Market Advisory Features
Economy Roars Ahead
Of Technology Stocks and Short-term Memory Loss
America Bets Its Bottom Dollar
The World Suddenly Looks Bleaker
It’s Security, Stupid
A Copper-bottomed Boom?
economy roars ahead
America’s economy, fuelled by strong investment, easy credit and heavy tax cuts, is growing faster than anyone expected, and faster than many can remember
AMERICA'S pre-millennial boom years were dubbed the “roaring nineties” by Joseph Stiglitz, a Nobel Prize-winning economist. In the flat years that followed—the “whimpering noughties” perhaps?—the economy rather lost its voice. But on Thursday October 30th the Department of Commerce announced that the country’s GDP grew at the astonishing pace of 7.2% in the third quarter (at an annualised rate). This is faster than at any time in the noughties or nineties. Indeed, it is the fastest quarter’s growth since 1984. The roar, it seems, is back.
America’s corporations, in particular, have regained their voice. Until recently, they had been working off the excesses of the late 1990s, when they had borrowed and spent as if it had been the end of the world, not just of the century. In the past year the corporate sector became a net saver, putting aside some of its profits to buy back shares and pay down debts. In recent quarters, businesses have also pared their inventories of goods to remarkably low levels and wrung large productivity gains out of their workforces. Now, America’s corporations appear to be coming out of this defensive posture and opening their shoulders. Business spending shot up by 11% in the third quarter, Thursday’s figures reveal, with investment in equipment and software growing by more than 15%. Now that they are adding capital again, America’s businesses may even start adding some labour. Nearly 2.7m workers, dropped from the payrolls since recession struck in 2001 will certainly hope so.
While America’s corporations have been strengthening their balance sheets, the same cannot be said for households. According to Thursday’s figures, consumer spending rose at an annual rate of 6.6% in the last quarter. Pre-tax incomes, however, grew by much less. Part of the difference was filled by borrowing, which grew in August at an annualised rate of over 5%.
Borrowing at such a rate seems unsustainable but, for the moment, households seem happy to add to their debts because they are easier than ever to service. Interest rates recall the fifties not the nineties. On Tuesday, the Federal Reserve voted to keep its target interest rate at its lowest level since 1958 for a “considerable period”. Rates on mortgages, personal loans and car loans are at the lowest that most borrowers can remember. Homeowners have taken full advantage of this retro fashion in the credit markets, refinancing their old mortgages and locking in low, fixed rates on their new ones. Indeed, according to new research by Fed staffers, financial obligations of all sorts (car loan and credit card repayments, as well as rent or mortgage payments) weigh less heavily on households now than they did 18 months ago, gobbling up about 18% of their disposable income.
Borrowing from the future is made even easier when the government does it for you. The federal government ran an unprecedented deficit of $374 billion in the fiscal year just ended—and this record is unlikely to stand for long. Ever since the economy started slowing, the administration has tried, unconvincingly, to sell its tax cuts as a stimulus package (albeit a remarkably expensive one). But there is no denying their stimulating effects in the third quarter, at least. Thanks to the child tax credits arriving through their letter boxes, and the lower taxes withheld from their pay, households had an extra $20-25 billion to spend this summer. And spend it they did. In a continuing debate between the followers of David Ricardo, who predict that people will save unsustainable tax cuts, and the followers of John Maynard Keynes, who assume they will spend them, the Keynesians appear to have the upper hand.
In reality, the Bush administration has borrowed to wage war on Iraq and on taxes alike. On current evidence, the latter war is enjoying more success than the former. But the triumphant phase of Mr Bush’s tax-cutting campaign may be nearing an end. The high summer spending is already showing signs of slowing down in autumn, and the next tax rebates do not come into effect until the spring of 2004. In the meantime, Mr Bush will have to hunker down for long months of skirmishing over his administration’s red-inked fiscal record.
Time for some
soul-searching by emerging-market investors, again. Thank you Russia, again
“ALL happy families are alike; all unhappy families are unhappy in their own way,” wrote Leo Tolstoy at the beginning of “Anna Karenina”. In capital markets unhappiness comes under the broad headings of economic risk and political risk, but these can be combined in cocktails of unique poisonousness. For the past 12 months or so, investors from happy countries, which is to say rich ones, have assumed that unhappy countries were becoming more content, which is to say stable capitalist democracies that more or less enshrine the rule of law. But how many are still haunted by their own miserable pasts?
The answer that investors want to hear is: a lot less than were, say, five years ago, when the Russian crisis sent emerging markets everywhere into a tailspin. And you can see why they might want to think this. If emerging economies could put themselves on the straight and narrow, everyone would be happier. Their populations would be lifted from fear and conditions of often-abject poverty, and investors would make pots of money investing in them. Thus have they piled into emerging-market stocks and bonds. An index of emerging-market shares compiled by Morgan Stanley has risen by 40% since the beginning of the year. In dollar terms, the worst-performing shares have been those listed in China (which have gone up by only 3%), while the best have been found, a little improbably, in Venezuela (up by 107%).
As go stocks, so go bonds. EMBI+, an index of emerging-market sovereign bonds compiled by J.P. Morgan, has returned 23% this year. Not one country in the index has seen its spreads widen against American Treasury bonds (still the risk-free interest rate, for better or worse) since this time last year. The spread for the index as a whole has more than halved since then, to under five percentage points. The prize for top performance goes to Nigeria, that haven of stability, whose bond spreads have narrowed by almost 24 percentage points. Lest anyone think that these moves merely or mostly reflect a weakening dollar, emerging stock and bond markets have also risen when measured in their local currencies.
