The fault lines in the US-China relationships have been increasingly exposed in recent weeks, rising from rhetorical barbs exchanged on trade, the treatment of foreign companies in China, strategic issues such as US support of Taiwan, Tibet’s Dalai Lama to possible trade wars between two countries, leading to April 15’s report by US Treasury on China’s status on currency front. Domestic pressure in the US Congress on the need for action with regard to the pegged Renminbi (RMB) is growing and on the other side of the equation, Chinese leaders, including Premier Wen Jiabao, have recently hit back at the US for what they characterized as interference in China’s security and economic affairs.
Arguably that way back in 1971 when the US dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10% surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. Way back then, the Japanese yen was around 350 to the dollar. It is mentioned by Paul Krugman in his recent writing in New York Times ‘Taking on China’ that unless China is facing with the threat of similar action, except that this time the surcharge would have to be much larger, say 25%, it is hard to see China changing its policies.
One thing that I note than despite the changes in Yen, now at around 90 – the Japanese are still producing massive trade surpluses, about half the size of Chinese surpluses with less than one-tenth of the people. That is an almost 75% devaluation and yet the world keeps buying Japanese products.
The Chinese could raise the value of its currency over the next year and they would still run a surplus because like Japanese, they make good stuff that we want at prices we like. And it would also introduce inflationary increases in our imports and higher prices for lower income families.
The US deficit stood at US$40bn, but that is down from the US$70bn it was only a few years ago. Over half that deficit is oil and energy. The US trade deficit is due to a lack of savings in the US. But on the other hand, America sounds increasingly determined to push its exports and its attitude to China has hardened. Mr Obama has set a goal of doubling exports in five years.
A stronger RMB would not suddenly bring back millions of jobs to America and it would not be a magic bullet either within China or outside. Rebalancing China’s economy will require big structural reforms towards domestic spending by boosting Chinese consumers’ purchasing power, discouraging excessive investment in manufacturing and squeezing corporate profits.
Cool and calm multilateral leadership will achieve more than a Sino-American currency spat.
Sunday, March 21, 2010
From China – RMB
Beijing vowed that it will retaliate if the United States declares China a currency manipulator and imposes trade sanctions, firing the latest salvo in a spat over the RMB. This seems to be the consensus view from people in China itself – a sentiment that I gathered during my recent trip to southern China recently. The Commerce Minister Chen Deming accused Washington of politicizing the RMB issue ahead of an April 15 deadline for the US Treasury to rule whether China is unfairly holding down its exchange rate to gain a competitive edge in global markets.
My sense is that US intensifying political pressure on China to revalue its currency will only be counter-productive. The stronger the pressure, the lower the chance China will bite the bullet. My contacts seemingly to suggest that the RMB revaluation is already on the list of agenda, but it will not be pursued aggressively as China doesn’t want to be seen to be dictated, and preferably want to make the change in its own accord. Over a decade or so, economic interests have strongly intertwined with nation pride and any submission to external pressure will be seen as a sign of weakness in current government. It might not be a sensible thing to do, but it is a big thing to be dealt with in China. Only those who had been suffering the humiliation prior to 1949 tend to have better appreciation of it.
In this trip, I realized that the top priority now for China is to cool down the asset bubble. It is of the opinion that the currency factor will only ignited more fires and to elevate long-term optimism in the investment in China’s properties and that would further complicate current situation. It is not uncommon that investors in China’s property to factor-in at least 15-20% appreciation of RMB in the next 3-5 years when they make decision to invest in property now – especially in the luxurious sector. Today, high property price is almost a nationwide phenomenon, especially after a strong dose of fiscal stimulus of RMB4 trillion and loose monetary policy (new loans made amounted to more than 30% of nominal GDP) to address the credit crisis in early 2009. Consequently, property prices in second, third and fourth tier Chinese cities have surged as well. At present, currency appreciation will not solve the problem of asset bubbles and if the government fails to rein-in inflation expectations, there is a real potential that exchange rate in real terms will even depreciate.
My sense is that US intensifying political pressure on China to revalue its currency will only be counter-productive. The stronger the pressure, the lower the chance China will bite the bullet. My contacts seemingly to suggest that the RMB revaluation is already on the list of agenda, but it will not be pursued aggressively as China doesn’t want to be seen to be dictated, and preferably want to make the change in its own accord. Over a decade or so, economic interests have strongly intertwined with nation pride and any submission to external pressure will be seen as a sign of weakness in current government. It might not be a sensible thing to do, but it is a big thing to be dealt with in China. Only those who had been suffering the humiliation prior to 1949 tend to have better appreciation of it.
In this trip, I realized that the top priority now for China is to cool down the asset bubble. It is of the opinion that the currency factor will only ignited more fires and to elevate long-term optimism in the investment in China’s properties and that would further complicate current situation. It is not uncommon that investors in China’s property to factor-in at least 15-20% appreciation of RMB in the next 3-5 years when they make decision to invest in property now – especially in the luxurious sector. Today, high property price is almost a nationwide phenomenon, especially after a strong dose of fiscal stimulus of RMB4 trillion and loose monetary policy (new loans made amounted to more than 30% of nominal GDP) to address the credit crisis in early 2009. Consequently, property prices in second, third and fourth tier Chinese cities have surged as well. At present, currency appreciation will not solve the problem of asset bubbles and if the government fails to rein-in inflation expectations, there is a real potential that exchange rate in real terms will even depreciate.
Thursday, March 18, 2010
Outlook – Palm Oil
Let me share key forecasts made by reputable houses on palm oil this year. In general, consensus expects CPO to trade in between RM2,400 to RM3,200.
Dorab Mistry, one the giants in this industry, projecting CPO futures to trade in the range of RM2,800 to RM3,200 range after July 2010 as current El-Nino driven hot weather may cause a production shortfall in the 2H2010. His forecasts was within palm oil’s most ‘bullish period’ that runs from the 2H2010 until 1Q2011 – represents a rise of up to 18.3% from current level. The peak soya oil flow from South America should be in the period May to August 2010 and CPO futures post July 2010 will scale new heights – in order to ration demand. He based his forecasts on crude oil trading at US$70-95 a barrel as well for the US dollar to start weakening in the 2H2010.
RHB Research says it is possible for CPO to pierce the RM3,000 level amid the current bullish momentum and it didn’t discount the fact that price may fall in the normal seasonal peak output period in the 2H2010.
