Embrace the Deficit?

By: Doug Noland | Wed, Dec 27, 2006
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Please accept my sincerest apologies for the website problems we've experienced over the past week.

The Dow dipped 0.8%, and the S&P500 declined 1.1%. The Transports were hit for 4.1%, and the Morgan Stanley Cyclical index fell 1.3%. The Morgan Stanley Consumer index added 0.3% (up 17.3% y-t-d), while the Utilities declined 1.0%. The broader market was on the defensive. The small cap Russell 2000 declined 1.5%, and the S&P400 Mid-cap index dropped 1.7%. Technology stocks were under pressure. The NASDAQ100 sank 3.3%, and the Morgan Stanley High Tech index gave up 2.2%. The Semiconductors lost 2.6%. The Street.com Internet Index fell 2.9% and the NASDAQ Telecommunications index 2.6%. The Biotechs declined 1.4%. Financial stocks were mixed. The Broker/Dealers dropped 1.4%, while the Banks added 0.2%. Although Bullion rose $5.70, the HUI Gold index fell 3.3%.

December 21 - Financial Times (Joanna Chung): "A surge in large initial public offerings and a frenzy of mergers and acquisitions have pushed the amount of money raised in the world's stock markets to a new record. Overall annual volume in the equity capital markets this year jumped 26 per cent to $756.5bn from $599.3bn in 2005, and surpassed the previous record set in 2000 when $627.1bn was raised during the height of the dotcom boom, according to data from Dealogic..."

Two-year government yields were unchanged at 4.72%. Five-year yields rose 2 bps to 4.59%, and 10-year Treasury yields added 2 bps to 4.62% (a 5-wk high). Long-bond yields jumped 4 bps to 4.76%. The 2yr/10yr spread ended the week inverted 10 bps. The implied yield on 3-month December '07 Eurodollars rose 2 bps to 4.815% (high since Nov. 16). Benchmark Fannie Mae MBS yields gained 3 bps to 5.71%, this week slightly underperforming Treasuries. The spread on Fannie's 5 1/4% 2016 note narrowed 3 to 34, and the spread on Freddie's 5 1/2% 2016 note narrowed 2 to 30. The 10-year dollar swap spread increased 1.5 to 49. Corporate bond spreads were generally narrower, with junk spreads narrowing moderately this week.

December 20 - Financial Times (Justine Lau and Tom Mitchell): "The corporate high-yield bond market has been riding high this year. Investors enjoyed low volatility and healthy returns of about 11 per cent - more than any other category of fixed-income assets. Issuers and private equity groups have benefited from easy access to capital as high demand pushed risk premiums lower. This led to record issuance of $122.7bn of bonds in the US and $66.2bn in Europe, according to Dealogic. Leveraged loan volumes also spiked, with a record $629bn originated across the US and Europe, according to S&P... 'Every single milestone in high-yield has been exceeded this year,' says Jim Casey, co-head of leveraged finance at JPMorgan... Some warn that this year's ample liquidity has spawned increasingly aggressive leveraged buy-outs and looser lending standards that may have suppressed early symptoms of distress in the market."

December 21 - Bloomberg (Caroline Salas): "Hybrid bond sales are accelerating as a growing number of debt investors seek higher yields and protection from leveraged buyouts that damage credit ratings. About $26 billion of hybrids, which have characteristics of debt and equity, were sold in the last four months, or 40 percent of this year's $65 billion total, according to...Lehman Brothers... Hybrid sales climbed 55 percent from 2005's issuance..."

Investment grade issuers included Goldman Sachs $2.5 billion, AIG $750 million, USB Realty $500 million, Merrill Lynch $850 million, Enbridge Energy $300 million, and Hellas II $275 million.

Junk bond funds saw outflows of $45.1 million this week. Issuers included Citizens Utility $400 million, Tital International $200 million, and Metals USA $150 million.

This week's convert issuers included Smith & Wesson $80 million.

December 21 - Financial Times (Michael Mackenzie): "Risk premiums for emerging market bonds fell to match their record low on Wednesday, only two days after upheaval in Thailand's markets... Investors measure the risk of emerging market debt by comparing their yields with those of US Treasuries, seen as the safest sovereign bonds. As measured by JPMorgan's EMBI+, that spread fell on Wednesday to 172 basis points...equalling a record low hit last in May... Analysts attribute the bullish performance in emerging markets to strong demand by investors hungry for yield. The class has become attractive as economies have improved in recent years, partly on the boom in commodity prices. 'There is a belief among investors that many emerging market countries are on a long-term secular path of improving credit fundamentals' said Mike Gomez, portfolio manager at Pimco... For the year to date, returns in the EMBI+ have risen by nearly 11 per cent, marking the fifth consecutive year of double-digit returns. The strong performance by the EMBI+ this month corresponds with emerging market bond funds attracting all-time record inflows..."