But these comfortable assumptions are being shaken by, among other things, recent shenanigans in Russia. Mikhail Khodorkovsky, the country’s richest man thanks to being the largest shareholder in Yukos, a giant oil company, was arrested at gunpoint at the weekend, charged with fraud and tax evasion, and plonked in jail in Moscow. Whatever you might think of Bill Gates, it is hard to imagine him suffering the same treatment. (“The gunpoint thing is kind of fun and Russian,” says one banker.) Mr Khodorkovsky’s arrest is a sharp reminder that Moscow, Russia, is not Des Moines, Iowa. Russian bonds fell sharply, though they recovered their poise. Shares dropped some 10%, though they too have clawed back some ground. Buttonwood suspects that further falls are on the cards: Russia has all the appearances of a bubble. Certainly, recent events may necessitate a little soul-searching at Moody’s, a credit-rating agency which, to widespread surprise, upgraded Russia’s creditworthiness by a couple of notches to investment grade just three weeks ago. They should, perhaps, also necessitate a little soul-searching by investors everywhere.
Quite why Mr Khodorkovsky was arrested is, of course, being discussed at length over vodka and champagne in Moscow bars. Buttonwood can’t help here, but the fact that nobody believes the straightforward official reason, such as it is, speaks volumes about the extent to which Russia’s present is still so bound up with its past.
And that is the case for many emerging economies into which investors have poured money in recent months. Poland, a country that has not been without problems over the centuries, has a government that is too weak to address the country’s unsustainable fiscal position, and its currency and bond markets have been falling sharply. Hungary (ditto) has a current-account deficit of 6% and rising, and a budget deficit of 5% of GDP. In Turkey, a country with an economic record second to most, the lira has fallen by 12% in the past couple of weeks or so, seemingly just because it is Turkey. “Investors just seem to have called it a day,” says Robert Beange, an economist at Lehman Brothers.
In Latin America, too, many countries are not as stable as investors might wish. Brazil, a serial defaulter of old, has being doing surprisingly well lately under a left-wing president who seems to have accepted the need for market forces. Brazil has been a trader’s dream this year. Presumably it will turn into a nightmare at some point. On the other hand, Argentina is a mess and is still not paying the interest it owes on some $84 billion of foreign debt on which it defaulted last year: since the middle of September, spreads on its bonds have blown out by almost five percentage points.
In Asia, South Korea seems to have got its house in order since the 1997/98 crisis, in a way that Japan has failed to do since its bubble burst at the beginning of the 1990s, but politics there is still haunted by relations with North Korea. The (extraordinarily vocal) prime minister who has governed Malaysia for the past 22 years, Mahathir Mohamad, is about to retire, leaving in his wake a healthy economy but little by way of democratic tradition. Taiwan, too, has done well but must still tiptoe diplomatically because of relations with China, which—lest investors forget—still regards the island as a province, is avowedly communist, and out of which few have made money in recent years.
In many emerging markets, lessons have been learned the hard way and quickly forgotten, thanks to the lure of easy money and the dread promise that this time things are different. Of course, many countries are indeed different, and in some ways healthier than they were. But it is the similarities to the past that interest Buttonwood right now. Investors in emerging-market shares at least have the reassurance that these are for the most part still cheap. Investors in bonds have no such reassurance—Russian bonds, by way of example, yield four percentage points less over Treasuries than they did before the 1998 crisis—and history, even very recent history, suggests that there is a good chance they won’t be given their money back.
stocks and short-term memory loss
LAST weekend, Buttonwood took his daughters to see “Finding Nemo”, a cartoon about a clown fish looking for his son (Nemo) who has swum off and been scooped up by a diver. The father is aided in his quest by Dory, a regal blue tang (whatever that might be) with short-term memory problems. Suffice to say that the film was jolly, but Dory’s condition struck a chord. Investors in the shares of companies involved in high-techery of one sort or another seem to be similarly afflicted. Put bluntly, the tech bubble is back. This time, the moves have been a bit more discriminate, so far; the claims less grandiose, as yet; and the effects on other companies less insidious, for now. But the extremity of the moves, the ludicrousness of the valuations, the spuriousness of the reasoning: Buttonwood freely confesses that, faint though the echo of the past might be, it makes him purr with pleasure.
You might remember that Nasdaq, the bellwether index of the high-tech world, hit an all-time high of just over 5,000 in March 2000. With the benefit of hindsight, the fact that the starched Morgan Stanley went dress-down when Nasdaq hit that round number should have signalled a top to investors with a toehold on sanity, even if AOL’s funny-money “takeover” of Time Warner did not. Stocks on Nasdaq fell a lot after that, as did just about every other stock that had been touched by technology. Spending on computers and software collapsed when the bubble burst. So did many of the companies that relied on them. But it seems that the hardened technology investor, far from being chastened by the intrusion of hard economics, merely thought his timing was a little awry.
Thus it has been that, having touched a low of 1,114 in October last year, Nasdaq has already climbed some 70%. This being an index, with winners and losers, some of the rises have been eye-popping. Most eye-popping of all has been a company called Evolving Systems, whose shares have evolved upwards by over 5,000% from their low last year. Buttonwood admits to never having heard of this company before, but according to its website it is “a leading provider of innovative software solutions to [America’s] largest telecom providers”. More heartening to aficionados of techno-speak is that Evolving Systems “delivers complex, mission critical software solutions that include our products and ServiceXpress integration”. Actually, of the top 20 Nasdaq performers this year, Buttonwood has heard only of Ask Jeeves, which almost certainly says more about his technological inadequacies than the companies themselves. Clued-up investors have clearly heard of them and, more to the point, like what they have heard: even the twentieth-best performer, a company called SMTEK International, is up by 1,477%.
