Commentary by Alice Schroeder
Oct. 1 (Bloomberg) -- If you owned stocks and gold and had to sell one, which would it be?
The Standard & Poor’s 500 Index has gained almost 60 percent since its low on March 9. Gold is near a record price. I know a fair number of people who would keep the gold.
I’ve never been a gold bug myself. They get no respect. They are associated with survivalists, conspiracy theorists and nutcases. They are always looking for the hyperinflation that never comes. Gold bugs pay a premium over the metal price for gold and silver coins on the notion that they will need the currency, come the Apocalypse.
On the other hand, the relationship between gold and financial crises goes back centuries. In the aftermath of the credit-bubble bust, we confront a Moby Dick-size pile of leverage and the question of whether this is inflationary or deflationary. So it’s worth considering what the price of gold may be telling us.
Leverage is a broad term that covers the complete history of finance, which all boils down essentially to the same structure: debt secured by assets. You give me a cow, I give you a piece of paper. Later innovations are simply variations of obligations secured by assets.
So a simple explanation of bubbles is that they form whenever someone creates a rationale to increase obligations too far beyond the level justified by the assets, regardless of the form of the asset or obligation.
Dutch Tulips
Consider tulip mania, which like all bubbles featured leverage; it was fueled not just by ordinary debt, but by leveraged tulip options. When the end came, the government of Holland declined to bail out those who had mortgaged their houses and businesses to buy tulip bulbs, and the multiyear depression that followed ruined an otherwise sound economy.
Our recent real-estate bubble wasn’t like tulip mania, in which the inflated asset had only a tenuous connection to the economy it came to dominate. The real-estate bubble swelled on the genuine beliefs among consumers about their future prospects and earnings. To be sure, some of those prospects and earnings were exaggerated to the point of fraud.
Thus the bubble burst when credit-card junkies had spent the last dollars they could justify, and the final peanut brain had been unearthed who could be persuaded to sign up for a negative-amortizing mortgage.
Because this link, however slim, remained between people’s prospects and earnings and the debt they could carry, real- estate prices even in hard-hit cities such as Las Vegas declined only by half. Stock-market losses were similar. These numbers are reported as if they were staggering, but they are less so compared with many bubbles.
Free Lunches
Some now blame consumers’ disinclination to spend and get the economy going again on banks’ newfound reluctance to lend. To the contrary, we are in the midst of a deflationary trend that is temporarily being masked by inventory restocking and free lunches like “cash for clunkers.” Consumers are done with borrowing. They will keep fueling the deflation by going through their attics and garages to find stuff they can sell on EBay to raise cash.
That’s because consumers have figured out that it was all a big head-fake from the Federal Reserve. Real incomes haven’t grown in years. Manufacturing and, increasingly, service jobs are still moving overseas. The Treasury is trying to pump the economy back to a high-water mark that was phony to begin with, and doing so in the face of a savings rate that is going up.
Trade Gap
The Treasury will succeed in printing enough money to forestall severe deflation. Even so, dollars will keep flowing out of the U.S. to other countries as the trade gap widens. Only when we start creating more jobs and higher earnings can this dynamic reverse. The question is, when will that be?
Enter the gold bugs. They aren’t just betting on inflation, as is the conventional wisdom. Gold has a wicked history of being an unreliable inflation hedge. It has, though, at times been a haven against sudden currency depreciation.
In all the talk of inflation because the Treasury is printing so much money versus deflation because it may not print enough, there is one type of inflation that is rarely discussed. This is the mega-inflation caused by a sudden currency devaluation. Currency is like any financial innovation, an obligation secured by assets. When the obligation is perceived to have increased far beyond the level justifiable by the assets, which in this case make up a country’s economy, a bubble has formed.
As in any bubble, those who recognize this need to act well in advance. Historically, governments have taken action to prevent currency flight when the owners of a severely overvalued medium of exchange start selling so much that it adds to the pressure on its price. They make private purchases of gold illegal, or tax the exchange of currency.
Right now, the American economy is worth less than the value implied by the market value of its obligations. How much less, no one knows. But gold bugs will tell you, privately, that this is why they are buyers. Might as well stock up, they say, before gold becomes a controlled substance.
I haven’t, so far, but the temptation is rising by the day.
Commentary by Jonathan Weil
Oct. 1 (Bloomberg) -- There was a stunning omission from the government’s latest list of “problem” banks, which ran to 416 lenders, a 15-year high, as of June 30. One outfit not on the list was Georgian Bank, the second-largest Atlanta-based bank, which supposedly had plenty of capital.
It failed last week.
Georgian’s clean-up will be unusually costly. The book value of Georgian’s assets was $2 billion as of July 24, about the same as the bank’s deposit liabilities, according to a Federal Deposit Insurance Corp. press release. The FDIC estimates the collapse will cost its insurance fund $892 million, or 45 percent of the bank’s assets. That percentage was almost double the average for this year’s 95 U.S. bank failures, and it was the highest among the 10 largest ones.
How many other seemingly healthy multibillion-dollar community banks are out there waiting to implode? That’s impossible to know, which is what’s so unsettling about Georgian’s sudden downfall. Just when the conventional wisdom suggests the banking crisis might be under control, along comes a reality check that tells us we’re still flying blind.
The cost of Georgian’s failure confirms that the bank’s asset values were too optimistic. It also helps explain why the FDIC, led by Chairman Sheila Bair, is resorting to extraordinary measures to replenish its battered insurance fund.
Georgian, which had five branches catering to local businesses and wealthy individuals, was chartered in 2001. By 2003, the closely held bank had raised $50 million from an investor group led by a longtime local banker, Gordon Teel, who remained chief executive officer until last July. It grew at a breathtaking pace, fueled by the real-estate bubble.
