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Reflections on world economy and more by Nick Rost van Tonningen of Canada

April 21, 2011

Having adamantly opposed capital controls since its founding in 1945, the IMF now has changed its tune, sanctioning them as a way of dealing with the tsunami of liquidity sloshing around in global capital markets. US Treasury Secretary Timothy Geithner called this a “good start” to dealing with this problem, blaming countries like China for driving capital into economies with free exchange rates. But the emerging economies’ governments don’t see it that way. They believe the IMF’s attention is focused on the wrong players, as witnessed by Brazil’s Finance Minister assessment (a hawk on the issue) that this is a “self-defence” measure to enable the countries “responsible for the deepest crisis since the Great Depression ... (that) yet have to solve their own problems ... to prescribe codes of conduct to the rest of the world including countries that are overburdened by the spillover effect of the policies adopted by them.”  Earlier Brazil’s Executive Director at the IMF (who of course reports to the Minister of Finance) had expressed a similar view to a Brazilian newspaper when he told it he objected “to countries that adopt ultra-expansive monetary policy to get over the crisis [and] provoke an expansion of liquidity on a global scale” then insisting on guidelines about how recipients should behave. This looks like a replay of the Doha debate when the emerging economies’ governments for the first time seriously challenged the tradition whereby the developed countries arranged world affairs to promote their own ends.  

The European debt crisis has disappeared from many people’s radar but hasn’t gone away. Italy & Belgium, the No. 2 & No.3 Eurozone countries in debt-to-GDP ratio terms (both well over 100%), are still growing their debt faster than their GDP, & Spain must, over the next 30 months,“roll over” 420BN Euros of debt (vs. 270BN Euros for Greece, Ireland & Portugal combined). 

Many pundits are forecasting a major commodity price correction. What they may be overlooking is that as the US dollar appears less of a ‘safe haven investment’, & inflation fears are growing, investors are seeking refuge in ‘hard assets’, including precious metals & commodities (by all accounts both China & India have been buying gold as if it is going out of style). 

Given the upcoming brouhaha over the debt ceiling, it may be useful to review its recent history. During Clinton’s second term it was constant at US$5.95TR while during Bush 43's eight years it was raised every year but one, to US$11.32TR by September 30th, 2008. The OMB now estimates it will have to be boosted to US$15.48TR to accommodate the Treasury’s borrowing programme for the fiscal year ending September 30th, 2011 (with a little room to spare).  

A key problem in the US deficit/debt debate is that polls show that most Americans consider it to be a less important issue than the economy/jobs : they have yet to connect the dots.  

Despite the impediments to the movement of people & goods posed by Israeli road blocks & other obstacles, the economy of the West Bank has been booming : in 2009 it grew by 8% & in 2010 by 9%, and Prime Minister Salam Fayyad thinks it will hit 9% again this year & could hit 13% by 2013. But it isn’t built on a very solid foundation. For most of the foreign capital flooded in has come in the form of loans (that must serviced) & has gone into real estate, rather than value-adding sectors that provide a long-term sustainable basis for growth & employment, like agriculture or industry. Meanwhile donors are paying the salaries of the 171,000 civil servants (one-quarter of the labour force). And if foreign money were to quit coming, & it could do so on in an instant, the air would go POOF out of the balloon (especially given the Israeli stranglehold on the movement of people & goods inside the territory & with the outside world)  

Rather ironically, as Americans’ support for the free market system has waned from 80% in 2000 to 59% last year, in Communist China it has waxed to 68% from 66% in 2002. 

One item in this week’s edition says the US debt-to-GDP ratio is 69%. This is a flawed number. For it excludes all moneys owed to the SS system & other ‘internal’ accounts. But this is unrealistic, certainly where SS is concerned; for sooner or later, & more likely the former than the latter, it will have to start cashing in its UST securities to meet its obligations to pensioners (note that last year already it paid out more than it took in). The real ratio is half as big again. 


No. 406 - April 21st, 2011 


  • It said on April 18th that, while maintaining the US’ triple-A rating, it is downgrading its outlook to “negative” due to a “material risk” policy makers may be unable to agree on how to cut its large budget deficits, & a 33% chance it could cut its long-term rating within two years (i.e. within the same time frame as the next election). The White House wasn’t pleased, the official US reaction was “We believe S&P’s negative outlook underestimates the ability of America’s leaders to come together to address the difficult challenges facing the nation” & Geithner told CNBC News “things are better than they’ve been ... you see people on both sides ... agreeing with the president that we have to put in place some reforms to bring down out long-term deficits.”