Three on the list—NetEase, Sohu and Sina (all up over 2,000%)—neatly combine technology, telecoms and the “China play”. The three, all based in China, earn revenues from text messaging in the Middle Kingdom, which, being cheaper than phoning, has become the communication of choice there. This year, the Chinese will apparently send some 200 billion text messages, which seems a lot, but then there are a lot of them. “I don’t think this is a bubble,” NetEase’s chief financial officer, Denny Lee, was reported as saying by Knight Ridder, a news agency.
Far from being solely
an American dream, indeed, the return of the tech bubble is very much a
worldwide phenomenon. The
Possibly, such stocks
were oversold, having climbed too close to the sun in the first place. And both
Softbank and Hikari Tsushin are still down by 90% or so from their peaks. The
same is true for most of the other shares that have climbed so spectacularly in
recent months. But then, few if any of them are exactly cheap because they
don’t make much money, if any. Nasdaq as a whole has a price-to-earnings (p/e)
ratio of 39, which means that it will take 39 years for the average company to
earn enough profits to repay investors. For many companies, it will take far
longer: in the case of
Such extreme valuations are odd, to say the least, since it is unlikely that more than a small fraction of these companies will be alive ten years from now, let alone 100. As Fred Hickey, the editor of High-Tech Strategist, neatly put it in a recent newsletter: “You cannot be a long-term technology investor because in the long term almost all of the stocks are dead.” Almost all of the big technology companies he tracked 20 years ago have ceased to be. Investors are presumably betting that their favoured stocks will not be among the deceased. Who, for example, could possibly think that Amazon will be among them now that its boss, Jeff Bezos, has said that Amazon is no longer just an online bookshop but “earth’s most customer-centric organisation”? Little wonder that Amazon had a p/e of 105 at last count.
Possibly, too, some of
these heroic multiples will be made to look more timid by a sharp rise in
profits. Net profits for
There is also evidence that technology spending, in America at least, is picking up. The question is: by how much? Less than enthusiastic investors are hoping for, probably. For one thing, companies’ technology spending is now being watched ever more vigilantly by chief financial officers, who might rightly wonder why their companies need to spend more on new technology when they are being so productive with the existing stuff. Moreover, the fall in technology spending has seemed more pronounced because the price of technology is falling.
Which certainly can’t be said of shares in companies that supply it. Every halfway decent earnings announcement is taken as a reason to bid a stock up further, as though these heady rises are bound to continue for the foreseeable future. Doubtless it will continue that way, with investors bidding shares ever upwards as economic recovery fuels their fantasies, and then offloading them on to the next eager punter. Margin debt on Nasdaq—money borrowed to buy shares—is almost as high as it was in March 2000. Of such joys are bubbles blown, until reality dawns and investors all wonder why they hadn’t sold earlier.
and investment were supposed to top the agenda of the APEC summit in Thailand
this week. But George Bush has other things on his mind
THE Thai authorities ensured that security was tight outside the Asia-Pacific Economic Co-operation (APEC) summit, which closed on Tuesday October 21st. But they and many of their neighbouring countries had hoped to leave security issues at the (heavily guarded) door. APEC’s charter is rooted in economics, and many of its members wanted this summit to focus on trade, not terrorism; on the WTO, not WMD. They did not have their way. On Friday, President George Bush was in Japan, talking about Iraq. The next day, he was in the Philippines, talking about terrorism. And from the moment he arrived in Bangkok on Saturday night, halfway through his six-nation tour of Asia, he talked about little other than North Korea.
North Korea wants nuclear weapons. Or, to be precise, it is acting like a regime that wants nuclear weapons, and intends to carry on doing so until America rewards it with a non-aggression treaty, diplomatic recognition and help with its energy needs. In the past year, the North has prompted a string of diplomatic crises by enriching uranium, expelling inspectors from the International Atomic Energy Agency (IAEA), extricating itself from the Nuclear Non-Proliferation Treaty and extracting plutonium (despite a 1994 agreement to freeze plutonium production). In April, Pyongyang told the Americans that it already had one or two bombs. Now, it claims to have reprocessed enough plutonium for five or six more.
In August, Kim Jong Il, North Korea’s president, was persuaded to enter into six-way talks in Beijing with America, China, South Korea, Japan and Russia. With all of the same players, except North Korea, assembled together in Bangkok, Mr Bush took the opportunity to revive this diplomatic quintet and redouble the pressure on Pyongyang. On Sunday, he once again ruled out a non-aggression treaty with North Korea. But he raised the possibility that he might find another, less formal, way to assure North Korea that America and its key allies in the region had no intention of attacking it. In return, North Korea would have to show that it had abandoned its nuclear ambitions. But its climbdown could perhaps proceed step by step, in tandem with, rather than in advance of, reciprocal gestures by the United States.
On Monday, Mr Bush issued a joint statement with Roh Moo-hyun, South Korea’s president, calling for the six-way talks to be resumed. The American president's new show of flexibility gives North Korea little excuse not to attend. It also, according to Ralph Cossa, head of the Pacific Forum of the Centre for Strategic and International Studies, sends a message to South Korea and China, alarmed by the Bush administration's taste for talking tough, and to hardliners in Mr Bush's own government, who are loth to grease the axis of evil in any way.
