Ray Hendon's Blog

Layoffs Drop and Unemployment Rate Dips

2009-08-07T08:00:00.001-07:00

The labor department estimates that July layoffs were the least since August of 2008. The chart below, provided by the New York Times, provides a clear picture of how the economy is slowly pulling itself out of the worst recession in over fifty years.

Certainly the rate of fall in the number of layoffs has not been smooth—it never is. But the trend is clear. Earlier projection of a bottoming in the third or forth quarter of this year are still looking accurate.

Fewer layoffs also resulted in a slight drop in the rate of unemployment. The chart below shows this:

It should be pointed out that much of the drop in the rate of unemployment was a result of 400,000 workers leaving the labor market. This “discourage worker” effect is well known in economic circles. When job get harder to find, many workers become so discouraged that they cease actively looking for work. It happens in every recession, and the effects are reversed when the labor market improves with recovery.

Another effect of discouraged workers is that while it cushions the rate of unemployment during the downturn, it is a drag on unemployment rates during the recovery. As jobs become easier to find, many of those who left the labor market because of their discouragement, re-enter the market when things get better. A higher participation rate of the labor force thus causes the unemployment rate to rise, or fall less, when things get better.

All in all, this is good news. The economy does appear to be bottoming. I guess that by October on November, the fall in GDP will reach zero, and there should be some recovery in December or January of 2010.

New Currency Bundle from WisdomTree

2009-05-13T21:34:00.001-07:00

One of the casualties of the world financial crash of 2008 was the carry trade. For the investor to make money on the interest rate differential between two currencies, it is imperative that the currency prices remain stable. Many of the emerging market currencies fell almost 50% from the last quarter of last year. This forced carry traders to liquidate their currency exposures. The carry trade went into a tailspin, and since then it’s been a waiting game for stability to return to world trade and to currency prices.

The picture has changed over the last few months, however, as the graphs below show. The first chart shows prices of the Mexican peso ETF of Rydex Investments (FXM) over the last year. The prices are the dollar value of 1000 pesos. From its peak in August of last year, the peso fell over 35% to its low in early March of this year, at which time it began something of a comeback.

Mexican Peso/Dollar 1-Year Prices

Almost all of the emerging market currencies have made similar recoveries from their lows, and they continue to improve as the world’s economies head to recovery--we hope!

Even the developed currencies like the Euro and pound sterling have taken their licks. The pound fell about 30% over the same period.

£/Dollar (FXB) 1-Year

There is another casualty of the financial carnage of last year. Prior to August of last year, ETF and ETN providers were flooding the SEC with proposals for foreign currency exchange traded products. I was running out of disk space trying to keep up with all the new filings. The collapse of the currency markets brought all these plans to a virtual standstill, and there were no new offerings for the rest of 2008.

Now, however, things have changed enough for one of the providers, WisdomTree, to follow through with their plans. On Wednesday, May 6, they brought the WisdomTree Dreyfus Emerging Currency Income Fund (CEW) to market.

This new EM bundle includes 11 currencies, ranged around the world from Central Europe, Africa, Latin America and Asia. WisdomTree chose to put their new ETF under the Investment Act of 1940. This means, among other things, investors will have daily transparency of holdings and prices for their new product.

Initial sales look robust, with an average daily volume over 100,000 shares. It carries an estimated interest yield of about 4.6%.

This is a most interesting product. The inclusion of 11 currencies provides a degree of diversification not provided by single-currency ETFs. The list includes: Turkish lira, Brazilian real, South African rand, Polish zloty, South Korean won, Chilean Peso, Mexican peso, Israel shekel, Indian rupee, Taiwanese dollar, and the Chinese yuan.

I like the geographic diversity: it covers all the continents except Australia. I also like the equal weighting scheme they use to determine how much of each currency to hold. The fund will be rebalanced quarterly, and WisdomTree will remove a currency if, in their assessment, the political or economic environment becomes hostile to an orderly currency market.

This new ETF is similar to an older currency product, the Global Emerging Markets Strategy ETN, (JEM). I covered this ETN when it was first introduced in my June 26, 2008, article, Currency Bundles Pegged to the Dollar. JEM has fifteen currencies represented in their bundle. Ten of the currencies are the same as CEW, but JEM includes Russia rather than China, and it includes currencies in five countries not covered by the WisdomTree product: Columbian peso, Philippine Islands peso, Argentine peso, the Indonesia rupiah, and the Hungarian forint.

The recent price history of JEM is shown below. The share price fell from about $51 in July to its low of about $38 in February of this year, a 25% fall.

JEM was introduced at a decidedly unfortunate time, with political and financial instability just beginning in some of its target currencies. The results show in the relatively few assets this ETN has gathered since its inception (Bloomberg lists $2.98 million in assets in their latest data).

Yields on this bundle have been quite good, however, with the last dividend yielding about 9% annualized, but this return has been swamped by falling prices of some of the more unstable currencies.

I prefer the bundle offered by CEW, because some of the more volatile currencies have been omitted. For example, it does not have Russia, Hungary, Argentina, or the Philippines in its mix. Plus, the inclusion of China, which follows a relatively tight peg to the dollar, will help stabilize price fluctuations.

I also prefer the ETF form to the ETN. With last year’s carnage of supposedly unsinkable financial giants, I wonder if the ETN has much of a future.

WisdomTree’s website goes into detail about the expected interest earnings and the standard deviation of the returns of each country.

Although listed as an “income” fund, it will not behave like a normal income fund that is denominated in U.S. dollars. The dividend comes from interest earnings on short term cash instruments in each of the markets they include in their basket. Currency price fluctuations can eat up the interest earnings in a hurry.

Investors must also be aware that by including 11 countries in the mix does not necessarily completely diversify the risks of systemic failure. Emerging Market currencies are prone to move in the same direction during major disturbances, as they recently proved, so the normal safety in numbers is trumped by the herding instincts of investors.

WisdomTree properly recommends keeping currency investing to a 10% maximum of your total portfolio’s value. Part of their case for holding currencies is to moderate the downside risks of portfolios dominated by equities and fixed income holdings. Currencies are remarkably uncorrelated with equity and bond prices, so there is an advantage of lowering total portfolio volatility when currencies are included in the mix. In this case, adding a volatile currency may actually lower overall portfolio volatility because of the counter-cyclical properties of currency holdings.

Depending on your own preferences for risks, and whether you want to hedge your emerging markets equities against possible dollar depreciation, this new ETF may provide your portfolio with some important benefits. I welcome this new offering as a potential tool in balancing the risks when taking on emerging market equity investments. I hope that as the market recovers, some of the other filings of 2008 will see the light of day. Currency investing is not for everyone, but for those who can use it, a wider set of options is welcome.

Signs of Recovery are Sprouting

2009-04-28T08:12:00.001-07:00

From Bloomberg today, two bright spots on the economic landscape:

The Conference Board’s sentiment index climbed to 39.2, the highest level since November, from 26.9 in March, the New York- based research group said today. The gain was the biggest since November 2005.
Home prices stabilize: A report from S&P/Case-Shiller today showed that the slide in home prices in 20 U.S. markets slowed in February for the first time since January 2007. Prices fell 18.6 percent in February from the same month last year after dropping 19 percent the previous month.

These are welcome developments. In a financial and economic world beset with bad news, these data emphasize that the dragon of recession can be slain. The programs put in place in the U.S. are beginning to take effect.

Further analysis of the Conference Board sentiment index is also illuminating. The Conference Board’s measure of present conditions rose to 23.7 from 21.9 the prior month. The gauge of expectations for the next six months surged to 49.5, the highest level since the collapse of Lehman Brothers Holdings Inc. in September of last year.

This jump in optimism is encouraging, because if and when the economic recovery begins, it must be supported by strong consumer spending. But, if consumers are pessimistic about the future, their wallets are likely to remain closed. The hunker-down syndrome is strong when the outlook is sour.

As for housing prices, recent reports show government efforts to support housing and revive lending may be starting to work. Combined purchases of new and existing houses have hovered around a 5 million annual pace since November, and sales at retailers improved in the first two months of the year.

Add to these new developments the fact that the American and many foreign equity markets are on a fairly sustained up-trend, and you get more signals that the worst may be over, and that investors and consumers are loosening their retrenchment. It looks good for an actual recovery some time this year.

Good News Amid the Bad Employment Numbers

2009-04-03T08:34:00.001-07:00

The three charts below explain our current economic state of affairs with good clarity. Three additional charts show signs of a recovery in the making.

The first chart tracks job losses over the last one year and two month period, beginning in January of 2008 and ending in March, 2009. The bad news, we lost 663,000 jobs in March, similar to the February numbers, but less than January of this year and December of 2008. So far, at least, job losses have stopped getting worse.

The Next chart shows stock prices (Dow Jones Industrial Average) over the same period. From early March, equity prices have been improving, although it is too early to know if the trend will continue. If the six –nine month lead times holds during this recession, then the economy could be expected to turn around sometimes from September through November of this year. There are forecasts that also focus on the last quarter as the turnaround time for the economy. (See below)

The next chart shows the overall unemployment rate, and it has reached a new high with the March report of 8.5%. I expect this number to continue rising, perhaps to as high as 9.5-10%, although I hope I am wrong. Employment is a lagging indicator, so I wouldn’t look for much improvement in this measure until the last quarter, if the turnaround occurs at that time.

In support of an early last quarter turnaround, Professor David Beckworth of Texas State University in San Marcos, TX, posts the following chart:

Projection of Industrial Production based on yield spread from the BAA grade commercial bonds to AAA

Mr. Beckworth insists that the BAA/AAA spread is a clear and unambiguous indicator of investor sentiment with respect to risks. The turnaround in his projection is roughly August–October of this year. This projection is for industrial production, which is not the same as GDP, but it is a large component of GDP and a good indicator of the general health of the economy.

These are tentative signs that a recovery may be building for an American recovery. The world’s economies are following about the same signs. Stock prices have recovered for emerging markets equities, for example the ETF, VWO, which is Vanguard’s Emerging Markets Index, shows a bottoming process in the following 1-Year chart:

The last chart, below, is share prices of two ETFs: VWO, and Brazil (EWZ), except I change the time frame to the last three months. This change will help highlight the recovery in prices of both VWO and EWZ during the first quarter of this year.

It’s too early to make a definitive call on this turnaround, but if it does hold, it bodes well for a general recovery, since the emerging markets are generally considered to more risky than developed economies. If investment money is beginning to flow once again into the developing economies, it indicates a strong reversal of risk preferences that characterized this market for much of the last year.

Another encouraging sign is the conclusion of the G-20 meeting yesterday, where a trillion dollars of new money was pledged to the IMF and World Bank to help the emerging markets with currency loans and international trade financing for those countries most strapped by the slowdown.

In my view, it is not Spring, yet. But there are some signs that the economic flowers are beginning to bloom.

Estimate of China's Growth in 2009 Cut by World Bank

2009-03-18T04:47:00.001-07:00

The 25.7 percent drop in exports has prompted The World Bank to cut its estimate of China’s 2009 growth from 7.5 percent to 6.5 percent. The cut on Wednesday was the second time in the last four months the World Bank has reduced its estimate of China’s growth. The estimate before November was 9.2 percent , but was reduced in that month to 7.5 percent The current estimate of 6.5 percent is the weakest since 1990, when the economy expanded by only 3.8 percent.

The fall in exports has continued in China over the last six months, as the world wide recession extends its reach. The report did not foresee a significant recovery for China until the world economy recovers, and most economists do not see this occurring until the last quarter of 2009 or even later.

Although Mr. Wen Jiabao, China’s Premier, said only last week that China would reach its 8 percent goal for growth this year, he is almost the only one who is holding to that outlook. Most private economists see a more dismal picture for China for the rest of this year, with their estimates ranging from 5 percent on the low end to 8 percent of Mr. Wen.

The World Bank did not factor into their estimate that Mr. Wen has stated that if their 8 percent target for growth begins to looks uncertain, he is prepared to increase stimulus spending enough to bring it up to target. It is likely that this possibility will be discussed at the G-20 meeting in London on April 2nd, as many of the members have endorsed a coordinated effort of stimulus spending in order to increase world trade.

The Chinese stock market has reflected the gloomier outlook for their economy. The chart below shows the exchange traded fund, FXI, which is Barclays’ Capital ETF that follows the FTSE/Xinhua China 25 index. This index has dropped 50 percent over the last year.

The index does appear to have stabilized in the $20 to $30 range since last November, however. It closed at $27.48 on Tuesday.

Looking for the Bottom of the Recession

2009-03-16T07:58:00.001-07:00

What are the signs of the recession reaching bottom? There are a number of indicators that may be of some help. For the stock market, which usually turns up a quarter or two before the economy follows, the signs are weak, but at least in the right direction: First, an upturn in the total stock index would be a good sign. The chart below is a three-month tracking of the Dow Jones Industrial Average.

But is the slight up-tick for the last week a telling indicator? Probably not, since it could just as easily turn down next week. One week does not make a trend.

