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September 2, 2010

The American investor rush into bonds defies common sense. The income they generate is minuscule, the more so on an after tax basis, and with interest rates at all but record low levels, the potential for capital appreciation is limited, to say the least. For this to prove a sensible investment will require two things. Inflation must remain subdued - possible but not probable given the amount of liquidity pumped into the system, the age-old tradition of governments inflating their way out of untractable debt problems, and the pressure of a growing global population & rising living standards on resource prices. And interest rates must remain low - which will require a willingness by the Fed not to raise interest rates if inflation were to rear its ugly head & by foreign investors to continue buying UST securities at current interest rates, when in recent years they have lost more on the US dollar’s depreciation against their own currencies than they generated in interest income.


It reflects on North America’s near-term priorities & longer term economic prospects when its working age adults average 13 days of vacation a year (vs. the Brits’ 26 & the French 38) while its childrens’ school year & days are among the shortest in the world. 

In 2005 China’s economy was half the size of Japan’s; this year it surpassed it as the world’s second-largest (along the way having tripled its copper-, & quintupled its iron ore-, imports). There is a lesson here for the US : the compounding effect of growth at 8-10% vs. that of 0-2% can amazingly rapidly close what once seemed all but inbridgeable gaps. And there is another lesson for the US in the Economist’s assessment of Japan’s basic problem : “it suffers from a gross misallocation of resources, both financial and human ... it has long kept the cost of capital low, to ... help stragglers ... the system almost guarantees that fresh capital goes to the losers of yesteryear ... it has lost its knack for getting the best out of its human capital.” (similarly in the US in recent decades the ‘best & the brightest’ went to Wall Street  to do things of limited, if any, real economic value - as Goldman’s CEO conceded last year - rather into economically worthwhile things like developing new technologies or educating new generations of scientists & engineers).  

At the end of WW II, the average American home owner had 80+% equity in his home. Over the next 20 years this slowly declined by one quarter to just over 60%, whence it rose to 70% by 1980, only to decline again to 60% by 1990, at which level it held more or less steady until 2004. But then ... BOOM ... it skidded to 35% in just four years, from which level it has since recovered to 38%. And Alan Greenspan wants people to believe he couldn’t foresee the potential consequences thereof? He’s selling himself short! 

The Canadian authorities have ‘rolled up’ an alleged homegrown terror plot involving three Muslim Canadian residents, a medical doctor, an X-ray technician & a former engineering student. Whether or not they will ultimately be found guilty or not, press reports that the Montreal Muslim community of which they were part has put its wagons in a circle around them may have the unfortunate effect of strengthening some people’s belief that all Muslims living in Canada want the privileges, but not the responsibilities, associated with living in, & have no loyalty to, this country. 

The scope of the floods in Pakistan, that now are abating but likely not soon or fast enough to let farmers get on with the fall planting of grain, can be gauged from the fact that at one point the flow of water in the Indus River was 40x normal (prompted first in late July by a cloudburst in its upper reaches that dumped over a foot of rain in a single day, i.e. more than usually falls in an entire month of monsoon rains, the effect of which was subsequently aggravated by weeks of unusually heavy monsoon rains).   

US analysts are forecasting 38% corporate earnings growth this year & 22% more in 2011. But only 29% of their 160,000 BUY/HOLD/ SELL recommendations identified by Bloomberg fall in the BUY-, & 57%  of them in the HOLD, i.e. cop-out-, categories.    

British scientists have unlocked wheat’s genome secrets. This is said to clear the way for developing higher-yielding strains that will help alleviate the global grain situation. But there are two problems. First of all, this will take time. And more importantly, farming is not simply a matter of creating something out of nothing; it is an intricate process that converts solar energy, water & plant nutrients into plant material. So higher-yielding wheats will require more water & fertilizer inputs, in the right amounts & at the right times to fulfill their promised potential (the lack of which proved the Achilles heel of India’s earlier, Dr. Norman Borlaug-inspired  Green Revolution). And the availability of water for irrigation purposes is becoming especially problematic. 