North Korea's response was both prompt and provocative. As the APEC leaders' summit began on Monday, it test-fired an anti-ship missile with a range of about 60 miles (100km). As the summit drew to a close on Tuesday, it fired another, according to reports from Japan's Self-Defence Agency. This was not a sign of “a positive attitude”, noted the Japanese, with remarkable understatement.
Mr Kim was not the only Asian leader to display a bad attitude in recent weeks. Mahathir Mohamad, Malaysia’s prime minister, last week accused Jews of ruling the world “by proxy”. When columnists and politicians around the world condemned the remarks, he shrugged off their denunciations, claiming the furore only proved his point. This week he also complained that Mr Bush's preoccupations with security were dragging the APEC summit away from its economic agenda. That agenda had included plans to reduce the costs of doing business across borders by 5% over the next few years by, among other things, streamlining customs procedures and speeding up applications for export permits. But the summit's final declaration calls instead for port security to be tightened as part of the ongoing war against terrorism. Likewise, APEC has long aimed to free up investment between its members. But Tuesday's declaration is more concerned with stopping terrorists moving their money around the globe.
Dr Mahathir has long resented the West's interference in Asian economic affairs. Indeed, America has always promoted APEC as an alternative to the Malaysian leader’s calls for an East Asian economic alliance. James Baker, America's secretary of state at the time APEC was founded in 1989, hoped the alliance would mollify East Asia’s aspirations for greater co-operation without “drawing a line down the middle of the Pacific”, as he put it. Thus far, the Pacific remains largely undivided, but APEC has few other achievements to its name. In Bogor, Indonesia, in 1994, it set itself ambitious goals to free up trade and investment within the grouping. But the deadlines were pushed far into the future— 2010 for richer members, 2020 for poorer—and few countries show any will to meet them. “Unless progress is made, people will go around thinking APEC is just leaders going around in funny shirts once a year,” warned Peter Charlton, an Australian businessman and evidently not one to appreciate the specially commissioned Thai silk jackets APEC leaders wore for their final group photograph.
Indeed, as APEC falters, Dr Mahathir’s original vision seems to be resurfacing after all, according to Fred Bergsten of the Institute for International Economics. The ten members of the Association of South-East Asian Nations (ASEAN) have held meetings with Japan, China and South Korea for seven years in a row. Last year, ASEAN began work on a trade agreement with China; this month, it signed similar accords with Japan and India. It also set out a bold vision to turn ASEAN into an Asian “economic community” inspired by the European common market. Individual countries within Asia, notably Thailand and Singapore, are also busy negotiating their own bilateral deals with key trading partners.
What, then, remains of East Asia's longstanding commitment to multilateral trade negotiations, embodied in the World Trade Organisation (WTO) and its forebears? The leaders assembled in Bangkok this week did acknowledge the “valuable work” done at the WTO's failed Cancún meeting last month. They also agreed that trade talks should pick up again from where they left off—using the draft agreement cobbled together the day before the Cancún talks collapsed—rather than starting again from scratch. But again, this consensus could barely contain Dr Mahathir, who described the Cancún breakdown as a “minor success” and urged the poorer world to offer its own agenda for the trade round.
Dr Mahathir is, as his people call him, “the old man” of the region. His remarks this week may be the parting shot of a veteran leader whose 22 years in power come to an end this month. But however offensive his rhetoric, Dr Mahathir's verbal broadsides will trouble Mr Bush much less than the missile diplomacy of North Korea's Mr Kim.
A former fund manager has admitted to obstructing an investigation into improper mutual-fund trading, making him the first executive to face a criminal charge in the rapidly widening probe into the industry’s practices
UNTIL this summer, most of the anger generated by three years of falling share prices was directed at Wall Street and its investment banks. America’s fund managers, many of which are based in understated Boston, kept a low profile and largely avoided the flak. After all, their interests were wholly aligned with those of their clients: to increase the value of their portfolios, and thus their own fee income. Right? Not necessarily, it seems. Both Eliot Spitzer, New York’s crusading attorney-general, and the Securities and Exchange Commission (SEC), America’s chief securities-regulator, have launched probes into the industry, and the states are starting to slap writs on fund managers suspected of wrongdoing. A combination of criminal charges from Mr Spitzer and the states, a new set of rules from the SEC and a separate slew of regulation from Capitol Hill looks likely to result in a thorough overhaul of American fund management.
The man at the centre of the latest fund scandal is James Connelly, a former senior executive at Fred Alger Management, a New Jersey-based fund group. On Thursday October 16th, Mr Connelly pleaded guilty to charges of obstructing an investigation by Mr Spitzer’s department into improper mutual-fund trading. The SEC also brought civil charges against Mr Connelly, accusing him of allowing certain customers to engage in “market timing”, ie, the rapid trading of mutual-fund shares. Mr Connelly settled these charges by paying a $400,000 fine (while admitting no wrongdoing). However, Mr Spitzer is seeking a custodial sentence of up to four years for the criminal charge. Mr Connelly is not the only fund manager in officials’ sights: last week, the state of Massachusetts issued subpoenas to three fund managers from Fidelity, Franklin Templeton Investments and Morgan Stanley, in an attempt to ascertain whether they helped another firm get around funds’ own prohibitions on market timing. The practice is not necessarily illegal, though it is often forbidden in firms’ own prospectuses because it tends to lower returns to long-term shareholders.
