Archive for the ‘Economy’ Category

China: Responsible economic policy

October 5, 2010

Higher prices for GI Joe? Source: Google Images

Very nice, short piece today from CSFB (below) on what China is doing to correct the global imbalances (i.e., to reduce its trade surpluses, which mirror US and other countries’ trade deficits) and to shift its economy to a healthier foundation based on domestic demand.  While President Obama gets pre-election press pressuring China’s prime minister to let his currency appreciate, and while Dems in Congress led by Chuck Schumer grandstand, threatening to raise tariffs on China before the election, the Chinese authorities have instituted large wage increases across the board.  As a result, the real value of the Chinese currency could appreciate sharply, even if the nominal value (the focus of American politicians) appreciates in baby steps.  Hopefully, Schumer, Obama and Co., and above all the angry voters they are courting, understand the economics: that wage inflation undermines the competitiveness of a country’s goods as much as does currency appreciation.  

In spite of President Obama’s tough talk (or because of it?), he appears to have received a boost from China’s prime minister, who lauded his administration’s economic policies, much-maligned these days by the Republicans (who have few ideas of their own).  But, what China bashers don’t realize, and CSFB points out, is that low inflation in the US (i.e. the affordability of America’s consumption binge) has been underpinned over the last 10-15 years by China’s low wages cum undervalued exchange rate, Sir Alan Greenspan’s claims to perfection notwithstanding.  From computers to home improvement, Chinese goods have been cheap.  We won’t be able to count on this any more.  With America still in a near-recessionary funk, we’re not worried about inflation, but that could change.  Enormous government budget deficits have been accommodated by a massive monetary stimulus.  Hence, inflation, and all the economic distortions implied, may be one of a slew of economic problems facing the world’s leading (though declining) power in the years to come. 

From CSFB today: 

In contrast to the exchange rate, wage rates among migrant workers have risen much more aggressively, and we believe that this marks the beginning of the end of China’s export empire. Among 31 provinces, 27 have raised the minimal salary by an average of 22% this year and the remaining four will introducing legislation for salary hikes later this year. We think the move has been pushed by Beijing as part of an effort to shift the economy from export-driven to domestic-consumption-driven. In a survey Credit Suisse conducted, 39% of CEOs from multinational corporations placed a wage increase as something about which they were “very worried” or “extremely worried,” versus 18% for exchange rate appreciation.

The key question to be answered is whether foreign direct investments will leave China or move to the inland provinces. We believe most will move inland rather than leave China. China’s domestic demand is a major attraction for FDI. Besides, China’s infrastructure and administrative efficiency probably will keep FDI coming, for now. However, we project 20%-30% salary increases at the migrant workers’ market every year over the next four years (at least). This would eventually erode China’s competitiveness and push up its export prices. Perhaps we have seen the best time for China as the anchor of global disinflation, though it may take more than a decade for China’s export machine to fall.

Dong Tao +852 2101 7469 dong.tao@credit-suisse.com

Christiaan Tuntono +852 2101 7409 christiaan.tuntono@credit-suisse.com

05 October 2010

The RMB exchange rate saw a surge in appreciation in recent days, but we doubt the trend will last long. The Chinese currency saw nine consecutive days of appreciation against the USD, amidst USD weakness and heightened pressure from the White House and the Capitol Hill. But to us, Beijing has, in fact, been pushing for real exchange rate appreciation through salary increases, much more aggressively than with the nominal exchange rate. With export orders softening and domestic salary surging, we project only marginal nominal appreciation, which is politically motivated. We look for USDRMB at 6.67 by end of 2010 and 6.35 by 2011.

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USA: Lay off the president, man!

September 28, 2010

Coming from me, a defense of Barack Obama may surprise my readers.  That’s because they may not have read the fine print!  Some of his policies I haven’t exactly agreed with (principally, the expensive health care reform, which at a time of rapidly rising sovereign debt, was imprudent).  I reluctantly supported Obama for president in 2008 because he was the better of the two candidates.  Reluctant because we could have chosen a more experienced hand (read here), especially on economic policy. 

Nevertheless, the president has done an exceptional job in tough times.  He has been lucky both before and after the election, but, judging by the recent grilling from his erstwhile supporters, his luck may be running out. They even talk about Obama losing his mojo.  You can criticize Obama and the Democrats, for sure, but what is the alternative?  The only thing innovative in the Republican Party these days is the Tea Party, and I for one don’t want to be dumbed down by the likes of Sarah Palin and the former witch from Delaware (Christine O’Donnell). As for the more “mainstream” Republicans such as future Speaker Boehner, is the answer really more tax cuts at a time of skyrocketing government debt?

What really gets me about this country is the electorate’s emotional bipolarity.  First Obama is viewed as nearly Jesus Christ, now he’s a bum.  C’mon people!  C’mon Velma Hart!

I cringe at charisma.  The Obama-euphoria of the campaign trail scared me, as many of his supporters failed to think critically about the choice.  Instead they anointed a messianic figure and expected him to deliver paradise.  Obama fanned the flames of euphoria then and is now getting burned.  Today, even though the administration managed to sidestep a 1930s-style economic meltdown by rescuing the banks and providing a huge Keynesian stimulus, we hear from Velma and Company that they’re upset they don’t “feel it yet.”  Jon Stewart is “saddened.”  As I have said before, Americans are spoiled. Unlike citizens in emerging markets, accustomed to crisis, accustomed to lines outside of banks, Americans want it all.  Now they are mad at Obama for only achieving what is humanly possible. He has delivered far more than Bill Clinton did by this time in his administration, and is even delivering on the liberal agenda – for example, by appointing two very young, very liberal female lawyers to the Supreme Court.