December 22 - Bloomberg (Lester Pimentel and Helen Murphy): "Ecuador's bonds had their biggest-ever decline after the incoming finance minister said the government may restructure its $11 billion debt in a way similar to Argentina, which defaulted on $95 billion in 2001."

Japanese 10-year "JGB" yields dropped 7 bps this week to 1.59%. The Nikkei 225 index added 1.1% (up 6.2% y-t-d). German 10-year bund yields jumped 8 bps to 3.875%. Emerging markets were mixed-to-lower. Brazil's benchmark dollar bond yields rose 4 bps this week to 5.98%. Brazil's Bovespa equities index dipped 0.6% (up 29.6% y-t-d). The Mexican Bolsa declined 1.3%, reducing 2006 gains to 42.9%. Mexico's 10-year $ yields added 4 bps to 5.53%. Russia's 10-year Eurodollar yields rose 3 bps to 6.58%. The Russian RTS equities index added 0.5% (up 65.5% y-t-d). India's volatile Sensex equities index fell 1.0%, lowering 2006 gains to 48.3%. China's Shanghai Composite index gained another 3.0%, increasing y-t-d gains to 102%. The major Thai stock index closed down almost 8% for the week, recovering about half of the drop suffered with the announcement of the implementation of capital controls.

Freddie Mac posted 30-year fixed mortgage rates added one basis point to 6.13%, down 13 bps from one year ago. Fifteen-year fixed mortgage rates rose 3 bps to 5.89% (up 10 bps y-o-y). And one-year adjustable rates dipped one basis point to 5.44% (up 22 bps y-o-y). The Mortgage Bankers Association Purchase Applications Index declined 5.9% this week. Purchase Applications were down 3.9% from one year ago, with dollar volume declining 0.7%. Refi applications dropped 14.6%. The average new Purchase mortgage slipped to $230,500 (down 3.4% y-o-y), and the average ARM dropped to $389,300 (up 10.5% y-o-y).

Bank Credit dropped $40.0 billion last week to $8.257 TN. Year-to-date, Bank Credit has expanded $751 billion, or 10.4% annualized. For the week, Securities Credit declined $8.1 billion. Loans & Leases sank $31.9 billion, yet still posting a y-t-d gain of $559 billion (10.6% annualized). Commercial & Industrial (C&I) Loans have expanded at a 13.8% rate y-t-d. For the week, C&I loans declined $7.2 billion, and Real Estate loans dipped $0.7 billion. Real Estate loans have expanded at a 14.4% rate y-t-d. For the week, Consumer loans fell $5.0 billion, and Securities loans dropped $13.3 billion. Other loans added $1.0 billion. On the liability side, (previous M3 component) Large Time Deposits rose $9.0 billion.

M2 (narrow) "money" supply fell $11 billion to $6.997 TN (week of 12/11). Year-to-date, narrow "money" has expanded $311 billion, or 4.8% annualized. For the week, Currency was unchanged, while Demand & Checkable Deposits declined $40.2 billion. Savings Deposits jumped $23.5 billion, and Small Denominated Deposits increased $2.2 billion. Retail Money Fund assets increased $3.6 billion.

Total Money Market Fund Assets, as reported by the Investment Company Institute, declined $2.0 billion last week to $2.375 Trillion. Money Fund Assets have increased $318 billion y-t-d, or 15.8% annualized. Money Fund Assets have expanded at a 22% rate over the past 20 weeks.

Total Commercial Paper declined $14.7 billion last week to $1.951 Trillion. Total CP is up $310 billion y-t-d, or 19.2% annualized. Total CP has expanded at an 18.3% rate over the past 20 weeks.

Asset-backed Securities (ABS) issuance slowed this week to $12 billion. Year-to-date total ABS issuance of $727 billion (tallied by JPMorgan) is running about 8% below 2005's record pace, with 2006 Home Equity Loan ABS sales of $490 billion about 5% under comparable 2005. Also reported by JPMorgan, y-t-d US CDO (collateralized debt obligation) Issuance of $349 billion is running 77% ahead of 2005.

Fed Foreign Holdings of Treasury, Agency Debt jumped $11.8 billion during the week to a record $1.742 Trillion (week of 12/20). "Custody" holdings were up $223 billion y-t-d, or 15.0% annualized. Federal Reserve Credit expanded $7.6 billion to $845 billion. Fed Credit is up $18.8 billion y-t-d, or 2.3% annualized.

