Rebalancing the World
For the week, the S&P500 increased 0.6% (up 6.1% y-t-d), and the Dow gained 0.6% (up 6.8%). The Banks rallied 1.7% (up 7.7%), and the Broker/Dealers jumped 2.3% (down 5.5%). The Morgan Stanley Cyclicals added 0.5% (up 12.2%), and the Transports increased 1.3% (up 16.0%). The Morgan Stanley Consumer index gained 0.7% (up 8.4%), while the Utilities were little changed (up 2.6%). The S&P 400 Mid-Caps rose 0.6% (up 13.5%), while the small cap Russell 2000 was unchanged (up 12.5%). The Nasdaq100 added 0.3% (up 13.1%), and the Morgan Stanley High Tech index gained 1.0% (up 6.9%). The Semiconductors were little changed (down 0.8%). The InteractiveWeek Internet index jumped 1.9% (up 25.1%). The Biotechs lost 2.4%, reducing 2010 gains to 22.0%. With bullion down $40, the HUI gold index sank 4.3% (up 16.3%).
One-month Treasury bill rates ended the week at 13 bps and three-month bills closed also at 13 bps. Two-year government yields dipped one basis point to 0.355%. Five-year T-note yields declined 4 bps to 1.15%. Ten-year yields were little changed at 2.56%. Long bond yields fell 5 bps to 3.93%. Benchmark Fannie MBS yields were down 5 bps to 3.33%. The spread between 10-year Treasury yields and benchmark MBS yields narrowed 5 bps to 77 bps. Agency 10-yr debt spreads narrowed 3 to 15 bps. The implied yield on December 2011 eurodollar futures declined 2 bps to 0.58%. The 10-year dollar swap spread was little changed at 6.75. The 30-year swap spread increased 0.75 to negative 37.75. Corporate bond spreads were mostly narrower. An index of investment grade bond risk declined 2 to 96 bps. An index of junk bond risk declined 10 to 500 bps.
October 22 - Bloomberg (Sapna Maheshwari): "Wal-Mart ... and PepsiCo Inc. helped lead $29 billion of company bond sales this week, as issuance accelerated amid better-than-expected earnings and sales forecasts... Companies issued $161.1 billion of debt in September, the second-most on record after May 2008..."
Debt issuance picked up this week. Investment grade issuers included Wal-Mart $5.0bn, Pepsico $2.25bn, Ebay $1.5bn, CSX $800 million, United Health Group $750 million, and Great River Energy $400 million.
Junk bond flows attracted inflows of $347 million (from Lipper), the seventh straight week of positive flows. Junk issuers included Calpine $2.0bn, Univision Communications $750 million, United Rental $750 million, Host Hotels & Resorts $500 million, Markwest Energy $500 million, American Achievement Corp $365 million, Accellent $315 million, Hanger Orthopedic Group $200 million and Prestige Brands $100 million.
Converts issues included Cubist Pharmaceuticals $400 million.
The list of international dollar debt sales included KFW $4.0bn, Bank Nova Scotia $2.5bn, Hutchinson Whampoa $2.0bn, Boligkreditt $1.5bn, Export Development Canada $1.0bn, SCF Capital $800 million, Posco $700 million, Abengoa Finance $650 million, and Banco Industr Commercial $400 million.
U.K. 10-year gilt yields were little changed at 2.95%, while German bund yields jumped 10 bps to 2.47%. Greek 10-year bond yields reversed course, rising 46 bps to 9.36%. Ten-year Portuguese yields rose 12 bps to 5.84%. Ireland yields surged 40 bps to 6.52%. The German DAX equities index jumped 1.7% (up 10.9% y-t-d) to the highest level since the 2008 crisis. Japanese 10-year "JGB" yields added one basis point to 0.89%. The Nikkei 225 slipped 0.8% (down 10.6%). Emerging equity markets were mixed. For the week, Brazil's Bovespa equities index declined 3.2% (up 1.4%), while Mexico's Bolsa gained 1.1% (up 9.3%). South Korea's Kospi slipped 0.3% (up 12.7%). India's Sensex equities index added 0.2% (up 15.5%). China's Shanghai Exchange added 0.1% (down 9.2%). Brazil's benchmark dollar bond yields declined 4 bps to 3.68%, and Mexico's benchmark bond yields sank 19 bps to 3.61%.