Israel’s military spending, at 7%, is the fifth highest globally in GDP terms, exceeded only by Eritrea (20.9%), Georgia (8.5%), Saudi Arabia (8.2%) & Oman (7.7%) and way above the US (4.3%), India & Pakistan (2.6% each), the UK (2.5%) & China (2.0%)   



No. 376 - September 2nd, 2010 


    · The Geneva-based WTO  reported on September 1st that in the First Half of 2010  the value of total world merchandise trade was up 25% YoY. 

Outside the US 12-mile zone things may be less gloomy than those inside are being led to believe.  


    · Three IMF staff papers made public on September 1st warn that a number of countries are running perilously close to their “debt limit”, the point at which markets start raising interest rates on new borrowing out of concern of a possible default. Of the 23 wealthy countries they analyzed, Greece, Iceland, Italy, Japan & Portugal were close to that point, and Britain, Ireland, Spain & the US moving into ‘dangerous territory’. But they were relatively upbeat on Greece; while the EU & the IMF have loaned it US$142BN & by their own estimate its debt-to-GDP ratio will hit 150% by 2013 despite drastic fiscal action, and some analysts believe the Greek people won’t tolerate the austerity needed & demand a default, the IMF economic hotshots say a number of countries over the past 30 years have cut spending on the scale required of Greece without defaulting, with one of them saying that ”Once countries endure pain of adjustment, they persevere … rather than default”. And with much of the debt problem being due to healthcare spending & pension obligations, they say the debt problems can be solved by getting healthcare spending & pension costs under control & boosting growth

This is ‘economic PhD. talk’, remote from the real world. Most of the countries they refer to were in the developing world where the ‘will of the people’ is more inchoate than in Greece.          


    · Who could have predicted that the once invincible American greenback would have to be propped up by China buying US Treasury Bills? HSBC’s London-based Chairman Stephen Green sees the new world order as a triangle, with the Asian “workshop” countries on one side, Western consuming nations on another & resource producers on the third. As Western consumers buy goods made in Asia with fuel & raw materials supplied by the resource producers, the latter two end up with exchange reserves & the former with debt. The West is past its “Best Before” date & faces a secular decline in its standard of living.

    · But Canada may be an exception. It has a relatively modest national debt. Its economy weathered the recession reasonably well & is growing jobs. But most importantly, as both a consuming & resource-based nation, it occupies two sides of the triangle. So,as the third of the world’s population living in China & India experience the most rapid improvement in living standards ever & need a constant flow of resources to sustain this, Canada can help supply them, thereby creating an opportunity to cut itself loose from the apron strings of a weakening United States. But to do so we must quit worrying about the accidental death of a few ducks & denigrating resource developers as “hewers of wood and drawers of water”, ignore environmentalists who want to turn Canada into a vast national park & turn the regulatory process for developers from a nightmare into a responsible & constructive process.


He makes some good points. But as the ex-CEO of one of Calgary’s biggest oilpatch companies, he myopically sees resource development as the be-all & end-all. But letting development happen on a ‘let her rip’ basis is neither “responsible” nor “constructive”. As to the national park idea, there is growing empirical evidence that there is more long-term sustainable development potential in tourism than in resource extraction, especially for a country, like Canada in the period ahead, that it is replete with space in a rapidly urbanizing world in which many people have increasingly less of it. 


    · “Plain vanilla” recessions are caused by inflation & excessive manufacturing inventories but depressions by the bursting of an asset bubble & a contraction of credit. In a depression interest rates go to zero but there is no revival in credit-sensitive spending. In a depression the banks sit on bags of cash but won’t lend. In depressions attitudes towards debt, discretionary spending & homeownership  change. In a recession the economy is revived, & in a depression sustained, by government. You decide which best fits the bill today.     

Toronto-based Gluskin Sheff’s David Rosenberg, formerly Merrill’s North American Economist, has been consistently bearish for some time & may be overstating the case. 


    · Stress, ignorance & fears that those  in charge are not just not fixing anything but making things worse are prompting anti-politician anger that’s getting more palpable by the minute. In the New York Times, David Brooks recounted how during a recent vacation in Montana everybody he met had expressed disgust with Washington, leading him to the conclusion that “the gap between the ... masters of the universe and the rest of the country is just too wide. Nobody is listening. Minds are made up. The situation is dangerous.”  In Toronto a loud-mouthed populist leads the polls in the mayoralty race despite his obstructionist record at council meetings, and his having admitted to marijuana possession- & DUI charges in the US & one of assaulting his wife in Toronto (which was later withdrawn). But this may actually be a plus with the big & growing  “I’m mad as hell and I am not going to take it anymore” crowd that feels short changed compared to, say, refugees, immigrants & public servants.  