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $757 billion y-t-d (19.1% annualized) to a record $4.804 Trillion.

December 21 - Bloomberg (Svenja O'Donnell): "Russia's foreign currency and gold reserves, the world's third largest, rose for a ninth consecutive week... The reserves advanced $2 billion to a record $295.8 billion in the week ended Dec. 15..."

Currency Watch:

December 18 - Bloomberg (Agnes Lovasz and Daniel Kruger): "Venezuelan leader Hugo Chavez is directing a growing share of the country's oil profits into euros as the dollar and crude prices fall. The dollar, down 9.4 percent against the euro this year, may face more pressure in 2007 because Venezuela and oil producers from the United Arab Emirates to Indonesia plan to funnel more money into the single European currency. 'The U.S. dollar has suffered a long process of deterioration,' Domingo Maza Zavala, one of seven board members at the central bank of Venezuela, said... 'The diversification strategy started this year.'"

December 18 - Bloomberg (Agnes Lovasz): "The Iranian government ordered its central bank to shift the country's dollar-denominated assets held overseas into euros, Agence France-Presse reported. Iran will also use the euro for foreign transactions..."

The dollar dipped slightly to 83.67. On the upside, the Romanian leu increased 2.3%, the New Zealand dollar 1.5%, the Colombian peso 1.3%, and the Swedish krona 0.8%. On the downside, the Iceland krona declined 5.0%, the Thai baht 0.8%, the Chilean peso 0.7%, the Hungarian forint 0.9%, and the Japanese yen 0.6%.

Commodities Watch:

December 22 - Bloomberg (Tony C. Dreibus): "Wheat rose the most in a month, extending the biggest one-year gain in 15 years, on speculation that drought damage to global crops will limit supplies in 2007. Global reserves of the grain will fall to a 24-year low of 120.7 million metric tons for the marketing year that ends May 1, the U.S. Department of Agriculture said..."

Gold rose 0.9% to $621, while Silver fell 1.4% to $12.655. Copper sank 5.1% to an eight-month low, while reducing y-t-d gains to 47.8%. February crude declined $0.89 to end the week at $62.31. January Unleaded Gasoline fell 3.8%, and January Natural Gas sank 11.6%. For the week, the CRB index declined 1.4% (down 6.9% y-t-d), and The Goldman Sachs Commodities Index (GSCI) dropped 1.6% (up 2.4% y-t-d).

Japan Watch:

December 21 - Bloomberg (Lily Nonomiya): "Japan's export growth unexpectedly accelerated in November, easing concern that expansion of the world's second-largest economy is faltering. Exports rose 12.1 percent and imports gained 7.5 percent..."

China Watch:

December 22 - Bloomberg (Nipa Piboontanasawat): "Combined profits at Chinese industrial companies increased 30.7 percent in the first 11 months from a year earlier, the government said. Total net income rose to 1.65 trillion yuan ($211 billion)..."

December 22 - Bloomberg (Yidi Zhao): "China's auto sales will rise to more than eight million in 2007, the state-run Xinhua News Agency said... China will be the world's third-largest automaker by the end of this month... China sold 6.45 million vehicles in the first 11 months, a 25.5 percent increase on a year earlier..."

December 20 - Financial Times (Justine Lau and Tom Mitchell): "A residential site in one of Hong Kong's most exclusive addresses went under the hammer for HK$1.8bn ($231m) yesterday, far surpassing analysts' expectations and breaking a record per-square-foot price set at the peak of the territory's property bubble in 1997. Sun Hung Kai Properties, Hong Kong's biggest developer, bought the prime site on the Peak, the neighbourhood of choice for Hong Kong's super-rich, for HK$42,196 per square foot in a fierce government land auction, more than doubling the previous record of HK$18,357. The price, about 60 per cent higher than expected..."

December 19 - Bloomberg (Nipa Piboontanasawat): "Hong Kong's jobless rate fell for a fifth straight month in November to the lowest in almost six years, helping sustain the longest economic expansion in a decade. The...unemployment rate...declined to 4.4 percent from 4.5 percent..."

India Watch:

December 21 - Bloomberg (Ashok Bhattacharjee): "India's economy is expected to expand close to 9 percent in the year ending March 31, Finance Minister Palaniappan Chidambaram said. 'We can grow at that or even a higher rate in the future,' Chidambaram said..."

December 20 - Bloomberg (Kartik Goyal): "India's export of gems, textiles and other manufactured products rose to $9.68 billion in November... Exports rose 34 percent from the year-earlier..."

