The Royal Bank of Canada (RBC) has joined the gold bull ranks. According to Myles Zyblock, the Chief Institutional Strategist at RBC Capital Markets, it could go as high as US$3,800 (i.e. almost triple) within three years although “The real fireworks might still be several quarters away.” - the real question that nobody addresses is what the price of gold might be, three years hence, in the currencies of the other 95% of the world’s population, in other words, what part of the increase in the US dollar price will be ‘real’ & what part merely a function of a cratering US dollar – as a contrarian this unanimity makes me nervous; on the other hand, this may just be the exception to the rule, i.e. this time ‘it is different”.   

A US ex-IMF staff member with homes in both the US & France recently noted France is in trouble & just cannot go on spending money the way it has been; so he is considering selling his house there. But, he said, the US is not that different; it actually has more debt than France & the average Frenchman doesn’t carry nowhere near much debt as the average American. And while many French at least know there is a problem, even if they don’t understand it well enough to do anything serious or smart about it, the average American doesn’t even know there is a problem, or is in denial - which is worse. He says Sarkozy is at least starting to try & bring government spending in line with revenues, while in America that conversation hasn’t really begun yet, and wonders “Maybe I should sell all my assets in the US too” (as George Soros’ original partner in the Quantum Fund, Jim Rogers, did several years ago, before moving, lock, stock & barrel, to Singapore.  

A recent Gallup poll on Americans’ views on five major achievements of Obama during his first two years in office found that only one, financial reform, was endorsed by a majority; the other four, incl. health care and the bank- & automaker bailouts, were given a firm ‘thumbs-down’. 

The latest issue of the Economist made the following judgment calls on Obama’s first two years in office. He was handed a “poisoned legacy”. As a Presidential candidate he had a “silver tongue, while in office he had developed “a tin ear”. And, while as a candidate he had promised hope & change, as President “he had delivered neither … although not entirely through a fault of his own” (although he certainly must take a goodly share of the blame).  
 

GLEANINGS VERSION II

No. 382 - October 28th, 2010 

THE BLAME-CHINA GAME (Time, Zachary Karabell) 

· At Washington’s insistence the IMF Annual Meeting became the latest battleground pitting the US against China. US Treasury Secretary Timothy Geithner urged it to pressure China to adopt a “more flexible, more market-oriented exchange rate management” (i.e. ‘you’re rigging your currency; so cut it out, or else! - what else?). Our conventional wisdom is that China’s policies have caused our trade deficit & the loss of American manufacturing jobs, and have enabled China to amass huge foreign currency reserves. We’re irked the Chinese save so much in the belief this worsens the global imbalances & endangers our recovery from the financial turmoil that shook the world. And we think the solution is for China’s currency to appreciate quickly by 20% to 40%.  

· The idea we aren’t responsible for our problems is a black-is-white, up-is-down view. American consumers demanded cheaper stuff, so companies responded by going to low-cost labour markets, Japan in the 70's, Mexico in the 90's & China since 2000. But we ignore this & blame China, not ourselves, for this. Our zero-sum attitude toward China is a relic from an era when nations defined economics while we now live in a global economy, and blaming it for our domestic problems reflects a dangerous refusal to accept the world as it is. Retaliating against China won’t bring back manufacturing jobs to the US, revive construction, retool the US labour force, rebuild rotting bridges or create a next generation energy grid.

While we can’t force China to bend we can cause serious disruptions to the global economy & risk plunging the world into chaos. Or, like the great nation we say we are, we can tend to our problems at home rather than look abroad for dragons to slay.  

Prior to 2005, the talk was also of a need for a 20% to 40% revaluation of the yuan & over the next three years it was in fact  allowed to nudge 20% higher, which did squat for the US trade deficit. Now the talk is of more of the same but, unless America gets its act together first, the outcome will likely be similar. And while China is still accumulating dollars, it is now shoveling them out the door again as fast as it can, making strategic investments, at the US’ expense, all over the world, incl. even Greece, that will boost its future global power & influence whereas the US keeps going deeper in debt, wasting money on peripherals & becoming more inward-looking. But Beijing is now hoisted on its own petard; for a creeping yuan revaluation could bring on the ‘mother’ of all ‘hot money’ flows while a big one-time adjustment could affect its economy in a way that would lead to serious domestic unrest. And the timing is getting worse as it faces a leadership change, & Washington a leadership race, in 2012 (the author is a 1996 Harvard Ph.D. who heads New York-based River Twice - which analyzes economic & political trends - after having been Executive Vice President & Chief Economist of, and manager of an award-winning stock portfolio at, Fred Alger Management, was designated a “Global Leader for Tomorrow” by the World Economic Forum in 2003, & proved prophetic in August 2007 when he told an interviewer that there was a risk that ”fewer wise decisions have been made by a great number of people on Wall Street than people ... suspect.”)  