Meanwhile, the Malaysian Palm Oil Board expect, palm oil production to slump to the lowest level in almost three years, draining stockpiles amid concerns that the dry weather will limit supplies in 2010. This may help extend 2009’s 57% gain in prices, which surged as demand expanded from China and India, the world’s largest consumers and importers.
Frost and Sullivan believes that supply is not keeping up with demand and this may push price to as high as RM3,500.
LMC International argues that CPO have now become ‘a part of the energy complex’ given the strong link between the vegetable oil and mineral oil prices. Energy prices today had created a floor to the vegetable oil prices and expecting CPO with a forecast of RM2,400 to RM2,600 for 2010. The fact that biofuel demand reacted much faster than food demand, in turn created a price band. Now, the world is studying vegetable oil and petroleum price differentials as the new keys to the market, in addition to the level of edible oil stocks.
ISTA Mielke GmBH forecasting a CPO trading range of RM2,400 to RM2,900 this year. The world is becoming more dependent on CPO and as such the price spread of CPO to soybean and other oils would eventually be eliminated. Palm oil is no longer the cheap, low quality oil and there is no other oil that can meet growing demand. Palm oil now accounts for 57% of world exports. It also raised concerns about the declining growth in the CPO production.
Dorab Mistry, one the giants in this industry, projecting CPO futures to trade in the range of RM2,800 to RM3,200 range after July 2010 as current El-Nino driven hot weather may cause a production shortfall in the 2H2010. His forecasts was within palm oil’s most ‘bullish period’ that runs from the 2H2010 until 1Q2011 – represents a rise of up to 18.3% from current level. The peak soya oil flow from South America should be in the period May to August 2010 and CPO futures post July 2010 will scale new heights – in order to ration demand. He based his forecasts on crude oil trading at US$70-95 a barrel as well for the US dollar to start weakening in the 2H2010.
RHB Research says it is possible for CPO to pierce the RM3,000 level amid the current bullish momentum and it didn’t discount the fact that price may fall in the normal seasonal peak output period in the 2H2010.
Meanwhile, the Malaysian Palm Oil Board expect, palm oil production to slump to the lowest level in almost three years, draining stockpiles amid concerns that the dry weather will limit supplies in 2010. This may help extend 2009’s 57% gain in prices, which surged as demand expanded from China and India, the world’s largest consumers and importers.
Frost and Sullivan believes that supply is not keeping up with demand and this may push price to as high as RM3,500.
LMC International argues that CPO have now become ‘a part of the energy complex’ given the strong link between the vegetable oil and mineral oil prices. Energy prices today had created a floor to the vegetable oil prices and expecting CPO with a forecast of RM2,400 to RM2,600 for 2010. The fact that biofuel demand reacted much faster than food demand, in turn created a price band. Now, the world is studying vegetable oil and petroleum price differentials as the new keys to the market, in addition to the level of edible oil stocks.
ISTA Mielke GmBH forecasting a CPO trading range of RM2,400 to RM2,900 this year. The world is becoming more dependent on CPO and as such the price spread of CPO to soybean and other oils would eventually be eliminated. Palm oil is no longer the cheap, low quality oil and there is no other oil that can meet growing demand. Palm oil now accounts for 57% of world exports. It also raised concerns about the declining growth in the CPO production.
From Guangzhou, China
This time around, I traveled quite extensive in southern part of China, venturing beyond my normal hunt in Guangzhou. I covered south of Guangzhou – Dongguan before heading to Fujian province. Noticeably that development outside the urban areas has been non-linear.
Interestingly, income growth for rural households in recent years has become much more solid than urban household income under the administration of President Hu-Premier Wen era. Going even deeper beneath the surface, I notice that farm income of rural households is rapidly being supplemented with income from both industry and construction. This compared to period of 1998-2002 President Jiang-Premier Zhu period, which such supplementary income had been virtually non-existence.
These shifts do not happen naturally and these are the economic side-effects of the 1990s policy model, which had a huge urban bias, driven by technocratic goals. The 1990s policy model had seen the increased dependency on the external sector and an investment-driven growth model. Another troubling issue was that China is among the most unequal societies in the world as measured by the Gini coefficient. In the 1990s, the Chinese states systematically favoured foreign firms at the expense of indigenous, largely rural-based entrepreneurs. It is no surprise that foreign firms account for over half of imports and exports. At approximately US$500bn and US$600bn, the domestic value-added of these exports could be as low as 20%.
Into the future, growth will be much centered on consumption as principal engine of the economy. Surveys show that young Chinese – the post-80s generations – consumers are attractive segment – not only due to its sheer size, but also because they have a taste for material things, are optimistic about the future and are socially active. Boosting consumption will be a multi-year effort for the government and consumption subsidies are just the start.
Consumption subsidies will continue to be expanded but the next range of policies is to boost income of the low income segment as they have the most pent-up demand and represent the largest part of the population. Various cities have already announced plans to raise minimum wages for 2010, ranging from 10-15% respectively. The minimum purchase price for key crops is likely to be raised again. Government has already expanded the scope and categories for the rural subsidy program and total home appliance sold through the subsidy program last year reached RMB65bn. The next step for the government’s appliance subsidy program could be a possible raise of maximum subsidy cap. High price items should benefit the most such s TV, air-cond, refrigerator, washing machine and PC.
The Chinese government is often pressed to ‘rebalance’ its economy. Usually, this is a code word for currency appreciation.
Interestingly, income growth for rural households in recent years has become much more solid than urban household income under the administration of President Hu-Premier Wen era. Going even deeper beneath the surface, I notice that farm income of rural households is rapidly being supplemented with income from both industry and construction. This compared to period of 1998-2002 President Jiang-Premier Zhu period, which such supplementary income had been virtually non-existence.
These shifts do not happen naturally and these are the economic side-effects of the 1990s policy model, which had a huge urban bias, driven by technocratic goals. The 1990s policy model had seen the increased dependency on the external sector and an investment-driven growth model. Another troubling issue was that China is among the most unequal societies in the world as measured by the Gini coefficient. In the 1990s, the Chinese states systematically favoured foreign firms at the expense of indigenous, largely rural-based entrepreneurs. It is no surprise that foreign firms account for over half of imports and exports. At approximately US$500bn and US$600bn, the domestic value-added of these exports could be as low as 20%.