Freddie Mac 30-year fixed mortgage rates increased 2 bps last week to 4.21%, and were down 79 bps year-over-year. Fifteen-year fixed rates added 2 bps to 3.64% (down 77 bps y-o-y). One-year ARMs sank 13 bps to 3.30% (down 124bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates up one basis point to 5.24% (down 77bps y-o-y).
Federal Reserve Credit declined $9.4bn to $2.284 TN. Fed Credit was up $63.8bn y-t-d (3.6% annualized) and $112bn, or 5.2%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 10/20) jumped $14.1bn (19-wk gain of $205bn) to a record $3.281 TN. "Custody holdings" have increased $326bn y-t-d (13.7% annualized), with a one-year rise of $394bn, or 13.6%.
M2 (narrow) "money" supply increased $3.9bn to $8.757 TN. Narrow "money" has increased $223bn y-t-d, or 3.3% annualized. Over the past year, M2 grew 3.3%. For the week, Currency added $1.0bn, while Demand & Checkable Deposits fell $17.4bn. Savings Deposits jumped $30.3bn, while Small Denominated Deposits declined $7.9bn. Retail Money Fund assets dipped $2.2bn.
Total Money Market Fund assets (from Invest Co Inst) fell $17bn to $2.782 TN. Year-do-date, money fund assets have dropped $512bn, with a one-year decline of $590bn, or 17.5%.
Total Commercial Paper outstanding rose $17.5bn to $1.145 TN, the highest level since mid-March. CP has declined $25bn, or 2.6% annualized, year-to-date, and was down $221bn from a year ago.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg's Alex Tanzi - were up $1.545 TN y-o-y, or 20.9%, to a record $8.951 TN.
Global Credit Market Watch:
October 21 - Bloomberg (John Gittelsohn and Jody Shenn): "Shoddy mortgage lending has led bankers into a two-front war, pitting them against U.S. homeowners challenging the right to foreclose and mortgage-bond investors demanding refunds that could approach $200 billion. While federal regulators and state attorneys general have focused on flawed foreclosures, a bigger threat may be the cost to buy back faulty loans that banks bundled into securities. JPMorgan Chase & Co., Bank of America Corp., Wells Fargo & Co. and Citigroup Inc. have set aside just $10 billion in reserves to cover future buybacks."
October 22 - Bloomberg (Simon Clark and John Glover): "Two years after assuring senior bondholders that they wouldn't lose their money if banks failed, the Irish government is making the same promise again. This time, some bondholders are skeptical the government will bail them out with taxpayer funds, sending down the price of senior guaranteed debt for Anglo Irish Bank Corp. to 90 cents on the euro..."
October 19 - Bloomberg (James G. Neuger and Rainer Buergin): "European governments left decisions to sanction euro-area budget violators in political hands, stopping short of the more automatic crackdown on runaway deficits demanded by the European Central Bank. Germany, which had pushed for 'quasi-automatic' sanctions and threatened to expel chronic high-deficit countries from the euro region, shifted its stance yesterday to embrace French calls to maintain a layer of political decision-making before penalties are imposed."
October 21 - Bloomberg (Laura Marcinek): "Private-equity firms invested a record $40.1 billion of cash in the third quarter... Equity investments rose from $36.4 billion in the second quarter and $17.8 billion in the first quarter, the... Private Equity Growth Capital Council said... Year-to-date equity investment climbed to an all-time high of $94 billion, topping the $80 billion spent in the same period in 2007, when credit markets began to freeze."
October 20 - Bloomberg (Sarah Mulholland): "Relative yields on commercial mortgage bonds have fallen to the lowest this year... The $3.6 billion commercial-mortgage backed bond issued by GS Mortgage Securities Trust, used as a market barometer... pays 279 bps more than the benchmark swap rate, down from 500 basis points at the end of 2009..."