The latest moves come
a month and a half after Mr Spitzer extracted $40m from Edward Stern to settle
allegations that his hedge fund, Canary Capital, was allowed to trade in one of
two ways beneficial to him, but costly to other investors. (Mr Stern admitted no
wrongdoing.) In addition to accusations of market timing, Mr Spitzer alleged
that Mr Stern was allowed to engage in “late trading”, ie, buying or selling
shares at the daily price struck at 4pm, but taking advantage of after-market
news. This is illegal. Three of the four firms alleged to have allowed Mr
Mr Spitzer is using the same tactics he employed to such effect when he spearheaded an investigation into conflicts of interest at investment banks. It starts with a high-profile charge sheet against firms (helped, if possible, by embarrassing, if not incriminating, e-mails), followed by criminal charges against targeted individuals and hefty fines for the institutions involved, without an admission of guilt. Such tactics worked against the banks, both because they have deep pockets and because they were desperate to put the episode behind them and rebuild tattered relationships with their big corporate clients.
The fund management industry is responding less calmly to the assault on its integrity. Vanguard, one of America’s biggest fund managers, for instance, reacted indignantly to the charges aimed at the industry. A note on the firm’s website declared that charges of inappropriate trading “would fly in the face of everything Vanguard stands for in terms of fiduciary responsibility, ethics and integrity”. This tetchiness may stem from the fact that, even before the current scandals, fund managers were nervous about their ability to draw in and keep new money from investors. The industry is now more mature than it was in the heady 1990s, and so fund managers have to compete harder for a steadier, slower-growing pool of money. Moreover, many investors have been put off by the rocky ride for shares since 2000 and have switched to other types of fund (see chart).
Most fund managers think the SEC’s renewed focus on the industry, when added to Mr Spitzer’s probes, will only make it harder for them to attract new investors. William Donaldson, the SEC’s chairman, recently published some proposed rule amendments that would curb late trading and market timing. Moreover, the SEC is also planning to require funds to publish their lists of holdings four times a year rather than twice, according to the Wall Street Journal.
Congress has also been examining the industry. A congressional committee has proposed a law requiring that commissions paid to salespeople to flog funds be disclosed in the spirit of transparency. Currently, what is classified as a “suitable” investment is broadly defined, and so a salesperson can get away with recommending a product that will net him a high commission even if it has a poor track record. This practice has gone hand-in-hand with a general increase in the fees charged by fund managers, despite an increase in competition and in the number of funds under management, which should have led to a fall in fees. This paradox is unlikely to escape regulators’ attention as their investigations intensify. Fund managers may soon find that a few shabby practices that benefited them little will cost them lots in the long term.
Money used to be
backed by gold. Now it is backed by the promises of central bankers. Are these
worth less than they were?
IN BETWEEN saving the world from terrorism, President George Bush is finding time to dash off to Asia at the end of this week, first to Tokyo and then to Bangkok, where he will attend a meeting of the clumsily named Asia-Pacific Economic Co-operation, which sounds a little better as its acronym. There he will meet, among others, Hu Jintao, the president of the country American manufacturers most love to hate when they are not investing there. It is a racing certainty that the subject of China’s currency, the yuan, and whether it should be revalued from its present 8.3 per dollar, will be high on the agenda, if not atop it. It is, of course, always lovely to talk, but although America wants a lower dollar, and wants one now (which is understandable for a country with a current-account deficit of 5% of GDP and a congenital inability to save), China couldn’t seem to care less.
Quite probably, then, tension will increase and the dollar will fall against other currencies that do not have such a firm peg. The rapidity of this fall will depend on two things. The first is the force with which Washington rattles its sabre. On this subject, Buttonwood merely notes that next year is election year. The second is whether other countries, especially those in Asia which together hold $1.7 trillion of IOUs issued by the American government, are prepared to see the Treasuries in their portfolios rapidly devalued, their export competitiveness choked and deflationary pressures intensified.
Japan has such worries in spades. Though the world’s second-biggest economy nowadays receives less attention than it did, Japan’s recovery started in the fourth quarter of 2001 and growth is picking up. But officials there are increasingly worried that a rising yen will choke it off. The yen is close to a three-year high against the greenback. Its rise accelerated after the recent G7 summit in Dubai, when America’s weak-dollar policy became most obvious. Yet Japan needs the yen to fall because it needs inflation to help wipe out the massive debts the country incurred both during the bubble and in trying to get the economy going again after it had popped. Last week, the Bank of Japan further eased monetary policy, not in the usual way, by lowering the rate of interest, but by printing more money. The money supply, narrowly measured, is already rising at an annual rate of 21%.
At some point, perhaps even the European Central Bank will wake up to the fact that the rising euro will keep the European economy close to recession. All of which is to suggest that none of the world’s major currencies is especially alluring; for one reason or another governments in all three might want them to fall. Of course, they cannot all fall against each other. They can, however, fall against something largely unloved by those under the age of 50, and famously dismissed by Keynes as a “barbarous relic”: gold.
All currencies are backed by something. When the world was on the gold standard, that something was the yellow metal: the value of each pound sterling, dollar or French franc was determined by the (fixed) amount of gold that the central bank agreed to deliver against it. Now those currencies are backed by something altogether less tangible: central bankers’ promises that the currencies will maintain their value. Quite probably, these promises are not worth as much as they were.
