Thursday, December 25, 2008

Crisis Deepens; Asian Exports Plunge

For anyone who thinks the Credit Crisis has retired. The rest of the world seems now to be tanking worse than the US.

Crisis Deepens In Japan And China As Asian Exports Plunge
Japan's Exports Plunged 27% Last Month In The Steepest Fall For Half A Century.

By Ambrose Evans-Pritchard | 22 December 2008

The shock data came as the Japanese Cabinet Office warned that the world's second biggest economy is now deteriorating at an "exceptionally high pace". Shipments collapsed to almost all markets in North America, Europe, and Asia, following a pattern already set in recent days by South Korea, Taiwan, and China. Thailand on Monday said its exports fell 19% in Novermber. It is unclear to whether the violent drop is distorted by a "one-off" inventory shock as end companies slash stocks, or whether it is the start of a trade slump that threatens Asia's entire export strategy.

"We think this is very serious," said Stephen Jen, currency chief at Morgan Stanley. "These export surplus countries are super-leveraged to the West, and now we're seeing a multiplier effect (in reverse) as the intra-Asian trade model is stress-tested. What's incredible is that Japan has run a trade deficit for two months in a row despite the [huge] fall in oil prices. The next country to watch is going to be Germany," he said.

The Baltic Dry Index measuring freight rates for bulk goods has crashed by 94% since peaking in June. Container shipping for manufactured goods has been less volatile but that too has begun to buckle. Denmark's Maersk and China's COSCO have both cut container rates from Asia by a quarter.

Importers have been struggling to secure letters of credit, the lubricant of the trading system. Even large banks in Asia have had trouble obtaining dollars needed for shipping deals. Masaaki Shirakawa, the Bank of Japan's governor, said the central bank was preparing to buy corporate debt and commercial paper in an emergency move to unlock the credit market. It cut interest rates to 0.01% on Friday, tantamount to zero.

"It's an exceptional step," he conceded, insisting that the authorities were taking on private credit risk with great reluctance. The bank is boosting its purchase of governement bonds from ¥1.2 trillion to ¥1.4 trillion ($156bn) per month in a return to 'quantitative easing'. In China, the central bank cut rates for a fifth time since September to 5.31% and trimmed the reserve requirement for lenders. The Govenrmment is rushing through a $585bn fiscal stimulus package.

Beijing is alarmed by outbursts of civil unrest, both in the country's hinterland as 9m migrant workers return home after losing their jobs, and in the export hub of Guangdong where violence has been simmering for months. Some 3,600 toy factories have already closed this year. Premier Wen Jiabao said over the weekend that the key priority is to find jobs for migrants and some 6m fresh graduates— the two groups most feared as a political tinderbox.

"If you are worried, I am more worried than you," he told students. Japan's economy minister Kaoru Yosano said Tokyo is mulling a range of drastic measures to support the economy, including the outright purchase of equities held by banks in distress. "We're ready to do everything we can to break the cycle of deterioration in sentiment," he said.

The Cabinet Office warned that the surge in the yen against all major currencies was now tightening like a vise on Japan's economy. "The tempo of the economic downturn is getting substantially faster. What's worse is that there are many negative factors that can make a recession deeper and longer," it said.

The yen has appreciated by a third to ¥89 against the dollar since the credit crunch began. It has doubled in value against sterling. There has been a dramatic reversal of the "carry trade" as hedge funds close worldwide bets that were financed at near zero rates in Tokyo. Japanese investors began to repratriate their vast foreign holdings.

The surging yen has played havoc with the balance sheet of Japan's leading exporters. Every one yen appreciation against the dollar and euro shaves Toyota's profits by $450m. The company is now underwater, facing its first loss since 1938. The risk is that Japan could slide back into a deflationary crisis and renewed perma-slump. The country's `Lost Decade' never seems to end.


Protectionist Dominoes Are Beginning To Tumble Across The World
The Riots Have Begun. Civil Protest Is Breaking Out In Cities Across Russia, China, And Beyond.

By Ambrose Evans-Pritchard | 22 December 2008

Greece has been in turmoil for 11 days. The mood seems to have turned "pre-insurrectionary" in parts of Athens— to borrow from the Marxist handbook. This is a foretaste of what the world may face as the "crisis of capitalism"— another Marxist phase making a comeback— starts to turn two hundred million lives upside down.

We are advancing to the political stage of this global train wreck. Regimes are being tested. Those relying on perma-boom to mask a lack of democratic or ancestral legitimacy may try to gain time by the usual methods: trade barriers, sabre-rattling, and barbed wire. Dominique Strauss-Kahn, the head of the International Monetary Fund, is worried enough to ditch a half-century of IMF orthodoxy, calling for a fiscal boost worth 2% of world GDP to "prevent global depression".

"If we are not able to do that, then social unrest may happen in many countries, including advanced economies. We are facing an unprecedented decline in output. All around the planet, the people have reacted with feelings going from surprise to anger, and from anger to fear," he said.