GEITHNER PROPOSES TARGETS FOR CURRENT ACCOUNTS (CMS FOREX, Nick Nasad) 

· At the G-20 he argued it will be difficult to agree on how to avoid a ‘currency war’ when the focus is on currencies & exchange rates; so it should be shifted to the current account imbalances between the major economies. Hence he called on the G-20 to target a 4% ‘cap’ on countries’ current account surpluses, urging those with persistent surpluses to “undertake structural, fiscal, and exchange rate policies to boost domestic demand” & those with ”significantly undervalued currencies” to allow them to “adjust fully over time”, in return for which, he said, the advanced economies “would pare their budget shortfalls.”

· While Canada’s Finance Minister, unsurprisingly, called it a “step in the right direction” & his Australian counterpart called it “constructive”, Japan’s Finance Minister said “setting numerical targets would be unrealistic” & India’s that caps would be hard to quantify, while Germany’s rejected “a command economy approach” & Desmond Lachman, a former Deputy Director of the IMF’s Policy Department, now a Resident Fellow at the American Enterprise Institute, called it “a good idea that is not going to go anywhere.” 

A current account deficit occurs when a country earns less from exports & its foreign investments than it spends on imports & investments abroad. In the decade ended in 2006 the US current account deficit ballooned almost four-fold to 6% of GDP as Americans went on a debt-financed consumption binge. Geithner is in effect proposing that everyone else should start consuming with the reckless abandon that got America in trouble. But the primary responsibility for getting out of an ‘over one’s head indebtedness’ situation is for the debtor to tighten his belt, painful as that may be, before creditors will step  in to help (the global situation is not unlike that in Europe where it took a near-death experience before Greece saw the light, except that in this case there is no IMF or EU to backstop the spendthrift, and that it is a key, not a peripheral, economy that is in trouble). As to Geithner’s suggestion that, in exchange for action by creditors, the US would “pare” its budget shortfall, he has got the priorities reversed & this claim cannot help but sound hollow to any outsider given the current state of the US political landscape.    

SOME FED OFFICIALS MULL MORE FLEXIBLE INFLATION MANDATE (WSJ) 

· Soft  prices in a weak economy are worrying the Fed & will result in a QE2 program of asset purchases, likely after the next FOMC meeting on November 2^nd & 3^rd (& the November 2^nd mid-term elections). But some Fed officials, incl. Secretary Geithner’s successor as New York Fed President, William Dudley (the only Regional Fed President who is a permanent voting member of the FOMC) think the Fed should go further & tolerate levels of inflation above its notional 2% target to compensate for earlier periods of weak price gains (this, of course, would only be a “temporary measure” to complement other stimulative efforts & be ended once the economy had fully recovered). 

This can be squared with the Fed’s legal mandate to pursue reasonable price stability by redefining “reasonable’ in the context of the other half of its mandate, maximum growth & employment. Those who make this argument fuss about deflation being hard to get under control once it gains a foothold (the argument traditionally used to justify vigilance on inflation) at a time that inflation, both core & nominal, is still relatively comfortably in positive territory. The question is whether Bernanke would sign off on the idea; for just last August he said that such a move would be “inappropriate” as it could lead to unwanted volatility & economic uncertainty. 

LAND OF THE FREE, HOME OF THE FINANCIALLY STRAPPED (G&M, Joanna Slater) 

· At a conference in New York this week, a high-powered panel addressed a once unthinkable scenario, that of a large US state defaulting. This being discussed so openly shows the extent of investors’ worries over the fiscal situation of many states & cities. The Great Recession left yawning holes in their budgets as their revenues collapsed. California earlier this month finally approved a budget, 100 days late, that filled a US$19BN budget gap for this year through cuts & delays, and some optimistic assumptions. Next spring Illinois will face a deficit of US$15BN, half its day-to-day spending, and Nevada isn’t much better off.  Absent a robust recovery soon, things can only get worse : federal stimulus spending, some of which went directly to the states, is nearly gone, and within a few years rising pension & benefit payments to retirees will add to the states’ fiscal ordeal.

