* MARCH 30, 2009
Inflation Is Tempting for Indebted Nations
By MARK WHITEHOUSE
LONDON -- U.S. President Barack Obama and U.K. Prime Minister Gordon Brown are seeking to lead the world into battle against the financial crisis, putting up trillions of dollars to revive their economies and bail out banks. Now, investors and other politicians are posing a troubling question: Can their governments handle the bill?
The answer, economists and analysts say, is almost certainly yes. But some offer a caveat: Countries with debt burdens mounting to levels not seen in decades will ultimately face a growing temptation to allow inflation to accelerate more than they typically would -- a move that would slash the value of their debts as the prices of everything else rose.
That could cause a lot of pain for all kinds of investors, from U.S. and U.K. pensioners on fixed incomes to big holders of U.S. Treasurys such as the Chinese central bank.
"It would be epic, it would be terrible, but it's probably easier than outright defaulting," says Kenneth Rogoff, an economics professor at Harvard University and former chief economist of the International Monetary Fund.
Messrs. Obama and Brown have cast themselves as the vanguard of efforts to lift the global economy out of recession, as leaders of the world's 20 largest economies prepare for a crisis-fighting summit in London on Thursday. Both have announced fiscal-stimulus packages, with the U.S. planning to spend some $787 billion. And both have turned to "quantitative easing," in which their central banks plan to print large amounts of money -- more than $1 trillion in the US, and at least £75 billion ($107.26 billion) in the U.K. -- in part to buy some of the same bonds the governments will issue to cover their gaping budget deficits.
If the stimulus measures show signs of working and preventing deflation, both the U.S. and the U.K. will face a new quandary: when and how to stop and get their budget deficits under control.
If they wait too long, they could launch an upward spiral of prices as too much stimulus money chases the same goods and labor -- a possibility that has recently raised increasing concern. Last week, Czech Prime Minister Mirek Topolánek, before resigning Thursday after an earlier no-confidence vote, echoed complaints from other European leaders when he called the U.S. spending plans the "road to hell." Meanwhile, poor demand at a U.S. government bond auction and the failure of a separate auction in the U.K. added to unease about the market's willingness to support the countries' heavy borrowing.
Some analysts have gone so far as to conjure up images of Germany in the 1920s or Zimbabwe in the 2000s, where the printing of money to cover chronic deficit spending debased currencies and bred hyperinflation. "Horror stories about how hyperinflation starts are going to be surfacing again," says Jan Loeys, global market strategist at JPMorgan Chase & Co. in London. "Investors are getting worried."
Most economists and analysts say that in the case of the U.S. and U.K., that kind of doomsday scenario is extremely unlikely. While they believe policy makers will prefer to err on the side of inflation, they don't expect it to get out of control. Heavy borrowing could boost both governments' net debt to nearly 100% of the nations' annual economic output, but that's still less than Japan, which so far hasn't had trouble issuing bonds despite its lower credit rating. At the right price, both countries' bonds have a lot of natural buyers, such as pension funds that need to lock in payments stretching far into the future.
More pernicious, though, will be the political cost of making the interest payments on all the new debt. If interest rates rise to a moderate level, economists estimate that annual debt payments could reach 4% of GDP, an amount roughly equivalent to the entire U.S. military budget, forcing tough decisions on what else to cut.
The debt-service burden could be even more troublesome in the U.K., which faces the prospect of sharp budget cuts and higher taxes after years of depending on the finance sector for much of its tax revenue.
The pressure of the debt payments has the potential to alter policy makers' attitude toward inflation. Typically, central bankers seek at all costs to keep inflation in check, because they see it as an inequitable tax that erodes the buying power of a country's currency and people's savings.
But in a country with heavy debts -- households in the U.S. and the U.K. are the world's most indebted -- the equation changes: Inflation can reduce the burden, because the face value of bonds and mortgage debts stay the same, while things like nominal wages, tax revenues and house prices tend to rise.
"The political economy of inflation in this situation might not be as clear-cut as it is in normal times," says Pierre-Olivier Gourinchas, an economics professor at the University of California, Berkeley.
Mr. Rogoff says annual inflation could go as high as 8% to 10% within three to five years in the U.S., and sooner in the U.K. That can have a big impact on bond prices. "All the elements are in place to pull the rug out from under investors," he says.
Write to Mark Whitehouse at mark.whitehouse@wsj.com
Sunday, March 29, 2009
George Soros, the man who broke the Bank, sees a global meltdown
From The Times
March 28, 2009
George Soros, the man who broke the Bank, sees a global meltdown
Alice Thomson and Rachel Sylvester
George Soros was 13 when the Nazis invaded his homeland of Hungary. As a Jew, he was forced to adopt a false identity and live separately from his parents in Budapest. Instead of being traumatised by the experience, though, he found the danger exhilarating. “It was high adventure,” he says, “like living through Raiders of the Lost Ark.”
Sixty-five years later, he still thrives on danger. He famously made $1 billion on Black Wednesday by shorting the pound, earning him the label of “the man who broke the Bank of England”. Last year, as the world tipped into financial chaos, Mr Soros pocketed another $1.1 billion by correctly predicting the downturn. “I’m an expert in crises,” he says.
The man who has a phobia about maths has made his name as the philosopher king of economics – his book The Crash of 2008, out in paper-back next week, has been a bestseller on both sides of the Atlantic. Since 1944 he has believed in what he calls “reflexivity” – the idea that people base their decisions on their own perception of a situation rather than on the reality.
He has applied this both to investment and to politics: his skill has been to predict moments of seismic change by identifying a disjunction between perception and reality.
Related Links
* Soros hints that pound has hit the bottom
* George Soros: Crunch will bite deeper in UK
* George Soros
When everyone else was convinced that the markets would automatically correct themselves, the 78-year-old “old fogey”, as he calls himself, was one of the few warning of recession. He put all his chips on “the Barack guy” early on when all around him were still gunning for Hillary Clinton. It’s almost as if he has been waiting for the Great Recession for the past ten years. When we ask whether he prefers booms or busts, he replies: “I have to admit that actually I flourish, I’m more stimulated by the bust.”
