A new gold standard?
 

Oct 20th 2004
From The Economist Global Agenda

A tussle for control of Gold Fields, a large South African gold-mining company, is likely to send ripples far beyond Johannesburg

CECIL RHODES, founder of Gold Fields, one of South Africa’s oldest mining companies, must be turning in his grave. On Monday October 18th Harmony, the country’s largest producer of gold, confirmed rumours that it was offering 1.275 of its own shares for every one of Gold Fields’. If accepted by Gold Fields’ shareholders, the deal would create the world’s largest producer of gold with an output of 7.5m ounces a year.

In making an initial bid for 34.9% of Gold Fields, which the company has rejected, Harmony is also doing more than shaking up the mining establishment in Johannesburg. By teaming up with Norilsk, a Russian mining company which already owns 20% of Gold Fields, Harmony has set off a chain reaction that is sending ripples throughout the mining world.

Because of that, the stakes are high. In August, Gold Fields announced plans to sell its mining interests outside South Africa to Iamgold of Canada in a deal that would give the South African company 70% of a new and enlarged venture. Harmony is contesting the deal. It says that its own offer, which puts a price tag of just over $8 billion on Gold Fields, would give the company’s shareholders “tangible value” today, not just the possibility of it in the future should the venture with Iamgold go ahead.

Harmony is not the only opponent of the deal with Iamgold. In March, Vladimir Potanin, a Russian tycoon who controls Norilsk, bought a stake in Gold Fields as a way of diversifying his own interests outside Russia. If the deal with Iamgold goes ahead, Mr Potanin’s interest in Gold Fields’ international assets, which include mines in a dozen or so countries around the world, would be diluted.

Indeed, Norilsk currently has the worst of both worlds. With only 20% of Gold Fields, the company cannot stop the deal with Iamgold going ahead—to block it, 50% of Gold Fields’ shareholders would have to say no; nor, at the moment, does Norilsk have a large enough shareholding to influence events in its favour. With Gold Fields’ annual meeting due in November, the deal with Iamgold could be sealed before the end of the year. And with only $1.2 billion in the bank at the last count, Norilsk cannot bid for Gold Fields on its own. Under South Africa’s rules against capital flight, outside bidders must pay for acquisitions with cash, not with their own shares.

So it was probably only a matter of time before Norilsk decided to team up with a fellow bidder such as Harmony. Yet, even at a premium of 29% to the average price of Gold Fields’ shares during the past month, Harmony’s offer is not a knock-out blow. The value of its own shares dropped by nearly 8% when the bid was unveiled; and the price of Gold Fields’ stock rose by just over 4%. So not only is its prey becoming more expensive; what Harmony has to offer is also diminishing in value.

Gold Fields needs to do some sort of a deal if it is to prosper. Though the price of gold has crept up of late, the value of the rand has risen too, making South African exporters less competitive: since the beginning of 2003, the South African currency has risen by about 30% against the American dollar. As Chris Thompson, Gold Fields’ chairman, recently told shareholders, this means that “the once indomitable South African gold-mining industry is struggling to achieve profitability despite a gold price that hovers around $400 an ounce.” On Wednesday, the price rose to a six-month high of nearly $424.

Without a strong performance from Gold Fields’ operations outside South Africa, said Mr Thompson, last year’s results would have been “quite poor”. As it was, the company’s net income for the year to the end of June 2004 was R768m ($111m), down significantly from the previous year’s figure of R2.95 billion.

Fortunately for Mr Thompson, the price of gold is more likely to continue rising over the next few months than it is to fall. This is because supply is expected to drop marginally while demand is likely to remain strong. Though consumption of gold for jewellery in India and the Middle East, both large consumers of the yellow metal, has fallen during the past three years, demand from investors is likely to rise as international tensions continue. Gold is seen by moneymen as a haven in times of geopolitical turmoil.

Harmony’s aim in bidding for Gold Fields is plain enough: it wants to get its hands on more of South Africa’s gold deposits despite the rising cost of producing the stuff there. Norilsk’s motives are also fairly clear: Mr Potanin would like to get a foothold outside Russia in case the government there decides to bully metals producers as it has done Yukos, the country’s largest oil company. The question is whether relations between Harmony and Norilsk will remain, well, harmonious in the months to come. If they do, the two firms stand a reasonable chance of succeeding in their quest.

Frozen by oil-price fears
 

Oct 21st 2004
From The Economist Global Agenda

Another week, another record: the benchmark price of oil breached $55 per barrel on Monday. Americans face a bleak and expensive winter. Central bankers—and even oil exporters—are worried too

THE word petroleum has its roots in the Latin word oleum, which means oil, and the Greek word petra, which means rock. The word petrified shares the same Greek root. As the price of oleum has soared, the links between fear and petroleum have become clear to economists as well as etymologists. Fears of a heating-oil shortage this winter helped to push the benchmark price of crude (West Texas Intermediate for delivery next month) over $55 per barrel, a new record, on Monday October 18th. The spike in oil prices, up by over 60% since the start of the year, is, in turn, raising fears for the global recovery.

Even oil exporters are worried. The high prices they currently enjoy will slow economic growth next year, warned the Organisation of the Petroleum Exporting Countries (OPEC) on Monday. If oil remains expensive, the cartel pointed out, people will buy less of it. China's demand already appears to be slowing. Its imports of crude oil, which grew by 37% in the year to August, were up just 5.7% last month, compared with the year before.

Last week, for the first time since June, American motorists paid more than $2 on average for a gallon of petrol. To fill their tank these days, they must shell out almost 30% more than last year. But the anxiety is not confined to the petrol pump. About 7.7m American households, most of them in the north-east, rely on oil to warm their homes. In a cold snap, they draw on stockpiles of heating oil, amassed at various points around the country.

But those stocks may not be piled high enough this year. According to government figures released on Wednesday, America has just 49.5m barrels of high-sulphur heating oil in its inventories. This time last year, it had 55.6m. In and around New York harbour, which receives oil imports and distributes them to New York, New Jersey and New England, stocks stand at little more than 75% of their levels last year. To heat their homes, New Englanders will have to pay 28% more this winter than last, the government’s Energy Information Administration predicts.

For their expensive winter, New Englanders can blame, in part, a tempestuous autumn. Last month’s Hurricane Ivan damaged platforms and pipelines in the Gulf of Mexico, some of which are not likely to reopen before the end of the year. The Gulf is now producing only 73% of the 1.7m barrels of oil it normally pumps each day. With less crude to distill, America’s oil refiners have failed to keep heating-oil stocks at last year’s levels.

It is not only New Englanders who are counting the higher costs of energy. In a speech last Friday, Alan Greenspan, chairman of America’s Federal Reserve, calculated that the country’s higher import bill for oil had already cost it 0.75% of its GDP. “More serious negative consequences” could follow if oil prices were to climb “materially higher”, Mr Greenspan said.

When the oil price started to catch everyone’s attention in the spring, economists tried to put things in perspective. Prices would have to pass $80 per barrel to match the oil-price peaks of 1981 in real (inflation-adjusted) terms, they pointed out. Besides, oil-consuming nations now use about half as much oil for every dollar of output as they did in the 1970s. According to an oft-cited rule of thumb: a sustained $10 increase in the price of oil would knock 0.4% off the GDP of the rich, oil-consuming nations of the Organisation for Economic Co-operation and Development. It would cost America just 0.3% of GDP. A drag, but not a shock.

But as the price has continued to rise, these historical comparisons have looked less comforting. Moreover, economists are now worried that their rough-and-ready rule may not be linear: that is, a rise in the oil price from $45 to $55 may be more damaging than a rise from $25 to $35. Increasingly, economists are abandoning their rules of thumb and crossing their fingers instead.

In the past week, two investment banks, J.P. Morgan and Morgan Stanley, have cut their forecasts for world growth to reflect the stubbornly high price of oil. As recently as September 1st, J.P. Morgan hoped America would grow by 4.5% this quarter. Now it expects growth of 3.5%. Japan is forecast to expand by 2.2%, the euro area by just 1.8%, much slower than the 2.8% growth predicted last month.

The European Commission shares these diminished expectations. Its official growth predictons, to be unveiled next week, will no doubt take note of the damage oil prices might do to the European economy in the year ahead. Of course, the continent's nippy hatchbacks consume much less petrol than America's sport-utility vehicles. Tax also accounts for a much higher share of the pump price. But the euro area produces much less oil than America. As a result, it is hit harder by high oil prices. On Wednesday and Thursday, finance ministers from the 12 members of the single currency discussed the dangers at one of their regular meetings. Nicolas Sarkozy, France's hyperactive finance minister, has proposed giving back to consumers the extra tax revenues governments have raised from higher fuel prices.

If the fiscal authorities do not provide a cushion, perhaps the monetary authorities will. If oil prices stay high in the year to come, interest rates might stay low. Most central banks around the world, with the notable exception of the European Central Bank, have set off on a course of monetary tightening. But they may stop or delay along the way, to cushion the impact of higher oil prices.

Mr Greenspan gave no hint of such a pause on Friday. That may be because oil-price shocks raise inflation even as they dampen demand. If workers press for higher wages to compensate for higher energy bills, an inflationary spiral can ensue. Central banks are thus reluctant to ease monetary policy in response to an oil-price shock, even one that slows the economy.

Inflation remains at bay, for the moment, and most workers expect it to stay that way. There is little sign yet that higher oil prices are feeding into higher wage demands. It would thus be too much to say that central bankers are petrified by petroleum. But as the price of oil sets new records, their rock-like confidence is beginning to crumble.

Buttonwood

Many unhappy returns
 

Oct 12th 2004
From The Economist Global Agenda

While rich-world investors struggle to make decent returns, investors from emerging markets are lending to America as never before

WHAT links the ludicrous price of property in London with financial markets? One answer is obvious: the buying power of the City shilling, or rather many millions of them. But there is another answer, less obvious, perhaps, but probably more powerful: that prospective returns from financial assets in general are now so low everywhere in the rich world that people have turned instead to real assets in the form of bricks and mortar. Though the British love affair with houses is legendary, the fact that this is happening everywhere except Japan (where house prices have been falling for 13 years) suggests that some powerful forces are at work.

One reason for the paucity of returns the world over comes from the inflation-adjusted level of short-term interest rates in America, which, despite three rises this year, are still abnormally low by historical standards. Thus have investors plonked their money in anything else that might earn a decent crust: longer-term Treasuries, corporate debt, emerging markets, you name it. So much money has found its way into riskier assets of one sort or another that there are now only paltry returns to be had over and above the meagre risk-free rate (ie, government bonds), a rate which has become steadily more meagre even as oil prices have risen sharply. The poverty of Treasury yields says a lot about the outlook for the American economy. It might also say a lot about the unwillingness of investors in emerging markets to invest in their own countries, suggests David Goldman, head of global markets at Banc of America Securities.

Economic theory would suggest that capital should flow from developed to developing countries, for the simple reason that the latter need the money and the former need the returns. And investors from rich countries have indeed increasingly invested their savings in emerging markets in recent years. According to the Institute of International Finance (IIF), capital flows into emerging markets will this year amount to $226 billion, an increase of 81% from the dog days of 2002. Much of this will be in the form of direct investment; portfolio flows, says the IIF, will fall by a quarter.