Russia has begun to shut down trade as it adjusts to the shock of Urals oil below $40 a barrel. It has imposed import tariffs of 30% on cars, 15% on farm kit, and 95% on poultry (above quota levels). "It is possible during the financial crisis to support domestic producers by raising customs duties," said Premier Vladimir Putin. Russia is not alone. India and Vietnam have imposed steel tariffs. Indonesia is resorting to special "licences" to choke off imports.

The Kremlin is alarmed by a 13% fall in industrial output over the last five months. There have been street protests in Moscow, St Petersburg, Kaliningrad, Vladivostok and Barnaul. Police crushed "Dissent Marchers" holding copies of Russia's constitution above their heads in Moscow's Triumfalnaya Square. "Russia has not seen anything like these nationwide protests before," said Boris Kagarlitsky from Moscow's Globalization Institute.

The Duma is widening the treason law to catch most forms of political dissent, and unwelcome forms of journalism. Jury trials for state crimes are to be abolished. Yevgeny Kiseloyov at the Moscow Times said it feels eerily like 1 December 1934 when Stalin unveiled his "Enemies of the People" law, kicking off the Great Terror. The omens are not good in China either. Taxis are being bugged by state police. The great unknown is how Beijing will respond as its state-directed export strategy hits a brick wall, leaving exposed a vast eyesore of concrete and excess plant.

Exports fell 2.2% in November [alone]. Toy, textile, footwear, and furniture plants are being closed across Guangdong, now the riot hub of South China. Some 40m Chinese workers are expected to lose their jobs. Party officials have warned of "mass-scale social turmoil".

The Chinese Politburo is giving mixed signals. We don't yet know how much of the country's plan to boost domestic demand through a $586bn stimulus package is real, and how much is a wish-list sent to party bosses in the hinterland without funding. Shortly after President Hu Jintao said China is "losing competitive edge in the world market", we saw a move towards export subsidies for the steel industry and a dip in the yuan peg— even though China already has the world's biggest reserves ($2 trillion) and the biggest trade surplus ($40bn a month).

So is the Communist Party mulling a 1930s "beggar-thy-neighbour" strategy of devaluation to export its way out of trouble? Such raw mercantilism can only draw a sharp [response] from Washington and Brussels in this climate. "During a global slowdown, you can't have countries trying to take advantage of others by manipulating their currencies," said Frank Vargo from the US National Association of Manufacturers.

It is a view shared entirely by President-elect Barack Obama. "China must change its currency practices. Because it pegs its currency at an artificially low rate, China is running massive current account surpluses. This is not good for American firms and workers, not good for the world," he said in October. The new intake of radical Democrats on Capitol Hill will hold him to it.

There has been much talk lately of America's Smoot-Hawley Tariff Act, which set off the protectionist dominoes in 1930. It is usually invoked by free traders to make the wrong point. The relevant message of Smoot-Hawley is that America was then the big exporter, playing the China role. By resorting to tariffs, it set off retaliation, and was the biggest victim of its own folly.

Britain and the Dominions retreated into 'Imperial Preference'. Other countries joined. This became the "growth bloc" of the 1930s, free from the deflation constraints of the Gold Standard. High tariffs stopped the stimulus leaking out.

It was a successful strategy— given the awful alternatives— and was the key reason why Britain's economy contracted by just 5% during the Depression, against 15% for France, and 30% for the US. Could we see such a closed "growth bloc" emerging now, this time led by the US, entailing a massive rupture of world's trading system? Perhaps. This crisis has already brought us a monetary revolution as interest rates approach zero across the G10. It may overturn the "New World Order" as well, unless we move with great care in grim months ahead.

This is where events turn dangerous. The last great era of globalisation peaked just before 1914. You know the rest of that story.


The Federal Reserve Is Damned Either Way As It Battles Debt And Deflation
We Know What Causes A Recession To Metastasize Into A Slump. Irving Fisher, The Paramount US Economist Of The Inter-War Years, Wrote The Text In 1933: "Debt-Deflation Theory Of Great Depressions".

By Ambrose Evans-Pritchard | 18 December 2008

"Such a disaster is somewhat like the capsizing of a ship which, under ordinary conditions is always near stable equilibrium but which, after being tipped beyond a certain angle, has no longer this tendency to return to equilibrium, but [has, rather,] a tendency to depart further from it," he said. Today we call this "Gladwell's tipping point". Once you pass it, you can't get back up. This is why the Federal Reserve has resorted [so quickly] to emergency measures that seem mad at first sight.

It has not only cut rates to near zero for the first time in US history, it is also conjuring $2 trillion of stimulus out of thin air. This is 'Quantitative Easing', or just plain 'QE' in our brave new world. The key is the toxic mix of high debt and deflation. An economy can handle one at a time, but not both.