This recession, he explains, is a “once-in-a-lifetime event”, particularly in Britain. “This is a crisis unlike any other. It’s a total collapse of the financial system with tremendous implications for everyday life. On previous occasions when you had a crisis that was threatening the system the authorities intervened and did whatever was necessary to protect the system. This time they failed.”
The financial oracle does not know how long it will last. “That depends on how it’s handled. Allowing Lehman Brothers to fail was the game-changing event. That’s when the financial crisis went over the brink.” We could end up with a depression. “Unless we handle it well then I think we would. The size of the problem is actually bigger than in the 1930s.”
The problem in Britain, he believes, is in many ways worse than in America or Germany. “American memory is seared by the Depression, the German memory is seared by hyperinfla-tion but Britain has a pretty serious problem in many ways worse than America because the financial sector looms bigger and the overvaluation of real estate is bigger than in America.”
He is not worried that an auction of government bonds failed this week – “that was a blip”, he says. He would still buy British bonds – “it depends on the price” – but he agrees with Mervyn King, the Governor of the Bank of England, that debt is a real problem. It will, he says, put people off investing in Britain. “I think it will have an effect, yes. It is a matter of worry because effectively the hole in the banking system is replaced by increasing the national debt.” There has been some talk that Britain might have to go cap in hand to the International Monetary Fund. “It’s conceivable,” Mr Soros says. “You have a problem that the banking system is bigger than the economy . . . so for Britain to absorb it alone would really pile up the debt . . . if the banking system continued to collapse, it’s a possibility but it’s not a likelihood.”
He refuses to say whether sterling has yet hit its lowest point. Has he shorted the pound recently? “I had shorted it last year, but I’m not shorting the pound now.” Is the euro under threat? “There is stress in the euro because of the differential in the interest rate that the different countries have to pay,” he replies.
Mr Soros is critical of the tripartite regulatory system set up when the Bank of England gained independence. “I have a different view on how the market operates than the prevailing view. I believe that the authorities have the responsibility to forestall, to counter the mood of the markets . . . I think that the problem was that the Bank of England didn’t have the supervisory authority.”
He does not, however, blame Gordon Brown. “He underestimated the severity of the problem, but then so did most people. Part of the perceived role of a leader is to cheerlead, so you can’t really blame him for that.”
From the day he was born, Mr Soros says, he was attracted to crisis. “It precedes me. I inherited it from my father.” His father had lived through the Russian Revolution and every day after school he would take his son swimming and talk about his experiences. “I sucked it in that way. And then when I was not yet 14, the Germans occupied Hungary, and I would have been deported to Auschwitz if my father hadn’t arranged for false papers. So that was a pretty profound crisis. I had to assume a false identity and live a different life.” He was separated from his parents. “We met occasionally in the swimming pool. But imagine you are 14 years old, you like adventure, and you have a father who seems to understand the situation better than others. It’s very exciting.”
He feels a similar thrill in an economic crisis. “On the one hand there’s tremendous human suffering, which is very distressing. On the other hand, to be able to handle the situation is exhilarating.”
He has always been something of an outsider. He thinks that this makes it easier for him to see through conventional wisdom. “I have always understood how normal rules may not apply at all times,” he says. In recent years he has been arguing against “market fundamentalism” – “the accepted theory was that markets tend to equilibrium”. He believes that the credit crunch has proved him right. “It reminds me of the collapse of the Sovi-et system, events are always exceeding people’s understanding. The situation is out of control. There’s a shortage of time to adjust to the change. Change is accelerating.”
Like Warren Buffett, he thinks that the complex financial instruments used by the banks were economic weapons of mass destruction. If anything he expected the tipping point to come earlier. “Everybody who realised that this was unsustainable expected it to collapse much sooner,” he says. “It is so devastating exactly because it took so long.”
The urgent task now, he says, is to realise that the system that collapsed was flawed. “Therefore you can’t restore it. You have to reform it.” He worries that politicians have not yet accepted the need for fundamental change and that “a lot of bankers have their head in the sand”.
H e was cast as the villain when Britain was forced out of the exchange-rate mechanism. “I didn’t speculate against sterling to benefit the public. I did it to make money,” he says.
He tells us that he has psycho-somatic illnesses – backaches and pains – that tip him off to changes in the market. “It’s as if you’re a jungle animal, and you see another animal facing you. You have to make a decision: fight or flight? Your hair stands up and you growl and you decide, ‘Am I going to attack because I’m stronger or am I going to run away because otherwise he’s going to eat me?’ You are very tense. And that’s the tension that gives you the backache.”
The G20 summit in London next week is, he says, the last chance to avert disaster. “The odds would favour that it fails because there are such differences of opinion. It’s difficult enough to get it right in your own country let alone with 20 governments coming together, but if it’s a failure I think then the global financial and trading system falls apart.”
If the G20 is nothing but a talking shop then he thinks we are heading for meltdown. “That could push the world into depression. It’s really a make-or-break occasion. That’s why it’s so important.” The chances of a depression are, he says, “quite high” – even if that is averted, the recession will last a long time. “Look, we are not going back to where we came from. In that sense it’s going to last for ever.”
Life and times
Born Budapest, 1930. A Jew, he survived the Nazi occupation using a false identity. Fled communist Hungary for Britain in 1947
Education Worked as a railway porter and waiter to pay his way as a student at the London School of Economics, graduating in 1952
Career Took job with Singer and Friedlander in London before moving in 1956 to New York, where he worked as a trader and analyst. In 1970 he set up his own private investment company, the Quantum Fund. Made his fortune, on September 16, 1992, when he short-sold more than $10bn of sterling. Now chairman of Soros Fund Management and the Open Society Institute and said to be worth $11bn
March 28, 2009
George Soros, the man who broke the Bank, sees a global meltdown
Alice Thomson and Rachel Sylvester
George Soros was 13 when the Nazis invaded his homeland of Hungary. As a Jew, he was forced to adopt a false identity and live separately from his parents in Budapest. Instead of being traumatised by the experience, though, he found the danger exhilarating. “It was high adventure,” he says, “like living through Raiders of the Lost Ark.”
