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Economists forecast 'not because they know, but because they are asked'
John Kenneth Galbraith
"The purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists."
There are many ways to get your bearings in an economic cycle. None is so reliable as a growing gap between words used to describe the current state of the economy and conditions observable on the ground.
ALAN GREENSPAN, the former chairman of America's Federal Reserve, always insisted when in office that it was extremely hard to spot bubbles before they had actually burst. This, he said, is one reason why policymakers should never try to prick them. Today, however, he seems to have no doubts that China's stockmarket is bubbling over. He recently declared that Chinese share prices were “clearly unsustainable”, with a risk of a “dramatic contraction”.
It is curious that China's bubble seems so blindingly obvious to Mr Greenspan and so many other Americans who remained in denial about their own dotcom mania right to the end. For according to The Economist's “Bubble guide” (see chart), China's recent share-price boom is still relatively modest compared with the giants of history. The chart plots the performance of Chinese share prices over the past five years against the three great bubbles of the 20th century: Wall Street in the 1920s, Japan in the 1980s and America's NASDAQ in the 1990s. The NASDAQ composite index saw a gain of more than 500% from 1995 to early 2000. Japan's Nikkei 225 jumped by 300% from 1984 to 1989. The Shanghai A-share index, having recovered most of its plunge in late May, shows a gain of about only 160% over the past five years.
Nor do the facts stop semiconductor dead fish (and the managements of these companies) from issuing optimistic forecasts. For a year now, they've been predicting margin expansion and a new up cycle, when all we continue to see is inventory building and demand sputtering.
It's certainly hard to support that view given recent tepid guidance from Texas Instruments (TXN, news, msgs), Fairchild Semiconductor International (FCS, news, msgs), Analog Devices (ADI, news, msgs), Altera (ALTR, news, msgs), Xilinx (XLNX, news, msgs), Molex (MOLX, news, msgs) and Microchip Technology (MCHP, news, msgs).
To me, this suggests that the so-called, and continuously proclaimed, bottom is really a prolonged top.
June 25, 2007 | Christian Science Monitor
Signs are appearing that private-equity groups may be having more difficulty making deals. Either way, signs are appearing that private-equity groups may be having more difficulty making deals, and how they conduct business is starting to change.
As of last Friday, for between $31 and $35 per share, anyone could own stock in the Blackstone Group, one of the nation's premier private investors. Similar private-equity groups are reportedly poised to offer shares as well. This means that these groups, which were set up to make money for pension funds and millionaires, are now bringing their hard-charging ways to Main Street.
"The optimist would say this is a chance for the little man to ride the coattails of the fat cats. After all, no one in those companies plans to retire tomorrow: They still work 23 hours a day and make billions of dollars," says Sam Stovall, chief investment strategist at Standard & Poor's in New York. "The cynic says, 'If someone had the ability to triple their money, why tell me?' "
Private-equity groups make most of their money by acquiring companies, stripping the fat from them, and reselling them as more-profitable enterprises.
While many Americans may not be familiar with the companies themselves, they would know many brands owned by them. Blackstone, for example, owns the manufacturer of Gold Toe socks; Michaels, the nation's largest chain of craft stores; and Orangina, the European soft drink.
... ... ...The risk of investing in private-equity funds and hedge funds was the subject of a letter written to the chairman of the Securities and Exchange Commission by Reps. Dennis Kucinich (D) of Ohio and Henry Waxman (D) of California.
"The value of public investors' interests in Blackstone LP would be tied to the performance of the underlying hedge and private equity funds, which have not been considered suitable investments for the general public because of their high risks and speculative nature," wrote the two congressmen, who urged the SEC to delay the Blackstone initial public offering that took place last Friday.... ... ...
Congress may also look into the tax rates paid by private-equity groups. The companies, which are set up as partnerships, have been paying taxes at a 15 percent capital-gains rate, according to reports. But they compete against firms such as Goldman Sachs, whose tax rate can be as high as 35 percent. Key Democratic lawmakers are considering the opportunity to raise new revenue to pay for other programs.
Blackstone and any other private-equity groups going public, traditionally very reticent to talk to the media, will also have to change the way they communicate, says Davia Temin, CEO of Temin and Co., a strategic-marketing firm in New York.
"They have not had to divulge a lot of information about themselves," she says. "They probably know all the rules. They just haven't been doing them."