Global Government Finance Bubble Watch:
October 18 - Dow Jones (Michael S. Derby): "A veteran Federal Reserve official cast his lot Wednesday with those who believe the government itself was a major player in driving events that led up to and created the financial crisis. 'The financial crisis was not a failure of our capitalist system,' Federal Reserve Bank of Philadelphia President Charles Plosser said. 'Nor was it largely the result of a lot of greedy evildoers whom we could just put in jail to solve the problem.' Instead, the official said 'it largely reflected a collection of incentives, some arising in private markets and some created by the government, that motivated individuals to act in ways that proved damaging to the nation's overall economy.'"
October 19 - Bloomberg (Sandy Hendry and Lilian Karunungan): "Quantitative easing in developed countries is a 'key theme' for credit risk in emerging markets, Andrew Colquhoun, head of Asia-Pacific sovereign debt at Fitch Ratings, said... Nations where monetary and fiscal discipline are weak and whose economies have strong links to the dollar are the most vulnerable, he said... 'This whole topic of the implications of quantitative easing globally is going to be the key theme for developing sovereign risk and sovereign ratings for the next 12-18 months,' said Colquhoun. "It could start to look bleaker than it does to some people now'... if markets remain volatile because of capital flows, he said."
October 19 - Bloomberg (Fabiola Moura and Michael Patterson): "The record surge in stock offerings that helped send developing nations' share of global market capitalization to an all-time high will probably last another two years, according to Citigroup Inc. The... emerging markets account for a record 25% of global equity market value, up from 11% five years ago... The MSCI Emerging Markets Index has gained 12% this year, topping the 5.1% increase in the MSCI World Index."
October 20 - Bloomberg (Simon Kennedy): "Bank of England Governor Mervyn King said global finance chiefs need to reach a 'grand bargain' to coordinate economic policies and avert a round of protectionism. Speaking before Group of 20 finance ministers and central bankers meet in South Korea on Oct. 22-23, King said major economies' policies are in 'direct conflict' with each other and that 'collective' action is required to rebalance the world economy."
October 18 - Bloomberg (Frances Yoon and Eunkyung Seo): "The Bank of Korea plans to adjust its foreign-exchange reserve portfolio to increase profit and manage risk amid heightened fluctuations in financial markets. 'Our bank will carefully diversify reserves for higher profit after considering the international investment environment and the reserves' growth trends," the central bank said in a report prepared for parliamentary audit. 'We will manage risks with attention to increased volatility.'"
The dollar index gained 0.5% (down 0.6% y-t-d). For the week on the upside, the Mexican peso increased 0.8% and the Japanese yen added 0.1%. On the downside, the Brazilian real declined 2.4%, the British pound 1.9%, the Swiss franc 1.9%, the Canadian dollar 1.5%, the South African rand 1.4%, the New Zealand dollar 1.2%, the South Korean won 1.1%, the Australian dollar 0.8%, the Taiwanese dollar 0.5%, the Danish krone 0.2% and the euro 0.2%.
October 21 - Bloomberg (Mark Drajem and Gopal Ratnam): "Rare-earth prices have jumped as Chinese export quotas crimped worldwide supplies for the elements used in the manufacture of disk drives, wind turbines and smart bombs. Prices have climbed sevenfold in the last six months for cerium oxide, which is used for polishing semiconductors, and other elements have more than doubled, according to Metal-Pages Ltd. in London..."
October 21 - Bloomberg (Chris Kay): "Arabica coffee rose to a 13-year high... on concern that output may fall next year in Brazil and Colombia, the world's two biggest growers of the variety. Robusta coffee reached a two-year high in London."
October 20 - Bloomberg (Supunnabul Suwannakij): "The worst floods in four years in Thailand, the world's biggest rice exporter, may cut production from the nation's main crop by up to 20%, likely extending a rally in prices, an industry group said."
October 21 - Bloomberg (Luzi Ann Javier and Supunnabul Suwannakij): "Rice stockpiles held by the world's five biggest exporters will likely decline next year, tightening global supply and supporting prices, the United Nations said. 'The danger will be for next year,' Concepcion Calpe, senior economist at the Food & Agriculture Organization of the U.N., said... Rough-rice futures in Chicago have surged 51% from this year's low..."