Now he is branded as anti-business.  There were a pair of articles in The Economist on this (see below).  I noted in my blog during the 2008 election that it did not make sense to elect a man with no economic policy experience to pilot us through the economic storm, who, as a young man, quit a job as an economic analyst because he didn’t want to become a tool of corporate exploitation.  Two years later, people have noticed that his passion is not for business.  Well, lay off him now.  His policies are not particularly anti-business – this government has spent more bailing out corporations than any previous one.  Furthermore, he is in good company taking on corporate abuse.  Anyone remember Teddy Roosevelt’s trust-busting?  Finally, if we continue to harp on this anti-business thing, it will become self-fulfilling.  The Obama administration’s credibility growing the economy could be irreparably damaged, which will hurt us all.

It is human to fight the last war.  So, to avert a depression, the Obama administration took actions that were not taken in the thirties.  Yet our undoing will be something unforeseen, and in my view, this is likely to come on the fiscal side.  Government debt is around 90% of GDP and deficits are in the double digits.  With economic growth likely to remain sluggish (economists have declared a “new normal”), it is not far-fetched for the United States to be in a Greek-style sovereign default over the medium term if a road map to solvency is not charted soon.  There are as yet few signs of determination in this administration to deal with this problem (they appointed a panel), not least because of the recent turnover in the economic team.

What I don’t like about Obama is the spin.  Spin is less than truthful.  I know all politicians do it, especially the successful ones. But, Barack Obama ran as a change agent, a post-partisan, and he has been, is, and will probably always be an aggressive left-of-center partisan.  Centrists, such as Evan Bayh, Joe Lieberman, Norm Coleman, Ben Nelson, Olympia Snowe and Susan Collins, need not apply.  He admires Ronald Reagan and is his heir in terms of image-making.  Now he is going around the country discussing his Christian faith.  Good timing.  The other side does it too.  It is demoralizing for a centrist like me to hear John Boehner savage Obama’s economic policy record and Obama call Boehner’s Pledge to America irresponsible.  Where lies the truth?  Same thing happened on health care.  The problem is, partisanship wins elections. 

On foreign policy, Obama savaged Bush for adventurism and questionable methods in war.  Yet in office, he has ramped up the use of targeted assassinations, sometimes resulting in the deaths of innocents.  The end justifies the means, the saying goes.  As a candidate, he lashed out at David Petraeus for the “surge” in Iraq; now he has hired him to salvage his Afghan policy.  Yet Obama supporters don’t bat an eye, as they swing from indicting Bush for torture to arguing for the necessity of targeted assassinations.

I would like to see a stronger Republican Party.  The country would benefit from an energetic opposition.  Yet, by shifting toward the loony right, Republicans are squandering the opportunity to harness the country’s frustration.  This could work out in the end for Barack Obama.  Taking a page from the Big Dog’s script in 1994-96 — after the Democrats in Congress suffer a beating this year, Obama finds a “Dick Morris” to guide his policy rightward over the next two years.  The Party of No (GOP) nominates someone or other like Sarah Palin in 2012, and No Drama wangles himself another term.  The country could do worse.

From The Economist, September 23, 2010:

WINSTON CHURCHILL once moaned about the long, dishonourable tradition in politics that sees commerce as a cow to be milked or a dangerous tiger to be shot. Businesses are the generators of the wealth on which incomes, taxation and all else depends; “the strong horse that pulls the whole cart”, as Churchill put it. No sane leader of a country would want businesspeople to think that he was against them, especially at a time when confidence is essential for the recovery. From this perspective, Barack Obama already has a lot to answer for. A president who does so little to counter the idea that he dislikes business is, self-evidently, a worryingly negligent chief executive. No matter that other Western politicians have publicly played with populism more dangerously, from France’s “laissez-faire is dead” president, Nicolas Sarkozy, to Britain’s “capitalism kills competition” business secretary, Vince Cable (see article); no matter that talk on the American right about Mr Obama being a socialist is rot; no matter that Wall Street’s woes are largely of its own making. The evidence that American business thinks the president does not understand Main Street is mounting (see article). A Bloomberg survey this week found that three-quarters of American investors believe he is against business. The bedrock of the tea-party movement is angry small-business owners. The Economist has lost count of the number of prominent chief executives, many of them Democrats, who complain privately that the president does not understand their trade—that he treats them merely as adornments at photocalls and uses teleprompters to talk to them; that he shows scant interest in their views on which tax cuts would persuade them to hire people; that his team is woefully short of anyone who has had to meet a payroll (there are fewer businesspeople in this White House than in any recent administration); and that regulatory uncertainty is hampering their willingness to invest.
Ignorant but not antagonistic That Mr Obama has let it reach this stage is a worry. But negligence is not the same as opposition. True, he has some rhetorical form as an anti-business figure—unlike the previous Democrat in the White House, Bill Clinton, who could comfortably talk the talk of business. Mr Obama’s life story, as depicted in his autobiography and on the campaign, was one of a man once mired in the sinful private sector (at a company subsequently bought by The Economist), who redeemed himself only by becoming a community organiser; his wife had a similar trajectory. There are the endless digs at Wall Street and Big Pharma, not to mention the beating up of BP. He remains a supporter of “card check”, which would dispense with the need for secret ballots in establishing a trade union. His legislative agenda has centred on helping poorer individuals (the health-care bill, part of the stimulus bill) or reining in banks (the financial-reform bill). The only businesses he has rescued are the huge union-dominated General Motors and Chrysler. Against this, it could have been much worse, especially given the opprobrium that now dogs Wall Street. A president who truly wanted to wage war on business would have hung onto GM, not rushed to return it to the private sector. Card check has not been pushed. The finance bill, though bureaucratic, is not a Wall Street killer. With the exception of a China-bashing tyre tariff and a retreat on Mexican trucks, Mr Obama has eschewed protectionism. A lot of government cash has flowed to businesses, not least through the stimulus package. And above all his policies have helped pull the economy out of recession. So what should he do? The same leftist advisers who have led Mr Obama into his “anti-business” hole are doubtless telling him that it is just a matter of public relations: have a few tycoons to stay in the Lincoln bedroom; celebrate Main Street’s successes, rather than just whining about bonuses; perhaps invite a chief executive to replace Larry Summers, the academic who announced this week that he was standing down as the president’s main economic adviser. Well, maybe. But once again this is advice from people who have never run a business. The main thing that is hurting business is uncertainty. Mr Obama was right to tackle big subjects like health care and Wall Street, but too often the details were left to others. Why, for instance, should a small American firm hire more people when it still does not know the regulations on health care, especially when going above 50 workers will make it liable to insurance premiums or fines? Fiscal policy is even more uncertain, thanks to Mr Obama’s refusal to produce a credible plan to rein in the deficit. Why should any entrepreneur plough money into a new factory when he has no idea what taxes he will eventually be asked to pay? These are questions that business needs answering in a businesslike way—and so does America. Otherwise the horse will not pull the cart.