It is only in very recent years that gold has lost its allure as a store of value. For centuries, the metal was virtually synonymous with money: the Egyptians were casting gold bars as money as long ago as 4000 BC. The gold standard’s heyday was from the 1870s to the 1930s (with a brief interruption in the first world war). Britain left the standard in 1931, a move pronounced as “the end of an epoch” by no less an authority than The Economist. America did the same in 1933. One by one, other rich countries followed suit. The gold standard was revived in a famous agreement in Bretton Woods, New Hampshire after the second world war, but only in America, which by then had three-quarters of the world’s gold stock. Although other currencies were fixed to the dollar, they were not fixed directly to gold. As other countries prospered, so America’s current-account deficit began to rise and its stock of gold began to dwindle. By 1971, inflationary pressures were driving up the real value of the dollar. In August of that year, President Richard Nixon took America off the gold standard once again.
Since then there has been a central-banking standard instead. The standard was set by Paul Volker, the Federal Reserve chief who quashed inflation (which erodes the value of money) with draconian interest rates in 1980, and killed off the bull market in gold, which had climbed from $35 an ounce in 1968 to $850 an ounce in 1980. In its place came a bull market in government IOUs. Bonds, after all, pay interest, unlike gold.
But hard money can be an unpleasant medicine, and the problems facing central bankers have not gone away since Mr Volker’s day. Inflation has shown up in more than the price of carrots: it has also pushed up the prices of shares and property. For understandable reasons, central bankers have been slow to spot and prick asset bubbles. Thus have they swelled and popped in America and Japan in recent years, leaving mountains of debt in their wake, and weakening the credibility of central bankers as they try to control economies by tweaking the short-term rate of interest.
It used to be that gold perked up only when inflation did. But perhaps central bankers’ lack of credibility explains why the price of gold has been rising even as deflationary pressures have mounted. It now fetches some $370 an ounce, down from its peak of nearly $390 last month, but way up from its price in the late 1990s, when it dipped to $253. Chris Wood, a strategist at CLSA, a stockbroker (and, in the interests of full disclosure, a former colleague at The Economist), reckons that the price could easily reach $3,400 or so—the level at the previous peak, adjusted for the rise in American personal income since then. “Gold will rise as confidence in the ludicrous powers still attributed to central bankers wanes,” he says. Possibly, the debt mountains that economies have built up will have to be inflated away. But no one knows how savage deflation will have to get before central bankers take that step, nor how dramatic tensions between America and the rest of the world have to become before faith in central bankers slips still further. The Bank of Japan might be providing an answer to the first of those questions; Mr Bush and his team an answer to the second.
America bets its bottom dollar
Britain and signs that the US economic revival was accelerating. With the blue chip index at 4,314 a fortnight ago, more than 300 points above its level on January 1, the safest bet of all seemed to be that the stock market would not fall for a fourth successive year.
Then came the International Monetary Fund's meeting in Dubai and the call by the G7 countries for "more flexibility" in global exchange rates. John Snow, the US treasury secretary, called it "a milestone change" and the markets knew what he meant - the US wants a lower dollar.
In itself, that might not be a problem. Given the US's huge current account deficit, the dollar probably is too high.
One reason for its perceived over-valuation is the determination of Japan and China to keep their currencies weak to help exports. This year Tokyo has spent the equivalent of Ireland's GDP in its efforts to keep the yen below 115 to the dollar. So the fact that Japan signed the G7 statement should be reassuring.
But that is not how stock markets see it. Wall Street and London have had a serious bout of nerves and the FTSE 100, even after gains over the past couple of days, has slipped back to 4,209. Part of the decline seems to be instinctive, reflecting the old rule of thumb that a falling dollar and falling stock markets go hand in hand.
The nervousness comes from fear that sterling and the euro could get caught up in action that is primarily designed to reduce the value of the dollar against the Japanese yen and the Chinese renminbi. German manufacturers, in particular, have been complaining about the strength of the euro and the last thing they want is the euro above $1.20, squeezing profits, adding to German unemployment and stifling activity across Europe.
In Britain, stock market investors have another worry: some of our biggest companies pay dividends in dollars. But the pension funds which are the main owners of UK plc have to pay out in sterling. BP and HSBC - two dollar-payers - together account for about 18% of the dividends paid by Britain's top 350 companies.
Investment bank Morgan Stanley calculates that a 10% fall in the dollar against sterling (it is 8% so far) would have a severe impact. It forecasts that growth in UK dividends will be just 1% this year and reckons that the falling dollar last year removed £600m from UK dividend payments. An 8% decline this year, followed by the same next year, would account for another £2.4bn. That cumulative £3bn is not theoretical money; it is hard cash paid by companies from their profits.
If that is a worry, it is nothing compared to the fear that Washington's lower dollar policy is the start of something more serious - a return to protectionism. The problem is simple: the US economy is reviving but not creating many jobs and for that Washington blames the Chinese.
As in Europe, US jobs are effectively being exported to China, where cheap labour is made even cheaper by the policy of pegging the renminbi to the dollar.
US politicians, it seems, have had enough. Stephen Roach, Morgan Stanley's chief economist, last week testified to a congressional committee and was deeply depressed by the experience. "Like it or not, the politics of protectionism are rearing their ugly head in the US Congress.
"This is not the view of just a few extremists. America's new-found protectionism is rooted in the election-year angst of the jobless recovery. The forces of free trade are silent - unwilling to be characterised as anti-worker in this climate."
Legislation has been introduced in both the Senate and House of Representatives that would slap tariffs on China. Markets hate the T-word as they slow growth and are effectively a tax on consumers.