Sixty-five years later, he still thrives on danger. He famously made $1 billion on Black Wednesday by shorting the pound, earning him the label of “the man who broke the Bank of England”. Last year, as the world tipped into financial chaos, Mr Soros pocketed another $1.1 billion by correctly predicting the downturn. “I’m an expert in crises,” he says.
The man who has a phobia about maths has made his name as the philosopher king of economics – his book The Crash of 2008, out in paper-back next week, has been a bestseller on both sides of the Atlantic. Since 1944 he has believed in what he calls “reflexivity” – the idea that people base their decisions on their own perception of a situation rather than on the reality.
He has applied this both to investment and to politics: his skill has been to predict moments of seismic change by identifying a disjunction between perception and reality.
Related Links
* Soros hints that pound has hit the bottom
* George Soros: Crunch will bite deeper in UK
* George Soros
When everyone else was convinced that the markets would automatically correct themselves, the 78-year-old “old fogey”, as he calls himself, was one of the few warning of recession. He put all his chips on “the Barack guy” early on when all around him were still gunning for Hillary Clinton. It’s almost as if he has been waiting for the Great Recession for the past ten years. When we ask whether he prefers booms or busts, he replies: “I have to admit that actually I flourish, I’m more stimulated by the bust.”
This recession, he explains, is a “once-in-a-lifetime event”, particularly in Britain. “This is a crisis unlike any other. It’s a total collapse of the financial system with tremendous implications for everyday life. On previous occasions when you had a crisis that was threatening the system the authorities intervened and did whatever was necessary to protect the system. This time they failed.”
The financial oracle does not know how long it will last. “That depends on how it’s handled. Allowing Lehman Brothers to fail was the game-changing event. That’s when the financial crisis went over the brink.” We could end up with a depression. “Unless we handle it well then I think we would. The size of the problem is actually bigger than in the 1930s.”
The problem in Britain, he believes, is in many ways worse than in America or Germany. “American memory is seared by the Depression, the German memory is seared by hyperinfla-tion but Britain has a pretty serious problem in many ways worse than America because the financial sector looms bigger and the overvaluation of real estate is bigger than in America.”
He is not worried that an auction of government bonds failed this week – “that was a blip”, he says. He would still buy British bonds – “it depends on the price” – but he agrees with Mervyn King, the Governor of the Bank of England, that debt is a real problem. It will, he says, put people off investing in Britain. “I think it will have an effect, yes. It is a matter of worry because effectively the hole in the banking system is replaced by increasing the national debt.” There has been some talk that Britain might have to go cap in hand to the International Monetary Fund. “It’s conceivable,” Mr Soros says. “You have a problem that the banking system is bigger than the economy . . . so for Britain to absorb it alone would really pile up the debt . . . if the banking system continued to collapse, it’s a possibility but it’s not a likelihood.”
He refuses to say whether sterling has yet hit its lowest point. Has he shorted the pound recently? “I had shorted it last year, but I’m not shorting the pound now.” Is the euro under threat? “There is stress in the euro because of the differential in the interest rate that the different countries have to pay,” he replies.
Mr Soros is critical of the tripartite regulatory system set up when the Bank of England gained independence. “I have a different view on how the market operates than the prevailing view. I believe that the authorities have the responsibility to forestall, to counter the mood of the markets . . . I think that the problem was that the Bank of England didn’t have the supervisory authority.”
He does not, however, blame Gordon Brown. “He underestimated the severity of the problem, but then so did most people. Part of the perceived role of a leader is to cheerlead, so you can’t really blame him for that.”
From the day he was born, Mr Soros says, he was attracted to crisis. “It precedes me. I inherited it from my father.” His father had lived through the Russian Revolution and every day after school he would take his son swimming and talk about his experiences. “I sucked it in that way. And then when I was not yet 14, the Germans occupied Hungary, and I would have been deported to Auschwitz if my father hadn’t arranged for false papers. So that was a pretty profound crisis. I had to assume a false identity and live a different life.” He was separated from his parents. “We met occasionally in the swimming pool. But imagine you are 14 years old, you like adventure, and you have a father who seems to understand the situation better than others. It’s very exciting.”
He feels a similar thrill in an economic crisis. “On the one hand there’s tremendous human suffering, which is very distressing. On the other hand, to be able to handle the situation is exhilarating.”
He has always been something of an outsider. He thinks that this makes it easier for him to see through conventional wisdom. “I have always understood how normal rules may not apply at all times,” he says. In recent years he has been arguing against “market fundamentalism” – “the accepted theory was that markets tend to equilibrium”. He believes that the credit crunch has proved him right. “It reminds me of the collapse of the Sovi-et system, events are always exceeding people’s understanding. The situation is out of control. There’s a shortage of time to adjust to the change. Change is accelerating.”
Like Warren Buffett, he thinks that the complex financial instruments used by the banks were economic weapons of mass destruction. If anything he expected the tipping point to come earlier. “Everybody who realised that this was unsustainable expected it to collapse much sooner,” he says. “It is so devastating exactly because it took so long.”
The urgent task now, he says, is to realise that the system that collapsed was flawed. “Therefore you can’t restore it. You have to reform it.” He worries that politicians have not yet accepted the need for fundamental change and that “a lot of bankers have their head in the sand”.
H e was cast as the villain when Britain was forced out of the exchange-rate mechanism. “I didn’t speculate against sterling to benefit the public. I did it to make money,” he says.
He tells us that he has psycho-somatic illnesses – backaches and pains – that tip him off to changes in the market. “It’s as if you’re a jungle animal, and you see another animal facing you. You have to make a decision: fight or flight? Your hair stands up and you growl and you decide, ‘Am I going to attack because I’m stronger or am I going to run away because otherwise he’s going to eat me?’ You are very tense. And that’s the tension that gives you the backache.”
The G20 summit in London next week is, he says, the last chance to avert disaster. “The odds would favour that it fails because there are such differences of opinion. It’s difficult enough to get it right in your own country let alone with 20 governments coming together, but if it’s a failure I think then the global financial and trading system falls apart.”