China: the price of directed lending

September 21, 2010
China: How long can that heart rate stay elevated?  Source: Google Images
China: How long can that heart rate stay so elevated? Source: Google Images

China is an economically successful country.  Growth rates of 8-11% per year.  Fx reserves north of $2.4 trillion, closing in on 20% of US GDP.  Investment rates that represent 40-50% of GDP (vs. 15-20% in the US).  Private credit growth of 32.5% last year, vs. 5.6% in the U.S.   A Human Development Index that now stands at 49.7, vs. 26.5 in India, and per capita income (PPP basis) that is twice as large as India’s.  Can China keep this up?

I have long said in this blog that China is not strictly comparable to Western market economies, where governments use market signals such as interest rates to nudge the massive private sector in a certain direction.  In China the central government directs banks to lend and pushes local governments to invest.  Not to scoff at the stimulus packages in Western countries — featuring government spending and liquidity injections, but in China, when the authorities mandate a stimulus, they sure get one.   The lead lining in the silver cloud, however, is that when loans and investment projects “season” in China, sizeable loan losses and fiscal liabilities can result.  This is just what rating agency Fitch argued at a conference in Shanghai and Beijing last week (see press release below).   

China has the wherewithal to handle some deterioration in its banks and sovereign balance sheet, given its low level of government debt (under a quarter of GDP), small deficits (under 3% of GDP), and full inoculation against a balance of payments crisis (featuring its Chinese wall of fx reserves and current account surpluses in the neighborhood of 5-10% of GDP).  Nevertheless, with a massive banking sector (broad money represents over 180% of GDP) and heavy state involvement in the sector, banking problems could conceivably become sovereign debt problems.  Fitch assigns China a Banking System Risk Indicator of D/3 (vs. C/3 in the US and B/1 in Canada).  This statistic ranks countries based on the quality of their banks (A-E, E being the lowest) and on systemic banking risk (1-3, 3 being the highest risk).  So, directed lending and stratospheric credit growth have a dark side. 

Furthermore, as Fitch suggests, China, like Japan, will have to shift to an economy driven more by its consumers and less by external demand (i.e. exports) in order to respond to angry trading partners like the U.S. and to have a more sustainable trajectory of economic growth.  Such a shift will be even more difficult with problems in the banking system and higher government debt.

Fitch: China’s Ratings Supported By Strong Sovereign Finances, But Possible Stimulus ‘Hangover’
17 Sep 2010 2:01 AM (EDT)


Fitch Ratings-Beijing/Singapore-17 September 2010: Fitch Ratings says China’s ratings remain supported by the sovereign’s strong finances, underpinned by the foreign reserves stockpile, and by the economy’s strong growth track record. However, the agency raises concerns over a potential ”hangover” from the government’s aggressive stimulus efforts in 2009, including strong credit growth, which could still see the emergence of problems requiring sovereign support to clear up, for example in the banking system. The hesitant recovery of the global economy remains a background source of risk for China.

Leading off Fitch’s annual Sovereign and Banking Conference in Shanghai and Beijing this week, Andrew Colquhoun, Head of Asia-Pacific Sovereigns, reviewed China’s robust economic performance through the global crisis. China’s strong growth owes much to the government’s stimulus efforts, but Mr. Colquhoun noted that some of the costs of the stimulus may be yet to materialise on the sovereign’s balance sheet, such as debts of local government investment companies and, in a downside case where banking sector problems emerge, holes in bank balance sheets. Mr. Colquhoun also discussed the longer-term prospects for a transition to a more consumption-led growth model in China in the context of a still-hesitant global economic recovery – potentially a bumpy transition.

Speaking on the prospects for Asia-Pacific banks, Jonathan Cornish, Head of Fitch’s North Asia Financial Institutions team says the agency sees risks building in banking systems across the region, particularly in China due to rapid asset growth – even though Asian banking systems have generally proved resilient during the global financial crisis, and have in general continued to benefit from a relatively benign operating environment as a result of the robust performance of many Asian economies.

Charlene Chu, Fitch’s Senior Director of Financial Institutions, provided an update of Chinese regulators’ efforts to curb the risks surrounding the growing popularity of informal securitisation, or the re-packaging of loans into wealth management and/or trust products, by Chinese banks. Ms. Chu was one of the earliest analysts to raise awareness about informal securitisation in China. She said that despite the recent tightening in regulations, net issuance of some wealth management and trust products has not slowed thus far in Q3, owing to a number of grey areas in the new rules that offer banks significant room to maneuver with this activity.

Li Zhenyu, director of financial institutions and structured finance at Lianhe Ratings, Fitch’s JV partner in China, also discussed the evolution of formal asset securitisation in China.