Another stock market measure is the price/earning ratio of the market. The market index value divided by the aggregate earnings of all the components is an important indicator of the value of equity holdings. The chart below shows a long, historical trend of this measure:

P/E Ratios for U.S. Equities

The P/E ratio in earlier recessions was lower than it is now, but this indicates that the bottom may at least be near. The current level of 13 is below the long term average of around 15, but it was below 10 in both the 1982 and 1930s recession.

One of the reasons business earnings (half of the P/E ratio) are so low is the inability of businesses to raise prices. We are currently in a period of deflation, which is not promising for a strong business environment. However, there are a couple of up-indicators for a return of rising prices: the prices of copper, corporate bonds and inflation-protected Treasury securities are higher today than they were in November.

For an Associated Press Report on the possibility of bottoming, follow the link:http://news.yahoo.com/s/ap/20090314/ap_on_bi_ge/wall_street_finding_the_bottom

The prices of homes is another indicator that many consider important to a recovery. The graph below shows the trend in this important variable:

Prices of Homes

Home prices have come down considerably from their previous high, but they still have a way to go before reaching the long term average. Also, home prices vary considerably within different markets. Some of the hardest-hit regions (Las Vegas, Phoenix, Miami) have already lost about 50% of their previous high.

The one variable yet to be considered is the broken banking system that afflicts most of the developed and emerging markets world. And on this front, there is not much encouraging news. It is impossible to foresee an economic recovery without a healthy banking system, and that is not present just now. The meeting of finance ministers in London over the weekend indicates they want to do something about it, but the language they chose in their press release was to "do everything possible" to correct the problem. This is not language that instills confidence in the investing community. It will be up to the heads of state, who meet on April 2nd to address this issue more fully.

The only encouraging statement coming out of the meeting of the finance ministers came from U.S. Treasury Secretary, Timothy Geithner, who indicated he would flesh out his proposal to strengthen American banks, "soon."

Two other items relevant to a recovery are consumer spending, which is still falling, and the huge amount of money market and cash holdings by investors and banks. Consumer spending needed to fall from its near 100% level just a few month ago. An economy needs to have savers, and this country lost theirs, at least in the aggregate, for many of the last few years. There is a recovery of savings underway, but it has a bit further to fall before stabilizing at the long-term average of 93%,

Cash holdings of investors in money market funds and banks are exceptionally high, which indicates to me that there is plenty of money poised to re-enter the equities market, once confidence is restored. We can only hope it is soon. Probably by the middle of April, we should see some signs of recovery of consumer confidence. The G-20 meeting will have concluded, with some expected gains from an agreement to strengthen the IMF lending to emerging markets, better international banking regulation and some coordination of stimulus spending plans.

Plus, there are other signs that the rate of getting worse is slowing down. Unemployment figures for March will help clarify this issue, and they should be out in early April. If we get some encouraging signs by the end of April, then we might expect a bottoming by the summer or fall quarter.

UPdate 3/16: Chairman of the Federal Reserve, Ben Bernanke, sees end of recession in 2009.

From NYT: “We’ll see the recession coming to an end probably this year.”

With those words, Federal Reserve Chairman Ben S. Bernanke staked a marker on what he believes will be the end of the malaise that has descended upon the United States economy. And, he said on a “60 Minutes” interview that ran Sunday evening, the country will begin to recover next year — “and it will pick up steam over time.”

To watch a video of the interview on 60 minutes, follow the links below.

The Chairman Part 1 (13:23)

The Chairman Part 2 (13:13)

Behind The Scenes #1 (0:57)

To read the complete transcript of Mr. Bernanke's inverview Follow this link to the CBS site.

Looking for the Bottom of the Recession

2009-03-16T04:52:00.001-07:00

But is the slight up-tick for the last week a telling indicator? Probably not, since it could just as easily turn down next week. One week does not make a trend.

P/E Ratios for U.S. Equities

One of the reasons business earnings (half of the P/E ratio) are so low is the inability of businesses to raise prices. We are currently in a period of deflation, which is not promising to a strong business environment. However, there are a couple of up-indicators for a return of rising prices: the prices of copper, corporate bonds and inflation-protected Treasury securities are higher today than they were in November.

For an Associated Report on the possibility of bottoming, follow the link:http://news.yahoo.com/s/ap/20090314/ap_on_bi_ge/wall_street_finding_the_bottom

The prices of homes is another indicator that many consider important to a recovery. The graph below shows the trend in this important variable:

Prices of Homes

Home prices have come down considerably from their previous high, but they still have a way to go before reaching the long term average. Also, home prices vary considerably within different markets. Some of the hardest-hit regions (Las Vegas, Phoenix, Maimi) have already lost about 50% of their previous high.

Two other items relevant to a recovery are consumer spending, which is still falling, and the huge amount of money market and cash holdings by investors and banks. Consumer spending needed to fall from its near 100% level just a few month ago. An economy needs to have savers, and this country lost their, at least in the aggregate, for many of the last few years. There is a recovery of savings underway, but it has a bit further to fall before stabilizing at the long-term average of 93%,

UPdate 3/16: Chairman of the Federal Reserve, Ben Bernanke, sees end of recession in 2009.

From NYT: “We’ll see the recession coming to an end probably this year.”

To watch a video of the interview on 60 minutes, follow the links below.

To read the complete transcript of Mr. Bernanke's inverview Follow this link to the CBS site.

Looking for the Bottom of the Recession

2009-03-15T11:00:00.001-07:00

What are the signs of the recession reaching bottom? There are a number of indicators that may help. For the stock market, which usually turns up a quarter or two before the economy follows, the signs are weak, but at least in the right direction: First, an upturn in the total stock index would be a good sign. The chart below is a three-month tracking of the Dow Jones Industrial Average.

But is the slight up-tick for the last week a telling indicator? Probably not, since it could just as easily turn down next week. One week does not make a trend.

P/E Ratios for U.S. Equities

One of the reasons business earnings (half of the P/E ratio) are so low is the inability of businesses to raise prices. We are currently in a period of deflation, which is not promising to a strong business environment. However, there are a couple of up-indicators for a return of rising prices: the prices of copper, corporate bonds and inflation-protected Treasury securities are higher today than they were in November.

For an Associated Report on the possibility of bottoming, follow the link:click here.

The prices of homes is another indicator that many consider important to a recovery. The graph below shows the trend in this important variable:

Prices of Homes

Home prices have come down considerably from their previous high, but they still have a way to go before reaching the long term average. Also, home prices vary considerably within different markets. Some of the hardest-hit regions (Las Vegas, Phoenix, Maimi) have already lost about 50% of their previous high.

Two other items relevant to a recovery are consumer spending, which is still falling, and the huge amount of money market and cash holdings by investors and banks. Consumer spending needed to fall from its near 100% level just a few month ago. An economy needs to have savers, and this country lost their, at least in the aggregate, for many of the last few years. There is a recovery of savings underway, but it has a bit further to fall before stabilizing at the long-term average of 93%,

G-20 Finance Ministers Meet in London This Weekend to Hash out the April Agenda for a New World Order

2009-03-14T07:57:00.001-07:00

In a move that sets the American tone for the meeting this weekend in London, President Obama called for coordination of increased stimulus spending by the G-20 members and for increased international cooperation in regulating the world's financial institutions. Most agree that a new world order is needed, but there is not agreement as to what should be emphasized first.

In recent past statements, Mr. Obama had downplayed America's role in working on international bank regulations. His Secretary of the Treasury, Mr. Timothy Geithner, has stated that America would not have a fully fleshed-out regulatory package in time for the London meeting. It is not clear from the statement whether the new statement of the President means that this problem has been overcome. But, it is reassuring that he is not backing away from this important agenda item.

There is not a unanimity among world leaders about the most important items on the G-20 agenda. Angela Merkel, Germany's Chancellor, has not agreed that a major stimulus program is necessary for the Euroland economies. Her current proposal of about $63 billion in stimulus spending is dwarfed by the U.S. efforts of almost $800 billion recently passed by Congress and by China's $500 billion that is already being spent. Japan is more in the German camp, having committed to stimulus spending, but not being willing to take on much more debt to bring it off. The U.K. is more in the American and Chinese camps.

Recent downturns in German exports, however, may move the German Chancellor off the dime, but so far, she thinks the major focus of the G-20 meeting should be bank regulation rather than deficit spending. Japan holds a similar position.

The International Monetary Fund has called on the trading nations of the world to commit to stimulus spending of 2% of GDP for 2009 and 2010, far above the current German efforts. Mr. Geithner, in a press conference later in the day, endorsed this goal, and he endorsed the IMF goal of funding an additional $500 billion in funding for their efforts to stabilize the weaker currencies of Asian and Central European economies.

In an earlier meeting between Mr. Obama with British Prime Minister, Mr. Gordon Brown, the Prime Minister emphasized an agenda for the G-20 that would completely restructure the original Bretton Woods agreement. This would mean a new structure for the IMF, the World Bank and internationalizing banking regulation. Mr. Obama did not specifically endorse these proposals at the meeting, but he may have come along some since that time.

The banks of the world are not enthusiastic about these new regulatory proposals. Their trade association has already met and drafted their own version of what would pass muster for them. You can guess as to the nature of their proposal.

Others think that Mr. Brown has set too ambitious an agenda for the meeting. He, it is said, needs to be seen as a heroic figure at the meeting, given his shaky status in his own country.

There is little doubt that the world needs a new Bretton Woods arrangement. Too much has changed since the 1944 agreement that reestablish mechanisms that promoted world trade. Before WWI, the British pound sterling had been used as the major trading currency in the world, but WWI and WWII saw the end of the preeminence of the pound, and Bretton Woods replaced it with the U.S. dollar.

A new agreement would not likely replace the dollar in its role as the major reserve currency in the world. There are simply no suitable currencies that have the heft to take its place. But the IMF and World Bank, just to name two, need to be restructured, allowing greater participation by China, India and Brazil, who are becoming important players in world trade. And, some mechanism needs to be reinforced to come to the rescue of the battered currencies of Europe's emerging markets. Adding a complete restructuring of the regulatory environment for the world's banks and coordinating stimulus spending to the agenda is a long reach.

This is a hugely important meeting, and its success or failure to rise to the occasion is still up in the air. My hope is that on areas where there is still disagreement, they will agree to meet again, perhaps later in the year, to reach a final settlement. Mr. Obama has not been if office long enough to be fully prepared for this giant a task.

Update 03/14/09

A report from the Wall Street Journal on Saturday concluded that there will not be a unified agreement from G-20 members to call for more stimulus spending. (Click here for full article.) Germany and France argued that their unemployment benefits and other social safety net made stimulus spending less necessary. There was agreement to increase funding for the IMF, but the amount will be left to a later decision, and there was agreement on licensing credit rating agencies. There will still be an emphasis by the U.S. to coordinate stimulus spending, however.

For Bloomberg's Saturday update click here. Their emphasis is on solving the banking asset problem--the difficulties of reaching an agreement and the difficulty of the problem itself.

G-20 Finance Ministers Meet in London This Weekend to Hash out the April Agenda for a New World Order

2009-03-14T07:30:00.001-07:00

Others think that Mr. Brown has set too ambitious an agenda for the meeting. He, it is said, needs to be seen as a heroic figure at the meeting, given his shaky status in his own country.

Update 03/14/09

G-20 Finance Ministers Meet in London This Weekend to Hash out the April Agenda for a New World Order

2009-03-12T23:50:00.001-07:00

There is not unanimity among world leaders about the most important items on the G-20 agenda. Angela Merkel, Germany's Chancellor, does not see that a major stimulus program is necessary for the Euroland economies. Her current proposal of about $63 billion in stimulus spending is dwarfed by the U.S. efforts of almost $800 billion recently passed by Congress and by China's $500 billion that is already being spent. Japan is more in the German camp, having committed to stimulus spending, but not being willing to take on much more debt to bring it off. The U.K. is more in the American and Chinese camps.

Others think that Mr. Brown has set too ambitious an agenda for the meeting. He, it is said, needs to be seen as a heroic figure at the meeting, given his shaky status in his own country.

China Prices and German Export Orders Fall

2009-03-11T10:01:00.001-07:00

Two significant signs of the worsening global slowdown come from China and Germany--two of the world's largest exporting countries.

Consumer prices in China fell 1.6 percent lower last month than the same month in 2008. This was the first decline since December 2002. February’s result represented a fast drop from an inflation rate of 8.7 percent in February of last year, when rising prices were a top priority for the Chinese government.

Producer prices are falling even faster. Oil and commodity prices contributed to the drop, but also a by a glut of factory capacity and falling of demand from both exporters and Chinese. Producer prices were 4.5 percent lower last month than a year earlier, after having shown annual increases of as much as 10 percent as recently as last summer.

Hong Kong business leaders also warned that their mainland factories are not running full capacity, but only a few have actually closed down. “They may be operating at one-third or half of production” capacity, said Clement Chen, the chairman of the Federation of Hong Kong Industries.