The “ME”-generation is more cognizant of the mote in others’ eyes than of the beam in its own; thus the Republican tax-hating grandmother running against Democratic Senate Leader Harry Reid in Nevada depends for her lifestyle in part on her husband’s public servant’s pension. 


    · The latest economic data (that revised Second Quarter economic growth from an unexciting 2.4% to an anemic 1.6% annual rate) had doomsayers pronouncing that the recovery was a mirage & that the recession that started in December 2007 never ended (interestingly enough, the National Bureau of Economic Research panel that determines the onset & end of recessions has yet to declare it officially ended - not unlike the early Thirties when it refused to be beguiled by several false starts?). If the unprecedented pump priming of 2008 & 2009 isn’t working it’s because this recession is unlike any since WW II; thus according to David Rosenberg, “After all the monetary, fiscal and bailout stimulus, the economy should be roaring ahead ... this is not a traditional recession.”

    · While Fed Chairman Bernanke on August 27th told the world the Fed isn’t out of “bullets” to pump more life into the economy (Congress, with voters in a mid-term election year madder than hornets, being in no mood for any new fiscal initiatives), the fact remains that with US$1+TR on deposit with the Fed (earning a measly 0.25% interest) banks aren’t short of cash to lend (validating once again the market saying that “you cannot push on a string” - i.e. make lenders lend or borrowers borrow if they see no sense in it & don’t want to).

    · Other post-war recessions were driven by drops in demand that in due course created enough pent-up demand to prompt higher levels of output, more hiring & renewed growth. What makes this one different is that household wealth (much of it belonging to a generation nearing retirement) has shrunk by US$11.7TR from its 2007 peak, that commercial banks had to write off US$350BN in bad loans (which won’t be the end thereof), that federal deficits have grown to unprecedented levels, that state & local government face massive budget shortfalls (that have forced them to slash spending since by law cannot run deficits, thus undoing the effect of much of Washington’s pump priming) & that the housing market is acting like a “boat anchor” on the economy. 

The hoi polloi’s gut tells them the party is over; but that doesn’t mean they have to like it, & they don’t; so they act like petulant children upon first encountering the word ‘NO’.  


(Bloomberg, Caroline Salas) 

    · He told Bloomberg Radio that “We cannot prevent slow growth for a number of years ... We are running out of policy bullets” & that, with the banks sitting on US$1+TR of excess reserves, “monetary policy is becoming ineffective.” And he prophesied Third Quarter GDP growth of < 1% & a 40% chance of a ‘double dip’ recession (while the consensus still expects decent Second Half GDP growth, albeit shaded down from 2.80% to 2.55%). 

His current economic guru status is based on his having called the recession before anyone else, & he has ever since been aggressively cashing in on it. 


    · The Labor Department reported on August 26th that in the week before new jobless benefit applications had declined for the first time in a month, & more than expected, by 31,000 to 473,000. On the other hand, the number of those getting pogey exceeded 10MM for the first time in four months, due to an increase in those getting extended benefits. 

At the macro level we may be seeing a breather in a weak recovery, not the much- ballyhooed “double-dip”; but at the micro level, on Main Street, ahead of the mid-term elections, that doesn’t matter : the only thing that counts there is the stubbornly high unemployment number. The Labor Department also reported that productivity in the spring quarter fell by the most in four years, indicating that companies had reached the limit of their ability to squeeze more work out of their existing work force.  


    · After three lacklustre months (it fell 0.1% in April, rose 0.1% in May & was flat in June) consumer spending rose by 0.4% in July, the most since March’s 0.5%, helped by a jump in demand for automobiles (which in August fell off dramatically to less than 1MM units in what traditionally is a good month for car sales). While some remain concerned this may be unsustainable if unemployment remains high, Peter Newland, an economist at Barclay’s Capital Research views the higher July spending as a good omen for the Third Quarter.   

