Gleanings II ~ 490 Nick Rost van Tonningen Posted by John on December 15, 2012
The fiscal cliff challenge could be solved within 48 hours by taking a leaf out of the pre-Eurozone EU days (or out of the process for electing a new Pope). In those days, when a deadline for a critical decision was imminent (or sometimes after it had passed but the clock had been stopped by mutual agreement), the countries’ leaders, each accompanied by a single adviser, would lock themselves into a room & engage in old-fashioned horse-trading until a deal was cut. In this case, seven people (the President, the House & Senate Majority & Minority Leaders, and two number crunchers) would decamp to Camp David on the understanding that they would stay there & keep themselves incommunicado until they had a deal. Both sides would, or at least should, have a good read on how much support there would be from how many of their followers for various deal components. The end result would likely be a much more encompassing deal than can be expected from the current process (& might even involve the broad outline of a deal on the debt ceiling). And it would, by definition, have broad bipartisan support & isolate the extremists in both parties. In this process the heavy lifting should be done by the four Congressional leaders with the President’s role being one of providing leadership by keeping them on topic & helping them to arrive, subject by subject, at a consensus that likely none of the five principals (incl. himself) would like 100% but could live with and, most importantly, be able sell to a majority of their troops – wouldn’t it just be delightful to see the dismay of the thousands of politicos, lobbyists & media types in Washington at being left out of the loop & in the dark.
The Republicans have made a strategic mistake. They should have conceded the revenue issue after token resistance, so as then to be able to turn tables on the President by asking “And now about spending cuts?” Everyone knows that the key problem is a spending one & that this President has a spending bias. But the empirical evidence shows that in situations such as the US is in, spending cuts produce better results faster than tax increases (because the latter are akin to giving another drink to an alcoholic). When Robert Rubin, Clinton’s one-time Secretary of the Treasury, was interviewed on CNN about the spending cuts that ne boasted Obama had proposed, the two lame examples he came up with were a) the money that was going to be saved by pulling out of Afghanistan & b) that which was going to be saved by having to pay less interest on the national debt because the deficit was going to be lower than it otherwise would have been, neither of which have any relevance to the need for cutting current spending!
On a few occasions in the past I have referenced the ‘Sword of Damocles’-like threat that derivatives pose to the global financial system. But a question as to the size of the, still largely unregulated, pool of derivatives outstanding prompted me to go to the BIS data base for the answer. Apparently the total outstanding as of mid year had a nominal value of US$1.150 QR (quadrillion/one million billions), i.e. roughly :
-10x the total assets of the global banking system
-15x global GDP
-70x US GDP; and
– 150x the total assets of the Top 4 US banks (JPM, BoA, Citi & Wells Fargo).
The good news is that this ‘nominal value” number grossly overstates the real financial risk involved. For in the very unlikely event this whole house of cards went POOF, the lion’s share of the nominal risk exposure could be eliminated by the “netting out” of positions leaving a real risk potential of 1%, possibly a little less, but likely a little more, but not as much as 2%, of the nominal value. The other bit of good news, for the leading US banks at least, is that a year or so ago they en masse ‘laid off’ much of their derivatives’ risk onto Uncle Sam (although in the worst case scenario this would further compound his already considerable fiscal problems).
