jobless workers & more aid to states - on the specious grounds they must now act to cut the budget deficit).  The biggest risk is the high jobless rate : 15.3MM people are out of work (nearly half of them for over six months, and even at last month’s job creation rate it would take five years to cut the unemployment rate to half its current 9.9%). State budgets are collapsing, necessitating tax hikes & spending cuts that will prompt  layoffs in the public sector & in businesses providing services to state- & local governments. Weaker house prices will  result from millions of foreclosure- & distressed home sales. And credit will stay tight as  small banks are dragged down by soured commercial real estate loans,

    · While so far Europe’s troubles haven’t affected US banks because they own little Greek, Spanish or  Portuguese debt (although they hold US1.2TR of other European debt, an amount similar to the subprime residential mortgage debt outstanding at the end of 2008), the two financial systems are tightly intertwined & it isn’t clear whether the former is prepared for the worst that could happen in the latter. While the EU bailout package has bought time, it will depend  for its success on deep budget cuts in countries in, or teetering on the edge of, recession, several of them with weak governments that may, or may not, be able to carry through the required changes & that, if they do, may well be weakened further by them. So debt restructuring may well be inevitable if the weaker countries are to start  growing again; but  this would require European banks to raise more capital : for German banks, for example, are already leveraged over 20x (vs. the US banks’ 8x) while sitting on US$650BN of debt of the four most stricken countries. 

The US external risks will be less amenable to management by Washington, or anyone else, than the US domestic ones. 


    · Quitting to make mortgage payments last summer has enabled Alex Pemberton & Susan Reboyras to stabilize their family business, go to Outback occasionally for a steak, take their gas-guzzling airboat out for the weekend & visit the Hardrock Casino. He says that “Instead of the house dragging us down, it’s become a life raft ... It’s really been a blessing.” People like them are resorting to a home-made mortgage modification that cuts their payments to zero & challenges lenders to ‘force me out if you can’. Traditional moral qualms have been rationalized away by blaming lenders for snookering them into taking out home loans they couldn’t afford. According to Alex’s mother Wendy, whose house a few blocks from her son’s is in foreclosure after she quit making her mortgage payments two years ago, “I tried to explain my situation (a bout with lung cancer) to the lender but they wouldn’t help ... They’re all crooks.” While there are no hard data on the number of households on the Robertson path of passive resistance, industry insiders say the number of those taking the “rent-free” approach is growing & starting to extend among the estimated one in four households ‘underwater’ on their mortgages that can afford to pay but see increasingly less sense in throwing good money after bad.

    · Foreclosure procedures have been launched against 1.7MM US households. But the process is slow & getting slower due to legal challenges, foreclosure moratoria, government pressures & lenders’ inability to cope with their unprecedented numbers. So in the last 27 months the average time between a borrower becoming delinquent & being evicted has gone from 251 to 438 days (in other words, extending the period of ‘free’ accommodation from 8½ to 14½ months). And for almost 20% of the over 650,000 households that have not made a mortgage payment in 18 months, lenders have yet to initiate repossession procedures, double the year-earlier rate.  

This is myopia cum instant gratification in the extreme : every one of the benefits quoted above falls into the ‘wants’ rather than ‘needs’ category. But as noted earlier, the resultant ‘savings’ on mortgage payments have helped to sustain consumption. 


    · In April it was flat on an MoM basis (after a 0.6% rise in March) despite personal incomes rising 0.4%, resulting in 3.6% higher savings. Meanwhile economists expect  425,000 new jobs to have been created in May, well in excess of the 290,000 April number (but the May number will be inflated by temporary hiring for the Census).  

On Main Street, people still lack confidence about the near term outlook. 


    · Forty-six percent of those surveyed in an AP/GfK poll said they were suffering from debt-related stress, while 53% said they didn’t, and half the former group described their stress as a “great deal” or “quite a bit”.  

While the macro numbers suggest people should feel better, with the economy growing & creating jobs, credit card debt down significantly & household balance sheets improved, it just doesn’t feel like much of a recovery yet on Main Street with unemployment remaining stubbornly high & more households at risk of foreclosure. 