Considering these changes, why go public? Diversification of personal assets might be one reason, says Clifford Smith Jr., professor of finance and economics at the University of Rochester's Simon Graduate School of Business. "It frees up personal funds," he says. "Here's a way to make sure if thing's don't look as rosy in the future, I have other irons in the fire." According to The Wall Street Journal, Blackstone's CEO, Stephen Schwarzman, raised more than $900 million, and co-founder Peter Peterson collected $1.9 billion in the offering. Mr. Schwarzman will still own more than $7 billion of the company's stock and Mr. Peterson $1.35 billion, according to the Journal.
But others think it might be an indication that the era of large returns on private equity is ending. "If you're not at the top, you are approaching it," says Mr. Mousseau of Cumberland Advisors. "The smart money is getting out on the equity side."
When asked about the signs he would be look to to indicate a turning point in the decline Hovnanian responded:
“Well clearly, one of the things we are much more focused on then we ever were before is MLS listings in a given market. That is a dynamic that’s changed, we’re tracking it in every market. At the moment, unfortunately, most markets are showing negative signs in terms of the increasing MLS listings and lower monthly sales every month. ”
All of a sudden, in an interruption of the spectacular rise of global stock markets driven by abnormally ample liquidity, all eyes are trained on rising interest rates.
But because of the hegemony of the US dollar, a fiat currency that by definition does not behave like other currencies, rising interest rates cannot have the effect against inflation predicted by mainstream economic theory.
All in all, exchange rates mask the reality that all currencies are decreasing in value. - Henry C K Liu
June 21, 2007 | Bloomberg.com
"Granddad Benny, is it true that central bankers used to believe they could steer the global economy with quarter-point twitches in overnight rates?''
Granddad looked up from his GoogleSoft iSpreadsheet, where a flashing red ``health care'' box was blocking 2027's planned expenditure from matching the income cell.
``Yes, Joel. For about a decade we all believed central banks could ensure people had jobs, and could afford food and housing and such. That all changed after the Gigantic Global Bubble Burst of 2008.''
Joel put down his Mandarin dictionary.
``That's what my socio-economics teacher says we'll learn about next week. She called it the Giglobubu. What happened in 2008, Granddad?''
``We're still not sure, Joel,'' Granddad said. ``At the time, some accused the New Zealand central bank, some said it was the bond market, while others blamed the aftershocks of a slump in the U.S. housing market. If she's smart, your teacher will probably spend a lot of time talking about China.''
"The World War II German invasion plan of 1940 (Sichelschnitt) was designed to deal with the Line. A decoy force
sat opposite the Line while a second Army Group cut through the Low Countries of Belgium and the Netherlands, as well as through the
Ardennes Forest which lay north of the main French defences. Thus the Germans were able to avoid a direct assault on the Maginot Line.
Attacking on May 10, German forces were well into France within five days and they continued to advance until May 24, when they stopped
"The term is sometimes used today to describe any comically ineffective protection."
Wikipedia - Maginot Line
Nystrom’s Comment: Whoa, Simon - hang on there just a sec! Let's examine that statement. We certainly had a central bank back during the panic of 1929, but it didn't "help contain the panic." Instead, the Fed's policies led directly to the Great Depression - the most prolonged financial and industrial slump in American history. Sure, there were booms and busts in the 19th century, but none were as bad as the Big One that started in ’29. Current Fed Chairman Ben Bernanke even admitted recently that it was the Fed that caused the Great Depression. But then he said with a wink, "we're sorry. We won't do it again."
That’s right Ben, next time it will certainly be much worse. Let's take a look at 2001, the last time we had something approaching a financial panic in the US. At that time, the Fed did “step up to the plate” to “open the monetary spigots” in order to stand as the “lender of last resort,” lowering interest rates in its own panic, and in effect “printing more money and loaning it out.”
A financial panic was not so much averted as it was postponed. Instead of a panic and a crash, we had the opposite: The housing bubble. The Fed’s torrent of artificially cheap money gave people an incentive to borrow, spend and speculate rather than save and invest. Thanks to the Fed's cheap money policy lowered real interest rates to levels below that of inflation. This might sound like confusing jargon to some, but this is what it means:
If your savings account is paying 1.5% interest, but inflation is running at 3% per year or higher, then it makes no sense at all to save. (The government says inflation is around 3%, but if you live in America, eat, drive and / or pay for a place to live, you know that inflation is actually much higher.)
As a result, money saved is worth less in the future – not more. Therefore it is better to spend now, before the money is eaten away by the hidden tax of inflation. Or better yet, if you can borrow money on an adjustable rate ARM at 4% to buy a house while prices are increasing at 20% per year (like in 2003), that is even better.
In other words, the Fed caused the housing bubble. Today government, businesses and individuals are all in more debt than they were in 2001, and 70% of Americans think the economy is getting worse. It makes me wonder what Ben will do for an encore. Encourage people to borrow yet more money?