Now for the bad news. The lessons of 2008 prime loan crisis were obviously wasted on the global banking system; for the nominal value of derivatives outstanding has more or less doubled since then, i.e. been allowed to continue to grow at a double digit compound annual rate. Secondly, the average quality of the players in the derivatives markets has likely suffered in the process (thus there are now an estimated 1,000 banks in the US with some degree of derivatives’ exposure, even though their aggregate global market share has been declining). The original players in the derivatives game 30 years ago were a relatively small number of big US banks who were soon joined by another small number of top drawer European banks with then, over time, more marginal players from more countries joining in who, to try & gain critical mass would offer finer pricing & more complicated, “Proprietary Products”. Secondly, 40+% of all derivatives outstanding are classified as “interest-rate derivatives”, i.e. bets on future interest rates. And with business people starting to get a bit more antsy about inflation & the higher interest rates that will accompany it, or follow in its wake, there will be great temptations for banks to sell such derivatives “naked”, at least for the time being; for with Chairman Bernanke having promised to keep them low for “an extended period of time” (14 of the 19 voting & non-voting members of the FOMC at last report were reported believing that the first change in interest rates will not come until 2015 at the earliest), doing so would generate some nice ‘risk-free’ cash flow for the foreseeable future (exactly the type of thinking that brought AIG to its knees five years ago). Thirdly, in any solving a derivatives’ crisis, all the netting required would take time, some counterparties would prove unable to meet their commitments, since the derivatives’ business is a sandbox still dominated by a relatively small number of very large banks, many, most or all of whom have exposures to derivatives out of all proportion to the size of their balance sheets, systemic illiquidity could temporarily paralyze the system, inflicting ‘collateral damage’ on smaller banks that had stuck to their traditional, safe but boring, commercial banking knitting. Last but not least, while the nominal value of the derivatives ‘book’ outstanding may vastly overstate the real risk they entail, many banks’ derivatives’ exposure is so overleveraged to their balance sheet that even relatively small loss experiences could raise havoc with their capital adequacy ratios.
The BIS statistics also showed that gold-based derivatives totaled US$320BN, a relatively minor amount in the derivatives market context, but not in gold market terms. For at US$1,700/ounce, one tonne of gold is worth approx. US$55MM. This means that this US$320BN mountain of ‘paper gold’ represents about 5,800 tonne-worth, the equivalence of two years’ newly mined production & of 15-20% of the world’s central banks’ reported gold holdings.
On the subject of gold there were two news ‘bytes’ worthy of note. South Africa not many years ago was the world’s No. 1 gold producer. Last year it was No. 4, behind China, Australia & the United States (& a nose ahead of Russia). But this year its gold output has been sliding seriously (October it was down 45.7% YoY) in part because of chronic labour unrest but in part also because its mines are, old, tired & increasingly high cost; so it’s likely to tumble further in the standings (this is the country that some misguided souls group with the BRIC ones?). The other somewhat related item was that the big gold mines have allowed their costs to get out of hand : in 2011 they were up 23% YoY, and the current year’s results may not be all that different. Letting them rip was OK when the price of gold was climbing inexorably. But for the past 15+ months it has been relatively flat, albeit still at near historically high levels. So the big producers have had to try & smooth their irate shareholders’ ruffled feathers by promising to make their bottom-, rather than their top-, lines their No.1 priority (which in the short-to-medium term will help shrink the newly mined supply, thereby possibly giving some more oomph to the next leg up of the price of gold out of the trading range it has been for the past 15+ months.
The Fed reported that in October US consumers’ debt load had increased by US$14.2BN (0.5%) to US$2.75TR, US$10.8BN of it due to increased auto- & student loans, & the remaining US$3.4BN to growth in credit card debt. Subsequently to this, however, its Flow of Funds report released on December 6th showed US household net worth had risen in the Third Quarter by US$1.7TR to US$64.8TR, US$800BN due to an increase in the value of their stocks & mutual funds, US$370BN to an increase in real estate values, & the balance to household debt having declined at a 2% annual rate (driven by mortgage debt declining at a 3% annual rate).
The latest Israeli opinion polls shows that, as of December 7th, the centre-right block was leading the centre-left one 69.5 vs. 50.5 (in terms of Knesset seats). This change from the 64.0 vs. 56.0 split of October 25th is attributed to the international reaction to the Netanyahu decision to build 3,000 more housing units in East Jerusalem (Israeli public opinion typically shifts sharply to the right in “them against us” circumstances). As to individual results, the Likud-Yisrael Beitenu merger resulted, as some had predicted, in a loss of public support : whereas the two parties had a combined 42 seats in the old Knesset & a November 29th poll gave the merged party 38, in the latest, December 7th, poll, that had shrunk further to 36. Kadima remains a non-event, with two seats, Labour went from 18 on the 29th to 19 on the 7th (it is hampered by its focus on domestic social issues that, although people tell pollsters are their top priorities apparently do not make them vote accordingly), Tsipi Livni’s new party went from 9 to 12, another new party, Yesh Atid, from 5 to 7, and Shas from 14 to 9 (the extreme right is even more split than usual).