Triple Play
From 2004 to 2007, total assets almost tripled to $2 billion from $737 million. Annual net income rose seven-fold to $18.3 million. The bank touted its philanthropy, including a $1 million pledge to a local children’s hospital, and boasted of a growing art collection showcasing Georgia painters.
As recently as its March 31 report to regulators, Georgian said it met the FDIC’s requirements to be deemed “well capitalized.” By June 30, that had dropped to “adequately capitalized,” after a $45 million second-quarter net loss.
Georgian also reported a 12-fold jump in nonperforming loans to $306.4 million from $24.7 million three months earlier, mostly construction loans. Georgian’s numbers made it seem as if the surge arose from nowhere. On its March 31 report, the bank said just $79.1 million of its loans were 30 days or more past due. That included the loans it had classified as nonperforming.
Survival Mode
Georgian’s new CEO, John Poelker, downplayed any concerns. “Whether there is enough capital for the bank to be a survivor isn’t an issue,” he told Bloomberg News for an Aug. 5 article.
What wasn’t made public until Sept. 25, the day it closed, was that Georgian Bank had agreed to a cease-and-desist order with the FDIC on Aug. 31 after flunking an agency examination. The 19-page order described various “unsafe or unsound banking practices and violations of law and/or regulations,” including failing to record loan losses in a timely manner. Georgian neither admitted nor denied the allegations.
The FDIC updates the public about the number of banks on its problem list once a quarter. An FDIC spokesman, David Barr, said Georgian was added to the FDIC’s internal list in July. He said the agency adds banks to the list based on exam ratings, not the data in their financial reports.
As for the 416 banks on the list as of June 30, up from 305 a quarter earlier, the FDIC said their combined assets were $299.8 billion. (The FDIC didn’t name the banks, per its usual practice.) If Georgian’s experience is any guide, the real-world value of those assets probably is much less.
Rising Losses
That might help explain why the FDIC keeps increasing its estimates for the losses it’s anticipating from future bank failures. In May, the agency said it was expecting $70 billion of losses through 2013. This week, it bumped that to $100 billion. The agency also said its insurance fund would finish the third quarter with a deficit, meaning liabilities exceed assets.
The FDIC, backed by the full faith and credit of the U.S. government, will get whatever money it needs to protect depositors. For now, it plans to raise $45 billion by collecting advance payments from the banking industry. Those payments will cover the next three years of premiums that the banks owe.
In effect, the FDIC is taking out a massive, no-interest loan to cover its bills. Borrowing from the future won’t improve its insurance fund’s capital, however, only its liquidity.
The big question is what the FDIC will do next time, should its loss estimates keep rising -- and there’s no reason to believe they won’t. By statute, the insurance fund is supposed to be funded solely by the banking industry. The FDIC could keep borrowing from the banks, directly or through more advances.
The agency could tap its $500 billion credit line with the U.S. Treasury. It still would have to pay back the money with fees from the industry, assuming the banks can’t persuade their minions in Congress to change the law. As it stands, the only way to boost the fund’s capital immediately is by charging the banks a lot more money for their insurance premiums.
Given the odds that other surprises like Georgian Bank are lurking, the FDIC will have to bite this bullet eventually.
By Courtney Schlisserman and Bob Willis
Oct. 1 (Bloomberg) -- Manufacturing in the U.S. expanded less than anticipated by economists and more Americans filed claims for unemployment benefits, pointing to a recovery that will be slow to generate jobs.
The Institute for Supply Management’s factory gauge decreased to 52.6 in September from 52.9 in August, the Tempe, Arizona-based group said today. Fifty is the dividing line between expansion and contraction. The number of jobless claims climbed to 551,000 last week, more than economists forecast, figures from the Labor Department showed.
Coming a day before the September jobs report, the figures caused stocks to slump on growing concern the seven-month rally has outpaced prospects for economic growth. Consumer spending, boosted last quarter by government programs such as “cash for clunkers,” may not be able to keep rising as quickly once the stimulus expires and unemployment keeps climbing.
“The balance of data is still pointing to the economy getting better,” said Conrad DeQuadros, a senior economist at RDQ Economics in New York. “The consumer is still facing significant headwinds in the labor market. I wouldn’t look for the consumer to significantly boost growth over the next couple of months.”
The Standard & Poor’s 500 Index closed down 2.6 percent at 1,029.85 today in New York, a day after completing its biggest back-to-back quarterly rally since 1975. Treasury securities jumped, sending the yield on the 10-year note down to 3.18 percent from 3.31 percent late yesterday.
Unexpected Drop
The ISM index, which dropped for the first time this year, was forecast to rise to 54, according to the median of 80 estimates in a Bloomberg survey of economists. Projections ranged from 51.5 to 56. Manufacturing accounts for about 12 percent of the world’s largest economy.
“We’re still in positive territory but we’re just not advancing at quite the same rate,” said Brian Bethune, chief financial economist at IHS Global Insight in Lexington, Massachusetts. “Retailers are anticipating a weak sales season and they’re playing it conservative on orders and hiring.”
The ISM report showed orders and production advanced at a slower pace last month, while the magnitude of reductions in inventories also cooled.
“The inventory correction, with the exception of a few industries,” has played out, Norbert Ore, chairman of the ISM’s factory survey, said in a press conference. “Overall, September was a good month. For the balance of the year, we should expect to see manufacturing holding this level, possibly improving from this level.”
More Claims
Last week’s jobless claims figures overshot the median estimate of economists surveyed by Bloomberg News which projected an increase to 535,000, raising concern tomorrow’s jobs report will also disappoint expectations that payroll decreases are slowing.
The Labor Department may say tomorrow that job losses in September totaled 175,000, according to the survey median, while the unemployment rate rose to 9.8 percent, the highest since 1983.
