A Question of Interest
Another Oil Shock?
Opec and the G7

Asia’s Stockmarkets Fall Out of Favor
Cheap money, pricey oil
China's economy: The Great Fall of China?
China and the Fed: twin piques
The search for investment paradise

The warrior president
A Remedy for Financial Turbulence?
Cash and carry
Hopeful signs of a job-full recovery

The Best Use of Aid?
Warnings to be ignored
The unstoppable, surging yen

The monetary authorities in America, Europe and China are all “behind the curve” on interest rates, but they are not all equally relaxed about it

CHEAP money and expensive oil sounds to many like a dangerous, inflationary combination. Nominal interest rates remain at historic lows in the United States, Japan and the euro area, while oil prices (unadjusted for inflation) are hovering around 13-year highs. China in particular is both awash with liquidity and thirsty for petroleum. Inflation there is at a seven-year high, with consumer prices rising by 3.8% in April compared with the year before, according to figures released on Friday May 14th. Meanwhile, sales of petroleum and related products grew by more than half over the same period. According to the International Energy Agency, China now consumes 6m barrels of oil per day, 1m more than a year ago.

Saudi Arabia, with its large reserves and spare capacity, remains the “swing producer” of the oil world. Its energy minister, Ali al-Naimi, has already urged petroleum exporters to raise the supply of oil in order to bring prices down. Many now fear that Alan Greenspan—who, as chairman of the Federal Reserve, acts as the swing producer of the financial world—will rush to tighten the supply of money. The futures market suggests that American interest rates, still at 1%, will double before the end of the year, and reach 3.5% by the end of 2005. Mr Greenspan himself, however, shows no signs of being rushed into anything. Oil prices may be surging and China may be overheating, but inflation in America remains manageable. According to figures released on Friday, consumer prices rose by 0.2% in April, month-on-month (the figure for the year to April was 2.3%). Mr Greenspan’s pace, then, as he promised at the Fed’s last meeting, is “likely to be measured”.

In the 1980s and 1990s, the Fed pursued a hawkish doctrine of pre-emptive strikes against any inflation-related activities it could espy, even if they did not yet show up in headline consumer prices. If you waited until you could see inflation, so the doctrine went, it was already too late. Now, some are asking whether the Fed has fallen “behind the curve”. In fact, the Fed has advertised its behind-the-curveness at every opportunity, telling the markets that rates would stay low for a “considerable period” and that it could be “patient” before raising them. Last year, the Fed felt that deflation was a remote but disturbing possibility; a little inflation would provide a welcome cushion against falling prices. It therefore made a strategic decision to stay behind the curve, making sure that modest inflation had returned before it tightened monetary policy.

The European Central Bank (ECB) of course is famous for falling behind the curve. It was slow to cut rates when the euro area stalled in 2001, and it refused to cut them despite a strengthening euro and a flagging recovery last year. But the ECB has remained stuck in place for so long that, like a clock that is 11 hours slow, it now looks to be ahead of events, not behind them. According to figures released on Friday, euro-area GDP grew at an annual pace of 2.4% in the first quarter, faster than anyone expected and faster than at any time since the first quarter of 2001. France grew by 3.2% at an annualised rate. Though modest by American standards, growth at this pace shows a euro-area economy beginning to fulfil its potential. The ECB, therefore, can afford to sit on its hands for the foreseeable future.

China’s monetary authorities do not have that luxury. In recent months, they have pulled on one lever after another in an attempt to stop the overlending and overinvestment that threaten to destabilise the economy. Reserve requirements for banks have been raised three times since last summer, to no avail: banks still managed to lend 21% more in the first quarter than a year ago. On Friday, the Chinese authorities ordered financial institutions to “immediately stop fresh credit” to projects in a long list of sectors that are growing too fast for comfort, including light industry, construction and textiles.

The Chinese authorities are attempting to restrain and redirect the flow of credit by fiat, because they are reluctant to raise its price. Some media reports had suggested that they might raise interest rates for the first time in nine years as soon as the Golden Week holiday ended last week. But raising rates could break China’s brittle state enterprises and lure in more speculative capital from abroad, exacerbating the overheating problem. China’s monetary policy must also be guided by the need to maintain the yuan’s peg to the dollar. Until Mr Greenspan raises interest rates, China’s monetary authorities will find it difficult to do so. His stately calm, then, is one reason for their frantic hyperactivity.

Some fear that China is destined for a hard landing. The growth in credit is unsustainable. Either it slows at the behest of China’s authorities, or it will collapse of its own accord. Given that China accounted for about a third of the growth in the world economy over the past three years (in purchasing power terms), a credit crunch in the Middle Kingdom could also spell trouble for lands to the east and west. Still, if China’s growth does sputter and stall, it will at least take the pressure off the oil price.

If China's soaring economy has a hard landing, the rest of the world will feel the bump

A FASCINATING drama is about to be played out in the world's biggest country. China's economy is growing too fast for comfort, and the country's leaders know it. In recent weeks they have promised forceful measures to cool things down, but it is not clear what they will or can do. Rumours are rife that China's central bank may raise interest rates for the first time in nine years.

The authorities have tried to restrain investment, prices and lending through administrative fiat. The challenge facing them would be difficult for policymakers anywhere: to slow the economy enough to ensure sustainable growth, but not so much as to cause a damaging crash, the much-feared hard landing. But the task of China's policymakers is doubly difficult because they have far fewer tools at their disposal than their counterparts in developed countries (see article). Thousands of state-owned firms, as well as the banking system, do not respond much to pricing signals or interest rates. It is not only 1.2 billion Chinese who should hope that their leaders succeed despite these handicaps. The rest of the world also now has a huge stake in China's continued economic health.

During the past three years China has accounted for one-third of global economic growth (measured at purchasing-power parity), twice as much as America. In the past year, China's official GDP growth rate has surged to 9.7%. Even this may underestimate the true rate, which some economists reckon was as high as 13%.

China's scorching growth has helped to prop up other economies by sucking in imports, which surged by 40% last year alone. While America's industrial output has shrunk over the past three years, China's has increased by almost 50%. As a result, its demand for commodities has skyrocketed, driving up prices. Last year it consumed 40% of the world's output of cement. It also accounted for one-third of the growth in global oil consumption, 90% of the growth in world steel demand, and more than the whole of the increase in copper demand. If China's economy slows sharply, commodity prices will fall everywhere, especially hurting producers in countries such as Russia, Brazil and Australia, which have gained so handsomely from China's boom.