December 22 - Bloomberg (Sam Nagarajan): "Money supply in India in the two weeks ended Dec. 8 grew at the fastest pace since November 1998. The M3...increased 20.2 percent...from a year earlier..."

December 20 - Bloomberg (Kartik Goyal): "India's direct tax revenue from companies and personal incomes rose 42.5 percent between April 1 and Dec. 18, boosted by faster economic growth."

December 20 - Bloomberg (Kartik Goyal): "India is exploring whether it can use a part of its near-record foreign-exchange reserves of $175.5 billion to fund the nation's bid to modernize roads, ports and airports, the finance minister said."

Asia Boom Watch:

December 21 - Bloomberg (Theresa Tang): "Taiwan's export orders rose at the slowest pace in 16 months in November as global demand for electronics such as semiconductors and liquid-crystal displays cooled. Export orders...climbed 10.6%..."

December 21 - Bloomberg (Kim Kyoungwha): "The Bank of Korea reduced the funds it makes available for small business loans for the first time since 2002, a move that may stem a surge in borrowing and stifle the fastest home price gains in almost 17 years."

December 21 - Bloomberg (Anuchit Nguyen and Shamim Adam): "Thailand posted a record trade surplus in November... The value of exports exceeded imports by $1.74 billion last month... Exports in November rose 21 percent from a year earlier to $11.9 billion..."

Unbalanced Global Economy Watch:

December 20 - Bloomberg (Brian Swint): "U.K. mortgage lending rose by a record in November in a sign that higher interest rates aren't cooling demand for housing, banking groups said. Net mortgage lending, a measure of home loans less repayment of debt, surged by 6.5 billion pounds ($13 billion)..."

December 18 - Bloomberg (Fergal O'Brien): "Europe's trade deficit with China surged 19 percent in the nine months through September... The trade deficit with China grew to 63.4 billion euros ($83 billion)..."

December 21 - Bloomberg (Fergal O'Brien): "Ireland's economy grew at the fastest pace in almost four years in the third quarter... Gross domestic product increased an annual 7.7%..."

December 19 - Bloomberg (Matthew Brockett): "German business confidence unexpectedly surged in December to the highest since reunification in 1990 as Europe's largest economy looked set to weather a tax increase next year."

December 20 - Bloomberg (Brian Swint): "Growth in M4...slowed in November... M4, measuring currency in circulation and deposits at banks, increased 13.1 percent from a year earlier, after a 14 percent annual pace in October..."

December 20 - Bloomberg (Simone Meier): "Swiss producer and import price inflation accelerated in November as faster economic growth fueled demand for construction materials and metals.... Prices for factory and farm goods as well as imports rose 2.8 percent from a year earlier, up from 2.4 percent in October..."

December 20 - Bloomberg (Jonas Bergman): "Sweden's economy will expand 4.3 percent this year as exports and consumer spending grows, the National Institute of Economic Research said."

December 19 - Bloomberg (Juho Erkheikki): "Finland's government raised its economic growth forecast for this year to 5.9 percent as companies invest more than projected and productivity improves."

December 19 - Bloomberg (Juho Erkheikki and Jonas Bergman): "Finland's unemployment rate unexpectedly fell to 6.7 percent in November, the lowest for that month since 1990, as companies hired more workers to meet rising demand for exports. The jobless rate fell from 7.2 percent in October..."

December 19 - Bloomberg (Harry Papachristou): "Unemployment in Greece fell to the lowest level in at least eight years in the third quarter as more jobs opened in services. The jobless rate...dropped to 8.3%..."

December 20 - Bloomberg (Elizabeth Konstantinova): "The International Monetary Fund raised its forecast for growth in Bulgaria this year to 6.2 percent, driven by domestic demand and investment as the country prepares to join the European Union on Jan. 1."

December 20 - Bloomberg (Svenja O'Donnell): "Net capital inflow into Russia may exceed $30 billion this year, Interfax said, citing Deputy Prime Minister Alexander Zhukov."

Latin American Boom Watch:

December 20 - Bloomberg (Patrick Harrington): "Mexico's unemployment rate fell in November as factories and shops hired for the holidays. Mexico's jobless rate fell to 3.58 percent from 4.02 percent in October..."

December 20 - Bloomberg (Daniel Helft): "Argentine tax revenue will rise 26 percent in 2006 from the previous year as the economy expands more than 8 percent for a fourth straight year..."

December 20 - Bloomberg (Eliana Raszewski): "Argentina's economy expanded 9.3 percent in October from the same month a year ago, the National Statistics Institute reported."

December 20 - Bloomberg (Eliana Raszewski and Daniel Helft): "Argentina's budget surplus excluding interest payments will exceed 3 percent of the country's gross domestic product by year-end, said Economy Minister Felisa Miceli."