The economy has lost 6.9 million jobs since the recession started in December 2007, the most of any downturn since the Great Depression. The 216,000 drop in payrolls reported for August, meanwhile, was the smallest in a year.
Autos, Houses
So far, the Obama administration’s $787 billion stimulus plan, which included the auto incentives and an $8,000 tax credit for first-time home buyers, is giving consumers reason to buy cars and houses.
Household purchases jumped 1.3 percent in August, the largest gain since October 2001, data from the Commerce Department also showed today. Incomes climbed 0.2 percent for a second month and inflation decelerated, the report also showed.
Inflation-adjusted spending on durable goods, including autos, furniture, and other long-lasting items, jumped 5.8 percent in August, also the most since the month after the 2001 terrorist attacks. Then, the introduction of zero-percent financing to revive sales boosted spending on durable goods by 14 percent.
Auto sales fell 35 percent in September from the previous month to a 9.2 million annual rate, after the clunkers plan expired, according to Bloomberg data.
Pending Sales
Lower home prices and mortgage rates combined with the first-time buyer credit have helped end the housing-market meltdown that sparked the financial crisis. The index of signed purchase agreements, or pending home sales, jumped 6.4 percent in August, a seventh consecutive increase, the National Association of Realtors said today in Washington.
The tax credit is due to expire at the end of November, raising concern sales will again slow.
Bed Bath & Beyond Inc., the largest U.S. home-furnishings retailer, last month said second-quarter profit rose 14 percent, fueled by rebounding home sales. The Union, New Jersey-based chain also increased its annual profit forecast.
Even so, “looking ahead to the remainder of our fiscal year 2009, we have assumed that the overall business climate will remain challenging,” Chief Financial Officer Eugene Castagna said on a conference call on Sept. 23.
Economists surveyed by Bloomberg earlier this month projected the economy will expand at an average 2.6 percent annual rate and grow 2.4 percent in 2010.
(Bloomberg) -- Zhou Youguang was a child of 6 when a revolution toppled China’s last emperor in 1912. He was 43 when he says he left a Wall Street banker’s job to help Mao Zedong’s Communists create what he thought would be a democracy after decades of warlord rule, occupation and civil war.
Now 103, he has seen China transformed from a country of 368 million being carved up by foreign powers to a nation of 1.3 billion and the world’s fastest-growing major economy, expanding at an average annual rate of 9.9 percent from 1978 to 2008. He says he still believes China will eventually become a democracy -- in spite of communism, not because of it.
“China will follow the mainstream of the world, sooner or later,” the pajama-clad Zhou said during an interview in the book-lined study of his third-floor walk-up apartment in central Beijing.
His experiences encapsulate the complicated legacy of the Communist Party, which celebrates 60 years in power this week with a military parade past Tiananmen -- the Gate of Heavenly Peace -- where Mao proclaimed the founding of the People’s Republic on Oct. 1, 1949.
While Zhou endured three years of forced separation from his family during the 1966-76 Cultural Revolution, he survived a purge of intellectuals that led many of his colleagues to commit suicide. He was also given the opportunity to devise a new system of spelling out Chinese characters with the Roman alphabet that helped hundreds of millions of Chinese peasants learn to read.
‘Lucky Ones’
“There were very few who returned from America who escaped the catastrophe,” Zhou said. “I was one of the very lucky ones.”
Like China’s leaders, Zhou divides Communist rule into two periods: the first three decades dominated by Mao, who died in 1976, and the second characterized by the opening of China to the world by paramount leader Deng Xiaoping, who died in 1997. While Deng’s era sparked rapid growth, Zhou, an economist by training, considers it a mixed success.
Deng “reformed the economy but didn’t reform politics,” Zhou said. “In the political scene, there was absolutely no change; it was an autocracy.”
That wasn’t the outcome Zhou Enlai promised Zhou in the late 1930s. The two, who aren’t related, met in Chongqing when the Yangzi River city became the wartime capital following Japan’s occupation of Nanjing in 1937.
Meetings of Intellectuals
Zhou Enlai -- who would become China’s premier in 1949 -- held monthly get-togethers with intellectuals, including Zhou, who worked for Sin Hua Trust & Savings Bank, which was founded in 1914 and became part of the Bank of China Ltd. in 2001.
“Zhou Enlai told me at those meetings that the Communist Party was a democratic party,” Zhou said.
Zhou left China for New York at the end of 1946, where he represented Sin Hua at Irving Trust Co., the bank’s U.S. agent, at its Art Deco headquarters on 1 Wall Street. He and his wife, Zhang Yunhe, returned to Shanghai in June 1949, as the Communists neared victory.
“We thought that with China liberated, there was hope; everyone wanted to come back home and do something,” Zhou wrote in a 2008 autobiography.
When he arrived, Shanghai -- occupied by the People’s Liberation Army the previous month -- straddled the communist- capitalist divide. Zhou lived in both worlds: working at Sin Hua and at what is now the Shanghai University of Finance and Economics as a professor. There he and his colleagues, most of them scholars who returned from the U.S., watched as textbooks were jettisoned for new ones reflecting Marxist theories of class struggle.
Common Language
In 1955, Zhou, whose hobby was linguistics, was asked during a Beijing conference to lead a group creating a standardized system of writing Chinese phonetically with Roman letters. The project would supersede a hodgepodge of Romanization systems and was part of a drive that included simplifying the way thousands of characters were written and teaching a common language, Mandarin, in schools throughout the country.
“I said no way, I’m an amateur,” Zhou said. It was too late; the premier, who remembered his avocation from their days in Chongqing, had already called Zhou’s colleagues in Shanghai and told them he wouldn’t be coming home.