Into the future, growth will be much centered on consumption as principal engine of the economy. Surveys show that young Chinese – the post-80s generations – consumers are attractive segment – not only due to its sheer size, but also because they have a taste for material things, are optimistic about the future and are socially active. Boosting consumption will be a multi-year effort for the government and consumption subsidies are just the start.
Consumption subsidies will continue to be expanded but the next range of policies is to boost income of the low income segment as they have the most pent-up demand and represent the largest part of the population. Various cities have already announced plans to raise minimum wages for 2010, ranging from 10-15% respectively. The minimum purchase price for key crops is likely to be raised again. Government has already expanded the scope and categories for the rural subsidy program and total home appliance sold through the subsidy program last year reached RMB65bn. The next step for the government’s appliance subsidy program could be a possible raise of maximum subsidy cap. High price items should benefit the most such s TV, air-cond, refrigerator, washing machine and PC.
The Chinese government is often pressed to ‘rebalance’ its economy. Usually, this is a code word for currency appreciation.
Wednesday, March 17, 2010
Greece’s Rescue Plan
As expected, the Eurozone countries drew up a rescue plan to safeguard the euro in case Greece defaults on its debt in the hopes of stabilizing its currency.
Broadcasting the fact that Greece's euro partners have drawn up an emergency loan strategy is meant to steady the bond markets and give investors confidence in Greece's ability to pull out of its debt crisis, in turn that decision will also pressures Greece to rely on its own measures for resolution. The objective would not be to provide financing at average Eurozone interest rates, but to safeguard financial stability in the euro area as a whole, the European finance ministers said in a statement. Contributing to the loan amount will be voluntary, although all Eurozone countries are likely to make a payment, in a sign of unity.
However, key details were omitted from the aid announcement, like what would trigger the emergency loan and how much Greece might receive. The ministers' vague outline of what the plan entails emphasizes their hope that the plan will never actually be needed.
The initial reaction to the Eurozone countries' pledge of support moved markets in a direction favoring Greece: Greek bonds' 10-year yields fell to 6.14%, resulting in a 300 basis-point spread over benchmark German 10-year bonds - the lowest spread since March 5, right after Greece released its austerity plan. Standard & Poor's took Greece off its "CreditWatch negative" list. Greece currently has an investment-grade BBB+ rating.
Greece has not yet made a formal request for aid, but has been asking for a declaration of support from its Eurozone counterparts. This decision marks the first time in the euro's 11-year existence that one Eurozone country might receive aid from another.
The countries have been clear in defining the aid to be different than a government bailout, which is prohibited under the Eurozone law.
The loans are not designed to be a desirable option but instead a last resort for Greece if it is not able to meet its debt obligations. Greece is encouraged to use the capital markets to find a better rate for refinancing to meet its $27.5 billion debt obligations maturing in April-May.
This plan however, will need approval from all European Union (EU) countries, scheduled to meet March 25-26.
Broadcasting the fact that Greece's euro partners have drawn up an emergency loan strategy is meant to steady the bond markets and give investors confidence in Greece's ability to pull out of its debt crisis, in turn that decision will also pressures Greece to rely on its own measures for resolution. The objective would not be to provide financing at average Eurozone interest rates, but to safeguard financial stability in the euro area as a whole, the European finance ministers said in a statement. Contributing to the loan amount will be voluntary, although all Eurozone countries are likely to make a payment, in a sign of unity.
However, key details were omitted from the aid announcement, like what would trigger the emergency loan and how much Greece might receive. The ministers' vague outline of what the plan entails emphasizes their hope that the plan will never actually be needed.
The initial reaction to the Eurozone countries' pledge of support moved markets in a direction favoring Greece: Greek bonds' 10-year yields fell to 6.14%, resulting in a 300 basis-point spread over benchmark German 10-year bonds - the lowest spread since March 5, right after Greece released its austerity plan. Standard & Poor's took Greece off its "CreditWatch negative" list. Greece currently has an investment-grade BBB+ rating.
Greece has not yet made a formal request for aid, but has been asking for a declaration of support from its Eurozone counterparts. This decision marks the first time in the euro's 11-year existence that one Eurozone country might receive aid from another.
The countries have been clear in defining the aid to be different than a government bailout, which is prohibited under the Eurozone law.
The loans are not designed to be a desirable option but instead a last resort for Greece if it is not able to meet its debt obligations. Greece is encouraged to use the capital markets to find a better rate for refinancing to meet its $27.5 billion debt obligations maturing in April-May.
This plan however, will need approval from all European Union (EU) countries, scheduled to meet March 25-26.
Thursday, March 11, 2010
China’s National People’s Congress
China’s National People’s Congress (NPC) remains in session. For the first time, I see less deliberation on income inequality among provinces, and seem to be more concerned about the strength and durability of global recovery and domestic private demand. It also plans a gradual exit of macro stimulus but leaves room for more tightening or relaxation later on.
The economic crisis has also exposed the inefficiencies of China’s export-dependent economic model. For years, China’s leaders have recognized the risks of the current economic model. Chinese President Hu Jintao came into office eight years ago with the ambitious goal of closing a widening wealth gap by equalizing economic growth between the rural interior and coastal cities. Hu inherited the results of Deng Xiaoping’s opening and international trade. Even Hu’s predecessor, Jiang Zemin also recognized these problems. To address them, he promoted a ‘Go West’ economic policy designed to shift investment further inland. But Jiang faced the same entrenched interests that have opposed Hu’s efforts at significant change.
Social pressures are convincing the government of the need to raise the minimum wage to keep up with economic pressures. The basic rural pension pilot program will expand to 23 counties in 2010 while the government’s contribution to rural medical insurance will increase. Tax rebate and other subsidies on electrical appliances and automobiles will continue this year with more funds budgeted for this purpose. At the same time, misallocation of labour and new job formation incentives in the interior are causing shortage of labour in some sectors in major coastal export zones.
The core of the Hu policies is an overall attempt to re-centralize economic control and that would allow the central government to begin weeding out redundancies left over from Mao’s era of provincial self-sufficiency, which the Deng and Jiang eras of uncoordinated and locally-directed economic growth often driven by corruption and nepotism exacerbated. In short, Hu planned to centralize the economy to consolidate industry, redistribute wealth and urbanize the interior to create a more balanced economy that emphasized domestic consumption over exports. However, Hu’s push, under the epithet ‘harmonious society’ has been anything but smooth and its successes have been limited at best.