The reason why it "departs further" from equilibrium is more or less understood. The burden of debt increases as prices fall, creating a self-feeding spiral [[a 'negative feedback' effect: normxxx]]. This is what Fisher called the "swelling dollar" effect. Real debt costs rose by 40% from 1929 to early 1933 by his count. Debtors suffocated to death.

Brian Reading from Lombard Street Research has revived this neglected thesis and come up with some disturbing figures. US household debt is now $13.9 trillion, down just 1% from its peak last year. Meanwhile household wealth has fallen 14% as property crashes, a loss of $6.67 trillion [[even more, if we add in the losses in the stock and bond markets: normxxx]]. The debt-to-wealth ratio is rocketing.

Clearly the US is already in the grip of debt-deflation. "The obvious conclusion is that the Fed should print money to purchase private sector assets so as to drive up their price," he said. Fed chief Ben Bernanke does not need prompting. He made his name as a Princeton professor studying the "credit channel" causes of depressions. Now fate has put him in charge of the channel.

Under his guidance, the Fed has this week pledged to "employ all available tools" to stave off deflation— and damn the torpedoes. It will purchase "large quantities of agency debt and mortgage-backed securities." It will evaluate "the potential benefits of purchasing longer-term Treasury securities," i.e, 'printing' money to pay the Pentagon.

Put bluntly, the Fed is deliberately stoking inflation. At some point it will succeed. Then the risk flips quickly to spiralling inflation as the elastic snaps back. That will be a second point of danger.

By late 2009, if not before, the bond vigilantes may start to fret about the 'liquidity lake'. They will worry that the Fed may have to start feeding its holdings of debt back onto the market. The Fed's balance sheet has already risen from $800bn in September to $2.2 trillion this month. It will be $3 trillion by early next year.

"The bond markets could go into free fall," said Marc Ostwald from Monument Securities. "The Fed went into this with all guns blazing just as the Neo-cons went into Iraq thinking it was a great idea to get rid of Saddam, without planning an exit strategy. As soon as we get the first uptick in inflation, the markets are going to turn and say this is what we feared would happen all along. Then what?" he said.

New Star's Simon Ward said all three measures of the US broad money supply are flashing recovery. M2 has risen at annual rate of 17% over three months. "It has all changed since the Fed began buying commercial paper in October. If the money supply is booming at 20% in six months, inflation will become a concern. Given that public debt ratios are already on an explosive path, we risk a debt trap," he said.

For now, the bond markets are quiet. Futures contracts are pricing in five years of deflation in the US. Yields on 10-year US Treasuries have halved since early November to 2.09%, the lowest since the Fed's data began. Three-month dollar LIBOR has plummeted to 1.53%. [[And the dollar has plummeted in value.: normxxx]]

It is the same pattern across the world. 10-year yields have fallen to 1.27% in Japan, 3% in Germany, 3.2% in Britain, and 3.49% in France. The bond markets seem to be betting that emergency action by central banks will take a very long time to work, if it works at all. By cutting to zero, the Fed has come close to shutting down the US 'repo' market that plays a crucial role in providing liquidity.

It has caused havoc to the $3.5 trillion money markets— as the Bank of Japan, burned by experienced, had warned. It has become even harder for banks to raise money. Some argue that 'extreme' monetary policy is already doing more harm than good. Mr Bernanke is known for his "helicopter speech" in November 2002, when he nonchalantly talked of the Fed's "printing press" and said it was the easiest thing in the world to "reverse deflation".

Less known is his joint-paper in 2004— "Monetary Policy Alternatives At The Zero-Bound". By then doubts were creeping in. He admitted to "considerable uncertainty" as to whether 'extreme' tools would actually work. Liquidity could fail to gain traction. Put another way, the Fed is flying by the seat of its pants. It should never have let debt grow to such grotesque levels in the first place.


Fresh Credit Strains In Europe As Deutsche Bank Shocks Markets
Deutsche Bank Has Refused To Redeem A Bond Issue In An Unprecedented Move That Has Rattled Europe's Credit Markets And Cut Short The Relief Rally Following America's Dramatic Move To Zero Rates.

By Ambrose Evans-Pritchard | 17 December 2008

The news set off a fresh flight from European bank debt. Credit default swaps (CDS) on the iTraxx Financial index measuring stress in the sector saw the biggest jump since the Lehman Brothers crisis, rising 20 points to 226. Adding to the gloom, Standard & Poor's warned that a fifth of all lower-rated companies in Western Europe and the UK are likely to default over the next two years, greatly exceeding the scale of bankruptcies after the dotcom bust. The agency said up to 75 companies that issue debt in the capital markets would fail in 2009 as they struggle to roll over debt. Four have failed this year.

Deutsche Bank, Germany's top lender, said it had 'chosen not to exercise' a "call option" on a subordinated bond worth €1bn (£930bn), breaking an iron-fast 'code' in the credit markets. The bank's share price fell 7% in Frankfurt, and the default insurance on the it's debt surged. "This has never happened before," said Willem Sels, a credit strategist at Dresdner Kleinwort. "Banks have never wanted to do it because it upsets investors and could mean that future funding will be hit."