Zhou’s pinyin system, which turned “Peking” into “Beijing,” uses markers to identify which of Mandarin’s four tones to use. It became the national standard in 1958 and has helped reduce China’s illiteracy rate to 10 percent today from about 80 percent in the 1950s.
Mao’s Purge
His new career also kept him relatively safe when economics professors, especially those who had lived in the U.S., became targets of Mao’s Anti-Rightist Campaign in 1957 to purge anyone he thought opposed his revolution.
“Every day there were people killing themselves,” Zhou wrote in his autobiography.
Zhou didn’t completely escape persecution. He was branded a “reactionary academic authority” in 1969 during the Cultural Revolution and sent to northwestern China’s Ningxia region, where, already well into his 60s, he spent a year toiling in rice paddies. He was allowed to return to his family in 1972. Since then he’s helped make pinyin a global standard and published books on linguistics.
Zhou never expressed regret in the interview for giving up his New York lifestyle. In 1949, the “common people trusted the Communist Party,” he said. Looking back over 60 years, he now believes the party, which he never joined, “cheated the Chinese people. They destroyed everything, especially the intellectuals.”
That doesn’t stop Zhou from saying that China’s economic boom will someday be accompanied by the democracy he had hoped to help create.
“I’m always optimistic,” he said.
By Bloomberg News
Oct. 1 (Bloomberg) -- The People’s Republic of China marked its 60th anniversary today with a parade through the heart of Beijing aimed at showcasing the country’s rising power and shoring up the Communist Party’s prestige at home.
About 200,000 people took part in the celebration, including President Hu Jintao, former President Jiang Zemin and members of the ruling Politburo Standing Committee who watched from the rostrum of Tiananmen -- the Gate of Heavenly Peace. It was there, on Oct. 1, 1949, that Mao Zedong declared the communists’ victory in a civil war.
China was “able and confident in playing its global role,” Hu said in a speech, in which he vowed that the country would seek “peaceful reunification” with Taiwan. The island has been ruled for much of the past 60 years by the Nationalists, who fled there following their defeat at Mao’s hands.
Hundreds of missiles and tanks and thousands of soldiers from the world’s largest standing army paraded down Chang’an Avenue through Tiananmen Square following Hu’s speech.
Hu, 66, wearing a black high-collared suit similar to one worn by Mao, had earlier reviewed the troops from an open-topped Red Flag limousine, yelling out “Hello comrades” and “Comrades it’s been hard on you.” Overhead, 151 military aircraft, including J-10fighter jets, flew past in 12 formations.
Hu and his fellow leaders are celebrating China’s newfound prominence on the global stage. China now produces in a day the equivalent of a year’s output five decades ago, and is poised to surpass Japan as the world’s second-largest economy by 2010. The Communists, who lifted 300 million citizens from abject poverty and raised the country’s international influence, must now meet increasing demands for domestic freedom and accountability.
‘Show-Off’
The celebration “is a show-off to beef up confidence in, and support to, the regime,” said Huang Jing, visiting professor at the National University of Singapore’s Lee Kuan Yew School of Public Policy. “Serious questions need to be asked how such a show of strength can translate into” transparency and tolerance for “ethnic, cultural and religious diversity.”
About 80,000 children in Tiananmen Square spelled out the Chinese characters for “national celebration” with red and gold placards to begin the celebration. Later, the placards read “obey the Party’s command” and “serve the people.”
The People’s Liberation Army displayed 52 types of new weapons, including unmanned aerial vehicles and aircraft with advance-warning radar. Five thousand soldiers marched through the square, past portraits of Mao and Sun Yat-Sen, Republican China’s first president after the fall of the Qing Dynasty in 1912.
Nuclear Strike
Among the new weapons, according to China Central Television, was a cruise missile called the Long Sword. As a battery of Dongfeng (East Wind) intercontinental ballistic missiles on mobile carriers drove by, the CCTV commentator reminded viewers that China abided by a pledge never to make a first nuclear strike.
The parade also included a flotilla of 60 parade floats bedecked with flowers and digital displays showcasing six decades of China’s political, scientific, technological and economic achievements.
Among those were floats with portraits of Mao, Deng Xiaoping, a leader who died in 1997, as well as Jiang and Hu. Each were accompanied by recordings of their famous speeches, and thousands of marchers surrounding the floats carried banners trumpeting catchphrases such as “implement and carry out scientific development.”
‘Three Represents’
Liang Xiaopeng, 20, was among the students escorting Jiang’s float touting the 83-year-old former leader’s “Three Represents” doctrine, which helped legitimize members of the business class in Chinese socialist theory.
“Today China showed its might, and that makes me very proud,” said Liang, a student at Beijing Printing College who wants to stay in Beijing and work for a publisher.
The celebration was an opportunity for the government to showcase its achievements to the country’s 1.3 billion people. CCTV’s broadcast of the event telecast preparations of the parade, complete with marching soldiers, jets and tanks, with the theme of Disney Co.’s “
Police kept most of Beijing’s 3.8 million private cars off of the roads today, and restricted access to the city center. South of Di’anmen Street, which bisects the inner city from east to west, police armed with machine guns blocked cars from heading toward Tiananmen Square this morning.
14th Parade
The PLA parade is the 14th since the army emerged victorious in the 1949 civil war against the Kuomintang, or Nationalist Party, which now governs Taiwan.
Economic growth and rising global influence have come at the cost of domestic expression. Opposition to Communist Party rule is banned while dissent, including the 1989 student demonstrations in Beijing’s Tiananmen Square, is crushed.
As many as 800 million Chinese, 60 percent of the population, still live in the countryside, and rapid development has left millions of them behind. Still socialist in name, China has a wider income gap than Taiwan and South Korea have now, or had during their export-led industrializations.