Factors supporting Newland’s more-optimistic-than-the-common-wisdom view include the savings rate declining to 5.9% of after-tax income from 6.2% in June (the highest rate in nearly a year), private wages & salaries rising at US$23.3BN annual rate in July after declining at a US$45BN rate in June, & the Conference Board’s Index of Consumer Confidence in August  rising to 53.0, from an upwardly revised 51.0 in July, rather than being flat at 51.0, as expected.  Morgan Stanley’s Richard Berner made an interesting & seemingly relevant point in 2007, namely that, while a shift to a higher savings rate initially has a disproportionate impact on consumption spending (since every incremental dollar saved cuts into consumption spending by the same amount), once the transition is completed, consumer spending starts growing again in line with income growth. 


    · The ISM’s Manufacturing Index rose to 56.3, from 55.5 in July, while a decline to 53.0 had been expected (with exports & higher domestic business capital spending getting the credit). This was the 13th month in a row this index has been in positive territory (i.e. > 50), although at its current level it is still well below April’s 60.4 (which had been a six-year high). And its index of manufacturing managers’ hiring intentions rose to 60.4, a post- December 1983 high. On the other hand, the flow of new orders abated to a 12-months’ low, after surging earlier in the year, which could slow manufacturing growth in the second half. 

Less positive developments included construction spending slipping 1.0%, twice the rate expected, to a US$805.2BN annual rate, an eight year low, & reports that private employers may have cut 10,000 jobs in August (while in July they had created 37,000 new ones, a downward revision of the initially-reported 42,000). 


    · The 89 year-old, Iraqi-born rabbi Ovadia Yosef is the spiritual leader of the ultra-Orthodox Shas Party, a key member of the Netanyahu coalition. In his weekly sermon to the faithful on August 28th, a few days before face-to-face negotiations were to resume in Washington, he told them “Abu Mazen and all these evil people should perish from this earth ... God should strike them and these Palestinians - evil haters of Israel - with a plague.”  

Coming from someone who in the 90's broke with other Orthodox Jewish leaders by voicing support for a territorial compromise with the Palestinians, this may be more a sign of the hardening of attitudes (& of growing fears they’re about to be sold ‘down the river’?) on the Right than a function of his dotage. And with the ten-months’ building freeze on the West Bank (but not East Jerusalem) set to expire on September 26th, right wing settlers are already gunning their bulldozers’ engines in anticipation of resuming building with a vengeance on that date (in fact, they announced on September 1st that they would resume building forthwith - further confirming their fears of a for them adverse outcome of the negotiation process that is about to start in Washington?).



    · The common wisdom is that “nothing will come of it”. But the domestic political environment is more favourable than perceived by some; for Netanyahu has no challengers &, due to greater security & an excellent economy, more political strength than any of his recent predecessors. Abroad it’s a different story : the country is increasingly isolated due to its endless conflicts with its neighbours & the growing opposition to its occupation, settlement expansion & excessive use of military force. Overarching all is Iran’s growing nuclear threat, which he came to power to save Israel from. But for that he needs US support, & it comes at a price. So, while his regime is seen as “hard-line”, it really is the most dovish since Yitzhak Rabin’s 15 years ago : he has obeyed every one of Obama’s dictats, accepting a two-state solution he opposed his entire career, declaring a 10 months’ moratorium on building in the West Bank & slowing down building in East Jerusalem, and easing the siege of Gaza after the Turkish flotilla debacle. The moment of truth will come later this month with the end of the building moratorium : if Netanyahu can show enough progress to keep his coalition intact & Mahmoud Abbas at the table, there is hope that ’s one year deadline may be met. And, since by then Iran is expected to take its next nuclear step, next summer could be a double whammy decision time in the Middle East. 