If the G20 is nothing but a talking shop then he thinks we are heading for meltdown. “That could push the world into depression. It’s really a make-or-break occasion. That’s why it’s so important.” The chances of a depression are, he says, “quite high” – even if that is averted, the recession will last a long time. “Look, we are not going back to where we came from. In that sense it’s going to last for ever.”
Life and times
Born Budapest, 1930. A Jew, he survived the Nazi occupation using a false identity. Fled communist Hungary for Britain in 1947
Education Worked as a railway porter and waiter to pay his way as a student at the London School of Economics, graduating in 1952
Career Took job with Singer and Friedlander in London before moving in 1956 to New York, where he worked as a trader and analyst. In 1970 he set up his own private investment company, the Quantum Fund. Made his fortune, on September 16, 1992, when he short-sold more than $10bn of sterling. Now chairman of Soros Fund Management and the Open Society Institute and said to be worth $11bn
Re-emerging As an Emerging Market
Re-emerging As an Emerging Market
By Desmond Lachman
Sunday, March 29, 2009; B01
Back in the spring of 1998, when Boris Yeltsin was still at Russia's helm, I led a group of global investors to Moscow to find out firsthand where the Russian economy was headed. My long career with the International Monetary Fund and on Wall Street had taken me to "emerging markets" throughout Asia, Eastern Europe and Latin America, and I thought I'd seen it all. Yet I still recall the shock I felt at a meeting in Russia's dingy Ministry of Finance, where I finally realized how a handful of young oligarchs were bringing Russia's economy to ruin in the pursuit of their own selfish interests, despite the supposed brilliance of Anatoly Chubais, Russia's economic czar at the time.
At the time, I could not imagine that anything remotely similar could happen in the United States. Indeed, I shared the American conceit that most emerging-market nations had poorly developed institutions and would do well to emulate Washington and Wall Street. These days, though, I'm hardly so confident. Many economists and analysts are worrying that the United States might go the way of Japan, which suffered a "lost decade" after its own real estate market fell apart in the early 1990s. But I'm more concerned that the United States is coming to resemble Argentina, Russia and other so-called emerging markets, both in what led us to the crisis, and in how we're trying to fix it.
Over the past year, I've been getting Russia flashbacks as I witness the AIG debacle as well as the collapse of Bear Sterns and a host of other financial institutions. Much like the oligarchs did in Russia, a small group of traders and executives at onetime venerable institutions have brought the U.S. and global financial systems to their knees with their reckless risk-taking -- with other people's money -- for their personal gain.
Negotiating with Argentina's top officials during their multiple financial crises in the 1990s was always an ordeal, and sparring with Domingo Cavallo, the country's Harvard-trained finance minister at the time, was particularly trying. One always had the sense that, despite their supreme arrogance, the country's leaders never had a coherent economic strategy and that major decisions were always made on the run. I never thought that was how policy was made in the United States -- until, that is, I saw how totally at sea Treasury Secretaries Henry Paulson and Timothy F. Geithner and Federal Reserve Chairman Ben S. Bernanke have appeared so many times during our country's ongoing economic and financial storm.
The parallels between U.S. policymaking and what we see in emerging markets are clearest in how we've mishandled the banking crisis. We delude ourselves that our banks face liquidity problems, rather than deeper solvency problems, and we try to fix it all on the cheap just like any run-of-the-mill emerging market economy would try to do. And after years of lecturing Asian and Latin American leaders about the importance of consistency and transparency in sorting out financial crises, we fail on both counts: In March 2008, one investment bank, Bear Stearns, is bailed out because it is thought to be too interconnected with the rest of the banking system to fail. However, six months later, another investment bank, Lehman Brothers -- for all intents and purposes indistinguishable from Bear Stearns in its financial market inter-connectedness -- is allowed to fail, with catastrophic effects on global financial markets.
In visits to Asian capitals during the region's financial crisis in the late 1990s, I often heard Asian reformers such as Singapore's Lee Kuan Yew or Japan's Eisuke Sakakibara complain about how the incestuous relationship between governments and large Asian corporate conglomerates stymied real economic change. How fortunate, I thought then, that the United States was not similarly plagued by crony capitalism! However, watching Goldman Sachs's seeming lock on high-level U.S. Treasury jobs as well as the way that Republicans and Democrats alike tiptoed around reforming Freddie Mac and Fannie Mae -- among the largest campaign contributors to Congress -- made me wonder if the differences between the United States and the Asian economies were only a matter of degree.
On Wall Street there is an old joke that the longest river in the emerging-market economies is "de Nile." Yet how often do U.S. leaders respond to growing signs of economic dysfunctionality by spouting nationalistic rhetoric that echoes the speeches of Latin American demagogues like Peru's Alan Garcia in the 1980s and Argentina's Carlos Menem in the 1990s? (Even Garcia, currently in his second go-around as Peru's president, seems to have grown up somewhat.) But instead of facing our problems we extol the resilience of the U.S. economy, praise the most productive workers in the world, and go on and on about America's inherent ability to extricate itself from any crisis. And we ignore our proclivity as a nation to spend, year in year out, more than we produce, to put off dealing with long-term problems, and to engage in grandiose long-term programs that as a nation we can ill afford.
A singular characteristic of an emerging market heading for deep trouble is a seemingly suicidal tendency to become overly indebted to foreign creditors. That tendency underlay the spectacular collapse of the Thai, Indonesian and Korean currencies in 1997. It also led Russia to default on its debt in 1998 and plunged Argentina into its economic depression in 2001. Yet we too seem to have little difficulty becoming increasingly indebted to the tune of a few hundred billion dollars a year. To make matters worse, we do so to countries like China, Russia and an assortment of Middle Eastern oil producers -- none of which is particularly well disposed to us.
Like Argentina in its worst moments, we never seem to question whether it is reasonable to expect foreigners to keep financing our extravagance, and we forget the bad things that happen to the Argentinas or Hungarys of the world when foreigners stop financing their excesses. So instead of laying out a realistic plan for increasing our national savings, we choose not to face up to the Social Security and Medicare crises that lie ahead, embarking instead on massive spending programs that -- whatever their long-run merits might be -- we simply cannot afford.