The biggest losers from a hard landing in China would be its Asian neighbours. China accounted, on average, for almost half of the total export growth of the other East Asian economies last year. By some estimates, Japan's exports to China and capital spending linked to its export industries accounted for one-third of Japan's total GDP growth last year. Indeed, a slowdown in China would expose the chronic weakness of private consumption in Asia. The recent burst in growth in the region has been much too dependent on exports to China. Although Japan's GDP grew at an annual rate of 4.5% in the second half of 2003, consumer spending rose by only 1%. In South Korea, Hong Kong, Taiwan and Singapore, consumer spending fell slightly, on average, last year.

A slump in China would have a much smaller impact on America and Europe, but some companies would be hurt. Exports to China accounted for about one-fifth of total export growth last year in America and the European Union. However, the biggest risk to these economies lies elsewhere—in the indirect effect of a sharp slowdown in China on financial markets. Another risk lies in the fact that America depends on China to help finance its budget and current-account deficits. China's purchases of American Treasury bonds, along with purchases by Japan, have helped to hold down yields and hence American mortgage rates. If China's economy continues to overheat, its current-account surplus could soon turn to deficit, and then its central bank would no longer need to buy American Treasuries to hold down its currency.

Fortunately, there are some reasons to hope that avoiding a hard landing in China, despite the difficulties, is possible. This time China's policymakers are stepping in to cool things down earlier than they did in the early 1990s, when inflation was far higher and investment and credit were growing even faster than today. And unlike the East Asian countries which suffered so badly during their economic crisis in the late 1990s, China has a current-account surplus and little foreign debt.

Perhaps the biggest worry for the world economy is the prospect of a “twin tightening” of monetary policy in both China and America. Interest rates of 1% in the United States are dangerously low for an economy with 5% real GDP growth. If America's Federal Reserve is forced to raise rates more rapidly than expected and this happens at about the same time that China's economy slows sharply, stockmarkets would take a beating and global growth could stall. Monetary-policy announcements from Beijing are still not as important as the Delphic words of Alan Greenspan, the Fed's chairman. But as the weight of China's economy in the world continues to grow over coming years, one day they will be.

As the Fed prepares to raise interest rates, the financial markets are bracing themselves for a reversal of fortune every bit as painful as the one they suffered ten years ago

“THIS year’s dramatic rally [in bonds] has assumed that inflation is conquered, at least for the foreseeable future. Rising yields would indicate a change in that sentiment. As for Wall Street, its giddy share prices are partly explained by low bond yields, so it would presumably suffer a sharp correction if those yields rose…at current levels the bond market deeply trusts the Federal Reserve’s ability to deliver low inflation.” Plus ça change. Buttonwood wrote the above sentences in October 1993, a month after joining The Economist, and ended his piece by quoting an analyst who expected a rise in rates by the Fed “to cause anything from panic to riot”. And a riot of sorts there was. As the Fed doubled rates in 1994, to 6%, bond yields shot up, the mortgage-backed securities market fell apart and stockmarkets had a horrid time. So did emerging markets: spreads over Treasuries on emerging-market debt soared and the year ended with Mexico’s tequila crisis.

Memories of that carnage continue to haunt dealing rooms around the world, which is one reason why markets have been so spooked by a mere hint from the Fed that it will put up rates at some point. That point, think markets, is much sooner than it was, following the stronger-than-expected payrolls number last Friday and a few signs—a high oil price among them—that inflation may be less quiescent than it was. In the topsy-turvy, good-news-is-bad-news world of financial markets, bond prices have fallen sharply again, pushing the yield on ten-year Treasuries from 3.65% in mid-March to 4.8%; stockmarkets have taken a pummelling, with the Dow closing below 10,000 for the first time since December on Monday; and emerging markets are once again being treated like lepers.

Strategists are busy trying to work out how much more financial assets will fall—or, indeed, if the worst is over. Many are wondering, and worrying, about a possible repeat of 1994. The Fed—whose chairman, Alan Greenspan, was also in charge back then—is all too aware of this. The language of its recent statement seemed calculated to soothe the market’s fears that it would raise rates as fast or as far as it did a decade ago, and made it clear that every move will be well telegraphed. Moreover, if the Fed is simply reacting to strong growth rather than creeping inflation, as it mainly seems to be, that should be good for corporate profits, and thus for equities and corporate bonds. The recent falls, on this argument, simply reflect a blowing-off of the froth on financial markets.

Perfectly decent this rationale may be, but Buttonwood doesn’t believe it for the reason that investors are always prone to think that this time things are different. Few of those that were around in 1994 are the ones making the decisions now; everyone is under pressure to generate stellar returns in an environment of rock-bottom interest rates, and they all seem to think that they can get out before being trampled under foot by everyone else heading for the exit. That includes the hedge funds and big investment banks that have been loading up on anything offering more than meagre returns. Though they all claim to be more sophisticated these days, it requires a huge amount of sophistry to justify the claim that after the extraordinary rises of last year, risky assets are still worth buying. As investors discover the hard way that they aren’t, events might turn out even nastier than they did in 1994.

For one thing, the incentive to bet on all manner of sure-fire winners has been much greater this time. Investors have been encouraged to keep gambling by the Fed, which will be raising rates later and from a lower level than it has done in past cycles. That matters for stockmarkets in part because the best of the rise in corporate profits, which have been helped by low rates, is probably over. Earnings are 14% above trend, according to Credit Suisse First Boston; in 1994 they were below trend. Financial stocks, which tend to do badly when rates rise, now account for 22% of stockmarket capitalisation compared with about 13% then. And the overall stockmarket is, of course, a lot more expensive now than it was then. Worryingly, retail investors have been seduced into putting their money into a rising market: flows into mutual funds at the beginning of this year were only a smidgen less than they were at the beginning of 2000, and far higher than they were in 1994.

Not that American stockmarkets have been the worst performers of late. The S&P 500 is down only 6% from its high. In contrast, Japan’s stockmarket fell by almost 5% on Monday alone, its sixth-worst daily performance since 1980. And anything related to emerging markets—especially China, which is trying to rein in its overheating economy—has suffered horribly. An index of emerging markets compiled by Morgan Stanley has now fallen by 17% from its peak. Argentine and Brazilian stockmarkets are both down by almost 30% from their recent highs.

Brazilian shares have, however, been something of a safe haven compared with its bonds. Since early January, their spread over Treasuries has widened by some four percentage points, which is quite an achievement given that Treasuries themselves have not seen the best of times. Indeed, emerging-market bonds in general seem to have gone out of fashion as quickly as the Spice Girls. The spread of J.P. Morgan’s EMBI+ index is now some 48% wider than it was on January 8th.