June 22 (Bloomberg)
U.S. economic growth will accelerate to a 3 percent annual pace in the middle of next year as the drag from the housing recession diminishes and corporate spending picks up, the International Monetary Fund said.
Gross domestic product will expand 2 percent this year and 2.75 percent next year, the Washington-based fund said today.
A measure of consumer-price inflation favored by the Federal Reserve will fall below 2 percent, the IMF predicted.
· U.S. household debt hit a record $11.4 trillion in last year's third quarter, which ended Sept. 30, after shooting up at the fastest rate since 1985, according to Fed data.
· U.S. households spent a record 13.75 percent of their after-tax, or disposable, income on servicing their debts in the third quarter, the Fed reported.
"The economy's increasing reliance on unprecedented levels of debt is clearly unsustainable and extremely troubling," said Charles W. McMillion, chief economist with MBG Information Services, a financial analysis firm. "The only serious questions are when and how will current imbalances be addressed and what will be the consequences."The Fed chairman told Congress in June: "I think we've learned very early on in economic history that debt in modest quantities does enhance the rate of growth of an economy and does create higher standards of living, but in excess, creates very serious problems."
Greenspan didn't define "excess," but economists see troubling possibilities: A sudden reversal in housing prices could trigger a recession if consumers cut back on spending and households have trouble paying their mortgages. The trade gap could swell to a point that forces a sharp fall in the dollar and surge in interest rates, also causing a recession.
Even since the war went bad, the intellectual promoters of America's Iraq adventure, from Donald Rumsfeld on down, have been asserting that the faltering situation is stabilizing, and will improve soon—perhaps in six months or so. Six months later, progress having failed to materialize, they unironically repeat the same projection. The blogosphere has dubbed these six-month blocks "Friedman units," after New York Times columnist Thomas Friedman. In housing, I give you "Lereah units," after former National Association of Realtors chief economist David Lereah, who would pronounce the end of housing's brief slump—and then make the same incorrect pronouncement a few months later. (See this great illustrated chart at Barry Ritholtz's blog.) So over the top was Lereah's enthusiasm in the face of data, he was dubbed the Baghdad Bob of real estate.
...In both Iraq and housing, folks who got us into the mess have repeatedly reassured the public that the debacle is contained, and that it is not contributing to instability and insecurity in adjacent areas. Both Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson have promised that (a) the problems in housing are confined to the subprime market, with little contagion; and (b) the decline in housing activity isn't affecting the economy at large. In both housing and Iraq, the facts on the ground tell us otherwise. The entire Middle East, from Iran in the east to Gaza in the west, is an insecure tinderbox. And housing subtracted a full percentage point from economic growth in the first quarter, while companies in sectors adjacent to housing—from Home Depot to Bear Stearns—have been bloodied.
...In 2004, Daniel Gross argued that Greenspan was advocating ARMs at precisely the wrong time. In March, he wrote that the housing bust was just beginning. And last month, Gross nominated Robert Toll and David Lereah for the Bubble Hall of Fame.
People prefer deception to truth. Lies, especially flattering lies, make them feel good about themselves. They are convenient and soothing, like diet cola - sweet and empty. The truth, by contrast, is too strong. It disturbs our digestion and troubles our sleep.
No, dear reader, give us mendacity any day.
One of the comforting lies that people want to hear today is that rising asset prices are the throbbing pulse of an economy in good health. And this is just one of the many 'fibs' that Americans happily lap up every day:
Tell Us Sweet Little Lies
These days, a chart of practically anything is surging. Watches, executive aircraft, stamps, stocks in Zimbabwe, stocks in India - you name it. If asset prices are a measure of health, almost all the worlds' economies are Olympic athletes.
Leading the field, of course, are the Chinese - who really do look like Olympians. They're out in front in every sport. Already racing ahead five times as fast as the United States, the Chinese spurted ahead even faster recently, leaving economists stunned. At the close of the merry month of May, output from Chinese factories, mines and utilities was running more than 18% ahead of the previous year. Overall, the economy grew at an 11.1% rate during the first quarter. And Honda Motor Company (NYSE:HMC) says its plant in China will boost production by 71% this year.
Chinese speculators sold off their Shanghai shares recently, but the market is still sky high and threatens to push higher in the weeks ahead. China is awash in money with more than $1 trillion in reserves. And every working day, it earns another $1 billion in trade surplus.
Banca Italease SpA shares dropped as much as 13 percent after the Italian leasing company said its clients have accumulated potential losses of 400 million euros ($537 million) on derivatives contracts.