Intriguingly, however, the wave of money flowing in will be more than matched by a veritable tsunami of money flowing out: outflows, says the IIF, will be higher than inflows by around half. Emerging countries will lend a net $74 billion this year, 90% more than last year.

But the main way in which emerging countries are in effect lending to rich countries—or rather one rich country, America—is by amassing foreign reserves, which are then invested mainly in Treasuries. The IIF expects emerging countries, led by China, to increase their foreign-exchange reserves by $246 billion this year, and by a further $225 billion next year. As Mr Goldman puts it: “As long as a rich Chinese won’t lend money to a poor Chinese unless the poor Chinese first moves to the United States, the lion’s share of the savings of billions of productive and thrifty Asians will find their way to the United States.” The effects, of course, are to support America’s current-account deficit, the dollar, Treasury bonds and risky assets of all sorts.

The export of capital from young, growing economies to old, mature ones is a recent and unusual phenomenon. The IMF, for one, thinks it unlikely to last, in part because there are costs to accumulating such huge foreign-exchange reserves, since they are likely to be inflationary. Perhaps so, but the causes of this export of capital are deep-seated: the trend can be traced back to the Asian financial crisis of 1997, which destroyed the savings of many investors there. The result is that Asian investors are content to lend money to the American government at 4% or thereabouts because they are confident of getting it back. To this extent, buying Treasuries is a strategy of diversification. It also allows rich Americans to spend more than they would otherwise do—and, of course, to invest in higher-yielding, emerging-market assets.

The accumulation of foreign-exchange reserves and generally better economic policies have presumably made emerging economies more stable than they were. That is why the credit ratings of such countries have improved a bit in recent years. How confident governments are that this will continue will be reflected in their willingness to let their currencies drift up against the dollar. The Chinese are reluctant to let the yuan, which is pegged to the dollar, rise for now, despite much foreign pressure; at some stage, when confidence in China and other Asian countries rises, so will their currencies.

A question mark also hangs over such things as property rights and robust legal frameworks. The absence of these is the reason why many emerging markets remain just that—and why people in them want to salt their money away in more stable places. Think, for example, of the immediate reaction of Russians to the travails of Yukos, a Russian oil company, which the government is taking away from its owners: capital flight.

Such countries are unlikely to become stable, western-style democracies overnight; indeed, many may never do so, whatever the wishes of rich-country investors. On the other hand, there comes a point where the opportunity cost for those in emerging markets of investing in US Treasuries—issued by a country which has the economics, perhaps even the politics, of an emerging market—becomes too great; and the risks of keeping so many of their eggs in this particular basket become similarly discomforting.

Oil and geopolitics

Crude arguments
 

Oct 7th 2004
From The Economist print edition

The problem with oil is not its shortage, but rather its concentration

AT THE end of the second world war, President Franklin Roosevelt attended a summit that changed the course of world history. No, not that meeting at Yalta, with Joseph Stalin and Winston Churchill. Immediately after that, Roosevelt travelled quietly to the USS Quincy, anchored near the Suez Canal. The man with whom he met had rarely set foot outside his home country, and insisted on bringing along his household slaves and royal astrologer.

That man was King Ibn Saud of Saudi Arabia. In the years before the war, the desert kingdom had gone from sleepy backwater to the most promising oil province in the world. Military planners in America were painfully aware of the swift decline in their own country's domestic reserves. So, in return for guaranteed access to Saudi Arabia's vast quantities of oil, Roosevelt promised the tribal chieftain America's full military support. In the decades since, the vow has proved to be one of the few fixed points of global politics—though for how much longer is an open question.

 

That close military relationship has helped feed a favourite current conspiracy theory, that of “blood for oil”, ie, that American blood in Iraq is being spilt for the benefit of oil interests. Another popular theory is that the oil is running out altogether. Politicians of both parties in America have latched on to these ideas, and now champion notions of “energy independence”. That blood is being spilt for oil; that oil is anyway running out; and that energy independence is therefore a magic solution: all are superficially attractive propositions. Yet they are also all wrong. Happily, three intelligent new books cut to the quick on these issues.

The biggest fallacy is that the world is about to run out of oil. A spate of recent books, with such titles as “Out of Gas”, argue that oil is scarce, and that an impending crisis will put the crises of the 1970s and early 1980s in the shade. Some see the recent rise in oil prices to $50 a barrel as a dire warning.

Nonsense, argues Peter Odell, a grand old man of oil forecasting who proved wrong the pessimists of the 1970s. In his new book, he points to two flaws in the argument that a peak in global oil production is coming, followed by decline: both technology and economics are ignored.

As experience has shown time and again, oil technology just gets better. The industry now uses tools unavailable in the 1970s—ranging from seismic imaging of reservoirs to advanced supercomputing—to tap oil from places unimaginable back then. As a result, proven reserves of oil are actually larger today than they were three decades ago.

Also, price signals matter: if there were a real scarcity of oil, prices would soar and companies would scramble to find more oil or its alternatives, while consumers would use less of it. Mr Odell argues, quite reasonably, that “non-conventional” oil—such as that made from Canada's mucky “tar sands”—will make up for an eventual decline in conventional sources of oil. His conclusion will anger some and surprise others: gas-guzzlers will have plenty to run on for the rest of this century.

The problem with oil is not its scarcity, rather its concentration. That is one powerful conclusion drawn by Michael Klare in “Blood and Oil”, a thoughtful and well-researched history of oil and geopolitics. Mr Klare is certainly critical of American policy, particularly of the way the United States has cosied up to nasty regimes because of their supplies of oil, helping prop up the House of Saud, for instance. Yet he counters the claim that the invasion of Iraq was “all about oil”.

Mr Klare provides a service when he puts America's close ties with Saudi Arabia in a historical context that mocks the charges—made by Michael Moore, for example, in his film “Fahrenheit 9/11”—that the Bush clan has done most to shape the relationship. He starts with that meeting between Roosevelt and Ibn Saud. He notes that it was the doctrine of Jimmy Carter, a Democrat, explicitly to defend America's access to oil exports from the Persian Gulf “by any means necessary”.

The independence myth

In short, the militarisation of America's energy policy has been a bipartisan affair. And it is Mr Klare's view that serious problems are in store. He notes that two-thirds of the world's proven reserves of conventional oil lie in the hands of five countries in the Persian Gulf, with Saudi Arabia atop one-quarter of the world's reserves. As oil gets depleted rapidly in other parts of the world, the West will come to depend ever more upon these currently undemocratic and perhaps unreliable countries.

For neoconservatives in Washington, that is one more reason for fostering, by force if necessary, liberal values and democracy in the Middle East. For many congressmen, it is a reason to call for energy independence. Yet the phrase has become misleading, for it is used to justify subsidies for pork-barrel projects or mere sops to the industry, such as drilling for oil in the Alaskan wilderness. Given that America consumes a quarter of the world's oil but has barely 3% of its proven reserves, it will never be energy-independent until the day it stops using oil altogether.

How to get there? Amory Lovins has some sharp and sensible ideas. In “Winning the Oil Endgame”, a new book funded partly by America's Defence Department, this sparky guru sketches out the mix of market-based policies that he thinks will lead to a good life after oil.

First, he argues, America must double the efficiency of its use of oil, through such advances as lighter vehicles. Then, he argues for a big increase in the use of advanced “biofuels”, made from home-grown crops, that can replace petrol. Finally, he shows how the country can greatly increase efficiency in its use of natural gas, so freeing up a lot of gas to make hydrogen. That matters, for hydrogen fuel can be used to power cars that have clean “fuel cells” instead of dirty petrol engines. It would end the century-long reign of the internal-combustion engine fuelled by petrol, ushering in the hydrogen age.

And because hydrogen can be made by anybody, anywhere, from windmills or nuclear power or natural gas, there will never be a supplier cartel like OPEC—nor suspicions of “blood for hydrogen”. What then will the conspiracy theorists do?

Economics focus

G-force
 

Oct 7th 2004
From The Economist print edition

The G7 no longer governs the world economy. Does anyone?

IN SEPTEMBER 1985, the Plaza hotel in New York was the scene of a plot to debauch the dollar. Finance ministers and central-bank governors from the United States, Japan, Germany, France and Britain conspired to narrow America's trade gap and thwart rising protectionism. They promised to curb fiscal deficits in America, cut taxes in Germany and sell dollars in the foreign-exchange markets. In the wake of the Plaza accord, as their agreement was known, the dollar lost almost 30% of its value. It was a triumph of macroeconomic diplomacy. The next year, these five nations admitted Canada and Italy to the elite. The Group of Seven, or G7, as the club was named, has met ever since.

Today the G7 is not what it was. In September 2003, it assembled in Dubai, with America's manufacturers once again bemoaning the dollar's strength. China had pegged the yuan at 8.28 to the dollar and Japan had spent more than ¥9 trillion ($76 billion) that year keeping the greenback above ¥115. The G7 issued a communiqué in effect urging Japan and China to allow more flexibility in their exchange rates. A year on, when G7 finance ministers met in Washington, DC, on October 1st, not much had changed. The yen has scarcely budged, China's peg remains firm and America's trade deficit has widened to almost $600 billion.

The G7 is but one of an “alphanumeric panoply of bodies” (the G10, G20, G24 and G77 are others) that attempt to co-ordinate the economic policies of nation states. A recent review* of these bodies, by Peter Kenen, Jeffrey Shafer, Nigel Wicks and Charles Wyplosz, makes an eloquent and considered plea for reform. Each of these groups was set up in response to some issue of the moment. But though the moments come and go, the groups, clubs and committees come and stay. The result is a disorderly scrum of bodies fighting for turf.

The authors (of whom two are academic economists and two are former officials) nonetheless find much to praise in the G7's economic statesmanship. Unencumbered by formal procedures, the politicians and governors often move with greater dispatch than the technocrats on whose turf they encroach. Whether it be financing the transition from communism, bailing out Mexico, or relieving poor countries' debts, the G7 members thrash out a joint position, then use their combined weight in the International Monetary Fund and the World Bank to advance their common purpose. At last weekend's meetings of the G7, the IMF and the Bank, America and Britain urged the Fund and the Bank to cancel all their loans to poor countries. Neither country's initiative made much progress. But what the G7 proposes, the Bank and the Fund find hard to oppose for long. The converse is not true. For example, the IMF's recent initiative to set up a bankruptcy court for sovereign borrowers had much to commend it. But without the G7's support, the idea has gone nowhere.

The Fund's original mandate was to manage the orderly adjustment of the balance of payments between its members. The G7 usurped that role at the Plaza hotel, but no one performs it now. Currency misalignments and trade imbalances are natural occasions for international co-operation: no exchange rate belongs to one country alone. Some economists, such as Milton Friedman, a Nobel laureate, argue that such co-operation is redundant. Exchange rates should be left to market forces, which can co-ordinate the policies of different countries for them. Currencies free to float leave national policymakers free to concentrate on their domestic “homework,” as Bernhard Winkler of the European Central Bank puts it: keeping prices stable and budgets in balance. Mr Winkler considers the Plaza accord and the Louvre accord of 1987, which halted the dollar's fall, to be signs of failure not triumph. They were needed only because the American government could not balance its books. Co-operation abroad is necessary only because of mismanagement at home.

