Archive for June, 2010

Choose: or Patraeus

June 24, 2010
President Obama and General Petraeus.  Source: 
President Obama and General Petraeus. Source:

Mr. President, you can’t have it both ways.  You can’t have General Petraeus come in and save your Afghan policy at the same time as you have been associated with, which called him “General Betray Us” on the pages of the New York Times in 2007.

I don’t want to be the guy always criticizing President Obama – I think in many ways he is doing a good job.  But I cannot help but shine light on hypocrisy in politics, on whichever side of the aisle it occurs.  With Obama, who cultivates an image of new politics and bipartisanship, I feel compelled to draw readers’ attention to misperceptions of the man.

The facts:

– In 2003, funded in part by anti-Bush billionaire George Soros, allowed an ad on its website that compared Bush to Hitler, later claiming they had nothing to do with it.

– In 2007, posted an ad in the New York Times, calling General Petraeus “General Betray Us,” and accusing him of cooking the numbers in order to make President Bush’s surge in Iraq look effective.  Senator (and Candidate) Obama relentlessly criticized the surge in Iraq and its architect, General Petraeus, only later admitting it might have worked and employing a similar strategy as president in Afghanistan.  Candidate Obama in 2007 failed to heed calls to criticize the “General Betray Us” ad.

– On February 1, 2008, endorses Barack Obama for President of the United States, and Obama accepts.

– On June 23, 2010, President Obama calls in General Petraeus to head up the NATO mission in Afghanistan, which involves a surge of troops and counterinsurgency operations, much like what successfully ended the Iraq civil war under Obama’s predecessor.

Can Obama supporters at least admit the hypocrisy please, even if it is true that most politicians do the same?  I know many say, the election is over, forget about what happened in the heat of the campaign.  I say, let’s be fair and hold all politicians accountable for what they do and say on the campaign trail, especially when it affects policy.

Will General Petraeus run for high office one day?  Interesting question…

India’s infrastructure bottlenecks

June 16, 2010

An excellent New York Times article yesterday discussed how democratic politics and bureaucracy in India prevent the elimination of infrastructure bottlenecks, especially in transportation.  The article focused on India’s railway system, where freight rates are expensive, travel times excessive, and traffic volumes inadequate to the task of fostering strong economic growth…of the pace we see in China.

It is an interesting comparison — China vs. India, one which would require more time and space to adequately address than this blog can provide.  For the moment, I will raise the long-standing dichotomy between two development models — the authoritarian and the democratic.  In Latin America, analysts have often underscored the success of the Pinochet model in Chile, whereby a brutal authoritarian regime from 1973-90 swept away roadblocks and bottlenecks caused by democratic politics, unleashing that country’s growth potential and allowing it to develop more rapidly than many of its historically more democratic neighbors.  Moreover, with a sound economy in place, Chile was able to make the transition to a functioning democracy with two relatively cohesive coalitions of the right and left.  Yet there was a cost in terms of social cleavages, human rights abuses, and at times political stability.  Throwing people out of helicopters is not civilization.

General Augusto Pinochet and friends, the junta that ruled Chile from 1973-90.  Source:
General Augusto Pinochet (seated) and friends, the junta that ruled Chile from 1973-90. Source:

Arguably, Russia and China have followed the Pinochet model, Russia after the economic disaster created under failed democrat Boris Yeltsin.  China has done quite well with this model, but nervous Chinese leaders understand that unrest, if not social upheaval, is always a possibility in China if the political monopoly fails to consistently deliver the economic goods.  India labors under a vibrant, if at times inefficient and somewhat corrupt, democracy.  Nevertheless, Indians know that if a government fails to deliver economic growth, they can “throw the rascals out” at the next election.  This introduces a measure of political stability into the system, which is often lacking in authoritarian regimes.  And, given India’s enormous ethnic and religious cleavages, it is perhaps this vibrant democracy that prevents the country from tearing itself apart.  Slow trains and slow growth — the price Indians pay for stability (and decency)?

Image above:  General Augusto Pinochet (seated) and friends, the military junta that ruled Chile from 1973-90.  Source:

Couples therapy: China and the U.S.

June 16, 2010
Nixon & Mao: Mutual dependence goes back a long way.   Source:
Nixon & Mao: Mutual dependence goes back a long way. Source:

I have long said in my China posts that China does not have a lot of options right now besides buying US treasuries.  The AP article below describes how China has increased its purchases of US debt in recent months.  If you are going to hold your currency undervalued in order to run massive current account surpluses and amass fx reserves — because you were spooked by how the likes of Korea, Indonesia and Thailand were brought to their knees with low fx reserves in the 1998 Asian Crisis — then you will have to invest your massive fx reserves somewhere.  The dollar is a logical choice because of trade, deep US markets and the dollar’s reserve currency status. 

Since the beginning of the Great Recession of 2008-09, many observers warned that Chinese fx reserves could be shifted suddenly to other currencies, perhaps the euro and the yen.  Even before the sovereign debt crisis in Europe unfolded earlier this year, I suggested that euro assets did not look so great — given the slow-growth, sclerotic economies in the euro zone.  The same goes for yen assets, given that Japan has barely grown in the last twenty years.   Other emerging market economies (Brazil, India) are growing smartly, but they have small asset markets, compared to the depth and variety of markets in developed countries.  Ben Bernanke used to argue before the Great Recession that capital floods the US market and causes, rather than finances, US current account deficits.  This is because the return on US assets — driven by robust US output growth — is better here than elsewhere.  Now, with the euro crisis in full swing and Japan still stagnant, his argument has some appeal again.  It is still specious because it gets US households with their abysmal savings record off the hook, and it gets Bush and his irresponsible tax cuts off the hook as well.  The latter got Bernanke appointed to the Fed, so was all in a day’s work.

