One of the more thoughtful market letters I get recently commented on the latest ten-year Budget forecast by the non-partisan CBO (Congressional Budget Office). It calls for revenues to rise from US$2,228BN in 2011 to US$4,961BN & expenditures from US$3,708BN to US$5,726BN, and the deficit to shrink from US$1,480BN to US$763BN & the deficit-to-GDP ratio from 9.8% to 3.2% of GDP, but the debt/GDP ratio to rise rising from 62.1% to 76.7%. The analysts has three problems with. The CBO appears to assume average annual GDP growth in excess of 3% (which is ludicrously unrealistic) & continued low interest rates (which it is equally unlikely). It understates the national debt, & the debt-to-GDP ratio, by 50% by excluding internally-held debt, such as that owed to the SS system which will start being drawn down in the foreseeable future. And it notes that the CBO doesn’t expect a single balanced budget year during the decade.

The Fed will become more dovish/more stimulus-biased this year. For three of the four regional Fed Presidents who rotated out of voting positions this year were the more hawkish ones last year (Minnesota’s Narayana Kocherlakota, Dallas’ Richard Fisher & Philadelphia’s Charles Plosser).

A harbinger : Brazil’s GDP has just surpassed that of the UK. Another : Italy says it will start penalizing primary dealers who fail to participate regularly in its securities’ auctions - it’s not a good sign when a government must resort to browbeating dealers into buying its paper. A third is Adam’s Smith’s observation that there has never been “a single instance” of souvereign debt being repaid once “accumulated to a certain degree” (which according to Ken Rogoff & Carmen Reinhart is a National Debt-to-GDP ratio of 90%) - nothing much has changed in the intervening 235 years. And finally, two years ago Fed Chairman Bernanke refinanced the mortgage on his US$840,000 home; but last September, just after launching Operation Twist to drive mortgage rates down & stimulate the economy, he did so again, switching into a US$672,000 30-year fixed rate at a purported 4% - since he is neither known to be stupid nor to make stupid moves in his personal life, we might all want to sit up & take notice!.

After ‘opting out’ at last month’s EU Summit, David Cameron’s Conservatives have, for the first time in 14 months, pulled ahead of Labour in the polls, at 39% (up 4 points) vs 38% (down one), whereas in January 2011 Labour had outpolled the Conservatives by 14 points. The wisdom of his move, much criticized by Britain’s desperate EU ‘partners’, will be borne out eventually.

According to one analyst ‘Japan is well on its way to becoming a capital importer’. This could cause the last thing the world needs right now, another souvereign debt crisis. For Japan has a debt/GDP ratio that makes Greece’s look modest by comparison (at last report 228% vs. 156%) & a budget deficit that more than doubled in recent years to the 9% of GDP range. It long got away with this because almost all its debt was held internally (so the government didn’t worry much about its rating & the rating agencies left them alone). But many of the mama-sans who traditionally bought lots of Japanese government bonds for their retirement , are now starting to dis-save in retirement. So the rating agencies recently woke up to reality. While not many years ago Japan was solidly triple-A rated, last August, five days before the country got its sixth prime minister in five years, Moody’s dropped its rating a notch to Aa3, thereby bringing it in line with those of S&P & Fitch, except that Moody’s still has a stable-, & the other two a negative-, outlook. And just before Christmas, Japan’s own rating agency, Ratings and Investment Information Inc., cut its rating for JGBs to AA+ on the grounds it could “no longer consider the government’s ability to adjust fiscal conditions on its own to be at a level required for the highest rating.” Longer term, Japan’s demographics are awful. Its population has been shrinking for years due to few births, virtually no immigration (which is unpopular & alien to its culture) and, most recently, evidence that young, well-educated Japanese are emigrating to Brazil (1½ +MM of whose people, i.e. close to 1%, are of Japanese extraction). Its womenfolks’ fertility rate is 1.37, the fifth lowest of the 222 countries for which data are available, ahead only of Taiwan, Singapore, Hong Kong & Macau, and well below China’s 1.61. And it is most severely affected by Asia’s “flight from marriage” (in part because, as young women become better educated, they find it hard to find marriage partners whom they deem their intellectual equal & young men are turned off by women better educated than they are, and in part also, in Japan’s case at least, in rebellion against the traditional attitude of ‘salarymen’ towards their wives). So in Tokyo one-third of women in their 30's have never been married, & nation-wide the ratio is 18%, vs 20% in Hong Kong, 16% in Taiwan, 15% in Singapore, 7% in South Korea & < 1% in India.