The volatile CRB index increased 0.4% (up 4.9% y-t-d). The Goldman Sachs Commodities Index (GSCI) slipped 0.3% (up 6.9% y-t-d). Spot Gold dropped 2.9% to $1,328 (up 21% y-t-d). Silver sank 4.1% to $23.285 (up 38% y-t-d). November Crude was little changed at $81.94 (up 3% y-t-d). November Gasoline declined 1.4% (up 1% y-t-d), while November Natural Gas sank 5.9% (down 40% y-t-d). December Copper dropped 2.9% (up 14% y-t-d). December Wheat sank 4.8% (up 24% y-t-d), and December Corn declined 0.5% (up 35% y-t-d).
China Bubble Watch:
October 22 - Bloomberg (Simon Kennedy): "China's reluctance to deliver 'shock therapy' through a faster appreciation of the yuan may be a bid to avoid repeating history: Japan's. As Group of 20 finance chiefs begin talks... in Gyeongju, South Korea, China is deflecting foreign pressure to fast-track the yuan's gains... Chinese officials link their resistance against an even quicker rise to fears it would hurt their economy the same way Japan's sank after 1985's Plaza Accord shot the yen higher. As Ministry of Commerce spokesman Yao Jian said... that 'rapid currency appreciation led exports to plunge, unemployment and economic slowdown' and easier interest rates which caused asset bubbles."
October 21 - Bloomberg: "China's economy grew 9.6% in the third quarter and inflation accelerated to the fastest pace in almost two years... Consumer prices jumped 3.6% in September from a year earlier..."
October 19 - Bloomberg: "Moves by the U.S. Federal Reserve to print cash would spur capital flows into China, hampering the Asian nation's efforts to damp inflation and counter yuan gains, said Yu Yongding, a former central bank adviser... Cash is pouring into China to profit from economic growth that's averaged more than 10% for the past five years and accelerating yuan gains... The nation's foreign-exchange reserves jumped by $100 billion in September to a record $2.65 trillion, the biggest increase since Bloomberg began tracking the data in 1995, and the inflation rate hit a 22-month high of 3.5% in August."
October 18 - Bloomberg: "China's stocks may extend this month's rally as record household deposits pave the way for more investment into Asia's second worst-performing equity market this year. 'We've seen money chasing real estate, commodities, art and even garlic this year,' said Leo Gao, who helps oversee $600 million at APS Asset Management Ltd. in Shanghai. 'If you look around, nothing is cheaper than stocks.' ... household deposits increased 1.04 trillion yuan ($156 billion) in September, the biggest rise in seven months, to 29.9 trillion yuan."
October 22 - Financial Times (Jamil Anderlini): "The chairman of one of China's biggest state lenders has called on the country's financial sector to speed up its expansion overseas in a strong sign that Beijing is considering allowing banks to resume offshore mergers and acquisitions. Xiao Gang, of the Bank of China, said in an essay... that the post-financial crisis environment provided excellent opportunities for expansion, calling this an 'inevitable trend'. 'The financial institutions devastated by the global crisis still need time to recover,' Mr Xiao wrote. "[Chinese] banks that have the ability should hasten their pace in 'going abroad' and increase their international competitiveness.'"
October 22 - Bloomberg (Mayumi Otsuma and Tatsuo Ito): "Japan is prepared to intervene in currency markets to stem the yen's advance, Economy Minister Banri Kaieda said, signaling that overseas opposition shouldn't deter authorities from correcting abrupt moves. 'Japan stands ready to take action whenever it's necessary,' Kaieda said... 'Intervention may cause tension with other countries, but I believe those actions are allowed when currencies are moving in a volatile way.'"
Asia Bubble Watch:
October 20 - Bloomberg (Eunkyung Seo and William Sim): "South Korea's unemployment rate climbed in September... to 3.7% from 3.4% in August..."