Deutsche Bank, run by Josef Ackerman, is within its legal rights. The contract lets the bank accept an automatic rise in interest costs after five years, or call the option and raise money on the open market. Ronald Weichert, the bank's spokesman, said it would have been "much more expensive" [[if not impossible: normxxx]] to secure fresh finance in the current climate. "The situation has changed, and we had to decide what to do in the appropriate interests of Deutsche Bank," he said.

The travails at Deutsche are the latest sign that credit stress is continuing to plague Europe's lenders, despite a blanket bail-out by EU governments in September. The European Central Bank warned in its Financial Stability Report this week that lenders are at risk from a deeper slowdown than expected. "Banks need to be especially vigilant in ensuring that they have adequate capital and liquidity buffers to cushion the risks that lie ahead," it said.

The European Central Bank (ECB) is coming under heavy pressure to follow the Federal Reserve and central banks of Canada, Britain, Switzerland and Sweden in slashing rates and exploring emergency options. Norway cut rates by 175 basis points to 3% on Wednesday. Eurozone prices fell 0.5% in November and may be flirting with deflation by the middle of next year.

The region is falling into deep recession. Berlin expects the economy to contract by 2% next year in the worst slump since World War Two, according to German press leaks. Italy is facing two years of contraction. Concerns are spilling over into the debt markets. Yields on Italy's 10-year bonds have risen to 132 basis points above German Bunds, partly on concerns that Italy may have trouble rolling over €200bn next year.

Jean-Claude Trichet, the ECB's president, this week hinted that the bank may hold rates at 2.5% in January. "Do we have a feeling there is a limit to the decrease in rates? At this stage certainly yes. We have to beware of being trapped at nominal rates that would be much too low."

ECB hawks have been warning that extreme rate cuts are 'unhealthy' and likely to lead to inflation down the road [[strongly reminiscent of Japan's (more or less successful) hawks in the early '90s: normxxx]], although there have been rumblings of discontent from the Dutch, Cypriot, Portuguese and Spanish members. There is now a stark divide in philosophy between the ECB and almost every other central bank. The result has been a sudden shift of funds into the euro over recent days, pushing it to $1.44 against the dollar and a record €1.0758 against sterling.

[ Normxxx Here:  Beware of a sudden surge in the dollar/euro exchange when the ECB finally caves.  ]


Sterling [The Dollar] Fall Is A Life-Saver For UK [US] Economy

By Ambrose Evans-Pritchard | 19 December 2008

The sharp slide in the pound has been a godsend for the UK economy and may have helped Britain avert a much more serious crisis, according to the German bank Dresdner Kleinwort. [[And the recent 'crash' of the dollar may just have similar effects for the US: normxxx]].

"If the currency had not gone down so far, think how much worse it could have been. A weaker sterling is just what you need in the current situation," said David Owen, the bank's chief economist for developed markets. He said exporters are taking advantage of the 20% fall in sterling [[or the over 10% slide of the dollar: normxxx]] to boost profit margins, giving them a vital cushion to help survive the collapse in lending. This is the same pattern seen after the ejection of the pound from Europe's Exchange Rate Mechanism in 1992.

"Export margins are going through the roof, and this helps not just manufacturing but also service exports. Profits are holding up surprisingly well. With banks threatening to cut off credit lines, these companies need all the help they can get," he said.

"We have been in a train-wreck since August 2007 and it is going on and on. Credit insurance [[think AIG: normxxx]] is drying up. We are hearing anecdotal evidence that banks are telling custormers not to rely on them for finance next year. If credit lines are cut off, even good companies will go into receivership," he said.

The concern is that there may be two more shoes to drop in this crisis. The wave of corporate defaults has hardly begun, and inventories are still too high for this stage of the cycle. [[In the US, we still have another wave of foreclosures due to ARMs mortgage rate resets and job losses, and expect more bank and other corporate failures. The government may bailout Citygroup and Detroit, but who else?: normxxx]]

"The good thing is that the authorities have thrown an awful lot of ammo at this problem. We're effectively moving towards zero interest rates in all the major economies. But we know from Japan that the central banks can pump liquidity into the system but that doesn't guarantee recovery if the banks won't lend," he said.

The risk [[for the UK: normxxx]] is that foreign investors stop buying Gilts and other forms of British debt, setting off a pound exodus that could spin out of control— as happened to Iceland's krona. UK bond auctions have held up well so far.

Mr Owen said newspaper columnists fretting about a sterling 'crisis' should remember what happened in the early 1930s when Britain was the first major economy to leave the Gold Standard and reflate through devaluation (and rate cuts). While the episode was humiliating at the time, it was a key reason why the UK economy contracted by just 5% during the Great Depresssion compared to 15% for France and 30% for the US.