Resuming some form of RMB appreciation is just a matter of timing, although any large and one-off revaluation is unlikely. Outward direct investment will continue to be encouraged, including in the resource sector and ‘orderly transfer’ of production capacity abroad. It helps to diversify China’s foreign asset holding as well as by-passing some fo the trade protection against Chinese exports.
The economic crisis has also exposed the inefficiencies of China’s export-dependent economic model. For years, China’s leaders have recognized the risks of the current economic model. Chinese President Hu Jintao came into office eight years ago with the ambitious goal of closing a widening wealth gap by equalizing economic growth between the rural interior and coastal cities. Hu inherited the results of Deng Xiaoping’s opening and international trade. Even Hu’s predecessor, Jiang Zemin also recognized these problems. To address them, he promoted a ‘Go West’ economic policy designed to shift investment further inland. But Jiang faced the same entrenched interests that have opposed Hu’s efforts at significant change.
Social pressures are convincing the government of the need to raise the minimum wage to keep up with economic pressures. The basic rural pension pilot program will expand to 23 counties in 2010 while the government’s contribution to rural medical insurance will increase. Tax rebate and other subsidies on electrical appliances and automobiles will continue this year with more funds budgeted for this purpose. At the same time, misallocation of labour and new job formation incentives in the interior are causing shortage of labour in some sectors in major coastal export zones.
The core of the Hu policies is an overall attempt to re-centralize economic control and that would allow the central government to begin weeding out redundancies left over from Mao’s era of provincial self-sufficiency, which the Deng and Jiang eras of uncoordinated and locally-directed economic growth often driven by corruption and nepotism exacerbated. In short, Hu planned to centralize the economy to consolidate industry, redistribute wealth and urbanize the interior to create a more balanced economy that emphasized domestic consumption over exports. However, Hu’s push, under the epithet ‘harmonious society’ has been anything but smooth and its successes have been limited at best.
Resuming some form of RMB appreciation is just a matter of timing, although any large and one-off revaluation is unlikely. Outward direct investment will continue to be encouraged, including in the resource sector and ‘orderly transfer’ of production capacity abroad. It helps to diversify China’s foreign asset holding as well as by-passing some fo the trade protection against Chinese exports.
Wednesday, March 10, 2010
Green Shots in Timber
I am seeing a reasonably strong turnaround in timber business in 2010. Japan housing starts plunged 28% in 2009 to its lowest level since 1964. A pick up in Japan housing starts has been a traditional catalyst for tropical plywood prices, as Japan is the single largest buyer of tropical plywood in the world.
I expect Japan housing starts to accelerate by early 2011 driven by stimulus measures including the largest ever home mortgage tax break, tax-free capital gains of up to 10mn yen and a 6.1mn yen and taxable limit on monetary gifts for buying a home.
Currently, inventories are very low and would have to be replenished in the event of an uptick in housing starts.
While we saw the low in plywood prices in May 2009, prices remained below the break-even points for the rest of the year and continue to be weak in January/February 2010. Our industry sources, however, reported that these are early indications of higher pricing for March contracts, possibly at about US$20/cu m higher versus end-2009. Notably also is that the US is also experiencing a surge in timber product prices on pent-up demand and supply chain destruction.
I expect Japan housing starts to accelerate by early 2011 driven by stimulus measures including the largest ever home mortgage tax break, tax-free capital gains of up to 10mn yen and a 6.1mn yen and taxable limit on monetary gifts for buying a home.
Currently, inventories are very low and would have to be replenished in the event of an uptick in housing starts.
While we saw the low in plywood prices in May 2009, prices remained below the break-even points for the rest of the year and continue to be weak in January/February 2010. Our industry sources, however, reported that these are early indications of higher pricing for March contracts, possibly at about US$20/cu m higher versus end-2009. Notably also is that the US is also experiencing a surge in timber product prices on pent-up demand and supply chain destruction.
Shipping Recovery Mounting
Shipping overcapacity appears to be reduced due to weaker-than-expected growth of shipping tonnage and stronger shipping demand. In the container shipping market, rates are rapidly rebounding on the back of increasing trade volume.
It is around the midpoint of the year when the demand weakens due to seasonality but actual shipping capacity accelerates that we particularly need to check the container shipping market. This year, container shipping stocks have shown better performance than bulk shipping stocks thanks to expectations for a further increase in container shipping rates.
Even though the Baltic Dry Index has turned strong in March, bulk shipping stocks have remained weaker than container shipping stocks due to the BDI moving up and down below 3,000p. The BDI surpassed the 3,000p mark again on March 4, yet the index moved around 2,700p in February, sharply down compared with the monthly average of over 3,000 during November 2009 to January 2010. The main culprit seemed to be negative sentiment caused by China’s monetary tightening moves and price negotiations for iron ore while shipping capacity growth remained still strong.
I think the biggest reason for stronger rates is the efforts to reduce the shipping capacity by increasing the volume of idle ships and slowing down the pace of transportations. In addition, demand has also turned stronger. I continue to expect the shipping companies will continue to keep the upturn in profitability, even without a sudden change in the demand side, given that they are likely to continue to control shipping capacity growth. There will be negotiations for a General Rate Increase for American routes. The Transpacific Stabilization Agreement recommended a $800/FEU increase for US west coast and a $1,000 increase for US east coast for 2010. That should have significant impact on earnings of shipping companies, and that deserve close attention.
Yet if the demand in China weakens, shipping rates will be affected. Whether commodity demand remains strong in China, it will remain to be a key factor to consider.
It is around the midpoint of the year when the demand weakens due to seasonality but actual shipping capacity accelerates that we particularly need to check the container shipping market. This year, container shipping stocks have shown better performance than bulk shipping stocks thanks to expectations for a further increase in container shipping rates.
Even though the Baltic Dry Index has turned strong in March, bulk shipping stocks have remained weaker than container shipping stocks due to the BDI moving up and down below 3,000p. The BDI surpassed the 3,000p mark again on March 4, yet the index moved around 2,700p in February, sharply down compared with the monthly average of over 3,000 during November 2009 to January 2010. The main culprit seemed to be negative sentiment caused by China’s monetary tightening moves and price negotiations for iron ore while shipping capacity growth remained still strong.
