By Ambrose Evans-Pritchard, Telegraph.co.UK | 9 August 2008
The psychology of global markets has shifted hugely over recent days as it becomes clear that Europe, Australasia and parts of Asia are sliding into recession. The US dollar has launched its best rally in half a decade, reflecting a recognition that half the world is in even worse shape than the US. In fact, America is the only G7 country to eke out modest growth this summer.
The US dollar index— currencies watched closely by traders— smashed through resistance yesterday in the biggest one-day move since the long dollar slide began seven years ago. "This was highly significant. Perceptions have changed," said Ian Stannard, currency strategist at BNP Paribas. (The greenback gained three cents to $1.5050 against the euro, with big moves against other currencies.)
Commodities tumbled as hedge funds and financial investors struggled to untangle themselves from crowded positions on the futures markets. Brent crude fell $4 to under $114 a barrel, down over 20% since peaking in early July. The Baltic Dry Index has now fallen every day for over three weeks, dropping 30% on fears that ship demand is fizzling out.
Copper fell to a six-month low on reports of rising inventories in China and Europe. Lead, nickel and tin all dived in frantic trading on the London Metal Exchange. "We see a deep global recession," said Albert Edwards, chief strategist at Société Générale. "Growth prospects in the Eurozone, Japan and the UK have deteriorated. Most now accept that recession has already begun in all three," he said. Mr Edwards predicted a "collapse" in emerging markets next. "You ain't seen nothing yet," he said.
The commodity slide boosts the dollar as petro-payments are recycled into euros, not the greenback. A Bundesbank study found that for every $1 sent to the Middle East or Russia for oil, the eurozone gets 40 cents back. Europe is the chief supplier of cars and industrial goods to the petro-economies. The US receives just
10 cents.
This bias is now going into reverse. Moreover, Danske Bank says there has been a $70bn net outflow of investment from the eurozone over the last year. It appears that foreign governments are sated on European bonds. The drip-drip of bad news in America is now being trumped daily by the icy douche splashing over Europe. The markets were stunned by leaks from Berlin last week that Germany's economy had shrunk by 1% in the second quarter. Yesterday Italy revealed a 0.3% contraction.
The last straw was an admission this week by European Central Bank president Jean-Claude Trichet that "downside risks had materialised" and there was no clear end in sight. The comments were followed by the ECB's lending survey yesterday, confirming that banks have cut back sharply on mortgages and household credit. BNP Paribas said it was now clear that the ECB had misjudged the severity of downturn. The monetary squeeze of the last year has raised mortgage costs by 150 basis points in Spain, Italy, Ireland and other states that rely heavily on floating-rate contracts. House prices are dropping in several regions at rates that match the US slide.
Bernard Connolly, global strategist at AIG, said the falling euro would come too late to prevent a severe economic crunch across southern Europe. "We think the EMU credit bubble is about to burst," he said. Current account deficits have already reached 10% of GDP in Spain and Portugal, and 14% in Greece. The region depends on foreign capital flows to keep its economies afloat. This is now under threat as investors become alert to the solvency risks of debt deflation, causing a blizzard of warnings from rating agencies on the health of the banks in these countries.
Over the last few months the US dollar appears to have hit the bottom of its cycle, suggesting its relentless slide since 2001 may finally be over. Arguably, the US is now super-competitive. Airbus and Volkswagen are shifting production plant across the Atlantic. US furniture and textile companies have stopped outsourcing to China, and are coming home. The International Monetary Fund says the dollar has fallen 25% to 30% on a global basis, just as it did in the late 1980s.
There was no shortage of dollar doomsters at that time, warning that America was finished— left behind by Japan and Germany. Events played out otherwise. America was on the cusp of a recovery. Will this be repeated? The US current account deficit has fallen from 7% of GDP to under 5% early this year, or nearer 4% after adjusting for the oil spike.
As the Habsburgs used to say, "the situation is desperate, but not serious".
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Governments Caused The Credit Crisis, But Capitalism Gets The Blame
By Ambrose Evans-Pritchard | 8 August 2008
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Credit crisis: Swept away by a tide of debtThe rising powers of Asia were preventing adjustment by holding down their currencies, and flooding the world with cheap credit in the process. Incipient bubbles were ubiquitous. "Most industrial countries are showing symptoms of over-heating in the housing market," it said. New-fangled securities were allowing banks to take "highly leveraged positions". It was unclear how these untested inventions would "handle a string of credit blow-ups".
"One simply cannot ignore the number of indicators that are now simultaneously exhibiting marked deviations," concluded the BIS. That was in June 2005. Regrettably, governments did exactly that. They ignored manifest risks. Real interest rates were held near or below zero in the US and a large arc of Europe until well into 2006.