Which may or may not be a sufficient fall to make such bonds attractive. Devotees point out that American companies’ junk bonds—a market with which emerging-market debt is often compared—have held up remarkably well in recent weeks, perhaps because the buoyant economy helps leveraged companies and the number of companies defaulting continues to fall. On the other hand, low interest rates and investors’ huge appetite for risk have helped many companies that would otherwise have gone bust to refinance their debts. Many of these companies will default when conditions tighten, if history is any guide. It usually is.

Just three months after calling for OPEC's oil-production quotas to be cut, Saudi Arabia is now calling for them to be raised

SAUDI ARABIA, the oil industry’s swing producer, has become its flip-flopper. In February, it persuaded the Organisation of the Petroleum Exporting Countries (OPEC) to cut its total production quotas by 1m barrels per day (bpd), to 23.5m, as a precaution against an oil-price crash this spring. That fear has since been replaced by its opposite. The price of West Texas crude hit $40 last week, its highest since the eve of the first Iraq war (see chart), prompting concerns that higher oil prices could sap the vigour of America’s recovery and compound the frailty of Europe’s. On Monday May 10th, Ali al-Naimi, Saudi Arabia’s energy minister, called on OPEC to raise quotas, by at least 1.5m bpd, at its next meeting on June 3rd.

Of course, OPEC's quotas do not mean quite what they say. Its members are currently producing at least 2m bpd more than their quotas officially allow. Some think that raising these limits will simply validate what OPEC members are doing anyway. Certainly, Purnomo Yusgiantoro, Indonesia's energy minister and president of OPEC, doubts his organisation's ability to bring down the high oil price. “There is not much OPEC can do,” he told the Financial Times in an interview published on Tuesday. The oil market, however, begs to differ. It responded to the Saudis' call for a quota rise on Monday by pushing the price of crude back below $39. Perhaps the market assumes that OPEC members, insofar as their capacity allows, will breach their higher quotas by much the same margin as they breached their lower ones.

Thus far, the high oil price has been largely a consequence of good things, such as a strengthening world economy, rather than a cause of bad things, such as faster inflation or slower growth. China’s burgeoning economy guzzled about 6m bpd in the first quarter of this year, 15% more than a year ago, according to Goldman Sachs. Demand was also strong in the rest of Asia, excluding Japan, growing by 5.2% to 8.1m bpd. As the year progresses, the seasonal rhythms of America’s drivers will dictate prices, at least of the lighter, sweeter crudes. Americans take to the roads en masse in the summer, and speculators are driving up the oil price now in anticipation of peak demand in a few months’ time.

Until recently, the rise in the dollar price of oil was offset outside America and China by the fall in the dollar itself. But the currency has regained some ground in recent weeks, and the oil price has continued to rise. Even so, talk of another oil-price shock is premature. The price of oil, adjusted for inflation, is only half what it was in December 1979, and the United States now uses half as much energy per dollar of output as it did in the early 1970s. But if oil cannot shock the world economy quite as it used to, it can still give it “a good kick”, warns Goldman Sachs. If average oil prices for the year come in 10% higher than it forecast, it reckons GDP growth in the Group of Seven (G7) rich nations will be reduced by 0.3%, or $70 billion.

The Americans are certainly taking the issue seriously. John Snow, their treasury secretary, called OPEC’s February decision “regrettable”, and the rise in prices since then “not helpful”. Washington pays close heed to the man at the petrol pump, who has seen the average price of a gallon of unleaded petrol rise by 39 cents in the past year. And the Saudis, some mutter, pay close heed to Washington.

Besides, the high oil price may have filled Saudi coffers, but it has also affronted Saudi pride. Mr al-Naimi thinks the high price is due to fears that supply might be disrupted in the future. These fears, he says, are “unwarranted”. But the hulking machinery in the Arabian desert that keeps oil flowing round the world presents an inviting target to terrorists should they tire of bombing embassies and nightclubs. On May 1st, gunmen killed six people in a Saudi office of ABB Lummus Global, an American oil contractor. Such incidents add to the risk premium factored into the oil price, a premium that the Saudis take as a vote of no confidence in their kingdom and its ability to guarantee the supply of oil in the face of terrorist threats. Oil infrastructure elsewhere is also vulnerable. A pipeline in Iraq carrying oil to Basra was struck by saboteurs last Saturday, slowing Iraq's output of oil by about a fifth until repairs are made. Kuwait is strengthening security at its ports in response to American warnings about possible sea-borne attacks.

As the markets fret over the spot price of oil (ie, for delivery now), Alan Greenspan, chairman of the Federal Reserve, is looking further ahead. The price of crude oil for delivery six years hence has risen dramatically in recent years, he noted in a recent speech. Futures prices were remarkably stable throughout the 1990s, despite wide fluctuations in spot prices. But they have risen from about $18 per barrel in 1999 to more than $27 per barrel now. Mr Greenspan is in little doubt as to the cause: “fears of long-term supply disruptions in the Middle East”.

Until recently, the long-term price of oil was driven by advances in geology and technology. Now, into that price-setting equation must be added the creeping advances in terrorism.

China and America are both about to start tightening monetary policy to ward off inflation. Financial-market traders have reasons to worry

FEW people can hold a candle to Alan Greenspan, the chairman of the Federal Reserve, when it comes to opaque utterances on monetary policy. But this week’s statement from the Fed was unusually clear. No longer would it be “patient” in raising interest rates; its ultra–loose monetary policy “can be removed at a pace that is likely to be measured”. The futures market thinks that the Fed will raise rates by a quarter of a percentage point by the time of its next meeting, in August. What is happening to interest rates in China, on the other hand, is anyone’s guess—including, it seems, the good folk at the People’s Bank of China, the central bank. In a recent visit, The Economist’s economics editor asked a couple of senior officials at the bank what the current interest rate was. After some embarrassed shuffling of papers, she was advised to look in the bank’s annual report of, erm, 2002. Yet no matter how much or how little Mr Greenspan or his counterparts in Beijing say, or how opaquely they say it, one thing is clear: monetary policy in both America and China is tightening. Many a rich-country investor has been fleeing low interest rates by placing bets on global reflation. Such trades will be sorely tested in coming months.

It is increasingly clear that short-term interest rates in America are about to rise, and given the wealth of robust data in recent weeks, that point will come sooner rather than later. The Fed has done little to dampen the market’s expectations that rates will rise to ward off inflationary pressures. In China, on the other hand, the price of money plays little or no role in allocating capital: you either get the money or you don’t. In recent years, most companies have, which is partly why the Chinese economy has been growing so fast. Understandably worried that rampant economic growth is stoking inflation—the economy grew by an annualised 9.7% in the first quarter, growth in fixed investment has been soaring by 170% in some sectors, and new lending at a few banks is rising at 40%—officials have been calling for restraint. Last week, the central bank upped banks’ reserve requirements for the second time in eight months, and apparently took the novel step of telling a clutch of big banks to stop lending for a bit.