Netanyahu may not be as strong domestically as he claims. Defence Minister Ehud Barak (who recently said Israel might be willing to turn parts of East Jerusalem over to the Palestinians, only to be immediately countermanded by a Netanyahu aide saying “Our position is that Jerusalem will remain the undivided capital of Israel”) has told him his Labor Party will leave the coalition by year end if there is more building & no serious progress in the talks, and wants him to dump his hardline rightwing coalition partners in favour of Tsipi Livni’s centrist Kadima Party (which would be a bitter pill for Netanyahu to swallow since her cooperation would come at a price). Either way Israel’s political elite may soon be faced with nasty choices they have long avoided. But what was fascinating was Netanyahu’s reaction to the killing near Hebron in the West Bank, the day before the talks were to start, of four settlers by a lone Palestinian gun man (for which Hamas subsequently took credit, as it did for the wounding of two more the following day near Ramallah). For, with Secretary Clinton by his side, he told reporters “We will not let terror decide where Israelis live or the configuration of our final borders. These and other issues will be determined in the negotiations for peace we are conducting...” For this was a stark departure from the Israeli tradition to react in an all but Pavlovian manner to let such incidents shipwreck whatever peace discussions/negotiations were ongoing at the time, thereby handing a few crazies with guns & explosives a big hammer with which to smash the process to smithereens (thus appearing to validate both the writer’s claim that, outward appearances to the contrary, Netanyahu is under Obama’s thumb, and the settlers’ fears of a for them unhappy outcome).The primary outcome of these talks was an agreement to meet every two weeks, starting on September 14th in Egypt. 


(CD, Hu Yuanyuan & Wang Xiaotian) 

    · In August China’s Purchasing Managers’ Index rose 0.5, to 51.7.  

This came after declining for three months from April’s 55.7. 


    · The EC’s Index of Economic Sentiment, reflecting both business & household sentiments, in August rose to 101.8, from 101.1 in July. In announcing this the Commission also noted a remarkable three point increase in the Consumer Confidence Index. Combined with the news of 3.9% annualized Second Quarter growth, this prompted speculation that, when the ECB Board met on September 2nd, it would revise its 1% GDP growth forecast for 2010 from 1.0% to 1.5% (in the event it raised it to the ‘1.4% to 1.8% range, centered on 1.6%’, & for 2011 to the 0.5% -2.3% range, centered on 1.4%, vs. its previous forecast of 1.2%).

    · This is largely due to improved economic activity in Germany (where a boom in exports produced 9% annualized growth in the quarter) & other Northern European countries which, however, is expected to decelerate as the year progresses, due to a slowdown in demand from China & to fiscal tightening in parts of Europe starting to bite. And while the ‘fringe countries’ (Portugal, Ireland, Greece & Spain) remain a drag on total Eurozone growth, their combined GDP of less than 20% of the total won’t be enough to derail the expansion. 

The US may have become a brake on, rather than an engine of, global growth. 

U.K RETAIL SALES SURGE (EJ, Business Browser) 

    · In August British retail sales grew at a faster-than-expected, three year-high rate, suggesting July’s surge in retail sales wasn’t a one-of event & that the economic recovery seen in the Second Quarter was being sustained into the Third 

Clothing sales growth was the strongest in the 22 years for which data are available.   


    · South Africa’s World Cup’s success story is unravelling as its poverty-, unemployment- & economic inequality problems resurface. Cosatu, the South African Trade Union Congress, a key player in the “Zuma for President” campaign, is now locked in a bitter pay dispute with his government just weeks before an important ANC policy conference. One million public sector workers are in the third week of a strike, seeking an 8.6% wage increase while the government has offered 7.0%, twice the rate of inflation. There are deep policy divisions between the government & Cosatu, & even deeper ones with ANC’s youth wing, another traditional Zuma core base of support (whose firebrand leader, Julius Malema, he tolerated until he praised President Mugabe, upon which Malema made things personal by accusing Zuma of kowtowing to the Queen while in Britain. And now he is being criticized more widely for being on a trade-boosting mission in to China rather than attending to matters at home. 

Giving in to their demands risks discombobulating the local & global business community while giving more money to those with jobs cuts into the resources available to create new jobs for those without any at all in a country in which the unemployment rate is North of 25% (Cosatu since turned down a new 7½ government offer). 


    · During demonstrations protesting against the recent rise in the prices of essential goods six people were killed when the police used live rounds because they “ran out of rubber bullets.” Bread prices have risen by up to 30% due to the weakening of the local currency, the Metical, against the South African Rand. One Maputo resident told Reuters  “I can hardly feed myself - I am enraged by this high cost of living.” 

This may only be a harbinger of things to come in the poorer parts of the world when the recently higher wheat-, & other grain-, prices start percolating down to the grass roots.

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