The C1

American intervention in the foreign-exchange markets peaked in 1989. Since then it has pursued a dollar policy of benign neglect. But other countries, such as China, have yet to heed Mr Friedman. China's peg to the dollar is a decade old. Its central bankers say they want a more flexible yuan—eventually. “China has an 8,000-year history,” one of them quipped this month. “A decade is truly a short period.”

The yuan accounts for less than 10% of the trade-weighted value of the greenback. But its peg is nonetheless an obstacle to a broad realignment of currencies. Other East Asian countries, which trade with China and compete against it, will not allow their currencies to strengthen much until China does also.

This month, the G7 finance ministers invited Chinese officials to dine with them for the first time. But the report's authors believe China warrants more than a meal. A new group is needed, comprising representatives of all the main currencies, and only them. The report recommends that America, the euro zone, Japan and China meet in a “G4”, overseeing balance of payments adjustment between these economic blocks.

The authors are right to give China a place in the highest councils of macroeconomic diplomacy. Without it, the G7 cannot hope to achieve much. But adding China to the group, or creating a G4, will not create consensus where none currently exists. Agreement at the Plaza hotel was possible only because the domestic politics of each country favoured it. Similarly, China's peg will remain until its authorities' fear of domestic inflation—or of American protectionism—outweighs their fear of floating. There is no easy alphanumeric solution to the imbalances of the world.

Pumping up the oil price
 

Oct 1st 2004
From The Economist Global Agenda

This week, the oil price touched $50 per barrel for the first time, not because of terrorism in the Middle East but because of gangsterism in Nigeria. A combination of past under-investment and current political strife has left producers struggling to keep up with demand

AS IT enters the sea off the southern coast of Nigeria, the Niger river divides and subdivides to form a delta of distributaries and swamps. But though the Niger delta derives its name from a river, it owes its notoriety to its wells. Oil wells, pumping over 2m barrels of the stuff each day, account for about 90% of Nigeria’s foreign-currency earnings and a large proportion of its civil strife. On Monday September 27th, one of several armed gangs in the region threatened to wage “all-out war on the Nigerian state”. The Niger Delta People’s Volunteer Force, led by Mujahid Dokubo-Asari, warned oil companies to shut down and foreigners to pack up by the end of the week. The oil markets did not wait even that long to take fright. During after-hours trading on Monday, the benchmark price of crude (West Texas Intermediate for delivery in November) topped $50 per barrel for the first time. It went on to set a new record of $50.47 on Tuesday, before falling back to a whisker over $49 by Thursday morning.

Mr Dokubo-Asari’s militia claims to be fighting for the rights of the Ijaw, one of the three main ethnic groups in the delta, but it is really fighting for the right to steal crude and sell it on the black market. It probably lacks the wherewithal to capture and hold an oil installation (many of which operate offshore), much less mount a serious military challenge to the Nigerian state. But it could make trouble. Five years ago, an Ijaw faction mounted a three-month blockade, stopping about 30% of Nigeria's oil flows.

Mr Dokubo-Asari’s declaration of war on Monday left Shell, the biggest oil company in the country, unmoved. Theft, sabotage and intimidation are almost routine costs of doing business in the delta, and with oil at $50 a barrel, business is still well worth doing. Besides, the war Mr Dokubo-Asari threatens may end before it begins. On Wednesday, he was reported to have agreed a deal with the government over oil revenues and ethnic rights. But on Friday, he accused the government of violating the truce and threatened to have his militia blow up a natural gas facility at Soku.

In truth, Nigeria's oil production is threatened by long-term decay as much as short-term disruptions. High oil prices this summer tempted the country to raise production to 2.5m bpd. But its time-worn infrastructure could not sustain this higher rate of pumping and piping much beyond July. Since then, according to Reuters news agency, the country’s oil output has eased back to 2.25m bpd.

In a world that produces 82m bpd, such fluctuations in supply should be just a drop in the barrel. But Nigeria’s difficulties are symptomatic of a broader problem upsetting the oil markets: a combination of past under-investment and current political strife.

Like Nigeria, the ten other member states of the Organisation of the Petroleum Exporting Countries (OPEC) have failed to expand, upgrade and refurbish their production capacity in line with rapid increases in world demand. As a consequence, the cartel’s production capacity is now stretched close to its limits. Exactly where those limits lie is unclear—the uncertainty is itself a source of volatility in the oil price. But the International Energy Agency (IEA), which advises oil-consuming nations, estimates that OPEC, excluding Iraq, could sustain output of about 27.8m bpd. Last month, it produced 27.5m bpd. This month, its margin of spare capacity narrowed even further.

Without a buffer stock of oil, the cartel cannot do its job of setting the price. If Nigeria, Iraq or Venezuela suffers a little local difficulty, other cartel members are supposed to step in and take up the slack. Markets now fear that supplies are drawn tight as a “taut piano wire”, says the IEA. The markets are thus tuned to respond to any disruption or disturbance, whether it be Hurricane Ivan menacing oil platforms in the Mexican Gulf or jokers with guns menacing oil firms in the Niger delta.

The IEA itself believes this tension will soon pass. OPEC, it points out, is now doing its best to keep prices down and will do better as new fields come on line. On Tuesday, Saudi Arabia said that two new oilfields, in Abu Safah and Qatif, would add another 500,000 bpd to the kingdom’s capacity, bringing it up to 11m bpd. Russia, the biggest oil producer outside of OPEC, is also ramping up production, even as it clamps down on Yukos, its biggest private-sector oil group. On Wednesday, the latest figures from America's Energy Information Administration showed that the country's stocks of crude are recovering from Hurricane Ivan more quickly than expected. The surprising rise in oil inventories, the first in nine weeks, prompted a rapid fall in the oil price.

The IEA also sees grounds for optimism on the demand side of the oil market. America's summer "driving season" put a premium on the "sweet", low-sulphur crude best suited to the nation's petrol pumps. In the winter months, oil refiners will use more of the heavier, high-sulphur crude, which is suited to heating the homes of the north-east. Saudi Arabia, which produces plenty of the heavier crude, will then be in a better position to meet the market’s needs; and Nigeria, which produces the sweeter oil, will be in no position to frustrate them. If the IEA is right, then, the world can soon look forward to a time when the oil price is once again set in Saudi Arabia’s desert sands, not Nigeria’s troubled swamps.

SURVEY: THE WORLD ECONOMY

The dragon and the eagle
 

Sep 30th 2004
From The Economist print edition

American consumers and Chinese producers have led a global boom. China is creating genuine wealth, but America's binge is based partly on an illusion, says Pam Woodall, our economics editor

OVER the past year the world economy has grown by almost 5%, its fastest pace in two decades. Growth has been powered by two high-octane fuels: America's exceptionally loose monetary policy, which has encouraged consumers to keep spending; and an unprecedented investment boom in China. America and China together accounted for almost half of global growth over the past year. If American consumers and Chinese producers were to retreat at the same time, global growth could slump.

Until the Federal Reserve started to lift interest rates in June, money had been cheaper than ever before, and not just in America: average short-term interest rates in the world's big economies were at their lowest in recorded history. Average real interest rates are still at their lowest since the high-inflation 1970s. By slashing rates to 1% after the stockmarket bubble burst, the Federal Reserve saved America from a deeper recession and the risk of deflation.

But inflation is now rising, so monetary policy needs to be tightened. How will the American economy—indeed, the world economy—fare if interest rates return to more normal levels of perhaps 4-5%? Super-low rates have encouraged consumer behaviour that will look a lot less sensible as interest rates rise. And to make things trickier, crude-oil prices have surged to new heights at the very time that the Fed has started to raise rates. Dearer money and dearer oil have already caused consumers to cut back.

China's breakneck pace of growth also looks unsustainable. In the year to the second quarter its GDP grew by almost 10%. Real fixed investment was increasing at an annual rate of 35% earlier this year; bank lending has been rising too fast, fuelling a property bubble; and inflation has moved above 5%. If China suffers a hard landing, the rest of the world will feel the bump: in the past three years, the country has contributed one-third of the world's growth in real output, measured at purchasing-power parity (see chart 1).

Only a few years ago, the term “the world economy” was used as shorthand for the economies of the developed world; China would at best rate a brief mention. But now it is too big to ignore (see chart 2, below). It was largely thanks to China's robust growth that the world as a whole escaped recession after America's stockmarket bubble burst in 2000-01. But its recent boom is also responsible for much of the surge in global energy demand that has pushed up oil prices. China's massive purchases of American Treasury bonds explain why the dollar has not fallen further or bond yields risen more sharply—even though America's huge current-account deficit continues to widen. Last but not least, many people blame the sickly state of America's jobs market on imports from China and on outsourcing.

China is home to one in five of the world's people, and has long been the most populous country on earth, but economically it has started to matter only recently. China's GDP already accounts for 13% of world output (at purchasing-power parity), second only to America's. By the end of this year China will probably be the world's third-biggest exporter (after America and Germany). It is also the largest recipient of foreign direct investment as multinationals have moved operations to China to take advantage of its low labour costs and huge domestic market. It is the new workshop of the world, producing two-thirds of all photocopiers, microwave ovens, DVD players and shoes, over half of all digital cameras and around two-fifths of personal computers.

But China is not only a big new producer, it is also a big new market. Its imports grew by 40% last year, and over the past three years it has accounted for one-third of the total increase in world import volumes. China has become a locomotive for the rest of East Asia, accounting for half the total export growth of the other East Asian economies last year. Indeed, exports to China have played a big part in Japan's recent economic recovery. China's demand for commodities has also rocketed, driving up world prices.

If China sneezes

Over the past year, China's policymakers have been trying to cool the economy, and there are signs that they are succeeding. Both investment and bank lending have already slowed quite sharply. But will the economy land gently or with a crash, as it did after the 1993-94 boom? A crash would dent growth in the rest of the world just when the Fed is raising interest rates.

Yet China's boom is itself partly the product of the Fed's super-lax monetary policy. With its currency pegged to the dollar, China has been forced to import America's easy monetary conditions. Its higher interest rates have attracted large inflows of capital that have inflated domestic liquidity, encouraging excessive investment and bank lending in some sectors which could lead to a bust. Fortunately the economy is not as overheated as it was in the early 1990s, when investment, credit and inflation were all growing much faster; and this time the authorities have acted sooner. But even if China can engineer a soft landing (which is generally defined as growth slowing to around 7%), growth in investment and imports of capital equipment and raw materials would slow much more severely, causing some global discomfort.

Some commentators liken China's boom to America's dotcom bubble in the late 1990s; but although investors have clearly got carried away, much of the exuberance about China is rational. The country's recent ups and downs are reminiscent of America's booms and busts during the period of industrialisation in the late 19th century. These did not prevent America becoming the world's economic giant, creating fast-growing markets for European goods. If China continues with its reforms, it will enjoy faster growth than America ever achieved. Within a decade it will probably be the world's largest exporter and importer, and one day it may overtake America as the world's largest economy.