Is there a problem with all this foreign investment in US assets?  Yes.  The US must reduce its imbalances with the rest of the world in order to avoid the financial havoc that a massive dumping of dollar assets in the future could wreak.  We’re okay now because dollar holders have few options and the rest of the world looks a bit dodgy.  But foreign holdings are large.  Foreign holdings of US treasuries represent 28% of US GDP, with China holding 23% of this and Japan coming in second with 20%.  The US government is in hock to East Asia.  

Another nettlesome problem of this foreign appetite for the relative safety of US treasuries is that it keeps interest rates low in America, putting less pressure on Barack Obama & Co. to come up with a medium-term fiscal consolidation plan.  They’re still talking about another fiscal stimulus.  US government debt is set to rise above 90% of GDP next year and deficits will hover near 10% this year and next.  Government debt is often measured relative to GDP, but a better measure is debt relative to government revenues; this is because governments after all must service debt with revenues.  US government debt to revenues last year was 300%, higher than just about any other investment grade country in the world, with the notable exceptions of Japan and India.  (Debt by this measure was likewise higher than in such euro-crisis countries as Greece and Italy.)  So, the US has a fiscal migraine, while the Obama administration fiddles.  The Economist last week said this about Obama: “…he has done little to fix the deficit, shown a zeal for big government and all too often given the impression that capitalism is something unpleasant he found on the sole of his sneaker.”  Scrape that off your sneaker, tell OMB Director Peter Orszag to zip up his pants, and get to work!

And let’s be glad the Chinese are still buying, but not get too cozy in the knowledge of the same…

Image above: Nixon and Mao: Mutual dependence goes back a long way.  Source:

From AP:

China and other countries buy US Treasury debt

China boosts holdings of US Treasury debt by $5 billion, second consecutive monthly gain


Martin Crutsinger, AP Economics Writer, On Tuesday June 15, 2010, 11:38 am EDT

WASHINGTON (AP) — China boosted its holdings of U.S. Treasury debt in April for the second straight month as total foreign holdings of U.S. government debt increased.

China’s holdings of U.S. Treasury securities rose by $5 billion to $900.2 billion in April, the Treasury Department said Tuesday. Total foreign holdings rose by $72.8 billion to $3.96 trillion.

The sizable gains are being driven by fears that Greece and other European governments could default on their debt. Worries over possible defaults have sparked a flight to safety and that has benefited U.S. Treasury securities. Treasurys are considered the world’s safest investment — the U.S. government has never defaulted on its debt.

The April increases eased concerns that lagging foreign demand will force the U.S. government to pay higher interest rates to finance its debt with private economists forecasting strong gains in May as well because of the debt crisis.

“We will state the obvious that flight to safety will most likely continue to favor the United States in the second quarter,” said Win Thin, senior currency strategist at Brown Brothers Harriman & Co. in New York. “Given that the European crisis intensified in May, we would expert further large-scale inflows.”

Gregory Daco, U.S. economist at IHS Global Insight, said that demand for U.S. debt was also being helped by the fact that the profit outlook for many U.S. companies is bright and the U.S. economy is forecast to grow at a stronger pace this year than Europe.

China is the largest foreign holder of Treasury securities. The monthly gains in March and April came after six consecutive months when China was either reducing its U.S. holdings or keeping them constant. The stretch raised concerns that China might shift money away from Treasury securities.

The 1.9 percent rise in total holdings of U.S. debt in April followed an even bigger 3.5 percent increase in March.

The Treasury reported that net purchases of long-term securities, covering U.S. government debt and the debt of U.S. companies, increased by $83 billion in April. That follows a record monthly gain of $140.5 billion in March.

The higher interest in U.S. bonds has helped push interest rates lower. It’s a welcome development for the government, which faces the task of financing record federal budget deficits. The federal deficit hit an all-time high of $1.4 trillion last year. It is expected to remain above $1 trillion this year and in 2011 as well.

Japan, the No. 2 foreign holder of Treasury securities, also increased its holdings in April. It boosted them by $10.6 billion to $795.5 billion.

Other countries registering gains in their holdings in April were the United Kingdom and various oil exporting nations.

India: More on inflation

June 15, 2010

As noted in an earlier post, inflation is a sensitive issue in India.  In addition to worrying about over-heating, today a preoccupation in many Emerging Market Economies (e.g. China and Brazil), Indian politicians are concerned that when food prices rise, millions may starve.  JPMorgan below analyzes the latest inflation report, including double-digit price hikes in the food category.  Moreover, with only modest capital expansion going on in India (outside of infrastructure), the industrial sector is bumping up against supply constraints, which can be inflationary.  Hence, JPM’s conclusion that the Reserve Bank of India will tighten monetary policy sooner rather than later…

From JPMorgan’s Emerging Markets Today, June 15, 2010:

WPI headline inflation came in at 10.16%oya (J.P. Morgan:

10.2%; consensus: 9.6%) in May. In line with the trend

over the last few months, food inflation subsided slightly

(12.1%oya; -0.3%m/m, sa), which was more than offset by

rising non-food inflation (9.4%oya; 1.8%m/m, sa). Core

inflation (non-food manufacturing + non-food primary) rose

8%oya (2.3%m/m, sa). Importantly, the February and March

inflation numbers were revised up. With these revisions,

headline WPI entered double digits in February (10.05%oya).