After experiencing a few emerging-market crises, I get the sense of watching the same movie over and over. All too often, a tragic part of that movie is the failure of the countries' policymakers to hear the loud cries of canaries in the coal mine. Before running up further outsized budget deficits, should we not heed the markets that now see a 10 percent probability that the U.S. government will default on its sovereign debt in the next five years? And should we not be paying close attention to the Chinese central bank governor's musings that he does not feel comfortable with the $1 trillion of U.S. government debt that the Chinese central bank already owns, let alone adding to those holdings?
In the twilight of my career, when I am hopefully wiser than before, I have come to regret how the IMF and the U.S. Treasury all too often lectured leaders in emerging markets on how to "get their house in order" -- without the slightest thought that the United States might fare no better when facing a major economic crisis. Now, I fear time is running out for our own policymakers to mend their ways and offer real leadership to extricate the United States from its worst economic calamity since the 1930s. If we insist on improvising and not facing our real problems, we might soon lose our status as a country to be emulated and join the ranks of those nations we have patronized for so long.
Desmond Lachman, a fellow at the American Enterprise Institute, was previously chief emerging market strategist at Salomon Smith Barney and deputy director of the International Monetary Fund's Policy and Review Department.
By Desmond Lachman
Sunday, March 29, 2009; B01
Back in the spring of 1998, when Boris Yeltsin was still at Russia's helm, I led a group of global investors to Moscow to find out firsthand where the Russian economy was headed. My long career with the International Monetary Fund and on Wall Street had taken me to "emerging markets" throughout Asia, Eastern Europe and Latin America, and I thought I'd seen it all. Yet I still recall the shock I felt at a meeting in Russia's dingy Ministry of Finance, where I finally realized how a handful of young oligarchs were bringing Russia's economy to ruin in the pursuit of their own selfish interests, despite the supposed brilliance of Anatoly Chubais, Russia's economic czar at the time.
At the time, I could not imagine that anything remotely similar could happen in the United States. Indeed, I shared the American conceit that most emerging-market nations had poorly developed institutions and would do well to emulate Washington and Wall Street. These days, though, I'm hardly so confident. Many economists and analysts are worrying that the United States might go the way of Japan, which suffered a "lost decade" after its own real estate market fell apart in the early 1990s. But I'm more concerned that the United States is coming to resemble Argentina, Russia and other so-called emerging markets, both in what led us to the crisis, and in how we're trying to fix it.
Over the past year, I've been getting Russia flashbacks as I witness the AIG debacle as well as the collapse of Bear Sterns and a host of other financial institutions. Much like the oligarchs did in Russia, a small group of traders and executives at onetime venerable institutions have brought the U.S. and global financial systems to their knees with their reckless risk-taking -- with other people's money -- for their personal gain.
Negotiating with Argentina's top officials during their multiple financial crises in the 1990s was always an ordeal, and sparring with Domingo Cavallo, the country's Harvard-trained finance minister at the time, was particularly trying. One always had the sense that, despite their supreme arrogance, the country's leaders never had a coherent economic strategy and that major decisions were always made on the run. I never thought that was how policy was made in the United States -- until, that is, I saw how totally at sea Treasury Secretaries Henry Paulson and Timothy F. Geithner and Federal Reserve Chairman Ben S. Bernanke have appeared so many times during our country's ongoing economic and financial storm.
The parallels between U.S. policymaking and what we see in emerging markets are clearest in how we've mishandled the banking crisis. We delude ourselves that our banks face liquidity problems, rather than deeper solvency problems, and we try to fix it all on the cheap just like any run-of-the-mill emerging market economy would try to do. And after years of lecturing Asian and Latin American leaders about the importance of consistency and transparency in sorting out financial crises, we fail on both counts: In March 2008, one investment bank, Bear Stearns, is bailed out because it is thought to be too interconnected with the rest of the banking system to fail. However, six months later, another investment bank, Lehman Brothers -- for all intents and purposes indistinguishable from Bear Stearns in its financial market inter-connectedness -- is allowed to fail, with catastrophic effects on global financial markets.
In visits to Asian capitals during the region's financial crisis in the late 1990s, I often heard Asian reformers such as Singapore's Lee Kuan Yew or Japan's Eisuke Sakakibara complain about how the incestuous relationship between governments and large Asian corporate conglomerates stymied real economic change. How fortunate, I thought then, that the United States was not similarly plagued by crony capitalism! However, watching Goldman Sachs's seeming lock on high-level U.S. Treasury jobs as well as the way that Republicans and Democrats alike tiptoed around reforming Freddie Mac and Fannie Mae -- among the largest campaign contributors to Congress -- made me wonder if the differences between the United States and the Asian economies were only a matter of degree.
On Wall Street there is an old joke that the longest river in the emerging-market economies is "de Nile." Yet how often do U.S. leaders respond to growing signs of economic dysfunctionality by spouting nationalistic rhetoric that echoes the speeches of Latin American demagogues like Peru's Alan Garcia in the 1980s and Argentina's Carlos Menem in the 1990s? (Even Garcia, currently in his second go-around as Peru's president, seems to have grown up somewhat.) But instead of facing our problems we extol the resilience of the U.S. economy, praise the most productive workers in the world, and go on and on about America's inherent ability to extricate itself from any crisis. And we ignore our proclivity as a nation to spend, year in year out, more than we produce, to put off dealing with long-term problems, and to engage in grandiose long-term programs that as a nation we can ill afford.
A singular characteristic of an emerging market heading for deep trouble is a seemingly suicidal tendency to become overly indebted to foreign creditors. That tendency underlay the spectacular collapse of the Thai, Indonesian and Korean currencies in 1997. It also led Russia to default on its debt in 1998 and plunged Argentina into its economic depression in 2001. Yet we too seem to have little difficulty becoming increasingly indebted to the tune of a few hundred billion dollars a year. To make matters worse, we do so to countries like China, Russia and an assortment of Middle Eastern oil producers -- none of which is particularly well disposed to us.