That strikes fear in the heart of many businessmen and workers in rich countries. In America's presidential-election campaign, China has been widely blamed for America's “jobless recovery”; yet faster growth in China should mean faster rather than slower growth elsewhere too. China has a unique combination of a huge population and an economy that is unusually open to the rest of the world, as measured by trade or foreign direct investment. China's catch-up in income and its integration into the world economy could be the single biggest driver of global growth over coming decades. Indeed, China's boost to global growth could exceed the much-trumpeted gains from the IT revolution.

China's road to prosperity is not without risks. Its economy may well stumble during the next year or so. But its future prospects remain excellent, built on genuine wealth creation as currently underemployed labour is put to productive use. In contrast, American consumers have been living in never-never land, financing their spending by borrowing against illusory gains in wealth.

Not as rich as you think

Economies can get truly richer only through increased productivity growth, either from technological advances or from more efficient production thanks to international trade. Thus China's integration into the world economy genuinely creates wealth. The same cannot be said of all the “wealth” produced by stockmarket or housing bubbles.

In recent years, many people around the world have found it easier to make money from rising asset prices than from working. Roger Bootle, the managing director of Capital Economics, a London consultancy, calls this “money for nothing”. The surge in share prices in the late 1990s boosted the shareholdings of American households by $7 trillion over four years, equivalent to almost two years' income from employment—without requiring any effort. The value of those shares has since fallen, but the drop has been more than offset by soaring house prices. Over the past four years the value of homes in America has increased by more than $5 trillion, making many Americans feel richer and less inclined to save. But much of this new wealth is an illusion.

The first mistake, at the end of the 1990s, was to believe that shares were actually worth their quoted price. The second mistake, today, is to view higher house prices as increased wealth. A rise in share prices can, in theory, reflect expected future gains in profits. The stockmarket boom did reflect some genuine wealth creation in the shape of productivity gains, however exaggerated they may have been. But rising house prices do not represent an increase in wealth for a country as a whole. They merely redistribute wealth to home-owners from non-home-owners who may hope to buy in the future. Nevertheless the illusion of new-found wealth has caused households as a whole to save less and spend and borrow more.

Historically low interest rates have fuelled housing bubbles in America and many other countries around the globe. At some stage prices will fall, obliging consumers to save much more and spend less. The unwinding of America's vast economic imbalances could depress growth there for many years, whereas China's slowdown looks likely to be fairly brief.

Oddly enough, China may be partly to blame for this wealth illusion in rich economies, because central bankers have been slow to grasp the consequences of China's rapid integration into the world economy. By producing goods more cheaply and so helping to hold down inflation and interest rates in rich economies, China may have indirectly encouraged excessive credit creation and asset-price bubbles there. Inflation has remained low, but excess liquidity now flows into the prices of houses and shares rather than the prices of goods and services. And to keep its exchange rate pegged to the dollar, China has been buying vast amounts of American Treasury bonds, which has helped to depress bond yields and mortgage rates, fuelling America's property boom.

This survey will explore the many ways in which China's rapid economic development is affecting the rest of the world, from jobs and growth to oil prices and inflation. The integration of China's 1.3 billion people will be as momentous for the world economy as the Black Death was for 14th-century Europe, but to the opposite effect. The Black Death killed one-third of Europe's population, wages rose and the return on capital and land fell. By contrast, China's integration will bring down the wages of low-skilled workers and the prices of most consumer goods, and raise the global return on capital.

Some central banks, slow to grasp the effect of these structural changes on inflation and monetary policy, have been running overly loose policies that have fuelled unsustainable booms in America and some other economies. In the short term, therefore, China could make growth more volatile, but in the long term it will be a powerful engine of global growth. The Black Death is thought to have originated in China and spread to Europe through trade. This time China will export vitality to the world economy instead.

Buttonwood

On top down under
 

Sep 28th 2004
From The Economist Global Agenda

Australia’s stockmarket, unlike those of other rich countries, has been hitting new heights this year—a case of the Old Economy striking back. But it might yet be undone by Chinese wobbles or a house-price collapse

CAST your mind back, if you will, to the late 1990s. Having decided that technology was the only business worth punting on, investors the world over poured billions of dollars into companies that, by way of example, thought it sensible to spend $200 billion on 3G mobile-phone licences. Those were the days when companies with even the most tangential connection to the New Economy (capitals obligatory) sucked in punters’ cash at a prodigious rate. Those, in contrast, which sold things that you could drop on your foot, or—horror!—stuff dug out of the ground, were about as popular as last year’s Nokia at a rave.

Nowhere, perhaps, was perceived as being more Old Economy than Australia, a country, after all, that seemed to exist merely to grow wheat, breed sheep and mine minerals. To anyone of a Luddite disposition, the weighting of information technology in the country’s All Ordinaries stockmarket index was pleasingly low. Australian shares rose in the late 1990s, but their performance was flaccid compared with the more virile show on Wall Street. Until, that is, the technology bubble popped, dragging broader markets down around the world, and exposing the greed of many corporate bosses and the shaky finances of the companies they ran—and not just those in the vanguard of the information revolution.

Though shares in most rich countries have risen strongly over the past couple of years as profits and confidence have returned, almost all of the big markets are still some way from their highs—in Japan’s case, a long way. The S&P 500 is still 27% below its peak, the FTSE 100 is down by a third, and the Eurotop 300 is off 42%. Japan’s Nikkei is almost three-quarters off its high in December 1989. Australia’s All Ordinaries index, by contrast, has been bouncing from one record high to another this year, during which it has risen by 10%, largely because of the soaring price of energy and metals. Unlike most other rich countries, Australia is a net exporter not just of metals and coal but of energy too: although it might depress consumption, the $50 a barrel that oil reached this week should therefore not trouble the economy too much.

A resurgent Japan, Australia’s biggest export market, is part of the explanation for bumper export prices. But the destination of choice for Australia’s exports is China, which has a scarcity of the very commodities that Australia has in abundance. Commodity exports to Japan have risen by 7% since 2001, but to China they have gone up by 45%. Australia is supplying much of the iron ore, non-ferrous metals and coal that China needs.

There has also been a more subtle reason for the rise in commodity prices and, by extension, the comparatively stellar performance of the Australian stockmarket. Following the Asian financial crisis of 1997, and with the world’s attention focused firmly on technology, investment by energy and mining companies dropped precipitously. With capacity thus constrained, a pick-up in demand from the likes of China could only lead to one result: higher prices. Thus has The Economist metals index risen from 69 at the beginning of 2003, to 107.5 now (the index was rebased to 100 in 1995). Thus do Australia’s ports, like those elsewhere in Asia, operate at full capacity. And thus, too, after two decades of under-investment, is oil at $50 a barrel.

The fall in investment by Australian mining firms in the late 1990s illustrates the point. From investing some 20% of sales in 1996, their capital expenditure dropped to almost nothing, and this year, despite high prices, will still be less than 10% of sales. Companies merged, too, to cut costs: in 2001, for instance, BHP, a big mining firm, tied the knot with Billiton, another one; in 2003, MIM was taken over by Xstrata, a mining company with a name presumably designed to hoodwink investors into thinking it did something new-fangled. Management of these companies often went from geologists to bean-counters, who were far more concerned with squeezing out profits. For all these reasons, it is perhaps unsurprising that profits at, for example, BHP Billiton grew by 40% last year and will probably go up even more this year.

Nor is that the end of the happy tale, for such companies negotiate long-term contracts, and many of the ones that mining and energy firms have in place now do not take account of today’s higher prices. They will next year, assuming prices stay at their present lofty levels. Small wonder that corporate profits in Australia grew by 15% last year and are expected to grow by 16% this year.

But the tale also has a twist or two. Australia’s good fortune relies on China avoiding a stumble. But that is not the stockmarket’s only vulnerability. The economy seems to have been growing at about 4% a year for ever. Brisk domestic demand is the main driver, which is why cyclical stocks, such as retailers, have done well. But strong exports of commodities have not been enough to boost overall exports—which, oddly, have been flat for the past few years—let alone offset Australians’ insatiable appetite for imports. That is why the country is likely to have a current-account deficit of 5.5% or so of GDP this year.

Worried that the country is overheating, the central bank has put up interest rates, and may again. That may not be wonderful news for the country’s banks, which account for a quarter of the stockmarket’s capitalisation. That is because higher interest rates are likely further to depress house prices, which had risen to giddy heights before suffering a reverse this year. And a collapsing housing market is generally not wonderful news for the financial firms that lent money to people to buy overvalued property. Largely unaffected by the technology bubble, it remains to be seen whether Australia can weather a property bubble.

OPEC’s liquidity trap
 

Sep 17th 2004
From The Economist Global Agenda

At its meeting in Vienna, OPEC, the oil-exporters’ cartel, has raised its production quotas by 1m barrels per day. But oil will flow no more freely than before

ONLY the words of Alan Greenspan, chairman of the Federal Reserve, attract closer scrutiny than the hints and whispers of oil ministers and officials from the Organisation of the Petroleum Exporting Countries (OPEC). Fed-watchers must wait until September 21st for another interest-rate announcement to pore over. But the OPEC cartel has provided plenty of words in recent days for its followers to hang on.

Last week, the oil minister from the United Arab Emirates said that OPEC was likely to consider raising the formal production quotas it sets for its members, in response to an oil price that has remained stubbornly above $40 per barrel. At the weekend, other OPEC delegates contradicted him, saying a rise in quotas was unlikely and a cut in production was quite possible before next spring. But at its meeting in Vienna on Wednesday September 15th, OPEC announced that it would raise its quotas by 1m barrels per day (bpd), to 27m bpd, with effect from November 1st. It also decided to meet again sooner than scheduled, agreeing to reconvene in Cairo on December 6th.

If OPEC’s signals are even harder to read than Mr Greenspan’s at the moment, it may be because the cartel finds itself in a position the central banker would dread. When Mr Greenspan sets his target for the federal funds rate, he can be sure it will be met. But when OPEC announces an output quota, it can be quite confident the target will be missed—the cartel is currently exceeding its official limit by as much as 2m bpd. Even worse, OPEC’s oil output is now almost as high as it can go. Raising quotas may thus have no discernible effect on production.

Cartels exist to place artificial constraints on supply. But the constraints on today’s oil supply are all too real. OPEC’s members, excluding Iraq, produced 27.5m bpd in August, according to the International Energy Agency (IEA), which advises oil-consuming nations. The most they could sustain with their current capacity is just 27.8m bpd, the IEA says. Only Saudi Arabia is said to have much spare oil ready to pump, but no one knows exactly how much, how quickly it could be brought to market, or indeed how marketable this sulphur-heavy variety of crude would be.

With supplies stretched this tight, any disruption or disturbance can move the oil price: the insurrectionist sabotage of pipelines in Iraq, the court-ordered sabotage of the Yukos oil company in Russia, or the meteorological sabotage wreaked by Hurricane Ivan in the Mexican Gulf. News of another fall in America’s stocks of crude added almost a dollar to the oil price during trading on Wednesday, leaving OPEC rather upstaged.