· Meredith Whitney, a financial analyst known for being bearish on banks (she blew the whistle on Citigroup before the system cracked) has a deja vu feeling; for she sees “a lack of transparency and an abundance of complacency on the part of investors and politicians, just as we saw before the banks imploded”. And investors are wary :  judging by credit default swap prices they now deem California & Illinois less creditworthy than Egypt, Bulgaria & Vietnam. But public finance ‘experts’ pooh-pooh the possibility of defaults at the state level & California’s State Treasurer claims only “thermonuclear war”  would prevent the state from repaying its debt.

The states will have to cut spending & raise taxes, and try & ‘off-load’ their financial burden onto Washington and cut their transfers to the cities, which will create a whole new set of stresses, incl. possibly early defaults. And they will improvise, for  “If states have shown us anything, is that they can find gimmick after gimmick after gimmick (to massage their finances) ... They’re creative, they’re good at it.” Former Treasury Secretary & Citigroup Vice-Chairman Robert Rubin & several distinguished economists on a panel at the conference agreed the likely outcome would be for Washington to help a state make an imminent bond payment, but only in exchange for strict conditions, possibly including an oversight authority that would in effect take fiscal decisions out of the state’s hands.  

California’s Treasurer may get his “thermonuclear war”, albeit not in the form he is talking about. And the states’ fiscal predicament is of critical importance to the US’ future; for they provide most of the people-related services, like education & health, that are critical to its longer-term economic well being. Gimmickry, to be successful, requires credibility, but in the absence thereof becomes counter-productive (just ask the Greek government). What might Washington use ‘to help a state make a debt payment”? And what if more than one or two states ended up on its door step at the same time? The irony of it all is that most states have far lower debt-to-GDP ratios than many supposedly more creditworthy souvereigns; but defaults or bankruptcies are typically caused not by a lack of assets but of liquidity (a lack of cash to meet their obligations promptly as they fall due). And that’s where the states are vulnerable; for they can borrow only for capital spending-, not operating- purposes.      

FOR THE FIRST TIME, U.S. TREASURY SELLS BONDS WITH A NEGATIVE YIELD 

(G&M, Brian Milner) 

· At the October 25^th UST bond auction investors snapped up US$10BN of five-year bonds at a 0.555% negative yield. But .... these were TAPS - Treasury Inflation-Protected Securities. This underscores investor interest in inflation-protected assets ahead of the now widely expected Fed QE2 move, after the next FOMC meeting, to buy up to US$1TR of bonds (in a vain?) attempt to reflate the struggling economy. Investors will get a positive yield if inflation will average over 1.56% over the life of these  bonds (regular five-year UST bonds currently yield 1.18%, almost 40 bps below the inflation rate - in other words, they generate a 40 bps negative ‘real’ rate of return).   

Obviously some investors disagree with the Fed’s view deflation is a greater risk than inflation. 

BERNANKE TREADS FINE LINE WITH GREENBACK (G&M, Kevin Carmichael) 

· The final communique of the G-20 meeting in South Korea said it had agreed to “move toward more market-determined exchange-rate systems ... to refrain from competitive devaluation of currencies ... (and that) advanced economies, including those with reserve currencies, will be vigilant against excessive volatility and disorderly movements in exchange rates” (words, words, words, but no action, and as we all know ‘action speaks louder than words’) But even before the meeting had ended did Bernanke come under fire from an unusual quarter, his fellow international policy makers, for being a poor steward of the world’s primary reserve currency. Germany’s Economics Minister, Rainer Bruederle, started the debate over the Fed’s QE plans when he said “An excessive, permanent increase in the money supply is ...  indirect manipulation” (which is what the US has been accusing China of). This suggests that even America’s old friends in the G-7 ‘club’, not just the emerging powers, are upset with its monetary policy

· In the past month traders, as policy makers & analysts have been absorbed by the Fed’s role in the “currency war”. China, accused of keeping too tight a leash on the yuan, has countered by arguing an unduly loose US monetary policy is the real problem by causing a stampede out of the US dollar in search of higher yields elsewhere (on the Monday after the G-20 meeting, 15 of the world’s 16 major currencies rose against the US dollar, with the Yen rising to a 15-year high & the Canadian dollar jumping 63¢ to US$98.01).

· But Bernanke is in a bind since the Fed believes that if it addressed foreign currency market volatility it could contravene its legal mandate of maintaining price stability & achieving “maximum”employment because deflation is a threat & the economy growing too slowly.   

When the global economy’s biggest player implies that, international considerations & obligations be damned, & domestic factors are all that matters,  it gives a powerful signal & incentive to others that the order of the day is ‘sauve qui peut’ (& the Devil gets the hindmost).     