October 20 - Bloomberg (Chinmei Sung): "Taiwan's export orders rose 16.68% in September from a year earlier, the Ministry of Economic Affairs said...
Latin America Watch:
October 21 - Bloomberg (Iuri Dantas): "Brazilian unemployment rate fell to a record low in September... Unemployment fell to 6.2%..."
Unbalanced Global Economy Watch:
October 22 - Bloomberg (Shamim Adam and Ilan Kolet): "The Group of Seven nations' share of the global economy will slide to less than 50% in 2012, signaling that developing markets may further outperform industrial nations... The seven economies will generate less than 50 percent of global GDP by 2012, from about 70% in the mid-1980s. China's output may surpass 10% of the world's within two years, compared with 2% in 1987."
October 20 - Bloomberg (Thomas Penny and Gonzalo Vina): "Chancellor of the Exchequer George Osborne detailed the deepest budget cuts ever in Britain, eliminating almost 500,000 public-sector jobs and imposing a levy on banks to extract the 'maximum sustainable' revenue. 'Today's the day when Britain steps back from the brink,' Osborne told lawmakers... as he outlined plans to virtually eliminate a 156 billion-pound ($245 billion) budget deficit. It's 'a day of rebuilding when we set out a four-year plan to put our public services and welfare state on a sustainable footing.'"
October 22 - Bloomberg (Christian Vits): "German business confidence unexpectedly climbed in October to the highest level in three and a half years..."
October 18 - Bloomberg (James G. Neuger and Jurjen van de Pol): "Germany's push for tough new sanctions against deficit-plagued euro-region governments ran into mounting resistance as France led the charge against automatic penalties. Battle lines over the enforcement of deficit ceilings hardened as Europe faces an end-of-October deadline to overhaul the euro's economic management to prevent a repeat of the debt crisis. 'A lot of member states are getting cold feet now' about proposed quasi-automatic sanctions, Dutch Finance Minister Jan Kees de Jager told reporters... 'We need effective sanctions and they should be as automatic as possible.'"
October 19 - Bloomberg (Brian Parkin): "German exports will rise at the fastest pace in a decade this year and exceed the 1 trillion- euro ($1.4 trillion) level for the first time in 2011, fueled by demand for cars and machinery from outside Europe, the BGA federation said. Exports will grow about 16%... the...group said... revising an August forecast of about 10%."
October 20 - Bloomberg (Juliann Neher): "Business-class airfares on long-haul international flights may rise as much as 10% in 2011, returning to pre-recession prices, after carriers cut seating capacity, American Express Business Travel said. The biggest increases for those tickets will be in the Asia-Pacific region..."
U.S. Bubble Economy Watch:
October 22 - Bloomberg (Lorraine Woellert): "Fannie Mae and Freddie Mac... may need as much as $363 billion in Treasury Department aid through 2013, the Federal Housing Finance Agency said. FHFA, which oversees the government-sponsored entities, offered the estimate as a worst-case scenario in an analysis modeled on the stress tests conducted on the nation's biggest banks last year... Aid to the two firms, which have drawn $148 billion since they were seized in 2008, could total as little as $221 billion in the event of a 'strong near-term recovery,' FHFA said."
Real Estate Watch:
October 20 - Bloomberg (David M. Levitt): "U.S. commercial property prices tumbled for a third straight month in August to the lowest level in eight years, pulled down by declining values for distressed real estate, according to Moody's... The Moody's/REAL Commercial Property Price Index fell 3.3% from the prior month to surpass the post-crash low in October 2009... The measure is 45% below its October 2007 peak and is at its lowest level since June 2002."
October 20 - Bloomberg (Danielle Kucera): "Apartment rents rose across the U.S. West and South for the third straight quarter as record foreclosures boosted demand for rental housing, RealFacts said. The average asking rent climbed to $958 a month from $950 in the second quarter... It declined 0.7% from a year earlier. Rents reached a record $1,002 in the third quarter of 2008."