The organisation’s current willingness to lift quotas counts for less than its hesitance to invest in new wells and fields. The number of wells drilled by cartel members last year fell by 6.5% from the year before, according to an OPEC report. The cartel has thus far rebuffed most offers from the world's big oil companies to tap its underexploited oilfields. In Vienna, the oil companies pressed their suit with renewed urgency, arguing that OPEC members must let them in now if they are to meet the world's much-expanded demand for oil in ten years' time. OPEC ministers were unmoved.

This reluctance is partly explained by fear: members recall the lessons of the early 1980s, when overcapacity in the industry threw the cartel into disarray, and of the Asian financial crisis, when fear of a deep world recession prompted OPEC to pump too much oil. Complacency is also a factor. OPEC’s nationalised oil companies make their exploration and drilling decisions on fiscal, not commercial, principles. As long as their oil revenues are keeping the government’s budget in surplus, they see no need to expand. Opening up to the oil majors might bring extra investment and cash, but, as Ali al-Naimi, the Saudi oil minister, said on Thursday, “At these prices we don't need it.”

The situation should improve this year and next. Two new oilfields in Saudi Arabia will be ready to pump 800,000 bpd by the end of September, according to the kingdom’s oil minister. These new developments were commissioned to replace ageing facilities elsewhere, the retirement of which may now be postponed. Both Kuwait and Algeria will also inflate OPEC’s supply cushion by the end of the year, according to their oil ministers.

But the new fields and wells touted on Wednesday will still fall short of what is needed to restore OPEC’s power over the oil price. By its own calculations, it would now need more than 3m bpd of spare capacity to function as a genuine swing producer, able to hold the price down as well as push it up. Until then, the physical limits on OPEC’s oil production will bite before the cartel’s quotas do.

If supply does not catch up with it, oil demand may falter—high prices tend to have that effect. The world economy is already slowing. China’s demand for oil, 6.5m bpd in the second quarter, is forecast to slip to 6.3m in the third, according to the IEA. America’s petrol consumption, seasonally adjusted, fell by about 200,000 barrels a day between April and July. The soft patch America’s economy is currently suffering is due “in large measure” to the steep rise in energy prices, Mr Greenspan has said. He has also given warning that the future balance between supply and demand in the oil market will remain “precarious”. OPEC-watchers, tired of poring over the cartel’s empty pronouncements, should perhaps mark the Fed chairman’s words instead.

Share trading

Less information, please
 

Sep 16th 2004 | NEW YORK
From The Economist print edition

Big shareholders are seeking more opaque markets

AFTER centuries of experimentation, the business of trading shares is still evolving. The latest mutation appeared on September 9th, when Pipeline Trading opened for business in a run-down office, with second-hand furniture and wires dangling from the ceiling, near New York's Grand Central Station. Ignoring (or ignorant of) appearances, 40 of the largest investment firms in the world found their way into Pipeline's system. By the end of day one, it had processed 800,000 shares; by day four, more than 3m.

Although this pales before the billion or so shares traded daily on the New York Stock Exchange (NYSE), Pipeline is on to something. Another firm with a vaguely similar business model, Liquidnet, was founded in the slump of 2001 and has done nothing but grow ever since. It processes 20m shares a day. Curiously, the essence of both companies' strategies is to provide less than competing exchanges and brokers.

Trades through Pipeline can be done in only two sizes: 25,000 shares for most stocks, 100,000 for the biggest. Customers must provide their own price demands and have no guarantee that their orders will be executed. Liquidnet does not even provide trading, but merely alerts customers to the existence of other customers who might like to do business and then provides a way for them to negotiate with each other through its systems. A third firm, POSIT, allows trading only for one minute every half-hour. For these minimal services, each of the firms charges two cents a share, less than investment banks, which charge five cents, but more than electronic networks, which charge fractions of a cent.

These strategies are a response to an odd problem. Trading shares in large quantities has become increasingly difficult in American markets. Even as the volume of trading has continued to grow, the size of trades has shrunk, from more than 2,000 shares in the average NYSE transaction in 1988 to 400 today. The reason is that big institutions—mutual, pension and endowment funds—have come to believe that hedge funds and investment banks are too adept at using the information in the orders to make money for themselves. For example, a hedge fund or a bank might trade on its own account before executing a client's order. In response, investors are splitting deals into tiny pieces. An “iceberg” offer of a few hundred shares is floated to see if demand or supply can be teased out for a bigger transaction.

Thus tactic has its limits. Extraordinarily sophisticated computer programs can exploit the smallest transactions. Exchanges are aware of this, but can do little to stop it. In response to a scandal seven years ago, the Securities and Exchange Commission put through far-reaching changes in how orders are handled. The worst abuses, which concerned the poor treatment of orders from small investors, were purged through increased transparency. However, an unintended consequence of increased disclosure was to put large investors at the mercy of traders.

The answer offered by Pipeline, Liquidnet and POSIT is a system that provides anonymity. Lacking exchange status, these firms do not have to reveal orders (executed trades are posted on the NASDAQ). Their limited product offerings strip out information that could corrupt a trade. Their answer is not perfect. Customers have to have some sort of guide to the prices they are likely to get. Because orders are not revealed in the three companies' systems, benchmarks are taken from the better-known markets, notably the NYSE and the NASDAQ. If these new trading systems gain a large market share, the established benchmarks will lose their validity. That, however, is a concern for another day.

Buttonwood

An oasis, not a mirage
 

Sep 14th 2004
From The Economist Global Agenda

The prospects for Japan’s economy and its stockmarket still look rosy

IF THIS week’s column is a little intemperate, it is because for the past week-and-a-half your columnist has been an ex-smoker. A better writer could describe the cravings, the mood swings, the madness. Suffice to say that Buttonwood’s daughters were especially uncaptivated by the chicken impressions at the weekend. It must be admitted that he has been an ex-smoker before. Alas, a three-year stint in smoking-friendly Tokyo led to relapse. But Buttonwood harbours no grudges, or at least not in this case: in the parched desert of dismal prospective returns around the world, Japanese stocks have stood out as a veritable oasis. And, unlike just about every other rich-country market, the Japanese market has actually gone up this year. But some of the recent numbers coming out of the country, which have been dreadful, have necessitated the sort of questioning that in times past would have called for a packet of fags. To be blunt: is the oasis in fact a mirage?

The latest reality check came from Japan’s revision of its second-quarter GDP numbers on Friday September 10th. These had been pretty bad when they were first released in the middle of August—growth of 0.4%, compared with the 1% that most economists had expected—and pundits had dismissed them as too awful to be believable: revisions were on their way, and big ones. Well, the numbers were indeed revised, but only by a fraction, and in the other direction: Japan apparently grew by only 0.3% in the second quarter. This provided yet more ammunition to those who think Japan’s recovery is unsustainable.

There are still lots of them, and they wield arguments aplenty: the high price of oil, a lack of domestic demand and the consequent reliance for growth on exports to China and America, two countries that are not without problems of their own. And, in the background, a sclerotic, corrupt and pitifully ineffectual political system, which has failed Japan so spectacularly in the long years since the popping of the bubble. The bond market, which has been right for all of that time, is again registering its despair. The 1.5% yield on the 263rd issue of ten-year bonds, though triple what it was in June of last year, is still a lot less than almost all of its predecessors, and down from 1.9% a few weeks back.

Buttonwood has, of course, the utmost respect for traders of Japanese government debt. However, as Arnold Schwarzenegger might say, the present lot are a bunch of economic girly-men. Yes, Japan has its problems, but its economy is on the mend. Odd though this may sound to those hardened in the Japanese school of disappointment, the surprises for investors in the country’s stockmarket are more likely to be of the good sort, not the bad. The Japanese establishment, as one economist put it rather neatly, has run out of stupid things to do to wreck its economy, and the “problems” that Japan has—huge and growing exports—are problems of which the likes of America can only dream.

Which is partly why the GDP figures look so odd. Perhaps they can be safely ignored: after all, Japanese economic statistics tend to be dodgy. For example, one big drag on GDP, according to the number-crunchers, was firms’ inventories, which fell even though they were already very low by historic standards. Of course, even if the figures are right, firms are shifting so many goods out of their factories that they will at some point have to replace the stocks they have already sold, which will be good for growth. By contrast, firms’ investment growth was revised up a bit, to 4.9%. Yet a survey by the finance ministry showed investment rising at double that pace. That would be no surprise, for the simple truth is that Japanese companies are fantastically profitable.

Depending on what numbers you look at, profit margins are either higher than at any time since the bubble burst, or their highest of modern times. In consequence, Japanese companies as a group—and not just a handful of exporters—are turning in wonderful profits. According to a survey by the Nikkei, the country’s main business daily, one in four listed Japanese companies will make record profits this financial year. Non-financial firms expect their profits to rise by 16% this year. Although this is less than last year’s 27%, it will almost certainly be revised upwards.

Companies have used a lot of this money to pay off all of those debts they piled up in the bubble years. Japanese corporate balance sheets are now in their best shape in decades, and at some stage in the none-too-distant future companies will have the confidence to start investing a lot more than they have done in recent years. That is when the virtuous circle could really kick in. Fearful for their jobs—the unemployment rate hovers near 5%—Japanese consumers have been loth to open their wallets. When companies start to invest and hire again in earnest, consumers will start to spend.

And the economy will grow still more strongly, presumably boosting profits. True, by the standards of other countries’ stockmarkets, Japanese equities are not a giveaway: Topix, the broad stockmarket index, trades at a price-earnings (p/e) ratio of some 19 times this year’s earnings. But by the country’s own standards, they are mouth-wateringly cheap: in each of the rallies of the 1990s, the p/e was four times that. For what it is worth, shares in Japan Tobacco, the world’s third-largest tobacco company, are already up by 14.5% this year. But Buttonwood no longer smokes, even vicariously.

The world economy

The risks ahead for the world economy
 

Sep 9th 2004
From The Economist print edition

Fred Bergsten explains why policymakers need to act now in order to avert the danger of serious damage to the world economy

FIVE major risks threaten the world economy. Three centre on the United States: renewed sharp increases in the current-account deficit leading to a crash of the dollar; a budget profile that is out of control; and an outbreak of trade protectionism. A fourth relates to China, which faces a possible hard landing from its recent overheating. The fifth is that oil prices could rise to $60-70 per barrel even without a major political or terrorist disruption, and much higher with one.

Most of these risks reinforce each other. A further oil shock, a dollar collapse and a soaring American budget deficit would all generate much higher inflation and interest rates. A sharp dollar decline would increase the likelihood of further oil price rises. Larger budget deficits will produce larger American trade deficits, and thus more protectionism and dollar vulnerability. Realisation of any one of the five risks could substantially reduce world growth. If two or three, let alone all five, were to occur in combination then they would radically reverse the global outlook.