Contacts:

Andrew Colquhoun
+852 2263 9938
andrew.colquhoun@fitchratings.com

Jonathan Cornish
+852 2263 9901
jonathan.cornish@fitchratings

Charlene Chu
+86 10 8567 9898 ext 112
charlene.chu@fitchratings.com

Protect Depositors First

September 20, 2010

FROM A BLOG POST OF SEPT 26, 2008:

            If there is anything that government should do, it is this bank bailout proposed by Treasury Secretary Paulson.  In America we debate whether government should be small and stay out of the way of households and businesses (the Republican view) or should help people realize their potential (the Democratic view).  This debate is reasonable and should continue.  What is not debatable is that government should step in when the market fails. 

Secretary Paulson’s rescue plan is vague, but the key elements are there — namely, we must remove the bad assets from the balance sheets of our financial institutions and help them recapitalize.  That’s it, folks.  All the rest is political posturing.

When passion, whether fear or exuberance, overwhelms rationality, which is critical to the functioning of markets, government must step in.  This calms nerves and allows us once again to determine a fair price for an asset.  So, all the talk from Republicans in Congress about the government bailout being “financial socialism” is poppycock.

 I worked for more than a decade as an emerging markets economist, during which banking crises swept the globe.  The much-maligned IMF and World Bank pressured governments in crisis to quickly clean up their banks’ balance sheets and recapitalize them, so that they could get back to providing credit for economic growth.  The U.S. has experienced exactly such a shock, not as large relative to our wealth as in these countries; but in absolute dollar terms, this is the biggest financial shock this planet has ever seen.

An IMF Working Paper, “Systemic Banking Crises: A New Database,” which came out this month (and I recommend you read), examines 42 financial crises in 37 countries from 1970-2007.  It suggests that the recapitalization of financial institutions is the surest way to minimize lost economic output from a financial crisis.  The paper notes that the average cost to the taxpayers of bank bailouts was 13.3% of GDP.  If handled correctly, the cost to the US Treasury of this crisis could remain as low as 5-7% of GDP.  Still, the dollar figures are enormous, and this is what gets headlines.  However, our economy is also enormous; and relative to the deep US tax base, the cost of this crisis should be modest.

On the other hand, if nothing is done, more financial institutions could fail, their assets could be sold in a disorderly fire sale, depressing real estate prices further, more job losses could occur, which would snowball into defaults on other consumer loans, business loans could go bad, losses in the financial system would mount, the recession would deepen, and tax revenues would drop.  The government would have to step in anyway to protect depositors, and the cost to the government of recapitalizing the banks later on could be even larger.  The hit to the American taxpayer could dwarf the costs we are facing now. 

Because of the bank failures of the Great Depression, our government insures traditional bank deposits up to $100k and last week agreed to protect money market mutual funds as well.  The government is on the hook for up to 75% of GDP or a whopping $11 trillion!  By helping banks get healthy again, the government would avoid paying out on this enormous liability.  Likewise, by holding the impaired assets and selling them gradually as the economy recovers, the government would help markets get back to doing what they do best, determining prices. 

            We have done this before.  In the eighties (during Republican administrations) when 2700 financial institutions failed, the Resolution Trust Corporation took over bad banking assets, costing the tax payer an estimated 3.7% of GDP, or over $200 billion.  And this wasn’t just on Wall Street.  The S&L crisis included lots of institutions in the Sun Belt where Republican voters live.    

How the pain of this adjustment is apportioned is important.  Affected players include bank managers and shareholders, bank creditors and borrowers, investors, depositors and taxpayers.  Critical to minimizing the damage to our economy is protecting depositors first.   Panic among depositors, a bank run, such as we saw during the Great Depression and have seen in emerging markets, would be much worse than what we are experiencing now.  Fairness in apportioning the pain is not unimportant, but getting back to growth and safeguarding the future should be our guides. 

             The government should purchase impaired assets for a price that allows banks to recapitalize, providing funds they can relend.  In exchange, the government can take stakes in some larger institutions, and attach conditions, such as firing senior managers and requiring the board to seek private sources of capital.  This would penalize current management and shareholders, sending an important message for the future, that you will pay a price if you mismanage your bank.  When we exit the crisis, the government can sell the mortgage assets and its equity stakes, lowering the ultimate cost of the bailout to the taxpayer. The fact that the assets the government is buying are secured by real estate, which has tangible economic value, means that recoveries could be sizable.

            In order to limit the government’s ownership stake in our financial system, the government could take equity stakes only in large, systemically-important institutions, where it would have a say in management.  This is what the government has already done with A.I.G., Fannie and Freddie.  With smaller institutions, the government could pay less for impaired assets and push them towards private sources of capital, or let them fail. 

            As for borrowers, the government should provide incentives for them to make their loan payments.  The program could lower their debt service burden, allowing many to keep their homes, on the condition they make the payments.  The risk of attaching a borrower rescue to the plan is that it sends a message that you can buy more house than you can afford because the government will bail you out.  And, to administer such a program with millions of borrowers could be difficult.

            Is it true that with Paulson’s plan the depositor is saved but the taxpayer takes a hit? Depositors, taxpayers, homeowners, and yes Barack and John, voters, are one in the same.  It is you and me.  Will everyone take the same hit?  No, but our social welfare net, perhaps buttressed by some relief to homeowners, should keep most everyone afloat.

            The United States is strong.  Our GDP represents one-quarter of global output and is more than three times the size of the next largest economy (Japan’s).  Although Bush’s tax cuts and spending increases have increased the deficit and debt, last year our government debt was below 60% of GDP, which is high, but less than that of other industrialized countries, such as Germany, Canada and Japan.  So, we have room to do this bailout, but not a lot of room. 

Longer term, America must correct the weaknesses that make our prosperity fragile.  We should take action to improve the quality of our GDP.  GDP is the measure of all purchases in the economy.  A lot of our purchases are wasteful – too many homes, cars, fuel, disposable paper-or-plastic, designer food, entertainment, etc.  By investing more in education, we can insure that we produce a higher-quality GDP, higher value-added goods, such as software, green and life-saving technologies, better and cheaper health care, knowledge-based services.  And of course, we must save more.