Central Bank Watch:
October 19 - Bloomberg (Caroline Salas and Scott Lanman): "Federal Reserve Bank of New York President William Dudley said slowing growth, 'weak' job creation and declining inflation add up to a 'wholly unsatisfactory' U.S. economy. 'Given the outlook that the upturn appears likely to strengthen only gradually, it will likely be several years before employment and inflation return to levels consistent with the Federal Reserve's dual mandate' for stable prices and maximum employment, Dudley said..."
October 20 - Bloomberg (Svenja O'Donnell): "Bank of England policy makers are starting to lean towards further emergency bond purchases to shore up the country's recovery as the government unveils the biggest budget cuts since World War II. 'Some of the members felt the likelihood that further monetary stimulus would become necessary in order to meet the inflation target in the medium term had increased in recent months.'"
October 18 - Bloomberg (Christian Vits): "European Central Bank President Jean-Claude Trichet rejected Bundesbank President Axel Weber's call to end the bond purchase program that has provided a lifeline for European governments and banks trying to shore up their finances. 'This is not the position of the Governing Council, with an overwhelming majority,' Trichet said... Weber, who also sits on the ECB's 22-member decision-making council, said the risk of 'exiting too late' from the emergency measures was greater than pulling out too soon."
October 20 - Bloomberg (Jody Shenn): "The Federal Reserve Bank of New York joined with the biggest bond investors in the U.S. in seeking to force Bank of America Corp. to buy back bad home loans packaged into securities as the battle over who will bear mortgage losses intensifies. The institution joined a group including Pacific Investment Management Co., BlackRock Inc. and Freddie Mac in a letter to the lender and to Bank of New York Mellon Corp., trustee for $47 billion of bonds created by Bank of America's Countrywide Financial Corp. unit..."
October 21 - Bloomberg (Caroline Salas and Jody Shenn): "The Federal Reserve Bank of New York's effort to recover taxpayer money used in bailouts during the crisis may be at odds with its mission to ensure the stability of the financial system. The New York Fed, which acquired mortgage debt in the 2008 rescues of Bear Stearns Cos. and American International Group Inc., joined a bondholder group including Pacific Investment Management Co. that aims to force Bank of America Corp. to buy back some bad home loans packaged into $47 billion of securities... 'This is an inherent conflict,' said former Atlanta Fed research director Robert Eisenbeis... 'They're transferring the loss from what would have been Bear Stearns through the Fed to the originators of the mortgages. That's an odd chain, and I don't know how you manage that.'"
October 20 - Bloomberg (David Wilson): "Pension funds for employees of U.S. state and local governments are headed for a shortfall of more than $1 trillion within three years, according to a study published by the National Bureau of Economic Research... Unfunded liabilities for public pensions will amount to an estimated $1.05 trillion in 2013 on an inflation-adjusted basis, using 2009 dollars, according to the research. The total is more than double the $511 billion figure in 2008..."
October 18 - Bloomberg (Brendan A. McGrail and Alexandra Harris): "The Elvis Presley Museum in the rock 'n' roll legend's birthplace of Tupelo, Mississippi, is tapping into $651 million in taxable state debt for a makeover. Mississippi leads taxable issuers this week..."
October 19 - Bloomberg (Michael B. Marois): "California, the U.S. state with the largest public-pension fund, faces liabilities that may exceed five times its annual tax revenue within two years unless lawmakers rein in benefits, according to a study. To keep their promises to retirees, the California Public Employees Retirement System, the biggest plan, the California State Teachers Retirement System, the second-largest, and the University of California Retirement System may have combined liabilities of more than 5.5 times the state's annual tax revenue by fiscal 2012, according to the study released today by the Milken Institute. Levies are forecast to reach about $89 billion in the year that began July 1."
New York Watch:
October 21 - Bloomberg (Oshrat Carmiel): "Home prices in New York's Hamptons, the beachside resort towns in Long Island swelled by summering Manhattanites, dropped 14% in the third quarter from a year earlier as buyers opted for less-expensive properties.
October 20 - Financial Times (Sam Jones): "Hedge funds have seen their biggest quarterly rise in assets under management in three years... The industry grew by $120bn in the three months to the end of September, primarily thanks to a 5.17% gain on investments... according to... Hedge Fund Research. The surge in money run by the industry... comes in spite of a rocky year for most managers, during which only a handful have been able to post consistent returns."