By then, the damage was done. US housing had succumbed to full-fledged mania. Variants were emerging— later in the cycle— across the Anglo-Saxon world, the Baltic, Club Med, and Eastern Europe. What occurred was a fatal cocktail, a mix of too much and too little government intervention at the same time. Bureaucrats (central banks) held down the price of credit: other bureaucrats (regulators) turned a blind eye to the excesses that cheap money caused in mortgages and the "shadow banking system"— that $3 trillion nexus of structured credit. Northern Rock continued to offer 125% mortgages. Honey-trap "teaser" loans continued to ensnare Americans.
Former Federal Reserve chief Alan Greenspan now says the world faces a "once or twice in a century event". Faith in the financial system has been called into question. Taxpayers will have to rescue more banks. Missing is any hint of apology for his role in incubating this crisis as monetary overlord for 20 years. Where did it all go wrong? One could start by looking at the trajectory of total US debt, up from 130% to 350% of GDP since 1982. "We've had a 30-year leveraging up of America, ending in an unchecked orgy," said Charles Dumas, from Lombard Street Research.
"The final straw was the Fed's hopelessly slow tightening from 2004 onwards. There was no excuse for the interest rates of 1%, and then they went through this ludicrous metronome dance of quarter-point hikes," he said. Mr Dumas said the fuel for the third-stage blast of the US debt rocket came from Asia's "savings glut". China, Taiwan, Vietnam and other exporters have built up huge surpluses by holding down their currencies through dollar pegs or "dirty floats".
Together with Russia and the Mid-East petro-powers, they have accumulated a war chest of some $6 trillion in reserves. This must be recycled into foreign assets. Most went into US and European bonds, pushing down the cost of long-term capital for the entire global system. On top of this, roughly $250bn a year fled zero-interest rates in Japan to chase better returns abroad through the "carry trade". Japan's emergency stimulus leaked everywhere.
The ensuing bond bubble depressed yields for pension funds and insurers obliged to buy "AAA" assets, leaving them struggling to match their long-term liabilities. They were easy prey when the sharks came along with sub-prime debt "sliced and diced" into irresistible blocks of "AAA" securities, promising high yields. Rules made matters worse. Professor Peter Spencer, from York University, said the Basle code on capital adequacy ratios caused a perverse side-effect. "By making banks raise capital against their balance sheets, it gave them a strong incentive to move off balance sheets," he said.
The Fed could have done a great deal to offset the tsunami of Asian money by squeezing liquidity at home. It chose not to do so. Mr Greenspan and his protégé, Ben Bernanke, saw no need to act because inflation was tamed. [[So, Alan repeated the classic mistake of the late '20s! : normxxx]] Cheap Asian goods flooded the world, keeping a lid on inflation in the West. It lulled the central banking fraternity into a false sense of security. As they slept, the excess money found its way into asset booms. This was the "Great Error".
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Europe's Junk Bond Market In Deep Freeze
By Ambrose Evans-Pritchard | 5 August 2008
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Many companies issued bonds at the top of the credit bubble to lock in super-cheap rates, giving them a big enough cushion to ride out a downturn, but time is eroding the comfort margin for some. Fitch Ratings said €15.8bn of these bonds will come due in 2009. Appetite for the bonds— those with a credit rating of BBB— or below, otherwise known as junk bonds— grew to €29bn in 2006 and €26bn in early 2007, before shuddering to a halt. The complete closure of this market is adding a drip-drip effect of slow damage to Europe's broader economy. Mid-sized companies that rely on junk bonds to raise money at a good rate are having to shelve expansion plans, or postpone the purchase of new equipment.
Those in difficulties are having to draw down credit lines from banks at a stiff rate, if they can do so at all. But this window is gradually closing as banks are forced to curtail lending to rebuild their capital ratios. Junk bonds have held up much better in America's deeper and more liquid credit markets, despite the US property slump and the first clear evidence of sharply rising corporate defaults. There has been a total of $43bn in fresh junk bond issues worldwide in the first half of this year, down by a third from the same period in 2007.
The travails of Europe's high-yield market is further evidence of the debilitating paralysis that has gripped the region's credit system ever since the crisis began. The iTraxx Crossover index measuring default risk on low to mid-grade bonds is still trading at distress levels of 540, near the peak reached in the days building up to the Bear Stearns panic in March. Euribor lending rates used to price floating-rate mortgages and many financial contracts have reached a record 5.36%. One-month secured lending (Eurepo) has jumped from 4.03% to 4.34% since June, flashing a clear warning signal of troubles in the money markets.