Horst Kohler, the president of Germany and past head of the IMF, earlier this year critiqued Anglo-Saxon capitalism, calling for a “continental European banking culture.”  It seems our heavy reliance on the market is at fault, whereas government intervention is the hallmark of continental European capitalism.  This is a legitimate debate.  Yet the higher GDP growth rates, higher labor productivity, lower unemployment rates, quicker rebounds from crises that characterize American capitalism demonstrate the benefits of the Anglo-Saxon variety.  On the other hand, the financial bubbles, crashes, skewed wealth distribution, job insecurity, and pollution and waste also characterize American capitalism. 

It is perhaps not as Kohler says that we have swung too far toward free markets, but that we have to develop better tools, better incentives to soften the excesses and clean up the messes. We will not avoid the booms and busts because government cannot possibly keep up with the innovation going on in our markets.  The role of government is to do two things: 1) set up incentives and penalties that encourage prudent behavior, and 2) do a good job cleaning up the inevitable mess.

            What are our political leaders up to?  The biggest financial crisis since the Great Depression comes in the middle of a very competitive election.  Our leaders on both sides of the aisle want to solve the crisis.  They genuinely do.  But they also want to exploit the crisis to enhance their appeal to voters.  Republicans want to appear in charge and able to make the difficult decisions to solve the crisis.  Democrats support a rescue, but only insofar as they can pin the blame for the mess on the last eight years of Republican government.  As for us — the voters, the taxpayers, the depositors — our interest is in our leaders making the right decisions, which in this case is to implement Paulson’s bailout.  We enjoy the political theater, yes, but please fix America’s problems.

Feel free to send this around…

Latin America: Economist Special Report

September 19, 2010
Latin America: anti-inflation consensus and strong fx reserves  Source: vivirlatinamerica.com
Latin America: anti-inflation consensus and strong fx reserves Source: vivirlatino.com

The Economist’s lengthy Special Report on Latin America last week is worth a read (see leader below), even though it failed to emphasize and adequately explain two critical causes of the region’s recent success — 1) the consensus among Latin American politicians that conquering inflation has benefitted the poor and strengthened democracy; and 2) the massive build-up in fx reserves that has insulated the region from the global crisis, driven in part by healthy macro policies.  These issues were mentioned in passing by The Economist, but not given the focus deserved.  On the other hand, the longer articles in the Report on education, the informal economy and productivity were rich in detail and deserve a read. 

Latin America’s performance during the global economic crisis that began in 2008 was notable for the fact that the recession there was mild and the subsequent rebound robust.  One used to say that when the United States sneezed, Latin America caught the flu, but this time, the region has been inoculated against the contagion that has spread throughout the advanced economies.  In the 1980s, 90s and early 2000s, when economic shocks occurred in the advanced economies — including rising interest rates and lower prices for commodities and financial assets, this led to fiscal and balance of payments crises in Latin America, and often near or outright sovereign defaults (a la Greece).  This time, the Latins were ready.  The reason — strong fx reserves immunizing them from shifts in international capital flows.  How did they achieve this Gibraltar of reserves?  Through higher demand for their commodities from China and others, to be sure, but also through sound macro policies — floating exchange rates, an inflation-targeting monetary policy, and at least some fiscal restraint.  These policies have ensured that the balance of payments (the supply and demand of foreign exchange) adjusts to shocks, thereby bolstering investor confidence, which in turn limits capital flight during a crisis.  It’s a completely new ball game for most Latin countries.  Let’s hope they don’t let the weakest of these pillars — the commitment to fiscal prudence — slip, or they risk a return to the bad old days of boom and bust, especially when commodity prices inevitably weaken.

The Economist likewise points to Latin America’s strengthening democratic institutions as providing the political stability required to promote growth.  No argument there, but I would give a lot of credit for this to the taming of the inflation monster in the region.  After years of hyperinflation, driven by fiscal deficits and monetary accommodation, Latins broke the cycle in the nineties.  When leftists subsequently came to power, the fear of a fiscally-induced return to inflation rocked the capital markets.  President Lula was a case in point (see my post on the matter).  During his election to a first term in 2002, the bond markets sold off to default spreads, but recovered early in his tenure when they realized that this leftist, former union leader, imprisoned by Brazil’s military regime in the 1970s, retained much of his predecessor’s macro policies.  He did so because he understood that his constituency, the poor, had been hurt by inflation more than any other segment in society.  You see, the poor cannot index to inflation.  The understanding of this dynamic has led to a broad consensus in Latin society on economic policy, even when political institutions are weak and ineffectual, as in Peru and Mexico and to some extent in Brazil.  Deeper reforms that would underpin improvements in productivity, education, and the state bureaucracy remain elusive.  However, the three key pillars to macroeconomic stability (and to the political consensus) — again, flexible exchange rates, inflation targeting and fiscal prudence — remain largely in place.  With GDP growth averaging 5.5% per year in the five years to 2008, the impetus to reform is currently lacking.  See my in-depth analysis of Latin democracy here in Scherblog, written during the region’s last major election cycle (2005-07), when I discussed the delicate balance between populism and reform.   

As  a long-time Latam hand (I managed Fitch’s Latin American Sovereign Ratings group for seven years), I believe more emphasis than you will find in The Economist Special Report should be paid to the region’s 1) anti-inflation consensus, and 2) victory over the rollercoaster of balance of payments crises.   Have a read in any case…

Leader on Latin America from The Economist (Sept. 11-17):

The United States and Latin America

Nobody’s backyard

Latin America’s new promise—and the need for a new attitude north of the Rio Grande

Sep 9th 2010

THIS year marks the 200th anniversary of the start of Latin America’s struggle for political independence against the Spanish crown. Outsiders might be forgiven for concluding that there is not much to celebrate. In Mexico, which marks its bicentennial next week, drug gangs have met a government crackdown with mayhem on a scale not seen since the country’s revolution of a century ago. The recent discovery of the corpses of 72 would-be migrants, some from as far south as Brazil, in a barn in northern Mexico not only marked a new low in the violence. It was also a reminder that some Latin Americans are still so frustrated by the lack of opportunity in their own countries that they run terrible risks in search of that elusive American dream north of the border.