In the last month or so winter in Edmonton has been AWOL. While its average daytime high for December is -5°C (23°F) & for January -7.3°C (19°F), for the last month it has consistently been in positive territory, occasionally going as high on 8°C (46°F). It feels more like early spring than mid-winter. And other than having had a 20 cm. dump of snow, one month’s worth, on November 11^th, there has been little snow, & what did fall has all but disappeared. But that’s nothing compared to North Dakota : on January 4^th temps in Bismarck hit an all-time record high of 55°F (13°C), & the weather forecast calls for highs in the 60+ degree (16°C) range later this week, and where the snow cover is a measly 0.5 centimetre (0.2 inches) vs. a ‘normal’ 45 cms (18 inches). The latter is of great concern to farmers, because of the threat of “winter kill” of perennial forage-, & fall-seeded cereal-, crops due to an insulating snow layer, and to municipal authorities due to the resultant increased grass fire hazard. This seems to be a tiny bit more evidence that, like it or not, climate change is a reality, & that the only question really worth debating is how much of it is be cyclical & how much might be Man-induced.

GLEANINGS VERSION II

No. 442 - January 5^th, 2012

SCARIER THAN NORTH KOREAN NUKES (VueWeekly, Gwynne Dyer)

• Western intelligence agencies have long warned of the terrible consequences of Iran getting ‘The Bomb’ & of the need to ‘bomb them before they bomb us’ (the Israeli line). And now North Korea’s nuclear arsenal is under the control of someone whose prime qualification is that he is less weird than his half-brother (which may not be quite fair to him; for he did go to school in Switzerland). But any threat that either poses to the world dwindles into insignificance compared to the news emanating from a Dutch bio-lab.
• The H1N1 flue initially prompted near-panic since its mortality rate was 60%. But that subsided when it was found to spread by close physical contact, unlike the common cold that does so by airborne water droplets coughed up by flu victims. But viruses can, & do, mutate. So the US National Institutes of Health funded Dr. Ron Fouchier of Rotterdam’s Erasmus Medical Centre to study how H1N1 might mutate into an airborne global killer. His finding : “In the laboratory, it was possible to change H1N1 into an aerosol-transmissible virus that can easily be rapidly spread through the air ... This can also take place in a natural setting. We know which mutation to look for in the case of an outbreak, and we can then stop the outbreak before it is too late.” (a not uncommon scientist’s hubris : leave it to us, we know what we are doing).
• No one seemed to care this would create that very airborne virus &, in line with scientific practice, publish the results in a scientific journal. Fouchier’s paper has been submitted for publication & while US National Science Advisory Board for Biosecurity still can order it edited to remove key information, the cat is out of the bag. There are terrorist organizations & governments that can duplicate Fouchier’s research once they know how he did it; and as former arms control researcher Mark Wheelis of the University of California (Davis) puts it “Blocking publication may provide some small increment of safety, but it will be very modest compared to the benefits of not doing the work in the first place.”

Never mind terrorists & governments. What about hackers replicating Fouchier’s work as a challenge, or Julian Assange-types doing so for misguided ego-tripping reasons?

THE FEDERAL RESERVE’S COVERT BAILOUT OF EUROPE

(WSJ, Gerald P. O’Driscoll Jr.)

• The Fed is using its “temporary US dollar liquidity swap arrangement” with other central banks to do Euro-dollar swaps with the ECB that in effect bail out European banks & governments in an off-balance sheet manner not unlike that which Goldman Sachs a decade ago employed, when ECB President Mario Draghi was Vice Chairman of Goldman Int’l, to obscure the extent of the Greek government’s indebtedness.
• But why? For the Fed could lend directly to the US branches of foreign banks, as it did in the wake of the Lehman collapse, & the ECB could lend Euros to the banks with which they could then buy dollars in FX markets awash with them. The reason : both need a fig leaf. The Fed was embarrassed by revelations of its earlier largesse towards foreign banks & doesn’t want foreign bank debt on its books, and the ECB, faced with government pressure to bail them out, believes it cannot legally do so & doesn’t want to sully its reputation as an inflation fighter.
• The Fed had US$600+BN in currency swaps on its books in the fall of 2008, most of which had been “unwound” by January 2010. A few short weeks ago the amount outstanding under its swap arrangement was just US$2.4BN. But in the week ended December 14^th that jumped to US$54BN, & in the following week by another US$8BN (incl. US$5BN with the Bank of Japan - a sign of problems there?). So the Fed, via the ECB, is bailing out European banks, & indirectly spendthrift European governments, while on December 14^th Fed Chairman Ben Bernanke assured Republican Senators, during a briefing on the European situation, that the Fed didn’t have “the intention or the authority” to bail out Europe (at the very time its swap lines with the ECB had just increased US$52BN).

