When someone shares with you something of value, you have an obligation to share it with others.
Tuesday 19 August 2008
Global recession will drive down energy prices by 30%
The probability is growing that the global economy – not just the United States – will experience a serious recession. Recent developments suggest that all G7 economies are already in recession or close to tipping into one.
Global recession will drive down energy prices by 30%
Published: 19 August, 2008 By Nouriel Roubini
NEW YORK: The probability is growing that the global economy – not just the United States – will experience a serious recession. Recent developments suggest that all G7 economies are already in recession or close to tipping into one.
Other advanced economies or emerging markets (the rest of the euro zone; New Zealand, Iceland, Estonia, Latvia, and some Southeast European economies) are also nearing a recessionary hard landing. When they reach it, there will be a sharp slowdown in the BRICs (Brazil, Russia, India, and China) and other emerging markets.
This looming global recession is being fed by several factors: the collapse of housing bubbles in the US, the United Kingdom, Spain, Ireland and other euro-zone members; punctured credit bubbles where money and credit was too easy for too long; and the severe credit and liquidity crunch following the US mortgage crisis; the negative wealth and investment effects of falling stock markets (already down by more than 20% globally).
Some other contributing factors are: the global effects via trade links of the recession in the US (which still counts for about 30% of global GDP); the US dollar’s weakness, which reduces American trading partners’ competitiveness; and the stagflationary effects of high oil and commodity prices, which are forcing central banks to increase interest rates to fight inflation at a time when there are severe downside risks to growth and financial stability.
Official data suggest that the US economy entered into a recession in the first quarter of this year. The economy rebounded – in a double-dip, W-shaped recession – in the second quarter, boosted by the temporary effects on consumption of $100 billion in tax rebates. But those effects will fade by late summer.
The UK, Spain, and Ireland are experiencing similar developments, with housing bubbles deflating and excessive consumer debt undercutting retail sales, thus leading to recession.
Even in Italy, France, Greece, Portugal, Iceland, and the Baltic states, frothy housing markets are starting to slacken. Small wonder, then, that production, sales, and consumer and business confidence are falling throughout the euro zone.
Elsewhere, Japan is contracting, too. Japan used to grow modestly for two reasons: strong exports to the US and a weak yen. Now, exports to the US are falling while the yen has strengthened. Moreover, high oil prices in a country that imports all of its oil needs, together with falling business profitability and confidence, are pushing Japan into a recession.
The last of the G7 economies, Canada, should have benefited from high energy and commodity prices, but its GDP shrank in the first quarter, owing to the contracting US economy. Indeed, three quarters of Canada’s exports go to the US, while foreign demand accounts for a quarter of its GDP.
So every G7 economy is now headed toward recession. Other smaller economies (mostly the new members of the EU, which all have large current-account deficits) risk a sudden reversal of capital inflows; this may already be occurring in Latvia and Estonia, as well as in Iceland and New Zealand.
This G7 recession will lead to a sharp growth slowdown in emerging markets and likely tip the overall global economy into a recession. Those economies that are dependent on exports to the US and Europe and that have large current-account surpluses (China, most of Asia, and most other emerging markets) will suffer from the G7 recession.
Those with large current-account deficits (India, South Africa, and more than 20 economies in East Europe from the Baltics to Turkey) may suffer from the global credit crunch. Commodity exporters (Russia, Brazil, and others in the Middle East, Asia, Africa, and Latin America) will suffer as the G7 recession and global slowdown drive down energy and other commodity prices by as much as 30%.
Countries that allowed their currencies to appreciate relative to the dollar will experience a sharp slowdown in export growth. Those experiencing rising and now double-digit inflation will have to raise interest rates, while other high-inflation countries will lose export competitiveness.
Falling oil and commodity prices – already down 15% from their peaks – will somewhat reduce stagflationary forces in the global economy, yet inflation is becoming more entrenched via a vicious circle of rising prices, wages, and costs. This will constrain the ability of central banks to respond to the downside risks to growth.
In advanced economies, however, inflation will become less of a problem for central banks by the end of this year, as slack in product markets reduces firms’ pricing power and higher unemployment constrains wage growth.
To be sure, all G7 central banks are worried about the temporary rise in headline inflation, and all are threatening to hike interest rates.
Nevertheless, the risk of a severe recession – and of a serious banking and financial crisis – will ultimately force all G7 central banks to cut rates. The problem is that, especially outside the US, this monetary loosening will occur only when the G7 and global recession become entrenched.
Thus, the policy response will be too little, and will come too late, to prevent it. – Project Syndicate
Exclusive Interview: Jim Rogers Predicts Bigger Financial Shocks Loom, Fueling a Malaise That May Last for Years
(The First of Two Parts.]
Keith Fitz-Gerald August 19th, 2008
VANCOUVER, B.C. – The U.S. financial crisis has cut so deep – and the government has taken on so much debt in misguided attempts to bail out such companies as Fannie Mae (FNM) and Freddie Mac (FRE) – that even larger financial shocks are still to come, global investing guru Jim Rogers said in an exclusive interview with Money Morning.
Indeed, the U.S. financial debacle is now so ingrained – and a so-called “Super Crash” so likely – that most Americans alive today won’t be around by the time the last of this credit-market mess is finally cleared away – if it ever is, Rogers said.
The end of this crisis “is a long way away,” Rogers said. “In fact, it may not be in our lifetimes.”
During a 40-minute interview during a wealth-management conference in this West Coast Canadian city last month, Rogers also said that:
• U.S. Federal Reserve Chairman Ben S. Bernanke should “resign” for the bailout deals he’s handed out as he’s tried to battle this credit crisis.
• That the U.S. national debt – the roughly $5 trillion held by the public– essentially doubled in the course of a single weekend because of the Fed-led credit crisis bailout deals.
• That U.S. consumers and investors can expect much-higher interest rates – noting that if the Fed doesn’t raise borrowing costs, market forces will make that happen.
• And that the average American has no idea just how bad this financial crisis is going to get.
“The next shock is going to be bigger and bigger, still,” Rogers said. “The shocks keep getting bigger because we keep propping things up … [and] bailing everyone out.”
Rogers first made a name for himself with The Quantum Fund, a hedge fund that’s often described as the first real global investment fund, which he and partner George Soros founded in 1970. Over the next decade, Quantum gained 4,200%, while the Standard & Poor’s 500 Index climbed about 50%.
It was after Rogers "retired" in 1980 that the investing masses got to see him in action. Rogers traveled the world (several times), and penned such bestsellers as "Investment Biker" and the recently released "A Bull in China." And he made some historic market calls: Rogers predicted China’s meteoric growth a good decade before it became apparent and he subsequently foretold of the powerful updraft in global commodities prices that’s fueled a year-long bull market in the agriculture, energy and mining sectors.
Rogers’ candor has made him a popular figure with individual investors, meaning his pronouncements are always closely watched. Here are some of the highlights from the exclusive interview we had with the author and investor, who now makes his home in Singapore:
Keith Fitz-Gerald (Q): Looks like the financial train wreck we talked about earlier this year is happening.
Jim Rogers: There was a train wreck, yes. Two or three – more than one, as you know. [U.S. Federal Reserve Chairman Ben S.] Bernanke and his boys both came to the rescue. Which is going to cover things up for a while. And then I don’t know how long the rally will last and then we’ll be off to the races again. Whether the rally lasts six days or six weeks, I don’t know. I wish I did know that sort of thing, but I never do.
(Q):What would Chairman Bernanke have to do to “get it right?”
Rogers: Resign.
(Q): Is there anything else that you think he could do that would be correct other than let these things fail?
Rogers: Well, at this stage, it doesn’t seem like he can do it. He could raise interest rates – which he should do, anyway. Somebody should. The market’s going to do it whether he does it or not, eventually.
The problem is that he’s got all that garbage on his balance sheet now. He has $400 billion of questionable assets owing to the feds on his balance sheet. I mean, he could try to reverse that. He could raise interest rates. Yeah, that’s what he could do. That would help. It would cause a shock to the system, but if we don’t have the shock now, the shock’s going to be much worse later on. Every shock, so far, has been worse than the last shock. Bear-Stearns [now part of JP Morgan Chase & Co. (JPM)] was one thing and then it’s Fannie Mae (FNM), you know, and now Freddie Mac (FRE).
The next shock’s going to be even bigger still. So the shocks keep getting bigger because we kept propping things up and this has been going on at least since Long-Term Capital Management. They’ve been bailing everyone out and [former Fed Chairman Alan] Greenspan took interest rates down and then he took them down again after the “dot-com bubble” shock, so I guess Bernanke could try to start reversing some of this stuff.
But he has to not just reverse it – he’d have to increase interest rates a lot to make up for it and that’s not going to solve the problem either, because the basic problems are that America’s got a horrible tax system, it’s got litigation right, left, and center, it’s got horrible education system, you know, and it’s got many, many, many [other] problems that are going to take a while to resolve. If he did at least turn things around – turn some of these policies around – we would have a sharp drop, but at least it would clean out some of the excesses and the system could turn around and start doing better.
But this is academic – he’s not going to do it. But again the best thing for him would be to abolish the Federal Reserve and resign. That’ll be the best solution. Is he going to do that? No, of course not. He still thinks he knows what he’s doing.
(Q): Earlier this year, when we talked in Singapore, you made the observation that the average American still doesn’t know anything’s wrong – that anything’s happening. Is that still the case?
Rogers: Yes.
(Q): What would you tell the “Average Joe” in no-nonsense terms?
Rogers: I would say that for the last 200 years, America’s elected politicians and scoundrels have built up $5 trillion in debt. In the last few weekends, some un-elected officials added another $5 trillion to America’s national debt.
Suddenly we’re on the hook for another $5 trillion. There have been attempts to explain this to the public, about what’s happening with the debt, and with the fact that America’s situation is deteriorating in the world.
I don’t know why it doesn’t sink in. People have other things on their minds, or don’t want to be bothered. Too complicated, or whatever.
I’m sure when the [British Empire] declined there were many people who rang the bell and said: “Guys, we’re making too many mistakes here in the U.K.” And nobody listened until it was too late.
When Spain was in decline, when Rome was in decline, I’m sure there were people who noticed that things were going wrong.
(Q): Many experts don’t agree with – at the very least don’t understand – the Fed’s current strategies. How can our leaders think they’re making the right choices? What do you think?
Rogers: Bernanke is a very-narrow-gauged guy. He’s spent his whole intellectual career studying the printing of money and we have now given him the keys to the printing presses. All he knows how to do is run them.
Bernanke was [on the record as saying] that there is no problem with housing in America. There’s no problem in housing finance. I mean this was like in 2006 or 2005.
(Q): Right.
Rogers: He is the Federal Reserve and the Federal Reserve more than anybody is supposed to be regulating these [financial institutions], so they should have the inside scoop, if nothing else.
(Q): That’s problematic.
Rogers: It’s mind-boggling. Here’s a man who doesn’t understand the market, who doesn’t understand economics – basic economics. His intellectual career’s been spent on the narrow-gauge study of printing money. That’s all he knows.
Yes, he’s got a PhD, which says economics on it, but economics can be one of 200 different narrow fields. And his is printing money, which he’s good at, we know. We’ve learned that he’s ready, willing and able to step in and bail out everybody.