Democracy may have replaced the dictators of old—everywhere except in the Castros’ Cuba—but other Latin American vices such as corruption and injustice seem as entrenched as ever. And so do caudillos: in Venezuela Hugo Chávez, having squandered a vast oil windfall, is trying to bully his way to an ugly victory in a legislative election later this month.

Yet look beyond the headlines, and, as our special report shows, something remarkable is happening in Latin America. In the five years to 2008 the region’s economies grew at an annual average rate of 5.5%, while inflation was in single digits. The financial crisis briefly interrupted this growth, but it was the first in living memory in which Latin America was an innocent bystander, not a protagonist. This year the region’s economy will again expand by more than 5%. Economic growth is going hand in hand with social progress. Tens of millions of Latin Americans have climbed out of poverty and joined a swelling lower-middle class. Although income distribution remains more unequal than anywhere else in the world, it is at least getting less so in most countries. While Latin American squabbling politicians blather on about integration, the region’s businesses are quietly getting on with the job—witness the emerging cohort of multilatinas.

As they face difficulties in an increasingly truculent China, no wonder multinationals from the rich world are starting to look at Latin America with fresh interest. Sir Martin Sorrell, a British adman, talks of the dawn of a “Latin American decade”. Brazil, the region’s powerhouse, is the cause of much of the excitement. But Chile, Colombia and Peru are growing as handsomely and even Mexican society is forging ahead, despite the drug violence and the deeper recession visited on it by its ties to the more sickly economy in the United States.

Two things lie behind Latin America’s renaissance. The first is the appetite of China and India for the raw materials with which the continent is richly endowed. But the second is the improvement in economic management that has brought stability to a region long hobbled by inflation and has fostered a rapid, and so far sustainable, expansion of credit from well-regulated banking systems. Between them, these two things have created a virtuous circle in which rising exports are balanced by a growing domestic market. Because they were more fiscally responsible during the past boom than in previous ones, governments were able to afford stimulus measures during the recession. There is a lesson here for southern Europe: Latin America reacted to its sovereign-debt crisis of the 1980s with radical reform, which eventually paid off.


The danger of complacency

Much has been done; but there is much still to do. Building on this success demands new thinking, both within Latin America and north of the Rio Grande.

The danger for Latin America is complacency. Compared with much of Asia, Latin America continues to suffer from self-inflicted handicaps: except in farming, productivity is growing more slowly than elsewhere. The region neither saves and invests sufficiently, nor educates and innovates enough. Thanks largely to baroque regulation, half the labour force toils in the informal economy, unable to reap the productivity gains that come from technology and greater scale.

Fixing these problems requires Latin America’s political leaders to rediscover an appetite for reform. Democracy has brought a welcome improvement in social policy: governments are spending on the previously neglected poor, partly through conditional cash-transfer schemes, a pioneering Latin American initiative. But more needs to be done, especially to improve schools and health care, if everyone is to have the chance to get ahead. Also needed is a grand bargain to tackle the informal economy, in which labour-market reform is linked to a stronger social safety-net. And, even if some things like infrastructure and research and development plainly need more government spending, the worry is that triumphalism over escaping the financial crisis may prompt a return to a bigger, more old-fashioned state role in the economy—despite the failure of these policies in the region in the past.

Getting these things right will be easier if relations with the United States improve. Latin America needs to shed its old chippiness, manifest in Mr Chávez’s obsession with being in the hated yanqui’s “backyard”. More sensible powers, notably Brazil, should be much louder opponents of this nonsense. As they start to pull their weight on the world stage, working with the United States will become ever more important.

The attitude of the United States needs to change too. Worries about crime and migration—symbolised by the wall it is building across its southern border—are leading it to focus on the risks in its relationship with the neighbours more than on the opportunities. This is both odd, given that Latinos are already the second-largest ethnic group north of the border (see article), and self-defeating: the more open the United States is towards Latin America, the greater the chances of creating the prosperity which in the end is the best protection against conflict and disorder. After two centuries of lagging behind, the southern and central parts of the Americas are at last fulfilling their potential. To help cement that success, their northern cousins should build bridges, not walls.

Russia: Is the sovereign rating useful?

September 8, 2010

 

Does Russia’s sovereign rating tell us any more than the oil price?

Fitch Ratings today published a press release revising the “Outlook” on its “BBB” rating of Russian government bonds to positive from stable (see a Fitch press release below).  Rating agencies – Moody’s, Standard & Poor’s and Fitch – have been under fire since their high structured real estate ratings were downgraded rapidly during the recent financial crisis, suggesting that these ratings were wrong and therefore not a useful guide to investors.  Over the last two years, financial regulators have had their plates full preventing a 1930s-style banking collapse.  As a result, though they would like to kick the rating agencies in the pants to shake out the mediocrity, they haven’t had the time.  Are credit ratings useful? 

Yes and no.  Sometimes rating agency analytical reports are good, comparatively unbiased guides to the safety of bonds from sovereign governments and corporations, especially relative to investment bank reports.  However, the ratings themselves are sticky and often follow changes in creditworthiness (sudden ones anyway) rather than lead them.  Rating agencies don’t want to stick their necks out.  Conflicts of interest (agencies are paid by the bond issuers) are not to be dismissed, though somehow there is a more arms-length analytical relationship between bond issuers and the agencies than between the same and the investment banks, who fall over themselves to extol the virtues of clients that issue debt or equity.