I think the biggest reason for stronger rates is the efforts to reduce the shipping capacity by increasing the volume of idle ships and slowing down the pace of transportations. In addition, demand has also turned stronger. I continue to expect the shipping companies will continue to keep the upturn in profitability, even without a sudden change in the demand side, given that they are likely to continue to control shipping capacity growth. There will be negotiations for a General Rate Increase for American routes. The Transpacific Stabilization Agreement recommended a $800/FEU increase for US west coast and a $1,000 increase for US east coast for 2010. That should have significant impact on earnings of shipping companies, and that deserve close attention.
Yet if the demand in China weakens, shipping rates will be affected. Whether commodity demand remains strong in China, it will remain to be a key factor to consider.
Higher Risk of Double Dipping
On one hand, imports into China have surged almost 44.7% from levels seen one year ago, while exports are up 45.7% but on the other hand, on-going troubles in Euro-zone and United Kingdom seems to have racked up spending its way through the global recession scenario. With the euro, the matter no matter longer concerns only one nation, but rather 16 countries simultaneously.
I am seeing the risks of a double-dip recession are rising, backed by a slew of poor economic data over the past two weeks, which lead me to believe that the US economy is heading for a U-shaped recovery. The macro news, including data on consumer confidence, home sales, construction and employment actually suggesting a significant downside risk even to the anemic levels of growth and the US economy continues to face challenges in 2H2010, particularly as historic levels of fiscal stimulus fade – and appears far too close to the tipping point of a double-dip recession.
On the real estate front, new home sales are collapsing again, existing home sales are also falling sharply and construction activity, both residential and commercial is falling sharply. Durable good orders are down, initial claims for unemployment benefits remain stubbornly high – way above the 400k mark. Real disposable income for 4Q has been revised downward while real disposable income before transfers for January was negative again. The manufacturing ISM index, while still expanding being above 50 – has now fallen a couple of notches and its production and new orders index levels are falling too and global PMIs suggests a loss of momentum in the global economy recovery. Real inventories look unchanged in 1Q relative to 4Q; auto sales were at best mediocre. Core CPI was falling and core PCE was closed to 0% suggesting anemic demand and economic weakness.
Along with the euro-zone crisis, in turn will be a drag on the potential for US export growth and the recent rally in the US dollar on risk aversion reflects this risk. Fiscal spending cuts, confidence hits and the looming threat of either rising unemployment or falling wages in the public sector – on top of private sector retrenchment – will remain. A similar retrenchment may well lie ahead in the UK, given rising fiscal sustainability concerns and the threat of a sterling crisis, contributing to the threat of a wider double-dip across high income countries.
I am seeing the risks of a double-dip recession are rising, backed by a slew of poor economic data over the past two weeks, which lead me to believe that the US economy is heading for a U-shaped recovery. The macro news, including data on consumer confidence, home sales, construction and employment actually suggesting a significant downside risk even to the anemic levels of growth and the US economy continues to face challenges in 2H2010, particularly as historic levels of fiscal stimulus fade – and appears far too close to the tipping point of a double-dip recession.
On the real estate front, new home sales are collapsing again, existing home sales are also falling sharply and construction activity, both residential and commercial is falling sharply. Durable good orders are down, initial claims for unemployment benefits remain stubbornly high – way above the 400k mark. Real disposable income for 4Q has been revised downward while real disposable income before transfers for January was negative again. The manufacturing ISM index, while still expanding being above 50 – has now fallen a couple of notches and its production and new orders index levels are falling too and global PMIs suggests a loss of momentum in the global economy recovery. Real inventories look unchanged in 1Q relative to 4Q; auto sales were at best mediocre. Core CPI was falling and core PCE was closed to 0% suggesting anemic demand and economic weakness.
Along with the euro-zone crisis, in turn will be a drag on the potential for US export growth and the recent rally in the US dollar on risk aversion reflects this risk. Fiscal spending cuts, confidence hits and the looming threat of either rising unemployment or falling wages in the public sector – on top of private sector retrenchment – will remain. A similar retrenchment may well lie ahead in the UK, given rising fiscal sustainability concerns and the threat of a sterling crisis, contributing to the threat of a wider double-dip across high income countries.
The UK 2010 Election Guide
The last possible date that a general election could be held is 3 June 2010 but Prime Minister Gordon Brown could call earlier resolution of Parliament. At present, there is a broad expectation that Brown will call the election in early May, coinciding with local council elections.
The general election for the House of Commons is based on a first-past-the-post vote in 650 constituencies. So, for a single party to have an overall majority in the House of Commons, it will need to win 326 seats. In the last election in 2005, the Labour Party won 355 of the 646 seats contested – an overall majority of 64 seats and the Conservative Party – the next largest, won 198 seats.
Recent opinion polls show that the Conservative Party currently has a lead over the Labour Party of around six percentage points, but the gap is narrowing. To the extent to which the Labour Party’s relative recovery in the polls on the back of stronger real economy remains debatable, but it is possible to see its share of the vote continues to rise.
From the market’s perspective, an outcome where no party won an overall majority would be one of considerable initial uncertainty. The possible constitutional processes that would follow such as an outcome may add further to that uncertainty in the immediate aftermath of the election. It is likely too that the party with the most seats would attempt to form a minority government, possibly relying on support from some of the smaller political parties in the House of Commons. If the largest party was well short of an overall majority, it may have to come to an agreement with the Liberal Democrat party, the likely terms of which would be the possibility of reform of the electoral system.
In such circumstances, markets may draw the conclusion that significant proposals for fiscal tightening would be postponed until after a later, possibly more conclusive election. It would be interesting to monitor the application of the government’s new Fiscal Responsibility Act, which requires that net borrowing halves from its peak by 201314 so the deficit could fall below 5.5% of less by that point.
The general election for the House of Commons is based on a first-past-the-post vote in 650 constituencies. So, for a single party to have an overall majority in the House of Commons, it will need to win 326 seats. In the last election in 2005, the Labour Party won 355 of the 646 seats contested – an overall majority of 64 seats and the Conservative Party – the next largest, won 198 seats.
Recent opinion polls show that the Conservative Party currently has a lead over the Labour Party of around six percentage points, but the gap is narrowing. To the extent to which the Labour Party’s relative recovery in the polls on the back of stronger real economy remains debatable, but it is possible to see its share of the vote continues to rise.