Mr Roach is stark in his warning: "This is not normal election-year bluster. Emotions in Washington are boiling over with rare intensity. Hopefully, reason will prevail and these bills will not pass. But that doesn't alter the disturbing endgame - protectionist measures are likely in one form or another. As one seasoned Washington insider put it to me: 'The political train has left the station. I can smell it - something big is coming. You on Wall Street need to prepare for it.' "
One way to reduce the tension would be for Beijing to accept that the
renminbi is undervalued. Jim O'Neill,
The nightmare is that the Chinese refuse to budge and the US jobless figures get worse. The next fortnight should give clues on both scores: the US treasury is due to testify to Congress on Wednesday week about whether China unfairly manipulates its currency. Today the US publishes its monthly employment figures.
So far, the markets are holding their nerve, but pessimistic noises are
everywhere. On Tuesday,
Morgan Stanley assesses the risk of US protectionism as "one in three", so is sticking to its year-end FTSE 100 target of 4,500 but Graham Secker, equity strategist, adds: "If it goes to one in two, we would have to reduce our forecast." Suddenly, summer seems a fond memory.
The prices of
commodities are rising steeply. There is a bit less to this than meets the eye,
COMMODITY prices are showing new zest. Copper, often seen as a harbinger of economic trends, is trading in the futures market at 30-month highs. The formerly boring market for nickel is at a three-year high. The price of platinum is at a 20-year peak: the car industry, one of its biggest consumers, is turning out lots of vehicles, if unprofitably. Gold fetches more than it has for seven years.
Not so long ago, in the 1990s, the long decline of commodity prices seemed to be supporting a pleasant new world of strong growth and low inflation. In those days, as stockmarkets boomed, the word “commodity” took on a new meaning. American business consultants, in the age of the new economy, took to using the C-word as a pejorative for almost any product, service or skill that had become standardised (or just looked as if it might) and thus doomed to low margins and shrinking prices. Now that the share bubble has burst and a recent surge of interest in bonds has waned, commodity markets are again having their day.
The Economist's industrial commodity-price index, which since 1864 has tracked the prices of stuff dug out of the ground, forged and smelted, has risen by 25% since the start of 2002 in dollar terms (see chart). In part, this increase seems to reflect growing confidence about global economic growth. Commodities are the first part of the manufacturing chain, and serve as a leading indicator of a pick-up in production. But by no means all of the rise in commodity prices can be chalked up to brighter growth forecasts.
Currency movements have also had a marked effect on commodity prices. The dollar's weakness over the past year, not to mention in the past few weeks, has done much to flatter commodity markets. Most commodity prices are quoted in dollars, whether they are traded in London or mined in Lusaka. For buyers of commodities in America, for example, prices certainly look higher. Buyers in the euro zone, however, are enjoying lower prices in terms of their own currency than at the beginning of 2002. Prices in yen are only a little higher than at the start of last year.
Those currency effects are also at work, albeit in a slightly different fashion, in the gold market, which has perhaps caught most attention recently. Gold bugs have been triumphant as the yellow metal has brushed almost $400 an ounce, a price not seen since the mid-1990s. Traditionally, gold has been thought to be a hedge against inflation. With inflationary risks low, this scarcely explains its recent popularity. More likely, the rise in the gold price says more about the dollar than about gold. In euro terms, for example, gold prices have barely budged.
The rising prices for base metals, such as copper, nickel and aluminium, are probably more significant. These owe much to a manufacturing rebound in Asia, especially in China. As production increases to meet the requirements of recovering global growth, demand for metals of all sorts is also growing. According to Capital Economics, a London consultancy, the full implications of growing demand from China and from rich countries are not yet reflected fully in commodity prices.
By raising commodity prices, China's booming economy has also helped those of other poor countries, which have long suffered as the prices of their main exports have withered. Chile and Peru have benefited from copper's rise. Buoyant nickel prices are a big boon to Russia. Dearer gold and platinum help African miners. The government of Ghana, for example, stands to earn a great deal more from the sale of its stake in Ashanti Goldfields, a mining company, than it did just a few months ago, thanks to rising gold prices.
For all the optimism, however, there is reason to be wary of claims that this is the beginning of a long bull run in commodities. In commodities, every bull market contains the seeds of its own destruction. Vietnamese coffee producers planted seedlings in the early 1990s, when prices were robust. As their harvests began to grow later in the decade, prices slumped. Much the same is true in metals industries, where rising prices lead to the opening of previously shuttered mines. Even as the gold market rises, it is watching for sales by central banks. Much of the recent increase in base-metal prices reflects producers' slow response to signs that the global economy is picking up. When they do respond, a flood of new output is to be expected, followed by falling prices. Oil has so far been the only commodity whose producers have been able to prop up prices by maintaining a cartel.
One extra factor pushing prices upwards is speculative buying. Hedge funds, in particular, have been keen. Many such investors, as well as more staid pension funds, whose staple fare is equities and bonds, have noted commodities' new allure and have piled in. Their bets are made easier by recently constructed indices in steel and gold. Some also suspect that hedge funds have increased the volatility of some markets: last year, a fund called Armajaro was reported to have taken a huge stake in the global cocoa market, just as prices reached 15-year highs. But mostly, their impact should be the opposite. The greater liquidity provided by such investors should reduce volatility, smoothing out any demand shocks.
Whatever the role of hedge funds, once institutional investors have piled into such “alternative” assets, it should mean that the end of the bull market cannot be too far away. Nevertheless, if the dollar continues to slide, prices could continue to rise in dollar terms for some time yet.