There’s this worry [whenever you have a major financial institution that looks ready to fail] that, “Oh my God, we’re going to go down, and if we go down, the whole system goes down.”
This is nothing new. Whole systems have been taken down before. We’ve had it happen plenty of times.
(Q): History is littered with failed financial institutions.
Rogers: I know. It’s not as though this is the first time it’s ever happened. But since [Chairman Bernanke’s] whole career is about printing money and studying the Depression, he says: “Okay, got to print some more money. Got to save the day.” And, of course, that’s when he gets himself in deeper, because the first time you print it, you prop up Institution X, [but] then you got to worry about institution Y and Z.
(Q): And now we’ve got a dangerous precedent.
Rogers: That’s exactly right. And when the next guy calls him up, he’s going to bail him out, too.
(Q): What do you think [former Fed Chairman] Paul Volcker thinks about all this?
Rogers: Well, Volcker has said it’s certainly beyond the scope of central banking, as he understands central banking.
(Q): That’s pretty darn clear.
Rogers: Volcker’s been very clear – very clear to me, anyway – about what he thinks of it, and Volcker was the last decent American central banker. We’ve had couple in our history: Volcker and William McChesney Martin were two.
You know, McChesney Martin was the guy who said the job of a good central banker was to take away the punchbowl when the party starts getting good. Now [the Fed] – when the party starts getting out of control – pours more moonshine in. McChesney Martin would always pull the bowl away when people started getting a little giggly. Now the party’s out of control.
(Q): This could be the end of the Federal Reserve, which we talked about in Singapore. This would be the third failure – correct?
Rogers: Yes. We had two central banks that disappeared for whatever reason. This one’s going to disappear, too, I say.
(Q): Throughout your career you’ve had a much-fabled ability to spot unique points in history – inflection points, if you will. Points when, as you put it, somebody puts money in the corner at which you then simply pick up.
Rogers: That’s the way to invest, as far as I’m concerned.
(Q): So conceivably, history would show that the highest returns go to those who invest when there’s blood in the streets, even if it’s their own.
Rogers: Right.
(Q): Is there a point in time or something you’re looking for that will signal that the U.S. economy has reached the inflection point in this crisis?
Rogers: Well, yeah, but it’s a long way away. In fact, it may not be in our lifetimes. Of course I covered my shorts – my financial shorts. Not all of them, but most of them last week.
So, if you’re talking about a temporary inflection point, we may have hit it.
If you look back at previous countries that have declined, you almost always see exchange controls – all sorts of controls – before failure. America is already doing some of that. America, for example, wouldn’t let the Chinese buy the oil company, wouldn’t let the [Dubai firm] buy the ports, et cetera.
But I’m really talking about full-fledged, all-out exchange controls. That would certainly be a sign, but usually exchange controls are not the end of the story. Historically, they’re somewhere during the decline. Then the politicians bring in exchange controls and then things get worse from there before they bottom.
Before World War II, Japan’s yen was two to the dollar. After they lost the war, the yen was 500 to the dollar. That’s a collapse. That was also a bottom.
These are not predictions for the U.S., but I’m just saying that things have to usually get pretty, pretty, pretty, pretty bad.
It was similar in the United Kingdom. In 1918, the U.K. was the richest, most powerful country in the world. It had just won the First World War, et cetera. By 1939, it had exchange controls and this is in just one generation. And strict exchange controls. They in fact made it an act of treason for people to use anything except the pound sterling in settling debts.
(Q): Treason? Wow, I didn’t know that.
Rogers: Yes…an act of treason. It used to be that people could use anything they wanted as money. Gold or other metals. Banks would issue their own currencies. Anything. You could even use other people’s currencies.
Things were so bad in the U.K. in the 1930s they made it an act of treason to use anything except sterling and then by ’39 they had full-exchange controls. And then, of course, they had the war and that disaster. It was a disaster before the war. The war just exacerbated the problems. And by the mid-70s, the U.K. was bankrupt. They could not sell long-term government bonds. Remember, this is a country that two generations or three generations before had been the richest most powerful country in the world.
Now the only thing that saved the U.K. was the North Sea oil fields, even though Prime Minister Margaret Thatcher likes to take credit, but Margaret Thatcher has good PR. Margaret Thatcher came into office in 1979 and North Sea oil started flowing. And the U.K. suddenly had a huge balance-of-payment surplus.
You know, even if Mother Teresa had come in [as prime minister] in ’79, or Joseph Stalin, or whomever had come in 1979 – you know, Jimmy Carter, George Bush, whomever – it still would’ve been great.
You give me the largest oil field in the world and I’ll show you a good time, too. That’s what happened.
(Q): What if Thatcher had never come to power?
Rogers: Who knows, because the U.K. was in such disastrous straits when she came in. And that’s why she came to power…because it was such a disaster. I’m sure she would’ve made things better, but short of all that oil, the situation would’ve continued to decline.
So it may not be in our lifetimes that we’ll see the bottom, just given the U.K.’s history, for instance.
(Q): That’s going to be terrifying for individual investors to think about.
Rogers: Yeah. But remember that America had such a magnificent and gigantic position of dominance that deterioration will take time. You know, you don’t just change that in a decade or two. It takes a lot of hard work by a lot of incompetent people to change the situation. The U.K. situation I just explained…that decline was over 40 or 50 years, but they had so much money they could have continued to spiral downward for a long time.
Even Zimbabwe, you know, took 10 or 15 years to really get going into it’s collapse, but Robert Mugabe came into power in 1980 and, as recently as 1995, things still looked good for Zimbabwe. But now, of course, it’s a major disaster.
That’s one of the advantages of Singapore. The place has an astonishing amount of wealth and only 4 million people. So even if it started squandering it in 2008, which they may be, it’s going to take them forever to do so.
(Q): Is there a specific signal that this is “over?”
Rogers: Sure…when our entire U.S. cabinet has Swiss bank accounts. Linked inside bank accounts. When that happens, we’ll know we’re getting close because they’ll do it even after it’s illegal – after America’s put in the exchange controls.
(Q): They’ll move their own money.
Rogers: Yeah, because you look at people like the Israelis and the Argentineans and people who have had exchange controls – the politicians usually figured it out and have taken care of themselves on the side.
(Q): We saw that in South Africa and other countries, for example, as people tried to get their money out.
Rogers: Everybody figures it out, eventually, including the politicians. They say: “You know, others can’t do this, but it’s alright for us.” Those days will come. I guess when all the congressmen have foreign bank accounts, we’ll be at the bottom.
But we’ve got a long way to go, yet.
[Editor’s note: After interviewing legendary investor Jim Rogers at his home in Singapore back in March, Investment Director Keith Fitz-Gerald caught up with Rogers again in July – this time in Vancouver, where both were speaking at the Agora Wealth Symposium. Rogers talked extensively about the ill-advised bailouts of Bear Stearns, Fannie Mae and Freddie Mac, and the potentially ruinous fallout from the financial “Super Crash” that’s about to engulf the U.S. market. And look for Part 2 of Money Morning’s latest interview with Jim Rogers tomorrow (Wednesday).]
Large US bank collapse ahead, says ex-IMF economist
By Jan Dahinten
SINGAPORE, Aug 19 (Reuters) - The worst of the global financial crisis is yet to come and a large U.S. bank will fail in the next few months as the world's biggest economy hits further troubles, former IMF chief economist Kenneth Rogoff said on Tuesday.
"The U.S. is not out of the woods. I think the financial crisis is at the halfway point, perhaps. I would even go further to say 'the worst is to come'," he told a financial conference.
"We're not just going to see mid-sized banks go under in the next few months, we're going to see a whopper, we're going to see a big one, one of the big investment banks or big banks," said Rogoff, who is an economics professor at Harvard University and was the International Monetary Fund's chief economist from 2001 to 2004.
"We have to see more consolidation in the financial sector before this is over," he said, when asked for early signs of an end to the crisis.
"Probably Fannie Mae and Freddie Mac -- despite what U.S. Treasury Secretary Hank Paulson said -- these giant mortgage guarantee agencies are not going to exist in their present form in a few years."
Rogoff's comments come as investors dumped shares of the largest U.S. home funding companies Fannie Mae and Freddie Mac on Monday after a newspaper report said government officials may have no choice but to effectively nationalise the U.S. housing finance titans.
A government move to recapitalise the two companies by injecting funds could wipe out existing common stock holders, the weekend Barron's story said. Preferred shareholders and even holders of the two government-sponsored entities' $19 billion of subordinated debt would also suffer losses.
Rogoff said multi-billion dollar investments by sovereign wealth funds from Asia and the Middle East in western financial firms may not necessarily result in large profits because they had not taken into account the broader market conditions that the industry faces.
"There was this view early on in the crisis that sovereign wealth funds could save everybody. Investment banks did something stupid, they lost money in the sub-prime, they're great buys, sovereign wealth funds come in and make a lot of money by buying them.
"That view neglects the point that the financial system has become very bloated in size and needed to shrink," Rogoff told the conference in Singapore, whose wealth funds GIC and Temasek have invested billions in Merrill Lynch and Citigroup.
In response to the sharp U.S. housing retrenchment and turmoil in credit markets, the U.S. Federal Reserve has reduced interest rates by a cumulative 3.25 percentage points to 2 percent since mid-September.
Rogoff said the U.S. Federal Reserve was wrong to cut interest rates as "dramatically" as it did.
"Cutting interest rates is going to lead to a lot of inflation in the next few years in the United States."
Commodities: World's biggest miner banks on China and India as a rich source of cash
Mark Milner 19 August 2008
BHP Billiton yesterday played down fears that the boom which has driven commodity prices to record levels could turn to bust as global growth slows.
The world's biggest mining group, involved in a $130bn (£70bn) hostile bid for rival Rio Tinto, said it expected demand from developing countries, led by China and India, to offset the impact of weakening demand from developed economies. Commodity prices enjoyed their best run for 35 years in the first half of 2008, according to the Reuters/Jefferies CRB index, but fell 10% in July.
Some analysts have argued that slowing demand from the US and western Europe will feed through to developing economies by reducing demand for their exports. Chief executive Marius Kloppers said yesterday that such a view over-estimated the importance of exports to the balance of the Chinese economy.
"We have always said that China is not an export-led economy. It is driven by domestic demand ... We think the supply side is going to have a harder time keeping up [with demand] than people think."
BHP said that in the year to the end of June, revenue rose by more than a quarter to $59.5bn while profit from operations climbed about 22% to $24bn. Net profit was a record $15.4bn, a 12.4% rise. The company underlined its confidence by increasing the dividend for the year by almost 50% to 70 cents a share.
"Our results were outstanding in the context of a challenging supply environment which was characterised by unexpected disruptions, rising input prices, skills shortages and the further devaluation of the US dollar," the company said in a statement.
Kloppers said that six months ago he had expressed the view that commodity prices would remain resilient and "that view has not much changed".
BHP has a broad range of commodities, spanning petroleum, aluminium, base metals, iron ore and manganese to coal and diamonds.
"I think there is a difference between those [commodities] more leveraged to the emerging economies and those more leveraged to the developed economies," he said.