The negative positions accumulated by Italease's clients widened to 400 million euros from 225 million euros at the end of 2006, the company said. The lender has already put aside 8.3 million euros of provisions.
would be interesting to know who the clients are.... i can smell write downs.....
Here are some interesting quotes from a Bloomberg article:
Trading of currencies in Japan using borrowed funds rose 41 percent in the first quarter to 109 trillion yen ($896 billion), exceeding 100 trillion yen for the first time, the Financial Futures Association of Japan said.
Japanese individuals' trading volume accounts for 20 percent to 30 percent of the interbank foreign-exchange market in the Tokyo time zone,'' Fukaya said. "They are also active in London time after going home. They are becoming a rival to be reckoned with for institutional investors.''
The rise of the carry trade among Japanese retail investors is a good indication that it won't continue much longer. When retail investors arrive on the seen it provides cover for the bigger players to exit. To the average retail investor what's been working lately will probably always work. They here their friends boasting about their easy profits and they hop aboard the train, not realizing the risks they face if their highly leveraged bets go bad from a rising Yen. Just as marginated Nasdaq investors got cleaned out quickly in the sharp decline of early 2000, I expect that many japanese retail investors will have their accounts purged early in the game when the Yen Carry Trade starts to unwind. When it does, over a hundred trillion Yen could potentially be subtracted from the money supply to pay off margin debt. In the meantime, it's the YCT is providing a lot of interest income and trading fees for Japanes banks and brokerages.
Consumer spending is 70% of the US economy, and the most recent numbers emerging are not the stuff of frothy good times. The June 1 Bureau of Economic Analysis Personal Income and Outlays Report starts out with a bang.
As the quotation below explains, income - real and disposable - actually fell. You will be comforted - but you should be terrified - to learn that spending rose nonetheless:
Personal income (DPI) decreased $9.7 billion, or 0.1%, in April, according to the Bureau of Economic Analysis. Personal consumption expenditures (PCE) increased by $52 billion, or 0.5%. In March, personal income increased $85.9 billion, or 0.8%, DPI increased $71.7 billion, or 0.7%, and PCE increased $42.4 billion, or 0.4%, based on revised estimates.
And further down on the same page:Personal outlays - PCE, personal interest payments, and personal current transfer payments increased $55.2 billion in April, compared with an increase of $44.2 billion in March. PCE increased $52 billion, compared with an increase of $42.4 billion. Personal saving - DPI less personal outlays - was a negative $132.8 billion in April, compared with a negative $67.8 billion in March. Personal saving as a percentage of disposable personal income was a negative 1.3% in April, compared with a negative 0.7% in March. These numbers are the stuff of real concern. The US housing market is in trouble, retails sales are flat, and that is what we get when people dis-save at nearly twice the rate of the previous month. This is a running-on-empty story and looks set to become a running-into-a-wall story.
... ... ...
With each repurchase announcement and buyout deal comes renewed speculation and buying pressure. Easy abundant credit is required. No matter how low you get your wage bill, no matter how inexpensively and innovatively you get your financing, ultimately you still need buyers. Sure, stagnant wages, declining tax bills and regulatory relief seem grand now, but they risk greater savings and reduced consumption. For now, debt has filled the gap and, in doing, opened another grand avenue to profit. So long as this lasts, it supports asset prices and economic activity.
Already the nimble have begun to realize that the future of lending at high rates with good repayment levels may well be outside the United States. Over the past few years, Americans have been consuming 60-70% of the world's excess savings. The US has 4.5% of the world's population, has 20% of global GDP, and is now growing more slowly than the European Union, India, China, and much of Latin America. The US is also far more indebted - thus the growing excitement about micro-credit and booming consumer-debt markets in Eastern Europe, Asia and beyond.
...the top 25 companies in the S&P 500 derive more than half of their sales from overseas operations, and S&P 500 companies as a whole obtain 27% or more of their sales from abroad. Thus, a weaker dollar and stronger growth abroad could be powerful offsets to fading domestic support for margins.
A weaker dollar, if sustained, could support earnings through three channels. First, it is already translating US companies’ overseas results in euros or yen into more dollars. On a trade-weighted basis, the dollar has declined by 3.4% from a year ago, and our empirical work suggests that a 10% decline would boost US earnings from abroad by at least 3% and as much as 6%, boosting overall earnings by 150 bp. So the 3.4% decline in the dollar may have boosted overall earnings by 50 bp. But the effect could be larger, because the fixed weights in the trade-weighted dollar may mask regional shifts in the currency’s impact.