There is still time to head off each of these risks. Decisions made in America immediately after this year's elections will be pivotal. China, the new growth locomotive, is key to resolving the global trade imbalances and must play a central role in future. Action by a number of other countries will be essential to maintain global growth and to avoid deeper oil shocks and new trade restrictions.

The most alarming new prospect is another sharp deterioration in America's current-account deficit. It has already reached an annual rate of $600 billion, well above 5% of the economy. New projections by my colleague Catherine Mann (see chart 1) suggest it will now be rising again by a full percentage point of GDP per year, as actually occurred in 1997-2000. On such a trajectory, the deficit would exceed $1 trillion per year by 2010.

There are three reasons for this dismal prospect. First, American merchandise imports are now almost twice as large as exports; hence exports would have to grow twice as fast as imports merely to halt the deterioration. (In the past, such a relationship occurred only after the massive fall experienced by the dollar in 1985-87.) Second, economic growth is likely to remain faster in America than in its major markets and higher incomes there increase demand for imports much faster than income growth elsewhere increases demand for American exports. Third, America's large debtor position (it currently is in the red by more than $2.5 trillion) means that its net investment income payments to foreigners will escalate steadily, especially as interest rates rise.

Of course, it is virtually inconceivable that the markets will permit such deficits to eventuate. The only issue is how they are to be averted. An immediate resumption of the gradual decline of the dollar, as in the period 2002-03, cumulating in a fall of at least another 20%, is needed to reduce the deficits to sustainable levels.

If delayed much longer, the dollar's inevitable fall is likely to be much larger and much faster. Moreover, much of the slack in America's product and labour markets will probably have disappeared in a year or so. Sharp dollar depreciation at that stage would push up inflation and macroeconomic models suggest that American interest rates could even hit double digits.

The situation would be still worse if future increases in energy prices and the budget deficit compound such developments, as they surely could. The negative impact would also be much greater in other countries because of their need to generate larger and faster domestic demand increases in order to offset declining trade surpluses.

Fears of a hard landing for the dollar and the world economy are of course not new. The situation is much more ominous today, however, because of the record current-account deficits and international debt, and the high probability of further rapid increases in both. The potential escalation of oil prices suggests a parallel with the dollar declines of the 1970s, which were associated with stagflation, rather than the 1980s when a sharp fall in energy costs and inflation cushioned dollar depreciation (but still produced higher interest rates and Black Monday for the stockmarket). Paul Volcker, former chairman of the Federal Reserve, predicts with 75% probability a sharp fall in the dollar within five years.

The prospects for the budget deficit and trade protectionism further darken the picture. Official projections score the fiscal imbalance at a cumulative $5 trillion over the next decade, but exclude probable increases in overseas military and homeland-security expenditures, extension of the recent tax cuts and new entitlement increases proposed by both presidential candidates. This deficit could also approach $1 trillion per year (see chart 2), yet there is no serious discussion of how to restore fiscal responsibility, let alone an agreed strategy for reining in runaway entitlement programmes (especially Medicare).

Different deficits

The budget and current-account deficits are not “twin”. The budget in fact moved from large deficit in the early 1990s into surplus in 1999-2001, while the external imbalance soared anew. But increased fiscal shortfalls, especially with the economy nearing full employment, will intensify the need for foreign capital. The external deficit would almost certainly rise further as a result.

Robert Rubin, former secretary of the Treasury, also stresses the psychological importance for financial markets of expectations concerning the American budget position. If that deficit is viewed as likely to rise substantially, without any correction in sight, confidence in America's financial instruments and currency could crack. The dollar could fall sharply as it did in 1971-73, 1978-79, 1985-87 and 1994-95. Market interest rates would rise substantially and the Federal Reserve would probably have to push them still higher to limit the acceleration of inflation.

These risks could be intensified by the change in leadership that will presumably take place at the Federal Reserve Board in less than two years, inevitably creating new uncertainties after 25 years of superb stewardship by Mr Volcker and Alan Greenspan. A very hard landing is not inevitable but neither is it unlikely.

The third component of the “America problem” is trade protectionism. The leading indicator of American protection is not the unemployment rate, but rather overvaluation of the dollar and its attendant external deficits, which sharply alter the politics of trade policy. It was domestic political, rather than international financial, pressure that forced previous administrations (Nixon in 1971, Reagan in 1985) aggressively to seek dollar depreciation. The hubbub over outsourcing and the launching of a spate of trade actions against China are the latest cases in point. The current-account, and related budget, imbalances may not be sustainable for much longer, even if foreign investors and central banks prove willing to continue funding them for a while.

The fourth big risk centres on China, which has accounted for over 20% of world trade growth for the past three years. Fuelled by runaway credit expansion and unsustainable levels of investment, which recently approached half of GDP, Chinese growth must slow. The leadership that took office in early 2003 ignored the problem for a year. It has finally adopted a peculiar mix of market-related policies, such as higher reserve requirements for the banks, and traditional command-and-control directives, such as cessation of lending to certain sectors. The ultimate success of these measures is highly uncertain.

Under the best of circumstances, China's expansion will decelerate gradually but substantially from its recent 9-10% pace. When the country cooled its last excessive boom after 1992, growth declined for seven straight years. A truly hard landing could be much more abrupt and severe. Either outcome will, to a degree, counter the inflationary and interest-rate consequences of the other global risks. But a slowdown, and especially a hard landing, in China would sharply reinforce their dampening effects on world growth.

The fifth threat is energy prices. In the short run, the rapid growth of world demand, low private inventories, shortages of refining and other infrastructure (particularly in America), continued American purchases for its strategic reserve and fears of supply disruptions have outstripped the possibilities for increased production. Hence prices have recently hit record highs in nominal terms. The impact is extremely significant since every sustained rise of $10 per barrel in the world price takes $250 billion-300 billion (equivalent to about half a percentage point) off annual global growth for several years. Mr Greenspan frequently notes that all three major post-war recessions have been triggered by sharp increases in the price of oil.

My colleague Philip Verleger concludes that this lethal combination could push the price to $60-70 per barrel over the next year or two, perhaps exceeding the record high of 1980 in real terms. Gasoline prices per gallon in America would rise from under $2 now to $2.60 in 2006. Prices would climb even more if political or terrorist events were further to unsettle production in the Middle East, the former Soviet Union or elsewhere.

Curtail the cartel

The more fundamental energy problem is the oligopolistic nature of the market. The OPEC cartel in general, and dominant supplier Saudi Arabia in particular, restrict supply in the short run and output capacity in the long run to maintain prices far above what a competitive market would generate. They do not always succeed and indeed have suffered several sharp price falls over the past three decades. They are often unable to counter excessive price escalation when they want to, as at present.

Primarily due to the cartel, however, the world price has averaged about twice the cost of production over the past three decades. The recent price above $40 per barrel compares with production charges of $15-20 per barrel in the highest-cost locales and much lower marginal costs in many OPEC countries. This underlying problem also looks likely to get worse, as the Saudis have talked openly about increasing their target range from the traditional $22-28 per barrel to $30-40.

There is a high probability that one or more of these risks to global prosperity and stability will eventuate. The consequences for the world economy of several of them reinforcing each other are potentially disastrous. All five risks can be avoided, however, or their adverse effects at least substantially dampened, by timely policy actions. The most important single step is for the president of the United States to present and aggressively pursue a credible programme to cut the federal budget deficit at least in half over the coming four years and to sustain the improvement thereafter. This will require a combination of spending cuts, revenue increases and procedural changes (including the restoration of “PAYGO” rules in Congress), as well as rapid economic growth.

Such a programme would maximise the prospects for maintaining solid growth in America and the world by avoiding the crowding out of private-sector investment and by reducing the likelihood of higher interest rates. It would represent the best insurance against a hard landing via the dollar, by buttressing global confidence in the American economy. It should be feasible, having been more than accomplished during the 1990s. Its absence would virtually assure realisation of at least some of the inter-related global risks within the next presidential term.

An energy stability pact

America and its allies must also move decisively on energy. Sales from their strategic reserves, which total about 1.3 billion barrels (including 700m in the United States), would reverse the recent price increases for at least a while and demonstrate a willingness to counter OPEC. For the longer run, America must expand production (including in Alaska) and increase conservation (especially for motor vehicles). Democrats and Republicans must together take the political heat of establishing a gasoline, carbon or energy tax that will limit consumption, help protect the environment and reduce the need for future military interventions abroad.

The most effective “jobs programme” for any American administration and the world as a whole, however, would be an initiative to align the global oil price with levels that would result from market forces. America should therefore seek agreement among importing countries (including China, India and other large developing importers as well as industrialised members of the International Energy Agency) to offer the producers an agreement to stabilise prices within a fairly wide range centred at about $20 per barrel.

Consumers would buy for their reserves to avoid declines below the floor of the range and sell from those reserves to preserve its ceiling. A sustained cut of $20 per barrel in the world price could add a full percentage point to annual global growth for at least several years. The resultant stabilisation of price swings would avoid the periodic spikes (in both directions) that tend to trigger huge economic disruption. Producers would benefit from these global economic gains, from their new protection against sharp price falls and from trade concessions that could be included in the compact to help them diversify their economies.

China must also play a central role in protecting the global outlook. Fortunately, it can resolve its internal overheating problem and contribute substantially to the needed global rebalancing through the single step of revaluing the renminbi by 20-25%. Such a currency adjustment would simultaneously address all of China's domestic troubles: dampening demand (for its exports) by enough to cut economic growth to the official target of 7%; countering inflation (now approaching double digits for inter-company transactions) directly by cutting prices of imports; and checking the inflow of speculative capital that fuels monetary expansion.

A sizeable renminbi revaluation is also crucial for global adjustment because much of the further fall of the dollar needs to take place against the East Asian currencies. These have risen little if at all, although their countries run the bulk of the world's trade surpluses. China has greatly intensified the problem by maintaining its dollar peg and riding the dollar down against most other currencies, further improving its competitiveness. Other Asian countries, from Japan through India, have thus intervened massively to keep their currencies from appreciating against the dollar (and, with it, against the renminbi). This has severely limited correction of the American deficit and thrown the corresponding surplus reduction on to Europe and a few others with freely flexible exchange rates. China should reject the US/G-7/IMF advice to float its currency, which is far too risky in light of its weak banking system and could even produce a weaker renminbi, and opt instead for a substantial one-shot revaluation. It should in fact take the lead in working out an “Asian Plaza Agreement” to ensure that all the major Asian countries make their necessary contributions to global adjustment.

Countries that undergo currency appreciation, and thus face reductions in their trade surpluses, will need to expand domestic demand to sustain global growth. China need not do so now because it must cool its overheated economy. But the other surplus countries, including Japan and the euro area, will have to implement structural reforms and new macroeconomic policies to pick up the slack. America and the surplus countries should also work together to forge a successful Doha round, renewing the momentum of trade liberalisation and reducing the risks of protectionist backsliding.

Risk in our times

The global economy faces a number of major risks that, especially in combination, could throw it back into rapid inflation, high interest rates, much slower growth or even recession, rising unemployment, currency conflict and protectionism. Even worse contingencies could of course be envisaged: a terrorist attack with far larger economic repercussions than September 11th or a sharp slowdown in American productivity growth, as occurred after the oil shocks of the 1970s, that would further undermine the outlook for both economic expansion and the dollar.