From the market’s perspective, an outcome where no party won an overall majority would be one of considerable initial uncertainty. The possible constitutional processes that would follow such as an outcome may add further to that uncertainty in the immediate aftermath of the election. It is likely too that the party with the most seats would attempt to form a minority government, possibly relying on support from some of the smaller political parties in the House of Commons. If the largest party was well short of an overall majority, it may have to come to an agreement with the Liberal Democrat party, the likely terms of which would be the possibility of reform of the electoral system.
In such circumstances, markets may draw the conclusion that significant proposals for fiscal tightening would be postponed until after a later, possibly more conclusive election. It would be interesting to monitor the application of the government’s new Fiscal Responsibility Act, which requires that net borrowing halves from its peak by 201314 so the deficit could fall below 5.5% of less by that point.
British Pound in the Hand of Speculators
I warned that sovereign debt problems posed a major threat to global currency especially the EU-related currencies as early as December 2009. And this threat could represent a catalyst for a return of global risk aversion as it has the ability to be contagious. Such fears can destroy investor confidence in the capital markets of troubled countries.
Despite the European leadership’s attempt to lessen the sense of urgency in the euro zone and the despite the ambitious plans rolling out to shave outsized deficits, the problems with government finances’ finances in the Eurozone and Britian are not finding a resolution.
In late November, the Dubai government created a hiccup in the rosy plans that many market participants were increasingly hitching their wagons and it is a wake-up call. Dubai World’s debt holders now are getting only 60 cents on the dollar for their government bond investment.
Now, Greece is the next in line – the weakest of the 16 members of European monetary union, and is running a budget deficit more than 4 times the limits set forth in the euro-zone’s fiscal constraint guidelines. The ratings agencies took the alert from Dubai.
The next hot spots – Portugal, Ireland and Spain all have severely bloated deficits and debt levels and the spill-over of Greece issue have created an irreparable moral hazard. As for the euro, this total breakdown in the foundation of the currency union has it on a path for destruction or at best, an extended period of uncertainty.
With all this development, I am becoming more worried about the United Kingdom. Among G-7 economies, the UK has the weakest performing economy, the largest deficit and the worst deterioration of its debt position. As conditions get worse in the euro-zone and it becomes increasingly evident that there are no clean fixes, the UK is the most likely candidate to come under the gun.
The British pound plunged to its lowest level in 24 years against the dollar at the height of the financial crisis, and now just a year later it appears another test of that level is in the cards.
While the uncertainty about the UK government’s finances continues to build, I expect the pound to be the next victim of currency speculators.
Despite the European leadership’s attempt to lessen the sense of urgency in the euro zone and the despite the ambitious plans rolling out to shave outsized deficits, the problems with government finances’ finances in the Eurozone and Britian are not finding a resolution.
In late November, the Dubai government created a hiccup in the rosy plans that many market participants were increasingly hitching their wagons and it is a wake-up call. Dubai World’s debt holders now are getting only 60 cents on the dollar for their government bond investment.
Now, Greece is the next in line – the weakest of the 16 members of European monetary union, and is running a budget deficit more than 4 times the limits set forth in the euro-zone’s fiscal constraint guidelines. The ratings agencies took the alert from Dubai.
The next hot spots – Portugal, Ireland and Spain all have severely bloated deficits and debt levels and the spill-over of Greece issue have created an irreparable moral hazard. As for the euro, this total breakdown in the foundation of the currency union has it on a path for destruction or at best, an extended period of uncertainty.
With all this development, I am becoming more worried about the United Kingdom. Among G-7 economies, the UK has the weakest performing economy, the largest deficit and the worst deterioration of its debt position. As conditions get worse in the euro-zone and it becomes increasingly evident that there are no clean fixes, the UK is the most likely candidate to come under the gun.
The British pound plunged to its lowest level in 24 years against the dollar at the height of the financial crisis, and now just a year later it appears another test of that level is in the cards.
While the uncertainty about the UK government’s finances continues to build, I expect the pound to be the next victim of currency speculators.
Thursday, March 4, 2010
Tag Team - Brazil and Iran for US
I hardly make comments on geopolitical matters. But I think it would be interesting to share a report by Stratfor on the relationship between Iran and Brazil and what it means for energy, trade, and US sanctions.
Brazilian President Luiz Lula Da Silva has been getting cozy with Iran of late. Da Silva came to Iran’s defense asserting that ‘peace in the world doesn’t mean isolating someone’. He also defended his decision to follow through with a scheduled visit to Iran on May 15 in spite of Iran’s continued flouting of international calls to curb uranium-enrichment activity. Now Lula is putting Brazil within firing range of one of Washington’s biggest foreign policy imperatives.
Tehran is more than happy to receive such positive attention from Brasilia. Brazil holds a non-permanent seat on the UN Security Council and UN sanctions against Iran require the support of at least 9 of the 15 member councils.
Despite the overabundance of mediators in the Middle East and Brazil’s glaring lack of leverage in the region, Lula remains fixated on the Iran portfolio. Within Brazil, many are puzzled and uncomfortable while countries like Russia and China are taking care to diplomatically distance themselves every time the regime flouts the West’s demand to show some level of cooperation on the enrichment issue.
So far, Washington and others find comfort in the fact that Brazil and Iran currently do not have much to boast beyond the diplomatic fanfare. Although Brazil is Iran’s largest trading partner in Latin America, the total annual trade between the two remains small at roughly $1.3 billion and since Brazil is already sulf-sufficient in oil, the country simply does not have a big appetite for Iranian energy exports.
Question now is that how far Lula go? Iran is facing escalating sanction pressure over its nuclear program and Brazil can be a good help in terms of banking and nuclear energy. One of many ways Iran has tried to circumvent this threat is by setting up money-laundering operations abroad to keep Iranian assets safe and trade flowing. When Ahmadinejad visited Brazil in May 2009, Iranian EDBI and Brazilian banking officials drafted a MOU that was on the surface a mere agreement to facilitate trade between the two countries but that could mean a lot of things, including the establishment of Iranian banks in Brazil to evade the US sanctions dragnet.