The Bush administration is playing with fire by adopting a weak-dollar policy for political ends
FIRST, an apology. Buttonwood has received a slew of e-mails from readers either chastising him for defending Richard Grasso in last week’s column or congratulating him on standing up for the erstwhile head of the New York Stock Exchange. Suffice to say that no defence was intended: Buttonwood suggests a little light reading of Jonathan Swift, an eighteenth-century Irish satirist. Second, another, more important apology. Underlying some of this column’s cheer these few weeks past has been an assumption that President George Bush and his administration were not as stupid, short-sighted, parochial and economically illiterate as they sometimes appear. Buttonwood now realises that this was a mistake and retracts this view as hopelessly optimistic and naive. Over the past couple of weeks, the risks to the world economy and financial markets everywhere have risen as the full force of their economic myopia has visited itself on the world stage.
The reason for this column’s volte face was the outcome of the G7 meeting in Dubai. The communiqué issued by the group of industrialised rich countries on September 20th called for “more flexibility” in exchange rates, which sounds innocuous enough but most certainly wasn’t. Whatever other countries thought this meant—and the British and the Japanese denied it—the signal the Americans wanted to send was unambiguously clear: the Bush administration wants a lower dollar. John Snow, the treasury secretary, even called the statement “a milestone change”. Perhaps he was even hoping for a new version of the Plaza Accord, an agreement reached by the then G5 in 1985 to drive the dollar lower. Certainly, the currency markets thought something along those lines: since the meeting the dollar has fallen another 5% against the yen, to stand at three-year lows, and has dropped against other currencies as well.
None of the noises
coming from Capitol Hill suggest that the markets are wrong in this view. This
week, Medley Global Advisors, a consultancy run by Richard Medley, a former
advisor to George Soros and a man with strong links to administrations past and
present, issued a report saying that it was indeed the government’s intention
to push the dollar lower. And a junior apparatchik in the Treasury claimed that,
specifically, it wanted to lower the value of the dollar against the yen (since
the Chinese are unlikely to play ball). Thus has the strong-dollar policy long
espoused by Robert Rubin, Bill Clinton’s treasury secretary, metamorphosed
into a weak-dollar policy. Mr Rubin, a former boss of
Unfortunately, there is no one of Mr Rubin’s calibre close to Mr Bush; no one, indeed, in whom financial markets place much trust at all. Mr Bush has surrounded himself with businessmen such as Mr Snow and the likes of Karl Rove, his chief political advisor and a politician to his bones. Mr Bush wants to get re-elected, whatever the cost. One of the biggest threats to this is the “jobless recovery”, which is being linked politically (regardless of any economic arguments to the contrary) with the trade deficit. Politically it plays well to bash foreigners (particularly the Chinese, the new whipping-boys) for “rigging” their currencies. Protectionist noises are becoming louder by the day. Legislation has been introduced in both houses of Congress that would slap hefty tariffs on Chinese imports. Congressmen in both parties are in favour and if anything the administration is egging on such sentiment. That factory employment has in fact been falling in America for the past 45 years is being ignored.
Though such rhetoric plays well with voters it has played very badly indeed with financial markets for the simple reason that such measures would undermine growth, not just in Asia and Europe but in America too. China is very unlikely to unpeg the yuan from the dollar. But other Asian countries have currencies that float more or less freely, and the yen has been floating upwards. Fears are rising that a strong yen (or other Asian currencies for that matter) will stifle growth everywhere, and stockmarkets have taken a bashing since the G7 announcement. Japan’s stockmarket, by way of example, has fallen some 6.5%.
Japanese policymakers will not want to have what—for the first time in years—looks like a sustainable recovery choked off by a higher yen. Japan, indeed, needs the opposite if it is to create the inflation the country needs. Perhaps the Japanese representatives at the G7 did not know what they were signing up to; or perhaps the Americans threatened tariffs against Japanese companies too: it would not, after all, have been the first time. Whatever the truth, the Bank of Japan has continued to sell yen as the currency has climbed. In September it has spent a record of nearly ¥4.5 trillion ($40.6 billion) on currency intervention.
The Dubai disagreement has increased the threat of rich and poor countries attempting tit-for-tat devaluations and succumbing to rising protectionist pressures. In the wake of the failure of the World Trade Organisation talks at Cancún, this is not a possibility that can be dismissed lightly. The worries about such a protectionist tide, and its effects on the world economy, have sent Treasury-bond yields skidding lower again. Only a couple of weeks ago, they yielded some 4.5%. Now they yield just 4%.
Of course America needs a lower dollar: it has been living beyond its means for years. In the 1940s (and briefly in the 1980s) America ran a current-account surplus. Now its current-account deficit is 5% of GDP and rising. Such a deficit will need to be corrected at some stage with a weaker dollar, but over time and gradually. The risk is that it happens suddenly. Asian countries have spent many billions of dollars intervening to stop their currencies rising against the dollar. As a result, they now hold an astonishing $1.7 trillion of Treasuries. Overseas investors now hold 36% of all Treasuries; in 1985, at the time of the Plaza Accord, they held just 14% of a much lower total.
The new, politicised weak-dollar policy is scarcely likely to make them want to add to this, and may even encourage them to sell some of those that they already hold. A big sell-off would mean plunging Treasury prices and thus their yields would rebound and more from their recent falls, leaving America with higher financing costs, the last thing its fragile economy needs. “As far as I or any of my friends can tell there is no one remotely close to the president that knows about international finance,” says one of Buttonwood’s old friends, far more senior than he. It shows.