Now a Senior Fellow at the Cato Institute, the writer once served as Vice-President & Economic Adviser at the Dallas Fed, and as Citigroup’s Director of Policy Analysis.

DETROIT POLICE STATIONS TO END 24-HOUR PUBLIC ACCESS

(Reuters, John Stoll)

• The city, financially up against the wall due to a shrinking population, escalating legacy costs & lower tax revenues, says it will run out of money in 90 days, faces a growing risk of becoming a ward of the state & currently has 3,000 police officers on its payroll, vs. 5,500 a decade ago. It proposes to lay off 100 of them to get federal funding to rehire them & may cut another 500 staff in its police- & fire departments. As another cost-saving measure it is now proposed to close eight precinct stations from 4:00 p.m. until 8:00 a.m., the period of peak criminal activity, & provide the public with 24-hour Internet access to the police.

Note the reference to legacy costs. They are, & will increasingly become, the prime headache of governments large & small, the prime target for budgetary axe wielders & the source of social unrest that pits hard-pressed tax payers against public sector retirees seeking to protect their tax payer paid-for entitlements. At its 1950 peak Detroit’s population was 1.85MM. Between 2000 & 2010 it shrank from 951,270 to 713,777; so while its population declined by 25%, its police department’s staff was cut 45%. On the other hand, in 2001 its ratio of police per 1,000 population was 5.8, vs. a national average for big cities of 2.0, & at 3,000 still is 4.2 per 1,000 (vs. 1.2 in Flint, 1.6 in Grand Rapids, & 1.9 in Lansing, all cities with populations < 200,000, which typically have higher police to population ratios). And yet Detroit has one of the US highest crime rates.

OIL LOBBY LAGGING REALITY (FP, Claudia Cattaneo)

• The CAPP, the lobby group for Canada’s oil & gas industry, is positive about the public perception of its activities in Canada & the US. According to President David Collyer “it is very important not to construe the very strong & vocal opposition from environmental activists, and what I would characterize as a very small part of civil society, as representative of civil society.” He may be out of touch. For a recent poll by Forum Research Inc. found a lack of support in Canada for the Keystone Pipeline (& the Northern Gateway Pipeline). While 60% of 1,140 randomly picked Canadians agreed oilsands oil is more ethical than that from the Middle East, nevertheless just 38% were in favour of the Keystone-, & 35% of the Northern Gateway-, Pipeline. Undaunted, Mr. Collyer says the game plan for 2012 is to continue working with policy makers, key “influencers” & “like-minded” organizations like the American Petroleum Institute, unions & Chambers of Commerce in the US.
• This feels like a timid, government-focused, indirect & risky approach, given the success of the environmentalist’s in-your-face campaign.

Interesting! Cattaneo usually comes across as somewhat of an industry shill. What Canadians do think about the Keystone is irrelevant; for they don’t vote in US elections. The Northern Gateway line, however, which is far more important from a national Canadian perspective, is another issue. And there ‘public’ interest is immense (over 4,000 people have registered to address the Panel that will soon start holding public hearings on it) &, while the Indians have yet to be bought off, the most recent polls show a majority of people in BC supporting the Northern Pipeline concept.