Stephen Jen, currency chief at Morgan Stanley, said sterling is a "high-beta" currency, meaning that it is highly-geared to the global economic cycle. It shoots up during good times and plunges during bad times. It should return to health if and when the world emerges from economic winter..

The Bank of England's view is that sterling has served its purpose well in this crisis, acting as a shock-absorber.


Mr Bernanke Correctly Judged The Risk Of Deflation

By Ambrose Evans-Pritchard | 17 December 2008

US consumer prices are dropping at the fastest rate since January 1932 on a strict dollar for dollar basis. New house building fell by 18.9% in November to 625,000, the lowest since records began half a century ago. It is not yet clear whether America is sliding into a deflation trap but the risk is grave enough to justify radical measures as insurance against a potentially disastrous chain of events.

The sort of deflation now spreading across North America, Japan, and parts of Europe is not of the
[often relatively] benign variety of the late 19th century when prices slid gently for year after year. Debt levels are much higher today [[incredibly so; in the 19th century, hardly anyone carried any debt, except for arrears on payments due, or the priveleged few— the latter perhaps a few percent of the total population: normxxx]], so the deflation effect [[of increasing the real value of the debt with time: normxxx]] is that much more dangerous.

The danger is that of a self-feeding downward spiral [[a 'negative feedback' effect: normxxx]] as the
real burden of debt keeps rising into the slump, as Irving Fisher dissected in his great opus "The Debt-Deflation Theory of Great Depressions".

US inflation was minus 1.7% in November, and minus 1% in October. This entirely vindicates the brave decision by Ben Bernanke at the US Federal Reserve— and our our own Mervyn King at the Bank of England— to "look through" the oil spike earlier this year and keep his focus on the underlying forces at work in the global economy. While Mr Bernanke may have been caught flat-footed by the onset of the credit crisis in the summer of 2007, he has since moved with impressive speed. The string of emergency rate cuts this year have now brought America to the brink of zero.

They may prevent the current credit crash from metastasizing into a full-blown depression. We do not yet know for sure. It takes a year or so for the effects of monetary policy to feed through the economy even when the banking system is functioning. It will take even longer this time. But matters would undoubtedly be worse if the Fed’s backwoodsmen had succeeded in imposing a liquidation squeeze on the US economy, as they did from 1930 to 1932.

Mr Bernanke has not run out of ammunition yet. He has a nuclear arsenal, and has begun to use it. [[And means to use it!: normxxx]] The Fed is already buying mortgage debt. It has infinite means of injecting stimulus into the economy by `quantititive easing’, if needs be. It can ultimately print money and hang it on Christmas trees.

Mr Bernanke correctly judged the risk of deflation. His critics did not anticipate this current, sudden price collapse. The burden in now on them to explain why they are so sure that deflation can be safely left to run its malign course.


[The Germany Bully] Gets A Free Ride With Its Beggar-Thy-Neighbour Policy
For The First Time In My Life, I Am Starting To Feel Twinges Of Anti-German Sentiment.

By Ambrose Evans-Pritchard | 15 December 2008

This does not come naturally. My father insisted on German au pair girls during my childhood as his gesture towards post-War comity. I later did a stint at Mainz University dabbling in Kant (great) and Hegel (a fraud).

But even Teutophiles who think that Germany has played an enlightened role for 60 years are losing patience with the antics of the finance ministry and Bundesbank, and with the dictatorial turn in Berlin's EU strategy. Put bluntly, Germany is pursuing a beggar-thy-neighbour policy. It is not fulfilling its responsibilities as the world's top exporter and pivotal power of Europe's monetary union. It is leaching off global demand, even as it patronizes Anglo-Saxons, Latins, and Slavs.

No doubt binge debtors in the Anglosphere are much to blame for this crisis. But Germany rode the boom too. It made those Porsches and BMWs driven by the new rich. Its banks are among the most leveraged in the world.

Nor should we not forget that the European Central Bank set interest rates at recklessly low levels early this decade to help Germany out of a slump. Can this be separated from the property bubbles in Club Med, Holland, Ireland, Scandinavia, and Eastern Europe now causing such grief? Within the EMU, Germany has gained a competitive edge against France, Italy, and Spain for year after year by screwing down wages. In pre-euro days the North-South rift did not matter. The D-Mark revalued. Balance was restored. In the monetary union, it is toxic.

Germany now has a current account surplus of 7% of GDP. It is hollowing the industrial core of Latin Europe. Yes, Club Med needs to pull its socks up, but the flip side of the coin is that Germany is in breach of EMU's implicit contract.

The rules of the game are that surplus countries should boost demand. The Gold Standard collapsed in the early 1930s because they— then the US and France— refused to do so. The burden of adjustment fell on deficit states, who had to tighten yet harder. The downward spiral dragged everybody into depression.

Germany and China are today's violators. Their trade surpluses over the last 12 months have been $283bn and $279bn, respectively. They are exporting excess capacity.