The gaps are made wider by the spread of corruption. Graft has reached into the senior ranks of officials, with those convicted including the former parliamentary vice chairman Cheng Kejie and Shanghai party chief Chen Liangyu.
Ethnic Tensions
Even as Tiananmen Square is festooned today with 56 columns representing the country’s biggest ethnic groups, many Uighurs and Tibetans say they see China as an empire diluting their indigenous cultures.
The worst riots in six decades broke out in the past two years in Tibet and the Uighur’s homeland of Xinjiang, two provinces on China’s western fringe, spurred by income gaps along ethnic and religious fissures.
The world’s most populous nation has also become the largest consumer of commodities and one of the biggest energy users. China last year passed the U.S. as the biggest emitter of greenhouse gasses, and widespread pollution of its atmosphere and waterways is rarely checked by public opposition.
The smog that enveloped Beijing for three days before today’s parade lifted overnight and the parade took place under clear blue skies.
By Bob Willis
Oct. 1 (Bloomberg) -- Goldman Sachs Group Inc. today said the economy probably lost more jobs in September than it previously anticipated, citing “disappointing” economic data including the number of people receiving jobless benefits.
Payrolls probably fell by 250,000 workers last month rather than the 200,000 Goldman had previously estimated, chief U.S. economist Jan Hatzius said in a note to clients.
Hatzius said declines in the Monster Worldwide Inc.’s index of online help-wanted ads, the Institute for Supply Management’s factory employment gauge and consumers’ assessments of the labor market from the Conference Board’s confidence survey prompted the change. Additionally, the total number of people receiving jobless benefits, including those getting extended benefits, remains elevated, he said.
The median estimate of economists surveyed by Bloomberg News projects the economy lost 175,000 jobs last month, compared with 216,000 in August. The economy has lost about 6.9 million jobs since the recession began in December 2007.
Last month, Goldman projected a 250,000 drop in payrolls for August, exceeding figure reported by the Labor Department. On Aug. 6, Goldman lowered its forecast for July payroll losses to 250,000 from a prior 300,000 projection, putting it in line with the government’s initial estimate of 247,000.
By Matt Townsend
Oct. 1 (Bloomberg) -- U.S. stocks fell the most in three months as Treasuries and the dollar rallied after a decline in a gauge of manufacturing and an increase in jobless claims spurred concern over the strength of a recovery from the recession.
JPMorgan Chase & Co., DuPont Co. and American Express Co. fell at least 4.2 percent to lead all 30 stocks in the Dow Jones Industrial Average lower. Treasury 30-year bond yields fell below 4 percent for the first time since April as a report showed inflation remains subdued. The dollar rallied against most of its major counterparts. Crude oil was little changed.
“The market had gotten a little ahead of the economy,” said Wayne Wilbanks, chief investment officer at Wilbanks, Smith & Thomas in Norfolk, Virginia, which manages $1.3 billion. “For the month of October we are on alert for a correction driven by the acknowledgment of a weak economic recovery.”
The Standard & Poor’s 500 Index slid 2.6 percent to 1,029.85 at 5:22 p.m. in New York a day after capping its biggest back-to-back quarterly rally since 1975. The Dow sank 203 points, or 2.1 percent, to 9,509.28. Both gauges lost the most since July 2. About 18 stocks fell for each that rose on the New York Stock Exchange, the broadest sell-off since April.
Benchmark indexes opened lower after the number of Americans filing first-time claims for unemployment benefits climbed by 17,000 to 551,000 last week. Stocks extended losses after the Institute for Supply Management said its manufacturing index dropped to 52.6 in September, lower than the reading of 54 projected by economists in a Bloomberg survey.
Not Double-Dip
Bonds rallied as signs recovery from the worst slump since the Great Depression will be slow prompted traders to reverse bets that yields would increase before tomorrow’s monthly employment report. The Labor Department may say that job losses last month totaled 175,000, according to a Bloomberg survey. The Treasury announced plans to sell $78 billion of notes and bonds over four consecutive days next week.
“We are not in the double-dip camp, but there are still headwinds for the economy,” said Kevin Flanagan, a Purchase, New York-based fixed-income strategist for Morgan Stanley Smith Barney. “There is a ton of money on the sidelines. Investors are feeling more comfortable with interest-rate risk and are moving out on the curve.”
The yield on the 30-year bond fell nine basis points, or 0.09 percentage point, to 3.97 percent, according to BGCantor Market Data. The yield touched 3.93 percent, the lowest level since April 29. The 4.50 percent security due in August 2039 rose 1 18/32, or $15.63 per $1,000 face amount, to 109 1/4.
The 10-year note yield touched 3.17 percent, the lowest level since May 21.
Prices Rise
The Fed’s preferred price measure, which excludes food and fuel, climbed 0.1 percent from the previous month and was up 1.3 percent from a year earlier, the smallest year-over-year gain since September 2001. Spending by U.S. consumers climbed 1.3 percent in August, Commerce Department figures showed in Washington.
The dollar gained much as 0.8 percent to $1.4517 versus the euro as Federal Reserve Chairman Ben S. Bernanke said he doesn’t see an “immediate risk” to the dollar’s status as the world’s main reserve currency.
The Dollar Index, which IntercontinentalExchange Inc. uses to track the U.S. currency versus six counterparts including the euro and yen, rose as much as 0.8 percent to 77.231 today.
“We’ve seen hiccups in consistent improvement to data,” said Todd Elmer, currency strategist at Citigroup Inc. in New York. “The underlying uptick in risk aversion lent the dollar some support ahead of the payroll report.”
Gold prices fell for the first time this week as the dollar’s rebound eroded the precious metal’s appeal as an alternative investment. Silver also dropped.
‘Problem For Gold’
“It’s all dollar-related,” said Leonard Kaplan, the president of Prospector Asset Management in Evanston, Illinois. “If we do see a significant rally in the dollar, that’s a problem for gold.”