Fortunately, policy initiatives are available that would avoid or minimise the costs of the most evident risks. America will be central to achieving such an outcome and the president and Congress will have to decide in early 2005 whether to address these problems aggressively or simply avert their eyes and hope for the best, taking major risks with their own political futures as well as with the world economy. China will have to play a new and decisive leadership role. The major oil producers and the other large economies must do their part. The outlook for the global economy for at least the next few years hangs in the balance.

The presidential election

How big was the bounce?
 

Sep 9th 2004 | WASHINGTON, DC
From The Economist print edition

George Bush is probably pulling ahead in the presidential horse-race, though not for the reasons you might think

SINCE John Kerry clinched the Democratic nomination this spring, the presidential race has pretty much been a tie. This week, plenty of Republicans were cock-a-hoop and many Democrats crestfallen. Both thought that George Bush had broken away. Looking at the polling numbers as the race rounds into its final lap, they may be right.

The most dramatic polls were those published immediately after the Republican convention. Among likely voters, a poll by Gallup for CNN and USA Today found Mr Bush seven points ahead; Time put the lead at 11 points; a Newsweek poll gives the same lead among registered voters. No challenger has overcome a deficit that size after Labour Day and come back to win.

All three polls need to be handled with care. Both Time and Newsweek conducted their research while the Republican convention was still going on; so whatever they were measuring, it was not the impact of Mr Bush's acceptance speech, or the convention as a whole.

The Time and Gallup polls surveyed likely voters (likely in the opinion of pollsters). But polls of registered voters are usually regarded as more accurate. The margin among registered voters was lower: eight points according to Time and one point according to Gallup. Newsweek's poll, also among registered voters, used an odd sample—38% Republicans, 31% each for Democrats and independents, when current party registration has Democrats with 33% and Republicans with 29%. All three measures may exaggerate the size of Mr Bush's lead. But they do not invent it. Other polls from the same period show the president ahead, albeit in a much closer race—by two points, according to Zogby, and one, according to both the American Research Group and The Economist's own poll, conducted by YouGov, a British polling firm.

 

The “bounce”—that is, the difference between Mr Bush's level of support before and after his convention—is also there, again modestly. In our poll and Gallup's Mr Bush increased his vote by two points. That is better than Mr Kerry's non-bounce (his vote actually fell after his convention).

Our poll, the first taken in the week after the convention, uses a different technique from the others. It is conducted essentially by e-mail, not by phone or face to face. That produces an unusually large sample (2,300). It may also make the results less vulnerable to a problem that pollsters have long recognised: people who feel the winds of public opinion shifting in their direction are more confident about telling pollsters what they think than those who don't.

This offers both good and bad news for Mr Kerry. On the plus side, traditional polls may be underestimating Mr Kerry's level of support because Democratic voters are descending into a “spiral of silence”: the more they feel isolated, the quieter they become. But it also carries a negative implication: plenty of Mr Kerry's own side now think he is going to lose.

This crisis of confidence seems to have infected the Kerry campaign. The past two weeks have seen a shake-up in the high command. Three of Bill Clinton's aides have come in: his press secretary, Joe Lockhart, his political director, Doug Sosnik, and a senior policy adviser, Joel Johnson. Also drafted in was John Sasso, who had been in charge of campaigning at the Democratic National Committee.

The change in personnel—rarely a good sign—seemed to presage a change in strategy. Mr Kerry made two phone calls soliciting advice from Mr Clinton, who was lying in a hospital bed awaiting quadruple bypass surgery. Mr Clinton apparently told Mr Kerry to concentrate more on the economy and to step up his attacks on Mr Bush. That has not stopped John Edwards being warned on the campaign trail by loyalists, “They're going to run you right over and make you look like idiots.”

Given that on some measures the national race is statistically tied, that might seem a little negative. It is not. State polls seem to have turned Mr Bush's way: according to new numbers from Gallup, for instance, he now has double-digit leads in both Missouri and Ohio, which he won last time, and a tiny one-point lead in Pennsylvania, which Al Gore won. And on the national level, the size and longevity of Mr Bush's lead is less important than the mere fact of it. As Andy Kohut of the Pew Research Centre says, Mr Bush showed at his convention that he could move the needle, while Mr Kerry could not.

Over the next few weeks, the underlying trends may help the president further. Traditionally, the best barometers of opinion in the final stages have been presidential approval ratings and the “right track/wrong track” measure (those who say the country is going in the right direction compared with those who say it is on the wrong track). Not this year. Even after Mr Bush's recent rise, his approval ratings are generally just above 50%, poised between the ratings of sitting presidents who have won re-election and those who have fallen short. Most pollsters reckon that, after September 11th 2001, the right track/wrong track indicator no longer has its old salience. Since it is an indicator of public morality, or economic success, it is less important in a foreign-policy election.

Karlyn Bowman of the American Enterprise Institute argues instead that there are three groups of voters to watch: those who identify themselves as independents or say they might change their minds; non-Latino Catholics; and “some college” voters (those with a year or two of university education). These groups, which overlap, each comprised over a quarter of the electorate in 2000. They are also the closest to swing voters this election has (“undecideds” don't count because they may well not turn out). Add in the particular importance of Catholics in Pennsylvania and “some college” voters in Ohio, and you see why both sides are tracking them.

Mr Kerry is not doing well with these three groups. He leads by three points among independents, but on the eve of his convention he led by 12. According to Zogby, Mr Bush leads among Catholics for the first time. According to Pew, “some college” voters preferred Mr Bush to Mr Kerry by 49% to 43%—and that was before the Republican convention. Looking at the horse-race numbers, the Kerry campaign may feel anxious; looking at these, alarm would be more justified.

This is the first presidential contest since the attacks on the World Trade Centre, and the first since 1972 to take place at a time of war. Normally, elections that take place at a time of war or foreign crisis produce a decisive victory. Until now, the contest has been tied. The question from the polling evidence is whether that may be beginning to change. A big Bush victory, while still not the most likely outcome, has become a real possibility.

Buttonwood

Memory superhighway
 

Sep 7th 2004
From The Economist Global Agenda

Intel’s wobbles, frothy multiples and the (umpteenth) commoditisation of new technologies

“THE shares are quoted considerably lower now, but even at current prices the return is much too low,” opined The Economist. It could, of course, have been any year and any industry: in its 161 years of existence, rarely has this newspaper tipped anything as a screaming buy. But in fact the year was 1898, and the shares in question were those of London’s new electricity companies. Overly rosy expectations for future profits had caused shares in these almost to double, before profits fell and the shares with them. The companies continued to struggle for many years thereafter—as, indeed, they did in America, where shares in the new electric utilities, having crackled with life in the closing years of the 19th century and the opening years of the 20th, then performed woefully until the end of the 1920s.

Worlds apart though they might seem, the difference between the St James’ & Pall Mall Electric Light Company, the then supplier of electricity to the area of London that The Economist now calls home, and the likes of Intel, supplier of chips to the world’s computers, is less than might first appear. A whizzy new technology, quickly adopted, electricity rapidly became commoditised and its price fell sharply—as, of course, did the profits of companies selling it. In similar fashion, the remains of yesterday’s shock troops of the information revolution are rapidly becoming its weary foot soldiers; and even today’s less elevated prices contain too much hope and hype.

On Thursday September 2nd, Intel apparently “shocked” investors when it announced that its revenues and profit margin would be lower than expected: its shares promptly fell by 7%, lopping $10 billion from its market capitalisation. Actually, that should be another 7% and another $10 billion, for Intel’s shares have now fallen by over a third this year, and by three-quarters from their high in August 2000, when they peaked at $75 or thereabouts. They then fell to a low of around $13 in October 2002, climbed sharply until January this year and then started to fall again. Much like Nasdaq as a whole, in other words. The tech-heavy index reached a high of 5,049 in March 2000, fell to 1,114 in October 2002, climbed back to around 2,100 by the end of January, since when it has slipped by 14%. Like Intel itself, Buttonwood avers, it has further to slip, and for much the same reasons: the industry is maturing and there is thus little reason to value technology shares higher than the overall market; quite the contrary, actually.

Once a growth industry, electricity companies swiftly metamorphosed into boring utilities. The same is probably true for today’s technology companies. As growth slows and competition pushes down margins, the industry is swiftly becoming commoditised.

Even Forrester Research, which made a name for itself with some ultra-bullish predictions in the late 1990s, now thinks that growth in spending on IT by America’s government and companies has slowed to 6% a year, as they digest the technology they have already bought. The debate now is between those, such as Dell Computer, who expect technology spending to grow at not much more than growth in GDP, and those, such as IBM, who expect it to grow at about twice that rate. In the 1990s, it grew three times faster than the overall economy.

Growth is, of course, a necessary but insufficient criterion for bumper valuations. Profits are quite important too—at least at some point. And these had indeed been growing fast until recently, in part because technology companies had cut costs so savagely after the bubble popped—some half a million jobs were cut in America in 2002 alone—and because spending on technology picked up a bit. Those perennial enthusiasts who comprise the technology investment community expected more of the same. Which is, of course, why the shares climbed so sharply through 2003 and into January.

But Intel’s announcement last week is the latest sign that both revenue and profit growth are slowing. Firm after firm has either announced disappointing results or expressed worries about the outlook in recent weeks, and many have reported a build-up in inventories. The big exception has been Dell, the world’s largest maker of PCs (and on one of whose products Buttonwood is scribbling his twopenny-worth). But then this is a company whose very raison d’être is commoditisation.

Buying into this vision does not come cheap, however. Dell’s shares trade on a price-earnings (p/e) multiple of 31. Perhaps it deserves such a valuation, but probably not. In the seven years to 1996, Dell increased its annual sales 20-fold, to $7.8 billion. Its p/e never exceeded 13. Now it is struggling to increase sales by 20% a year. Whether lesser tech companies deserve anything like the similarly giddy multiples they command is even more questionable.

Pip Coburn, a technology strategist at UBS, expects tech-sector multiples to contract in coming months to 15-25 times earnings. This, after all, is where they were from 1992 to 1996, before they shot to the stars in the late 1990s, and the capitalisation of technology companies rose from about 7% of the total stockmarket to almost 35%. It is now less than 15% and, to this columnist’s jaundiced eye, Mr Coburn’s analysis would seem, if anything, a touch rosy.

In the early 1990s, technology spending was rising swiftly and, to many, the potential of the technology companies seemed almost limitless. Neither is now true, but only gradually and reluctantly are investors coming to realise that while new technologies can be splendid for the economy as a whole, investments in the companies that supply them are often dreadful. As Fred Hickey, editor of the High-Tech Strategist, so memorably put it: “You cannot truly be a long-term technology-stock investor because in the long term almost all the stocks are dead.” Including, alas, the St James’ & Pall Mall Electric Light Company. In his idler moments, Buttonwood wonders whether its place has been taken by the mobile-phone shop where he is about to haggle over an upgrade.