China’s problems, while not nearly as bad as America or Europe, are beginning to take a toll. China’s growth rate has already been declared to be about 6%, substantially below the near 10 percent rate of the last decade.

On the positive side, the stimulus spending package is already showing up in investment totals, as China is pumping about $500 billion into its economy. No one, at least yet, has predicted their economy will turn negative for 2009.

These developments in China, and reports that Germany is now facing a worsening economy, will probably contribute to the sense in the upcoming G-20 meeting in London that there needs to be a world-wide coordination of stimulus spending. Mr. Obama has already put this at the top of his agenda, and Chinese officials have voiced similar sentiments.

Only Chancellor Angela Merkle of Germany has not seen the need for a large stimulus plan. Perhaps the 38 percent plunge in January export orders, the biggest drop since data for a reunified Germany started in 1991, will get her attention. “The annual slump is absolutely catastrophic,” said Alexander Koch, an economist at UniCredit MIB in Munich. “The extent of declines is terrifying.”

From Bloomberg, "Export factory orders for Germany sank 11.4 percent in January from December, according to today’s report, with orders from outside the 16-nation euro region dropping 18.2 percent. Domestic demand dropped 4.3 percent in the month.

Pan-European Slump

Production is slumping across Europe. In the U.K., factory output dropped 6.4 percent in the three months through January, the most in at least four decades. French industrial production declined 3.1 percent in the month, five times the pace predicted by economists.

The German economy, Europe’s largest, will shrink 2.5 percent this year, the International Monetary Fund said on Jan. 22, three times as much as previously forecast. The European Central Bank expects the euro-region economy to contract about 2.7 percent in 2009."

The Battle of the Budget Shapes UP

2009-02-28T09:04:00.001-08:00

President Obama's budget, submitted this week to Congress, is stirring things up, as should be expected. Combating the deepening recession with a near-trillion dollars stimulus plan, and keeping to his campaign promises to reform health care, energy production, combat global warming, and increase education spending, his $3.6 trillion proposal is both ambitious and startling.

The battle lines are already forming. Republicans, as expected, will attack it,hurling labels: "socialism," "unAmerican," "Big Government," etc. Even some democrats are unhappy with cutting farm subsidies to some of their big contributors--those who take in over a half a million dollars a year.

Mr. Obama is fighting back, however. His website has a video presentation of his weekly "radio" address in which he lays out his defense. (Click here to see it)

The video can be accessed directly.

President Obama's Budget Defense

The vested interests, such as the medical and insurance industries, do not like it. So, we can expect a repeat of the advertising blitz that doomed the Clinton proposal in his first year in office. This time, though, the Obama Administration knows what to expect, so I would expect orchestrated counterattacks to shore up the defenses.

There is no way to overstate the sea-change this budget represents. It abandons the Reagan approach that defined government as the problem, and reinstates the Roosevelt approach that placed the federal government front and center of shaping American welfare. It will be interesting to see how this looming battle plays out. Can Mr. Obama use his popular mandate to force through this kind of change? Stay tuned for a round-by-round accounting.

Update on Health Care initiative: (3/5/09)

Although Mrs. Hillary Rodham Clinton has not directly participated in any of the White House’s planning sessions on health care, her presence is felt in Mr. Obama’s efforts to pass his own health care reform proposals. The work she did 15 years ago, although ultimately unsuccessful, is being used as a model of what and what not to do for the current efforts.

First, the Obama plan is not being drafted in secret, and then handed over to Congress to pass. Mr. Obama’s plan is broadly defined, and Congress will be allowed to shape the details. Secondly, Mr. Obama is introducing his plan only six weeks into his Presidency. Mr. Clinton waited for 11 months to make his move. The delay, according to some, was one of the major factors in its defeat.

Another factor was the focus of the new plan, which stresses cost control, and it allows everyone to keep their current coverage if they want to. One of the things about the Clinton plan that was attacked was the fear that everyone was going to be forced into one type of access to health care.

Mr. Obama has also included at least partial funding ($635 billion) for his proposal in his first budget submitted to Congress. Mr. Clinton did not do this, choosing to focus initially on balancing the budget, which did not allow any room for health care spending. Now, however, the need for health care reform is widely seen as a necessary step to control the costs of Medicare and other federal spending that touches on health care. This means that the proposals of Mr. Obama are facing far less resistance from Congress and, oddly enough, even from the health care industry than the Clinton plan when it was introduced.

These differences may be critical in gaining passage of this most important piece of legislation. Although Mrs. Clinton may be engaged in diplomacy in foreign lands today, her efforts of a decade and a half ago are helping the new President do what he promised to do about bringing important changes to Washington. She may not get the credit for the success, and certainly Mr. Obama deserves all he will get for getting the job done, but Mrs. Clinton knows that her past efforts are providing some broad shoulders for the current Administration to stand on.

Picture of an Economy Collapsing

2009-02-28T08:08:00.001-08:00

Graph of Quarterly Change in GDP

See update to this chart for late February, below.

To continue reading and see the latest update, follow this link.

The Dollar as Beauty Queen

2009-02-24T09:02:00.001-08:00

Like the great American humorist, Samuel Clements ( Mark Twain), reports of the death of the dollar have been highly exaggerated. I follow commentary and developments in the currency markets, and there has been a downbeat attitude about the dollar for years, especially from those who fail to understand the strength of greenback as the ultimate reserve currency.

If we line up the current levels of American unemployment, GDP, budget deficits and the current account deficit, the dollar can be made to look like a pig. The problem, though, is that a currency's value is never a matter of absolute value. It's always about relative value.

Certainly the absolute picture of the American economy is gloomy. But, then, so is almost everybody else on the world stage. In Europe, both the developed and developing nations are worse. Their banking crisis is similar to ours, and their exports are falling fast, as the recession strikes all parts of

Euro/Dollar--Feb 08 to Present

the continent. To read the entire article and see additional graphs, click, here.

U.S.-Canada Relations Front and Center

2009-02-19T08:19:00.001-08:00

For many years the tradition for a new American President has been to make Canada his first international stop. This underscores the close relationship between the neighboring countries.

President Obama and Ottawa from the American side of the St. Lawrence River

We share a long, un-guarded border with Canada, and we also share a common British heritage that covers a wide swath of commonality in language, legal system, political tradition and general culture. We also trade together. We export more to Canada than any other country, and Canada sells 33% of its GDP to Americans. There is good reason Canada gets the first Presidential visit, and I am glad Mr. Obama has continued the tradition today when Air Force One touches down on Canadian soil.

To continue reading this blog, please here to continue.

Report on G7 Meeting in Rome and Looking Ahead to London's G20 Meeting on April 2nd

2009-02-15T10:07:00.001-08:00

A general view of the Group of Seven (G7) Finance Ministers and Central Bank Governors meeting in Rome, Saturday, Feb. 14, 2009.

The group shot above show the attendees of the meeting. The photo below is a close up of U.S. Federal Reserve Chairman Ben Bernanke, left, U.S. Treasury Secretary Timothy Geithner, second from left, and U.S. Deputy Assistant Secretary of Treasury Mark Sobel who accompanied Mr. Geithner to the meeting.

Continue reading article here.

All Eyes on Rome as the G7 Members Meet

2009-02-13T09:40:00.001-08:00

All eyes should be on Rome today (Friday, Feb. 13) and tomorrow. The G7 meeting is taking place there, and the American representative, our Secretary of the Treasury, Timothy Geithner, will have his first chance to meet the finance ministers of Canada, France Germany, Italy, Japan, and the United Kingdom.(click here for an earlier review of Mr. Geithner)

The meeting is important because Mr. Geithner will be forced, to some degree, to put some meat on his proposal to salvage the American banking system. His proposal of a few days ago, as to how to spend the balance of the TARP funds, has not been greeted with any enthusiasm in America.

American banks are in horrid shape, especially our largest ones. Today, the market capitalization of our top banks is below $500 billion. Yet the International Monetary Fund estimates that the write-downs of their loan portfolios will rise to $2.2 trillion once a full accounting is required. When this happens, Mr. Geithner will be forced to step up to the task of rescuing them. But it is hard to imagine a scenario where the American taxpayer will pony up $2 trillion and not want a piece of the action. Yet “nationalization” of our banking system is not something he, or many others, want.

For the balance of this article and details of what is faced at the G7 meeting, click here.

Unemployment Reaches for the Sky as Economy Deteriorates

2009-02-08T09:38:00.001-08:00

The American economy lost almost 600,000 jobs last month and the unemployment rate jumped to 7.6 percent, its highest level in more than 16 years, the Labor Department said Friday. Overall, the Labor Department reported that since the U.S. economy went into recession in December, 2007,

3.6 million jobs have been lost.

Businesses in all sectors except health care are cutting back on their payrolls. It is a major retrenchment and is still getting worse. The chart above shows the change in employment levels by month. Considering that the U.S. needs, on average, about 1.5 million new jobs each month in order to keep up with labor force growth, the effects on the economy are worse than the bar chart shows. As jobs become harder to get, as they are now, this discourages many workers from even looking for work. These “discouraged workers,” as they are called, are then no longer counted in the labor force—thus understating the unemployment levels.

To read the balance of this article, and see additional graphs, check here.

Picture of an Economy Collapsing

2009-01-31T05:08:00.001-08:00

Graph of Quarterly Change in GDP

The graphic above shows the dramatic drop in annualized GDP quarterly growth for the fourth quarter of last year. Two other points are well demonstrated in this data: (To read the balance of this article, follow this Link.

Unemployment Gets Worse in Every State

2009-01-29T04:58:00.001-08:00

The Bureau of Labor Statistics provided the data for the chart below.

In a sea of bad news, the water just got a little deeper, as every state in the United States reported a month over month and year over year rise in their unemployment numbers.

It is not surprising that the agricultural states in the center of the country have the lowest levels of unemployment, since so much of farm labor is supplied by the families that own the farm. The industrial states are suffering the most, as they are most dependent on factory employment. But, even the service industries are hurting, as California, Florida and Nevada, three states that have large service industry composition, all show unemployment of 10% or higher.

Bailed-out Banks Keep Senior Executives

2009-01-27T14:25:00.001-08:00

A report from the Associated Press today discloses that nine out of ten banks that got bailout funds have kept their senior management in place. In other words: "The same executives who were at the controls as the banking system nearly collapsed are the ones the government is counting on to help save it."

The regular employees of these banks have not been so lucky. The same report details how there have been about 100,000 job cuts in the banking industry since the failures began. Unfortunately, the job cuts are coming from the ranks, not from the top.

The taxpayers, too, are not getting a fair deal for the billions they are handing over to the failed banks. We will have no say or right to questions decisions by the same executives who misguided their corporations to bankruptcy.

In another report, the high-flying execs at Citibank caved under pressure from President Obama and decided today to abandon plans for a luxurious new $50 million corporate jet from France. The decision came 24 hours after the banking giant, which was rescued by a $45 billion taxpayer bailout, defended buying the state-of-the-art Dassault Falcon 7-X U.S. skies -- as a smart business deal.

To see the pictures of the Falcom 7-X and read the balance of the blog, click here.

Asia Takes a Hit

2009-01-22T09:45:00.001-08:00

From the looks of the chart below, don’t talk of decoupling in Taiwan. In a country where almost 50% of GDP comes from exports, the world wide recession is having a devastating effect. With exports down 40% from last year, Taiwan is suffering a 20% drop in GDP if last month’s losses are annualized.

Compare this with an expected GDP drop in Germany or America of from 1-2% and you see how the losses in their major markets translate in a multiplier effect of around 10 times in Taiwan. They are not decoupled with America and Western Europe. They depend on demand from these regions to fuel their internal employment and growth.

For the rest of the article, follow this Link

Pictures of a Global Recession

2009-01-17T06:53:00.001-08:00

The graphic below, supplied by the New York Times, provides a strong image of how the global recession is affecting countries around the world. For December of ’08, the three largest exporters in the world , China ($105.7 billion), the U.S. ($98.1 billion), and Germany ($96.1 billion) all showed losses from December of ’07. China slowed 3% in December and 2% in November. The U.S. slowed 4% from a year year, and Germany dropped 21%.

To see the graphics of these and other nation's export performance, click here.

Economic Outlook for 2009

2009-01-05T10:33:00.001-08:00

Predictions for the American economy are all over the map. The most optimistic prediction I see calls for the first half of 2009 to continue its decline, with unemployment reaching 7-8% by the end of June. Recovery will begin in the second half, and the economy will end the year with a net growth of 1% to 1.5%.

A less optimistic outlook sees the decline continuing until the third or fourth quarter of the year, with net growth for the year as at or near zero and unemployment reaching as much as 8% to 9%, with even 10% a possibility.

The most pessimistic projections see the recession lasting through the entire year, with the highest level of unemployment reaching from 10% to 12%. A few of the pessimistic school see an even more protracted downturn, lasting as long as to 2011. This group sees negative growth for all of 2009 and even through 2010 in some cases.