There is the ever-controversial nuclear issue. There is a report that Brazil’s Office of Institutional Security, which answers to the president, has begun consultations to establish what points can be included in a possible nuclear deal with Iran that could be signed during Lula visit to Iran in May. Brazil is reportedly working on a new uranium-refining technique called magnetic levitation, which is being developed by the navy at the Aramar lab in Sao Paulo.
There is a possibility that Brazil is not only working toward self-sufficiency in nuclear power, but also may be positioning itself to become a supplier of nuclear fuel for the global market.
Brazilian President Luiz Lula Da Silva has been getting cozy with Iran of late. Da Silva came to Iran’s defense asserting that ‘peace in the world doesn’t mean isolating someone’. He also defended his decision to follow through with a scheduled visit to Iran on May 15 in spite of Iran’s continued flouting of international calls to curb uranium-enrichment activity. Now Lula is putting Brazil within firing range of one of Washington’s biggest foreign policy imperatives.
Tehran is more than happy to receive such positive attention from Brasilia. Brazil holds a non-permanent seat on the UN Security Council and UN sanctions against Iran require the support of at least 9 of the 15 member councils.
Despite the overabundance of mediators in the Middle East and Brazil’s glaring lack of leverage in the region, Lula remains fixated on the Iran portfolio. Within Brazil, many are puzzled and uncomfortable while countries like Russia and China are taking care to diplomatically distance themselves every time the regime flouts the West’s demand to show some level of cooperation on the enrichment issue.
So far, Washington and others find comfort in the fact that Brazil and Iran currently do not have much to boast beyond the diplomatic fanfare. Although Brazil is Iran’s largest trading partner in Latin America, the total annual trade between the two remains small at roughly $1.3 billion and since Brazil is already sulf-sufficient in oil, the country simply does not have a big appetite for Iranian energy exports.
Question now is that how far Lula go? Iran is facing escalating sanction pressure over its nuclear program and Brazil can be a good help in terms of banking and nuclear energy. One of many ways Iran has tried to circumvent this threat is by setting up money-laundering operations abroad to keep Iranian assets safe and trade flowing. When Ahmadinejad visited Brazil in May 2009, Iranian EDBI and Brazilian banking officials drafted a MOU that was on the surface a mere agreement to facilitate trade between the two countries but that could mean a lot of things, including the establishment of Iranian banks in Brazil to evade the US sanctions dragnet.
There is the ever-controversial nuclear issue. There is a report that Brazil’s Office of Institutional Security, which answers to the president, has begun consultations to establish what points can be included in a possible nuclear deal with Iran that could be signed during Lula visit to Iran in May. Brazil is reportedly working on a new uranium-refining technique called magnetic levitation, which is being developed by the navy at the Aramar lab in Sao Paulo.
There is a possibility that Brazil is not only working toward self-sufficiency in nuclear power, but also may be positioning itself to become a supplier of nuclear fuel for the global market.
Tuesday, March 2, 2010
From Berkshire Hathaway
The latest version of Berkshire Hathaway, which released few days ago is really written to a bigger audience than usual. As always, the insights in the company’s letters are absolutely wonderful and it is my pleasure to see deeper into this and how we can apply the lessons to our own portfolio and financial life.
Buffet notes that it is easy to identify many investment areas that will grow quickly but it is not easy to predict how quickly those opportunities will evolve or how individual companies will fare over the years. The idea here is that many investment possibilities – while packed with huge profit potential are also very fleeting. Others, while a bit less exciting, have relatively certain longevity.
Buffet is also speaking to the fact that Berkshire Hathaway doesn’t want to depend solely on financing to do its deals. Quite the opposite – the company carries a large cash hoard that it can use to pursue opportunities, especially at times when the rest of the world desperately needs financing, such as the credit crunch we recently experienced. According to Buffet, having a cash hoard allows him to sleep well. My suggestion is to both keep an emergency cash fund completely separate from the investment portfolio plus a cash position ready to be deployed when new opportunities present themselves.
Don’t micromanage. Buffet says Berkshire keeps the managers of its subsidiaries on rather long lashes. And while he admits that this sometimes means problems get recognized late in the game, he believes of letting talented people perform freely outweighs the downside. In my opinion, as long as you have selected quality to begin with, there is no reason to continually tweak your positions. By all means, keep a watchful eye on things and cut dead weight when warranted.
In his final guiding principle, Buffet points out that Berkshire doesn’t want in-and-out investors but rather partners who are looking for a long term relationship. Once again, I think this is applicable to all of us. As shareholders, we should invest in firms that we want to own for the long haul.
What Buffet really likes are insurance companies, as they provide him with steady cash-flows that he can use to invest elsewhere. Regulated utilities are his second best choice, again, the idea here is predictability and major cash-flows. He also likes those conservatively managed, tends to boast recognizable brands and are focused on products or markets that are already easy to understand. Last but not least are Berkshire’s financial firms.
Buffet notes that it is easy to identify many investment areas that will grow quickly but it is not easy to predict how quickly those opportunities will evolve or how individual companies will fare over the years. The idea here is that many investment possibilities – while packed with huge profit potential are also very fleeting. Others, while a bit less exciting, have relatively certain longevity.
Buffet is also speaking to the fact that Berkshire Hathaway doesn’t want to depend solely on financing to do its deals. Quite the opposite – the company carries a large cash hoard that it can use to pursue opportunities, especially at times when the rest of the world desperately needs financing, such as the credit crunch we recently experienced. According to Buffet, having a cash hoard allows him to sleep well. My suggestion is to both keep an emergency cash fund completely separate from the investment portfolio plus a cash position ready to be deployed when new opportunities present themselves.
Don’t micromanage. Buffet says Berkshire keeps the managers of its subsidiaries on rather long lashes. And while he admits that this sometimes means problems get recognized late in the game, he believes of letting talented people perform freely outweighs the downside. In my opinion, as long as you have selected quality to begin with, there is no reason to continually tweak your positions. By all means, keep a watchful eye on things and cut dead weight when warranted.
In his final guiding principle, Buffet points out that Berkshire doesn’t want in-and-out investors but rather partners who are looking for a long term relationship. Once again, I think this is applicable to all of us. As shareholders, we should invest in firms that we want to own for the long haul.
What Buffet really likes are insurance companies, as they provide him with steady cash-flows that he can use to invest elsewhere. Regulated utilities are his second best choice, again, the idea here is predictability and major cash-flows. He also likes those conservatively managed, tends to boast recognizable brands and are focused on products or markets that are already easy to understand. Last but not least are Berkshire’s financial firms.