I did it my way—and I’ll do it again
 

Sep 3rd 2004
From The Economist Global Agenda

George Bush accepted the Republican nomination for the presidency on Thursday night. He defended his record, and promised much the same in his second term. John Kerry was quick to respond with a speech that suggests the campaign is about to get even nastier

WHATEVER else he does, George Bush does not run from who he is. To rapturous cheers and applause, he accepted the Republican Party’s nomination for re-election on Thursday September 2nd. Repeating not only themes from past speeches but also a brace of campaign-tested lines, he made a simple pitch: at home and abroad, America needs more of what he has shown in his first four years as president.

Many, to put it mildly, would disagree—from the hundreds of thousands that protested this week in New York, where the Republican convention is being held, to the ranks of the Democratic Party, unusually united this year in its desire to send Mr Bush into retirement. The Democratic challenger, John Kerry, returned to the campaign trail less than an hour after Mr Bush’s speech, giving a sharply critical talk of his own in Ohio, a crucial battleground state.

The president began his speech by dealing with his domestic record and plans. He touched briefly on themes that are close to the hearts of social conservatives, such as his opposition to abortion and gay marriage. But he also reiterated his 2000 campaign theme of “compassionate conservatism”, and added a new theme: the “ownership society”. Broadly speaking, he wants to cut taxes and put more decision-making (and risk) in individual hands by encouraging saving for retirement, health care and home ownership.

More controversially, Mr Bush also revived his call for a partial privatisation of Social Security, the cornerstone federal pensions programme. Social Security is facing huge deficits once the baby-boom generation retires. The president advocates individual accounts, into which workers would put part of their pay cheques, to be invested in assets of their choosing. Mr Bush sold this as a way to guarantee benefits. But with a stockmarket slump and corporate scandals still fresh in the memory, peddling investment accounts as a guarantee against insecurity may be a tough sell.

Unsurprisingly, the nasty fiscal situation that Mr Bush would face in a second term went unmentioned, though it loomed over his speech like a ghost at the banquet. Big deficits—caused by a combination of an economic downturn and Mr Bush’s tax cuts—are expected to last at least ten years. The cost of switching to Mr Bush’s Social Security plan is estimated at about $1 trillion. He cannot push this plan, extend his tax cuts and follow through with other new domestic programmes announced on Thursday (including more spending on housing and higher education) without plunging the budget further into the red. He described Mr Kerry as a “tax-and-spend” type, but his plans seem to show him as a “cut-taxes-and-spend” type, not obviously a superior breed.

Funding the baby boomers' retirement is a long-term worry, which will really begin to bite only after the winner of this election finishes his four-year term. Finding jobs is a more immediate concern, which has been gnawing at Mr Bush for the past four years. Hiring was strong in the spring—adding almost 300,000 workers per month to the payrolls on average—but dismal in June and July. In his speech, Mr Bush blamed foreign oil and frivolous lawsuits, and promised to set up “American opportunity zones”, whatever they may be. The morning after his speech, the Bureau of Labour Statistics brought him some small comfort. Firms added 144,000 workers to the payrolls in August, and the figures for July and June were revised up a little. The unemployment rate fell a notch, to 5.4%, largely because 152,000 people dropped out of the labour force. The summer job market turned out to be far worse than the president had expected in the spring, but better than he may have feared on Thursday night.

The second half of Mr Bush’s speech, devoted to foreign policy, was rhetorically stronger and drew bigger cheers. The president, of course, defended his decisions to go into Afghanistan and Iraq, and said that “the wisest use of American strength is to advance freedom”—a far cry from his goal of a “humble” foreign policy in the 2000 campaign.

After nearly a week of criticism of Mr Kerry, the delegates nonetheless revelled in every one of Mr Bush’s attacks on the Massachusetts senator. As often before, the president derided Mr Kerry for voting against an $87 billion package to fund post-war operations in Iraq and then explaining the decision as “complicated”. “There is nothing complicated about supporting our troops in combat,” said Mr Bush.

While he defended his assertiveness, however, Mr Bush offered no new plans in foreign policy. He had nothing to say about reform of the intelligence services. Iran and North Korea did not figure either. Nor, unsurprisingly, did the still-at-large Osama bin Laden. With nearly 140,000 American troops tied down in Iraq, there is simply little room for new threats against America’s enemies. Mr Bush’s speech was more a plea to trust him for what he has done in the past than a signal of what he hopes to do in the future.

Not standing pat

No sooner had the red, white and blue balloons settled on the floor in Madison Square Garden than the Democratic challenger returned to the campaign trail, giving a tough late-night speech in Springfield, Ohio. Mr Kerry has been hurt in polls by advertisements claiming that he exaggerated his heroism and his wounds in Vietnam. Some Democratic strategists have criticised his campaign for not fighting back early, or angrily, enough.

That may be changing. Mr Kerry’s speech explicitly compared his volunteering for Vietnam with “those who refused to serve when they could have”. This not only hits at Mr Bush. Mr Kerry noted that Dick Cheney, the vice-president, received five draft deferments. Mr Kerry also slammed his opponent as the first president since Herbert Hoover to see payrolls fall during his tenure, attacked the administration for awarding no-bid contracts in Iraq to Halliburton, Mr Cheney’s old firm, and accused Mr Bush of depending on the Saudi royal family to control the oil price.

Election day is two months away, and the Democrats seem to be showing that they can punch as low as the Republicans. Negative campaigning is nothing new in American politics, but the enthusiasm for it at the Republican convention, and the vigour with which the Democrats are responding, will make this election campaign a particularly nasty one.

Buttonwood

Growing pains

Sep 2nd 2004
From The Economist Global Agenda

Emerging economies’ stockmarkets, especially those in Asia, look attractive

OUR emotional responses to the world—how we react to other people and events—are largely shaped in early childhood. Changing these responses, however destructive they are, is hard. It is, however, possible. Likewise, emerging markets, as Buttonwood has commented before, are shaped by their own, usually miserable, pasts—a big reason, of course, why they are still emerging. Think of China and Russia and their decades of communist rule. But change they can. Russia has thrown off its communist yoke; China has been dabbling with a perestroika of sorts. The question is whether such change is in the right direction; and if so how quick it is. Also, just as important is whether investors are rewarded for taking the risk of buying assets in such economies, when both the pace and direction is uncertain. Ponder, if you will, the example of the Russian government and its treatment of Yukos.

Domestic investors in the emerging economies themselves, long dogged by unstable regimes and disastrous economic policy, are of course very interested in the answers to these questions. If they did not have strong qualms about the risks and rewards of investing at home, they would hardly be investing so much of their hard-earned savings in US Treasury bonds that yield a sniff over 4% (thereby financing America's huge current-account deficit). But investors from rich countries are also interested, for the good reason that expected risk-adjusted returns in their domestic markets are now so low. Where, when public pension systems are so strained and unreliable and likely to become more so as their populations age—the subject of last week’s central bankers’ shindig at Jackson Hole, Wyoming—should they pop their cash? The answer increasingly given by many is emerging-market equities. And perhaps to the surprise of those who think this column merely a font of scepticism, Buttonwood is inclined to agree.

After putting in a performance last year of which even Michael Phelps would have been proud (had he been a country, the American swimmer would have come 16th in the Olympic medals table), emerging-market equities have had a rough few months. The MSCI emerging-market index peaked in early April and then, well, sank. In part, this was because investors became convinced that inflation in the rich world (and the emerging part, too) was about to take off and thus that central banks, the Fed not least, would have to increase interest rates sharply.

But their pasts also caught up with many a market. In Russia, for example, there were worries that if the government was able to use the courts to go after Yukos, one of the country’s biggest oil companies, then no one was safe. In India, the newly elected coalition government had to seek the support of the communists, who are not known for their reformist credentials. China seemed about to suffer one of its periodic busts, the severity of which could be predicted only by the height of the euphoria in the preceeding burst of enthusiasm from investors worldwide for the Middle Kingdom. And if China sneezed, an epidemic seemed likely to afflict the rest of Asia. In fact, thanks to a combination of cheap valuations, robust foreign flows, and stimulative monetary policy, Asian shares look likely to bob up quicker than most.

In 2002, foreign investors only popped $300m, net, into emerging stockmarkets, according to the Institute of International Finance. Last year, that had risen to over $27 billion, the highest in seven years; and this year the IIF expects the number to reach $33 billion or so, though it expects flows to Asia, which almost doubled last year, to fall. Alas, its calculations were published in April, just as stockmarkets peaked and foreigners headed for the exits. Its predictions have presumably been reduced since then. But better, surely, to be invested in assets that have been shunned than those that everyone loves and, almost by definition, already owns. And there are good reasons to suppose that emerging stockmarkets will start to look decidedly attractive again to those that have fled, if only because almost everything else looks so pug ugly.

For one thing, the interest-rate cycle seems to be turning. Rising interest rates, or at least the threat of them both in American and in many emerging countries, have cast a pall. But given ample evidence of a slowdown, the Fed is unlikely to be in a hurry to put up rates very fast or very much, even though they are, by historical standards, ludicrously low. With the probable exception of China, central banks in some emerging markets already seem to be cutting. South Korea, South Africa and Hungary have all reduced rates in recent weeks.

Possibly, it is true, these rate reductions are cause for worry, since they reflect economic weakness, in Asia not least. Stockmarkets in Taiwan (another candidate for a rate-cut) and South Korea have also been battered by weak demand for their high-tech exports. Profits growth has stalled. While oil-exporting countries have gained from a strong oil price (though not necessarily investors in their oil companies: see Yukos), oil importers have suffered—and most of Asia falls into the latter camp. The higher oil price has added up to $100 billion to non-Japan Asia’s oil bill compared with last year, according to Credit Suisse First Boston.

On the other hand, China does not seem headed for a bust, not for now at any rate. Nor does Japan, though growth there is slowing. As long as these two carry on growing, there is every reason to think that companies elsewhere in the region should continue to prosper. The big question for the world economy is whether Asia can detach itself, and take over leadership, from a slowing United States. A punt on Asian assets—which have anyway provided much of the world’s growth in recent years—is in essence a bet that it can. Assuming, that is, that America doesn’t fall through the floor.

Moreover, current emerging-market valuations do not need to be bailed out by rapidly rising profits in the same way that they do on Nasdaq, to reach, at random, for one example. They are, in fact, quite cheap, especially in Asia, which should provide comfort even if America slows and its stockmarkets fall. The price/earnings ratio for emerging markets as a whole is now just over 12—about half its level in 1994, when the Fed was last tightening rates, and getting on for a historical low. On present expectations for next year’s profits, South Korea’s stockmarket has a p/e multiple of just six.

The Bank Credit Analyst, an independent research company, suggests a longer-term reason for the attractiveness of Asian shares: the region’s companies are making more money. The Asian crisis of the late 1990s shattered elements of the Asian growth model, which had relied on size for its own sake, and put the money generated by rising productivity into the hands of consumers. But profits as a percentage of GDP and returns on equity have risen sharply since the crisis, as a result of restructuring and a focus on profitability. Only when the pain gets bad enough, it seems, will economies, like people, change.