Price volatility
A debate is raging as to whether the recent surge in commodity prices has come to an end. After reaching highs this year, the price of many raw materials has tumbled.
The price of oil surged from $90 a barrel at the beginning of the year to a record $147 in July.
The price then started to weaken as US demand slowed with the downturn in the economy. Yesterday it briefly edged above $115 a barrel on fears that tropical storm Fay - which is building strength in the Caribbean - could disrupt production in the Gulf of Mexico, before falling back to $111.
Gold had risen steadily to breach $1,000 a troy ounce in March as the value of the dollar plunged, but is now back below $800. Soaring demand from China and India had driven industrial metals such as copper and aluminium to their highest points in 10 years.
These booming markets attracted financial speculators who pushed prices even higher. But weakness in the world economy has meant a fall in consumption, taking commodity markets off the boil.
Consumption of aluminium, which Kloppers said is called the middle-class metal because it is heavily used in packaging, fridges and beverage cans, was much more linked to developed economies. Coking coal and iron ore were tied to developing economies where demand was more likely, on average, to be stronger.
BHP said that in the short term it expected commodity prices "to remain high relative to historical levels, albeit with higher volatility".
Although commodity prices increased strongly over the second half of the group's financial year, BHP said its costs had risen sharply, with higher charges for diesel, coke and explosives adding to the burden of labour shortages.
Kloppers said that, unlike a number of its peers, BHP had increased its volume by 7% over the year and was looking for further growth in the current period. He noted supply remained constrained by the length of time needed to bring new projects on stream because of bottlenecks within the industry.
BHP's confidence was well received. Its shares rose 8p to £15.37 with stocks across the sector getting a boost from the company's upbeat tone. Matthew Kidman, head of investment at Wilson Asset Management, said: "The outlook still looks good even though there may be some impact over the next six months from the weakness in western economies. BHP doesn't appear to be too worried, because of the ongoing demand coming from China's industrialisation."
BHP's bid for Rio Tinto is being vetted by the European commission competition authorities, which are expected to rule on the matter towards the end of the year. If successful, it would be the world's second-largest takeover, behind Vodafone's acquisition of Mannesmann in 2000.
Exclusive Interview: Jim Rogers Continues to View China as the World’s Best Long-Term Profit Play
[The Second of Two Parts.]
Keith Fitz-Gerald August 20th, 2008
VANCOUVER, B.C. - Despite its many problems, China remains such a strong long-term profit play that giving up on that country now would be like selling all your U.S. stocks at the start of the 1900s - before America created massive wealth by evolving into a world superpower, global investing guru Jim Rogers said in an exclusive interview with Money Morning.
"I have never sold any of my Chinese companies," Rogers said. "You know, selling China in 2008 is like selling America in 1908. Sure, let’s say the market goes down another 40% - so what! You look back over 100 years, you look back from the beauty of 1928, or even 1938 [in the depths of the Great Depression], and there is somebody who bought shares in 1908. He was still a lot better off having not sold in 1908."
During a 40-minute interview during a wealth-management conference in this West Coast Canadian city last month, Rogers also said that:
• The anti-travel policies China has put in place to reduce gridlock and slash pollution during the Summer Olympic Games may actually have created a "bottom" in China stocks - possibly creating a great entry point for long-term investors.
• The 34-day worldwide Olympic torch relay leading up to the opening ceremonies likely re-awakened China’s deeply felt nationalism - which will be key as that country strives to build demand for its domestically produced products.
• And noted that the country must still deal with such problems as pollution, rising inflation and an overheated economy.
A long-time China bull, Rogers first made a name for himself with The Quantum Fund, a hedge fund that’s often described as the first real global investment fund, which he and partner George Soros founded in 1970. Over the next decade, Quantum gained 4,200%, while the Standard & Poor’s 500 Index climbed about 50%.
It was after Rogers "retired" in 1980 that the investing masses first really got to see him in action. Rogers traveled the world (several times), and penned such bestsellers as "Investment Biker" and the recently released "A Bull in China." He also made some historic market calls: Rogers predicted China’s meteoric growth a good decade before it became apparent to everyone else, and he subsequently foretold of the powerful updraft in global commodities prices that’s fueled a year-long bull market in the agriculture, energy and mining sectors.
Rogers’ candor has made him a popular figure with individual investors, meaning his pronouncements are always closely watched. Here are some of the highlights from the exclusive interview we had with the author and investor, who now makes his regular home in Singapore:
Keith Fitz-Gerald (Q): There’s a lot of talk that the Chinese will use the Olympics to launch a new wave of nationalism and to move ahead. Are the Olympic Games as relevant as some people think?
Jim Rogers: They’ve already got tremendous nationalism. But the international reactions about Tibet and the Olympic torchbearers re-awakened it.
And the politicians, of course, need it because they’ve got their own problems with inflation and overheating and [pollution and] the rest of it. So, like politicians throughout history, they fan it - do their best to say: Hell, it’s not our problem. It’s the evil farmers. It’s the French. See that store over there: It’s their fault. It’s the Americans."
So that is happening, anyway.
As far as the Olympics themselves, they’re irrelevant.
America had the Olympics in ‘96 and it had no effect on the American economy - before or after. Some people in Atlanta were affected before and after. And some people who were involved with the Olympics were affected before and after.
America at that time had 270 million people. China’s got five times as many people, and it’s a much bigger country geographically.
Sydney, Australia had the 2000 Olympics. It had virtually no effect on the Sydney, or on the Australian economy - even though Australia had 18 million people. It’s tiny … nothing. Yes, it had an effect on some people.
Greece, in 2004, had the Olympics. You haven’t heard stories of a major collapse or a major revival of Greece in 2005, because the fact is that the Games didn’t have much of an effect - not a noticeable effect, anyway. It had spot effects only, so I ignore the Olympics as far as the Chinese economy - and its stock market - is concerned.
(Q): Are you still bullish on China?
Rogers: Oh, yeah. I never sold anything in China. In fact, I bought more. I bought Chinese Airlines (PINK: CHAWF) last week. I flew one coming here. Maybe I made a mistake [with the investment], because it was emptier than I thought it would be.
(Q): Any thoughts why?
Rogers: One thing, you know, is that China’s made it extremely difficult to get a visa right now. In the past, it’s been hard to get a seat because Chinese airlines were so full. On this flight there were empty seats.
That brought home to me that they are cutting back enormously on visas right now. Discouraging travel, trying to clean the air, trying to protect against somebody blowing up the Forbidden City, et cetera. So the fact that planes are empty right now may be smarter than I thought.
Maybe I did get the bottom on the airlines, because if they are going to reissue the visas again, after all this, after September [after the Olympic Games have concluded], then the planes are going to fill up pretty quickly again. I would have picked the stock up at a bottom.
(Q): Yes.
Rogers: Anyway I’m still around China. I have never sold any of my Chinese companies. You know, selling China in 2008 is like selling America in 1908. Sure, let’s say the market goes down another 40% - so what! You look back over 100 years, you look back from the beauty of 1928, or even 1938 [in the depths of the Great Depression], and there is somebody who bought shares in 1908. He was still a lot better off having not sold in 1908.
[Editor’s note: After interviewing legendary investor Jim Rogers at his home in Singapore back in March, Investment Director Keith Fitz-Gerald caught up with Rogers again in July - this time in Vancouver, where both were speaking at the Agora Wealth Symposium. In Part 1 of this two-part series, Rogers talked extensively about the ill-advised bailouts of Bear Stearns, Fannie Mae and Freddie Mac, and the potentially ruinous fallout from the financial "Super Crash" that’s about to engulf the U.S. market. In this second installment, Rogers emphasizes China’s long-term profit promise - something he highlighted in his recent bestseller, "A Bull in China," which contains detailed research on dozens of China’s top stocks. Part 1 of this Money Morning interview with Jim Rogers ran yesterday (Tuesday).]
Dollar surge will not stop America feeling the effects of a global crunch
By Ambrose Evans-Pritchard 17/08/2008
Two alerts landed on my desk this weekend from the elite markets team at Goldman Sachs. One was entitled "The Dollar Has Bottomed!". Those betting on an imminent disintegration of American economic and political power may have to wait another cycle. Rival hegemons are falling like ninepins.
The US dollar index hit an all-time low in March. It crept slowly upwards in the early summer before smashing through layers of resistance over the past month.
The surge against sterling, the euro, the Swiss franc and the Australian dollar is one of the most spectacular currency shifts in half a century. "Something fundamental has changed," said the bank. Indeed.
US industry is now super-competitive, if small. Mid East funds are drawing up shopping lists of Wall Street takeover targets. Airbus and Volkswagen are shifting plant to America to escape crushing labour costs.
US exports have risen 22pc over the past year, outstripping Chinese growth. The US non-oil trade deficit has shrunk by two fifths since 2002. It is now running at $300bn a year. This is 2.1pc of GDP.
The other note advised clients to "Take Profit on Globalization Basket", especially on Eastern Europe currencies. Goldman Sachs has quietly dropped its talk of $200 oil. Even Russia's petro-rouble is now deemed suspect.
The twin missives more or less sum up the dramatic change in mood sweeping financial markets since it became evident that the entire bloc of rich OECD countries has succumbed to the delayed effects of the credit crisis.
Japan contracted by 0.6pc in the second quarter, Germany by 0.5pc, France and Italy by 0.3pc. Spain recalled the cabinet last week for an emergency summit. New Zealand and Denmark are in recession. Iceland contracted at a catastrophic 3.7pc in the second quarter.
"The whole decoupling thesis has started to come apart at the seams," said David Bloom, currency chief at HSBC. "Canada is frozen over. We have Arctic conditions in Sweden, and the UK is falling off the white cliffs of Dover."
The UK economy is not my brief, but I see that hedge funds are circulating a report from the US guru Jeremy Grantham predicting a very bad end to Gordon Brown's debt experiment.
"The UK housing event is probably second only to the Japanese 1990 land bubble in the Real Estate Bubble Hall of Fame. UK house prices could easily decline 50pc from the peak, and at that lower level they would still be higher than they were in 1997 as a multiple of income," he said.
"If prices go all the way back to trend, and history says that is extremely likely, then the UK financial system will need some serious bail-outs and the global ripples will be substantial."
For months the exchange markets ignored this impending train crash, just as they ignored the property bust in Europe's Latin Bloc, or the little detail that UBS alone had just lost the equivalent of 8pc of Switzerland's GDP. All they cared about in the currency pits was the interest rate gap: US low, Europe high.
Now the paradigm has flipped. The Fed may have been right after all to slash rates to 2pc. The European Central Bank may have panicked by tightening in July. Note that the elder Swiss National Bank did not do anything so rash.
Bulls now believe America is turning the corner. Financial stocks are up 20pc since early July. Some "monoline" bond insurers have risen 1,200pc in a month as fears of Götterdämmerung give way to sheer intoxicating relief, and a "short-squeeze". Such are bear-trap rallies.
Regrettably, I remain beset by gloom. The US fiscal stimulus package that kept spending afloat in the second quarter is running out fast. There is nothing yet to replace it. The export boom cannot keep adding juice as the global crunch hits. My fear is that the US will tip into a second, deeper leg of the downturn, setting off a wave of savage job cuts. This will start to feel more like a real depression.