Which will have the greater effect—tightening by the Fed or the People’s Bank—is a moot point (another way of saying that your columnist hasn’t the foggiest). Undeniable is the fact that the combined impact has already been big. Most obvious has been the effect on government bonds, and especially those issued by the United States government. In a few weeks, the yield on ten-year Treasuries has risen from a low of 3.65% to 4.5%. The threat of higher interest rates and inflation at home has played its part in this move, of course, but so have the effects of rising inflation (or falling deflation in the case of Japan) in Asia, since Asian central banks have lately intervened much less in foreign-exchange markets to stop their currencies rising. (They had been popping the dollars they bought into Treasuries.) As inflationary pressures rise in China, expect the chatter about revaluing the yuan against the dollar—to which it is pegged—to become noisier again.

If the attractions of Treasuries have waned, investors have started to look in horror at emerging-market bonds. The spread of J.P. Morgan’s EMBI+ index over American Treasuries has risen by more than a percentage point from its low on January 8th, a statistic that does not fully capture how badly such bonds have performed, since Treasury prices are themselves a lot lower. Last year’s poster children have become this year’s street urchins. Bonds issued by the likes of Brazil, Turkey and Russia have, to quote one normally sober investment bank, suffered “violent re-pricing”. Down, that is.

Stockmarkets have stumbled everywhere, caught between the joys of heady economic growth and the potential pain of higher interest rates. The riskiest are among the hardest hit. Despite the hoopla surrounding the IPO of Google, the Nasdaq index is lower than it was at the start of the year. Any currencies that had strengthened in recent months from the “carry trade” (investors fleeing low interest rates in America in search of higher yields), such as sterling or the Australian dollar, have weakened sharply. The latter has also been clobbered by falling metals prices, as fears mount that China may not provide an inexhaustible source of demand: The Economist’s dollar metals index has fallen by 6.4% from its peak on April 20th. Worries about the sustainability of Chinese growth have also knocked many an Asian stockmarket.

In America, the fretful will tell you, there are striking similarities to 1994, when inflationary pressures were rising, the Fed was forced to double interest rates (to 6%) and there was widespread carnage in the bond market. The sanguine reply is that the Fed will move rates much more cautiously than last time—and telegraph every move to a market that is all too aware of those similarities. Buttonwood has his doubts: because returns are far lower than in 1994, leverage in the financial system is far higher.

China has also been here before, as it happens at about the same time. In 1993-94, investment grew at over 60%, GDP growth rose to over 15% and inflation peaked at 28%. Things didn’t turn out too well after that. Back then, though, the world probably didn’t care very much because China didn’t play such a big part in either global growth (of which the country has accounted for a full quarter over the past five years, on a purchasing-power-parity basis) or as a source of growth elsewhere. Buttonwood is, of course, aware of the old saw that history never repeats itself, but he can’t help worrying that two of the most important economies in the world are about to start tightening monetary policy at the same time. And no one knows how fast or how far they will have to go.

China and Japan are locked in a fierce diplomatic and economic struggle to win access to Russian oil

THE oil city of Daqing, in the bleak plains of north-eastern China, was once a proud symbol of the country's self-reliant spirit. The discovery of huge reserves there in 1959 allowed China to end its dependence on Soviet oil supplies, and fortified the country in its subsequent cold-war struggle with its fellow communist neighbour. Daqing's ubiquitous rigs still pump away, but output from the ageing field is dropping off. Meanwhile, China's economic boom has produced a growing hunger for energy that only foreign supplies can satisfy. Energy strategists in Beijing now see great promise in the former Soviet Union. Unfortunately, so too does China's old rival, Japan.

If China has its way, Daqing would be the terminus of a crude-oil pipeline beginning 2,300km (1,430 miles) away in Angarsk, at the southern end of Lake Baikal in eastern Siberia. And if Daqing has its way, it would become a refining centre for the Russian oil, which would help revive the fortunes of a city plagued a couple of years ago by large-scale protests involving laid-off oil workers. The pipeline could provide 20m-30m tonnes of crude a year, the equivalent of up to 30% of China's current imports. But Japan's rival idea is to pipe the oil instead to the port of Nakhodka, where it could be shipped to Japan and other markets (including China). A branch line could in theory be built to Daqing, but doubts abound on all sides as to whether there would be enough oil in Angarsk to fill it.

Promising though eastern Siberia's oil resources appear to be, they have yet to be tapped commercially. Even to be sure of filling the original proposed pipeline to Daqing, Russia would have to depend initially at least on supplies from the better developed fields of western Siberia. But this did not stop Japan wading in a year ago with its proposal for a route that would cost nearly twice as much (about $5 billion) and take far longer to build than the Daqing line—to the intense fury of the Chinese who thought they had a deal sewn up.

Many analysts believe that the Russians may now favour Japan over their “strategic partners” in China. The Japanese scheme would avoid dependency on a single market. It also includes provisions for billions of dollars of Japanese investment in oil exploration in eastern Siberia—much needed if Russia is to realise the full potential of the area (though possible Japanese investors, worried about the economic viability of the project, have been lukewarm to the idea). And the chief Russian backer of the Daqing proposal, the private oil company Yukos, suffered a severe blow to its political influence with arrest of its chairman, Mikhail Khodorkovsky, last year on charges of fraud and tax evasion.

Oksana Antonenko of the International Institute for Strategic Studies in London believes the Russians have already decided on the Nakhodka route. This, she says, would fit better with Mr Putin's plans to develop the Russian Far East, since the Nakhodka line would be better able to supply domestic markets as well as foreign buyers. The possibility of building a branch line to Daqing would theoretically be kept open, “but this diversion would simply not ever happen.”

Where would this leave China? Its biggest concern is protecting itself against the price volatility of international markets. At present, China imports about a third of its oil requirements. This could rise to some 60% by 2030. More than half of China's oil imports come from the Middle East. The oil is shipped through the Malacca Strait between Malaysia and Indonesia, an area notorious for well-organised piracy. China's navy is ill-equipped to carry out duties much beyond its shores. Instability in the Middle East, and its impact on prices, has focused the minds of policymakers across North-East Asia on the need to diversify their supplies.