Gold futures for December delivery fell $9.50, or 0.9 percent, to $999.80 an ounce on the Comex division of the New York Mercantile Exchange.
Oil for November delivery rose 12 cents to $70.73 a barrel at the 2:30 p.m. close of floor trading on the New York Mercantile Exchange. Futures are up 59 percent this year.
Unrepentant bears
The end is nigh (again)
Pessimistic commentators remain anything but convinced by the stockmarket rally
ALBERT EDWARDS first made a bearish call on the American stockmarket at the end of 1996. As an investment-bank strategist (then at Dresdner Kleinwort, now at Société Générale), he was subjected to a fair degree of ridicule over the next decade, particularly during the dotcom boom. But in the long run Mr Edwards turned out to be right, with last year’s financial calamities his apparent vindication. Had investors sold the S&P 500 index on his recommendation, bought Treasury bonds and held them for the past 13 years, they would have received a higher return.
But in recent months stockmarkets have staged a remarkable rally: the MSCI world index has climbed by 64% since March (see chart 1). Some forecasters say cheerily that the world economy is likely to make a sprightly recovery. Mr Edwards, though, remains bearish. He is one of a stubborn bunch of pessimists who believe that share prices are overvalued and the economic recovery is built on sand. These unrepentant bears are used to betting against the consensus and are not put off by the rally. “I am willing to be patient,” says another notable pessimist, David Rosenberg of Gluskin Sheff, a Canadian asset-management firm. Lately the bears have been encouraged by disappointing American data, for example on durable-goods orders and new-home sales.
The best-known sceptic is Nouriel Roubini, an economics professor at New York University’s Stern School of Business, unimaginatively dubbed Dr Doom (the moniker was first assigned in the financial world to Henry Kaufman, a bond strategist at Salomon Brothers in the 1970s and 1980s). Back in 2005 and 2006, Mr Roubini sounded warnings about the property bubble and the dangers of the American current-account deficit. When the credit crunch hit in 2007, he was treated as a prophet and quickly became a fixture on the conference circuit, delivering jeremiads in heavily accented English (he was born in Turkey and grew up in Iran and Italy).
Mr Roubini’s latest pronouncement, made in early September, was to warn of a slow, U-shaped economic recovery, with below-trend growth for two to three years. (Optimists predict a V-shape, with recovery as rapid as the slide into recession.) He fears that surplus economies like China and Japan will not boost consumption enough to make up for the downturn in American consumer spending.
Shock therapy
In general, the bears take the line that the unprecedented actions of governments and central banks (enormous fiscal deficits, near-zero interest rates and “quantitative easing”) may have jolted the global economy temporarily into life, but they have not resolved the underlying causes of the mess. In particular, they worry that consumers and companies remain excessively indebted, and that deleveraging will quickly stamp out any recovery.
Their usual template is Japan. Its example inspired Mr Edwards to come up with the “Ice Age” thesis in the 1990s as he mused on how assets should be priced in a world of low nominal GDP growth. He thought that the dividend yield on American and European equities would eventually exceed the yield on government bonds. This had come to pass in Japan in the late 1990s and again in the early 2000s, but had not occurred in most Western countries since the late 1950s. It implied a huge derating of shares.
“The bulls’ view of the world was that low bond yields and low inflation should cause high price/earnings ratios,” explains Mr Edwards. But in his view the bulls were ignoring the corollary; that low inflation would lead to low earnings growth. When investors cottoned on to the subdued outlook for profits, as they did in Japan, the effect on share prices was dramatic.
Mr Edwards admits that he consistently underestimated the determination of the authorities to prevent a bear market. As they cut interest rates in response to each market wobble, the result was a series of bubbles, first in technology shares and then in housing.
The other bears agree, and see the recent market rally as simply the authorities’ latest attempt to prop up asset prices. George Magnus, an economic adviser at UBS, a big Swiss bank, says: “This recovery is entirely dependent on the unprecedented largesse of governments and central banks. Things may be better than last autumn when there was an imminent threat of a financial collapse but the recovery is built on very short-term foundations.” In particular, businesses emptied their inventories last year; manufacturing has enjoyed a rebound in recent months as companies have stopped slashing stocks, but Mr Magnus argues it is not self-sustaining.
Mr Rosenberg says government incentive schemes have been behind the housing-market rally and the jump in car sales. Activity was similarly boosted in the fourth quarter of 2001 after the Federal Reserve slashed interest rates in response to the terrorist attacks on New York and Washington. But he points to the sharp slowing of American car sales in September after the cash-for-clunkers programme ended and thinks the same may occur in housing when a subsidy to first-time buyers expires at the end of November.
Because the recovery is so dependent on government support, the bears think it will soon peter out. Mr Edwards worries that the economy will start to turn down in the first half of next year. Mr Magnus thinks the global economy might be able to eke out a meagre growth rate but “if you don’t have credit growth operating, it is hard to sustain spending while unemployment is still rising.”
The bears argue that although governments may have stabilised the banking system, they have not been able to restart private-sector lending. In America bank lending has been falling rapidly over the past three months while in the euro zone broad-money growth has slipped to just 2.5% year-on-year (see the left panel of chart 2). In recent months consumers in Britain and America, two of the most heavily leveraged economies, have been repaying debt (see the right panel).
The problem, according to Mr Magnus, is that household balance-sheet problems tend to last. “They are often linked to property and property busts which take years to play out,” he says. Mr Edwards thinks the outcome will be a reverse of the 1990s boom, when rising asset prices boosted consumer confidence, spending and the economy. Now that share and house prices have dropped, consumers will increase their savings and reduce consumption, weighing the economy down.