Notably, half of US foreign affiliate income originates in Europe, and the dollar has declined by 10.4% against the euro over the past year. It’s reasonable to expect those effects to continue over the remainder of 2007.
A weaker dollar is also helping the top and bottom lines by combining with domestic factors to promote stronger pricing power for US companies (see for example, “The Dollar and Inflation,” Global Economic Forum, May 5, 2006). The effect of a weaker dollar has begun to show up in US import prices; excluding fuels, such prices rose by 2.7% in the year ended in April.
Against the backdrop of decelerating earnings, there’s thus no mistaking the near-term risks to US markets from these developments, but what about the parallel risks to US growth? With mortgage originators tightening lending standards and adjustable-rate mortgages resetting this year and next, this latest rate backup could hobble any recovery in housing, potentially put further pressure on home prices, and thus undermine wealth for the hitherto unsinkable US consumer.
Together with the rise in energy and food quotes, the backup in yields and an incipient decline in equity markets seem to have the makings of another perfect storm for growth.
In my view, it is premature to reach that conclusion. Most important, the reason that rates are rising matters. As I see it, it is primarily strong global growth and a change in the mix of global saving and investment — and not a drying up of global liquidity — that are pushing up real yields (see “The Conundrum Unwinds,” Global Economic Forum, May 21, 2007).
... ... ...
To assess its impact on
growth, it is important to set this change in financial conditions in perspective. Four factors are critical in that regard. US
- First, the restraint is modest, at least so far. For example, US equity prices following the selloff are still up 5-8% this year and 18-20% over the past twelve months.
- And real rates are below historical norms and ‘fair value,’ given current economic circumstances, as my colleague Joachim Fels’ work suggests.
... ... ...
In my view, the correction in equities is a healthy development, since it will remind investors of their risk.
Risks in this context abound. A major surge in yields could present more of a headwind to US and global growth, especially if it significantly undermined asset prices. And if global central banks go too far in tightening, growth abroad might be threatened.
The real danger for investors lies in lingering upside risks to US inflation, partly from domestic causes, but also from incipient inflation abroad and from rising protectionist sentiment...
New York Times
On this occasion in Riverside, two lenders had put 100 properties on the block. By the end of the day, 93 had sold. Most of those properties were in fast-growing exurban and desert communities in Riverside and San Bernardino Counties east of Los Angeles.“We went into hibernation, and we’re back!” said Robert Friedman, the chairman of the Real Estate Disposition Corporation, which is based in Irvine.
The company sold more than 265 properties in San Diego, Los Angeles and Riverside during two weekends in May, and it is planning to hold auctions in Sacramento, Modesto, the Bay Area and Atlanta this summer.
Mr. Friedman described his trade as a “countercyclical business,” and he said that the banks unloading the properties preferred not to be identified.
In some cases, he said, the institutions sold the properties for less money than they were owed.Foreclosures have surged in Southern California in the last year, particularly in outlying areas.
In seven counties, lending institutions foreclosed on 6,007 properties in the first quarter of 2007, up from 721 properties in the first quarter of 2006, according to DataQuick Information Systems, a research company based in San Diego.
In Riverside and San Bernardino Counties, lenders foreclosed on 255 homes in the first quarter of 2006. That number grew to 2,369 in the first quarter of 2007, according to DataQuick.
John Karevoll, an analyst for DataQuick, said the data show “pockets of distress” in outlying areas that experienced a lot of new building.
New York Times
As part of a $12.5 billion stock repurchase, I.B.M. used a foreign subsidiary to buy back shares through foreign exchanges. The subsidiary then used the shares to pay its corporate parent in America for goods and services.
“It’s just a way to bring the profits into the United States without paying taxes by using the stock as currency,” said H. David Rosenbloom...
On May 31, the Internal Revenue Service issued a notice declaring that the technique could not be used to eliminate taxes. The notice said it would disallow any transactions beginning on that day.The technique “raises significant policy concerns,” the I.R.S. said. The I.R.S. shut down a simpler version of the same shelter in September.
The technique was believed to be in wide use by corporations that have substantial profits offshore and are also buying back large amounts of their own shares to return value to investors. I.B.M. appears to be the only company that publicly disclosed its use of the tax shelter....
By avoiding the 35 percent federal tax on profit, a company can buy three shares for every two it would be able to acquire with profits that had been taxed.The tax shelter is known as “Killer B,” after the letter used to designate a provision in the tax code governing certain corporate reorganizations.
By avoiding the 35 percent federal tax on profit, a company can buy three shares for every two it would be able to acquire with profits that had been taxed.
Over the last 45 years, a variety of techniques to get around the rule have been put forth by accounting firms, but the shelters are typically demolished by the I.R.S. once it learns about them.
