Friday, October 24, 2008

Can We Avoid A 1930s Replay?

Do Our Rulers Know Enough To Avoid A 1930s Replay?
Events Are Moving With Lightning Speed As The Global Credit Freeze Evolves Into Something Awfully Like A Classic Trade-Depression.

By Ambrose Evans-Pritchard | 26 October 2008

The commodity and emerging market booms are breaking in unison, leaving no more bubbles left to burst. Almost every corner of the world is now being drawn into the vortex of debt deflation. The Baltic Dry Index (BDI) freight rates for Capesize vessels used to ship grains, coal, and iron ore have fallen 95% since May [[almost 5% a day last week: normxxx]], hence the bankruptcy of Odessa’s Industrial Carriers last week with a fleet of 52 vessels. Cargo deliveries dropped 15.2% at the US Port of Long Beach last month, but that is a lagging indicator. From what I have been able to find out, shipping is slowing as fast as it did in the grim months of late 1931.

"The crisis is now in full swing across the entire world," said Giulio Tremonti, Italy’s finance minister. "It is hitting the real economy, the productive forces of industry. It’s global, it’s total, and it’s everywhere," he said. Italy’s industrial output has fallen 11% in the last year. Foreign orders have dropped 13%. But we are all in much the same boat. Europe’s car sales fell 9% in September (32% in Spain). US housing starts fell to a 45-year low in September.

Last week, the International Monetary Fund had to rescue Hungary and Ukraine as contagion swept Eastern Europe. It would not surprise me if Russia itself were to tip into a downward spiral towards bankruptcy (again) and fascism (again). Russia’s foreign reserves have fallen by $67bn since August. Ural crude prices fell to $65 a barrel last week, below the budget solvency threshold of the now extravagant Russian state.

The new capitalists have to repay $47bn in foreign loans over the next two months. In Russia, oligarch fiefdoms built on leverage— Mikhail Fridman (Alfa), Oleg Deripaska (Basic Element), and Vladimir Lisin (Novolipetsk)— are lining up for state bail-outs from a $50bn rescue fund. Brazil is in free-fall as well. Sao Paolo’s Bovespa index is down a third in dollar terms in a month. Hopes that the BRIC quartet (Brazil, Russia, India, and China) would take over as the engine of world growth have proved yet another bubble delusion.

China says 53% of the country’s 3,600 toy factories have gone bust this year. Economist Andy Xie says China is at imminent risk of its own crisis after allowing over-investment to run rampant, like Japan in the 1980s. "The end is near. They’ve been keeping this house of cards going for a long time with bank support," he said. Lord (Adair) Turner, the head of Britain’s Financial Services Authority, offers soothing words. "There is no chance of a 1929-33 depression. We know how to stop it happening again," he said.

I hope Lord Turner is right, but his Olympian certainty bothers me. It assumes that the economic elites:

a) Understand what happened in the 1930s— on that score I suspect that few, other than the Fed’s Ben Bernanke [[who seems, nevertheless, to be taking his cues from Hank Paulson, who seems to be playing it by ear: normxxx]], have delved into the scholarship (sorry, Galbraith’s pot-boiler The Great Crash does not count).

b) That central banks will now jettison the dogma of 'inflation-targeting' that got us into this mess by lulling them into a false sense of security as credit growth and housing booms went mad. Will they now commit the reverse error as credit collapses?

c) Understand that non-US banks— especially Europeans— have used the 'shadow banking system' to leverage a $12 trillion (£7 trillion) spree around the world, and that this must be unwound as core bank capital shrivels away.

Yes, the Fed made frightening errors in the early 1930s by raising rates into the crisis, but they were constrained by the norms of the age: the fixed exchange system (Gold Standard), and fear of the bond markets. Are today’s central banks doing much better? The Europeans [[read: ECB President Jean-Claude Trichet: normxxx]] fell into the trap of equating this year’s oil and food spike with the events of the early 1970s.

As readers know, I view European Central Bank’s decision to raise rates to 4.25% in July— when Spain’s property market was already crashing, and Germany and Italy were already in recession— as replay of the 1930s ideological madness.

You could say the ECB also acted under the constraints of the age: its rigid inflation mandate. But I suspect that Bundesbank chief Axel Weber and German finance minister Peer Steinbruck were quite simply too arrogant to listen to anybody. Mr Steinbruck insisted that "German banks are far less vulnerable than US banks" just days before the collapse of Hypo Real with €400bn (£311bn) of liabilities. Had he not read the IMF reports showing that German and European lenders have an even thinner Tier 1 capital base than American banks?