MALIA FOR PRESIDENT (NYT, Thomas L. Friedman) 

    · There are three schools of thought in America’s energy conversation. The petro-determinists never tire of warning we will remain dependent on oil for a long time to come, the same notion they have been peddling since the First Oil Price Crisis in 1973 & one intended to brainwash people into believing that breaking our oil addiction isn’t just difficult but impossible. The eco-pessimists say it is  too late since we cannot rewire ourselves, & the billions in China, India & elsewhere in the Third World who aspire to our lifestyle, to want & expect less growth; they may be sincere but underestimate the power of innovation & the ability of billions of people to solve problems. And the Obama realists, the political pros, who advise Obama this is not the time to lay out a big new ‘Obama End to Oil Addiction Act’ because Democrat lawmakers are suffering from “legislative fatigue”.

    · Obama told a recent press conference that that morning, while he was shaving, his daughter Malia had asked him “Did you plug the hole yet, Daddy?” He should listen to her rather than his advisers & start thininking like a child (who still has 360 vision); for they get it & wonder if it makes sense to continue to depend on an energy source that will destroy many animal species, beaches & ecosystems before future generations can enjoy them. 

It’s easy for a newspaper columnist to make this case, & even easier for the rest of us to agree with him in principle. But Obama is faced with the reality of politics still being ‘the art of the possible’ & that, unless there is a groundswell of change at the US political grassroots, all one can reasonable expect of him, & all he can hope to achieve, is to introduce a marginally greater bias in US energy policy-making in a long-term common sense direction. Having said that, the question does arise if he is doing all he can to encourage the emergence of such a groundswell of grass roots emotion (& the likely answer is that his ‘measured approach’ to problems falls short on that count).   


    · Aeromexico Flight 006 from Paris to Mexico City was diverted to Montreal after being denied  access to US air space because one of its passengers was on a US “no-fly” list. But after Canadian police arrested what a Mexican State Senator described on Twitter as “a dark, Muslim-looking person”, the plane & passengers were allowed to resume their journey. 

The individual, travelling on a US passport, was subsequently turned over to US authorities.  


    · When I first heard rumours on Twitter of an Israeli attack on the Gaza flotilla, I ignored them on the grounds that “Israel wouldn’t be so obtuse as to use lethal force on self-described peace activists in international waters with scores of reporters watching”.But it turned out that not only was it so obtuse as to shoot itself in the foot, for good measure it also blasted American toes in the process & undermined its own long-term strategic objectives.

    · Back in 1973 Abbe Eban, then Israel’s long-time Foreign Minister noted “The Arabs never miss an opportunity to miss an opportunity.” But now a rabbi told me on my Facebook page  that “it is now israel that never misses an opportunity to miss an opportunity.” For under Benjamin Netanyahu Israel has locked itself onto a path that undermines its own interests, & one that could prove catastrophic. Storming a Turkish-flagged ship in international waters (one month after Turkey had - ill-advisedly? - voted for Israeli membership in the OECD) was a huge setback to its efforts to win new sanctions on Iran (circumscribing the nuclear ambitions of which are purportedly Israel’s top priority),  in the process making the latter the big winner in this fiasco, especially since it also antagonized its main support base in the US where, as Peter Beinart recently pointed out in an article in the New York Review of Books young Jews in America identify much less with Israel than their elders did (while in US domestic political terms the Muslim voting block is growing,& becoming increasingly pro-actively anti-Israel, by leaps & bounds, especially in key Midwestern states). 

The most startling startling thing about israeli policies vis a vis its neighbours under Netanyahu &, before that Ehud Olmert, has been a seemingly complete inability to see things beyond the end of their nose & a tendency to react to provocations in a manner not in Israel’s long-term interests.  


    · China’s manufacturing job growth has accelerated to the fastest pace in five years, with the Average Factory Employmeny Index reaching 52.7 in May despite the Manufacturing Purchasing Managers Index slipping to 53.9 from 55.7 in April. This news came the day after Honda offered a 24% pay raise to striking workers at a plant that had shut down its other three Chinese plants. While faster job growth & higher wages will help Beijing’s efforts to shift the world’s third-largest economy away from export dependence, but will also stoke inflation, making it that much more important to help contain domestic price pressures by ending the yuan’s peg to the dollar. According to Huang Yiping, an economics professor at Peking University & once Chief Asia Economist at Citigroup, “After three decades of rapid growth partly driven by cheap labour, China must adjust” to higher wages.