The Caixin Media Company is China’s most prominent independent source of economic & financial news. It recently reported that a group of academics had found that 16.4% of urban 21-25 year olds with an undergraduate degree or better had reported being unemployed, compared to only 4.2% of those in the same age cohort in the cities who had never gone to school or had dropped out before middle school – just imagine the frustration the former must feel to have survived, say, 15 years of highly competitive & brutally stressful schooling only find out, when all is said & done, that for them there is no pot of gold at the end of the rainbow (while watching their luckier class mates enjoying the “good life”). This is another problem facing the incoming Xi Jinping Administration; for few things are potentially more socially-destabilizing than well-educated youngsters with no future. And what loss of face for the individuals & their parents!
Former German (Social Democrat) Chancellor from 1974 to 1982, Helmud Schmidt, now 94, last month told an economic conference in Hamburg that “public confidence in European governments and the EU has been shattered and Europe is on the verge of revolution.”
Hugo Chavez went back to Cuba for more cancer surgery. There were complications. If he were to kick the bucket, either before or after his January 10th Inauguration Day, the Constitution he put in place himself calls for the election of a new President within 30 days.
GLEANINGS II – 490
Thursday December 13th, 2012
LOW INTEREST RATES PUTTING STRESS ON WORLD ECONOMY (CP)
- Bank of Canada Governor Mark Carney has warned before about the dangers of low interest rates, but now the Bank’s Governing Council has formally weighed in on the issue by adding it to the list of risks facing Canada & the world. For in its December 6th semi-annual report it warned that its own low-interest policies, & those of other central banks, are adding another layer of risk to an already fragile global financial system & economy. For the resultant low yields on fixed income assets have driven insurance companies, pension funds, & investors generally into taking greater risks in search of higher returns.
A few years ago, during the US subprime loan crisis there was much chatter about “moral hazard”, a phenomenon which was then defined as financial intermediaries routinely taking dumb risks because they expected to transfer the cost of being wrong onto someone else. This is just another aspect of the same phenomenon, except that in this case the takers of undue risks are driven into doing so by the those supposed pillars of financial rectitude, the central banks. As far as the local economy is concerned, its report warned that the overbuilding of condos in major cities could lead to a more widespread housing collapse, that it was vulnerable to a number of interrelated, mostly external risks and that while the rate of growth of household borrowing has slowed, it is still growing faster than disposable incomes, & still way too hig
IN EUROZONE, A BLEAK OUTLOOK TURND DARKER (G&M, Eric Reguly)
- On December 7th the ECB announced that it was holding its benchmark lending rate at 0.75% despite revising its outlook for economic growth (or lack thereof). It now expects the Eurozone economy to contract 0.5% this year (down from the minus 0.4% it had expected earlier). And its forecast for 2013 now is for a further 0.3% contraction (disastrously down from its previous 0.5% growth forecast). That same day, across the Channel the Brits also lowered their forecasts. This suggests that economic performance in both places during the next couple of years will be insufficient to bring down unemployment (11.7% in the Eurozone & 7.8% in Britain). And yet both kept their rates steady, with the ECB noting that inflation, while coming down, is still above the 2% target, & that borrowing costs for the struggling eurozone countries had dropped dramatically since it had announced, but not yet implemented, Outright Monetary Transactions program to buy their bonds.
One critic of the ECB’s rate inertia opined that it appears to believe in “green shoots sprouting in winter and half-empty glasses turning half-ful, (rather) than in their own staff’s projections.”