Peer Steinbrück, Germany's finance minister, seems in no mood to yield. He prefers to mock the "crass Keynesianism" of the British. Nobel Laureate Paul Krugman was so disgusted that he broke away from his Stockholm banquet to pen The Economic Consequences of Herr Steinbrück.

"The world economy is in a terrifying nosedive, visible everywhere. The high degree of European economic integration gives Germany a special strategic role right now, and Mr Steinbrück is doing a remarkable amount of damage. There's a huge multiplier effect at work; it is multiplying the impact of German boneheadedness," he said.

Meanwhile, the Bundesbank has been doing its bit for depression. Germany's two ECB members— caught in a 1970s time-warp— orchestrated the mad rate rise in July. They are now trying to head off cuts in January, saying the ECB cannot risk using up its ammo. Even Switzerland's uber-hawks have ditched that doctrine.

Worst of all is Germany's [wicked] role in dredging up the EU Constitution (Lisbon Treaty) after it had been rejected by French and Dutch voters. Having made one blunder, they are now making another by refusing to accept the Irish verdict as well. Why are they so maniacal about this? Because the treaty establishes German primacy in the EU's voting structure. This is raw national interest— camouflaged, of course.

So Brian Cowen— already the most reviled Taoiseach [[the equivalent of a prime minister: normxxx]] since the creation of the Irish state— is bludgeoned into a second vote. This is what now passes for EU statecraft. A tactical case can be made, that fear will induce Irish voters to change their minds as GDP contracts by 4% next year. Even if that proves correct, will it convince anybody that the European Project is advancing with democratic assent?

What if the Irish vote 'No' again? Will Germany carry out its threat to "suspend" them from the EU, and thereby risk a final revulsion against Europe and the unravelling of the post-War order? One notes that Germany has acquired the taste for bullying small nations [[wrong; Germany and Germans have always had 'the taste for bullying small nations' and 'underdogs'— one had been led to expect that they had outgrown it— one was obviously wrong: normxxx]]. Mr Steinbrück threatened to "take a whip" to Switzerland. The sooner Germans take a whip to Mr Steinbrück and all he stands for, the better. Otherwise the rest of us will have to start examining our options.


Switzerland May Have To 'Print' Money To Stave Off Deflation
The Swiss National Bank Has Cut Interest Rates To 0.5% And Opened The Door For Emergency Stimulus, Becoming The First Country In Europe To Flirt With Zero Policy Rates.

By Ambrose Evans-Pritchard | 12 December 2008

South Korea cut to 3% and Taiwan cut to 2%, the lowest in 30 years. Both countries are facing a collapse in exports to China and traditional markets in the West. Thomas Jordan, a board member of the Swiss National Bank (SNB), said the bank was mulling 'extreme' measures to stabilise the financial system and cushion the economy as it falls into recession next year.

"We could engage in 'quantitative easing' and we could intervene in foreign exchange markets or we could buy up bonds and try to influence long-term interest rates. All these options are open and we're not limited in any way in choosing from among these instruments," he said. Quantitative easing is the tool pioneered by the Bank of Japan to stave off deflation. It is tantamount to just printing money.

David Bloom, currency chief at HSBC, said the shift in policy was breathtaking. "The SNB are the hard men of central banking; they are even harder than the European Central Bank. What they are saying is that inflation is no longer a problem, it's the solution. They want stimulus any way they can get it."

The banking sector makes up 20% of Swiss GDP, leaving the country extremely exposed to the credit crisis. The liabilities of Credit Suisse and UBS are equal to seven times national GDP. This has echoes of the situation in Iceland before the country collapsed, although Swiss banks have a much better mix of assets.

"The crucial difference is that the Swiss own half a trillion dollars of external assets. They have a current account surplus of 16% of GDP. This is their ace in the hole. If push ever comes to shove, the Swiss taxpayers have the money to pay," said Mr Bloom.

Switzerland, Sweden, Britain, and Canada are all now following the US Federal Reserve in taking revolutionary action to head off a slump next year, while the ECB has moved with much greater caution. It is unclear whether this reflects a rift in doctrinal policy, or whether the ECB is less able to respond to crises because of its treaty-bound institutional structure. The ECB's chief theorist, Lorenzo Bini-Smaghi, said it was hazardous for central banks 'to cut rates too low and risk using up ammunition'.


Asian Trade In 'Free Fall' As Exports To West Dry Up
The Economic Downturn In Asia Has Taken A Sharp Turn For The Worse As Japan Slides Into Deep Recession And Exports Contract In China, Korea, And Taiwan.

By Ambrose Evans-Pritchard | 10 December 2008

Asian trade in 'Free-Fall'

A blizzard of grim data this week points to a full-blown trade slump across Asia, confirming fears that the region's strategy of export-led growth would backfire once the West buckled. Flemming Nielsen, from Danske Bank, said exports from Korea and Taiwan both shrank by over 20% last month. "The numbers are terrible. Intra-Asian trade is in free-fall. Taiwan's exports to mainland China in November were down a whopping 42%."