December 21 - Bloomberg (Eliana Raszewski): "Argentina's trade surplus widened in November to $872 million... Exports rose 26 percent to $4.1 billion while imports rose 20 percent to $3.2 billion..."

December 21 - Bloomberg (Alex Emery): "Peru's exports rose in November as sales of copper, zinc and fishmeal surged and the Andean nation added 11 new export markets. Exports rose 34 percent from a year earlier..."

December 19 - Bloomberg (Helen Murphy): "Colombia's imports rose 39.9 percent in October from a year earlier, led by a surge in purchases of automobiles and auto parts."

December 20 - Bloomberg (Theresa Bradley): "Venezuela's unemployment rate fell to its lowest in almost eight years in November as oil-fueled government spending spurred economic growth and a boom in consumer purchasing. The jobless rate dropped to 8.8%..."

December 19 - Bloomberg (Helen Murphy): "Colombia's industrial output in October expanded to a record high led by non-metallic minerals and vehicles. Industrial production, excluding coffee processing, increased 17.3 percent..."

Central Banker Watch:

December 20 - Bloomberg (John Fraher and Chris Burns): "European Central Bank President Jean-Claude Trichet suggested the bank is ready to raise interest rates next year if needed as the fastest economic growth since 2000 stokes inflation in the dozen euro nations. 'Our message is very, very clear: We will do whatever is necessary to ensure price stability,' Trichet said..."

December 21 - Bloomberg (Tasneem Brogger): "Iceland's central bank unexpectedly raised its benchmark interest rate to a record 14.25 percent as a widening current account deficit threatens to undermine the krona and push up inflation."

Bubble Economy Watch:

December 18 - Bloomberg (Kathleen M. Howley): "U.S. home-renovation spending will set records this year and next as a slump in housing demand prompts owners to improve properties instead of selling, according to a Fitch Ratings forecast. Spending on floor tile, granite countertops, wood flooring and other renovation supplies probably will reach $227 billion this year... Spending reached an all-time high of $215 billion in 2005."

December 19 - Econoplay.com (Gary Rosenberger): "Producers of paper packaging report more signs of economic slowing in the fourth quarter - but are pushing for substantial price increases anyway in January that would raise the cost of containers above record highs last seen in 1995. The immediate reason given for the increase, the fourth in about one year, is rising raw materials costs. But it was also paved by more than five years of industry consolidation that ushers in a new paradigm where pricing power now heavily favors producers."

December 21 - Bloomberg (Mary Schlangenstein): "...American Airlines, the world's largest carrier, raised round-trip fares as much as $40 in most U.S. markets to help offset higher fuel prices."

Financial Sphere Bubbly Watch:

December 22 - Bloomberg (Robin Stringer): "The London Ambulance Service has set up a mobile treatment center in the financial district and a 'booze bus' in the West End to cope with the masses of workers celebrating record bonuses this year. The field hospital in Finsbury Circus, the heart of the City of London, is designed to relieve pressure on ambulances and emergency rooms elsewhere, the Ambulance Service said in an e-mailed statement. It expects 'substantially' more than 30,000 revelers to descend on the area."

Mortgage Finance Bubble Watch:

December 21 - Financial Times (Saskia Scholtes): "Bonds backed by risky US "subprime" mortgages were downgraded in record numbers in the fourth quarter, Fitch Ratings said... The development is the latest in a series of ominous signals for the fast-growing sector, which has seen the failure of two lenders this month. Subprime mortgages are higher-interest loans made to borrowers who are seen as risky because of past payment problems or large debt burdens. The loans are often packaged into securities and sold to investors to help lenders reduce their risks. More than $500bn of these securities have been issued this year. In recent months, a growing number of these borrowers have fallen behind on payments. Fitch has downgraded 100 of these securities since October."

December 19 - MarketNewsInternational (Ted Kim): "Despite one of the busiest issuance weeks ever, when five fixed-rate transactions totaling $18.0 billion priced, spreads tightened across most commercial-mortgage-backed security AAA-rated tranches last week. Year-to-date, spreads on 10-year AAA generic tranches tightened 7 basis points and 10-year AAA Super Seniors tightened 4 bps...this has been a record-breaking year in terms of new issuance...by year end, domestic fixed-rate CMBS issuance is expected to total almost $165 billion...and total issuance, including floating-rate issues, will be $200 billion, about 19% more than the year before."