Obviously S&P doesn’t see eye-to-eye with Geithner; for it commented “More than two years after the beginning of the recent crisis, U.S. policy makers have still not agreed on how to reverse the recent fiscal deterioration or address longer-term fiscal pressures.”  And, even using the most optimistic budget cut- & GDP growth- forecasts, the debt will continue growing faster than GDP for some time; i.e. the US debt-to-GDP ratio will continue to grow to levels even more incompatible with a triple-A rating. But what must have really irritated Washington was that following the S&P announcement Hong Lie, a spokesman for the Chinese Foreign Ministry made a statement saying among others that “U.S. Treasury bonds are a reflection of the U.S. government credit and are important investment products for domestic and international institutional investors ... We hope the US government will earnestly adopt responsible policy measures to guarantee the interests of investors.”    


  • Former US Secretary Henry Paulson last week told reporters at the Boao Forum  “Our (US) problems are of our own making and we have to solve them ourselves”, currency is not the biggest issue with regard to our deficit with China, imports from China are not costing jobs in the US since “If we didn’t import from China, we’d import from someone else”, and Chinese imports help increase choice for American consumers & “keep inflation down.”

This is not the song he was singing 2½ years ago. The Boao Forum is an annual conference on Hainan Island that brings together Asian business & political leaders to exchange views on issues important to them. During the meeting Lou Jiwei, the head of China’s US$300+BN wealth fund, expressed concern about the outlook for the global economy with the continuing debt crisis in Europe & US housing slump, and natural disasters setting back the Japanese economy. This year it was marked by growing resentment at the rich countries seeking to impose burdens on the emerging economies while not giving them a voice in global financial decision-making (especially as related to their monetary policies that have inundated them with unwanted capital).


U.S. LACKS CREDIBILITY ON DEBT, SAYS IMF (FT, Chris Giles & James Politi) 

  • On April 11th it said the US lacks a “credible strategy” for stabilizing its debt, that in 2011 it will be the only advanced economy to increase its budget deficit though its  economy is growing fast enough to cut borrowing, & that meeting the 2010 G-20  pledge to halve deficits by 2013, will require tough austerity measures that its economy “appears sufficiently strong” to handle.

Obviously, the IMF & Bernanke don’t see eye-to-eye; but its views will have greater currency with foreign investors than Bernanke’s whose credibility is sinking lower than a snake’s belly.



(Business Insider) 

  • In nine months his Total Return Fund has gone from being 50% to 30% invested in UST securities, the least in its 23-year history. He is concerned about inflation & about the US Treasury for years having to raise massive amounts of new debt to fund major deficits & he believes that the 25 year era of generally declining interest rates is ending.

It’s an economic truism that the value of a good in endless supply will gravitate to zero, and UST securities are not exempt from that. Only those who can/must match assets & liabilities should now buy bonds (PIMCO’s CEO & Gross’ co-CIO, Mohamed El-Erian, said after the S&P announcement “This is a timely reminder of the seriousness of America’s fiscal issues, for the country and for the rest of the world ... The continued failure to come up with a credible medium-term fiscal reform program would increase borrowing costs for all segments of U.S. society” - i.e. the Fed may lose control over US interest rates).  


  • He told NBC’s “Meet the Press” on April 17th he is confident Congress will raise the debt limit & may need to do so before agreeing on future deficits, and that “responsible people (on Capitol Hill) understand that.” Two days earlier the House had approved the Ryan “Path to Prosperity” Plan that would slash spending US$6TR over 10 years by cutting benefits for the elderly (Medicare) & the poor (Medicaid), and taxes for the rich & corporations, while Obama would do so by US$4TR over 12 years by taxing the rich & cutting defence spending.

Let there be no mistake, these are not real savings, just proposals to spend less than originally intended. Both parties now have drawn lines in the sand; but they’re like parallel lines, bound never to meet, except in infinity. The House bill hasn’t got a snowball’s chance in hell to pass in the Senate &, even if it did, the President would veto it in a heart beat. Geithner’s choice of words may offend many members of Congress, & not just Tea Party hardliners. And the key issue is not if, when or by how much the debt limit is raised, but how much damage will be done to the US’ & the dollar’s credibility on the way through.    