Since the beginning of the economic recovery in November 2001, employment in housing and housing-related industries has accounted for 43% of the increase in private-sector payrolls, according to Asha Bangalore, an economist for Northern Trust Corp.
The latest preliminary GDP report confirms that the historic decline to residential fixed investment continues weigh heavily the US economy with GDP registering a mere 0.6% for Q1 2007 a fact now not so underestimated by the Federal Reserve Chairman Bernanke.
“Of course, the adjustment in the housing sector is still ongoing, and the slowdown in residential construction now appears likely to remain a drag on economic growth for somewhat longer than previously expected.”
“The incoming data on new home sales and inventories suggested that the ongoing adjustment in the housing market would probably persist for longer than previously anticipated. In particular, the demand for new homes appeared to have weakened further in recent months, and the stock of unsold homes relative to sales had increased sharply.”
... ... ...
The Census Department’s New Residential Home Sales Report that, while vexing traditional media sources, clearly showed a decline in sales activity for new homes priced at or above $300,000 while also showing a significant jump in sales for new homes priced below that, especially below $200,000.
There now is ample evidence to suggest that the pricing trends for new homes that was established during the historic run-up are now in the process of reverting as homebuilders slash prices to counter slumping demand.
... ... ...
With the weakening trend continuing, total residential construction spending fell 14.41% as compared to April 2006 while private single family construction spending declined by a grotesque 25.60%.
Maybe this explains why Fannie Mae and Freddy Mac, the goliath mortgage holders that own most of the mortgages in the USA, are now suddenly gearing up (with the sudden and inexplicable approval of OFHEO, the oversight group that is supposed to monitor them) to buy up an initial $20 billion of the mortgages in the collapsing subprime group.
This is a blatantly obvious move to bail out the damned banks, who would otherwise be stuck with that equity tranche crap! Hahaha! There seem to be no depths of corruption and depravity to which these people will sink!
Mish's Global Economic Trend Analysis
The influx of hedge funds into the credit markets may well have resulted in a paradigm change in how the markets behave in the next downturn. Specifically, credit assets could behave in a more correlated, synchronous fashion if one or a number of hedge funds were forced to liquidate positions following some catalyst event in the markets. Investor redemptions and/or increased margin calls from prime broker banks could exacerbate a larger unwind of credit assets.
Forced Unwind Example
Assuming a hedge fund leveraged 4.0x (20% margin) were operating near or at maximum permissible leverage, the fund could be forced to sell as much as 25% of its assets in the event of an initial 5% price decline in the value of its assets. Any collective, downward pressure on prices in the market arising from the hedge fund unwinding or an increase in margin requirements from the prime brokers would magnify the total amount of assets the fund is forced to sell. For example, an increase in the prime broker’s margin from 20% to 25% on average would require a fund to deleverage as much as 40% to meet its margin calls and restore leverage to within acceptable limits.
The inherent instability of hedge funds as an investor class — arising in large part from their reliance on short-term, margin-based leverage — is distinctly different from more traditional buy-and-hold institutional investors and relationship-oriented bank lenders. Given the continued growth of hedge funds in the credit markets, the potential for a more synchronous, forced unwind of credit assets cannot be discounted. For example, Amaranth was reported to have sold leveraged loans and residential mortgage-backed securities to meet margin calls on its natural gas positions.Credit Implications
Given the current environment, Fitch believes liquidity risk is among the more important issues facing credit investors. Tight credit spreads and abundant capital have allowed even the most distressed issuers to readily access funding and refinance maturing debt. This apparent in the low default rate for corporate debt — recently under 1% according to Fitch’s high yield default index — even as many credit metrics have eroded. For example, high yield issues rated ‘CCC’ or lower represented $125 billion of issuance at the end of March, or 17% of U.S. high yield volume.
Even a temporary dislocation in the credit markets could negatively affect funding access for more marginal credits with upcoming debt maturities, leading to a rash of defaults.
Of particular importance is an assessment of liquidity sources and liquidity uses, including on- and off-balance-sheet debt, loan maturities, and contingent liquidity claims. The growing role of hedge funds in the credit markets without question has introduced greater liquidity in the near term. Of concern would be an ill-timed event that led to a sudden reversal of this liquidity across multiple segments of the credit markets.
Money Has No Meaning
Money has no meaning yet the process continues with escalating leverage and bigger and bigger deals, with each player hoping for the big score, even though money itself has lost all meaning to the most important players.