HOENIG SAYS EXCESSIVE LIQUIDITY CAN LEAD TO ‘VERY BAD OUTCOMES’

(Bloomberg, Joshua Zumbrun) 

· Kansas City Fed President Thomas Hoenig believes pumping excessive liquidity into the banking system may potentially harm the economy & cause higher unemployment. He told an economic forum in Albuquerque, NM, on October 21^st “Monetary policy is all about an environment that’s supposed to be stable ... When you try to use it in a way that floods the market with liquidity, you can ... get very bad outcomes”. While Chicago Fed President Charles Evans believes the US economy is in a liquidity trap & a bit more inflation would help it grow more faster,  Hoenig maintains “Fine tuning inflationary expectations with the blunt instrument called monetary policy is a highly risky endeavour” &, in response to a question, “I don’t think we’re in a liquidity trap because we are, in fact, growing and will continue to grow unless we create another crisis.” [Hoenig has been the Kansas Fed’s President since 1991 & is the Fed’s longest-serving policy maker. He has dissented from every FOMC decision this year, opposes further asset purchases because the benefits thereof “are likely to be smaller than the costs”, & has argued for some time that the Fed should start taking steps to lift interest rates from near zero, saying “I am for non-zero ... (albeit) against high interest rates while we are in a fragile recovery.”]  

As he worries about his colleagues making light of inflation, and about the potential costs & benefits of a QE2 program, other FOMC members, incl. Boston Fed President, Eric Rosengren, believe  ‘vigorous action is required’ to counteract the risk of deflation & further asset purchases can be effective. And the Fed may have painted itself into a corner; for the UST market has already “priced in” a big asset purchase program, even though Rosengren recently implied it may be focused on securities other than UST paper [such as mortgage-backed securities (MBS)? - which , of course, would result in still more risk being “off-loaded” from the private- onto the public- sector, especially since the legal status of some MBS has come into question following revelations some foreclosures may have be inappropriate, if not outright illegal, with some investors, incl. Fanny Mae, pressuring banks take back MBS they had earlier sold them].  

TREASURY HID A.I.G LOSS (NYT, Mary Williams Walsh) 

· Earlier this month the US Treasury issued a report saying tax payers would ultimately lose only US$5BN on their US$182BN AIG rescue (a fraction of its earlier estimates). But Neil M. Barovsky, the Special Director General for the Troubled Asset Relief Program (TARP) - a holdover from the Bush Administration, a Goldman alum & a Henry Paulson protege - said on October 25^th  this was due to it abandoning its usual method for valuing investments which “In our view ... is a significant failure in their transparency ... The American people have a right for full and complete disclosure about their investment in A.I.G. ... and the U.S. government has an obligation, when they are describing potential losses, to give complete information.” He said that, after he had written Treasury Secretary Geithner in mid-October recommending he  correct the report, perhaps by adding a footnote saying its methodology for calculating its losses had changed, he had been informed (by a third tier Treasury official) that its methodology hadn’t changed, only its assumptions.

It’s all a matter of valuation. With the government’s 79% stake soon to rise to 92%, the publicly  traded ‘float’ is small, & he questions  the Treasury’s key assumption, that it can  sell off a significant portion of its holding without a severely negative effect on the market price of AIG shares.  

Next month the Treasury will issue its audited financial statements. Since they must pass an auditor’s scrutiny, the potential loss could go back up again to possibly as much as US$40-US$50BN (which could result in a loss of credibility for the Treasury it doesn’t need at this time). 

NATURE TALKS HEADED FOR SUCCESS (BBCNews, Richard Black) 

The UN talks in Japan on the Convention on Biological Diversity on a new deal to protect nature & equitably share in its benefits in its dying moments seemed on track to a positive ending. Western nations conceded the thorniest issue, the sharing of natural genetic resources (which would compensate developing countries when products are made from genetic material of organisms originating in their territories - important in plant breeding &, increasingly, drug manufacture). The other key issue, money, that had Brazil & its allies arguing that by 2020 US$200BN per year should be made available for biodiversity conservation, was supposedly solved by an agreement to have such a plan in place by 2012 when Brazil will host the Second Earth Summit in Rio de Janeiro.  

As most of these meetings are wont to, the main area of agreement is to keep talking. Canada made the limelight by being named one of the “Dodos of the Week” by an umbrella group of NGOs for consistently opposing language in an agreement on the sharing of genetic resources that would strengthen the rights of indigenous people.