One can only guess what French President Nicolas Sarkozy has been saying to ECB chief Jean-Claude Trichet, but he must have warned in blunt terms that Europe’s leaders would exercise their Maastricht powers to bring the bank to heel unless it slashed rates. Democracies cannot subcontract monetary policy (with all its foreign policy implications) to committees of economists in a fast-moving crisis. Those accountable to their electorates have to take charge.

Whatever occurred behind closed doors, the ECB is now tamed. It has cut rates to 3.75%, and will cut again soon, perhaps drastically. The risk is that rates have come down too late in Europe and Britain to stop a nasty dénouement, given the 18-month lag in monetary policy.

We should be thankful that President Sarkozy and Gordon Brown took action in the nick of time to save our banking systems. Their statesmanship should at least spare us mass bankruptcy and unemployment. But it will not spare us a decade-long toil of pitiful growth— or none at all— as we purge debt. The world stole prosperity from the future for year after year, with the full collusion of governments, regulators, and central banks. Now the future has arrived.

Heavy Industry: Hurting The Real Economy
The Impact Of The Financial Crisis On Some Of The Most Basic Industries

By Economist.Com | 17 October 2008

It is about as far as you can get from the woes of Wall Street: the mucky business of digging ore out of the ground, shipping it across the oceans and turning it into steel, the feedstock of industry. So the recent slump in raw-material prices and the decline in shipping costs indicate just how far-reaching the consequences of the global financial crisis will be for the real economy. Since the early summer the price of steel has fallen by 20-70% and the key rate for bulk shipping of commodities is down by more than four-fifths.

There are even stories of grain cargoes piling up in ports in the Americas. Their buyers’ letters of credit have not been honoured, because of a lack of confidence in the banks that underwrite them. At least one Australian producer has had the same problem with iron ore shipments to China. And shipowners are having trouble raising finance for new vessels.

The most spectacular reflection of falling activity has been the Baltic Dry Index (BDI), which traces prices for shipping bulk cargoes such as iron ore from producers such as Brazil and Australia to markets in America, Europe and China. The index has plunged by 85% after hitting a record high of 11,793 points in late May. It is a leading indicator of international trade and, by extension, of economic activity.

In the past couple of years the index has been driven up by the boom in China, as that economy sucks in raw materials in bulk-carrying ships and pumps out finished products, which are exported in vessels. The weakness is because of the slowing of world demand and the arrival of new capacity following the recent boom in shipbuilding. There are also signs of slowing demand for the container ships that take China’s manufactured goods to Western markets. The latest forecasts show growth in container demand falling from 15% a year to barely 5%.

Steel prices have also been falling fast from record highs. In America the price of coil steel, used to make cars and white goods, has fallen by 20% since May. The price of steel billets, which are traded on the London Metal Exchange, has tumbled by 70% since May. Steelmakers, including ArcelorMittal, the industry leader, and Russian and Chinese firms, are moving to cut production.

Although China’s iron ore imports in the first nine months of the year were up by 22% on 2007, there are fears among Australian mining firms that the cuts in Chinese steel production could presage a pause in China’s boom. Mount Gibson, an Australian producer, has given warning that stockpiles of ore are piling up in China. Iron-ore prices on the spot market have fallen by roughly half this year, to $100 a tonne or less. The prices of copper, nickel and zinc have also fallen by half or more this year, and aluminium is down by a third.

Those drops, in turn, have battered the share prices of mining companies. BHP Billiton and Rio Tinto, two giants that are big exporters of iron ore from Australia to China, say that they will not be too badly hit by falling demand. They do expect rivals with higher costs to rein in their output. To some extent, that is already happening. Ferrexpo, a Ukrainian iron-ore producer, has said it will postpone a decision about whether to expand. Rio Tinto itself has reduced output at one Chinese aluminium mill.

Alcoa, a big American aluminium firm which reported a sharp fall in profits this month, has shut a smelter in America and says it will halve its planned investments next year. Other firms have scrapped planned nickel and zinc mines. Nonetheless, the bigger mining firms are far from despair. Alberto Calderon of BHP points out that the Baltic Dry Index is extremely volatile; in his view, it is not a good indicator of the long-term prospects of the mining industry.

He expects the Chinese economy to keep growing by 6-9% a year for the next five years. Rio Tinto is even more sanguine: it does not foresee China’s growth falling below 8%. Tom Albanese, its boss, says the Chinese economy is merely "pausing for breath". Both firms point out that some metals, such as copper, are still in short supply, and that the credit crunch will only make it harder to finance new mines. By delaying expansions and squeezing marginal producers, it might actually sow the seeds for a recovery in metals prices sooner than most analysts expect. At any rate, BHP is still keen to buy Rio Tinto— an indication, presumably, that it still thinks raw materials is a good business to be in.



The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

No comments:

Post a Comment