The futures market is pricing a 33pc fall in US house prices from peak to trough, based on the Case-Shiller index. Banks have not come close to writing off implied losses on this scale.
Daniel Alpert from Westwood Capital predicts that a mere 28pc fall would alone lead to a $5.4 trillion haircut in US household wealth, and leave lenders nursing $1.25 trillion in losses. So far they have confessed to less than $500bn.
Meredith Whitney, the Oppenheimer's bank Cassandra, predicts a gruesome 40pc fall in prices. If so, expect prime borrowers facing negative equity to start throwing in the towel en masse. "I do not think we are near the end of writedowns. I continue to see capital levels going lower, and stocks going lower," she said.
So no, this painful ordeal is far from over. We are not witnessing a dollar rally so much as a collapse in European and commodity currencies. The race to the bottom has begun in earnest.
One year ago, Jim Cramer, a stock promoter on CNBC, screamed like a crybaby on TV for the Fed to save the Wall Street. It was probably the starting point for the crisis. Soon the European Central Bank injected EUR95bn into the eurozone banking system to resuscitate the interbank market. One year on, the crisis continues with no end in sight. Losses at prominent financial institutions are still piling up, having reported $450 billion of losses. Their survival is often in doubt.
The economies, however, have done better than I expected. The fiscal stimulus in the US prevented a technical recession. Europe and Japan also avoided a technical recession in the first half. Inflation, however, has picked up more than I expected. The core CPI in the US surpassed 5%, eurozone 4%, and Japan 3%. Emerging economies are experiencing double-digit inflation on average. The global inflation is probably around 5.5% now, the highest in a quarter century.
The growth and inflation surprises are related. Central banks around the world have put growth ahead of inflation. Through repeated market bailouts with liquidity injections, they have prevented financial markets from clearing, i.e., postponing the economic impact of the financial crisis. Hence, growth rates have surprised on the upside. On the other hand, liquidity injections, as I predicted in August 2007, would push up commodity prices. Oil price doubled, and rice price trebled at their recent peaks from one year ago. Despite its recent 17% decline, the CRB index remains 50% higher than the level in August 2007.
What happens now? First, the financial crisis due to property price decline will continue. The losses at global financial institutions may be only half over. The US financial institutions increased their debts by $1 trillion to $15 trillion in the past year. Deleveraging has not happened. Without deleveraging assets remain stuck on the balance sheets of the financial institutions. We don't know how much they are really worth. As long as central banks continue to support the failing financial institutions, they have no incentives to sell their assets and recognize the losses. Hence, the financial crisis continues in slow motion with occasional explosions to shock the market.
Second, the economic impact will become more obvious in the second half of 2008. The US and Japan may experience negative growth and Europe is likely to slow down sharply. East Asia depends on manufacturing exports and is hurt badly between weakening demand and rising oil price. They will likely slow down dramatically also. The reasons for the slowdown are (1) credit crunch depressing investment, (2) trade slowdown, and (3) negative wealth effect from property deflation.
Third, the second round of financial crisis from economic slowdown will begin to unfold. In addition to the buildup of leverage related to property, leverage has risen in many other areas like credit card debt, merchandize financing, and business debt due to LBOs. As economies slow down and unemployment rates rise, the resulting income slowdown could cause highly leveraged businesses and households to default. As with debts in the property sector, financial institutions have kept massive amounts in those sectors on their books in the form of securitized assets or derivatives.
Some financial institutions are already reporting losses from holding credit debts. This is just the beginning. The US unemployment rate has risen only one percentage point from one year ago. It may have two percentage points more to go. Unemployment rates in Europe, Japan, and manufacturing part of the emerging economies are just beginning.
In the business world, apart from financial institutions, there are no major bankruptcies yet. In the past five years, private equity funds (PEs) have acquired companies worth trillions of dollars mostly with debt financing. The businesses they own have very high debt equity ratio. If their businesses slip, they are likely to go into bankruptcy. The PE boom of the past five years was powered by cheap debt financing like the property boom. I believe the PE industry is heading towards a major crisis.
The auto sector, for example, already exposes the debt problems on consumer side, business side, and PE side. As oil price surges and property price falls, auto demand is falling around the world. Auto production has high fixed cost. If sales fall, auto producers can go into deep losses. If they have high debts, bankruptcies are likely to follow. The US auto makers, for example, are most vulnerable. They depend on financing incentives to promote big car sales. High oil price and the credit crisis are destroying this business model. The auto financing business is also in deep trouble. The US government may be soon forced into bailing out the US auto sector. But a bailout would still wipe out the share value that PEs hold.
Stagflation remains the dominant trend. Only the economies that export oil continue to boom. The emerging economies that depend on manufacturing exports suffer from rising cost and weakening demand. These forces push them towards stagflation. The prices of commodities have dropped sharply in the past month. The CRB index has declined by 17% from its recent peak. Oil price, for example, has dropped by $20/barrel from its recent peak of $147. Many analysts attribute it to worries over weakening demand. However, demand weakness has been around for a long time. It didn't stop the oil price doubling from August last year to its recent peak. Further, commodity prices are still high. The CRB index remains higher than its previous peak.
The trigger for the recent correction was due to euro's depreciation against the dollar. The market pushed euro up since the crisis began, believing that the ECB would continue to raise interest rate to hold down the eurozone's inflation in contrast to the Fed's priority of financial stability over inflation. The recent weak data on the eurozone economy have shaken the market's confidence in the ECB's ability to raise interest rate. The re-pricing of the ECB policy has led to euro depreciation.
The dominant trade since the crisis began was to short financials, long commodities, and short dollar. We cannot get the accurate data on how much money has been deployed in these related trades. My guesstimate is that it involves hundreds of billions of dollars. When euro depreciates, traders need to unwind their short dollar position, which triggers unwinding of the 'long commodities and short financials' positions. For example, US financial stocks have rebounded by one third from their recent lows. It is not really due to improved outlook for their earnings outlook. The technical trading dynamic is the driving force.
The theory for the 'long commodities and short dollar' combination is that commodities are priced in dollars and, when dollar depreciates, commodity prices should rise. However, when inflation picks up everywhere, even if the dollar remains stable, commodity prices will rise. Moreover, I believe that the dollar's strength is temporary. It is due to deteriorating outlook for other economies, not improving outlook for the US. When the bad news on eurozone economy is fully priced in, the spot light will switch back to the deteriorating situation in the US.
The US monetary policy means dollar weakness for years to come. The US financial system may be bankrupt as a whole, if their assets are priced at market clearing levels. Through credit default swaps, financial institutions are tied together and, if one goes under, the whole system may go under. The Fed may be forced into bailing out everybody. Printing money would be its main source of funds. Monetization of financial losses on such a scale dramatically increases dollar supply. Hence, dollar will likely remain weak for years. Of course, it is not a straight line down. The dollar may bounce from time to time due to bad news elsewhere.
This is why the prices for commodities will resume upward trend and precious metals may make new highs soon. The main force is monetary growth, not weak dollar. Money eventually becomes price. It first goes into goods or services where demand and supply are relatively inelastic. Commodities and agriculture inflate first due to their relative inelasticity on both demand and supply side, at least in the short term. The manufactured goods and services inflate next due to 'cost push'. Wages rise last as labor demands compensation for inflation.
Many prominent economists (e.g., Martin Fieldstein) argue that wages won't rise with inflation because labor unions are weak in the US, Japan and many other major economies. This view may be naïve. Labor unions may be demand rather than supply driven. In the past two decades OECD economies saw declining inflation and robust growth. Labor didn't need to defend their share of the economic pie. As inflation erodes their share of the pie, labor has incentives to organize. Even in Hong Kong, labor unions have successfully negotiated in several sectors for wage rise to compensate for inflation. Union power may return quickly across the world. The bottom line is that money will find its way to become inflation. As long as central banks keep printing money, i.e., keeping interest rates below inflation, inflation will remain high. And, it is not realistic to assume that labor won't demand wage increase when everything else is inflating.
The global economy may experience a recession in 2009. The definition for a global recession is for growth rate to fall below 2.5%. The global growth rate may be 3.5% in 2008 (2% for developed economies and 7% for developing economies). Next year the developed economies may see growth rate below 1% and developing economies about 5%, about 2% growth rate for the global economy, while inflation may rise to 6.5%-developed economies at 5% and developing economies at 10%-vs. 5.5% in 2008. Stagflation fits 2009 perfectly even better than 2008.
Beyond 2009, the US, Europe, and Japan will remain sluggish with high inflation, i.e., stagflation will haunt them for years. Developing economies could break out of the stagflationary trap through promoting trade among themselves. In particular, strengthening the trade between manufacturing part of the emerging economies and the resource part could allow them to regain growth and tame inflation.
The resource block of the emerging economies has gained income share in the global economy due to rising commodity prices. Compared to the 90s, oil alone has given them extra $1.5 trillion per annum or 10% of the whole emerging economy GDP. As long as the Fed, ECB and BoJ tolerate negative real interest rates, their income gain will last. This source of income is the foundation for demand within the emerging economy block.
The manufacturing block of the emerging economies has been trading with developed economies to benefit from labor cost difference. This trading model is running unto insurmountable barriers as the demand from the developed economies wither with falling property price and the cost of production surges with rising commodity prices. They need to reorient their trade towards the resource block of the emerging economies that have money to spend. Of course, the trade platform needs to be restructured to fit the needs of the new consumers. The process may take a couple of years.
The next upturn will begin with a new trade boom among emerging economies. When trade takes off, the emerging economies are in a position to tighten monetary policy and strengthen their currencies to combat inflation. Trade upturn and strengthening currencies are necessary conditions for the next bull market.
If emerging economies manage to create an upturn among them, which has never happened before, it would reinforce the stagflation within the developed economies: their currencies will weaken relative to emerging economies's while the boom of emerging economies keeps commodity prices high. Pundits are already debating if the shape of the current downturn is V, U, W, or L. I think that it is probably L- a long bottom.
The above discussion is to shed some light on the appropriate timing for bottom fishing. Investors around the world are anxious that they may miss the bottom. The sovereign wealth funds have participated in the recapitalization of loss-making financial institutions. They have lost big and should have. In previous financial crises only the third round of recapitalization was profitable. Asset prices in the current cycle are still some distance from the bottom. Stock markets may hit bottom in the second half of 2009. Property market may bottom in 2010. It is too early for bottom fishing.
Further, when markets hit bottom, they will remain at the bottom for a long time. The odds of a quick recovery like in 1999 and 2003 are extremely low. I think that, after hitting bottom, stock markets will remain low for one year and property for two years. Hence, investors don't have to hurry even when markets bottom. There is plenty of time for investors to put together a portfolio at the bottom to benefit from the next upturn.
The current economic downturn is only beginning. The downward trajectory will last at least for another year. When the bottom is reached, the global economy will remain sluggish for one year and much longer for developed economies. The hope for the next upturn is for trade among emerging economies to take off.
Stagflation remains the dominant macro theme. Commodities and precious metals remain in bull territory. Their recent decline is a correction. As long as central banks tolerate negative real interest rates, they will do well. Indeed, similar to the 70s, they may do well for the next decade. Of course, investors should watch out for their high volatility.