Breadline in N.Y. in 1930

To view the rest of the article, click here.

The Need for Counter Cyclical Measures in a Falling Economy: Another Picture of Unemployment

2008-12-22T10:08:00.001-08:00

Many journalists, when writing about the economy, focus on the broadest pictures: Gross National Product, total Non-farm employment, etc. But, sometimes the big picture needs supplementing with a narrower focus.

In looking at employment, for example, it helps to break the total employment picture down into three primary sectors.

Cyclical Services, which include information services, fire, professional and business services plus leisure and hospitality (sports, hotels, gambling, e.g.), Employment in this sector follows the general business cycle.
Acyclical Services, which include health, education, other services, and government. These services, as the name implies, do not vary with the business cycle as much as the other sectors.
Goods, i.e., produced goods, which are generally measured with industrial production figures.

Below is a graph of these three sectors, measured in total payrolls for each sector as annualized six-month changes. This chart shows how wide a path unemployment is cutting through our economy. Most everyone is feeling it.

The see the graph and further analysis of sector analysis, follow this link.

Deflation as a Symptom: Leading Economic Indicators

2008-12-18T09:15:00.001-08:00

Few economic events stir up fear faster than deflation. In a technical sense, deflation is merely the opposite of inflation; overall prices drop rather than rise. It doesn't mean that all prices drop, but the average of all prices drops during deflation.

The fear factor that deflation brings is because it is associated with bad economic times rather than good times. The NY Times graph below does a good job of showing this association. Note that in the shaded areas, areas when the economy is in recession, is also the time, for the most part, when price deflation occurs. There are brief periods where year over year prices may fall for a short time without being in recession, but in all cases where falling prices lasted for a long time, a recession or depression was in

process.

To read the balance of the article, including the analysis of the chart, and to see the latest release of leading economic indicators for November, follow this link.

Chinese Yuan To Fall in Coming Months

2008-12-12T09:02:00.001-08:00

A report from Hong Kong states that the yuan is set to fall for about the next six months. The Chinese monetary authorities have signaled they will allow the fall by small amounts in order to make Chinese exports more attractive to foreigners. The China economy is heavily dependent on exports, and a strong yuan discourages sales to foreigners by making them more expensive.

China was criticized by American and European governments last year for purposely undervaluing the yuan in order to support Chinese goods over those in the western nations. In response to this criticism the yuan was allowed to rise for some of last year and into 2008. But, as the chart below shows the last six months the yuan has fallen in dollar terms, as reflected by the Wisdom Tree Chinese Yuan Fund (CYB).

To view the chart and the rest of the article, click here for rayhendon.com.

Pictures of the Real Estate Bubble Bursting

2008-12-11T09:27:00.001-08:00

The bursting of the real estate bubble is no longer news. We can watch it unfold before our very eyes, as if we were watching some distant star explode a billion light years away. The three pictures shown below show a snap shot of the real estate explosion and subsequent implosion.

The first chart shows Washington DC housing prices from 2001 through part of 2008. The dates are fixed on all charts. Washington DC was chosen because of its similarities to the national average. You can see the darker blue bars, which represent the national average, are fairly close to Washington D.C.'s figures.

Overall, the nation's capital had a rather mild expansion and an equally mild crash. Prices rose about 25% at the peak in early 2005, and down less than 20% in the middle of this year.

All charts from the NY Times

A more pronounced bubble is seen in the Los Angeles chart, below. LA prices rose over 30% at their peak (in mid 2004), and have plunged closer to 30% since.

To read the rest of the article and see graphs of Los Angeles and Las Vegas, click Here

For a more detailed analysis of the current economic crisis, see my most recent article on Seeking Alpha.

November Job Losses Highest in 34 Years

2008-12-05T09:02:00.001-08:00

The American economy lost 533,000 jobs in November, the most in 34 years. The unemployment rate shot up to 6.7 percent, the highest in 15 years. The last time that job losses in a single month were this bad or worse was in December, 1974.

The chart below provides a picture of how the recession has deepened throughout the year.

source: Bureau of Labor Statistics

If anyone had doubts about the severity of the recession that began at this time last year, there are none left. The current slowdown points to a more bad news for the United States and the rest of the world as the continuing economic crisis searches for a bottom that appears to be far lower yet.

Almost no sector in the economy was spared. Cutbacks hit factories, often the highest paying jobs, construction companies, financial firms, retailers, leisure and hospitality, and others. Government and health services were two of the few who did not post job losses.

The forecast for losses in November had been 320,000, so economists were show to have missed the mark by more than 66%, a sure sign that the severity of the recession far exceeds general expectations.

Job losses in September and October also turned out to be much worse. Employers cut 403,000 jobs in September, versus 284,000 previously estimated. Another 320,000 were chopped in October, compared with an initial estimate of 240,000.

The recession is going to be the Grinch who stole Christmas, deepening as the holiday season nears. With high unemployment, gift giving is likely to be pared back by many consumers.

Investor sentiment will also reflect this reality, and further pressure will be placed on the stock markets around the world. Within five minutes after the opening bell on Friday, the Dow Jones Industrial Average was down over 100 points.

My fear of unemployment as high as 10% was buttressed by today's news. A bottom for this recession seems much deeper than it is now.

34 Year High in Job Losses for November

2008-12-05T07:32:00.001-08:00

The chart below provides a picture of how the recession has deepened throughout the year.

source: Bureau of Labor Statistics

The recession is going to be the Grinch who stole Christmas, deepening as the holiday season nears. With high unemployment, gift giving is likely to be pared back by many consumers.

My fear of unemployment as high as 10% was buttressed by today's news. A bottom of for this recession seems far away.

China Turns Inward

2008-12-03T07:42:00.001-08:00

Speaking at the Clinton Global Initiative conference in Hong Kong, the chairman of China’s sovereign wealth fund , Mr. Lou Jiwei, said on Wednesday that China had no plans for further investments in Western financial institutions. “Right now we do not have the courage to invest in financial institutions because we do not know what problems they may have,”

The sovereign wealth fund had invested heavily in Barclays and Morgan Stanley, only to see the value of its investments plummet as the American and U.K. financial sector crashed.

Follow this link to read the full article: Link to full article.

U.S. and World Economies--Slow, Slower, Slowest

2008-12-01T10:19:00.001-08:00

There is no good news today for the world’s economies, including America. In the United States, the monthly survey of business by The Institute for Supply Management showed that manufacturing activity fell to 36.2 from October's 38.9. A figure below 50 indicates the sector is contracting. The Associated Press reports: “The November reading is the lowest since May 1982. . ., when the economy was in the midst of a painful recession. Economists said the report indicates that the economy is likely in a steep recession and times will remain tough for manufacturing companies in the coming months.”

This kind of drop in manufacturing is also shown in American automobile sales, which have put the three domestic automobile manufacturers at the doorway of bankruptcy. Of course, a slowdown of the auto industry also spills over into steel and many other members of the manufacturing sector.

Below is a video presentation by Mark Vitner on Bloomberg TV about the U.S. ISM index (to see the video and read the rest of the article about the world wide slowdown, click here).

International Economic Growth:OECD Estimates for 2009

2008-11-26T03:56:00.001-08:00

The OECD has released its estimates for growth in the major economies for 2009. Robust growth of 6% to 8% is seen in China and India. Less, but still good growth for Indonesia, while Russia, Brazil, and South Africa are less than robust, but still growing. Australia and Turkey are growing, but even less than the others.

For most of Europe, the United States and New Zealand, it is recession. Mexico, Spain and Scandinavia are expected to produce near zero growth. Iceland, the tiny dark blue dot in the north Atlantic, is projected to have a -9.335% drop in GDP.

OECD Visualization of World Growth for 2009

The table below details the specifics of GDP projections for many countries.

Almost all of the largest economies and some of the smaller ones, have growth stimulus packages in place or on the table. This will help keep the recessions from going deeper in the red, especially if they all are implemented at roughly the same time.

If one country increases government spending is a stimulus program, then there will be an expected positive addition to GDP. But, some of that growth will be exported to their trading partners. For example, if the U.S. were to enact a stimulus program by itself, it would lose some of the growth to imports from Mexico, Canada and China. But, if all four countries enact similar programs at the same time, there will be an even larger expansion in all countries. The mathematics of this are somewhat complex, and they lack definitive precision. But, the modeling that is used by economists are well tested over decades of experience. Mr. Obama's economic team will be using this type of modeling in order to determine how large a stimulus is needed to grow our economy out of the recession.

One variable not tested in this type of modeling, however, is how the credit markets will accommodate simultaneous borrowing by many countries at the same time. Is there enough world demand for debt to buy all the bonds that would be issued with the huge influx that would come from simultaneous borrowing? I don't know the answer to this question, but it does seem to me to point to some limits on the ability of the world economy to engage in large-scale borrowing at the same time.

On the positive side, China is able to buy $2 trillion itself, out of current reserves. If they stay positive in their trade balance, then they could buy even greater quantities next year. There is still plenty of international credit available, even if the large banks are dried up for now.

Conservatives, Liberals and Progressives Speak on the new Stimulus Plan

2008-11-23T18:29:00.001-08:00

Watch a well informed discussion of the new stimulus plan President-Elect Obama offered in his weekly radio (and YouTube) address. George Stephanopoulos leads the discussion between George Will, Arianna Huffington, David Brooks and Robert Kuttner on the merits of the plan.

This is well worth the time if you want to see a well informed and civil discussion. Every point of view is represented and debated--liberal, progressive and conservative.

Discussion of President Obama's Proposal on Stimulus Spending

In another interview, Paul Krugman, 2008 Nobel Prize winner in economics, noted the need for a massive spending and employment program to get the economy away from the doorway of a major depression. We are not there, he insisted, but we could get there without an immediate implementation of a plan to get people employed and money flowing again.

Mr. Krugman also emphasized that there are two crises happening at the same time: a financial crisis on Wall Street, where the American Banking system is breaking down, and another crisis on Main Street where breadwinners are losing their jobs, can't get loans and can't make their house payments. So far, the Bush Administration has addressed only the Wall Street side of the problem. Mr. Obama's plan goes a long way to begin a remedy of the second. Mr. Krugman sees possibly another one and a half million additional jobs lost before Mr. Obama takes office.

Late breaking news on Sunday said that the Democrats in Congress would have a $700 billion stimulus plan ready for Mr. Obama's signature on the day he is sworn into office.

President-Elect Obama's Stimulus Plan

2008-11-23T03:18:00.001-08:00

Mr. Obama announced on Saturday a rough sketch of a major stimulus plan that would add several million new jobs to our faltering economy. American workers will rebuild the nation's roads and bridges, modernize its schools and create more sources of alternative energy, creating 2.5 million jobs by 2011, Obama said in the weekly Democratic address, posted on his Web site.

"These aren't just steps to pull ourselves out of this immediate crisis," he said. "These are the long-term investments in our economic future that have been ignored for far too long."

To watch a video of Mr. Obama's Weekly Address to the Nation and to read the entire article:Click Here

Tim Geithner: The New Man at Treasury

2008-11-22T07:00:00.001-08:00

A brief profile of Tim Geithner published last year at New York Times:

"If the brave new world of finance is daunting, the man in charge of it is not. With a boyish charm and a dry sense of humor, Mr. Geithner has taken advantage of the current calm waters of the financial markets to take an active stance, rallying Wall Street to peel apart the market of credit derivatives to try to understand its potential risks. . . .

To read the whole story, follow this link: to RayHendon.com

How Bad Can it Get?

2008-11-20T10:31:00.001-08:00

How Bad Can it Get?

My last blog on the economy was entitled: It’s Worse Than We Think. So what comes after, worse than we think? Worser is not a word, but it’s what comes to mind today when I see the latest employment and price data.

To continue reading, follow this link to the complete article.

Report of the G-20 Meeting

2008-11-16T10:25:00.001-08:00

Here is a link to the full text of the press release of the attendees: Press Release of G-20 Members

There were two agendas at the G-20 meeting on Saturday:

Strengthen the world's economies and reduce the effect of the world-wide recession that is getting worse daily.
Find a way to share the authority over the structure of the global financial system. Europe, Asia and Latin America are all clamoring for more say-so in how things work.

On the first agenda, that of working together to strengthen the world's economies, there is progress to report. All that could reasonably be expected from the Conference would be to reach agreement on what to do for the next meeting, and this was accomplished. They agreed to meet at the end of April, about 100 days after Mr. Obama assumes his duties as President of the United States, and take up a specific list of agenda items:

Stimulus spending
Interest rate cuts
IMF funding and lending to shore up currencies under attack
Regulatory oversight on banks and other financial institutions
Oversight on credit default swaps and credit rating agencies
Transparent accounting standards for all world-wide financial institutions
A Supervisory College to meet and discuss world banking developments
Limiting compensation for financial executives

There has been no agreement on the structure of any of these issues, but there is agreement that these are the items that will be worked on for the next meeting. It is a rich agenda, and one full of difficulties to resolve. Bank regulation, alone, poses a host of thorny issues that will test the ability of the G-20 to work together.