The RBI in its April policy review projected inflation to

stabilize just below 10% by June/July before declining on

base effects. The economy has seen little in the way of

significant capital expansion outside of infrastructure,

whereas IP has sizzled for the last six months, including as

late as April when it reached 17.6%oya, close to its highest

in 20 years. Indeed, May PMI, which strongly leads the IP

cycle, rose to its highest since June 2008 as did the ordersto-

inventory ratio suggesting that capacity constraints are

increasingly binding. On balance, we believe that the RBI

could raise rates by 25bp before the July policy review,

followed by another 25bp rate hike at the review. To

alleviate the liquidity squeeze, the RBI will likely look at

other options, such as reducing SLR further or opening

special discount windows.

India: Solid GDP growth, weak finances

June 14, 2010
India's fractious politics keeps government debt high.  Source: Google Images
India’s fractious politics keeps government debt high. Source: Google Images

In an earlier post, I discussed  a theory I developed that democratic countries with divided, often coalition, governments generally produce weaker public finances than countries where two dominant parties alternate in power.  India is the posterchild for the former, with government debt at about 80% of GDP, very high for an emerging market economy.  In order to keep weak coalitions together, governments must buy off constituencies, at the expense of sound public finances.  We shall see if India’s current government led by the Congress Party can deliver on promises to reduce the government debt burden.

India’s weak fiscal position (with government deficits at around 6% of GDP)  have constrained its credit ratings to low investment grade.  Below find a press release issued today by Fitch in which the rating agency adjusts the rating outlook on India’s sovereign bonds to stable from negative, not due to improved management of government finances, but to stronger GDP growth prospects.  The one-off positive impact on government accounts of recent telecoms auctions also helped sovereign creditworthiness.

CSFB published a note today (also below) explaining how output growth is starting to bump up against capacity constraints.  Fitch forecasts output growth at a healthy 8.5%, though the Reserve Bank of India might tighten monetary policy, keeping the expansion in check.  This is because of another important characteristic of Indian political economy — political sensitivity to inflation.  India is a populous country with high levels of poverty, so when inflation creeps up even a point or two, especially for food prices, people starve (or at least become more malnourished).  In a place as big as India, this can mean millions more malnourished people.  Complicated policy making…

From Fitch Ratings:

Fitch Revises India’s Local Currency Outlook To Stable; Affirms at ‘BBB-‘   
14 Jun 2010 5:33 AM (EDT)

Fitch Ratings-Mumbai/Hong Kong/Singapore-14 June 2010: Fitch Ratings has today revised the Outlook on India’s Long-term local currency Issuer Default Rating (IDR) to Stable from Negative. At the same time, the agency affirmed India’s Long-term foreign and local currency IDRs at ‘BBB-‘. The Outlook on the foreign currency IDR remains at Stable. Fitch has also affirmed the Short-term foreign currency IDR at ‘F3’ and the Country Ceiling at ‘BBB-‘.

“India’s strong growth prospects and the one-off positive impact from the telecoms auctions underpin Fitch’s forecast that government debt to GDP ratio will decline, easing the near-term pressure on India’s local currency ratings. However, public finances remain a clear weakness, and downward pressure on the ratings could resume if India veers too far off the deficit reduction path as outlined by the Thirteenth Finance Commission,” said Andrew Colquhoun, Director in Fitch’s Asia-Pacific Sovereigns Group.

Fitch projects general government debt to fall to 80% of GDP by end-March 2011 (end-FY11) from 83% at end-FY10, reflecting the impact of strong GDP growth on the denominator and the one-off revenues from the 3G licence and broadband spectrum auctions. The agency has revised India’s FY11 growth forecast up to 8.5% from 7% on signs of strong growth momentum, including industrial production growth of 17.6% in April 2010, year-on-year. The telecom licence auctions together netted the government INR1,060bn, representing about 1.6% of projected FY11 GDP, as against the INR350bn budgeted originally (Fitch’s February review of India took the cautious approach of assuming zero auction revenues). The agency anticipates some pressure on the government to spend some of the revenue windfall and estimates an additional 0.3pp spending in FY11, still delivering a net 1.3pp fiscal saving.

However, fiscal management remains relatively weak. Fitch anticipates that the central government’s deficit on the government basis (including privatisation and auction receipts as revenue and excluding some off-budget items) to be at 5.7% of GDP in FY11, just 1pp down from FY10, despite the 1.6% of GDP reaped from the telecom auction. The report of the Thirteenth Finance Commission (TFC) in February laid out a path of deficit reduction towards a “golden rule” of borrowing only to finance investment by FY15. India’s track record on sticking with medium-term fiscal plans is not good, although the Congress-led government has at least voiced its commitment to debt reduction. If the authorities stray too far from the TFC’s consolidation path and debt ratios resume rising, it could impact the ratings negatively.

A significant drop in the country’s growth momentum to below Fitch’s projections would worsen India’s debt dynamics and put downward pressure on its ratings. However, India’s credit profile continues to benefit from the largely local-currency profile of its debt (95% of the stock), and from the sovereign’s stable access to domestic-currency financing, mainly from the banking system. Signs that India’s banking system was under stress would likely be negative for the sovereign ratings, although this is not the agency’s base case. Inflation remains uncomfortably high, with wholesale prices up 10.2% in the year to May, prompting the central bank to hike rates twice in response so far in 2010. An intensified inflation shock that is severe enough to disrupt macroeconomic and/or financial stability would be negative for India’s ratings.