Stocks, bonds, properties are still in bear markets. They have at least one year to go before hitting bottoms. When they do, they won't recover quickly. Investors should not hurry for bottom fishing.
7 comments:
Global recession will drive down energy prices by 30%
Published: 19 August, 2008
By Nouriel Roubini
NEW YORK: The probability is growing that the global economy – not just the United States – will experience a serious recession. Recent developments suggest that all G7 economies are already in recession or close to tipping into one.
Other advanced economies or emerging markets (the rest of the euro zone; New Zealand, Iceland, Estonia, Latvia, and some Southeast European economies) are also nearing a recessionary hard landing. When they reach it, there will be a sharp slowdown in the BRICs (Brazil, Russia, India, and China) and other emerging markets.
This looming global recession is being fed by several factors: the collapse of housing bubbles in the US, the United Kingdom, Spain, Ireland and other euro-zone members; punctured credit bubbles where money and credit was too easy for too long; and the severe credit and liquidity crunch following the US mortgage crisis; the negative wealth and investment effects of falling stock markets (already down by more than 20% globally).
Some other contributing factors are: the global effects via trade links of the recession in the US (which still counts for about 30% of global GDP); the US dollar’s weakness, which reduces American trading partners’ competitiveness; and the stagflationary effects of high oil and commodity prices, which are forcing central banks to increase interest rates to fight inflation at a time when there are severe downside risks to growth and financial stability.
Official data suggest that the US economy entered into a recession in the first quarter of this year. The economy rebounded – in a double-dip, W-shaped recession – in the second quarter, boosted by the temporary effects on consumption of $100 billion in tax rebates. But those effects will fade by late summer.
The UK, Spain, and Ireland are experiencing similar developments, with housing bubbles deflating and excessive consumer debt undercutting retail sales, thus leading to recession.
Even in Italy, France, Greece, Portugal, Iceland, and the Baltic states, frothy housing markets are starting to slacken. Small wonder, then, that production, sales, and consumer and business confidence are falling throughout the euro zone.
Elsewhere, Japan is contracting, too. Japan used to grow modestly for two reasons: strong exports to the US and a weak yen. Now, exports to the US are falling while the yen has strengthened. Moreover, high oil prices in a country that imports all of its oil needs, together with falling business profitability and confidence, are pushing Japan into a recession.
The last of the G7 economies, Canada, should have benefited from high energy and commodity prices, but its GDP shrank in the first quarter, owing to the contracting US economy. Indeed, three quarters of Canada’s exports go to the US, while foreign demand accounts for a quarter of its GDP.
So every G7 economy is now headed toward recession. Other smaller economies (mostly the new members of the EU, which all have large current-account deficits) risk a sudden reversal of capital inflows; this may already be occurring in Latvia and Estonia, as well as in Iceland and New Zealand.
This G7 recession will lead to a sharp growth slowdown in emerging markets and likely tip the overall global economy into a recession. Those economies that are dependent on exports to the US and Europe and that have large current-account surpluses (China, most of Asia, and most other emerging markets) will suffer from the G7 recession.
Those with large current-account deficits (India, South Africa, and more than 20 economies in East Europe from the Baltics to Turkey) may suffer from the global credit crunch. Commodity exporters (Russia, Brazil, and others in the Middle East, Asia, Africa, and Latin America) will suffer as the G7 recession and global slowdown drive down energy and other commodity prices by as much as 30%.
Countries that allowed their currencies to appreciate relative to the dollar will experience a sharp slowdown in export growth. Those experiencing rising and now double-digit inflation will have to raise interest rates, while other high-inflation countries will lose export competitiveness.
Falling oil and commodity prices – already down 15% from their peaks – will somewhat reduce stagflationary forces in the global economy, yet inflation is becoming more entrenched via a vicious circle of rising prices, wages, and costs. This will constrain the ability of central banks to respond to the downside risks to growth.
In advanced economies, however, inflation will become less of a problem for central banks by the end of this year, as slack in product markets reduces firms’ pricing power and higher unemployment constrains wage growth.
To be sure, all G7 central banks are worried about the temporary rise in headline inflation, and all are threatening to hike interest rates.
Nevertheless, the risk of a severe recession – and of a serious banking and financial crisis – will ultimately force all G7 central banks to cut rates. The problem is that, especially outside the US, this monetary loosening will occur only when the G7 and global recession become entrenched.
Thus, the policy response will be too little, and will come too late, to prevent it. – Project Syndicate
Exclusive Interview: Jim Rogers Predicts Bigger Financial Shocks Loom, Fueling a Malaise That May Last for Years
(The First of Two Parts.]
Keith Fitz-Gerald
August 19th, 2008
VANCOUVER, B.C. – The U.S. financial crisis has cut so deep – and the government has taken on so much debt in misguided attempts to bail out such companies as Fannie Mae (FNM) and Freddie Mac (FRE) – that even larger financial shocks are still to come, global investing guru Jim Rogers said in an exclusive interview with Money Morning.
Indeed, the U.S. financial debacle is now so ingrained – and a so-called “Super Crash” so likely – that most Americans alive today won’t be around by the time the last of this credit-market mess is finally cleared away – if it ever is, Rogers said.
The end of this crisis “is a long way away,” Rogers said. “In fact, it may not be in our lifetimes.”
During a 40-minute interview during a wealth-management conference in this West Coast Canadian city last month, Rogers also said that:
• U.S. Federal Reserve Chairman Ben S. Bernanke should “resign” for the bailout deals he’s handed out as he’s tried to battle this credit crisis.
• That the U.S. national debt – the roughly $5 trillion held by the public– essentially doubled in the course of a single weekend because of the Fed-led credit crisis bailout deals.
• That U.S. consumers and investors can expect much-higher interest rates – noting that if the Fed doesn’t raise borrowing costs, market forces will make that happen.
• And that the average American has no idea just how bad this financial crisis is going to get.
“The next shock is going to be bigger and bigger, still,” Rogers said. “The shocks keep getting bigger because we keep propping things up … [and] bailing everyone out.”
Rogers first made a name for himself with The Quantum Fund, a hedge fund that’s often described as the first real global investment fund, which he and partner George Soros founded in 1970. Over the next decade, Quantum gained 4,200%, while the Standard & Poor’s 500 Index climbed about 50%.
It was after Rogers "retired" in 1980 that the investing masses got to see him in action. Rogers traveled the world (several times), and penned such bestsellers as "Investment Biker" and the recently released "A Bull in China." And he made some historic market calls: Rogers predicted China’s meteoric growth a good decade before it became apparent and he subsequently foretold of the powerful updraft in global commodities prices that’s fueled a year-long bull market in the agriculture, energy and mining sectors.
Rogers’ candor has made him a popular figure with individual investors, meaning his pronouncements are always closely watched. Here are some of the highlights from the exclusive interview we had with the author and investor, who now makes his home in Singapore:
Keith Fitz-Gerald (Q): Looks like the financial train wreck we talked about earlier this year is happening.
Jim Rogers: There was a train wreck, yes. Two or three – more than one, as you know. [U.S. Federal Reserve Chairman Ben S.] Bernanke and his boys both came to the rescue. Which is going to cover things up for a while. And then I don’t know how long the rally will last and then we’ll be off to the races again. Whether the rally lasts six days or six weeks, I don’t know. I wish I did know that sort of thing, but I never do.
(Q):What would Chairman Bernanke have to do to “get it right?”
Rogers: Resign.
(Q): Is there anything else that you think he could do that would be correct other than let these things fail?
Rogers: Well, at this stage, it doesn’t seem like he can do it. He could raise interest rates – which he should do, anyway. Somebody should. The market’s going to do it whether he does it or not, eventually.
The problem is that he’s got all that garbage on his balance sheet now. He has $400 billion of questionable assets owing to the feds on his balance sheet. I mean, he could try to reverse that. He could raise interest rates. Yeah, that’s what he could do. That would help. It would cause a shock to the system, but if we don’t have the shock now, the shock’s going to be much worse later on. Every shock, so far, has been worse than the last shock. Bear-Stearns [now part of JP Morgan Chase & Co. (JPM)] was one thing and then it’s Fannie Mae (FNM), you know, and now Freddie Mac (FRE).
The next shock’s going to be even bigger still. So the shocks keep getting bigger because we kept propping things up and this has been going on at least since Long-Term Capital Management. They’ve been bailing everyone out and [former Fed Chairman Alan] Greenspan took interest rates down and then he took them down again after the “dot-com bubble” shock, so I guess Bernanke could try to start reversing some of this stuff.
But he has to not just reverse it – he’d have to increase interest rates a lot to make up for it and that’s not going to solve the problem either, because the basic problems are that America’s got a horrible tax system, it’s got litigation right, left, and center, it’s got horrible education system, you know, and it’s got many, many, many [other] problems that are going to take a while to resolve. If he did at least turn things around – turn some of these policies around – we would have a sharp drop, but at least it would clean out some of the excesses and the system could turn around and start doing better.
But this is academic – he’s not going to do it. But again the best thing for him would be to abolish the Federal Reserve and resign. That’ll be the best solution. Is he going to do that? No, of course not. He still thinks he knows what he’s doing.
(Q): Earlier this year, when we talked in Singapore, you made the observation that the average American still doesn’t know anything’s wrong – that anything’s happening. Is that still the case?
Rogers: Yes.
(Q): What would you tell the “Average Joe” in no-nonsense terms?
Rogers: I would say that for the last 200 years, America’s elected politicians and scoundrels have built up $5 trillion in debt. In the last few weekends, some un-elected officials added another $5 trillion to America’s national debt.
Suddenly we’re on the hook for another $5 trillion. There have been attempts to explain this to the public, about what’s happening with the debt, and with the fact that America’s situation is deteriorating in the world.
I don’t know why it doesn’t sink in. People have other things on their minds, or don’t want to be bothered. Too complicated, or whatever.
I’m sure when the [British Empire] declined there were many people who rang the bell and said: “Guys, we’re making too many mistakes here in the U.K.” And nobody listened until it was too late.
When Spain was in decline, when Rome was in decline, I’m sure there were people who noticed that things were going wrong.
(Q): Many experts don’t agree with – at the very least don’t understand – the Fed’s current strategies. How can our leaders think they’re making the right choices? What do you think?
Rogers: Bernanke is a very-narrow-gauged guy. He’s spent his whole intellectual career studying the printing of money and we have now given him the keys to the printing presses. All he knows how to do is run them.
Bernanke was [on the record as saying] that there is no problem with housing in America. There’s no problem in housing finance. I mean this was like in 2006 or 2005.
(Q): Right.
Rogers: He is the Federal Reserve and the Federal Reserve more than anybody is supposed to be regulating these [financial institutions], so they should have the inside scoop, if nothing else.
(Q): That’s problematic.
Rogers: It’s mind-boggling. Here’s a man who doesn’t understand the market, who doesn’t understand economics – basic economics. His intellectual career’s been spent on the narrow-gauge study of printing money. That’s all he knows.
Yes, he’s got a PhD, which says economics on it, but economics can be one of 200 different narrow fields. And his is printing money, which he’s good at, we know. We’ve learned that he’s ready, willing and able to step in and bail out everybody.
There’s this worry [whenever you have a major financial institution that looks ready to fail] that, “Oh my God, we’re going to go down, and if we go down, the whole system goes down.”