The Baltic Dry Index measuring freight rates for bulk goods began to collapse in June, dropping 96% over the five months in the most dramatic fall in shipping fees ever recorded. It was a leading indicator of what we are now seeing in Asian trade. Fan Gang, a top adviser in Beijing, said China's exports would also show a decline when data is released this week. "Things are not good: industrial growth will be around 5% and export growth will be negative," he said. Economic expansion of 5% would be a major shock and entail recession in the Chinese context.

Japan's economy shrank 0.5% in the third quarter and risks sliding back into deflation and perma-slump. Exports fell 7.7% in October on crumbling demand for cars and machinery. Over 1,000 Japanese companies went bust last month as the high yen squeezed margins. Sony is laying off 16,000 staff.

Japan's industrial output is expected to fall by a post-War record of 8.6% in the fourth quarter. Tokyo is already planning "purchase vouchers" to kick-start spending in the world's second largest economy. A fresh stimulus package worth 20,000bn yen (£146bn) is being prepared for early next year.

"We need policies to keep the economy from falling apart," said economics minister Kaoru Yosano. "Japan will endure hardship next year." Zahra Ward-Murphy, from Dresdner Kleinwort, said Japan has slimmed down its bloated debt structure since its Lost Decade, but is still only half-reformed and over-reliant on exports. "It has not rebalanced the economy towards internal growth: now exports are tanking," she said.

Tokyo is once again running low on policy options. The Bank of Japan is wary of cutting rates below the current level of 0.3% for fear of damaging the money markets, a key lubricant of the credit system. [[It cut interest rates to 0.01% last Friday, tantamount to zero. : normxxx]] It may soon need to revert to emergency forms of monetary stimulus known as 'quantitative easing'.

Earlier rescue plans have already pushed Japan's national debt to 170% of GDP, the world's highest. Private savings have collapsed from 14% of GDP in the early 1990s to 2% today. Japan goes into this downturn without a cushion.


BIS Warns Of Collapse In Global Lending
The City Of London Has Suffered A Dramatic Collapse In Its Core Business As Global Lending Falls At The Steepest Rate Since Records Began, According To New Figures From The Bank For International Settlements (BIS).

By Ambrose Evans-Pritchard | 9 December 2008

Cross-border loans worldwide fell by $1.1 trillion (£740bn) in the first half of the year, reflecting the scramble by the financial industry to cut leverage by pulling credit lines and slashing risky exposure. Foreign lending by UK banks fell by a staggering $884bn, equal to 81% of the entire contraction in international lending. The City is facing a double blow since worldwide issuance of bonds and securities has also gone into freefall, plummeting 77% from over a trillion dollars to $247bn in the third quarter.

The City has been the epicentre of Europe's structured credit industry. The collapse in bond issuance reflects the near-total closure of the capital markets in the late summer as credit spreads surged. Bonds issued in euros dropped by 94% from $466bn to $28bn over the quarter.

The UK banking sector includes branches of US, European, Asian and Mid-East institutions. These banks tend to use London as a base for their global credit and investment operations. Though foreign, they make up a crucial part of the City nexus and are a mainstay for accounting firms, lawyers and the panoply of financial services that enrich the City.

In its quarterly report, the BIS warned the US Federal Reserve, the Bank of England and other central banks that near-zero interest rates and emergency monetary stimulus may come at a cost. By opening the cash spigot, the authorities risk displacing the money markets and may "discourage banks from lending to other banks". The money markets are a crucial lubricant for the financial system, but they cannot function if rates fall too low. The sector can wither away, as Japan discovered during its "Lost Decade".

The BIS also hinted that the European Central Bank and Sweden's Riksbank may have blundered by raising rates this year to contain the oil shock. It said short-term energy spikes have no lasting effect on inflation or wage deals. "Evidence suggests an absence of strong second-round effects on inflation. The temporary inflationary impulse will soon drop out," it said.


Deflation Virus Is Moving The Policy Test Beyond The 1930s Extremes
Debt Deflation Is Tightening Its Grip Over The Entire Global System. Interest Rates Are Creeping Towards Zero In Japan, America, And Now Across Most Of Europe. China Will Not Lift Us Out— They Are The Most Vulnerable Of All

By Ambrose Evans-Pritchard, Telegraph, UK | 9 December 2008

We are beyond the extremes of the 1930s. The frontiers of monetary policy are being pushed to limits that may now test the viability of paper currencies and modern central banking. You cannot drop below zero. So what next if the credit markets refuse to thaw? Yes, Japan visited and survived this policy Hell during its lost decade, but that was a local affair in an otherwise booming global economy. It tells us nothing.

This time we are all going down together. There is no deus ex machina to lift us out. Certainly not China, which is the most vulnerable of all.