DIAMONDBACK TO CLOSE AFTER CLIENTS PULL OUT (Reuters, Svea Herbst-Bayliss)
- Founded in 2005 by three alums from Steven A. Cohen’s successful SAC Capital Advisors, this hedge fund quickly attracted US$6BN in investor money from clients such as New Mexico’s pension fund & Blackstone’s fund-of-funds unit & rewarded them with average annual returns of 9%, even during the financial crisis when many of others bled red ink. But it all came to a screeching halt in 2010 when federal agents raided its Stanford, Conn. headquarters & locked its employees in a conference room while they boxed up company records as part of an insider trading probe (in the aftermath of which its AUM dwindled to US$1.45BN). Then in mid-November investors asked for US$520MM of their money back, 5x the amount expected, prompting management to announce in a letter dated December 6th “the most prudent course is to wind down … terminate the fund & return investor capital.”
Investors typically don’t have that much patience, or loyalty, these days.
SALES OF AMERICAN EAGLE GOLD COINS SOAR (FT, Jack Vardy)
- In November sales were up 131% MoM to a level over 3x those during the year-earlier period, & to their highest level in over two years, as in the aftermath of the Presidential election American retail investors resumed fretting about the apparent lack of action in addressing their country’s fiscal situation. Sales of Maple Leaf gold coins at the Royal Canadian Mint also soared.
Net new sales of the 14 US listed ETFs have also been strong (up US$282MM in the week ended December 7th) during which the price of gold softened by US$10/ounce).
FOOD PRICES TO RISE IN 2013 (G&M, Tavia Grant)
- A University of Guelph paper released on December 6th forecasts food prices will rise between 1.5% & 3.5% in 2013, up from just 1% this year. According to Sylvain Charlebois, lead author of the report and a researcher in food distribution & policy “This year, we saw the national inflation rate exceed food inflation. Next year it’s actually going to be the opposite – we’ll likely see food prices exceed the national rate. Geopolitical factors will create upward pressure on food prices, especially grain, driving increases in meat & eggs. On the other hand, Wal-Mart Canada’s expansion, Target’s foray into Canada, & the strong Canadian dollar will have a dampening effect on food prices. The full impact of this year’s crippling drought in the US won’t be felt until early 2013 when it will start push the cost of proteins up : meat between 4.5% & 6.5%, egg prices up to 5%, and grains, fruits & vegetables 1% to 3%.
Longer term the university expects food prices to increase steadily in the coming years. But, it says Canadians can mitigate the impact of the higher prices by wasting less food; for they waste as much as 38% of the food they buy.
KING ABDULLAH FIRST LEADER SINCE UN VOTE TO VISIT WEST BANK (NYT)
- He flew into Ramallah by helicopter on December 7th (to boost the status of Mahmoud Abbas the day before Hamas’ Qatar-based Leader Khaled Meshaal, visited Gaza?).
Jordan controlled the West Bank from 1948 until Israel seized it during the 1967 Six-Day War. He has a vested interest in a two-state solution, if only because of the occasional chatter in Israel that Jordan might be an alternative homeland for the Palestinians. Such talk is extremely disconcerting for the Jordanians who already share their land with large numbers of them (30% of Jordan’s 6½ MM population is of Palestinian descent).
COWARDICE AT THE HEART OF OUR RELATIONSHIP WITH ISRAEL (DT, Peter Osborne
–The Conservative Party has its very own pro-Israel cheering section. It’s called the Conservative Friends of Israel (CFI). About 80% of all Conservative MPs & most Cabinet Ministers are members. The late Conservative politician & historian Robert Rhodes James in 1995 in the Jerusalem Post called it “the largest organization in Western Europe dedicated to the people of Israel.” On December 11th it hosted a luncheon in central London which was attended by about 100 MPs, incl. Six Cabinet Ministers & 40 peers, & addressed by Prime Minister David Cameron, a self-professed “passionate friend of Israel”
-While Tony Blair sometimes seemed to go as far as regarding the interests of Britain & Israel as identical, William Hague & David Cameron have tried to be more robust, albeit with little success. The government’s formal decision is excellent, it supports a two-state solution, but, having done that, it refuses to take concrete steps to help bring it about.