Uncertainty over the Daqing scheme and worries about the Middle East have made China all the keener to explore other options. A long-standing proposal for an oil pipeline from Central Asia to China, which had made little headway because of cost concerns, is back on the table. President Nursultan Nazarbayev of Kazakhstan is due to visit Beijing in mid-May and is expected to sign an agreement on the construction of a 1,200km cross-border section of the pipeline from Atasu in Kazakhstan to Dushanzi in China's Xinjiang region. Work could begin this summer and be completed possibly within a couple of years.

The pipeline would link up with Kazakhstani pipelines connecting to the Caspian Sea region, far to the west. Even so, the oil would still have far to go before reaching the booming coastal areas of China where it is needed most. It is an extremely costly proposition (Chinese reports suggest around $3 billion just for the route from Kazakhstan to Xinjiang) for a projected supply of 20m tonnes a year. But Scott Roberts of Cambridge Energy Research Associates, a consultancy firm, says that while the costs are high “there is a strategic value at stake. China's oil security is increasingly important to its overall economic and political security and from that standpoint, yes, it makes great sense if you can ensure that the supply reaches your market reliably.”

China has offered a spectacular demonstration of its willingness to lavish money on strategically important energy schemes, with its 4,000km (2,500 mile) natural-gas pipeline from Lunnan, in Xinjiang, to Shanghai. This $15 billion project, one of China's costliest-ever infrastructure developments, is due to become fully operational later this year, ahead of schedule. China sees the development of Xinjiang's backward economy as important to the country's stability. It is also eager to promote the use of gas, which is less polluting than China's main energy source, coal. By the time the Xinjiang gas reaches consumers in eastern China, its price will hardly be competitive with that of alternative fuels. But that is of little concern in Beijing.

As the world’s leading search engine prepares to announce its stockmarket flotation, some words of caution

FOR two days in a row Buttonwood has tapped the words “Google” and “IPO” into the Google search engine. Yesterday there were 269,000 hits, and when he started writing this morning there were 293,000. The number will doubtless be still larger tomorrow, for the crescendo of speculation about when the company will announce its stockmarket flotation has reached Mahlerian proportions. Google, reported the Wall Street Journal this week, has appointed Morgan Stanley and Credit Suisse First Boston to lead the issue. The “IPO of Google…could trigger a new wave of IPO filings among other technology companies,” say the reporters. Recalling the listing of Netscape in 1995, which kicked off the dotcom bubble, they go on to say: “With nearly insatiable investor interest, it could put a price tag of $25 billion on a company that didn’t exist a decade ago.” To those many technology junkies in this dangerous state of euphoria, Buttonwood has one word of advice: resist.

The creative destruction that propels all economies forward is nowhere more evident than in the technology sector. In the pre-bubble days of long ago, when Google’s two founders, Larry Page and Sergey Brin, were still at high school, investors emphasised the destructive part. Tech companies came and tech companies went. Rare was the company that traded on a price-to-earnings (p/e) multiple of more than 20, because waiting twenty years to get your money back seemed more than a little risky if the company was unlikely to be around in ten. Even those that survived and prospered were treated with caution. In 1985-97, when Microsoft's sales were growing by a compound 44% a year, its p/e ratio ranged between 18 and 29.

In these more heady times, technology investors emphasise the creative part. Yahoo!, another search engine (among other things), and the yardstick by which Google’s worth will doubtless be measured, trades now on a p/e ratio for last year’s earnings of 131, a prospective p/e of 64 and enjoys a market capitalisation of $37.9 billion. Earlier this month, the company announced first-quarter numbers that were described by one analyst as “just incredible”. For the record, Yahoo! made $101m of net profits.

Nobody knows how much Google is making: the company makes North Korea look a model of openness. Even its bankers are being kept in the dark by all accounts. Still, it seems to have a good enough business model, perhaps even a very good one. Google’s is the most widely used search engine and it has found a way to make money from this by delivering advertisements to those that use it.

Such “contextual advertising”, in which sponsored links pop up whenever users put in words that are related to their products, allows companies to target their adverts more effectively. Not only do they pay only when a user clicks on a sponsored link, they know how many of these translate into sales. The only problem is that some companies, including Axa, a big French insurer, are suing Google, claiming that such techniques infringe their trademarks on certain words and phrases. Unabashed, Google is expanding the basic idea to other areas, such as shopping comparisons and a free service that would allow companies to track subjects in e-mails and advertise accordingly. Yahoo!’s revenues from such businesses in the first quarter were $635m—an increase of 235% from the year before, and Google’s search-engine technology is more sophisticated.

For now, at least. Yahoo!, which used Google until earlier this year, is getting into the search business. And as a listed company it can use its shares as a currency to buy the technology that it needs, much as Cisco did so successfully in the 1990s in another area: internet infrastructure. Microsoft, too, is developing its search-engine technology. It wants to be able to incorporate its engine into its technology so that users need not open up a browser. And Microsoft, in case you hadn’t noticed, has a habit of subsidising such projects with the huge amounts of cash that it makes elsewhere.

In short, then, Google’s position is not cast in stone; the technology is constantly developing. As Fred Hickey, editor of High-Tech Strategist, puts it: “Technology is a constantly moving market; there is a risk of obsolescence.” Netscape, remember, was all but destroyed by Microsoft, a risk that applies to all internet companies. Such considerations, points out Mr Hickey, dryly, “do not seem to be reflected in the $25 billion valuation”.

What does seem to be reflected is a lot of enthusiasm, which some might describe as bubble-like. To be sure, things are looking up in the world of technology. E-commerce is growing by leaps and bounds. Some of the dotcom survivors, such as Amazon (which is also developing a search engine) and eBay, as well as Yahoo!, are prospering. There are even signs of recovery in Silicon Valley. “Everyone is excited by the dotcom recovery,” says Mr Hickey.

Including, one assumes, the venture capitalists who want to cash in their chips on a successful investment to compensate for their many dotcom disasters, and who seem to be putting pressure on Google’s two founders to list. Given the heady valuations that the company is likely to attract, the two would be wise to do so. For the same reasons, punters would be much wiser to read about Google’s IPO than to invest in it, if only to tell their children about a company they haven’t heard of because it no longer exists.

Economics focus

A remedy for financial turbulence?
 

In the first of a series of articles on the Copenhagen Consensus project*, we look at financial instability

THE severity and frequency of financial crises, especially the combined currency and banking collapses of the past decade, have made financial instability a scourge of our times, one that bears comparison with damage inflicted by famine and war. In a new paper for the Copenhagen Consensus, Barry Eichengreen, from the University of California, Berkeley, has reviewed the literature, attempted to count these costs, and to weigh them against the costs of a particular proposal for remedial action.