October 19 - Bloomberg (Christian Baumgaertel): "Hedge funds attracted a net $19 billion of new capital in the third quarter, the most since the end of 2007, Hedge Fund Research Inc. said."
Rebalancing the World:
These are really strange times. Markets are still digesting Chairman Bernanke's discussion of a new Fed "mandate" approach for targeting a higher inflation level. A heavily promoted "QE2" announcement arrives on November 3. It's just the dimensions of the Q that has everyone unsure and uneasy. Atlanta Fed President Dennis Lockhart jumped into the fray this week with suggestions that $100bn monthly Treasury purchases might be on the table. His comments were soon followed by a report from an advisory service that had the Fed contemplating a $500bn purchase target over a six month period.
The markets were forced to calm down a little when a Financial Times article suggested the Fed may instead settle on a more incremental meeting-to-meeting approach. We'll find out in 10 days or so. Either way, the Fed is determined to convince the marketplace that ultra-loose monetary policies are here to stay. Such an assurance does wonders for market risk perceptions.
Meanwhile, there's the issue of intractable global imbalances - and yet another G20 meeting and comforting communiqué. Media focus today was on a letter presented by Treasury Secretary Timothy Geithner in which he recommended that member countries commit to specific caps on trade surpluses - more specifically not allowing current account surpluses in excess of 4% of gross domestic product. "G20 countries with persistent surpluses should undertake structural, fiscal and exchange rate policies to boost domestic sources of growth and support global demand."
The response was less than enthusiastic. From the Wall Street Journal: "'Japan's traditional belief is that...while fiscal balances can be controlled through policy, trade as well as current-account balances can't,' a person familiar with the Japanese government's thinking said." German Finance Minister Rainer Bruederle rejected a "command economy" approach and "planned economy thinking." At the same time, Geithner's proposal was sufficiently toothless to garner little in the way of response from the Chinese.
U.S. authorities remain hopeful that global policy and currency adjustments will somehow work to rectify financial and economic imbalances. Having our trade partners stimulate domestic consumption, while allowing their currencies to appreciate, would go a long way, it is hoped, in shrinking our Current Account Deficits and stabilizing the global system. Such an approach was tried and failed with the Japanese in the eighties. Nonetheless, global rebalancing some years ago became the boilerplate solution for all that ails the U.S. and global economies.
Secretary Geithner apparently assured G20 finance ministers that the U.S. would work to reduce its fiscal deficits and act to support a strong dollar. From Brazilian Finance Minister Guido Mantega: "He guaranteed US policy is not to weaken the dollar, on the contrary, it is to strengthen the dollar. He said the impact of the Fed policy was being overestimated. It is difficult, if you weaken the dollar and want the Chinese to let the yuan appreciate."
Well, for policies virtually guaranteed to devalue the dollar one would implement near-double-digit fiscal deficits, near-zero interest rates, and a strategy of open-ended monetization of Treasury debt. The G20 ministers clearly want to avoid confrontation and are presenting at least a semblance of a unified front for tackling deep structural issues. While they must think it, they don't dare address the U.S. as an unmitigated policy "Basket Case." Perhaps they even believe their policies can successfully rebalance the world. Or has "rebalance" simply become tantamount to "kicking the can."
The U.S. has run Current Account Deficits almost exclusively going all the way back to 1983. Imports did sink during the early-nineties recession, leading to a single miniscule ($2.9bn) surplus in 1991. Yet by the end of the decade the Deficit had ballooned to a record $301bn. The full force of Bubble Economy Maladjustment, however, took hold beginning in the boom year 2000. The deficit jumped to $416bn in 2000 and, despite the tech wreck and recession, remained near $400bn annually during 2001-02. By 2003 the deficit had swelled to $520bn, then to $630bn and to $747bn by 2005. The Deficit reached a record $803bn in 2006.