THE GRANDDADDY OF ALL BUBBLES? (BW, Peter Coy & Roben Farzad) 

  • Price rises not supported by fundamentals are evident in assets ranging from US farm land, Israeli biotech, Australian housing & Chinese cemetery sites. Commodity prices have soared. Global junk bond issuance is at an all-time high. The S&P 500 trades at 22x earnings, vs. a 16x long-term average. The Fed continues to pump  unprecedented amounts of liquidity into the system despite pressure from Beijing to start raising rates to help relieve inflationary pressures in China (last October the Chinese nouveau riche penchant for old wines resulted in Chateau Lafite Rothschild 1869 wine going for US$233,000 per bottle at auction in Hongkong). But the Fed insists it’s not to blame for any of this, and that rising oil & food prices are solely due to “rising global demand & disruptions in supply”.

Given the recent rise in farm product prices & the longer-term outlook for them, any assertion that the rising price of US farm land is “not supported by fundamentals” is questionable. And the Fed’s claim of being blameless reminds one of Greenspan’s claims, since wholly discredited, that the tech- & housing bubbles were not his doing.  


  • It has been cranking out papers on monetary policy & commodity prices seeking to discredit the notion its monetary policy has caused the spike in commodity prices, & to justify ignoring the impact of high commodity prices on headline inflation & continuing to focus on core inflation. One by the San Francisco Fed said it had ‘found no evidence’ QE had fueled the rise in commodity prices & another by the Chicago Fed concluded that therefore commodity prices could be ignored unless they spill over into core inflation, which by definition is all but impossible

“The lady doth protest too much, methinks.” The Chicago Fed President & the former San Francisco Fed President, & now Fed Vice-Chair, are Bernanke’s dovish soul mates.  


  • The 56 economists surveyed had on average cut their First Quarter GDP growth number to 2.7% from 3.6% just two months ago. But since they envisage a monthly average 200,000 new jobs to be created, and  unemployment to decline to 8.3% (from 8.8% in March) & the price of oil to < US$100 by yearend, they expect growth to pick up again in the Fourth Quarter (to a 3.6% annual rate). One in three expects a Fed rate hike in the Fourth Quarter (& most others in the First Quarter of 2012) as headline inflation heads for 2.8% by Dec. 31st (though core inflation, at 1.7%, will stay in the Fed’s comfort zone).    

One can only hope their economic forecast will be proven right, but odds it won’t be. 


  • Housing starts were up 7.2% MoM in March to a 549,000 annual rate & building permit issuance 11.2% (a disproportionate share of both accounted for by apartments & condos).

Unfortunately these increases were from five decade-low levels (a ‘healthy’ level of housing starts is 1.2MM), the National Association of Home Builders’ Confidence Index slipped to 16 in April, from 17 in March (readings < 50 indicate conditions perceived as ‘poor’), & existing home sales, while up 3.7% MoM in March from February’s depressed levels, were down 6.3% YoY  


  • He will trot out a new Middle East peace proposal when he addresses the US Congress next month (to counter the Palestinian drive for global recognition of statehood that last week was endorsed by the IMF, the World Bank & the UN. all of whom declared it “ready to function as a souvereign state’?), & is apparently also contemplating the withdrawal of some Israeli forces from the West Bank, albeit not from Israeli settlements. Israeli Defence Minister Ehud Barak, the leader of the now truncated Labor Party, warns of a “diplomatic tsunami” if the Palestinian drive for statehood succeeds, & his Cabinet colleague Dan Meridor told a group of reporters & diplomats the regional unrest has shortened the time frame for reaching a peace deal, since it is strengthening Hamas vis a vis the Fatah-controlled Palestinian Auhority.


Now that the ‘Palestinian statehood express has left the station’, the window has slammed shut on Netanyahu’s ability to control the agenda & he must start playing by the other guy’s rules (thus any withdrawal of Israeli forces from the West Bank has lost most of its currency as a bargaining ‘chip’ since, as one Israeli analyst has pointed out, once the Palestinian state comes into being, keeping them there will be a breach of international law). Meridor is Deputy Prime Minister & Minister of Intelligence & Atomic Energy; a long-time member of Likud, he left it in the late 90's to found the Centre Party but lost his seat in the 2003 election. Subsequently rebuffed by Kadima, he rejoined Likud, but only after Netanyahu had promised him a spot high enough up on the Likud candidate list for the 2009 election to ensure he got a seat in the Knesset. 


  • By April 19th over 60 honoured Israeli intellectuals & artists, half of them winners of the country’s most prestigious awards for excellence in science, art & culture, had signed a one-page declaration endorsing a Palestinian state based on the 1967 borders that was to be made public on the 20th. It states, among others, that an end to Israel’s occupation “will liberate two peoples and open the way to a lasting peace.. The land of Israel is the birthplace of the Jewish people where its identity was shaped ... (and) The land of Palestine in the birthplace of the Palestinian people where its identity was formed.”