India’s strong external finances, including its sovereign and overall net creditor status and official reserves of USD271bn by June 4 2010 (up 3.6% on a year earlier), continue to support its foreign currency ratings. By contrast, poor physical infrastructure, underdevelopment reflected in low average incomes, and weak governance indicators relative to rated peers constrains the ratings.

Contacts: Andrew Colquhoun, Hong Kong, Tel: +852 2263 9938; Vincent Ho: +852 2263 9921.

From CSFB today:

Devika Mehndiratta
+65 6212 3483
April IP surprised on the upside, with the index rising 17.6% yoy compared with our and consensus estimates of 14.3%. In seasonally adjusted level terms, the IP index had been flat in recent months – after strong gains from June to December 2009, IP was flat in January and February and then declined in March (Exhibit 6). In April, the IP index increased by a notable 3.4% mom.
The large upward surprise in April IP was not that broad-based, however. It was dominated by a 33% mom jump in the capital goods sub-index. This sub-index has been volatile recently (Exhibit 7). It jumped over 30% in December/January, fell back in February/March and was up again by 33% mom in April. A breakdown by product for capital goods is not available for April yet, but data until March showed that these large ups and downs were limited to only a few goods such as computers, ship building & repair, railway wagons, and oil wells/platforms.
Capacity constraints could become an issue. Even if we assume that the broad trend in capital goods (even though volatile) indicates that corporate investment activity is picking up, it is possible that, in the months ahead, capacity constraints start to show up. Anecdotal evidence suggests that industries such as autos, fast moving consumer goods, steel and power are operating near full capacity (the power sector has been capacity constrained for years). This could slow the pace of month-on-month rises (from around 3% pace in April) in industrial production going ahead.
Could the RBI now hike policy rates inter-meeting before the scheduled July meeting? An inter-meeting hike is not entirely inconceivable, but we would still maintain that it is unlikely. This is because: 1) the RBI has indicated ‘cautiousness’ in its policy stance in recent comments, and 2) monetary conditions have anyway tightened in recent weeks triggered by the large one-off 3G auction-related borrowings by telcos. The short-term call rate has consequently moved up from the reverse repo rate (3.75%) to the repo rate (5.25%) without the RBI having taken any policy tightening action since April.

If the Turks want to hang out with this guy…

June 8, 2010
What would Ataturk say?    Source: Google Images What would Ataturk say? Source: Google Images

Turkish President Gul pictured with the world’s most notorious extremist, who is quoted in the article below as saying that the Zionists are  “holding up the flag of the devil itself…” and are “the backbone of the dictatorial world order,” taking a page again from Julius Streicher’s Der Stuermer.  In its drive to be a regional power, Turkey is starting to make strange bedfellows.  What would Ataturk say?

Maybe Ahmadinejad is pre-empting the Security Council’s likely announcement of tougher sanctions with more hateful attacks against Israel.  But as we know from the Hamas Covenant, the Zionists control the UN Security Council, like almost everything else in the world and throughout history (tongue in cheek, however painfully)…

From Today’s CNN wire service:

Istanbul, Turkey (CNN) — Iranian President Mahmoud Ahmadinejad hit a strident tone on a variety of topics during a press conference on the sidelines of an Asian security summit in Istanbul on Tuesday.

A key item on the agenda at the summit is last week’s Israeli raid on an aid flotilla in the Mediterranean. Ahmadinejad said the confrontation revealed Israel’s “devilish” nature.

“It showed violence and hatred and war-mongering attitudes,” he said at a news conference. “The devilish sound of the uncultured Zionists was coming out from their deceit. … They were holding up the flag of the devil itself.”

The raid led to the deaths of nine people, all Turkish citizens — including one Turkish-American. Turkey is urging Israel to accept an international probe into the incident.

Ahmadinejad congratulated Turkey, which has been in a war of words with Israel following the raid, for its response.

Iran’s own nuclear program has been another major topic at the summit. The United States expects to bring a new resolution on increased sanctions against Iran over its nuclear program to a vote in the United Nations Security Council this week.

By calling for a resolution instead of sitting down for talks with Iran, the United States is “gravely mistaken,” Ahmadinejad said.

“Within the framework of respect and justice, we’re ready to negotiate with everyone. Anyone who is going to resort to the language of force and aggression, the response is clear,” he said.

Ahmadinejad went on to commend Turkey and Brazil for recently negotiating a deal with Iran on a uranium enrichment swap.

“The initiative marked the beginning of a new path — the beginning of an end to unilateralism in the world,” he said.

The United States, he added, missed an opportunity by not embracing the deal.

Asked whether the raid on the flotilla last week will change the way countries vote in the Security Council, Ahmadinejad said the raid will actually change many things.

For Israel, he said, “it has actually rung the final countdown for its existence. It shows that it has no room in the region and no one is ready to live alongside it. Actually, no country in the world recognizes it, and you know that the Zionist regime is the backbone of the dictatorial world order.”

He added, “Maybe at the Security Council, it will impact temporarily. The Zionist regime, with what it has done, it actually stopped its possibility to exist in the region anymore.”

Is there a Yuan bloc in Asia?