U.S.-SAUDI FIGHTER DEAL SENDS ‘STRONG MESSAGE’ (AF-P)

• President Obama on December 29^th in Honolulu announced, & the parties involved in Riyadh on December 31^st signed, a US$29.4BN deal to supply Saudi Arabia with 84 new F-15A fighter jets (which one senior Pentagon official said “ will be the most capable and versatile aircraft in the Royal Saudi Fighter inventory”), modernize 70 existing planes, & provide munitions, spare parts, training & maintenance. Pentagon officials say delivery will take place over 15-20 years & will also include Black Hawk & Apache attack helicopters. Aircraft deliveries will start in early 2015 & the modernization of existing planes in 2014, but the first payments are expected to start flowing soon. Andrew Shapiro, the Assistant Secretary of State for Political-Military Affairs, told reporters “This sale will send a strong message to countries in the region that the United States is committed to stability in the Gulf and broader Middle East ... It will enhance Saudi Arabia’s ability to deter and defend against external threats to its sovereignty”, & Deputy White House spokesman Josh Earnest (sic) in Honolulu that this will support 50,000 American jobs & provide a US$3.5BN annual boost to the US economy. Shapiro also said “This is not solely directed toward Iran. This is directed toward meeting our partner Saudi Arabia’s defence needs”, & that, in line with U.S. law, it had been determined the sale would not undercut Israel’s qualitative edge.

The helicopters’ greatest potential usefulness may well be in internal-, rather than external-, security activities. By 2014/2015 the Middle East could, & will, be a different place; already US influence there is on the wane for local & US domestic reasons, and because Obama’s foreign policy focus is shifting from the Middle East to the Asia-Pacific. Meanwhile, Israel has just reneged on a hitech defence-related contract with Turkey for fear it would in the end benefit its enemies, & it should not surprise anyone if, despite Shapiro’s comment, this sale will prompt Israeli demands to have its Air Force’s capability “up gunned” as well (egged on to do so by the military-industrial complex).

ITALY’S MONTY CALLS FOR MORE FIREPOWER FOR BAILOUT FUND

(G&M, Brian Milner)

• Prime Minister Mario Monti warned on December 30^th the EU will have to arm its bailout fund with a lot more ammunition to regain market confidence & get the debt crisis under control, & called for a “united, joint and convincing response.”

This is ‘too little, too late’. It also somehow doesn’t jive with his earlier view that at their current levels his government’s bonds are “good value”. And a “united, joint and convincing response” would be a real departure from what so far has been a disunited, disjointed & unconvincing one.

EURO LEADERS AIM TO BUY TIME TO SAVE EURO

(Bloomberg, Patrick Donahue)

• Even with US$200+BN needing to be rolled over by members of the 17-member Euro bloc in the First Quarter alone, Europe’s leaders returned to work this week still seeking to ‘buy time’ for the Spanish & Italian governments to wrest control over their debt & rescue the single currency from fragmentation in its 10^th anniversary year. In her New Year’s speech Chancellor Angela Merkel said, among others, that “The road to overcoming this won’t be without setbacks, but at the end of this path Europe will emerge stronger than ever.”

No doubt Europe will survive in some way, shape or other. But “stronger than ever”? As noted above, Brazil is in the process of surpassing the UK in terms of the size of its GDP & before too long will be snapping at Germany’s heels. The impact of 5-7% compound annual rate of growth vs. 2-3% is awesome but often lost on many people.

GERMAN BOND SALE SEES BETTER DEMAND (Reuters)

• On January 4^th Germany sold 4BN Euros in 10-year bonds, seeing better demand thant at last November’s “disastrous” sale, even though the lower yields (1.93%, down from 1.98% in November) kept some investors on the sidelines.

Happiness is relative. It was a much better, & slightly cheaper, outcome than last November. But the plan had been to raise 5, not 4, BN Euros-worth, total bids were only 1.3x the amount sold, the government’s bond agency was active in the aftermarket, & the Euro weakened afterwards.

ISRAEL MEETING A PRELUDE TO TALKS (AF-P)

• Israeli & Palestinian negotiators headed to Jordan on January 2^nd for their first face-to-face meeting in 16 months at the invitation of Jordan’s Foreign Minister, Nasser Judeh. Quartet Envoy Tony Blair & officials from the four parties making it up (EU, Russia, UN & US) were also expected to attend. Israeli Intelligence Minister cum Deputy Prime Minister Dan Meridor called it “a positive development ... It is the first time in a long while that the Palestinians have been prepared to come and talk to us directly, without preconditions.”