As of yet, there has been no agreement as to who will fund the IMF in its increased lending activities, which is essential to stop the excessive volatility of the currency markets. There are, generally, three nations that have the wherewithal to do this: Saudi Arabia, China and Japan. All three of these countries have huge reserves of foreign currencies (China as over $2 trillion), and they will be needed if the plunge in currency values of both emerging and developed markets is to stop. There will probably be much discussion on this issue before the next meeting.

As to the second agenda, the spreading of authority, there is little talk, so any analysis of this issue will have to be done by reading between the lines. The background for this agenda has its roots in the vast changes that have taken place in the world economy since the 1944 Bretton Woods Agreement . The United States probably produced at least half the GNP of the world when the meeting took place. It now accounts for about 25%. Also, the economic power has shifted from Western Europe and North America to be more dispersed over all continents. Asia has enormous economic power since the rise of China, India, South Korea, and Taiwan. Plus, there are a host of South East Asian economies that are growing fast and that are now fully integrated into the world's finance system. In addition Europe has not only recovered from the devastation of WWII, but has coalesced within the EEC, and Eastern Europe is taking off.

The first reading between the lines is the fact that it was the G-20 that was called into meeting rather than the G-7 or G-8. This reflects the reality of the new power dispersion. In times past, it would have been the top industrialized nations meeting at the behest of the U.S.

The second reading regards the desire to expand the powers and monies available to the IMF. This institution, which has contributed to world economic stability over the years, has been a virtual fiefdom of the United States. But the ousting by Europe last year of Mr. Bush's appointee to head the IMF set the tone for things to come. In my view, it would be beneficial to expand the membership and voting of the IMF, to include the emerging markets. If this step cannot be done, then continuing the G-20 as the major tool of international policy making would be an important step. Over time, the members will sort things out and determine where the consultative power lies.

Below is a list of the world's top 20 economies, measured in U.S. dollars for the year 2007. This is not the exact membership of the Group of 20, however.

The G-20 has added Saudi Arabia, South Africa and Argentina, and eliminated Spain, the Netherlands and Belgium. the European Union was also added as a single member.

The list goes a long way in explaining how things need to change in regulating the world's economies. Although the United States still dominates--no one else is even close, there are many new, major players on the list. China will probably soon replace Germany as the third largest economy, and Brazil has been gaining on Canada the last few years. Turkey is now growing fast, and Indonesia will likely pass Belgium before long. The new world order needs to reflect these realities.

The final analysis may reflect that the most significant part of the G-20 meeting of 2008 was that the G-20 meeting was called. If they did nothing else, the fact that all twenty of the members came and participated marks a boundary of recognition that things have changed. Managing the world's economies will no longer be confined to the top seven or eight nations of the world. Power has shifted to include the newer, faster growing economies.

Join me in welcoming Mr. Obama to the world of international economics and finance. I hope he puts a strong team together, soon. There is some heavy lifting ahead.

Brief on the G-20 Conference Today in Washington

2008-11-15T04:24:00.001-08:00

The emergency meeting of the Group of 20 this Saturday, November 15, was called because the world’s financial system is broken. The meeting was suggested by French President, Nicolas Sarkozy to President Bush. Although Mr. Bush did not want to take up the issues that will be brought up at the meeting, he agreed to host it at Mr. Sarkozy’s insistence.

The primary issue to be discussed will be helping the developed and emerging markets out of the deepening recession that the world now faces. But, included in the discussions will be proposals made by European and emerging market leaders to reform banking regulations that would prevent the kind of financial meltdown that started the downward spiral this year.

Mr. Bush has publicly warned about stifling economic growth by excessive regulation, while the European leaders and Brazil, specifically, are more prone to take a strong government hand when they see a larger public need.

This argument is ancient in origin, and there has never been a consensus about the exact amount of regulation that is needed in every situation. Don’t look for a resolution to this issue at the meeting today. Mr. Bush couldn’t do anything about it even if he wanted to, given his status as out-going President, and the discussions today will last only about five hours.

Another meeting is planned after Mr. Obama assumes the Presidency, and at that meeting, more detailed work can be done to help coordinate government efforts to stave off what threatens to be a major downturn in many of the world’s economies. America is just entering a recession now, and the prognosis is looking increasingly bad. Europe is already in a recession, lead by Germany, the world’s third largest economy. Almost all the emerging markets, with the exceptions of China and India, are in recession, and even China and India are experiencing significantly lower growth rates for 2009.

The following description from Economix of the NY Times will be helpful in understanding the structure of The Group of 20:

The Group of 20, or G-20, is an international body that meets to discuss economic issues. Some of the things members discuss are ways to expand (or at least stabilize) the international economy, to reform international economic financial institutions like the International Monetary Fund, and to coordinate economic and financial policies (like policies that reduce tax evasion)

Members – 19 countries with some of the world’s biggest industrial and emerging economies, plus the European Union – represent about 90 percent of the world’s gross national product, 80 percent of world trade (including trade within the European Union) and two-thirds of the global population. Member countries usually meet annually.

The annual meeting already took place last weekend in São Paulo, Brazil. This weekend’s meeting was not on the regular schedule and was arranged specifically to address concerns about the international financial crisis. It is unprecedented because heads of government will be attending.

The member countries are Argentina, Australia, Brazil, Britain, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey and the United States. The European Union is also a member, represented by the rotating council presidency and the European Central Bank.

The membership of the G-20 has not changed since it was established, and the organization says there are “no formal criteria for G-20 membership.” With the exceptions of Argentina, Saudi Arabia and South Africa, all of the member countries fall within the list of the top 20 biggest state G.D.P.’s in the world.

Usually, the attendees of the annual meetings are the finance ministers and central bank governors of the member countries, plus top leadership of the World Bank and the International Monetary Fund.

This is the first time that heads of governments will attend a G-20 meeting.

A number of economist and other leaders are hoping specific policy proposals will be discussed at this meeting, but the expectations for what can and will be accomplished in the next 24 hours are relatively low.

The last-minute nature of the meeting allowed for little preparation time. The meeting itself is also relatively short.

“I would be surprised if much happens,” said Edwin M. Truman, a senior fellow at the Peterson Institute who served as the assistant secretary of the Treasury for international affairs during the founding of the G-20. “When you think about it, it’s 20 people, and they’re all heads of government. They’ll meet tonight for dinner, informally, and then they’ll meet tomorrow for just five hours. That’s not a lot of time for everyone to talk.”

There is only so much that attendees at this event can commit to, anyway, since any major policy changes will likely have to be approved by leaders’ full governments back home. President Bush — as an outgoing president — would have an especially hard time committing to anything substantial. (Former Secretary of State Madeleine K. Albright, and former Representative Jim Leach will meet with representatives of G-20 nations on President-elect Barack Obama’s behalf this weekend.)

The smaller G-7 and G-8 have memberships of only the largest economies, which exclude, China, Brazil, India and Russia, to name a few, and there has been strong criticism leveled at these groups because they exclude far too many of the world’s economic powerhouses. Most would agree with this criticism, and for this reason, and bolstered by the enormous growth of the emerging countries, the G-20 will probably assume a much larger role in the future in discussions of global economic issues. We may be seeing the first emergence of this new role in today’s meeting.

I look for much more substance from the second meeting than this one, but this one is important as a necessary first step.

Economy: It's Worse Than We Think

2008-11-13T08:41:00.001-08:00

The evidence is mounting that the American economic downturn is going to be much worse than generally thought. A downturn that was thought to see unemployment at 8%, which is a recession level, is seen now to have an easy potential of 9% or 10%--levels not seen for decades--a deep recession.

Here are the culprits:

Falling home prices are not showing signs of stopping. This quotation from the AP sets the latest news:

The number of homeowners caught in the wave of foreclosures in October grew 25 percent nationally over the same month in 2007, data released Thursday showed.More than 279,500 U.S. homes received at least one foreclosure-related notice in October, an increase of 5 percent over September, according to RealtyTrac Inc. One in every 452 housing units received a foreclosure filing, such as a default notice, auction sale notice or bank repossession.

More than 84,000 properties were repossessed in October, RealtyTrac said.

A nasty brew of strict lending standards, falling home values and a tough economy is filtering through the housing market. By the end of the year, the company expects more than a million bank-owned properties to have piled up on the market, representing around a third of all properties for sale in the U.S.

The problem with home foreclosures is that once the mortgagee takes them over, the prices falls much more than if the home had been sold while occupied. Repossessed homes tend to sit vacant for longer, deteriorating and bringing down the entire neighborhood as they fall further into to disrepair. This puts pressures on all the other homes in the neighborhood, making it more likely that other owners will walk away from their mortgages which may be twice the current market value. It is a vicious cycle, and once started, it spirals quickly down.

Lending standards have tightened to the extent that many consumers can no longer get automobile or furniture loans. This is pushing General Motors, Ford and Chrysler into bankruptcy, imperiling over three million jobs in the process.
Rising unemployment is sapping the spirit and incomes from ten million Americans right now. This has a tremendous effect on the morale of everyone they know and everywhere they live. Unemployment is a killer for spending plans. Those unemployed tend to pull back significantly on their spending, and their gloom spreads to their friends and relatives. It is contagious and destructive and will kill consumer spending which has, for the last five to ten years, been the mainstay of the American economy. An AP report released today (11/13) shows the extent of new jobless claims:

The number of newly laid-off individuals seeking unemployment benefits has jumped to a seven-year high, the government said Thursday.

The Labor Department reported that jobless claims last week increased by 32,000 to a seasonally adjusted 516,000. That is the highest total since just after the Sept. 11 terrorist attacks and second-highest since 1992.

The total was much higher than analysts expected. Wall Street economists surveyed by Thomson Reuters expected claims to increase only slightly to 484,000.

The four-week average of claims, which smooths out fluctuations, rose by 13,250 to 491,000, the highest tally in over 17 years.

Thursday's figure is the first time claims have topped 500,000 during the current economic slowdown. Jobless claims above 400,000 are considered a sign of recession. A year ago, claims stood at 338,000.

Falling economies around the world. As the world’s economies fall into below-trend growth, their spending slows down. The buy fewer airline tickets, fewer American cars, less software, and less American wheat. America does import much more than we export. But, we still export a lot, and many jobs depend on them.

the Commerce Department said the trade deficit declined by a bigger-than-expected amount in September, falling by 4.4 percent to $56.5 billion as imports experienced a record plunge.

The import decline was led by a huge fall in imported oil as the average price for crude dropped by a record $12.41 per barrel and the volume of shipments fell to the lowest level in five years. But demand for other types of imports also fell, with imported cars and car parts dropping to the lowest level in more than five years, an indication that foreign automakers are feeling the pinch hitting U.S. consumers.

The feedback loop in this kind of international recession is horrible. U.S. and European economies enter into recession. This feeds back to the emerging markets as a lower demand for their products, thus inducing recession in their economies. The recession there reduces demand in the U.S. and Europe for things they make: airplanes, large computer, computer software, agricultural commodities, etc. This further reduces employment in the U.S. and Europe, etc., etc.

It will take a Herculean effort by all the world’s economies to break this cycle. There is a meeting beginning the 15^th in Washington of the G-20, approximately the 20 largest economies in the world, and they will attempt to address the problem. Probably not much will come of the first meeting since American leadership is in a transition stage that won’t formally begin until January 20. But a second meeting will most likely be agreed to, and at the second one I would expect much better results of a comprehensive and coordinated efforts to bring the world recession under control.

For a more detailed look at this meeting, see my recent article @ http://seekingalpha.com/article/105737-the-g-20-sings-a-song-of-sixpence

Pictures of an Employment Crisis

2008-11-08T12:26:00.001-08:00

The five graphs below show with stunning visibility how bad the economy is today. Chart 1 shows changes in nonfarm employment from 1990 through the end of October, 2008. You can see the dramatic drop of 240,000 jobs lost last month in this graph. Also shown are the relative lengths of the last two recessions: the 1991 drop was relatively short, lasting about one year. The 2001-02 recession was much longer and less well defined than previous recessions. There was an increase in jobs shortly after 2002, only to plunge back into the red again in 2003.

This graph also shows the anemic recovery that followed. Note that the job creations shown in the space above the zero line after 2003 were well below those of the earlier recovery. We never made a full recovery from the 01-02 recession.

Chart 1: Change in Nonfarm Employment

All data from Bureau of Labor Statistics: Graphs from NY Times

Chart 2, below, shows the overall unemployment rate over the same period. Again, the recovery during the early period of President Clinton’s Presidency showed a rapid recovery—seen by the falling unemployment rate to a low of around 4% when he left office. Beginning in 2001 the unemployment rate increased 2003. After 2003 a fairly good recovery began and lasted from 2004 until 2007. At that point, things began getting bad again. What was an anemic recovery quickly gave way to a more serious downturn, which we are just beginning to experience.