June 8, 2010
Asian currencies tracking China's yuan?  Source:  Google Images
Asian currencies tracking China’s yuan? Source: Google Images

Interesting Economist article (below) discussing whether other Asian currencies — the Korean won, Thai Baht, Singapore dollar, Malaysian Ringgit, New Taiwan dollar, Vietnamese dong, Indian rupee, Indonesian rupiah — track the Chinese yuan in order to maintain competitiveness in US markets relative to China as well as access to the Chinese market.  There have been a number of econometric studies on the matter.  The bottom line is that many Asian currencies, like the Chinese yuan, track the US dollar closely — some call it Bretton Woods II — though the correlation has declined since the economic crisis, as the US economy and US monetary policy have been going through anomalous conditions.  Tying strictly to the US dollar right now might mean some unwanted inflation in accelerating Asian economies.  Still, China’s currency remains essentially fixed to the dollar.  Ultimately, a revaluation of the Chinese yuan, and its Asian brethren, is needed to address the current account imbalances that persist and threaten global economic stability.  The euro crisis has, however, thrown a wrench into that adjustment, leading to some safe haven capital flows into the US dollar, just when the greenback needs to decline in an orderly fashion.

 From the Economist on-line:

 Asian currencies

Chips off the block

Currencies around Asia are more flexible than you think

Jun 3rd 2010 | HONG KONG | From The Economist print edition

AMID all the diplomatic ding-dong over China’s yuan, it is easy to lose sight of emerging Asia’s other currencies. There is not much din over the dong, for example. While China has kept the yuan pegged to the dollar since July 2008, ignoring complaints that it is artificially cheap, Vietnam’s currency, the dong, has depreciated by 13% against the greenback over the same period, unremarked and unprotested. South Korea and Taiwan, the only countries besides China ever to be labelled currency manipulators by America’s Treasury, have seen their currencies cheapen by 17% and 6% respectively.

China’s critics justify their preoccupation by invoking a “yuan block”. China’s neighbours and rivals are reluctant to allow their currencies to rise too far against the yuan, for fear of losing China as a customer, or losing out to it as a competitor. Thus although China accounts for only 19% of America’s imports, its peg, it is argued, frustrates a broader realignment of currencies in the region.

Does such a yuan block exist? For over a decade before July 2005, it was impossible to say. Since the yuan did not move independently of the dollar, it was hard to know if China’s neighbours were in thrall to its currency or America’s. But for the following three years, China allowed the yuan to crawl slowly upwards against the dollar. A 2007 study by Chang Shu, Nathan Chow and Jun-Yu Chan at the Hong Kong Monetary Authority took advantage of this interlude to measure the influence of China’s yuan on other regional currencies.

Using a method popularised by Jeffrey Frankel of Harvard University and Shang-Jin Wei of Columbia, they looked at the fluctuations of Asian currencies against the Swiss franc. Insofar as the Thai baht and the dollar mirrored each other’s moves against the Swiss currency, the authors could conclude that the baht was under the dollar’s spell. But if the baht and the yuan strengthened against the franc when the dollar did not, they could identify the separate pull of China’s currency.

That pull was strongest on the Korean won, Thai baht, New Taiwan dollar and Singapore dollar. But it also seemed to reach as far as the Indonesian rupiah and even the Indian rupee. The economists’ results suggested that if the yuan were to appreciate by 1%, independently of the greenback, the Singapore dollar, New Taiwan dollar and the Thai baht would rise by 0.58%-0.68% in sympathy. The Korean won would strengthen one for one.

Since July 2008 the yuan has not moved an inch against the dollar. Does that mean that other members of the yuan block have also stood still? Hardly. Malaysia untethered its currency from the dollar one day after China in July 2005. But unlike China it did not retether it during the crisis. The ringgit fell by 15% from April 2008 to March 2009, before regaining much of that ground over the next 14 months. The won’s wobbles have been even greater. It lost 40% of its value from February 2008 to March 2009, and remains 25% below its pre-crisis peak.

Most of emerging Asia’s currencies strengthened against the dollar this spring. The ringgit rose by 8% from February to May, after Malaysia’s independent-minded central bank raised interest rates in March and again on May 10th. In April Singapore’s Monetary Authority said it would allow a “gradual and modest” appreciation of its currency. But since the debt crisis in Greece unnerved investors, these currencies have mostly lost value again.

This block isn’t scared any more

The flexibility shown by Asia’s currencies is noteworthy, even if most of their flexing has been downwards. Economists used to accuse the region of a “fear of floating”. In 2003 Michael Dooley of the University of California, Santa Cruz, with David Folkerts-Landau and Peter Garber of Deutsche Bank argued that a de facto dollar standard prevailed in much of the region, akin to the “Bretton Woods” regime of fixed dollar parities that emerged after the second world war. But a paper published on May 19th by Ila Patnaik and her colleagues at the National Institute of Public Finance and Policy in Delhi documents a gradual thinning out of the Bretton Woods II regime.

They use a similar method to Messrs Frankel and Wei to show how closely Asia’s currencies track the dollar, euro, yen and pound. They give each country a Bretton Woods II score, based on the rigidity of its currency, especially relative to the dollar. In 2003 the average score in Asia was about 0.85 (a score of one represents a hard peg to the dollar). But the score has since dropped steadily to 0.75.

The new flexibility should stand Asia’s economies in good stead. Their ties to the dollar once guaranteed stable prices at home, as well as competitive exports abroad. But America’s monetary policy, suited to an economy with flat prices and high unemployment, is too loose for a region now growing so rapidly. As Asia’s recovery outstrips America’s, the region’s central banks will have to raise interest rates, as Malaysia, Vietnam and India have already done. Their currencies will appreciate as a result.

This appreciation will be easier to stomach if the yuan also strengthens. But China’s neighbours should not wait for this to happen. Even members of the so-called yuan block should not let the yuan block their progress.

How do you say W in Hebrew: Bibi

June 7, 2010
When is tough effective?