30 May 2007 (www.un.org)
A midyear review of the world economic situation showed that while the global economic outlook was quite positive, large uncertainties surrounded it, Rob Vos, the Director of the Development Policy and Analysis Division of the Department of Economic and Social Affairs (DESA), told correspondents at a Headquarters press conference today.
Launching the midyear update of the 2007 World Economic Situation and Prospects report, he said those uncertainties included a weak United States housing market and global imbalances.
In terms of the United States housing sector, he noted that a recession in the housing sector had continued in 2007, with a slowdown in activity and a large number of unsold homes. While house prices had not fallen, that might happen in the months and years to come if the recession continued as expected.
A decline in prices would affect the domestic market, particularly household consumption in the United States, resulting in the risk of a serious recession in its economy, slowing growth from 2.1 per cent to 0.5 per cent in 2007 and 2008. That would then significantly slow the world economy and transmit the recession into the rest of the world. There had also been problems in the United States subprime mortgage market, which showed the risk of a spill over from the housing to financial markets.
Global imbalances were projected to stabilize in 2007 and 2008, but were still very large, he said. The United States deficit had increased to $860 billion at the end of 2006, and was expected to fall to $800 billion in 2007. That deficit was basically being financed by surpluses in the developing and oil exporting countries, as well as some major developed countries, in particular Japan and Germany. The European Union, at large, was projected to continue to have a slight deficit on its current account.
United States debt, which had now deepened to well over $3 trillion, might turn out to be unsustainable in the rest of 2007 or next, putting further downward pressure on the United States dollar, he said. Since its peak in 2002, the dollar had depreciated vis-à-vis the major currencies by some 35 per cent and by 25 per cent against a broader range of other currencies.
With that increased debt the risk of a sharp depreciation of the dollar continued, he said. If countries willing to invest in United States dollar assets expected further depreciation, they might be less willing to hold dollar assets, triggering a much sharper fall in the United States dollar. The risk of disorderly adjustment and the steep fall of the dollar existed. The policy challenge was how to prevent a hard landing of the United States dollar and forge a benign adjustment of the global imbalance.
Continuing, he said the current tendency in macroeconomic policy was not all in the right direction, particularly in the surplus countries where there had been a tightening of monetary and fiscal policies, particularly in Germany and Japan, making it more difficult for the United States to lower its external deficits by export growth. The United States would also need to adopt some contractionary policies to slow down its deficit. Another way to compensate without a major recession in the world economy was for the surplus countries to make more expansionary adjustments in their economies. The more expansionary fiscal policies of some Asian countries seemed to be insufficient to compensate for the possible deflationary effects of an adjustment in the United States.
The report called, therefore, for a coordinated strategy that would think about how to adjust global imbalances while avoiding recessionary tendencies in the global economy, he said. International policy coordination could take place outside of the mediation of the International Monetary Fund, provided that the Fund pushed ahead with its reforms and enhanced representation of the votes and voices of its members.
Providing an overview of the global economy, he explained that the world economy had decelerated from 4 per cent in 2006 to 3.4 per cent in 2007 and was expected to stabilize at 3.6 per cent in 2008. While still robust by historic standards, there had been a slight slowdown in the global economy in all country groups.
While the growth of the developing countries and economies in transition remained robust, there had also been a slowdown, he said. China and India remained dynamic, keeping growth rates up. Some accounts, including a report of the International Monetary Fund, anticipated a decoupling of growth between the United States economy and that of developing countries. He did not see much of that, however. A strong link still existed between growth in the United States and what happened in the rest of the world.
He noted that the major slowdown in the global economy had been in the United States economy from 3.3 per cent in 2006 to 2.1 per cent in 2007. That weakness was mainly due to the weak housing sector. Overall activity in that sector was down by some 20%. While business investments in the United States had been very weak, a recovery was expected in 2008, pulling up the growth rate projections for 2008. That recovery, however, might be uncertain for a number of reasons.
Japan’s growth remained robust, he added. Its economy was expected to expand by 2.1 per cent in 2007 and slow to 1.9 per cent in 2008, basically because of having reached growth capacity. The outlook in Western Europe was for mild deceleration in 2007-2008, but growth rates would remain above the trends of the past years. Strong growth momentum had been maintained among the new members of European Union.
While there had been a noticeable slowdown among developing countries, growth remained very robust, he said. The good news continued to come from Africa, where growth was expected to remain up at 6 per cent per year in 2007 and 2008, as a result of strong commodity prices, rising mining and hydrocarbon outputs, strong public consumption and increased investment in infrastructure.