Furthermore, sometimes a bond issuer’s profile is so tied to the price of a commodity (say, oil) that an investor is better off tracking the commodity price than bothering with ratings.  This is the case with “Rising Power” Russia.  Russia’s economy has long been dominated by energy exports.  Little has been done to diversify the economy in the way that its BRIC peers — China, Brazil and India — are diversified.  Energy prices rise and Russia’s ratings improve, and vice versa.  Yet the agencies go to great lengths to spell out the details of Russia’s credit profile in their reports.  As I said, sometimes the reports are good, especially for an econ nerd; but, the rating actions themselves – the reason agencies are paid so handsomely — can be of little use.

With oil prices rising rapidly over the last decade, Russia’s sovereign ratings rocketed from near-default levels (CCC) in 2000 to investment grade levels (BBB) today.  The ratings peaked at BBB+ from 2006 to 2008, when the price of a barrel of oil topped out at around $140 before collapsing to near $50 during the dog days of the global economic crisis in the fall of 2008.  That’s coincidentally when Fitch put Russia’s ratings on a Negative Outlook, before lowering the ratings to BBB in February 2009.  Since then, oil prices have clawed back to around $75 per barrel, and Fitch has again moved the Rating Outlook, first to Stable and then today to Positive.  This is all well and good, but the oil price was nearly as useful a guide as the ratings over this time frame, just as it was in 1998 when Russia defaulted on its bonds amid oil prices in the neighborhood of $10 a barrel.  Yes, the rating reports are informative, but if the agencies are to be more useful to investors (and society), they should try harder to predict financial developments and have their ratings lead, rather than follow, these developments.  And, they should show some skill at this before the regulators get around to kicking them in the pants.   

FROM FITCH RATINGS TODAY:

  Fitch Affirms Russia at ‘BBB’; Revises Outlook to Positive   
08 Sep 2010 8:04 AM (EDT)

Fitch Ratings-London-08 September 2010: Fitch Ratings has today affirmed Russia’s Long-term foreign and local currency Issuer Default Ratings (IDRs) at ‘BBB’. The Outlooks for the Long-term IDRs have been revised to Positive from Stable. At the same time, Fitch has affirmed Russia’s Short-term foreign currency IDR at ‘F3’ and the Country Ceiling at ‘BBB+’.

“The Russian economy is recovering after being hit hard by the global financial crisis. The outlook revision to positive reflects Fitch’s belief that the decline in inflation, shift to a more flexible exchange rate policy, sizeable repayments of private sector external debt, stabilisation of the banking sector and rising foreign exchange reserves should serve to reduce the country’s financial vulnerabilities,” says Ed Parker, Head of Emerging Europe in Fitch’s Sovereigns team.

Real GDP grew by 5.2% year-on-year in Q210, having contracted by 7.9% in 2009. Fitch forecasts growth of 4.3% in 2010 GDP and 4% in 2011 and 2012 – broadly in line with estimated potential. Recovery appears to be fairly balanced, and is supported by the rebound in oil prices, rising real incomes and stabilisation of financial confidence and capital flows.

The private sector has strengthened its balance sheets, where vulnerabilities had built up in the boom years. It repaid a net USD80bn in external debt in the two years to June 2010, including USD51bn of short-term debt, reducing its refinancing requirements and foreign currency exposures. Banks are liquid and have high reported capital ratios of around 19%. Asset quality appears to have stabilised, though Fitch estimates total problem loans at about 25% (including restructured loans at extended maturities and off-balance sheet exposures). A sizeable current account surplus, which Fitch forecasts at 4.6% of GDP in 2010, is helping Russia to rebuild its foreign exchange (FX) reserves, which have risen by USD92bn from their low in Q109 to USD476bn – the third-highest in the world – providing a formidable buffer against shocks. Russia is a large sovereign and overall net external creditor, the latter equivalent to 24% of GDP at end-2009, compared with a net debtor position for the ‘BBB’ range median.   

Inflation has declined to 6.1% in August, from double-digit rates 12 months previously. The Central Bank of Russia has shifted to a more flexible exchange rate and independent monetary policy regime, with positive real interest rates, which has the potential to help reduce inflation, dollarization and the risk of financial instability. However, the Central Bank of Russia has yet to build up a track record in this area.

Russia’s public finances have deteriorated over the past two years, though remain a rating strength. Fitch forecasts the budget deficit at 4.7% of GDP in 2010. Moreover, the budget balances at an oil price of around USD100pb, highlighting its vulnerability to a severe and sustained oil shock. However, general government debt is low, at only 10% of GDP at end-2009, compared with the 10-year ‘BBB’ range median of 35%. Moreover, the government has USD127bn (9% of GDP) in its sovereign wealth funds (1 September 2010), providing substantial financing flexibility, as demonstrated in 2009.

Weaknesses that weigh on Russia’s sovereign rating include its poor governance, institutions and corruption; a weak business climate that constrains investment, diversification and growth; exposure to commodity prices (and therefore the global economy); and a history of high and relatively volatile inflation.

In terms of potential triggers for future rating actions, a tightening of fiscal policy that significantly reduces Russia’s non-oil and gas budget deficit and its vulnerability to oil price shocks could lead to an upgrade. Material structural reforms that improve the business climate, banking sector and governance could also lead to an upgrade. A longer track record of implementing a more flexible exchange rate policy and anchoring inflation at the mid-single digit rate could put upward pressure on the ratings; as could a material strengthening in the external balance sheet. Conversely, a severe and sustained drop in oil prices could lead to negative rating action.

China: Growth slowing

July 15, 2010
China: the government tries to manage the economy.  Source:  Google Images China: the government tries to manage the economy. Source: Google Images

Shallow piece in the NYTimes today on a modest slowdown in economic growth reported in China for the second quarter, prettily written by non-economists.  For a better analysis, not so elegantly written, have a look at the CSFB note from today (below) that explains that growth has slowed due to slackening investment (in Chinese terms — down from a strong expansion of 3% per month in April and May to 1.4% month/month in June) and to downturns in the property and stock markets.  CSFB sees this modest slowdown as exactly what the Chinese authorities are looking for to keep inflation in check and as giving no indication that monetary policy will be tightened much further from its current setting.  CSFB notes that consumer demand and, notably, exports remain quite robust in China.  