Monday, March 1, 2010
Foundation for the Study of Cycles
Prediction 1 – Starting this year, most US stocks are likely to fall in a zigzag pattern for nearly three long years! Now P/Es are already back up again to grossly overvalued levels.
Prediction 2 – Gold will skyrocket far higher than $2,00 per ounce by the end of 2011. Between now and 2012, there will be periods when silver and other metals do better than gold.
Prediction 3 – The US dollar index will begin to sink in 2010 and will not hit bottom until early 2012. Currencies are not a beauty contest. They are an ugly contest and among many ugly currencies, the dollar usually wins the prize.
Prediction 4 – Most commodities will not make new, all time high! Oil will not return to its all-time highs. Unlike gold, it is driven less by currency disasters and more by consumer or industrial demand.
Prediction 5 – The US economy will suffer a severe double-dip recession in 2011, probably worse than 2009.
Prediction 6 – The US budget deficit will surpass $2 trillion in 2012. Politicians know they are rigging the numbers.
Prediction 7 – Bond prices will plunge because of out-of-control deficits and a sinking dollar. You will see a major spike upwards in yields and that could give investors a huge buying opportunity to lock in those higher yields for years to come.
Prediction 8 – 2012 will be the year of maximum turmoil in markets and peak tension in society. A convergence of cycles – dollar cycle + stock market cycles + consumption cycles + GDP cycles – all bottoming in this same approximate time frame.
Prediction 9 – 2012 will bring a massive wealth shift from old fortunes that are destroyed to new ones that are created.
Prediction 2 – Gold will skyrocket far higher than $2,00 per ounce by the end of 2011. Between now and 2012, there will be periods when silver and other metals do better than gold.
Prediction 3 – The US dollar index will begin to sink in 2010 and will not hit bottom until early 2012. Currencies are not a beauty contest. They are an ugly contest and among many ugly currencies, the dollar usually wins the prize.
Prediction 4 – Most commodities will not make new, all time high! Oil will not return to its all-time highs. Unlike gold, it is driven less by currency disasters and more by consumer or industrial demand.
Prediction 5 – The US economy will suffer a severe double-dip recession in 2011, probably worse than 2009.
Prediction 6 – The US budget deficit will surpass $2 trillion in 2012. Politicians know they are rigging the numbers.
Prediction 7 – Bond prices will plunge because of out-of-control deficits and a sinking dollar. You will see a major spike upwards in yields and that could give investors a huge buying opportunity to lock in those higher yields for years to come.
Prediction 8 – 2012 will be the year of maximum turmoil in markets and peak tension in society. A convergence of cycles – dollar cycle + stock market cycles + consumption cycles + GDP cycles – all bottoming in this same approximate time frame.
Prediction 9 – 2012 will bring a massive wealth shift from old fortunes that are destroyed to new ones that are created.
From Monetary Frontline
Monetary base (or M0) is one monetary aggregate that the Federal Reserve actually controls. It exploded in the middle of 2008 as the Fed started quantitative easing and pushed rates to zero in an attempt to thaw out the credit markets that had frozen.
On the other hand, broader measure on money – M2 rose into 2009 and has then gone sideways. Normally, the stimulus of such raw money growth into M0 would have M2 exploding upward, given the money multiplier effect.
We know that a US bank can lend out about 9 times the deposits it has on hand. It can be multiplied rather quickly if banks choose to lend. If increases in central bank money may not results in commercial bank money because the money is not required to be lent out – it may instead result in a growth of excess reserves. Indeed, this described the situation with US bank excess reserves growing oer 500-fold, from under $2 billion in August 2008 to over $1,000 billion recently. What is essentially happened is that banks are not putting these funds to work but simply hold reserves – simply a substitution on the bank’s balance sheet of idle cash for old government bonds.
All those mortgage bonds and other assets the Federal Reserve has purchased have been put right back into the Fed by the banks. There has been no money multiplier. If fact, the money multiplier is at its lowest level ever. Bank lending has fallen percentage wise the most in 67 years. The actual amount of bank loans is falling each and every quarter with no signs of a bottom. Consumers are reducing their debt and leverage. Bank loans are being written off at staggering rates. Over 700 banks are officially on watch by the FDIC with more banks being closed each week.
There is at least $300-400 billion in losses on commercial real estate waiting to be written down. Housing foreclosures are rising and hundreds of billions have yet to be written off.
Effectively, the Fed had become a cash machine rather than a monetary expansion machine. At the end of last year, the multiplier had actually fallen to less than 1.0 and the trend remains downward. If someone had told you five years ago that the money multiplier would be down to 1.0, we would have laughed. The laugh, however, would have been upon us, for it is here and it is still falling.
On the other hand, broader measure on money – M2 rose into 2009 and has then gone sideways. Normally, the stimulus of such raw money growth into M0 would have M2 exploding upward, given the money multiplier effect.
We know that a US bank can lend out about 9 times the deposits it has on hand. It can be multiplied rather quickly if banks choose to lend. If increases in central bank money may not results in commercial bank money because the money is not required to be lent out – it may instead result in a growth of excess reserves. Indeed, this described the situation with US bank excess reserves growing oer 500-fold, from under $2 billion in August 2008 to over $1,000 billion recently. What is essentially happened is that banks are not putting these funds to work but simply hold reserves – simply a substitution on the bank’s balance sheet of idle cash for old government bonds.
All those mortgage bonds and other assets the Federal Reserve has purchased have been put right back into the Fed by the banks. There has been no money multiplier. If fact, the money multiplier is at its lowest level ever. Bank lending has fallen percentage wise the most in 67 years. The actual amount of bank loans is falling each and every quarter with no signs of a bottom. Consumers are reducing their debt and leverage. Bank loans are being written off at staggering rates. Over 700 banks are officially on watch by the FDIC with more banks being closed each week.
There is at least $300-400 billion in losses on commercial real estate waiting to be written down. Housing foreclosures are rising and hundreds of billions have yet to be written off.
Effectively, the Fed had become a cash machine rather than a monetary expansion machine. At the end of last year, the multiplier had actually fallen to less than 1.0 and the trend remains downward. If someone had told you five years ago that the money multiplier would be down to 1.0, we would have laughed. The laugh, however, would have been upon us, for it is here and it is still falling.
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