This is nothing new. Whole systems have been taken down before. We’ve had it happen plenty of times.
(Q): History is littered with failed financial institutions.
Rogers: I know. It’s not as though this is the first time it’s ever happened. But since [Chairman Bernanke’s] whole career is about printing money and studying the Depression, he says: “Okay, got to print some more money. Got to save the day.” And, of course, that’s when he gets himself in deeper, because the first time you print it, you prop up Institution X, [but] then you got to worry about institution Y and Z.
(Q): And now we’ve got a dangerous precedent.
Rogers: That’s exactly right. And when the next guy calls him up, he’s going to bail him out, too.
(Q): What do you think [former Fed Chairman] Paul Volcker thinks about all this?
Rogers: Well, Volcker has said it’s certainly beyond the scope of central banking, as he understands central banking.
(Q): That’s pretty darn clear.
Rogers: Volcker’s been very clear – very clear to me, anyway – about what he thinks of it, and Volcker was the last decent American central banker. We’ve had couple in our history: Volcker and William McChesney Martin were two.
You know, McChesney Martin was the guy who said the job of a good central banker was to take away the punchbowl when the party starts getting good. Now [the Fed] – when the party starts getting out of control – pours more moonshine in. McChesney Martin would always pull the bowl away when people started getting a little giggly. Now the party’s out of control.
(Q): This could be the end of the Federal Reserve, which we talked about in Singapore. This would be the third failure – correct?
Rogers: Yes. We had two central banks that disappeared for whatever reason. This one’s going to disappear, too, I say.
(Q): Throughout your career you’ve had a much-fabled ability to spot unique points in history – inflection points, if you will. Points when, as you put it, somebody puts money in the corner at which you then simply pick up.
Rogers: That’s the way to invest, as far as I’m concerned.
(Q): So conceivably, history would show that the highest returns go to those who invest when there’s blood in the streets, even if it’s their own.
Rogers: Right.
(Q): Is there a point in time or something you’re looking for that will signal that the U.S. economy has reached the inflection point in this crisis?
Rogers: Well, yeah, but it’s a long way away. In fact, it may not be in our lifetimes. Of course I covered my shorts – my financial shorts. Not all of them, but most of them last week.
So, if you’re talking about a temporary inflection point, we may have hit it.
If you look back at previous countries that have declined, you almost always see exchange controls – all sorts of controls – before failure. America is already doing some of that. America, for example, wouldn’t let the Chinese buy the oil company, wouldn’t let the [Dubai firm] buy the ports, et cetera.
But I’m really talking about full-fledged, all-out exchange controls. That would certainly be a sign, but usually exchange controls are not the end of the story. Historically, they’re somewhere during the decline. Then the politicians bring in exchange controls and then things get worse from there before they bottom.
Before World War II, Japan’s yen was two to the dollar. After they lost the war, the yen was 500 to the dollar. That’s a collapse. That was also a bottom.
These are not predictions for the U.S., but I’m just saying that things have to usually get pretty, pretty, pretty, pretty bad.
It was similar in the United Kingdom. In 1918, the U.K. was the richest, most powerful country in the world. It had just won the First World War, et cetera. By 1939, it had exchange controls and this is in just one generation. And strict exchange controls. They in fact made it an act of treason for people to use anything except the pound sterling in settling debts.
(Q): Treason? Wow, I didn’t know that.
Rogers: Yes…an act of treason. It used to be that people could use anything they wanted as money. Gold or other metals. Banks would issue their own currencies. Anything. You could even use other people’s currencies.
Things were so bad in the U.K. in the 1930s they made it an act of treason to use anything except sterling and then by ’39 they had full-exchange controls. And then, of course, they had the war and that disaster. It was a disaster before the war. The war just exacerbated the problems. And by the mid-70s, the U.K. was bankrupt. They could not sell long-term government bonds. Remember, this is a country that two generations or three generations before had been the richest most powerful country in the world.
Now the only thing that saved the U.K. was the North Sea oil fields, even though Prime Minister Margaret Thatcher likes to take credit, but Margaret Thatcher has good PR. Margaret Thatcher came into office in 1979 and North Sea oil started flowing. And the U.K. suddenly had a huge balance-of-payment surplus.
You know, even if Mother Teresa had come in [as prime minister] in ’79, or Joseph Stalin, or whomever had come in 1979 – you know, Jimmy Carter, George Bush, whomever – it still would’ve been great.
You give me the largest oil field in the world and I’ll show you a good time, too. That’s what happened.
(Q): What if Thatcher had never come to power?
Rogers: Who knows, because the U.K. was in such disastrous straits when she came in. And that’s why she came to power…because it was such a disaster. I’m sure she would’ve made things better, but short of all that oil, the situation would’ve continued to decline.
So it may not be in our lifetimes that we’ll see the bottom, just given the U.K.’s history, for instance.
(Q): That’s going to be terrifying for individual investors to think about.
Rogers: Yeah. But remember that America had such a magnificent and gigantic position of dominance that deterioration will take time. You know, you don’t just change that in a decade or two. It takes a lot of hard work by a lot of incompetent people to change the situation. The U.K. situation I just explained…that decline was over 40 or 50 years, but they had so much money they could have continued to spiral downward for a long time.
Even Zimbabwe, you know, took 10 or 15 years to really get going into it’s collapse, but Robert Mugabe came into power in 1980 and, as recently as 1995, things still looked good for Zimbabwe. But now, of course, it’s a major disaster.
That’s one of the advantages of Singapore. The place has an astonishing amount of wealth and only 4 million people. So even if it started squandering it in 2008, which they may be, it’s going to take them forever to do so.
(Q): Is there a specific signal that this is “over?”
Rogers: Sure…when our entire U.S. cabinet has Swiss bank accounts. Linked inside bank accounts. When that happens, we’ll know we’re getting close because they’ll do it even after it’s illegal – after America’s put in the exchange controls.
(Q): They’ll move their own money.
Rogers: Yeah, because you look at people like the Israelis and the Argentineans and people who have had exchange controls – the politicians usually figured it out and have taken care of themselves on the side.
(Q): We saw that in South Africa and other countries, for example, as people tried to get their money out.
Rogers: Everybody figures it out, eventually, including the politicians. They say: “You know, others can’t do this, but it’s alright for us.” Those days will come. I guess when all the congressmen have foreign bank accounts, we’ll be at the bottom.
But we’ve got a long way to go, yet.
[Editor’s note: After interviewing legendary investor Jim Rogers at his home in Singapore back in March, Investment Director Keith Fitz-Gerald caught up with Rogers again in July – this time in Vancouver, where both were speaking at the Agora Wealth Symposium. Rogers talked extensively about the ill-advised bailouts of Bear Stearns, Fannie Mae and Freddie Mac, and the potentially ruinous fallout from the financial “Super Crash” that’s about to engulf the U.S. market. And look for Part 2 of Money Morning’s latest interview with Jim Rogers tomorrow (Wednesday).]
Large US bank collapse ahead, says ex-IMF economist
By Jan Dahinten
SINGAPORE, Aug 19 (Reuters) - The worst of the global financial crisis is yet to come and a large U.S. bank will fail in the next few months as the world's biggest economy hits further troubles, former IMF chief economist Kenneth Rogoff said on Tuesday.
"The U.S. is not out of the woods. I think the financial crisis is at the halfway point, perhaps. I would even go further to say 'the worst is to come'," he told a financial conference.
"We're not just going to see mid-sized banks go under in the next few months, we're going to see a whopper, we're going to see a big one, one of the big investment banks or big banks," said Rogoff, who is an economics professor at Harvard University and was the International Monetary Fund's chief economist from 2001 to 2004.
"We have to see more consolidation in the financial sector before this is over," he said, when asked for early signs of an end to the crisis.
"Probably Fannie Mae and Freddie Mac -- despite what U.S. Treasury Secretary Hank Paulson said -- these giant mortgage guarantee agencies are not going to exist in their present form in a few years."
Rogoff's comments come as investors dumped shares of the largest U.S. home funding companies Fannie Mae and Freddie Mac on Monday after a newspaper report said government officials may have no choice but to effectively nationalise the U.S. housing finance titans.
A government move to recapitalise the two companies by injecting funds could wipe out existing common stock holders, the weekend Barron's story said. Preferred shareholders and even holders of the two government-sponsored entities' $19 billion of subordinated debt would also suffer losses.
Rogoff said multi-billion dollar investments by sovereign wealth funds from Asia and the Middle East in western financial firms may not necessarily result in large profits because they had not taken into account the broader market conditions that the industry faces.
"There was this view early on in the crisis that sovereign wealth funds could save everybody. Investment banks did something stupid, they lost money in the sub-prime, they're great buys, sovereign wealth funds come in and make a lot of money by buying them.
"That view neglects the point that the financial system has become very bloated in size and needed to shrink," Rogoff told the conference in Singapore, whose wealth funds GIC and Temasek have invested billions in Merrill Lynch and Citigroup.
In response to the sharp U.S. housing retrenchment and turmoil in credit markets, the U.S. Federal Reserve has reduced interest rates by a cumulative 3.25 percentage points to 2 percent since mid-September.
Rogoff said the U.S. Federal Reserve was wrong to cut interest rates as "dramatically" as it did.
"Cutting interest rates is going to lead to a lot of inflation in the next few years in the United States."
Commodities: World's biggest miner banks on China and India as a rich source of cash
Mark Milner
19 August 2008
BHP Billiton yesterday played down fears that the boom which has driven commodity prices to record levels could turn to bust as global growth slows.
The world's biggest mining group, involved in a $130bn (£70bn) hostile bid for rival Rio Tinto, said it expected demand from developing countries, led by China and India, to offset the impact of weakening demand from developed economies. Commodity prices enjoyed their best run for 35 years in the first half of 2008, according to the Reuters/Jefferies CRB index, but fell 10% in July.
Some analysts have argued that slowing demand from the US and western Europe will feed through to developing economies by reducing demand for their exports. Chief executive Marius Kloppers said yesterday that such a view over-estimated the importance of exports to the balance of the Chinese economy.
"We have always said that China is not an export-led economy. It is driven by domestic demand ... We think the supply side is going to have a harder time keeping up [with demand] than people think."
BHP said that in the year to the end of June, revenue rose by more than a quarter to $59.5bn while profit from operations climbed about 22% to $24bn. Net profit was a record $15.4bn, a 12.4% rise. The company underlined its confidence by increasing the dividend for the year by almost 50% to 70 cents a share.
"Our results were outstanding in the context of a challenging supply environment which was characterised by unexpected disruptions, rising input prices, skills shortages and the further devaluation of the US dollar," the company said in a statement.
Kloppers said that six months ago he had expressed the view that commodity prices would remain resilient and "that view has not much changed".
BHP has a broad range of commodities, spanning petroleum, aluminium, base metals, iron ore and manganese to coal and diamonds.
"I think there is a difference between those [commodities] more leveraged to the emerging economies and those more leveraged to the developed economies," he said.
Price volatility
A debate is raging as to whether the recent surge in commodity prices has come to an end. After reaching highs this year, the price of many raw materials has tumbled.
The price of oil surged from $90 a barrel at the beginning of the year to a record $147 in July.