Benjamin Netanyahu subscribes to the George W. Bush school of anti-diplomacy.  It’s nice to blow off steam, especially when you are in the right.  But does brandishing your sword make an effective foreign policy?  Ask Kaiser Wilhelm II, the arch-villain of World War I, whose bluster and belligerence led to the encirclement of Germany, his gravest fear.  Ask most Americans after W left office — did W’s shooting from the hip help America’s image in the world?  Improve America’s security? 

I had meetings with Netanyahu in my capacity as a sovereign analyst for Israel several years ago.  He was then finance minister and a very effective one.  I always came away with the belief that his Achilles’ heel was his hubris.  His narcissism was always the elephant in the room, and more so than the average politician.  I can’t help but believe that his leadership has had something to do with such recent diplomatic fiascoes as the Biden visit and the Gaza flotilla.

Netanyahu, though ineffective, may be right about Gaza.  If you don’t understand why Israel is touchy about Hamas and Gaza, please read the Hamas Covenant in this link, as translated by the Yale University Avalon project, especially Art. 22.  It reads like Der Stuermer.  Here are a few snippets (out of order):

“Israel will exist and will continue to exist until Islam will obliterate it…

The Zionist plan is limitless. After Palestine, the Zionists aspire to expand from the Nile to the Euphrates. When they will have digested the region they overtook, they will aspire to further expansion, and so on. Their plan is embodied in the “Protocols of the Elders of Zion”, and their present conduct is the best proof of what we are saying…

The Prophet, Allah bless him and grant him salvation, has said:

“The Day of Judgement will not come about until Moslems fight the Jews (killing the Jews)…”

In their Nazi treatment, the Jews made no exception for women or children… 

With their money, they took control of the world media, news agencies, the press, publishing houses, broadcasting stations, and others. With their money they stirred revolutions in various parts of the world with the purpose of achieving their interests and reaping the fruit therein. They were behind the French Revolution, the Communist revolution and most of the revolutions we heard and hear about, here and there. With their money they formed secret societies, such as Freemasons, Rotary Clubs, the Lions and others in different parts of the world for the purpose of sabotaging societies and achieving Zionist interests. With their money they were able to control imperialistic countries and instigate them to colonize many countries in order to enable them to exploit their resources and spread corruption there.

They were behind World War I, when they were able to destroy the Islamic Caliphate, making financial gains and controlling resources. They obtained the Balfour Declaration, formed the League of Nations through which they could rule the world. They were behind World War II, through which they made huge financial gains by trading in armaments, and paved the way for the establishment of their state. It was they who instigated the replacement of the League of Nations with the United Nations and the Security Council to enable them to rule the world through them. There is no war going on anywhere, without having their finger in it…

There is no solution for the Palestinian question except through Jihad…

Initiatives, and so-called peaceful solutions and international conferences, are in contradiction to the principles of the Islamic Resistance Movement…

Israel, Judaism and Jews challenge Islam and the Moslem people…

…the ferocity of the Zionist offensive and the Zionist influence in many countries exercised through financial and media control, as well as the consequences that all this lead to in the greater part of the world…”

There you have it.  That’s who’s in power in Gaza.  Hence, the blockade (to prevent the flow of weapons and to pressure Gazans to kick the genocidal extremists out).  History has shown that civilized people should believe what extremists write in their books and manifestos.

As for Turkey, the AK Party did a nice job cleaning up its image in recent years in order to appear to the world as a sort of Islamic version of a European Christian Democratic party.  This has kept Turkey’s secular generals from kicking them out, as they did to the Islamists not long ago. Now, ensconced in power, Turkish Prime Minister Erdogan and his cronies are trying to reorient foreign policy in a more “Islamist” direction, putting ideologues in key foreign policy posts, taking on Israel, championing the oppressed Muslims of Gaza.  Yet, he shows he either hasn’t read the Hamas Covenant or doesn’t care, when he says that Hamas is not a terrorist organization, but a resistance movement (see article).  Sir, is the PKK terrorist or a resistance movement (the PKK is the Kurdish “liberation” movement on Turkish soil that the Turks believe is “terrorist”)?  Were the Turks who murdered masses of Armenians in the early 1900s, which Hitler later said was his inspiration for the Final Solution, genocidal killers?  C’mon, it’s not so hard to tell right from wrong in this world!  Turks should have a re-think about how moderate the Islamism of the AK Party really is.

Israel’s blockade of Gaza could be counterproductive.  It certainly has become a diplomatic liability.  If there is a better way to staunch the flow of weapons to Gaza that Iran is ready to send, if there is a better way to empower those that would topple the would-be committers of genocide running Gaza today, then I say scrap the blockade.  Israel certainly needs to scrap its bunker mentality and engage with the rest of the world, before, like Wilhelmine Germany, it becomes encircled.  P.R. should be a top Israeli priority; and, in order to clean up the country’s global image, Israelis should perhaps start by voting Netanyahu out of office at the next opportunity.  Read about his vehement defense of the Gaza flotilla raid. He may be right, but he certainly is not very diplomatic.  

China: A bully like Wilhelmine Germany?

June 2, 2010
South China Sea where China and its neighbors dispute control over strategic islands and energy resources.  Source:  Google Images
South China Sea where China and its neighbors dispute control over strategic islands and energy resources. Source: Google Images

People like the analogy.  The rise of Germany after 1890, mismanaged by Germany and its adversaries, and the rise of China today — mismanaged or well-managed?  A NYTimes article today discusses the conflicting claims over rich offshore oil resources in the South China Sea among China and its much smaller neighbors, notably Vietnam, with which China fought a war in 1979 (though that was over Cambodia).  These conflicting claims on China’s flank remain unresolved.  Tension in the South China Sea bubbles dangerously below the surface, not unlike the way Morocco and the Balkans did for decades before WWI.  The US takes no sides in these disputes, but the South China Sea constitutes a potential flashpoint for tension between the US and China, in addition to Taiwan.  Some estimates put the quantity of shipping that takes place through the strategic sea lanes in the South China Sea at around 50% of world shipping, depicted with arrows in the map shown above.