Chart 2: Unemployment Rate

Chart 3 shows the unemployment rate among different ethnic groups. Blacks have always had a higher unemployment rate than whites, and since the Department of Labor began keeping track of unemployment by ethnic groups, Hispanics have traditionally been lower than Blacks and higher than Whites. Also, once Asians were tracked, their rates of unemployment have more closely mirrored that of Whites. All groups, however, are suffering with the current downturn.

Chart 3: Unemployment by Ethnic Group

Chart 4 shows that the unemployment crisis also affects those who keep working. The number of part-time workers who want full-time work rises dramatically once the unemployment rate begins climbing. This reflects the reality that many full-time workers are effective in getting only part-time work during the down-turn.

Chart 4: Part-Time Workers who want full-time work

This is a hidden cost of unemployment, since these workers don’t show up on the unemployment statistics or unemployment benefits program.

Chart 5: Real Weekly Wages

Chart 5 shows the effects of unemployment in terms of the general wage level of all workers. The real wage is the dollar wage per week adjusted for inflation, showing that even those who continue working in a downturn often end up getting behind the inflation curve. During recession they work for less purchasing power than when the economy was sound.

It doesn’t look good for the coming months. Many respected economists predict that the unemployment rate could reach eight percent before it begins getting better. You can surmise from these charts, that this will be especially hard on the minority populations. They will work less than they want and for real wages below what they need.

This is not a pretty picture, and it points to the need for a significant stimulus program that will directly create jobs. In a nation that needs to rebuild its infrastructure after decades of neglect, there will be plenty of men and women willing to work on such projects. Job creation, in my view, will be much more effective in easing the pain of unemployment than stimulus checks. Those checks that were mailed earlier this year were not spent as freely as Congress had expected. During tough times, when jobs are harder to get and hold, the fear factor enters the equation. Stimulus checks given at that time are often hoarded rather than spent.

The details of a new stimulus package will soon be discussed in Congress and the White House. We should forget about trying to balance the budget, and go with a huge public works program. The nation is in need, and quick and powerful action is necessary to bring us out of this trying period.

China Shows Signs of Slowing

2008-11-07T06:23:00.001-08:00

After years of hyper growth, averaging close to 10% a year, the great engine of growth that is China, is faltering. A series of government reports released over the last few weeks indicated that China’s exports are moderating. Real estate construction projects are being suspended. Consumer confidence is in decline. And many factories in southern China are closing, putting tens of thousands of migrant laborers out of work. Another sign, orders for Christmas from the Western nations, were down 20 percent this year. Big retailers and toy marketers are gloomy about the upcoming holiday season sales.

Newly released data suggests that nearly every sector of the economy is slowing and credit is tightening. While few economists expect China to fall into recession, analysts are forecasting the worst growth in more than a decade, with the economy expected to expand by as little as 5.8 percent in the fourth quarter this year, down from about 11 percent in 2007.

5.8 percent growth would be welcomed in any of the developed nations today; most all of the west is looking at declines in GDP for 2009. But for China, a moderation of this magnitude, spells trouble. China’s huge population is still largely rural, with hundreds of millions of farm laborers still stuck in medieval farming methods. The high growth generated over the last ten to twenty years in China has been the ticket for millions of these folk to make their way to the cities and find work in the burgeoning factories that lead China’s export industry.

A slowdown of the growth rate raises fears of political unrest within the Communist Party, so they are taking strong steps to keep the growth rate as high as possible. The government is preparing a large economic stimulus package, pushing new infrastructure projects, offering aid to exporters and searching for ways to prop up the nation’s severely depressed stock and real estate markets.

Domestically, there are also signs of a slowdown: Auto sales have plummeted this year. Air travel is in decline. Property sales have dried up, and weakness in the property market is hitting the makers of steel, cement and glass. “There is a nose dive in real estate construction in south China and east China, the two real estate boom areas,” said Yang Dongsen, a cement industry analyst at Merchant Securities. The real estate slowdown is expected to affect retail sales, which for the last few years had been lifted by new-home buyers purchasing appliances, decorations and other household goods.

It does not help that China’s stock markets have also collapsed, after a stunning rise in 2006 and 2007. Share prices in Hong Kong are down about 50 percent, and the Shanghai composite index has fallen 67 percent this year, wiping out nearly all the gains it had made in the previous two years.

These data do not necessarily spell doom for China’s growth, but they do point to a period of economic adjustment that they must navigate. The west and the east are, to a large degree, joined. They depend on us for demand for their factories, and we depend on them for supplying us with inexpensive goods. The developing markets in Latin America are, themselves, dependent on China for purchasing their raw commodities, such as iron ore and petroleum. The downturn in Europe, Latin America and America is too severe not to be felt in the China. As much as they would like to be insulated from our economic problems, the interdependence is unavoidable. It will probably be some time before China will be worried about inflation and growth that is too fast.

What Currencies are overvalued and Which under Valued

2008-11-06T09:37:00.001-08:00

From our friends at Economy.com we learn of a new international currency comparator: The IPod inedx. From their table below Australia, Indonesia, Canada, and Korea are selling the IPod for less than $140. Argentiana, Brazil and Russia over over $250. This index gives you a good indicator of which currencies may decline in the future and which are more likely to rise.

>Just what we needed: A way to track shifts in global purchasing power that fits in your pocket. And is less greasy & caloric than the alternative...

Australia is the cheapest place in the globe to buy an Apple iPod, highlighting just how far the currency has plunged since July. The CommSec iPod index shows that Australia is the cheapest place of 62 countries to buy an Apple iPod 8gb nano music player when measured in US dollar terms.

The value of the iPod index is to highlight implications of currency changes and country relativities.

In other words, it's an update of The Economist's Big Mac Index. If you're clueless, all it takes is a common good or service that's sold in identical form the world over. The local price is simply converted to a common currency (typically U.S. dollars, though I wonder for how long?) and you can see who's living how high, in relative terms. Pretty neat.<

Perhaps this is a little better than the Big Mac Index. It's more currency, and it reflects relative currency valuation more precisely than the Big Mac. After all, the Big Mac takes a lot of locally prices labor and vegetable prices, as well as local rents. The IPod is made in America and shipped, whole, to each country where it is sold. To me, this makes it a more pure reflection of local currency value.

The Thin Line Between Recession and Deflation

2008-11-01T09:12:00.001-07:00

There is no longer any debate about the U.S. entering a period of a declining economy. Everyone who watches the leading indicators had been expecting a recession since the beginning of the year. Finally, in the third quarter, it came.

Nor is there any debate about the global slowdown. It's not that the United States controls the rest of the world. It's just that the same things that have pushed us into recession are also affecting the rest of the world: overextended credit based on loose credit standards, and a growth spurt based on the loose standards. As is almost always the case, growth spurts go too far, too fast, and have to be brought back to earth and consolidate before taking off again. I think it will be some time before the emerging markets take off again, but they will, eventually. Just not any time soon. This is also true of the United States and Europe. We will resume our growth, eventually. But there is going to be some time before we are ready to sustain more growth.

And therein lies a problem. With everyone declining at the same time, we can go too far to the downside and experience deflation--a spiral to the downside that frightens economists. Depression, which is the companion of deflation, is not something anyone who knows would want to see. There is nothing uplifting about suffering for years, where entire economies collapse under the weight of falling demand, falling employment and falling production. Recessions are a necessary adjustment to a period of excess. Depressions are not necessary, but they can happen if the economy isn't handled well.

A recession could see unemployment in the U.S., for example, reach 7% or 8%. A depression could see 25%. There is no comparison, though, between this set of numbers. The level of suffering under a depression is much more than, say seven multiplied by three or four (7% x 3 = 21%). From depression come revolutions and war, as scape-goats are sought and found. Demagoguery rules when things look hopeless, and those afflicted by unemployment and despair are easily swayed into despotic politics. It happened in post WWI Germany, when the onerous provision of the Treaty of Paris pushed Germany into the arms of Adolph Hitler. It has happened in Argentina where bad conditions led to the fascism of Juan Perón. This specter could easily be duplicated in many of the emerging markets if things get bad. The democracies in South East Asia, for example, are too fragile to handle a period of major deflation.

These conditions make it exceptionally important that the American, Japanese and European economies be handled properly during the downturn. The burden falls on these three regions because it is demand from the large economies that drive production and growth in the smaller ones. During this time we cannot look for strictly balanced budgets. Deficit spending, if done on public projects that are needed and useful (roads, bridges, schools, etc.), can go a long way in reducing the ill effects of unemployment and help keep consumer spending up. Longer unemployment benefits, veteran help for college and home loans are other measures that were especially effective after WWII that saw the return of more than a million soldiers and sailors to the economy.

We will have our hands full for most of 2009. Most of the predictions I see point to a possible end of the recession by the third quarter of next year--if things go well. One thing about deflation: it can be stopped by printing enough money. But, the balance between enough and too much is sometimes hard to find. And that task, in my view, will be the defining test of our next President. Go too far, and we have hyper inflation, which, in its own way, is as bad as deflation. Not go far enough, and we have deflation and depression. It's a thin line between these poles. I hope for a wise President and an equally wise Congress to keep the proper balance on this line.

Even though there will be plenty of skeptics who think "wise President" and "wise Congress" are oxymoron terms, I disagree. There are times when it appears that way, but I think when things get bad, there is a tendency of Americans to pull together. We will certainly have this test to pass in the coming year.

Things Got Bad and Things Got Worse

2008-10-31T08:35:00.001-07:00

It's Friday, October 31st, and things just got worse for Senator McCain. In the major tracking polls, he has not been over 45% for three weeks, and over the last three days, while his assault on Senator Obama has intensified, he has not budged in the polls. At a time when he needed a breakthrough, he has been mired in his own mud and stuck in place.

Mr. McCain goes into the campaign's final weekend a bigger underdog than any victorious candidate in a modern election. And with the economic news consistently going against him, it doesn't look good.

A Bloomberg article frames the facts: "With four days until Election Day, national polls show his Democratic rival Barack Obama leading by an average of 6 percentage points, and battleground polls show Obama ahead in more than enough states to win the decisive 270 Electoral College votes.

'There will not be a comeback curmudgeon by the name of John McCain,'' Kenneth Duberstein, who served as a chief of staff for President Ronald Reagan, said on Bloomberg Television's ``Conversations with Judy Woodruff,'' which will air later today. ``I think it's going to be Barack Obama. And I think it is going to be somewhere between 320 and 350 electoral votes.' "

Polls have been wrong before, of course, but modern polling has consistently gotten better. And with the advantage as high as it is for Mr. Obama, there appears to be little hope for the Senator from Arizona.

If the election goes as it looks, with not only Mr. Obama taking the Presidency, but also with expanded majorities in the House and Senate, then the new administration will at least begin next year with a mandate to make some major changes. If there has been one theme in this election that has worked, it has been that of change. Almost 90% of Americans believe the U.S. is on the wrong track, so they appear to be ready for a change.

My hope, if Mr. Obama wins, is that the change will get us back on track and allow America to recover its place as a world leader, not only in military might and economic strength, but in moral leadership as well. I am not convinced that Americans have abandoned their commitments to democracy, equality and fairness--those qualities that have served as a beacon of hope to the rest of the world during my lifetime. This leadership has been squandered over the last decade by corrupt and foolish political and business leaders. It's asking a lot of a single election to correct this huge a problem, but my hope is that it will at least start to reverse the process that has gotten us into this mess.

3rd Quarter GDP Goes Negative

2008-10-30T06:10:00.001-07:00

We now have confirmation that the U.S. is beginning a recession. Reuters reports: >

The economy shrank at a 0.3 percent annual rate in the third quarter, its sharpest contraction in seven years as consumers cut spending and businesses reduced investment in the face of rising fears that recession was setting in.

The Commerce Department said the third-quarter contraction in gross domestic product was the steepest since the corresponding quarter in 2001 though it was slightly less than the 0.5 percent rate of reduction that Wall Street economists surveyed by Reuters had forecast.>

The culprit was what all of us expected: consumer spending, which has propped up GDP growth for the last few years, finally succumbed to higher oil prices, lower home prices, and the shut-off of the second mortgage spigot that had fueled the borrowing binge of the last few years.

>Consumer spending, which fuels two-thirds of economic growth, fell at a 3.1 percent rate in the third quarter — the first cut in quarterly spending since the closing quarter of 1991 and the biggest since the second quarter of 1980. Spending on nondurable goods — items like food and paper products — dropped at the sharpest rate since late 1950.

Continuing job losses coupled with declining gains from stocks and other investments have put consumers under severe stress. The report showed that disposable personal income dropped at an 8.7 percent rate in the third quarter — the steepest since quarterly records on this component were started in 1947 — after rising 11.9 percent in the second quarter when most of economic stimulus payments still were flowing.