And despite the bursting of the mortgage finance and housing Bubbles and the resulting worst recession in decades, the Current Account Deficit remained at $378bn last year. The deficit will likely jump to $500bn this year - an almost unimaginable scenario for an economy operating at almost 10% unemployment. History offers nothing remotely comparable to our decades of exchanging new financial claims for foreign-produced goods and services.
Having de-industrialized and failed to invest sufficiently in productive capacity during our prolonged Credit Bubble, there will be no near-term exporting our way out of trade deficits. And there is little evidence that help is on the way with the current elixir of massive non-productive government debt expansion and ultra-ultra-loose monetary policy. While extreme government stimulus has stabilized incomes, consumption and imports, it has done little to promote the type of productive investment necessary to rebalance our maladjusted economy.
Secretary Geithner sticks with his reference to a strong dollar policy. Meanwhile, the Federal Reserve is on course to further monetize our nation's ballooning federal debt. Mr. Geithner wants foreign currencies to appreciate against the dollar, yet the overriding policy prescription is for more aggressive foreign stimulus to boost our trading partners' domestic consumption. After all these years, it is astounding that policymakers still believe there is a chance to inflate debt levels and grow out of global structural imbalances.
The cumulative international reserve positions held by global central banks increased $1.5 TN the past year (to $8.951 TN). U.S. current account deficits and the massive flow of finance away from the U.S. has inundated the world with dollar balances - dollars that are then accumulated by foreign central banks and recycled chiefly back to our Treasury market (Bubble). I believe a strong case can be made that this dynamic helps explain global "liquidity" overabundance and the return of Bubble Dynamics throughout international risk markets. Inflationary effects are most pronounced in Asia. Yet most disdain the notion of new Bubbles and would certainly downplay the inflationary consequences of this unprecedented global debt monetization.
I have seen ample confirmation this year of my Global Government Finance Bubble thesis. And from my analytical framework, I would warn that the effects from another year of similar global monetization could prove quite different than what was previously experienced. If, as appears to be the case, Bubble Dynamics have become more deeply entrenched, one could expect heightened price instability throughout global markets. In this same vein, additional QE might end up throwing gas on an increasingly raging fire of destabilizing speculation.
Has faltering dollar confidence finally reached the proverbial "tipping point"? For the most part, the dollar enjoyed positive market sentiment throughout QE1 and the past year's massive expansion of global central bank assets. Policy-related inflationary effects were somewhat muted, as global financial and economic systems were still restrained by post-crisis impairment. These restraints are dissipating - especially outside the U.S. Going forward, expect a continuation of inflationary policymaking to elicit increasingly robust global inflationary responses.
It's difficult to discern "what's in the markets" right now in regard to QE2. If the Fed doesn't deliver a big headline number, there could be some near-term angst for the popular global "reflation trade". But when the Fed actually implements large-scale Treasurys purchases - injecting liquidity into the marketplace - current market dynamics seem to dictate that this intervention will only exacerbate the torrent of flows exiting the U.S. in search of higher returns in "undollars" ("emerging" securities markets, gold, silver, metals, agriculture, commodities, foreign economies, etc.).
With Fed-induced liquidity racing out to play robust inflationary biases overseas, how much monetization will be necessary for the Bernanke Fed to inflate U.S. consumer prices to its desired level? And, with the G20 seemingly in agreement to press forward with more domestic stimulus, I'll assume that global central banks have no option but to retain their steadfast backstop bid for the global surfeit of U.S. dollars. These dynamics would appear to ensure the ongoing monetization of enormous quantities of government debt.
Such a scenario would seem to assure unwieldy global financial flows and Acute Monetary Disorder. For years now, it has been a dangerous case of using "Keynesian" policies to perpetuate Bubbles and attendant imbalances. Today, inflationism fuels Bubble dynamics on an unprecedented global scale. Policymakers can insist on referring to "global rebalancing," but the reality is more in line with desperate and universal inflationism.
"Monetary policy is about an environment that's supposed to be stable. When you try to use it in a way that floods the market with liquidity, you can in fact get very bad outcomes." Kansas City Federal Reserve President Thomas Hoenig, October 21, 2010.