Growth in East Asia had accelerated to over 8 per cent in 2006, but there would be some moderation in 2007 and 2008, he said. China had again exceeded expectations in 2006 with 10.7 per cent growth. Other countries in the region had experienced acceleration in 2006. There would, however, be some slowdown in the region in 2007. Growth for China was expected to slow to 10.1 per cent, which was still very high, and slightly below 10 per cent in 2008. Growth in South Asia remained strong in 2006. Growth in India would slow to 8.5 per cent after reaching 9 per cent in 2006.
Growth in Western Asia and Latin America had continued to be stronger than in the past, he said. Despite the decline of oil revenues, the oil-exporting economies in Western Asia would still reach a growth rate of 5.1 per cent in 2007 and 4.9 per cent in 2008. Growth had been stronger than expected in Latin American in 2006, he added.
Turning to the least developed countries, he said growth had been strong on average, but varied among those countries, with strong growth being recorded in the oil exporting countries, including Angola and Equatorial Guinea. Some non-oil economies had performed well, with a strong expansion of public consumption and infrastructure. Several countries had recovered from political conflict and had undergone political and economic reforms. Others had received increased aid, boosting growth rates in such countries as Madagascar, Senegal, United Republic of Tanzania and Zambia. The political situations in other countries had been less favorable, and social tensions continued to limit growth, including in Haiti, Chad and Guinea. “That’s good news, but there is quite a bit of variety among the performance of these countries, particularly among the African countries,” he said.
The robust growth of the world economy was also built on a strong performance in trade, he said. World trade had grown at almost 10 per cent in 2006 and was expected to moderate to some 7 per cent in 2007 and 2008. That was still twice as much as the growth of world output, which meant that the ongoing globalization process continued with world trade increasing as a share of total output.
Trade among the developing countries had been strong, he added. Exports from China and India had increased by more than 20 per cent in terms of volume. Many other countries in Africa and Latin America had had very strong export growth in the double digit range.
Commodity prices remained robust, but seemed to have peaked, he said. Oil prices had reached an unprecedented high of a yearly average of $65 per barrel in 2006, peaking at $80 per barrel in the middle of the year and slowing down to $60 per barrel at the end of the year. Oil prices were expected to remain at $60 in 2007, which would represent a drop of some 8 per cent, and were expected to rise in 2008.
He said metal prices had increased by some 50 per cent in 2006, particularly on strong demand from China and the recovery in Japan and Europe. Some metal prices were expected to slide, moderating in 2007 and 2008. Prices of agricultural commodity prices were a bit diverse in terms of performance. Some products had a stronger performance, particularly corn in the United States, as many farmers had switched from soy beans to maize given the demand for maize for use as biofuel. Other food prices, however, had been on the decline. A diverging pattern was expected in 2007 and 2008.
Financial conditions for developing countries remained favourable, he said. The persistent current account deficit in the United States would likely induce higher benchmark interest rates, pushing up yield spreads for developing country lending.
Favourable conditions had kept up capital flows, although they were expected to be slightly lower in 2007 compared to 2006. Foreign direct investment had continued to increase, but was concentrated in a handful of developing countries. Official development assistance had declined to $103 billion in 2006, which represented a decline in real terms of some 5 per cent from 2005, he said.
The net outward transfer of financial resources from developing countries to developed countries at the end 2006 had reached $658 billion from developing countries and another $125 billion from countries with economies in transition. That trend had been continuing for decades, which raised the question of sustainability. Africa was now showing a negative net transfer of $95 billion for the continent as a whole and $10 billion for sub-Saharan Africa, excluding Nigeria and South Africa.
Responding to questions, he said the outlook for the price of oil was uncertain and depended on geopolitical factors. The market was quite tight, and supply constraints were strong. Any further shift in demand would keep the price of oil up. He expected the price to stay up for that reason. Oil prices could also be volatile because of shocks in the Middle East.
Regarding inflation, he said he saw inflationary pressures in some countries. He was not too worried about inflationary pressures in Europe, however. Inflation was still quite low. He did, however, see emerging inflationary pressure in India. While oil prices were pushing up inflationary pressures in some countries, on average they were quite low.
Asked about the “meltdown” in the United States subprime market, he said he had not seen a spill over of the problem, which had basically been contained.
Regarding differences between DESA’s research and that of the International Monetary Fund, he said the difference was mainly in method and focus. DESA’s focus was on developing countries. It tried to give as broad a picture as possible.
Asked what impact China had on the developing world and the United States economy, he said the United States economy still dominated the global economy.
“If the United States sneezes, it creates a flu elsewhere,” he said. That was still the case. China was, however, having a growing impact on the global economy. China was an important and growing factor in world economic growth, but still not the main factor driving the global economy’s overall outlook.
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