What should be underscored about China is that the state still calls a lot of the shots in that economy, much more so than in Western economies (well, okay, there is always France).  The central government directs banks to lend and regulates credit to local governments, which impacts investment, including real estate and infrastructure.  So, in addition to the traditional levers of fiscal and monetary policies which we’re familiar with in the West, the Chinese government has more heavy-handed policy tools (although in the wake of the financial bailouts in the West, we shall see how interventionist the state becomes). 

Also worth understanding is that while China now plays a major role in the world economy, it cannot alone drive the world out of its doldrums.  Whether or not there is a double-dip recession, and odds are there may well be in some countries, will be determined in the massive economies of the US, Europe and Japan, still reeling from the financial shocks and consequent poor public debt dynamics of the last few years. 

From CSFB today:

China
Dong Tao
+852 2101 7469
dong.tao@credit-suisse.com
The economy expanded by 10.3% yoy in Q210, less than the market consensus of 10.5%. While the headline growth figure seems acceptable, we estimate that annualized quarter-on-quarter growth dropped to about 1.9%, from 2.7% in Q110. A large part of the growth deceleration came from inventory corrections and a slowdown in fixed asset investment. Based on our calculations, total fixed investment growth moderated to about 9% qoq (sa) in 2Q from about 13.4% in 1Q. However, the growth momentum was supported by robust consumption and rebounding exports. Meanwhile, inflationary pressure has eased.
Retail sales grew by 18.3% yoy, versus 18.6% yoy in May. Sales have remained very solid despite the anecdotal evidence of slowing auto and home appliance sales. We think it is the consumers from smaller cities and rural areas, who are less exposed to the property and stock market downturns, who have delivered. The resilience in private consumption continues to be the pillar of our argument that economic growth will moderate but not collapse in H210 and that Beijing is in no hurry to ease.
Fixed asset investment grew 24.5% yoy in June, versus 25.6% in May, and, on our calculations, fixed investment growth moderated to 1.4% mom (sa) in June from over 3% in the previous two months. In view of tightened credit conditions faced by local governments, we expected infrastructure investment to decelerate further, although remaining large in absolute terms. Housing construction activities seem to have held up well for now, but we anticipate a sharp slowdown in H210 if transaction volumes do not pick up quickly. The slowdown in fixed asset investment will be the key determinant for growth over the next 12 months, in our view.
Industrial production growth saw a sharp fall to 13.7% yoy in June, from 16.5% in May and 18.6% during the first five months. On a seasonally adjusted month-on-month basis, we estimate that industrial production declined by 0.8%, the first decline since November 2008 (excluding the Chinese new year period). This is consistent with the decline in power consumption growth in June and the suspensions of production in the steel and auto sectors. We believe inventory corrections will continue for at least a few more months, based on our discussions with manufacturers, who are concerned about the property sector and a global “double-dip”. Government policies, such as suspending export tax rebates and promoting energy-saving measures, and its supportive stance towards labour compensation, may also play a role. The floods along the Yangtze River are likely to cause production problems as well.
CPI inflation softened to 2.9% in June from 3.1% in the previous month. Inflation softened by 0.6% on a month-on-month basis. This occurred despite bad weather conditions. In view of the slowdown in economic activity in H210, we expect a further small easing in production costs. However, surging wage rates and rising food prices may prove to be stubborn. Food prices have started to rise again in July, as reduced production of summer crops has been confirmed. More importantly, ‘hot money’ is competing with the state purchasing agent in purchasing grain from farmers. A crucial factor that pulled headline inflation down was falling pork prices. However, that trend has reversed and pork prices have edged up over the past 2-3 weeks. The consequences of “foot and mouth disease” and surging feed costs are starting to become evident, and we expect a significant rise in pork prices in H210. Pork counts about 8% of China’s CPI basket. We are revising down our year-average CPI forecast for 2010 to 3% from 3.7%, based on a weaker outlook for growth and falling production costs. However, we set our year-end inflation target at 3.3% to reflect the inflationary pressure from food and services (through wage hikes). We now expect one 27bps interest rate hike in both the one-year lending and deposit rates by the end of this year, and two more hikes in 2011.
While growth momentum may have fallen ‘one notch’, we believe demand for commodities may have gone down ‘two notches’. However, we still think that economic growth is unlikely to collapse in the way it did in 4Q08, as consumption remains solid and liquidity remains ample. Other than for CPI and the interest rate outlook, we are not changing any of our forecasts.
We believe that this set of data will not result in much in terms of policy changes. The moderation in growth is exactly what Beijing has aimed at, in our view, and the pace of softening seems to be acceptable (the government focuses on the year-on-year growth number). The government has already entered a ‘pause’ phase in its tightening strategy, and we do not expect much in the way of new tightening measures. Neither do we expect the policy gear to be shifted to easing mode, at least in Q310. The central bank has resumed the net draining of liquidity in its open market operations this week after the listing of a major commercial bank, and the authorities have reiterated their determination to squeeze the ‘bubble’ in the property market.

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:  http://acalzonquitao.files.wordpress.com/2008/09/_pinochet_junta.jpg
General Augusto Pinochet (seated) and friends, the junta that ruled Chile from 1973-90. Source: http://acalzonquitao.files.wordpress.com/2008/09/_pinochet_junta.jpg

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: http://acalzonquitao.files.wordpress.com/2008/09/_pinochet_junta.jpg

Couples therapy: China and the U.S.

June 16, 2010
Nixon & Mao: Mutual dependence goes back a long way.   Source: www.china-profile.com
Nixon & Mao: Mutual dependence goes back a long way. Source: http://www.china-profile.com

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:  http://www.china-profile.com

From AP:

China and other countries buy US Treasury debt

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

ap

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.