Like Argentina in its worst moments, we never seem to question whether it is reasonable to expect foreigners to keep financing our extravagance, and we forget the bad things that happen to the Argentinas or Hungarys of the world when foreigners stop financing their excesses. So instead of laying out a realistic plan for increasing our national savings, we choose not to face up to the Social Security and Medicare crises that lie ahead, embarking instead on massive spending programs that -- whatever their long-run merits might be -- we simply cannot afford.
After experiencing a few emerging-market crises, I get the sense of watching the same movie over and over. All too often, a tragic part of that movie is the failure of the countries' policymakers to hear the loud cries of canaries in the coal mine. Before running up further outsized budget deficits, should we not heed the markets that now see a 10 percent probability that the U.S. government will default on its sovereign debt in the next five years? And should we not be paying close attention to the Chinese central bank governor's musings that he does not feel comfortable with the $1 trillion of U.S. government debt that the Chinese central bank already owns, let alone adding to those holdings?
In the twilight of my career, when I am hopefully wiser than before, I have come to regret how the IMF and the U.S. Treasury all too often lectured leaders in emerging markets on how to "get their house in order" -- without the slightest thought that the United States might fare no better when facing a major economic crisis. Now, I fear time is running out for our own policymakers to mend their ways and offer real leadership to extricate the United States from its worst economic calamity since the 1930s. If we insist on improvising and not facing our real problems, we might soon lose our status as a country to be emulated and join the ranks of those nations we have patronized for so long.
Desmond Lachman, a fellow at the American Enterprise Institute, was previously chief emerging market strategist at Salomon Smith Barney and deputy director of the International Monetary Fund's Policy and Review Department.
Tuesday, March 24, 2009
China ‘Super Currency’ Call Shows Dollar Concern
China ‘Super Currency’ Call Shows Dollar Concern (Update1)
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By Li Yanping
March 24 (Bloomberg) -- China’s call for a new international reserve currency may signal its concern at the dollar’s weakness and ambitions for a leadership role at next week’s Group of 20 summit, economists said.
Central bank Governor Zhou Xiaochuan yesterday urged the International Monetary Fund to create a “super-sovereign reserve currency.” The dollar weakened after the Federal Reserve said it would buy Treasuries and the U.S. government outlined plans to buy illiquid bank assets
“China is concerned about the potential for a slide in the dollar as the U.S. attempts to stimulate its economy,” said Mark Williams, a London-based economist at Capital Economics Ltd. The “rare” sight of a Chinese official attempting to reframe an international debate may be “a sign of China becoming more engaged,” he said.
Zhou’s comments may also signal ambitions for the yuan to play a bigger global role. The central bank this week signed a currency swap with Indonesia, adding to agreements since December with South Korea, Hong Kong, Malaysia and Belarus. It’s also preparing for trade settlement in the Chinese currency with Hong Kong, Macau and the Association of Southeast Asian Nations.
“There is concern and even frustration among top policymakers in Beijing about China’s high exposure to U.S. dollar-denominated financial assets,” said Brian Jackson, senior strategist at Royal Bank of Canada in Hong Kong.
Yuan forwards rose the most in three months with traders betting on appreciation for the first time since September on speculation that the U.S. policies will weaken the dollar. The 12-month forward rate gained 0.9 percent.
Support for Dollar
U.S. policy makers testifying before lawmakers in Washington today affirmed their support for the dollar.
Treasury Secretary Timothy Geithner, asked at a House Financial Services Committee hearing whether he rejected moving toward a global currency, replied, “I would, yes.”
“I would also,” said Federal Reserve Chairman Ben S. Bernanke. The question was asked by Representative Michele Bachmann, a Minnesota Republican.
Premier Wen Jiabao called on March 13 for the U.S. “to guarantee the safety of China’s assets.” China’s Treasury holdings climbed 46 percent in 2008 and now stand at about $740 billion, according to U.S. government data. The nation is the biggest holder of U.S. debt.
Raising Yuan’s Status
China is promoting use of the yuan to smooth currency volatility and to serve “a long-standing interest” to raise its status to that of a global reserve currency, said Ben Simpfendorfer, an economist at Royal Bank of Scotland Group Plc in Hong Kong. Such moves are not “a knee-jerk response” to the economic crisis, he said.
“If turning the Chinese yuan into a global reserve currency sounds ambitious, then encouraging its adoption as a regional reserve currency is more straightforward,” said Simpfendorfer.
G-20 leaders will gather in London on April 2 to forge a common response to the financial crisis that has spawned a global recession. The summit will discuss proposals for reforms of the International Monetary Fund.
Flexing ‘Some Muscle’
The timing of Zhou’s proposal is “the latest example of China’s policy of neo-assertiveness in world affairs,” said Glenn Maguire, chief Asia economist at Societe Generale SA in Hong Kong. “China is starting to flex some muscle and generally steer the debate in China’s own direction.”
Zhou’s article highlighted the “dilemma” that countries issuing reserve currencies face in balancing their own monetary- policy goals with other nations’ demand for their money.
The global crisis raised the question of which reserve currency would secure “global financial stability and facilitate world economic growth,” Zhou said. He proposed expanding the use of the IMF’s Special Drawing Rights, which are currency units valued against a composite of currencies.
“The basket of currencies forming the basis for SDR valuation should be expanded to include currencies of all major economies, and gross domestic product may also be included as a weighting,” said Zhou.
Some economists back his case.
“The world economic landscape has been changed since the establishment of the SDR 40 years ago,” said Ha Jiming, chief economist at China International Capital Corp. in Hong Kong. “Specifically, no such reserve currency would make sense without the yuan being included.”
To contact the reporters on this story: Li Yanping in Beijing at yli16@bloomberg.net
Last Updated: March 24, 2009 13:00 EDT
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By Li Yanping
March 24 (Bloomberg) -- China’s call for a new international reserve currency may signal its concern at the dollar’s weakness and ambitions for a leadership role at next week’s Group of 20 summit, economists said.