Investment-grade bonds have fared better in Europe, but even this sector has seen a 27% fall in new issues to $671bn this year.
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Deutsche Calls The Top Of The Commodity Cycle
By Ambrose Evans-Pritchard | 4 August 2008
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The report comes on cue. The CRB commodity index fell 10% last month, the steepest one-month drop since the onset of the Volcker crunch in 1980. Most raw materials have been slipping for months. Crude was the last to turn after peaking at $147 early last month. Deutsche Bank says this year's oil surge has been a quirk. Misjudging demand, Saudi Arabia cut output by 400,000 barrels a day (bpd). Several upsets hit the non-Opec bloc of Russia, Norway, the UK, and Mexico. Rebels caused mayhem in Nigeria. Global supply is now creeping back into surplus.
The Saudis are adding 500,000 bpd. Deepwater projects are coming on stream off the US, Mexico, China, and Africa. The Caspian is cranking up a gear. Non-Opec will add 2.2m bpd over this year and next, says the International Energy Agency. "Demand destruction" has reached tipping point. Americans drove 3.7% fewer miles in May, year-on-year. Thirteen hybrid car models went on sale in the US last year, exploiting the new lithium ion battery technology.
China, India, and rising Asia— the chief victims of the oil spike, with energy use per unit of GDP four times Western levels— have begun to cut fuel subsidies. The IEA said this alone would trim demand by 100,000 bpd. Above all, the economic sick list is lengthening. Japan's industrial output fell 2% in June; petrol sales slumped 8.9%. China's purchasing managers' index (CLSA) fell below 50 in July.
If this turns out to be accurate, manufacturing output is now contracting in China. The closure of Beijing's smokestacks before the Olympics may have contributed, but slumping export orders led the slide. Mingchun Sun, Lehman Bros' China expert, says the country is at risk of a "vicious circle" as crumbling asset prices combine with tight credit, a strong yuan, and the global downturn. As of May, property prices had fallen by 19% from their peaks in Guangzhou, 9.5% in Beijing, and 9.4% in Shenzen. They are still falling. Indeed, China's house price upset may soon match the Anglo-Saxon, Baltic, and Club Med debacles.
The entire economic system of the North Atlantic is now in or near recession. European Central Bank insiders are saying the eurozone may have contracted in the second quarter. Europe's credit crunch is getting worse, not better. The benchmark cost of money— Euribor— reached a record 5.4% last week, if you can get it. Distressed banks are trimming overdraft lines. The delayed effects of the 'super-euro' are starting to hit as currency hedges run out. "Headwinds are combining to deliver a perfect storm," said BNP Paribas.
French confidence is at a 21-year low. Spanish car registrations have fallen for five months, dropping 31% in June and 27% in July. Daimler, BMW, Renault and Michelin have issued dire profit warnings. Berlin says Germany's economy is now shrinking. By raising rates last month, the ECB may have ensured a very hard landing in Europe. Yes, oil and food price rises have pushed headline inflation to 4.1%, but core inflation has fallen from 1.9% to 1.8% over the past year. ECB chief Jean-Claude Trichet warns of a 1970s wage-price spiral.
So does Tim Besley, the ultra-hawk on the UK's Monetary Policy Committee. "As history has shown, perhaps if a little more was done in the 1970s— or even a lot more— we may have avoided many of the issues that we faced for almost 20 years. Once inflation gets significantly out of control, it's extremely difficult to bring it back," Prof Besley told The Daily Telegraph. Yet, history has shown vividly that, if central banks over-tighten into a downturn in a highly indebted economy, they risk setting off a deflation spiral even harder to "bring back".
The household debt burden is much higher than in the early 1970s. Half the world economy is leveraged to a bursting property bubble. Real wages are falling across the OECD. The biggest single threat to global stability today is that policymakers misread their historic parallels. For commodity perma-bulls, the slowdown hardly matters. This is a supply story. Oil companies have been unable to raise output for four years. As the oil crunch spills over into food, 30% of the US corn harvest is being switched to biofuels.
Some 26% of the copper that ever existed in the Earth's crust has been lost, according to a Princeton study. We are exhausting our patrimony of resources. I have much sympathy for this view. Asia's industrial revolutions are obviously a game-changer. The term "commodity super-cycle" does not do it justice. We are living through a step-change into an era of permanent shortage [[not shortage so much as more expensive commodities— in real terms; a historial trend of ever cheaper commodities going back centuries is to be reversed: normxxx]]. Right now [though], a gently rising supply of commodities is colliding head on with a manufacturing recession and a global building bust of majestic proportions. Bonds beckon.
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Normxxx
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