The costs can be reckoned in stalled growth and stunted lives. The typical financial crisis claims 9% of GDP, and the worst crises, such as those recently afflicting Argentina and Indonesia, wiped out over 20% of GDP, a loss greater even than those endured as a result of the Great Depression. According to one authoritative study, the Asian financial crisis of 1997 pushed 22m people in the region into poverty. For developing countries, currency crises are an important subset of financial crises. Mr Eichengreen, while cautioning against taking the precision of such estimates too seriously, reckons that the benefit which emerging-market countries would reap if such crises could be avoided altogether would be some $107 billion a year.

One ready way to secure those benefits, you might think, would be to stifle financial markets. In impoverished parts of Africa, for example, credit crunches are relatively rare, because credit is always hard to come by. But as a rule such a solution would be more costly than the problem. Wherever financial markets are absent or repressed, savings go unused, productive economic opportunities go unrealised and risks go undiversified. If India's banks and stockmarkets were as well developed as Singapore's, India would grow two percentage-points a year faster, according to one study.

To grow fast, and keep growing quickly, countries need deep financial markets—and the best way to deepen financial markets, most economists agree, is to liberalise them. Does this mean that countries must open their financial markets to foreign capital, thus exposing themselves to the risk of currency crises? Or should they impose capital controls, confining the perversity of financial markets to national borders, where the central bank retains the power to offset it? Foreign direct investment aside, China's capital markets are still largely closed to outsiders. Yet it has no shortage of credit. For other countries, though, the evidence is mixed. A fair reading of the studies, and there have been many, suggests that, for most countries, opening up to foreign capital will deliver faster growth in most years—punctuated by a damaging financial crisis about every ten years. Some economists argue that periodic credit crunches are the price emerging markets must pay for faster growth.

What might be done to make financial crises less common? The answer depends on the causes of financial meltdown. Governments bring some crises on themselves by pursuing fiscal and monetary policies that are inconsistent and unsustainable. Such self-defeating policies may be the symptom of deeper flaws in the body politic. If so, there is little outsiders can do. But some countries' financial fragility results simply from their need for foreign investment. In the most susceptible countries, firms and banks borrow heavily in dollars, while lending in local currencies. If the value of the local currency wobbles, this mismatch between domestic assets and foreign liabilities is cruelly exposed.

Why are the assets and liabilities of emerging markets so ill matched? Perhaps because poorly supervised and largely unaccountable managers have scant reason to be careful with other people's money. But Mr Eichengreen offers another reason. International investors are very choosy about currencies. Most consider only bonds denominated in dollars, yen, euros, pounds or Swiss francs. This select club of international currencies is locked in for deep historical and structural reasons. Thus, poor countries that want to borrow abroad must bear currency mismatches through no fault of their own.

If this is the problem, possible solutions follow naturally: either create a common world currency, used by rich and poor alike, or invent a liquid, international market for bonds denominated in the pesos, bahts and rupiahs that emerging markets are obliged to use. The first solution, even if it were desirable, is politically impossible; the second is merely very difficult. Mr Eichengreen spells out in his study an ingenious plan to make it a little easier. Briefly, he proposes the creation of a market for lending and borrowing in a synthetic unit of account, a weighted basket of emerging-market currencies. Such bonds would be popular with investors, since the currency would be more stable than the sum of its parts and, at first at least, carry attractive yields. Importantly, such a market, if it could be established, would eventually let emerging-market economies tap foreign capital without currency mismatches. This is because those, such as the World Bank, that issued such bonds would be keen to reduce their exposure to the basket by lending to the countries in that basket in their own currencies.

However, there is a cost: the extra yield that the Bank and others would need to offer to attract buyers of the new instruments. Mr Eichengreen estimates that this initial cost would be no more than $545m a year—a small sum compared with the $107 billion that would be saved if currency crises could be avoided.

American banks continue to make vast profits. Will the good times end when the Fed raises interest rates?

IN RECENT years, Buttonwood has written many an article on the American banking system. Learned, pithy and opinionated, the only thing about his analysis that could possibly be faulted is that it sometimes turned out to be spectacularly wrong. In the late 1990s, faced with banks’ record profits, Buttonwood opined that it could not last. The gist of the argument (and there were, you can be sure, many subtleties) was that although there were good reasons why banks had become more profitable—such as a robust economy and a more diverse set of businesses—the biggest reason was that they were taking more risk. And since risk was not being rewarded properly in the febrile 1990s, your columnist was convinced the banks would come a cropper. The occasion when Buttonwood delivered these forthright views at length to a deeply sceptical Alan Greenspan (who thought he must be looking at a different country) has gone down in Economist folklore.

Mr Greenspan’s scepticism, you might not be surprised to hear, was warranted. American banks cruised through the downturn following the stockmarket crash of 2000 with barely a dent in the bumper, and since then their profits have accelerated. Last year Citigroup, the largest financial firm in the world, made more money than any other company has ever made before. In the first quarter of this year, it made another $5.3 billion, putting it on course to break last year’s record. Bank after bank has announced a sharp increase in profits in the first quarter. And yet bank shares have foundered: the banking bit of the S&P 500 is some 7% off its high. Investors, it seems, doubt whether the good times can continue. And the reason for these fears is a slew of robust economic statistics suggesting that the Fed is likely to raise interest rates sooner rather than later. This, they think, will hurt banks.

Though fully in agreement with these views, his dismal track record at the very least requires Buttonwood to put the case for the defence. Far from falling, bank profits could actually rise when the Fed puts up rates. All things equal, says David Fanger of Moody’s, a rating agency, banks make more money when interest rates are high than when they are low, because they benefit more from paying low or no interest on checking (current) accounts and so forth. The attraction of such cheap sources of funding is the main reason why banks have built up their branch networks in recent years, helping them to suck in deposits, which have been growing at almost 10% a year. The cheap funding from deposits, says Mr Fanger, accounts for 25-40% of profits, depending on the bank. It would mean still more profits were rates to rise.

But while banks’ funding will benefit from the rise in short-term rates, they will lose out (in one way, at least) if higher long-term rates do not rise too. Banks essentially take two risks. The first, dubbed “maturity transformation” risk, involves borrowing short and lending long. The bigger the difference between short- and long-term rates, the more money banks make. Thanks to the largesse of the Fed and its 1% short-term rates, the yield curve—the difference between short and long rates—has been at or near a record high over the past couple of years. The difference between two- and ten-year Treasuries—a good way of measuring the slope of the curve—has been two-and-a-half times its average of the past 20 years, says David Hendler of CreditSights, an independent research firm. As a result, he says, “you could have strapped any monkey to a trading chair and made money.”