Consumers cut spending on durable goods like cars and furniture at a 14.1 percent annual rate in the third quarter, the biggest cut in this category of spending since the beginning of 1987. Car dealers have said that sales have virtually stalled, in part because tight credit makes it hard for even creditworthy buyers to get loans.<

These are not good numbers, and point to a protracted downturn. If there is some kind of symmetry in business cycles, then the seven years of credit boom would be followed by seven years of credit bust. I hope it won't be that way, and there will certainly be efforts by our political establishment to crank out another stimulus package, soon. There is already one on the table in Congress, and it is hard to see that it will not be passed.

The statistical evidence that stimulus works is quite high, so that is good news. The economy desperately needs a shot in the arm. But, whether it will be enough to turn things around and stay turned around, is another question. It is unlikely to be large enough to make a miracle, and that is what is needed for now. But it looks as if there could be several quarters of decline, putting the recovery at or beyond June of 2009. And that's the best outlook. It may be even worse, but I think there will be a Herculean effort from our new president to shorten the cycle once he takes office in late January.

Effects of Another Stimulus Package

2008-10-29T08:43:00.001-07:00

Looks like we're in for another round of fiscal stimulus. (Does stimulus come in rounds? Just asking...) Anyway, Menzie Chinn at the venerable Econobrowser blog revisits Mark Z.'s Congressional testimony from last summer, wherein he rated the relative oomph of various legislative stimuli. (Also available in this Dismal Scientist article .)

Chinn avers:

Onebig caveat to the argument for infrastructure spending is that it usually takes a long time to plan such projects. Hence, it is not clear when the spending for such projects would actually occur, and hence the stimulus to the economy (this is called an outside policy lag, in the jargon). The "one-year horizon" shown in the table is for the horizon of one year from beginning of spending, not the beginning of planning and appropriation.

I have two observations here. First, if the spending could be directed to the states which had construction about to start, but hindered by financing or state revenue issues, then the problem of timing could be partly mitigated. I admit that it is unlikely that there are a tremendous number of such projects (although I am happy to be corrected). That leads me to my second observation.

The CBO study Options for Responding to Short-Term Economic Weakness (January 2008) laid out three principles for effective stimulus, loosely characterized as "timely, targetted, and temporary". Spending on infrastructure is problematic on this first count if one believes the recession will be short. If one believes that it will be prolonged (in the now outdated lingo, "L-shaped" instead of "V-shaped"), then this drawback is not so significant.

Rise of Japanese Yen May Bring Retaliation

2008-10-27T05:57:00.001-07:00

From the NY Times: <Currency market traders were keeping nervous watch for central bank intervention, after Group of 7 finance and monetary officials expressed concern about the recent excessive volatility in the yen’s exchange rates.

“We are concerned about the recent excessive volatility in the exchange rate of the yen and its possible adverse implications for economic and financial stability,” the G-7 statement said. “We continue to monitor markets closely and cooperate as appropriate.”>

If intervention were carried out, central bankers would likely sell yen for other currencies, driving down the yen and providing support to other currencies.

Although I am bullish on the yen over a long period, it does look as if its rise in value has been to fast for too long, so be prepared for a downturn of some duration.

If this program is carried out, look for the exchange traded fund, UUP, to rise dramatically. This ETF is long on the U.S. dollar and short on the yen and other developed market currencies. A dramatic fall in the yen plays into this short position.

However, in a late development: French Finance Minister Christine Lagarde said the Group of Seven nations doesn't plan to intervene to sell the yen after warning today against the currency's ``excessive volatility.''

``The yen has over the past 48 hours seen brutal trading that reflects a great volatility that's linked to current market moves,'' Lagarde said in an interview with Bloomberg News in Montpellier, France. ``We wished to support this possible intervention of Japanese authorities knowing this would be about a purely Japanese intervention.''

Asked specifically if the G-7 would intervene to sell the yen, after it rose to its highest in almost 13 years against the dollar, Lagarde said ``no.''

Japan, however, will probably enter the market to keep the rise in check. This may be enough to satisfy the G7 members, and allow them to keep out of the market.

Opportunity in the Currency Market Turmoil

2008-10-25T10:36:00.001-07:00

If you think that the American equities markets have been hit hard lately, take a look at some of the emerging markets. The graph below charts the last six months of the Dow Jones Industrial Average, the iShares ETF, EEM, which tracks emerging markets around the world, and EWY, the South Korean ETF from iShares. Many emerging markets have fallen 60% or more over this period.

Their currencies have also taken a significant hit. The chart below shows the U.S. dollar as measured against developed market currencies over the same period, with EEM and JEM, a basket of emerging market currencies in Asia, Latin America, Europe, the Middle East and Africa.

While the currency hit has been only about a 25% loss, it is about a 45% difference with the U.S. dollar. Also shown are the Mexican peso (FXM) and the Brazilian real (BZF), to show how similar the currency drops have been for all emerging markets. However you look at it, it has been a grim picture.

There are a couple of driving forces that explain the reaction of investors. The first is that everyone is concerned that the slowdown in America and European economies will disproportional affect emerging markets, since the western nations buy much of all EM goods. During a downturn, demand for many of the goodies the EM countries produce will fall, and their export trade, which largely drives their economies, will falter.

A second reason is an extension of this phenomenon. Hedge Funds have been particularly large investors in the EM economies over the last decade. And, their investments have covered the complete range of securities: currency holdings, equities investments and their sovereign debt. But, now that the party is over, the Hedge funds are having to pony up on margin. This leads them to dump much, if not all, they bought. This is exacerbating the downturn, just when it is hurts the most. Isn’t that always how it goes?

During this huge sell-off, two currencies have become safe haven plays: the U.S. dollar and the Japanese yen. The number one and two economies in the world, regardless of how bad it looks, are still the safest places to put one’s confidence—or at least that is what the financial markets around the world are telling us.

This concentration of trends does, however, bring with it a potential upside.

Given the serious decline in currency prices in the emerging markets, and
Given that most all of them have financed much of their expansion of export production capacity with debt, and
Given that much of that debt is owed to the U.S., Japan and western Europe,
Therefore, the banks and Treasuries of all the lending countries are getting antsy about being repaid.

Debt repayment by the EM countries is partially impaired by their falling economies. That is to be expected, because economic downturns are always expected after a period of rapid expansion. But, the problem is made much worse by the fact that their currencies are falling at the same time. Much of the debt they owe is denominated in dollars, so they now have a double whammy to face. Their revenues are falling because of their shrinking production, and their currencies are depreciating at the same time that the U.S. dollar and yen are increasing. Now, they have twice to three times as much problem in repaying their debt.

Lenders are quite upset. But, the lenders (large banks) have the ears of their respective governments, and no one in any government want more bad news to capture the headlines of the financial pages. They are working as hard as they can to contain the carnage that has already been unleashed. If they add defaults of some of the major EM countries to the list, it would set off a new round of tumbling confidence and stock prices.

Therefore, there is a move afoot to help the EM countries by a coordinated effort of the developed nations to enter the foreign exchange markets and buy EM currencies—helping prop them up, at least until things settle down a bit. If this rescue effort comes about, then look for EM currencies to have a good bump. ETNs such as JEM would benefit, as would individual currencies such as Brazil, Mexico, South Africa, Russia, etc..

This is far from a done deal, and any monies put into this type of speculation would be an usual risk. The deal may not come off, and their currencies could continue their decline. If there is intervention, then I would take a short term view of the improvements in currency prices, and have a strong idea of when to get out. For those with a strong risk appetite, this may be a good place to look.

I'm still bullish on the Dollar (UUP) and the Yen (FXY), and I consider these currency plays to be much less risky than betting on an intervention in the EM currencies.

Economic Outlook is Dismal

2008-10-23T09:36:00.001-07:00

Housing Market

The number of homeowners ensnared in the foreclosure crisis grew by more than 70 percent in the third quarter of this year compared with the same period in 2007, according to data released Thursday.
Nationwide, nearly 766,000 homes received at least one foreclosure-related notice from July through September, up 71 percent from a year earlier, said foreclosure listing service RealtyTrac Inc.

By the end of the year, RealtyTrac expects more than a million bank-owned properties to have piled up on the market, representing around a third of all properties for sale in the U.S.

Six states — California, Florida, Arizona, Ohio, Michigan and Nevada — accounted for more than 60 percent of all foreclosure activity in the quarter, with California alone making up more than a quarter of all U.S. foreclosure filings.

Last month, foreclosure resales accounted for more than half of existing home sales in California last month, as home sales jumped 65 percent from a year ago, while the statewide median home price fell 34 percent to $283,000, according to MDA DataQuick.

Alan Greenspan's Testimony (From NY Times)

Alan Greenspan, the former Federal Reserve chairman, said Thursday that the current financial crisis had uncovered a flaw in how the free market system works that had shocked him.

Mr. Greenspan told the House Oversight Committee on Thursday that his belief that banks would be more prudent in their lending practices because of the need to protect their stockholders had proved to be wrong.

Mr. Greenspan said he had made a “mistake” in believing that banks operating in their self-interest would be enough to protect their shareholders and the equity in their institutions.

Mr. Greenspan said that he had found “a flaw in the model that I perceived is the critical functioning structure that defines how the world works.”

China's Growth in Question

BEIJING — For three decades, China has fueled its remarkable economic rise by becoming the world’s workshop and unleashing a flood of low-priced exports. But faced with a possible global recession and weakening demand for Chinese exports, the question now is whether the ruling Communist Party can prevent the financial crisis from derailing the country’s economic miracle.

This question is pressing not just for China but also for the rest of the world. American officials and many economists say continued Chinese growth is vital to the global economy as the United States and Europe face severe downturns.

Yet to navigate the crisis, many analysts say, China will need to recalibrate its economic model, stoke domestic investment with heavy government spending and promote policies to increase consumer demand in a nation known for high savings rates.

At the geopolitical level, China would seem well positioned to expand its influence. It sits on $1.9 trillion in foreign exchange reserves, accumulated from giant trade surpluses and heavy foreign investment in China, and it could acquire discounted stakes in Western banks and industrial companies.

But for now, most analysts say China’s top priority is protecting its own economy. Chinese leaders say the domestic financial system is largely insulated from the global crisis — China’s banks remain domestically focused and have relatively small exposure to toxic securities sold by American and European banks. But economic growth has fallen to the lowest level in five years, unemployment is a growing concern, and scores of factories are closing in the country’s export region. Domestic stock exchanges have lost 65 percent of their value, and real estate sales have plummeted.

China still seems likely to avoid an outright recession, but a significantly slower growth would pose a political challenge for the Communist Party, which derives much of its legitimacy from delivering jobs and increasing wealth. Conventional wisdom holds that China’s output must grow at a minimum of 8 percent for the economy to produce enough jobs to absorb increases in the working-age population, and many economists expect growth to drop below that level next year.

Housing Starts Hurting

2008-10-18T07:56:00.001-07:00

Back and Forth on Housing Starts

Economic hard times inspire two contradictory responses. One is to simply to want it to stop hurting. The other is to want the system purged and cleansed, at whatever up-front cost. The two are not mutually exclusive; indeed it's quite common to wish for each in turn, or even simoultaneously. But they point in opposite directions, and underly pretty much all the debate we're hearing among economists, policymakers and talk-show guests—such as this one .

Sorting them out, however, is necessary before you can intepret news such as today's about U.S. homebuilding. From Aaron Smith:

Builders slashed housing starts and residential building permits in September to their lowest level since early 1991 as they worked to realign supply and demand. Housing starts dropped 6.3% to an annual rate of 817,000 units, and permits fell 8.3% to an annualized pace of 786,000 units. The rate of decline in homebuilding has clearly intensified: Housing starts over the past three months have contracted at a 68.3% annualized rate, the worst such reading since March 1980.

You can see this as disastrous, an economic train wreck. All those lost housing jobs, all that idle investment in land, lumber and equipment. The ripple effects—on employment, retail sales, overall growth—will be severe. Somebody—like maybe a presidential candidate?—should propose a plan to boost housing construction and save the economy.

Or not. As Aaron also writes:

Although significant progress has been made in lowering the supply of new homes to a level more consistent with the current low demand, we think further cutbacks in homebuilding will be forthcoming to more quickly draw down inventories.

Progress? Yes. Remember that what ails the economy—the financial side of it, at least—stems from the plunge in house prices that followed the end of the recent bubble. Rising defaults, underwater mortgages, frozen securities markets and the global banking crisis all began there. Any recovery, therefore, depends on house prices stabilizing. But house prices can't stabilize if builders keep pumping inventory into an already glutted market. Something's got to give. And the faster and deeper it gives, the sooner we can begin to climb out of this hole.

Let me amend that. The faster and deeper it gives, up to a certain point. That being the point at which all those lost construction jobs and all that idle investment is enough to sink demand for new houses, so that even as prices plummet and "affordability" rises in some technical sense, it still doesn't revive the economy.

At which point we abandon all talk about system-cleansing, and just hope someone can make it stop hurting.