Bad headline. The meeting produced zilch. It was a dumb, Quartet-sanctioned, anti-Hamas move orchestrated by Israel to try & shipwreck the earlier-announced, but still very tentative, rapprochement, & agreement to hold elections by mid-year, between Fatah & Hamas. As should, have been expected, Hamas’ reaction was “We demand a boycott of this meeting ... Going to such a meeting is only betting on failure”. And those expecting anything positive to have come from this were self-delusionary; for PLA President Mahmoud Abbas has no room to manoeuvre since anything short of an end to the Israeli settlement-building frenzy would result in him, & his Fatah party, being run out of town on a rail, handing any subsequent election to Hamas (an outcome that no one supposedly wants).

ISRAEL BANS 12 'JEWISH EXTREMISTS’ FROM WEST BANK (msnbc.com)

• Jewish radicals opposed to government actions against non-approved West Bank settlement ‘outposts’ have in recent months carried out numerous attacks on Israeli army facilities, and Palestinian mosques, cemeteries, farmland & cars. With the government long criticized for failing to crack down on Jewish extremists, the IDF finally announced on January 5^th that it had banned 12 of them from entering the West Bank for periods of ranging from three months to one year without, however, naming them.

It is starting to look as if over time the extremists could possibly start posing a greater threat to the survival of the state of Israel, as presently constituted, than the Palestinians.

ARAB LEAGUE BODY ASKS SYRIAN OBSERVERS TO LEAVE (CBCNews)

• The Arab Parliament, an 88-member committee composed of four members from each of its member states, asked on Sunday January 1^st that its observer mission be recalled forthwith from Syria since its presence has failed to halt its government’s violent crackdown on dissidents & since Arabs are getting angry that the violence has continued despite the monitors’ presence. Ali Salem al-Deqbasi, the advisory group’s Kuwaiti head, said “The mission of the Arab League team has missed its aim of stopping the killing of children & ensuring the withdrawal of troops from Syrian streets, giving the Syrian regime a cover to commit inhumane acts under the nose of the Arab League observers.”

In this age of grass roots mass media there have been videos of monitors ignoring people trying to show them childrens’ bodies & of a monitor saying he had seen snipers on roofs only to have the Sudanese general heading the mission telling the press he had been misquoted (only then, a couple days later, reversing himself & starting to talk about the danger of rooftop snipers). And there have been reports the government is now using artillery against demonstrators to cut the risk of defection among soldiers on foot & in close contact with demonstrators.

CHINA CUTS BACK ON FOREIGN AUTOMAKERS (AF-P)

• The Beijing government announced on December 29^th that, effective January 30^th it will “withdraw support” for foreign investment in auto manufacturing to encourage domestic manufacturers & “because of the need of the healthy development of domestic auto making”, in what is now the world’s largest car market. No further details were provided.
• This comes amid an auto sales slump. While in 2010 sales were up 32% to a record 18.06 units, the sector lost steam following the phase-out of some sales incentives, such as tax breaks for small-engine cars, & last November sales were down 2.4% YoY to 1.66MM units. This comes on the heels of Beijing’s decision last months to hike tariffs on US passenger cars & SUVs with engine capacities of 2.5 litres or more.

This is not good news for North American & European, and Japanese & Korean, auto makers who have been counting on the (expanding Chinese market to boost their global sales & more fullyutilize more of their excess capacity.

CHINA UNVEILS PROGRAM TO RIVAL US SUPREMACY IN SPACE

(G&M, Edward Wong)

• On December 29^th, in a confirmation of its previous vows to do so, it announced a five year plan for launching a space lab, getting to the moon & collecting soil samples there, building a more powerful manned space ship & space freighters, and vastly expanding its version of the Global Positioning System for military & civilian purposes. This broadens its challenge to the US from just building more submarines & testing its first aircraft carrier. China has consistently stuck to a timeline for its space program while NASA’s tends to change with Presidents; thus, while President Bush 43 called for a return to the moon by 2020, President Obama wants it to send astronauts to an asteroid. Meanwhile NASA last summer ended its 30 year-old space shuttle program & henceforth will have to rely on Russia to transport its astronauts to the International Space Station.

So one advances as the other retreats. The wisdom of either depends whether one views a space program as a good use of resources. Remember how President Reagan helped bring the Soviet Union to its knees by making it overreach? In China’s case, its demographic time bomb (fewer young people, dramatically fewer women of child-bearing age & an aging population) and its people’s rising expectations could lead it down the same garden path if it were to use its resources in a sub-optimal manner on a host of ‘marquee-type’ projects.