Banks have played the yield curve for all they are worth, in the sure knowledge that the Fed will give ample warning before it alters short-term rates. Although commercial lending has dropped, banks’ holdings of government securities have grown, as have their investments in mortgage-backed securities, which have gone up by almost $100 billion, or a third, since last September. The market for interest-rate swaps is another favoured playground. Here, banks simply pay a low, short-term floating rate and receive a high, fixed one. Half the top 20 American banks get at least 10% of their profits from this spread, according to Mr Hendler; for J.P. Morgan Chase, it was an astonishing 33% last year.

The fear, of course, is that banks could lose heavily if long-term rates rise sharply, because the securities that they have bought already would fall in value (although, of course, they would be able to earn a decent spread on new ones). And many other investors have also taken full advantage of the steep yield curve, which might mean a decidedly nasty fall as they head for the exits at the same time.

Most economists put “fair value” of ten-year Treasuries at 5.5% or so. This would mean big losses on all those bonds and swaps positions that banks had taken out when rates were a lot lower and prices higher. It would, however, be mainly a valuation loss, and banks might avoid the worst of it by transferring positions to that part of their balance sheet that they do not have to mark to the market price. They would, however, be left with low-yielding assets at a time when the cost of their liabilities in the capital markets was rising. Of course, banks are not stupid: they know that the Fed will raise rates at some point. But the pressure on them to increase profits is so great that most of them have stayed put for as long as possible. All of this means, at the very least, lower profits on existing positions. And if short-term rates rise sharply, as they did in 1994, banks will be in trouble.

But the second risk that banks take—credit risk—is just as big a concern in a rising interest-rate environment. Credit costs have fallen sharply in recent years for consumers and companies alike, thanks to a buoyant economy and low rates. Mr Fanger argues that those costs are likely to remain low because the Fed will be raising rates at a time when the economy is humming along nicely. But given how high consumer and corporate debts are, and how low the price now charged to lend to riskier borrowers is, such a view seems overly sanguine. You may feel, however, that such warnings can be safely ignored.

Good news on jobs in America may have troubling repercussions for emerging markets

IN FINANCE as in medicine, prevention is better than cure. The International Monetary Fund’s Global Financial Stability report, published on Tuesday April 6th, is the equivalent of a twice-yearly check-up for the international financial system. At the moment, the system seems to be in rude health, the report says. The IMF does worry, however, that proper precautions for the future are not being taken. Unfortunately, in finance as in medicine, no one listens to the doctor until nasty symptoms start to show.

As the report confirms, the past 12 months have seen the re-emergence of emerging markets. A strengthening world economy has rediscovered an appetite for their goods, and a raging thirst for their bonds. Spreads—the premium creditors demand from emerging-market governments, over that asked of more trusted governments—have fallen dramatically, despite rising somewhat in February (see chart above). Brazil’s turnaround has been among the most dramatic. As a presidential candidate in 2002, Luiz Inácio Lula da Silva struck fear into the hearts of Brazil’s foreign creditors. But as president, in 2003, he raised $4.4 billion from them. Even Indonesia, laid low by the Asian financial crisis in 1997, got back on its feet in March with its first bond issue for eight years.

What explains this renewed enthusiasm for emerging markets? Their “fundamentals” have certainly improved. Exports are strong, public finances are more stable, and currencies more flexible. Countries that once sought to maintain currency pegs with inadequate reserves now do the opposite. With some exceptions, they no longer have an official parity to defend, but they have accumulated large, sometimes vast, stocks of foreign exchange anyway.

Emerging markets, then, have become better bets. But that, the IMF judges, is not the main reason why they have enjoyed so much custom from foreign punters recently. More important is the fact that investors have more money to play with and nowhere better to place it. With short-term interest rates pinned to the floor by the Federal Reserve, the rich world has grown unprofitable for yield-hungry prospectors. Emerging markets look enticing by comparison: J.P. Morgan’s index of emerging-market bonds, the EMBI+, returned about 30% last year.

Flat yields in mature markets make emerging markets look good. But there is more to it than that. The ample liquidity sloshing around in the rich world is also an invitation to enter into the so-called “carry trade”. Carry traders borrow at low, short-term rates. They then invest the proceeds in higher-yield assets. Some simply buy long-dated American bonds. But the more adventurous look further afield, betting on richer-yielding emerging-market bonds with money borrowed at cheap rates in mature markets.

The problem is those cheap rates may not last much longer. Interest rates in Britain have already started rising. On Thursday April 8th, the Bank of England held rates steady at 4%, but it is expected to raise them another notch next month. When the Federal Reserve follows suit, the liquidity that lubricates the carry trade may dry up. A warning shot came late last week: America’s monthly jobs report was surprisingly strong—308,000 workers were added to the payrolls in March. That was followed up on Thursday by the news that the number of Americans making initial jobless claims fell to 328,000 in the week ending April 3rd, the lowest for more than three years. This gathering strength in the labour market threatens to remove the Fed’s last, best excuse for keeping interest rates at 45-year lows.

The market, of course, is not wholly unprepared—it knows the Fed will tighten monetary policy. But it does not know when, or by how much. Many analysts expect a rate rise before the summer is out. Others still maintain that the Fed will wait until after America’s November presidential election. When the Fed does finally get going, most assume it will take cautious, baby steps. But no one really knows how quickly it will move.

The IMF fears the bond market will be caught out in 2004, much as it was in 1994. Back then, markets were similarly bracing themselves for a gradual shift to a tighter monetary policy. Short-term interest rates were low and longer-term rates high, in anticipation of the economy reaching full strength. As a result, the “yield curve” at the beginning of 1994 was unusually steep—almost as steep, indeed, as at the start of this year (see second chart).

Sure enough, in February 1994, the Fed started raising rates. But it went further and faster than anyone had anticipated: seven hikes in 12 months doubled the federal funds rate to 6%. As short-term rates caught up with long, the yield curve flattened out. The liquidity tap was turned off; the carry trade miscarried. Investors could no longer borrow cheap money to lavish on emerging markets. Emerging-market bond yields shot up. The result was Mexico’s “tequila” crisis, in which the country found itself with more debt than it could repay and a currency peg it could not defend.

This time might be different. In 1994, Alan Greenspan acted so precipitously because he was spooked by the prospect of inflation. But the spectre that haunted him then is no longer a worry: Mr Greenspan, if anything, thinks inflation today is too low. More importantly, few emerging markets are any longer in the business of defending unsustainable currency pegs, as Mexico was in 1994. If emerging markets do fall out of favour with foreign investors, their exchange rates can take some of the strain.