Andrew Cassel in West Chester on October 17 at 11:45 AM

Small Men in Big Jobs

2008-10-11T08:29:00.000-07:00

October 11, 2008
I don’t know if the market turmoil of last week marks the end of the financial crisis. But I do know that the crisis has changed the very nature of financial markets for far into the future. All over the world, the “hands off” approach to financial markets is being abandoned as quickly as it was adopted decades ago. The hype and certainty of the “let the markets be markets” mentality is now recognized as silly and irresponsible, as the life savings of millions of innocent investors have been wiped out or severely reduced, and the world’s financial system teeters under threat of collapse. An orgy of irresponsible risk-taking by our financial and political leaders has shown them to be small men in big jobs.

We now find ourselves in a strange, upside down universe, where the lead role of socializing the financial system in America is being led by a President who just weeks ago was touting the benefits of deregulation and singing the praises of neglectful capitalism. All the followers of the Reagan Revolution, it seems, are now counter-revolutionaries, looking in every quadrant for targets of their finger pointing—everywhere but where it belongs—right at themselves.

Fortunately, the American people, while fooled then, aren’t now. We get it that our welfare is too important to abandon to the greedy gyrations of unfettered financial markets. We knew it in the 1930’s, but, after decades of successful regulation, we forgot what got us there.

We need to turn the corner, and, if the polls are correct, voters will set this straight in a few weeks. There will be pain ahead, but we will recover. Americans can rise to the occasion, and the occasion is now.

Latest Articles by Ray

2008-10-08T14:36:00.001-07:00

Do Currencies Belong in Your Portfolio

2008-09-22T10:44:00.000-07:00

Whether you know it or not, you are probably investing in foreign currencies now. If you own an ETF or mutual fund in any international equity or fixed income product, you are taking a currency risk. It’s not an indirect risk; it’s as direct as it gets. Foreign holdings are priced in their native currencies, and every price movement is captured in the dollar denominated net asset value [NAV].
Even if you sell your foreign assets and invest only in American firms, you do not escape exposure. On average, large American firms do about 30% of their business in the international sphere. Their profits are immediately affected by movements in the currency markets. You can’t escape currency risks, but you can be aware of them, and you can do something to accommodate them.
The first line of defense against unhealthy currency risks is to make sure your portfolio is fully diversified in its international holdings. This spreads your currency exposure as widely as possible. Just as in stocks and bonds, where diversity is of utmost importance, the same applies to currencies and all other asset classes you own.
For many investors, just making sure your international holdings are well diversified is probably enough to reduce the currency risks to an acceptable level. But, you may want to add additional currencies to your portfolio, because there are substantial benefits derived from doing so. The most widely acknowledged benefit is the low correlation that currencies have with virtually all other classes. This feature of currenices is unique in its level of non-correlation. Other asset classes claim to be of low correlation (real estate, bonds, emerging markets for example), but when the correlations are quantified, currencies stand far above all others.
Just ask yourself, since early November of 2007 when equity markets began their slide, wouldn’t it have been great to have assets in your portfolio that actually increased in value over the period? Wouldn’t that help you keep on course for achieving your financial goals? It’s easy to talk “buy and hold,” but it isn’t so easy to actually stick to your guns when your investments drop by 20% or 30% in a steep market slide. This kind of market sends investors panicking to the sell window just when they should be standing fast.
Currency investing may provide just the cushion you need during rough periods, helping you to stay the course. And staying in the game is what it’s all about; you can’t win if you don’t play. If you panic and sell during the lowest periods, then you will be buying back at higher prices later - buying high and selling low - not what the doctor ordered.
If you decide to take a second step and buy currencies directly, you will discover some of the other properties of Forex (Foreign Exchange Currency) trading: first, currencies may actually make money for you by appreciating in price, and secondly, you will earn interest on your foreign currency holdings.
In Forex trading, a strategy that seeks to buy currencies that are expected to rise in price is called a “value strategy,” and it’s no different than your expectations that some equities are undervalued. If your analysis tells you that the Chinese Yuan, for example, is undervalued, then buy the Yuan. It’s available in an ETF (CYB) (from WisdomTree) or in an ETN (CNY) (from Van Eck/Morgan Stanley). If you are right, you’ll profit from the Yuan’s rise. If not, you will at least experience the second benefit from owning a foreign currency - you will earn interest on your investment. This comes about because the banks that hold the currency you bought use your investment deposit to purchase commercial and government-issued short-term interest bearing investments.
So, while you are technically holding currency, you are actually holding short-term debt obligations denominated in the currency you bought. When the debt instrument matures, the interest owed is paid and passed on to you. With the Yuan and most other emerging market currencies, where it’s often difficult to find local short-term deposit possibilities, the fund managers use futures contracts that accomplish roughly the same thing - you profit from receiving the differential between the spot price and the forward contract price. Either way, you earn something on your holdings.
This feature of earning interest on the currency you own is a significant strategy for making money on foreign exchange investments. It’s called the “carry trade,” and is responsible for trillions of dollars of currency trading. But, it is also possible you may incur a loss if the price of your currency falls during the time you were earning interest. This possibility makes holding foreign currencies different from holding U.S. dollars in a money market account. Money market funds are managed to keep a constant value - not difficult since there is no chance of the dollar falling in dollar value.
But when your money crosses an international border, the currency risk raises its head. This is a good reason not to engage in the carry trade - you might lose. Although currencies usually have lower volatility than equities, there are still risks. You must be comfortable that you want to take the risks and that you can afford the potential losses that may result from currency investing.
Once you have decided to allocate an appropriate amount to currencies in your portfolio, then the fun begins. Now you can choose among all the currencies available for trading, and the list is getting longer every month. This is a good thing, in my view, for not too long ago, if you wanted to hold Forex, you had to open a special trading account with one of the online trading brokers. It’s a fast-moving, wild and wooly environment, highly leveraged, where fortunes are made and lost on an hourly basis. This is not suitable for most investors, especially those who have lives outside the Forex arena.
Fortunately, a new kind of ETF and ETN has been recently introduced that allows an average individual investor to buy a fairly good range of currencies. There are currently about twelve pairs available, and additional pairs can be bought if you select one of the bundled exchange-traded products. Speaking of pairs, don’t be put-off by this terminology. In fact, one cannot speak of the dollar rising or falling without referencing another currency. The dollar can’t rise or fall in relation to itself; it can only change with respect to some other currency. Neither can any other currency. So, when you buy Mexican Pesos in the U.S., you are borrowing dollars from yourself and investing them in Pesos. You own a currency pair: U.S. Dollar/Mexican Peso. If you were in London and bought Pesos, your pair would be the Pound Sterling/Mexican Peso.
I’m going to post these lists in two groups: individual currency ETFs or ETNs, and bundled currencies of both formats.
Individual Currency Products:
Rydex Shares ETFs: Currencies: Australian Dollar (FXA), British Pound (FXB), Canadian Dollar (FXC), Euro (FXE), Japanese Yen (FXY), Mexican Peso (FXM), Swedish Krona (FXS) and Swiss Franc (FXF)
WisdomTree ETFs: Currencies: Euro (EU), Japanese Yen (JYF), Brazilian Real (BXF), Indian Rupee (ICN), New Zealand Dollar (BNZ), and South African Rand (SZR)
Barclays iPath ETNs: Currencies: Euro (EROS), British Pound (GBB), Japanese Yen (JYN)
Elements ETNs: Currencies: Australian Dollar (ADE), British Pound (EBG), Canadian Dollar (CUD), Euro (ERE), Swiss Franc (SZE)
Van Eck/Morgan Stanley ETNs: Currencies: Chinese Renminbi-Yuan (CNY), Indian Rupee (INR)
Bundled Currencies Product
PowerShares ETFs: Bundles: Group of 10 Carry Trade (DBV), U.S. Dollar UP (UUP), and U.S. Dollar Bearish (UDN)
Barclays ETNs: Barclays iPath Optimized Currency Carry (ICI), Barclays GEMS Index (JEM), Barclays Asian and Gulf Currency Revaluation Note (PGD).
In lieu of recommendations, let me leave you with disclosure on my current holdings: (BZF), (FXM), (JEM) and (UUP). If you will read through the currency posts I have made over the last year at Seeking Alpha, you will get a good idea of why I have chosen these products. But, I do not recommend others necessarily follow suit. My rationale is: the first two are individual carry trade holdings that pay high interest rates. The second two are bundles to give my portfolio more diversity and earn some interest; JEM holds fifteen emerging markets currencies and pays a good dividend. UUP holds the G10 currencies doubled up with leverage for the bullish dollar - strictly a value play.
I also keep tight limits on currencies as a percentage of my total portfolio. This year I have gradually allowed my allocation to be just under 15%. This is toward the high end of most recommendations. But this is a new area of investing, indeed, as all alternative asset classes are, and there is no consensus in the financial advisor community about it. Some don’t recommend any, some recommend more. Use your best judgment to keep the risks balanced and within your comfort zone.
You should support any decision you make with the full knowledge of the risks involved and a thorough investigation on your own about each possible investment. There are good reasons to own foreign currencies. There are also good reasons not to own them. Good luck!

Hard Times for Soft Currencies

2008-09-22T10:41:00.000-07:00

August has been hard on emerging market currencies. Note the table below to see how much the currencies of some of the emerging markets fell last month.
*I put the PowerShares DB US Dollar Bullish Fund ETF (UUP) in the chart to show that part of the decline was due to the relative strength of the U.S. dollar.
There are two primary reasons for the battering these currencies took in August: economic slowdowns in America and Europe, and global inflation.
The slowdown in the developed economies affects emerging markets because they depend so much on exports. Investors fear it will get worse; if demand for finished products or commodities falls even a little, export-dependent economies will be hurt a lot. This describes most emerging markets today and accounts for much of the recent fall in the value of their currencies.
Unfortunately, the EM world has more than slowing demand to deal with. At the same time, that demand for their products is leveling off or falling, the tremendous growth in exports over the last few years has pushed wages and local prices up. This reaction has two unsettling effects: it encourages increased spending within the local economies, putting upward pressure on domestic prices, and it encourages businesses to raise prices to cover the higher labor costs. Combine these two factors with the increase in commodity prices that has spiked world-wide over the last few years, and you get a triple whammy of inflationary pressures.
The final result of this rather long chain of events is a tendency for local economies to raise interest rates in order to relieve inflationary pressure and ease the devaluation of their currency. Not every country does it this way, but, as you can see from the first table, many do.
Political instability itself has made its own contribution to the currency troubles in Thailand and Malaysia. These countries simply cannot fight inflation, a declining economy, a falling currency, and failing politics at the same time. Political turmoil must be addressed first, before economic and currency problems can be addressed with serious purpose.
This is a good time for currency investors to reassess where they want to be standing over the coming months. The urgency behind this need to reassess is in the nature of the currency market itself. To put it simply, the carry trade gets carried away with itself. It pours too much money into too few economies with too little ability to handle the hot inflows.
The chart below shows how the Mexican peso ETF (FXM), grew from September of last year to this month. Note the huge surge in assets under management that began around April, ’08. Mexico began raising the interest rates to suppress inflation, and the carry trader responded in a typical fashion by flooding Mexico with dollar purchases of the peso to take advantage of the higher rates.

There is no telling if this is the beginning, end, or middle of the hot money cycle for Mexico. A recent speech made by their finance minister hinted that inflation was less of a threat than it had been, thus calling into question the almost certain anticipation of continued rate increases by the Mexican central bank. The peso dropped over 1% by the end of the day.
This episode should reinforce your desire not to be long on pesos the day the U.S. Federal Reserve announces a rate increase. The mountain you see in the chart above will find it way back across the Rio Grande faster than it came south, carrying the remnants of your profits with it.
However, the events of August do not necessarily mean that the end has arrived. August is just one month. The encouraging part of this news is that while the emerging markets are taking a short term hit, there is good reason to expect them to recover without the trauma that has characterized past currency collapses. The example of Mexico bringing inflation down is a good example.
Another reason for my optimism is that the recent EM expansion was accomplished in a relatively healthy way rather than an unhealthy one. The economies of all the prime movers in the EM world are well positioned with actual production capacity, rather than the promise of capacity that exemplified past hot money expansions. At the start of the last upswing, their currencies were reasonably valued, their domestic budges were healthy, and their political systems were stable. In the 1997—99 crash, none of these descriptions would have been accurate. There was more hype and less reality behind the emerging markets boom then.
It’s also possible that the current level of inflation will moderate. There are signs other than in Mexico that high interest rates are slowing things down. If this holds, the end will come with a whisper rather than a crash, as cash balances are shifted in a convergent and orderly way.
In the meantime, I am not panicking. My carry trade holdings are intact. This may, of course, prove to be a big mistake. I may be wrong and the entire carry trade will unwind tomorrow. But, I’m taking my chances. The only recent change in my currency portfolio is the addition of UUP, the dollar bullish ETF from PowerShares. This is a way of partially hedging my bets.
If any action is called for, it is to be vigilant in following developments in the international sphere. An old saying in the currency trading community is that the carry trade is like picking up pennies in front of a steam roller. You want to keep a keen eye on the guy at the controls as well as the pennies.