Real Estate Bubble Watch:

December 20 - New York Times (Ron Nixon): "About one in five subprime mortgages made in the last two years are likely to go into foreclosure, according to a report released yesterday, ending the dream of homeownership for millions of Americans. At that rate, about 1.1 million homeowners who took out subprime loans in the last two years will lose their houses in the next few years, the report said. The foreclosures will cost those homeowners an estimated $74.6 billion, primarily in equity. The report, written by the Center for Responsible Lending, a research group in Durham, N.C., was based on data supplied by Moody's... The highest default rates are expected to be in cities in California, Nevada, Michigan and New Jersey as well as Washington, D.C..."

M&A and Private-Equity Bubble Watch:

December 19 - Financial Times: (James Politi and Lina Saigol): "The bull run of mergers and acquisitions gathered pace yesterday as deals worth nearly $90bn were announced around the world, driven by the commodities boom and cheap debt. The frenzy was led by Statoil of Norway's purchase of Hydro in a $29bn transaction. Thomson Financial...said $87bn of transactions were announced in 24 hours, adding to the $3,500bn of takeovers agreed so far this year. This has made 2006 the busiest year on record for M&A globally, exceeding the volumes of the internet bubble of the late 1990s."

December 21 - Financial Times (Lina Saigol and James Politi): "A raft of hostile bids made 2006 the biggest year for mergers and acquisitions, with $3,900bn in global deals fuelled by cheap debt, ambitious chief executives and hunger for growth. The value of deals worldwide was 16 per cent higher than at the height of the dotcom boom in 2000, according to Dealogic... Companies launching hostile bids rose dramatically, with 355 deals so far this year, up from 94 last year and well above the previous record of 272 in 1999... The surge of deals was bolstered by a tide of private equity cash looking for investments. Buy-outs reached a record $709.8bn, more than double the 2005 level... Europe-targeted M&A reached $1,530bn, while US deals totalled $1,440bn. In Asia-Pacific, excluding Japan, deals reached $381.5bn. Investment banks sucked up fees of $18.8bn from the boom, from $17.2bn last year... Global high-yield borrowing reached its highest volume on record with $261.4bn. Initial public offerings and overall equity capital market volumes also achieved new highs of $237.8bn and $756.5bn respectively."

December 19 - Financial Times: (Anuj Gangahar): "Overseas companies listing on the US and London markets for the first time have raised a record $20.9bn this year through depositary receipts. This represents a 75 per cent increase over the whole of 2005 and is already the highest full-year IPO total for depositary receipts, exceeding the previous record of $17.1bn set in 1994 and the $16.9bn total in 2000."

December 20 - Bloomberg (Ian McKinnon): "Private equity funds are investing earlier in new energy companies and taking more risk to generate acceptable returns as competition for experienced executives in the industry increases, Lime Rock Partners Co-founder Jonathan Farber said. A 'tremendous scarcity' of executives with a track record of creating value for shareholders 'is a huge problem for all of us,' Farber said..."

Financial Sphere Bubble Watch:

December 20 - Financial Times (Ben White): "Goldman Sachs has awarded chief executive Lloyd Blankfein $53.4m in total compensation for 2006 as it was revealed that Wall Street banks will pay a record $23.9bn in bonuses this year, an increase of 17 per cent over 2005. The figures from New York State comptroller Alan Hevesi come as a wave of deal-making and robust market conditions helped big Wall Street banks...book their biggest annual profits yet. The figures from Mr Hevesi amount to $137,580 per Wall Street worker, a jump of 15 per cent from last year. Top executives and traders will earn far more than that... Mr Hevesi's numbers do not reflect the potential value of stock option awards... Mr Hevesi estimated Wall Street bonuses would generate $1.6bn in tax revenues for New York State and another $500m for New York City. He also said the average Wall Street bonus is now two-and-a-half times the average annual salary for all non-financial jobs in New York City."

Energy Boom and Crude Liquidity Watch:

December 18 - Bloomberg (Matthew Brown and Tarek al-Issawi): "Saudi Arabia's government will raise spending by 19 percent next year from the amount budgeted for in 2006, the official Saudi Press Agency reported, citing a decree from King Abdullah Bin Abdel Aziz al-Saud."

December 18 - Bloomberg (Massoud A. Derhally): "Saudi Arabia may attract as much as $25 billion of investment into its petrochemicals industry 'in the next few years,' Al Hayat reported, citing oil and gas officials attending the Gulf Petrochemicals and Chemicals Association Forum..."

December 22 - Bloomberg (Nariman Gizitdinov): "Hong Kong Billionaire Stanley Ho's Shun Tak Holdings Ltd. plans a $10 billion gaming and tourism resort on the Kapchagai lake near Kazakhstan's financial capital Almaty to tap the nation's burgeoning oil wealth. 'It won't be just a gaming center, but a city that will attract tourist from all over the world,' President Nursulan Nazarbayev said... The center will include a new international airport, sporting complexes and schools, he said."