-The absolute truth is that Netanyahu is leading Israel down a blind alley, a path to self-destruction. A few hours before the December 11th CFI luncheon, Mark Simmonds, a junior Foreign Office Minister, acknowledged this in the House of Commons when he went on record as saying “I think the door is beginning to close on the realistic possibility of a two-state solution”. William Hague himself believes settlement construction will render it wholly impossible within two years at most. And on December 5th a former British Ambassador to Israel, the Hebrew-speaking Sir Sherard Cowper-Coles, made a speech in which he said, among others, ”I believe passionately that Israel on its present course is embarked on a pathway to assisted suicide … assisted by the Congress of the United States. The idea that the problem can be solved by walling up the Palestinians in the Middle Eastern equivalent of the Bantustans which the South African government embarked on in the 1940’s is not only offensive morally, it is deeply out of keeping with everything we know about human history. It will not work, it cannot work, it should not work. And anyone who has real affection for the Jewish people will want to help them avoid this looming disaster.”
Israel was founded as a democratic Jewish homeland. Today this has become an oxymoron. For if it insists on giving its Arab citizens second tier status, as it has started to do & on putting the non-citizen Arabs in ghettoes, it can hardly be called democratic anymore. But if it deals with them in any other way short of expulsion, it will lose its Jewishness. The third option, of course, would be to agree to a two-state solution but realistically speaking its own policies have wasted valuable time & have made an acceptable two-state solution more unlikely by the day.
A MESS OF ISRAEL’S OWN MAKING (G&M, Ian Buruma)
- The UNGA vote infuriated Prime Minister Netanyahu. He called Abbas a liar & authorized 3,000 more homes for East Jerusalem. But Israel has only itself to blame. Mr. Abbas & his Prime Minister have been more moderate & open to negotiations, than any Palestinian leaders before. Improving the economy, not violent confrontation, has been the their main concern. And the Palestinian police has worked with the Israelis to contain violence. But by building ever more settlements, the Israeli government undermined the authority of Abbas & Fatah & led ever more Palestinians to conclude Hamas has the better approach. And far from intimidating the Palestinians in Gaza, the Israelis made Hamas look heroic.
- Israel is using colonial methods, ruling by proxy, dividing potential rebels, rewarding obeisance & punishing opposition. But history has shown this to be a road to nowhere. Humiliation is not a basis for stability. Demoralizing those still willing to talk invites disaster & makes the chances of a peaceful settlement vanish & violence the only option. And it’s was one for the colonial power & the colony to be distant from each other, but something quite different when the colonial power & the colony are joined at the hip, and surrounded by unsympathetic countries.
The author is Professor of Democracy, Human Rights & Journalism at Bard College in upstate New York. He has sometimes been criticized for his too laid-back views on radical Islam, as witnessed by his comment on the French law banning the wearing of burkas (“Living with values that one does not share … is the price to be paid for living in a pluralist society”). Nevertheless, in 2010 he was one of Foreign Policy’s Top 100 Global Thinkers (& he cannot be all bad; for he was born in the same city I was, albeit to a British mother).
THE ISRAEL-PALESTINE PROBLEM HAS A SIMPLE SOLUTION (DT, Matt Hill)
- The makings of a solution are in place. There is widespread acceptance (except in Netanyahu’s head?), incl. the PA &, now it seems even Hamas, of the concept of a two-state solution. There is an established 1967 border that, with minor adjustments could form the basis of an agreed-to border. Jerusalem was partitioned prior to 1967 & could be again (albeit not so according to Netanyahu). And Palestinians in diaspora could return to their homeland as citizens of the new Palestinian state (with their “right to return” to their original roots on the Israeli side of the border presumably ‘bought off’ with gobs of money that would grubstake the new Palestinian state?). All that stands in the way of a solution along these lines is political stubbornness (or, rather, lack of statesmanship on the part of Israeli & the US?). The last time the two sides sat down, in Annapolis in 2007, their proposals on where the border would run in a two-state solution agreed on all but 250 sq. kms., less than 1% of the total landmass involved (this may understate the magnitude of the problem; for all of Jerusalem, for instance, accounts for less than 0.5%). But Netanyahu keeps insisting the conflict is insoluble & any talk of a one-state solution plays right into his hand. The real obstacle to a solution is rooted in politics, not in immutable facts. So we should not let leaders without vision off the hook by pretending they have no choice.