Vietnam is pursuing the negotiating strategy of the weak — internationalize the conflict.  This reminds me of Yasser Arafat’s never-ending call back in the day for an “international conference” over the Arab-Israeli conflict; whereas Israel, like the Chinese, always preferred bilateral talks.  Both China and Israel resist international conferences where smaller countries can gang up on them.  Recall the Madrid Conference on the Mideast in 1991, cobbled together by the Bush administration (with the gifted handiwork of Sec. of State  Jim Baker).  Israel was isolated and ganged up on in Madrid.  Israel ultimately preferred secret bilateral talks with the Palestinians in Oslo.

In any event, the South China Sea issue won’t go away, and one wonders if, like Wilhelmine Germany, China will succeed in alienating everyone with its bullying tactics or will seek to find a mutually beneficial solution.  It is hard to find such a win-win solution in a dispute over territory and resources.

(from a Feb. 5, 2010 blog post.)

Hotspots for sovereign credit risk: Fitch report

June 1, 2010
What Greece needs is a thunderbolt from Zeus, not a bailout from Frankfurt.  Source:
What Greece needs is a thunderbolt from Zeus, not a bailout from Frankfurt. Source:


Like a thunderbolt from Zeus, financial markets are struck by the perils of a sovereign debt default.  In financial crises, markets and policy makers fight the last war.  In the Great Depression, countries made the mistake of balancing budgets instead of offering a Keynesian stimulus; in today’s crisis, they are spending like crazy by issuing debt (like crazy).  Sovereign balance sheets are in a woeful state. 

Fitch Ratings explains what is going on in Greece, what countries like the US must do to keep their AAA ratings, and what Latin America’s outlook is.  Fitch delivered its annual Sovereign Hot Spots seminar, which I used to run in New York.  Read the summary below and access the powerpoint presentations and the video of the conference to bone up on sovereign credit risk, which preoccupies global markets these days, as it well should.

Fitch belatedly downgraded Mexico, which lacks a dynamic economy and resists reforms to the oil sector and taxes that could improve creditworthiness.  These factors have long been at play in Mexico.  In addition, Fitch highlights Mexico’s dependence on the US market, as opposed to peer countries such as Brazil that export increasingly to China.  This factor is discussed as a weakness for Mexico these days, whereas for years it was alluded to as a strength.  (Who better to export to than the US, went the argument.) On the other hand, Brazil’s ratings are being held down because of its woeful fiscal accounts, in spite of its strong external balance sheet (which Mexico lacks).  I won’t quibble with the importance of public finances to sovereign creditworthiness; I will just point out that time and time again, analysts have let sovereigns off the hook that had strong public finances and weak external finances (e.g. Asia crisis countries and some countries today in Eastern Europe).  This has caused lots of Wall Street analysts to get it badly wrong in the past. (Did they call the 1998 Asia crisis or the problems Eastern Europe is currently having? No.)  Brazil has the reverse profile — strong fx reserves and weakening (though not fragile) public finances.  By penalizing Brazil too much for Lula’s loosening of the fiscal purse, analysts may miss the boat on Brazil (or may already have).

Finally, it might not be enough to say, as Fitch does, that AAA countries remain AAA because of their financial flexibility, but must find an “exit strategy” from all the rising debt over the medium term, as the US and others sure need to do.  This is ratings stickiness again, folks.  Rating agencies have a difficult time adjusting their ratings because it suggests their analysts might be wrong.  Maybe some AAA countries should have already lost their stellar ratings.  Economists are always good at finding powerful intellectual arguments to explain their current positions — remember Alan Greenspan before Congress on low interest rates.  Have a read of the Fitch summary below — it is chock full of good sovereign credit analysis. 

From Fitch:

“Sovereign Hotspots: Diverging Trends” began Tuesday, 2 March, with a conference in New York discussing the divergence of fiscal prospects between high-grade advanced economies and emerging markets. The conference focused on recent credit pressures and bond market volatility in Europe, as well as credit trends in Latin America. Additionally, Fitch distributed a press release commenting on Chile’s sovereign ratings following the country’s catastrophic earthquake and aftershocks. The event concluded with an analyst panel providing more details on specific countries in Latin America and an investor panel debating recent developments and prospects for the global economy and emerging markets in particular.

Below are some highlights of the conference, followed by links to each presentation. If you would like to hear a replay of the event, please click here. For information on next week’s events in London, Frankfurt and Paris, which will include presentations on Emerging Europe, the Middle East and North Africa, please click on or contact Katie Donnelly at 1-212-908-0828.
New York Conference Highlights:
High Grade and Euro Area Sovereign Risk      
Diverging Trends – ‘Advanced’ and ‘Emerging Market’ Sovereigns

Emerging markets (EM) have weathered the global economic and financial crisis relatively well due to their generally strong balance sheets.  Foreign exchange reserves for EM excluding China have shown a strong recovery since February 2009 and are now near pre-crisis levels.  In addition, lower public debt ratios, combined with less sensitive tax bases have led to more solid fiscal positions in EM relative to developed markets (DM).  Over the next two years, Fitch foresees a continued divergence in public debt paths, with government debt/GDP declining in EM and increasing in DM.
High Grade Sovereigns and the Meaning of ‘AAA’