    · After halting minimum wage increases last year, provincial governments have resumed raising them, as have companies from Dell Inc. to the Taiwan-owned Hon Hai Group (the assembler of Apple’s iPhones which has been plagued by a string of suicides at its Shenzen plant to the point where it it is now installing nets all around the plant to intercept those jumping off the roof). A People’s Bank of China survey found that one in four workers interviewed expected at least a 10% pay hike this year & Credit Suisse in Hongkong expects “double digit wage growth a year for the migrant workers over the next few years.” 

Rather significantly, while Hon Hai had indicated a week earlier it it was considering a 20% pay hike for workers at its Shenzen plant, it subsequently offered them 30% (presumably under pressure from Apple that has been embarrassed by claims the suicides were prompted by poor working conditions, with Apple CEO Steve Jobs’ claim that it is “not a sweat shop” being accorded just about as much credibility as Richard Nixon five decades earlier when he declared on TV “I am not a crook”). But even in a country like China the news of such pay hikes will spread quickly, so 20-30% could soon become the “norm”, rather than the 10% indicated in the central bank’s survey. One positive aspect of such pay hikes will be, however, that, since the estimated 145MM migrant workers originate largely from the rural and/or poorer Western parts of the country & send most of their earnings home to their families, such wage hikes will help to “spread the wealth” from the industrializing coastal regions into the boonies and, in the process, broaden the geographic base for a domestic consumption ‘boom’, which is a stated Beijing & global objective.



(EJ, David Marples) 

    · After two decades of setbacks, Russia has become an activist player on the European stage again, anxious to reassert its influence in its ‘neighbourhood’. It has been aided by three unrelated factors. While the Bush program of enforcing democracy by threats or military action alienated its allies & caused acute anxiety in Russia, Obama’s failure to offer any new foreign affairs’ initiatives has been tantamount to isolationism. With NATO pre-occupied with the struggle against the Taliban in Afghanistan, Moscow knows first hand this likely will end in failure; so that longer that takes, the better it expects that to be for Russia. And the change in the Ukraine's presidency : Viktor Yanukovych has been pressured from the get-go by Moscow seeking to exploit  its economic weakness to wring out  concessions that already have included an extension of the Sevastopol naval base lease until 2042, the reintroduction of its security forces - the FSB - in the Crimea (a potential tinderbox & Yanukovych stronghold), the  Crimean parliament decision to elevate Russian to the status of an official language alongside Ukrainian & now Putin’s push to merge the Ukraine’s Naftohaz with Gazprom (that would give the latter control not just over the Ukraine’s energy supplies but also over movement of gas to Western Europe).

    · Earlier this year Russia formed a customs union with Kazakhstan & Belaurus, both states ruled by authoritarian leaders for two decades, although neither is a Moscow acolyte & both pursue strategies that can best be described as “evasive action” to avoid being sucked back into the Russian sphere. But Moscow’s biggest recent setback also originated with Belaurus & involved the former Kyrgyz president Kurmanbek Bakiyev. For it  had long been scheming to get a more friendly regime in Kyrgyztan than Bakiyev’s (who came to power in 2005 after the “Tulip Revolution” removed Askar Askayev, who now lives in Moscow). But Bakiyev is now in Minsk where Belaurus President Alyaksandr Lukashenka has ignored requests for his extradition & incensed Moscow by declaring he should be allowed to return to Kyrgyzstan to take part in a referendun on his presidency.  

    · And Russia is punching above its weight. It is overstretched militarily; while it could beat up on the Georgians in 2008, it couldn’t handle anything much bigger. Its machinations are so transparent as to make its neighbours  wary. Although its economy has recovered from the recession, it remains overdependent on oil & gas & helplessly vulnerable to fluctuations in their prices. Its population has declined at an alarming rate since 1991 (although it grew slightly in 2009). But while its resultant deep social problems thus seem to preclude a return to superpower status, it remains deeply dissatisfied withe the status quo. 

Like it or not, Moscow may have to get used to its superpower days being over.

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