This message will fall on deaf ears since the hardliners are neither intellectual nor artistic, as well as wilfully deaf.  


  • The head of Iran’s Farmers Home Association, a former Minister of Agriculture, says drought has ravaged the winter wheat crops & that as a result the wheat harvest will fall 30% short of the 15.5MM ton forecast, making it necessary to resume wheat imports.

The problem, however, goes much deeper. Much of Iran’s land mass is arid or semi-arid, and  rapid population growth has led to the growing of crops on land not suited thereto & to husbandry practices that maximize harvests in the short run at the expense of long-term sustainability.     


  • Beijing has made controlling inflation & managing growth its top priorities. So it has introduced price controls on some food stuffs and raised interest rates 4x in the past six-, & bank reserve requirements 9x in the past sixteen-, months. But in March prices generally were up 5.4% YoY, a 32-month high, & food prices 11.7%, while First Quarter GDP growth, at 9.7%, was only marginally down. The pundits expect three more interest rate hikes this year & price controls to be extended to more food stuffs, and to pharmaceuticals, textiles & some household goods (price controls have a poor record of achieving what they are supposed to, & a good one of creating undesirable economic & fiscal side effects).

On April 17th it did indeed further increase the banks’ reserve requirements. Beijing is caught between a rock & a hard place; for both high inflation & slow growth have proven to be conducive to social unrest. And it’s getting annoyed with Washington’s endless outpourings of liquidity. But, while there has been much talk of the inflationary aspects of skyrocketing house prices (they are up 34% YoY to over 25x average annual earnings), there has been less coverage of the role played in the process by Beijing’s massive infrastructure investment programme.      


  • The 79 year-old President of Cuba at the end of his April 16th opening address to a four-day meeting of the Communist Party Congress, its first since 1997, held in conjunction with celebrations marking the 50-year anniversary of the Bay of Pigs invasion, proposed politicians & senior officials should be limited to two five-year terms. This came after he had enumerated a long list of proposed economic changes that will drastically change Cuba’s social system. And he warned major changes are needed if Cuba is to survive, that problems have been ignored for too long & that “No country or person can spend more than they have ... two plus two is four. Never five, much less six or seven, as we have sometimes pretended.”

To many people’s disappointment he specifically rejected the idea of private property. 


  • During the go-go years Iceland’s banks were the most reckless & irresponsible in the world & when they crashed they were 10x the size of the country’s economy. And the government’s refusal to take their debts on its books, forcing creditors to take the hit with the benefit of hindsight is increasingly looking to have been a smart move (although the decision to do so was less a matter of smarts than of an inability to bail them out since  doing so was simply beyond its means). There ought to be a lesson here for the EU & the IMF that forced bailouts on Greece, Ireland & now Portugal that left creditors whole while saddling their governments with unsustainable debts.
  • For while Iceland experience was not painless - its economy shrank 7% in 2009, unemployment quadrupled & the national debt more than doubled to 100% of GDP  its economy is now starting to recover (GDP is expected to grow by 2½% this year & unemployment has begun to decline) while in Ireland where the government let the banks’ debts be offloaded onto the taxpayers’ shoulders, growth this year may (optimistically) be in the 2% range & the debt-to-GDP ratio is expected to hit 125% in two years.    

And the proof of the pudding is in the eating : it is now cheaper to insure Icelandic debt against default that it is to do so for Greek, Irish or Portuguese debt. 


  • On April 19th it raised 1.4BN Euros of three month money at a 4.10% annual yield (up from 3.80% tow months ago), and the yield on its 10-year benchmark bond soared to over 14%. And while the EC issued what it called a “very firm denial” of Greek media reports that Athens was going to reschedule its debt, Clemens Fuest, a German Professor of Business Taxation at Oxford University who is also Chairman of the German Ministry of Finance’s Technical Advisory Committee told Reuters : “One must recognize realities. I am expecting a haircut. The interest payments are breaking Greece” (even though it has announced that it expects to raise 50BN Euros by 2015 from the privatization of the country’s power & telecom companies & the ATEbank).

And the  President of the Association of German Public Sector Banks subsequently commented  that the banks would be able to cope with a restructuring of Greece’s debt (taken as a sign that the banks would not oppose such a move - while this will be helpful to Chancellor Merkel at one level, it won’t help her much with Franz & Hildegard German Taxpayer (who detest the idea of a single one of their hard-earned going to those lazy Greeks.

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