The IMF is still worried, however. “Valuations on emerging-market bonds, especially sub-investment grade bonds, appear vulnerable to an increase in underlying US treasury yields,” it says. As the Fund points out, the notion that this time it’s different has led many an over-optimistic soul to repeat this time exactly the same mistakes he made last time.

At last, American firms are hiring again in earnest: payrolls grew by 308,000 in March. If the job gains continue, interest rates will rise, and so will President George Bush’s fortunes

FOR months, America’s jobless recovery has bemused economists, bound the hands of the Federal Reserve and benighted the administration of George Bush. Despite impressively fast economic growth, firms have been depressingly slow to hire. Last month, however, America’s corporations made up for lost time: 308,000 workers were added to the payrolls in March, according to figures released on Friday April 2nd. That is twice the number hoped for by even the most optimistic forecaster. Has spring finally arrived for America’s barren labour market?

Actually, the weather may have helped. The construction industry, which lost 21,000 workers in February, gained 71,000 last month thanks to the balmier climate, which brought many building plans out of hibernation. The resolution of a strike by Californian grocery-store workers also boosted the job figures for retailing, which added 47,000 workers in March. This was a welcome, but one-off, development: strikes only end once. More promising was the great strength showed by service industries, which hired an extra 230,000 people in March. Even manufacturing, which lost jobs for 43 months in a row, seems to have finally hit bottom: the sector's payrolls were unchanged in March.

Paradoxically, despite these widespread gains, the unemployment rate—the percentage of the workforce who are not in fact working—edged up from 5.6% to 5.7%. But the paradox is only apparent: many Americans, despairing of ever finding a job, had dropped out of the workforce altogether in recent months and were therefore not counted as unemployed. New glimmers of hope about their job prospects may have tempted some of them back into the labour force and thus back into the unemployment statistics.

Good news for the jobs market is bad news for the market in bonds, the price of which falls when interest rates rise. The Federal Reserve has so far stayed its hand, keeping the federal funds rate at 45-year lows, mainly because of the slack in the labour market. With so many workers standing idle, the Fed has argued, the economy is performing well below its potential and is thus still in need of a stiff monetary stimulus. That argument will be a little harder to make after Friday’s figures. If they mark a sustained turn in the labour market, interest rates may also now turn upwards before the summer is out.

And what of Mr Bush’s political fortunes? Will Friday’s figures defuse one of the more incendiary charges laid against him by his Democrat critics: that he has presided over the worst jobs record since the Depression-era president, Herbert Hoover? They will certainly help. But even after last month’s strong hiring, payroll employment is still down almost 1.9m from where it stood when Mr Bush came to office. Voters’ perceptions of the economy will also take time to change. Only economists and political campaigners pay much attention to the statistics; ordinary people wait to see how they and their neighbours are doing. Until those feelings of job insecurity pass, Mr Bush's own job security will be far from assured.

The yen is surging again. Will the Japanese authorities halt its rise? Can they?

“THIS intervention is stupid,” said Fumihiko Igarashi, an opposition politician in Japan’s lower house of parliament. “It’s a fight we can’t win.” Indeed, on the day he spoke, Wednesday March 31st, the Japanese monetary authorities ceded one round in their fight with the currency traders. They watched the yen strengthen past ¥105 to the dollar, having intervened furiously in the markets only last month to keep it from crossing that threshold. The defeat became a rout as the yen pushed on to reach a four-year high, at ¥103.4 to the dollar. Traders and analysts are now anticipating the day when the yen is worth a full cent.

Did the finance ministry, which sets Japan’s yen policy, go down fighting, its interventions overwhelmed by the sheer weight of market sentiment? Or had it already thrown in the towel and given up intervening altogether? In the whole of March, the authorities sold a massive ¥4.7 trillion ($45.2 billion) in their attempt to keep the currency down. But analysts reckon most of that ammunition was fired in the first part of the month. For the past couple of weeks, the ministry has been denying rumours that it has given up on its efforts to keep the yen down. It insists there has been no change in policy. On Wednesday, currency traders obviously concluded that the ministry doth protest too much.

Japan’s GDP grew at an annualised rate of 6.4% in the final quarter of 2003 and its trade surplus ballooned by more than 50% in February, compared with a year earlier. Manufacturers are brimming with a confidence they have not felt for nearly seven years, according to the quarterly Tankan survey released on Thursday, and some of that optimism is even spreading to the service sector, ending four years of negative thinking. It is easy to conclude, therefore, that Japan’s strengthening economy warrants a stronger yen. But that conclusion would be a little hasty. For Japan, a cheap yen is not just a way to conquer foreign markets; it is also a way to conquer deflation—and with the GDP deflator, a broad measure of the price level, still falling by 4.4%, that battle has yet to be won.

Inflation is often described as the result of too much money chasing too few goods. Japan’s deflationary dilemma is the converse of this: not enough money, chasing too many goods. The Bank of Japan is doing its best to fix the first part of this problem, flooding the banking system with reserves. But as Andrew Smithers, an independent financial analyst, points out, this policy is fraught with difficulty, because one never really knows how much money is enough. The right amount will vary as the economy grows, and as the demand for money fluctuates. This is precisely the reason why most central banks target the price of money, in the form of short-term interest rates, rather than its quantity.

Japan cannot do this, of course: its short-term interest rates, at zero, are already as low as they can go. But as an alternative, Mr Smithers points out, it can still target the exchange rate—the foreign price of money. The finance ministry sold ¥20 trillion last year trying to keep the exchange rate steady. But, Mr Smithers argues, this did not go far enough. In an ideal world, he says, the ministry would go on selling until the currency was thoroughly debauched and the economy decisively reflated.

However, the Americans, at the other end of the yen-dollar exchange rate, do not necessarily see things this way. “No one has devalued their way to prosperity,” asserted John Snow, America’s treasury secretary, earlier this month—ignoring the prominent example of President Franklin Roosevelt, who devalued his way out of America’s own deflationary trap in the 1930s. Alan Greenspan, the chairman of the Federal Reserve, echoed Mr Snow’s criticism: he recently said that the pace of Japan’s currency intervention was “unsustainable”. The scale of the dollar reserves that Japan has built up as a result of its intervention was “awesome”, he said.

Awesome these dollar purchases undoubtedly are, but shocking also is the supply of dollar assets coming to market. America’s federal government alone will need to issue over $500 billion-worth of Treasuries this fiscal year to cover the gaping hole in its budget. At the moment, foreign central banks are the star bidders every time these bonds are put up for auction. But if the Bank of Japan takes a back seat in future, other buyers will have to be tempted into the market by means of higher interest rates. The United States Treasury, in other words, will have to make its debt more attractive to hold and thus more costly to service. Japan may not be the only loser in the currency-intervention game.