Unfortunately, politics is reality. One disturbing fact is that the first post-ceasefire poll suggested almost half the Israelis interviewed hadn’t learnt a damned thing from the past & still had their head in the sand when they said Netanyahu should have mounted a ground invasion (although polling techniques being what they are the question’s phrasing may well have predestined the poll’s outcome).Netanyahu’s latest settlement building binge in East Jerusalem will effectively cut it off from the West Bank – the whole settlement exercise has, of course, been (indirectly) funded by the US aid to Israel & could, of course, also have been brought to a screeching halt long ago by the suspension of that aid.
CHINA SURPASSES THE U.S. AS THE WORLD’S TOP TRADING PARTNER (AP)
- In 2006 the US was the top trading partner for 127 countries & China for 70 but by 2011that had reversed to China’s 124 vs. the US’ 76. This is changing lives everywhere, with more farmers planting soybeans to sell to China & more students signing up to learn Mandarin. And it is gradually translating into political influence, first in neighbouring Asia, then in Africa & now into America’s traditional backyard, Latin America (& even with China’s economy now slowing, its share of global output & trade is expected to keep rising). One example of this trend is Shin Cheol-soo. For a decade his business produced components for US automakers. But earlier this year he uprooted his family from Detroit & moved back to South Korea to focus more on sales to China : while last year his company, ENA Industry Co. sold half its output to US factories, with China having surpassed the US as the world’s largest car market, he plans to have sales to China rise five-fold to 30% of their total by 2015.
“The US”, he shrugs,”is a tiger with no power.”
CHURNING THE OCEANS (The Economist)
- Both China & India are transforming their navies “from forces concerned for… denying their neighbouring waters to hostile powers to instruments that can project force far beyond their shores.” China’s plans to build a ‘blue water navy have received most notice. Last year its first-ever aircraft carrier, bought from the Ukraine, began sea trials & other, locally-built, carriers are on the way, and by 2020 it plans to have 73 large naval vessels & 78 submarines, incl. 12 nuclear-powered ones. But India has had two carriers for half a century, aims to have three carrier groups operational by 2020, & by 2022 160 naval vessels, and, like China, a sea-based-, as well as land-based-, nuclear deterrent. And while India is paranoid about China seeking to bottle up its navy with naval bases around the Indian Ocean, incl. in Pakistan, Sri Lanka, Myanmar & Bangladesh, China is pre-occupied with what is sees as India’s efforts to undermine its territorial claims over almost the entire, supposedly hydrocarbon-rich, South China Sea & its growing defence ties with the US, Japan, South Korea & other South East Asian nations.
And in any confrontations between their two navies, the US Navy’ will be hampered by its longer supply lines & a scarcity of resources (although this may not matter much since any such event may not last long).
SCANDINAVIAN AIRLINES’ ‘DIRTY HARRY TACTICS’ RAISE EYEBROWS (Epoch Times)
- A month ago, on November 12th, all SAS flight staff received an ultimatum : agree to lower wages, longer hours & a higher retirement age, or have the Company declare bankruptcy; you have a week to decide! The highly unusual aspect of this was that the Swedish government stood four square behind the Company in this.
The Company has been a perennial money loser, in part because its business plan focuses on short haul flights where the competition from outfits like Ryan Air is murderous. In the event, after a marathon 30-hour negotiating session on November 18th & 19th it got all eight unions in three countries to agree to a deal that will include a 15% across-the-board wage & salary cut. This will give it access a new US$520MM credit facility from its banks & shareholder governments to keep going as it seeks US$450MM in savings, among others by cutting its staff 40% , switching most of its remaining staff from defined benefit-, to defined contribution-, pension plans, & consolidating its administrative operations in Stockholm – all this is ‘Socialist Scandinavia’?. WOW!
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