Central bank Governor Zhou Xiaochuan yesterday urged the International Monetary Fund to create a “super-sovereign reserve currency.” The dollar weakened after the Federal Reserve said it would buy Treasuries and the U.S. government outlined plans to buy illiquid bank assets
“China is concerned about the potential for a slide in the dollar as the U.S. attempts to stimulate its economy,” said Mark Williams, a London-based economist at Capital Economics Ltd. The “rare” sight of a Chinese official attempting to reframe an international debate may be “a sign of China becoming more engaged,” he said.
Zhou’s comments may also signal ambitions for the yuan to play a bigger global role. The central bank this week signed a currency swap with Indonesia, adding to agreements since December with South Korea, Hong Kong, Malaysia and Belarus. It’s also preparing for trade settlement in the Chinese currency with Hong Kong, Macau and the Association of Southeast Asian Nations.
“There is concern and even frustration among top policymakers in Beijing about China’s high exposure to U.S. dollar-denominated financial assets,” said Brian Jackson, senior strategist at Royal Bank of Canada in Hong Kong.
Yuan forwards rose the most in three months with traders betting on appreciation for the first time since September on speculation that the U.S. policies will weaken the dollar. The 12-month forward rate gained 0.9 percent.
Support for Dollar
U.S. policy makers testifying before lawmakers in Washington today affirmed their support for the dollar.
Treasury Secretary Timothy Geithner, asked at a House Financial Services Committee hearing whether he rejected moving toward a global currency, replied, “I would, yes.”
“I would also,” said Federal Reserve Chairman Ben S. Bernanke. The question was asked by Representative Michele Bachmann, a Minnesota Republican.
Premier Wen Jiabao called on March 13 for the U.S. “to guarantee the safety of China’s assets.” China’s Treasury holdings climbed 46 percent in 2008 and now stand at about $740 billion, according to U.S. government data. The nation is the biggest holder of U.S. debt.
Raising Yuan’s Status
China is promoting use of the yuan to smooth currency volatility and to serve “a long-standing interest” to raise its status to that of a global reserve currency, said Ben Simpfendorfer, an economist at Royal Bank of Scotland Group Plc in Hong Kong. Such moves are not “a knee-jerk response” to the economic crisis, he said.
“If turning the Chinese yuan into a global reserve currency sounds ambitious, then encouraging its adoption as a regional reserve currency is more straightforward,” said Simpfendorfer.
G-20 leaders will gather in London on April 2 to forge a common response to the financial crisis that has spawned a global recession. The summit will discuss proposals for reforms of the International Monetary Fund.
Flexing ‘Some Muscle’
The timing of Zhou’s proposal is “the latest example of China’s policy of neo-assertiveness in world affairs,” said Glenn Maguire, chief Asia economist at Societe Generale SA in Hong Kong. “China is starting to flex some muscle and generally steer the debate in China’s own direction.”
Zhou’s article highlighted the “dilemma” that countries issuing reserve currencies face in balancing their own monetary- policy goals with other nations’ demand for their money.
The global crisis raised the question of which reserve currency would secure “global financial stability and facilitate world economic growth,” Zhou said. He proposed expanding the use of the IMF’s Special Drawing Rights, which are currency units valued against a composite of currencies.
“The basket of currencies forming the basis for SDR valuation should be expanded to include currencies of all major economies, and gross domestic product may also be included as a weighting,” said Zhou.
Some economists back his case.
“The world economic landscape has been changed since the establishment of the SDR 40 years ago,” said Ha Jiming, chief economist at China International Capital Corp. in Hong Kong. “Specifically, no such reserve currency would make sense without the yuan being included.”
To contact the reporters on this story: Li Yanping in Beijing at yli16@bloomberg.net
Last Updated: March 24, 2009 13:00 EDT
Wednesday, March 18, 2009
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Pimco Predicts Inflation, Joining Buffett, Marc Faber
Pimco Predicts Inflation, Joining Buffett, Marc Faber (Update3)
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By Wes Goodman
March 11 (Bloomberg) -- Pacific Investment Management Co. which runs the world’s biggest bond fund, joined investors Warren Buffett and Marc Faber in saying inflation will quicken, sounding a warning for Treasury investors.
U.S. government and Federal Reserve efforts to snap the recession will increase costs for goods and services as soon as 2010, Pimco said in a report today on its Web site by Chris Caltagirone and Bob Greer. Commodity producers are also delaying projects, which may limit supply and lead to higher prices when global growth resumes, according to Pimco.
“Inflation will rise,” Pimco said. Treasury securities that give investors protection against higher prices in the economy are “attractive now.”
Pimco is among a growing list of investors who are warning that programs to counter the U.S. slump will increase consumer prices as the economy starts to revive. Investor Jim Rogers, author of the books “Hot Commodities” and “Adventure Capitalist,” said this week U.S. policies will hurt conventional Treasuries, those that don’t offer inflation protection.
President Barack Obama is asking Congress to pass a budget that will result in a record $1.75 trillion deficit. He has already signed into law a $787 billion package of tax cuts and government spending.
Rate Cut
Fed policy makers cut the target for overnight loans between banks to a range of zero to 0.25 percent in December, and the central bank has more than doubled its assets to $1.9 trillion in the past year.
U.S. yields indicate inflation forecasts rose this year.
The difference between rates on 10-year notes and Treasury Inflation Protected Securities, or TIPS, which reflects the outlook among traders for consumer prices, widened to 87 basis points from nine basis points on Dec. 31. The spread has averaged 2.27 percentage points for the past five years.
Conventional Treasuries returned 5.7 percent over the past 12 months, according to Merrill Lynch & Co.’s U.S. Master index, as the deepening U.S. recession led investors to seek the relative safety of government debt.
TIPS fell 9.5 percent, based on Merrill’s inflation-linked index, indicating investors saw less need to protect themselves against rising prices for goods and services.
The yield on conventional 10-year notes was little changed today at 3 percent as of 6:01 a.m. in London.
Buffett, the billionaire investor, said March 9 on the CNBC television network that efforts to stimulate a recovery may lead to inflation rates exceeding those in the 1970s.