"Embrace the Deficit"?:

Financial historians will reflect back on this period's prevailing complacency, especially with respect to the massive U.S. Trade and Current Account Deficits, with astonishment and disbelief. Yet for now years of Credit and asset inflation - parceling out unimaginable financial rewards along the way - have Wall Street reassured that There's Simply Not an Imbalance Not to Love. The Street now appreciates that massive and intractable Trade Deficits provide the fountainhead of global liquidity overabundance. Moreover, the markets keenly recognize that the Bernanke Fed (like Greenspan's) is content to acquiesce to deficit and liquidity excesses. There is today no constituency for reining in the Bubble(s).

This week's release of a record quarterly Current Account Deficit ($225.6bn in Q3) garnered little attention from the media and even less in the markets. This despite the Deficit having now reached $900 billion annualized, or 6.8% of GDP. For perspective, the deficit for all of 1998 was $229 billion. At $877 billion, the Current Account Deficit over the previous four quarters compares to 2005's $812 billion, 2004's $664 billion, 2003's $537 billion, and 2002's $506 billion. And it is worth noting that the third quarter's deficit was up 36% from Q2 2004's $166 billion, back when the Fed commenced its fateful "tightening" cycle.

Bear Stearns' chief economist David Malpass provided commentary this week to The Wall Street Journal - "Embrace the Deficit." Mr. Malpass did a commendable job articulating Wall Street's dangerously flawed analysis of Credit Bubble-induced imbalances.

Mr. Malpass: "For decades, the trade deficit has been a political and journalistic lightning rod, inspiring countless predictions of America's imminent economic collapse. The reality is different. Our imports grow with our economy and population while our exports grow with foreign economies, especially those of industrialized countries. Though widely criticized as an imbalance, the trade deficit and related capital inflow reflect U.S. growth, not weakness -- they link the younger, faster-growing U.S. with aging, slower-growing economies abroad. Since the 2001 recession, the U.S. economy has created 9.3 million new jobs, compared with 360,000 in Japan and 1.1 million in the euro zone excluding Spain."

My comment: The 2006 backdrop has been noteworthy for the continued rapid expansion of the U.S. Current Account Deficit despite the marked economic slowdown at home coupled with continued overall robust growth abroad. This outcome should provoke recognition and alarm with regard to our economy's deep structural shortcomings. But with stocks up double-digits and the economy plugging along, the "analysis" will naturally propound that deficits are in fact constructive.

Year-to-date Imports from China are running 17% ahead of 2005, with Mexico up 18.4% and Taiwan 10.7%. And while it may be the merry holiday and bonus season, I'm not sure why Mr. Malpass's analysis would emphasize the "aging, slower-growing" Japanese and "euro zone excluding Spain" economies, when our y-t-d $191 billion Trade Deficit with China dwarfs Japan's $73 billion, Germany's $30 billion, Ireland's $17 billion, Italy's $17 billion, and France's $10 billion. I can understand why Wall Street would hope to convince us that demographics and "sound" U.S. growth are the principal factors, although in reality they have very little to do today's runaway global trade imbalances. Look instead to the Credit Bubble.

Mr. Malpass: "Supporting the 'solid-growth' view are rising global stock markets, strong growth of corporate profits, the narrow credit spread between Treasurys and riskier bonds, and low interest rates relative to inflation and to growth..."

My comment: I am aware of very few indicators - certainly including exuberant global equity and debt markets, booming corporate profits, and meager little Credit spreads - that are not consistent with the view of rampant global liquidity excesses.

Mr. Malpass: "The trade deficit and a low 'personal savings rate' are key parts of the bond market's multi-year pessimism about the U.S. growth outlook."

My comment: It is disconnected analysis to subscribe "multi-year pessimism" to bond prices, when booming equities and shrinking risk premiums are distinctly non-pessimistic. Credit, liquidity and speculative excess explain inflating asset prices without analytical conflict.

Mr. Malpass: "Like young households, many companies also spend more than they produce, using bonds and bank loans, some from foreigners, to make up the difference. They add employees, machines, supplies and advertising before they produce. Growing corporations are expected to be cash hungry. This leverage is treated as a positive for companies but a negative for countries, a key inconsistency in popular economics."