The debt problem will act as a permanent drag on the hopes for recovery. Japan had lots of economic rebounds and stockmarket rallies in the course of the 1990s. Over the entire decade, however, the economy was sluggish and investors lost a large proportion of their money. The Nikkei 225 average, Tokyo’s best-known stockmarket measure, is still only a quarter of its peak, reached at the end of 1989.
The bears think many Western economies will face a similar period in the doldrums. “My forecast is not a V-shaped recovery or a W [a second dip, then recovery] but a long series of Us with periods of expansion followed by contraction,” says Mr Magnus. “There is a lot of volatility but the economy doesn’t really go anywhere.”
Just as monetary easing has not resulted in any surge in lending, the bears also think the fiscal element will run out of steam. “The fiscal stimulus has to end, because we can’t keep expanding the deficit,” says Mr Edwards. Either voters will be unwilling to sanction higher deficits, or the markets will take fright and push up bond yields, killing the recovery by a different method. British political debate is already dominated by the need to cut spending and raise taxes.
A rally too far
Given this outlook, the bears believe stockmarkets have got far ahead of themselves: the S&P 500, having sunk below 680 in early March, stood at 1,057 at the end of September. “If the S&P 500 was at 840-860, I would say this is a natural market reaction to the end of a recession, but let’s get a grip,” says Mr Rosenberg. “The market is up 60% from the lows, not 20%. Normally, it takes three years of recovery before the market is up 60%. The rally has occurred while the American economy has shed 2.5m jobs. This market is pricing in 4% economic growth, but what if there’s only 1-2% growth next year?” he asks.
In addition, Mr Rosenberg says investors should be suspicious that the recovery is so dependent on low interest rates and government action. “What is the appropriate multiple that investors should place on earnings that are being propped up by the government? All asset prices are going up together, from gold to Treasury bonds. People say the rally is driven by liquidity. But when every analyst is talking about liquidity you know the top is near,” he argues.
Conventional analysts tend to argue that on the basis of profit forecasts for 2010, stockmarkets are reasonably valued. But bears doubt that profits will rebound so dramatically. They tend to prefer longer-term measures. Andrew Smithers of Smithers & Co, a consultancy, produced a timely book in 2000 arguing that Wall Street was in bubble territory. On his two favourite measures, the q ratio (which compares share prices with the replacement cost of net assets) and the cyclically adjusted price/earnings ratio (which averages profits over ten years), the American market is still overvalued, by 41% and 37% respectively. As chart 3 shows, Wall Street got back to an average valuation by the March lows, but never looked particularly cheap by historical standards.
The bears quoted above are all academics or strategists who can afford to take a detached view when the markets move against them. Mr Magnus is a veteran observer who has seen a few market cycles. Mr Rosenberg has escaped from the optimistic consensus at Wall Street (he worked until last year at Merrill Lynch, which used a bull as a corporate symbol). Mr Edwards has the security of regularly finishing top of polls of London’s favourite strategists, despite (or perhaps because of) his bearish views. Mr Smithers runs his own firm.
Things are rather different for Bill Fleckenstein, who runs a hedge fund at his firm, Fleckenstein Capital. A noted sceptic on the dotcom and housing booms, he closed his short-only fund (which bet on falling prices) in 2008. “I always knew the response to the recession would be printing money and didn’t want to be short any more,” he says. “If they print enough money, stocks can go anywhere they want to.” Crispin Odey, a London hedge-fund manager, has expressed similar views. But this is tactical, rather than strategic, bullishness. Mr Fleckenstein thinks the authorities’ tactics are eventually doomed to failure. “You cannot print your way to prosperity,” he says. In that sentence, he sums up the bearish case.
Charlemagne
The Atlantic gap
The honeymoon between Europe and Barack Obama's America is over
A “FLASHING yellow light”. That is how one American official describes warning signs of trouble between his administration and Europe. Less than a year after Barack Obama’s election, European euphoria over the end of the Bush era is fading. Relations are still far better than in the dark days before the Iraq war. But as the official puts it, there is “a lot of sniping” going back and forth across the Atlantic. And, he adds, there is a recognition at the “highest levels” that such snippiness is becoming unhelpful.
European Union politicians and officials are dismayed that, with a poisonous debate over health reform chewing up his political capital in Congress, Mr Obama may not secure legislation fixing binding emissions targets for America before the climate-change summit in Copenhagen in December. They also think the health-care impasse explains the lack of progress on the Doha world-trade talks. Nor did Europeans enjoy the G20 meeting that Mr Obama hosted in Pittsburgh. Despite hogging a ludicrous number of seats at the table, the EU came away with only one big Europe-specific agreement: alas, for them, it was a plan to cut their voting power at the IMF.
From the American side, there is frustration that the Obama administration’s multilateral humility has not been matched with more European help in Afghanistan, or a promise in every European capital to back tougher sanctions on Iran. (Yes, it looks as if they are building a bomb, goes the line in some places that do business in Iran, but if we stop selling things, the Chinese will just take our place.)
The sense of a honeymoon ended is widespread, at least at official level. In a revealing coincidence, 24 hours before the American official talked of a “flashing yellow light”, an EU official used the same metaphor to describe east European alarm at the clumsy way in which the Obama administration cancelled plans for a missile-defence system in Poland and the Czech Republic.
Doubts about the Obama administration have been a dirty secret in European policy circles for months, even as polls like the latest German Marshall Fund’s “Transatlantic Trends” survey continued to find Obamamania in western Europe. But the grumbling is slowly becoming public. In Brussels on September 30th America’s assistant secretary of state for European affairs, Philip Gordon, warned the Europeans that the Obama administration needed something in return for its punt on multilateralism. If “in a year from now”, Europeans have not decided to offer more help in Afghanistan and tougher sanctions on Iran, he said, “plenty of Americans will say, you know what, let’s do it our way.”