The price then started to weaken as US demand slowed with the downturn in the economy. Yesterday it briefly edged above $115 a barrel on fears that tropical storm Fay - which is building strength in the Caribbean - could disrupt production in the Gulf of Mexico, before falling back to $111.
Gold had risen steadily to breach $1,000 a troy ounce in March as the value of the dollar plunged, but is now back below $800. Soaring demand from China and India had driven industrial metals such as copper and aluminium to their highest points in 10 years.
These booming markets attracted financial speculators who pushed prices even higher. But weakness in the world economy has meant a fall in consumption, taking commodity markets off the boil.
Consumption of aluminium, which Kloppers said is called the middle-class metal because it is heavily used in packaging, fridges and beverage cans, was much more linked to developed economies. Coking coal and iron ore were tied to developing economies where demand was more likely, on average, to be stronger.
BHP said that in the short term it expected commodity prices "to remain high relative to historical levels, albeit with higher volatility".
Although commodity prices increased strongly over the second half of the group's financial year, BHP said its costs had risen sharply, with higher charges for diesel, coke and explosives adding to the burden of labour shortages.
Kloppers said that, unlike a number of its peers, BHP had increased its volume by 7% over the year and was looking for further growth in the current period. He noted supply remained constrained by the length of time needed to bring new projects on stream because of bottlenecks within the industry.
BHP's confidence was well received. Its shares rose 8p to £15.37 with stocks across the sector getting a boost from the company's upbeat tone. Matthew Kidman, head of investment at Wilson Asset Management, said: "The outlook still looks good even though there may be some impact over the next six months from the weakness in western economies. BHP doesn't appear to be too worried, because of the ongoing demand coming from China's industrialisation."
BHP's bid for Rio Tinto is being vetted by the European commission competition authorities, which are expected to rule on the matter towards the end of the year. If successful, it would be the world's second-largest takeover, behind Vodafone's acquisition of Mannesmann in 2000.
Exclusive Interview: Jim Rogers Continues to View China as the World’s Best Long-Term Profit Play
[The Second of Two Parts.]
Keith Fitz-Gerald
August 20th, 2008
VANCOUVER, B.C. - Despite its many problems, China remains such a strong long-term profit play that giving up on that country now would be like selling all your U.S. stocks at the start of the 1900s - before America created massive wealth by evolving into a world superpower, global investing guru Jim Rogers said in an exclusive interview with Money Morning.
"I have never sold any of my Chinese companies," Rogers said. "You know, selling China in 2008 is like selling America in 1908. Sure, let’s say the market goes down another 40% - so what! You look back over 100 years, you look back from the beauty of 1928, or even 1938 [in the depths of the Great Depression], and there is somebody who bought shares in 1908. He was still a lot better off having not sold in 1908."
During a 40-minute interview during a wealth-management conference in this West Coast Canadian city last month, Rogers also said that:
• The anti-travel policies China has put in place to reduce gridlock and slash pollution during the Summer Olympic Games may actually have created a "bottom" in China stocks - possibly creating a great entry point for long-term investors.
• The 34-day worldwide Olympic torch relay leading up to the opening ceremonies likely re-awakened China’s deeply felt nationalism - which will be key as that country strives to build demand for its domestically produced products.
• And noted that the country must still deal with such problems as pollution, rising inflation and an overheated economy.
A long-time China bull, Rogers first made a name for himself with The Quantum Fund, a hedge fund that’s often described as the first real global investment fund, which he and partner George Soros founded in 1970. Over the next decade, Quantum gained 4,200%, while the Standard & Poor’s 500 Index climbed about 50%.
It was after Rogers "retired" in 1980 that the investing masses first really got to see him in action. Rogers traveled the world (several times), and penned such bestsellers as "Investment Biker" and the recently released "A Bull in China." He also made some historic market calls: Rogers predicted China’s meteoric growth a good decade before it became apparent to everyone else, and he subsequently foretold of the powerful updraft in global commodities prices that’s fueled a year-long bull market in the agriculture, energy and mining sectors.
Rogers’ candor has made him a popular figure with individual investors, meaning his pronouncements are always closely watched. Here are some of the highlights from the exclusive interview we had with the author and investor, who now makes his regular home in Singapore:
Keith Fitz-Gerald (Q): There’s a lot of talk that the Chinese will use the Olympics to launch a new wave of nationalism and to move ahead. Are the Olympic Games as relevant as some people think?
Jim Rogers: They’ve already got tremendous nationalism. But the international reactions about Tibet and the Olympic torchbearers re-awakened it.
And the politicians, of course, need it because they’ve got their own problems with inflation and overheating and [pollution and] the rest of it. So, like politicians throughout history, they fan it - do their best to say: Hell, it’s not our problem. It’s the evil farmers. It’s the French. See that store over there: It’s their fault. It’s the Americans."
So that is happening, anyway.
As far as the Olympics themselves, they’re irrelevant.
America had the Olympics in ‘96 and it had no effect on the American economy - before or after. Some people in Atlanta were affected before and after. And some people who were involved with the Olympics were affected before and after.
America at that time had 270 million people. China’s got five times as many people, and it’s a much bigger country geographically.
Sydney, Australia had the 2000 Olympics. It had virtually no effect on the Sydney, or on the Australian economy - even though Australia had 18 million people. It’s tiny … nothing. Yes, it had an effect on some people.
Greece, in 2004, had the Olympics. You haven’t heard stories of a major collapse or a major revival of Greece in 2005, because the fact is that the Games didn’t have much of an effect - not a noticeable effect, anyway. It had spot effects only, so I ignore the Olympics as far as the Chinese economy - and its stock market - is concerned.
(Q): Are you still bullish on China?
Rogers: Oh, yeah. I never sold anything in China. In fact, I bought more. I bought Chinese Airlines (PINK: CHAWF) last week. I flew one coming here. Maybe I made a mistake [with the investment], because it was emptier than I thought it would be.
(Q): Any thoughts why?
Rogers: One thing, you know, is that China’s made it extremely difficult to get a visa right now. In the past, it’s been hard to get a seat because Chinese airlines were so full. On this flight there were empty seats.
That brought home to me that they are cutting back enormously on visas right now. Discouraging travel, trying to clean the air, trying to protect against somebody blowing up the Forbidden City, et cetera. So the fact that planes are empty right now may be smarter than I thought.
Maybe I did get the bottom on the airlines, because if they are going to reissue the visas again, after all this, after September [after the Olympic Games have concluded], then the planes are going to fill up pretty quickly again. I would have picked the stock up at a bottom.
(Q): Yes.
Rogers: Anyway I’m still around China. I have never sold any of my Chinese companies. You know, selling China in 2008 is like selling America in 1908. Sure, let’s say the market goes down another 40% - so what! You look back over 100 years, you look back from the beauty of 1928, or even 1938 [in the depths of the Great Depression], and there is somebody who bought shares in 1908. He was still a lot better off having not sold in 1908.
[Editor’s note: After interviewing legendary investor Jim Rogers at his home in Singapore back in March, Investment Director Keith Fitz-Gerald caught up with Rogers again in July - this time in Vancouver, where both were speaking at the Agora Wealth Symposium. In Part 1 of this two-part series, Rogers talked extensively about the ill-advised bailouts of Bear Stearns, Fannie Mae and Freddie Mac, and the potentially ruinous fallout from the financial "Super Crash" that’s about to engulf the U.S. market. In this second installment, Rogers emphasizes China’s long-term profit promise - something he highlighted in his recent bestseller, "A Bull in China," which contains detailed research on dozens of China’s top stocks. Part 1 of this Money Morning interview with Jim Rogers ran yesterday (Tuesday).]
Dollar surge will not stop America feeling the effects of a global crunch
By Ambrose Evans-Pritchard
17/08/2008
Two alerts landed on my desk this weekend from the elite markets team at Goldman Sachs. One was entitled "The Dollar Has Bottomed!". Those betting on an imminent disintegration of American economic and political power may have to wait another cycle. Rival hegemons are falling like ninepins.
The US dollar index hit an all-time low in March. It crept slowly upwards in the early summer before smashing through layers of resistance over the past month.
The surge against sterling, the euro, the Swiss franc and the Australian dollar is one of the most spectacular currency shifts in half a century. "Something fundamental has changed," said the bank. Indeed.
US industry is now super-competitive, if small. Mid East funds are drawing up shopping lists of Wall Street takeover targets. Airbus and Volkswagen are shifting plant to America to escape crushing labour costs.
US exports have risen 22pc over the past year, outstripping Chinese growth. The US non-oil trade deficit has shrunk by two fifths since 2002. It is now running at $300bn a year. This is 2.1pc of GDP.
The other note advised clients to "Take Profit on Globalization Basket", especially on Eastern Europe currencies. Goldman Sachs has quietly dropped its talk of $200 oil. Even Russia's petro-rouble is now deemed suspect.
The twin missives more or less sum up the dramatic change in mood sweeping financial markets since it became evident that the entire bloc of rich OECD countries has succumbed to the delayed effects of the credit crisis.
Japan contracted by 0.6pc in the second quarter, Germany by 0.5pc, France and Italy by 0.3pc. Spain recalled the cabinet last week for an emergency summit. New Zealand and Denmark are in recession. Iceland contracted at a catastrophic 3.7pc in the second quarter.
"The whole decoupling thesis has started to come apart at the seams," said David Bloom, currency chief at HSBC. "Canada is frozen over. We have Arctic conditions in Sweden, and the UK is falling off the white cliffs of Dover."
The UK economy is not my brief, but I see that hedge funds are circulating a report from the US guru Jeremy Grantham predicting a very bad end to Gordon Brown's debt experiment.
"The UK housing event is probably second only to the Japanese 1990 land bubble in the Real Estate Bubble Hall of Fame. UK house prices could easily decline 50pc from the peak, and at that lower level they would still be higher than they were in 1997 as a multiple of income," he said.
"If prices go all the way back to trend, and history says that is extremely likely, then the UK financial system will need some serious bail-outs and the global ripples will be substantial."
For months the exchange markets ignored this impending train crash, just as they ignored the property bust in Europe's Latin Bloc, or the little detail that UBS alone had just lost the equivalent of 8pc of Switzerland's GDP. All they cared about in the currency pits was the interest rate gap: US low, Europe high.
Now the paradigm has flipped. The Fed may have been right after all to slash rates to 2pc. The European Central Bank may have panicked by tightening in July. Note that the elder Swiss National Bank did not do anything so rash.
Bulls now believe America is turning the corner. Financial stocks are up 20pc since early July. Some "monoline" bond insurers have risen 1,200pc in a month as fears of Götterdämmerung give way to sheer intoxicating relief, and a "short-squeeze". Such are bear-trap rallies.
Regrettably, I remain beset by gloom. The US fiscal stimulus package that kept spending afloat in the second quarter is running out fast. There is nothing yet to replace it. The export boom cannot keep adding juice as the global crunch hits. My fear is that the US will tip into a second, deeper leg of the downturn, setting off a wave of savage job cuts. This will start to feel more like a real depression.
The futures market is pricing a 33pc fall in US house prices from peak to trough, based on the Case-Shiller index. Banks have not come close to writing off implied losses on this scale.