My comment: This protracted Credit Bubble would be much less perilous if our nation was expanding debt to finance sound investment. Or, if our mounting foreign borrowings were funding wealth-creating capacity - providing the ability at some point to satisfy our debt obligations with valued goods or services, or at least significantly reduce the scope of future deficits through the exchange of goods for goods - our current standard of living would not be so susceptible to the whims and fragilities of finance and global financial markets. Instead, we are the subprime borrower living beyond our means, yet for now luxuriating in our competitive advantage in issuing AAA securities in exchange for endless imports. These days, the vast majority of new debt liabilities issued to our foreign creditors are collateralized by inflated asset market prices (chiefly real estate and securities). This creates a Ponzi Bubble Dynamic where the perceived soundness of the underlying debt issued is dependent upon unrelenting Credit and Speculative excess (and resulting asset inflation).

Mr. Malpass: "While the net foreign debt of the U.S. is growing (the result of capital inflows), household net worth is growing faster, meaning foreigners are investing in the U.S. too slowly and conservatively to keep up with our growth. Their capital mingles with domestic savings, providing $2.7 trillion of net international capital to combine with $27 trillion in net U.S. household financial savings as of Sept. 30."

My comment: This is especially shaky analysis. U.S. household net worth has been expanding rapidly owing to Credit-induced home price and securities markets (price and volume) inflation. The $2.7 Trillion of debt instruments we have created to pay for imports is no more "capital" in the traditional meaning of the term than the $27 Trillion of debt held by households is national "savings." Our economy consumes more than it produces, financing this deficit through the endless inflation of additional debt instruments. Wall Street can stick with the fanciful tale that our Trade Deficits are instigated by "capital" inflows. It is, however, clearly a case of Credit excesses fostering over-consumption and mal-investment, creating progressively unwieldy dollar liquidity outflows to the world (that, by their nature, must be recycled back to U.S. debt instruments).

Mr. Malpass: "The already-large foreign demand for investments in the U.S. is likely to grow from here, putting upward pressure on the trade deficit even if foreign growth continues to accelerate. The U.S. offers a relatively high and steady return on investment -- high because of the innovation and growth taking place here..."

My comment: Well, it is a safe bet that Trade Deficits will grow until our foreign Creditors and/or global markets impose some discipline on our Credit system. Foreign (largely dollar) reserves have increased more than $750 billion this year, placing the bullish notion of insatiable demand for (private-sector) U.S. investment on rather suspect analytical footing. The necessity of foreign central bank operations (after receiving dollar instruments from their domestic companies and financial institutions) to recycle massive U.S. Current Account and investment/speculative flow imbalances governs the unparalleled "official" accumulation of U.S. debt instruments. This should certainly not be analyzed in terms of a positive U.S. "investment" backdrop nor should the interest payments monetized (added on to existing debt obligations) be confused with the concept of "return on investment." The U.S. Economic Sphere is in a seemingly permanent deficit position, one accommodated until it isn't by Financial Sphere Credit Inflation and foreign "official" recycling operations.

Mr. Malpass: "The trade deficit is the mechanism allowing consumption and investment in the U.S. to grow faster than in Europe and Japan. The issue for the U.S. is whether it's worth the interest costs. It's the same question facing a small business: Should it borrow money to expand the payroll, train employees, buy land and machines, conduct R&D, build inventory?"

My comment: The U.S. Bubble economy has been sustained in 2006 only through the massive expansion of Credit (certainly including securities finance/leveraging!) - more than last year but less than next. But in no way is the Trade Deficit the "mechanism allowing consumption and investment in the U.S. to grow faster..." Instead, the deficit has evolved to become one of the prevailing unavoidable consequences of the Credit Inflation required to hold the downside of the Credit Cycle at bay. Of course, Wall Street, politicians, and the Bernanke Fed will work in earnest to avoid the downside of Credit excess. And, the way these Credit booms work, things tend to run amuck on the upside when they are turning most susceptible to faltering to the downside.

And, yes, as difficult as it is for me to accept, "they" really have come to Embrace the Trade Deficit. I guess "they" have no choice. As is often said, "people will believe what they have to believe." All the same, it's been stupefying to witness over the course of many years the seed of this spurious notion mature into a full-fledged national self-deception - ripening to the point of achieving ratification from top policymakers (including our Fed chairman), affirmation from the financial markets, and acceptance throughout. Students of economic history are all too familiar with the repeated bouts of turmoil, wreckage and revulsion - the legacies of absolutely ridiculous notions that somehow came to be readily embraced in the heat of intoxicating booms. Reading Mr. Malpass's piece yesterday - and knowing that his views would be anything but dismissed as bullish tripe - left me again with that uncomfortable feeling that we're living today in one of those extraordinary periods that will be studied and contemplated for many decades to come.

 


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
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