Can a transatlantic bust-up be averted? It would help if some misunderstandings were cleared up. The EU is an elite, supranational project, and only indirectly democratic. This creates a structural problem whenever it talks to the Americans. Eurocrats often get on well with administration officials (another secret is that European bigwigs found the second-term Bush lot congenial to deal with). The bigger problem is usually Congress, which acts as a lightning rod for American popular opinion. In Europe no such partisan democratic body exists (the European Parliament is more remote from voters and less powerful than Congress, and MEPs live in a warm bath of mushy conventional wisdom). Euro-types boast that the EU stands for stirring values like leadership on climate change or opposition to the death penalty. It is less clear that you could win a mandate for such things from European voters, which may be why they are not directly asked.
If people in Brussels struggle to understand how troublesome Congress can be to an American administration, they should try this mental aid. Congress is a bit like France: prickly, status-obsessed, ruthless in defending national interests and addicted to subsidies for special interests such as farmers or industrial champions. Both are ambivalent about free trade: as the Copenhagen climate talks near, it is France and certain American senators who want to talk up “green tariffs” in case China and India duck binding limits on carbon.
Look east not west
Many Europeans may also be labouring under a second misapprehension. Because they believed that George Bush was wicked and Mr Obama seemed to agree, they assumed that they and America’s new president occupied the same moral high ground. You can overstress biography, but a Kenyan-American raised in Hawaii and Asia could be forgiven for remembering that Europe was a continent of colonial powers before it proclaimed itself a beacon of moral values, and for considering the Pacific to be just as strategic as the Atlantic.
There are misunderstandings on the American side, too. American diplomats insist that Europeans see a failed Afghan state as a direct threat to their security. That is not true. “A very small number” of European governments believe Afghanistan is on the front-line of the war on terror, says one senior Brussels man. Most sent troops just to maintain good relations with America. Europe’s governments fear there is no strategy for winning the war but “some are afraid to tell the Americans the truth.”
Finally, Americans may not realise how horrible their health-care debate looks to outsiders. It is not just that it is blocking other legislation. The partisan nature of today’s Congress looks mad to Europeans brought up to value consensus. Europeans also know that “European-style” health care does not include death panels prescribing euthanasia for grannies and are offended by the way such tosh is alleged in America.
The end of the transatlantic relationship has been predicted many times. In truth, lots binds the rich democracies on both sides. But disillusion is a dangerous emotion. Both sides must keep talking, before the warning lights turn red.
Europe.view
Lostpolitik
Will the Free Democrats quell east Europe's fears?
EASTERN EUROPE owes a huge debt to the Germans. By showing that capitalism worked better than planned economies, West Germany helped win the cold war. East Germans kept trying to escape, forcing the Soviet-backed regime to build the Berlin Wall, destroying communism’s claim to be popular. East German people-power brought that wall down and tore up Stalin’s map of post-war Europe by demanding unification. In the 1990s Germany forced expansion onto the European Union’s agenda and then made it happen (and paid for it, German taxpayers would add sourly). And to this day, Germany’s Vergangenheitsbewältigung is a template for other countries wanting to come to terms with their past.All the odder, therefore, that Germany is not more popular in the east. The burgeoning trade and political ties between Berlin and Moscow have spooked the countries in between. Germany and Russia are planning a condominium, just like 70 years ago, the worriers say. An opinion poll last year showing that a substantial majority of Germans would oppose the military defence of the Baltic states if they were attacked further stoked those fears. The countries between Russia and Germany feel squeezed—all the more so now that America is distracted, NATO divided, and Britain out of the game.
Whose foreign policy?Germans find that sort of talk rather hurtful, especially when it is laced with crude references to the Nazi past. Some Polish politicians have made a speciality of that. The result is a vicious circle. German policymakers see the easterners as ungrateful and mad, so concentrate more on the profitable business of selling things to Russia. The easterners see a game being played over their heads, and get even crosser.
Until this weekend, the easterners had a point. Even the best German diplomats could not conceal the fact that Germany’s economic relationship with Russia to some extent trumped the security fears of the nominal allies in the east. German scepticism about NATO expansion was well-known. Even the departure of the Russia-loving Gerhard Schröder, who after leaving the chancellery went to work for a German-Russian gas pipeline, made little difference. Angela Merkel might have the right instincts, the Poles and others reckoned, but she was constrained by the grand coalition with Mr Schröder’s old party, the Social Democrats.
This weekend’s election offers a glimmer of light. The Social Democrats are out and the liberal Free Democrats (FDP) are in. Their leader, Guido Westerwelle (pictured at right, above), is likely to be Germany’s new foreign minister. Although a foreign-policy novice, one of his few notable campaigns was against Mr Schröder’s business dealings. The ex-chancellor fought a lengthy legal battle to gain an injunction preventing Mr Westerwelle from repeating allegations of improper conduct.
It would be premature for the east Europeans to pin much hope on Mr Westerwelle. Even in the days of his FDP predecessor, the legendary Hans-Dietrich Genscher, it was the federal chancellery, not the foreign ministry, that largely decided Germany’s foreign policy. Freed from the baleful influence of the Social Democrats, Mrs Merkel may be tougher with Russia on some issues. But Germany’s business lobby is the biggest supporter of the “Russia First” policy. And conservatives in Mrs Merkel’s CDU/CSU have the closest ties to German industry.
What could make a difference is having a solidly pro-nuclear German government. If Germany makes serious plans to extend the lives of its nuclear power stations, it reduces the country’s dependence on imported Russian gas—the cornerstone of the “special relationship” between Berlin and Moscow. Perhaps countries such as Poland, which love whinging about energy security but have been slow in doing anything practical, may then get round to following Germany’s example. Just don’t expect gratitude.
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