Daniel Alpert from Westwood Capital predicts that a mere 28pc fall would alone lead to a $5.4 trillion haircut in US household wealth, and leave lenders nursing $1.25 trillion in losses. So far they have confessed to less than $500bn.
Meredith Whitney, the Oppenheimer's bank Cassandra, predicts a gruesome 40pc fall in prices. If so, expect prime borrowers facing negative equity to start throwing in the towel en masse. "I do not think we are near the end of writedowns. I continue to see capital levels going lower, and stocks going lower," she said.
So no, this painful ordeal is far from over. We are not witnessing a dollar rally so much as a collapse in European and commodity currencies. The race to the bottom has begun in earnest.
Not time for bottom fishing
Andy Xie
19 August 2008
One year ago, Jim Cramer, a stock promoter on CNBC, screamed like a crybaby on TV for the Fed to save the Wall Street. It was probably the starting point for the crisis. Soon the European Central Bank injected EUR95bn into the eurozone banking system to resuscitate the interbank market. One year on, the crisis continues with no end in sight. Losses at prominent financial institutions are still piling up, having reported $450 billion of losses. Their survival is often in doubt.
The economies, however, have done better than I expected. The fiscal stimulus in the US prevented a technical recession. Europe and Japan also avoided a technical recession in the first half. Inflation, however, has picked up more than I expected. The core CPI in the US surpassed 5%, eurozone 4%, and Japan 3%. Emerging economies are experiencing double-digit inflation on average. The global inflation is probably around 5.5% now, the highest in a quarter century.
The growth and inflation surprises are related. Central banks around the world have put growth ahead of inflation. Through repeated market bailouts with liquidity injections, they have prevented financial markets from clearing, i.e., postponing the economic impact of the financial crisis. Hence, growth rates have surprised on the upside. On the other hand, liquidity injections, as I predicted in August 2007, would push up commodity prices. Oil price doubled, and rice price trebled at their recent peaks from one year ago. Despite its recent 17% decline, the CRB index remains 50% higher than the level in August 2007.
What happens now? First, the financial crisis due to property price decline will continue. The losses at global financial institutions may be only half over. The US financial institutions increased their debts by $1 trillion to $15 trillion in the past year. Deleveraging has not happened. Without deleveraging assets remain stuck on the balance sheets of the financial institutions. We don't know how much they are really worth. As long as central banks continue to support the failing financial institutions, they have no incentives to sell their assets and recognize the losses. Hence, the financial crisis continues in slow motion with occasional explosions to shock the market.
Second, the economic impact will become more obvious in the second half of 2008. The US and Japan may experience negative growth and Europe is likely to slow down sharply. East Asia depends on manufacturing exports and is hurt badly between weakening demand and rising oil price. They will likely slow down dramatically also. The reasons for the slowdown are (1) credit crunch depressing investment, (2) trade slowdown, and (3) negative wealth effect from property deflation.
Third, the second round of financial crisis from economic slowdown will begin to unfold. In addition to the buildup of leverage related to property, leverage has risen in many other areas like credit card debt, merchandize financing, and business debt due to LBOs. As economies slow down and unemployment rates rise, the resulting income slowdown could cause highly leveraged businesses and households to default. As with debts in the property sector, financial institutions have kept massive amounts in those sectors on their books in the form of securitized assets or derivatives.
Some financial institutions are already reporting losses from holding credit debts. This is just the beginning. The US unemployment rate has risen only one percentage point from one year ago. It may have two percentage points more to go. Unemployment rates in Europe, Japan, and manufacturing part of the emerging economies are just beginning.
In the business world, apart from financial institutions, there are no major bankruptcies yet. In the past five years, private equity funds (PEs) have acquired companies worth trillions of dollars mostly with debt financing. The businesses they own have very high debt equity ratio. If their businesses slip, they are likely to go into bankruptcy. The PE boom of the past five years was powered by cheap debt financing like the property boom. I believe the PE industry is heading towards a major crisis.
The auto sector, for example, already exposes the debt problems on consumer side, business side, and PE side. As oil price surges and property price falls, auto demand is falling around the world. Auto production has high fixed cost. If sales fall, auto producers can go into deep losses. If they have high debts, bankruptcies are likely to follow. The US auto makers, for example, are most vulnerable. They depend on financing incentives to promote big car sales. High oil price and the credit crisis are destroying this business model. The auto financing business is also in deep trouble. The US government may be soon forced into bailing out the US auto sector. But a bailout would still wipe out the share value that PEs hold.
Stagflation remains the dominant trend. Only the economies that export oil continue to boom. The emerging economies that depend on manufacturing exports suffer from rising cost and weakening demand. These forces push them towards stagflation. The prices of commodities have dropped sharply in the past month. The CRB index has declined by 17% from its recent peak. Oil price, for example, has dropped by $20/barrel from its recent peak of $147. Many analysts attribute it to worries over weakening demand. However, demand weakness has been around for a long time. It didn't stop the oil price doubling from August last year to its recent peak. Further, commodity prices are still high. The CRB index remains higher than its previous peak.
The trigger for the recent correction was due to euro's depreciation against the dollar. The market pushed euro up since the crisis began, believing that the ECB would continue to raise interest rate to hold down the eurozone's inflation in contrast to the Fed's priority of financial stability over inflation. The recent weak data on the eurozone economy have shaken the market's confidence in the ECB's ability to raise interest rate. The re-pricing of the ECB policy has led to euro depreciation.
The dominant trade since the crisis began was to short financials, long commodities, and short dollar. We cannot get the accurate data on how much money has been deployed in these related trades. My guesstimate is that it involves hundreds of billions of dollars. When euro depreciates, traders need to unwind their short dollar position, which triggers unwinding of the 'long commodities and short financials' positions. For example, US financial stocks have rebounded by one third from their recent lows. It is not really due to improved outlook for their earnings outlook. The technical trading dynamic is the driving force.
The theory for the 'long commodities and short dollar' combination is that commodities are priced in dollars and, when dollar depreciates, commodity prices should rise. However, when inflation picks up everywhere, even if the dollar remains stable, commodity prices will rise. Moreover, I believe that the dollar's strength is temporary. It is due to deteriorating outlook for other economies, not improving outlook for the US. When the bad news on eurozone economy is fully priced in, the spot light will switch back to the deteriorating situation in the US.
The US monetary policy means dollar weakness for years to come. The US financial system may be bankrupt as a whole, if their assets are priced at market clearing levels. Through credit default swaps, financial institutions are tied together and, if one goes under, the whole system may go under. The Fed may be forced into bailing out everybody. Printing money would be its main source of funds. Monetization of financial losses on such a scale dramatically increases dollar supply. Hence, dollar will likely remain weak for years. Of course, it is not a straight line down. The dollar may bounce from time to time due to bad news elsewhere.
This is why the prices for commodities will resume upward trend and precious metals may make new highs soon. The main force is monetary growth, not weak dollar. Money eventually becomes price. It first goes into goods or services where demand and supply are relatively inelastic. Commodities and agriculture inflate first due to their relative inelasticity on both demand and supply side, at least in the short term. The manufactured goods and services inflate next due to 'cost push'. Wages rise last as labor demands compensation for inflation.
Many prominent economists (e.g., Martin Fieldstein) argue that wages won't rise with inflation because labor unions are weak in the US, Japan and many other major economies. This view may be naïve. Labor unions may be demand rather than supply driven. In the past two decades OECD economies saw declining inflation and robust growth. Labor didn't need to defend their share of the economic pie. As inflation erodes their share of the pie, labor has incentives to organize. Even in Hong Kong, labor unions have successfully negotiated in several sectors for wage rise to compensate for inflation. Union power may return quickly across the world. The bottom line is that money will find its way to become inflation. As long as central banks keep printing money, i.e., keeping interest rates below inflation, inflation will remain high. And, it is not realistic to assume that labor won't demand wage increase when everything else is inflating.
The global economy may experience a recession in 2009. The definition for a global recession is for growth rate to fall below 2.5%. The global growth rate may be 3.5% in 2008 (2% for developed economies and 7% for developing economies). Next year the developed economies may see growth rate below 1% and developing economies about 5%, about 2% growth rate for the global economy, while inflation may rise to 6.5%-developed economies at 5% and developing economies at 10%-vs. 5.5% in 2008. Stagflation fits 2009 perfectly even better than 2008.
Beyond 2009, the US, Europe, and Japan will remain sluggish with high inflation, i.e., stagflation will haunt them for years. Developing economies could break out of the stagflationary trap through promoting trade among themselves. In particular, strengthening the trade between manufacturing part of the emerging economies and the resource part could allow them to regain growth and tame inflation.
The resource block of the emerging economies has gained income share in the global economy due to rising commodity prices. Compared to the 90s, oil alone has given them extra $1.5 trillion per annum or 10% of the whole emerging economy GDP. As long as the Fed, ECB and BoJ tolerate negative real interest rates, their income gain will last. This source of income is the foundation for demand within the emerging economy block.
The manufacturing block of the emerging economies has been trading with developed economies to benefit from labor cost difference. This trading model is running unto insurmountable barriers as the demand from the developed economies wither with falling property price and the cost of production surges with rising commodity prices. They need to reorient their trade towards the resource block of the emerging economies that have money to spend. Of course, the trade platform needs to be restructured to fit the needs of the new consumers. The process may take a couple of years.
The next upturn will begin with a new trade boom among emerging economies. When trade takes off, the emerging economies are in a position to tighten monetary policy and strengthen their currencies to combat inflation. Trade upturn and strengthening currencies are necessary conditions for the next bull market.
If emerging economies manage to create an upturn among them, which has never happened before, it would reinforce the stagflation within the developed economies: their currencies will weaken relative to emerging economies's while the boom of emerging economies keeps commodity prices high. Pundits are already debating if the shape of the current downturn is V, U, W, or L. I think that it is probably L- a long bottom.
The above discussion is to shed some light on the appropriate timing for bottom fishing. Investors around the world are anxious that they may miss the bottom. The sovereign wealth funds have participated in the recapitalization of loss-making financial institutions. They have lost big and should have. In previous financial crises only the third round of recapitalization was profitable. Asset prices in the current cycle are still some distance from the bottom. Stock markets may hit bottom in the second half of 2009. Property market may bottom in 2010. It is too early for bottom fishing.
Further, when markets hit bottom, they will remain at the bottom for a long time. The odds of a quick recovery like in 1999 and 2003 are extremely low. I think that, after hitting bottom, stock markets will remain low for one year and property for two years. Hence, investors don't have to hurry even when markets bottom. There is plenty of time for investors to put together a portfolio at the bottom to benefit from the next upturn.
The current economic downturn is only beginning. The downward trajectory will last at least for another year. When the bottom is reached, the global economy will remain sluggish for one year and much longer for developed economies. The hope for the next upturn is for trade among emerging economies to take off.
Stagflation remains the dominant macro theme. Commodities and precious metals remain in bull territory. Their recent decline is a correction. As long as central banks tolerate negative real interest rates, they will do well. Indeed, similar to the 70s, they may do well for the next decade. Of course, investors should watch out for their high volatility.
Stocks, bonds, properties are still in bear markets. They have at least one year to go before hitting bottoms. When they do, they won't recover quickly. Investors should not hurry for bottom fishing.
Post a Comment