Inflation Rate
The U.S. consumer price index was unchanged in the 12 months ended Jan. 31, according to the Labor Department, meaning bond investors aren’t losing anything to inflation now. The index climbed to 14.8 percent in March 1980, the highest level since the 1940s.
In Japan, the biggest economy after the U.S., consumer prices failed to rise in January for the first time in more than a year. China’s prices declined in February for the first time since 2002, the statistics bureau said yesterday.
Faber, publisher of the Gloom, Boom and Doom Report, said on March 9 on Bloomberg Television that the U.S. is laying the foundation for an increase in prices.
“The massive money printing we have and the massive deficits we have now will make it difficult when there are some price pressures for the Federal Reserve to actually increase interest rates,” Faber said.
Monthly Loss
Pimco’s CommodityRealReturn Strategy Portfolio handed investors a loss of 9.8 percent in the past month, underperforming 70 percent of its competitors, according to data compiled by Bloomberg.
Bill Gross, manager of the company’s $138 billion Total Return Fund, increased his holdings of U.S. government debt to 15 percent in February.
Gross also boosted the world’s biggest bond fund’s holdings in mortgage-backed securities to 86 percent of total assets, up from 83 percent last month, according to the Newport Beach, California-based company’s Web site.
While the government debt category includes Treasuries, Gross has said in the past that Pimco is not interested in buying the securities.
Gross missed out on the biggest Treasury market rally in 14 years in 2008, saying yields were too low because inflation will accelerate as the deficit surges. The fund returned an average of 4.37 percent over the past five years, beating 98 percent of its peers, Bloomberg data show.
Rogers said March 9 that sovereign bonds are poised to fall. Inflation erodes a bond’s fixed payments.
“Governments are printing money everywhere, borrowing stupendous amounts,” he said. “Throughout history that has led to problems in the bond markets, and it will this time too.”
To contact the reporter on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net.
Last Updated: March 11, 2009 02:37 EDT
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By Wes Goodman
March 11 (Bloomberg) -- Pacific Investment Management Co. which runs the world’s biggest bond fund, joined investors Warren Buffett and Marc Faber in saying inflation will quicken, sounding a warning for Treasury investors.
U.S. government and Federal Reserve efforts to snap the recession will increase costs for goods and services as soon as 2010, Pimco said in a report today on its Web site by Chris Caltagirone and Bob Greer. Commodity producers are also delaying projects, which may limit supply and lead to higher prices when global growth resumes, according to Pimco.
“Inflation will rise,” Pimco said. Treasury securities that give investors protection against higher prices in the economy are “attractive now.”
Pimco is among a growing list of investors who are warning that programs to counter the U.S. slump will increase consumer prices as the economy starts to revive. Investor Jim Rogers, author of the books “Hot Commodities” and “Adventure Capitalist,” said this week U.S. policies will hurt conventional Treasuries, those that don’t offer inflation protection.
President Barack Obama is asking Congress to pass a budget that will result in a record $1.75 trillion deficit. He has already signed into law a $787 billion package of tax cuts and government spending.
Rate Cut
Fed policy makers cut the target for overnight loans between banks to a range of zero to 0.25 percent in December, and the central bank has more than doubled its assets to $1.9 trillion in the past year.
U.S. yields indicate inflation forecasts rose this year.
The difference between rates on 10-year notes and Treasury Inflation Protected Securities, or TIPS, which reflects the outlook among traders for consumer prices, widened to 87 basis points from nine basis points on Dec. 31. The spread has averaged 2.27 percentage points for the past five years.
Conventional Treasuries returned 5.7 percent over the past 12 months, according to Merrill Lynch & Co.’s U.S. Master index, as the deepening U.S. recession led investors to seek the relative safety of government debt.
TIPS fell 9.5 percent, based on Merrill’s inflation-linked index, indicating investors saw less need to protect themselves against rising prices for goods and services.
The yield on conventional 10-year notes was little changed today at 3 percent as of 6:01 a.m. in London.
Buffett, the billionaire investor, said March 9 on the CNBC television network that efforts to stimulate a recovery may lead to inflation rates exceeding those in the 1970s.
Inflation Rate
The U.S. consumer price index was unchanged in the 12 months ended Jan. 31, according to the Labor Department, meaning bond investors aren’t losing anything to inflation now. The index climbed to 14.8 percent in March 1980, the highest level since the 1940s.
In Japan, the biggest economy after the U.S., consumer prices failed to rise in January for the first time in more than a year. China’s prices declined in February for the first time since 2002, the statistics bureau said yesterday.
Faber, publisher of the Gloom, Boom and Doom Report, said on March 9 on Bloomberg Television that the U.S. is laying the foundation for an increase in prices.
“The massive money printing we have and the massive deficits we have now will make it difficult when there are some price pressures for the Federal Reserve to actually increase interest rates,” Faber said.
Monthly Loss
Pimco’s CommodityRealReturn Strategy Portfolio handed investors a loss of 9.8 percent in the past month, underperforming 70 percent of its competitors, according to data compiled by Bloomberg.
Bill Gross, manager of the company’s $138 billion Total Return Fund, increased his holdings of U.S. government debt to 15 percent in February.
Gross also boosted the world’s biggest bond fund’s holdings in mortgage-backed securities to 86 percent of total assets, up from 83 percent last month, according to the Newport Beach, California-based company’s Web site.
While the government debt category includes Treasuries, Gross has said in the past that Pimco is not interested in buying the securities.
Gross missed out on the biggest Treasury market rally in 14 years in 2008, saying yields were too low because inflation will accelerate as the deficit surges. The fund returned an average of 4.37 percent over the past five years, beating 98 percent of its peers, Bloomberg data show.
Rogers said March 9 that sovereign bonds are poised to fall. Inflation erodes a bond’s fixed payments.
“Governments are printing money everywhere, borrowing stupendous amounts,” he said. “Throughout history that has led to problems in the bond markets, and it will this time too.”
To contact the reporter on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net.
Last Updated: March 11, 2009 02:37 EDT
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