Countries with high financing flexibility are better positioned to withstand economic/financial shocks than countries that are less flexible in terms of funding, with financing flexibility largely depending on the size of the economy (i.e., the amount of real & financial assets to absorb sovereign liabilities) and the depth of demand for a country’s currency (reserve currency status implies strong underlying demand for assets in that currency).  However, while high-grade sovereigns have the capacity to maintain solvency and the cost of debt service is still below mid-1990s levels, Fitch views these sovereigns’ fiscal exit strategies as key to their ratings outlook, with the urgency among the larger AAA-rated countries being greatest for the UK, Spain and France. 
Greece and the Euro Area

With Greece’s greatest problem being its non-credible statistics and poor track-record, Greece needs to bolster credibility and investor confidence in the long-term solvency of the state in order to gain market access at an ‘affordable’ price. At present, the EU is playing a game of “constructive ambiguity” aimed at stabilizing markets and reducing liquidity risk while putting additional pressure on Greece to restore fiscal discipline.  However, it should be noted that at this stage it is not clear that contagion risk is that severe, as so far spread widening has been ‘rational’, focusing on large deficit countries.
View full presentation
Latin America Overview

Although the average rating continues to be higher for Emerging Europe than for Latin America, the change in the average regional rating has been much better for the latter, with five positive rating actions taking place since July 2009.   Thus, while Latin America has been a mixed bag, with the number of negative rating actions exceeding the number of positive rating actions since the onset of the crisis, the region has generally been quite resilient to the global economic storm.  After an estimated 3% decline in GDP in 2009, Fitch anticipates overall GDP to grow by 4% in 2010, aided by supportive monetary and fiscal policies, a renewed credit cycle and stronger domestic demand (particularly in Brazil, Chile, Panama and Peru), as unemployment rates (which rose only modestly during the crisis) are declining, real wages are recovering and consumer confidence is increasing across the board.  In addition, both domestic and foreign direct investments are expected to rebound, general government debt is anticipated to stabilize and current accounts to remain resilient in 2010, with further accumulation of international reserves taking place.

Nonetheless, Latin America still faces important challenges as it copes with a sluggish global economic recovery as well as significant budgetary rigidity, which may hinder fiscal consolidation.  Additional challenges for the region include sustaining prudent policies through a sluggish recovery and avoiding election-related market uncertainty as presidential elections approach in Colombia (May 2010), Brazil (Oct 2010), Peru (Apr 2011), Guatemala (Aug 2011) and Argentina (Oct 2011).  Thus, while Latin America’s economy will rebound in 2010, the pace of the recovery will differ across countries and growth will still be below the rates observed in 2006-2007.  Since Fitch is currently not seeing a strong reform momentum throughout the region, sovereign creditworthiness trends are likely to remain stable to slightly positive.
Mexico: Explaining the Downgrade

Mexico was downgraded to ‘BBB’ with Stable Outlook in November 2009 primarily for structural reasons, including its low non-oil tax base and high oil dependence, combined with uncertain oil prospects (in fact, oil production has been declining in recent years despite an increase in capex, indicating the need for further reforms at Pemex).  In addition, the 2009 tax package, while in the right direction was insufficient, demonstrating the reluctance of political parties to come together to implement major fiscal reforms to improve tax revenues.  Other factors that led to the downgrade include a relatively modest fiscal buffer (the commodity stabilization fund is small compared with Chile’s, Russia’s and Kazakhstan’s), a limited external cushion (i.e., a weak international liquidity ratio compared with ‘BBB’ peers) and Mexico’s historical growth performance, which has been lagging that of its peers.  While Peru, Chile and Brazil have increased their trade links with China and reduced their ties with the US, Mexico still exports over 70% of its products to its North American neighbor.  As a result, the sluggish rebound of the US economy will continue to constrain Mexico’s growth in 2010.  Factors that led Fitch to change its Outlook on Mexico from Negative to Stable include the country’s well capitalized banking system and low balance of payment risk, as well as its track record of disciplined macroeconomic policies, its smooth external debt profile and its demonstrated ability to tap international markets under difficult external conditions.
Brazil: Beyond the Economic Resilience

Investor confidence towards Brazil is supported by the country’s strong external balance sheet, its robust external solvency ratios (Brazil has long been a net external creditor) and the healthy economic rebound anticipated for 2010, with the expected 5.5% growth in GDP being the strongest in Latin America and only behind India’s and China’s.  However, Fitch has not taken a positive rating action as the agency considers that Brazil’s resilience is already captured in its current ratings to a certain degree and that its stronger external balance sheet has been at a fiscal cost.  In fact, the deterioration in public finances and high government debt burden due to double-digit current spending and significant budget rigidity are dampening the country’s upward credit trajectory.  Moreover, Brazil’s domestic debt composition needs to improve further, as a large proportion of its debt is still contracted at floating rates and 2010 maturities are on the higher side when compared to those of its peers.  Finally, with 2010 being an election year, needed reforms are likely to stall until the next administration takes over.  Fitch will observe how the next administration will handle challenges such as the realization of expenditure reforms, the definition of BNDES’ role and the simplification of the tax system, as well as the management of oil sector development given recent discoveries, among other things.
View full presentation 
The presentations will be available free of charge for three months. If you have problems accessing these presentations or for more information, please email Frank Laurents at, or telephone +1 212-908-9127.

Additional information can be found on the Fitch Ratings website,

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Image: What Greece needs is a thunderbolt from Zeus, not a bailout from Frankfurt. Source:

(from a blog post of March 5, 2010.)