As the risk grows, officials at the highest level of the British Government have begun to circulate a six-year-old speech by Ben Bernanke— at the time of its writing, a garrulous kid governor at the US Federal Reserve. Entitled Deflation: Making Sure It Doesn’t Happen Here, it is the manual of guerrilla tactics for defeating slumps by monetary means.

"The US government has a technology, called a printing press, that allows it to produce as many US dollars as it wishes at essentially no cost," he said.

Critics had great fun with this when Bernanke later became Fed chief. But the speech is best seen as a thought experiment by a Princeton professor thinking aloud during the deflation mini-scare of 2002. His point was that central banks never run out of ammunition. They have an inexhaustible arsenal. The world’s fate now hangs on whether he was right (which is probable), or wrong (which is possible).

As a scholar of the Great Depression, Bernanke does not think that sliding prices can safely be allowed to run their course. "Sustained deflation can be highly destructive to a modern economy," he said [[and Japan has most recently borne witness to: normxxx]]. Once the killer virus becomes lodged in the system, it leads to a self-reinforcing debt trap— the real burden of mortgages and other loans rises, inexorably, year after year; house prices fall, inexorably, year after year. The noose tightens until you choke. Subtly, it shifts wealth from workers to bondholders [[and like well heeled lenders: normxxx]]. It is reactionary poison. Ultimately, it leads to civic revolt. Democracies do not tolerate such social upheaval for long. They change the rules. [[And it was why Thos. Jefferson, for one, so sternly warned us against bankers in general and central banks in particular. And just perhaps why both Central banks in the US prior to the Fed were each ended by act of Congress in order to end a serious deflation, brought on by severe recession, panic, and hard money. Very hard, as the Fed of 1930 can attest to.: normxxx]]

Bernanke’s central claim is that the big guns of monetary policy were never properly deployed during the Depression, or during the early years of Japan’s bust, so no wonder the slumps dragged on. The Fed can create money out of thin air and mop up assets on the open market, like a sovereign sugar daddy. "Sufficient injections of money will ultimately always reverse a deflation." Bernanke said the Fed can "expand the menu of assets that it buys".

US Treasury bonds top the list, but it can equally purchase mortgage securities from US agencies such as Fannie, Freddie and Ginnie, or company bonds, or commercial paper. Any asset will do. The Fed can acquire houses, stocks, or a herd of Texas Longhorn cattle if it wants. It can even scatter $100 bills from helicopters. (Actually, Japan is about to do this with 'shopping' coupons!)

All the Fed needs is the 'emergency powers' under Article 13(3) of its code. This "unusual and exigent circumstances" clause was indeed invoked— very quietly— in March to 'save' the US investment bank Bear Stearns. There has been no looking back since. Last week the Fed began printing money to buy mortgage debt directly. The aim is to drive down the long-term interest rates used for most US home loans. The Bernanke speech is being put into practice, almost to the letter.

No doubt, such reflation a l’outrance can "work", but what is the exit strategy? The policy leaves behind a liquidity lake. The risk is that this will flood the system once the credit pipes are unblocked. The economy could flip abruptly from deflation to hyper-inflation.

Nobel Laureate Robert Mundell warned last week that America faces disaster unless the Bernanke policy is reversed immediately. This is a minority view, but one held by a disturbingly large number of theorists. History will judge.

Most central bankers suffer from a déformation professionnelle. Those shaped by the 1970s are haunted by ghosts of libertine excess. Those like Bernanke who were shaped by the 1930s live with their Depression poltergeists.

His original claim to fame was work on the "credit channel" causes of slumps. Bank failures can snowball out of control as the "financial accelerator" kicks in. The cardinal error of the 1930s was to let lending contract [[at least during the first half of 1930, in order to stave off the loss of gold, mostly to France: normxxx]].

This is why he went nuclear in January, ramming through the most dramatic rates cuts in Fed history. Events have so far borne him out. A case can be made that Bernanke’s pre-emptive blitz has greatly reduced the likelihood of catastrophe. It was no mean feat given that he had to face down a simmering revolt earlier this year from the Fed’s own regional banks.

The sooner the Bank of England tears up its rule books and prepares to follow the script in Bernanke’s manual, the more chance we too have of avoiding a [horrible end]. Monetary stimulus is a better option than the fiscal sprees that leave us saddled with public debt— the path that nearly wrecked Japan [[and who is not yet out of the woods: normxxx]].

Yes, I backed the Brown stimulus package— with a clothes-peg over my nose— but only as a 'one-off' emergency. Public spending should be a last resort, as Keynes always argued. Of course, Bernanke should not be let off the hook too lightly. Let us not forget that he was deeply complicit in creating the disaster we now face. He was a cheerleader of Alan Greenspan’s easy-money stupidities from 2003-2006. He egged on debt debauchery.

It was he who provided the theoretical underpinnings of the Greenspan doctrine that one could safely ignore housing and stock bubbles because the Fed could simply "clean up afterwards". Not so simply, it turns out.

As Bernanke said in that 2002 speech: "the best way to get out of trouble is not to get into it in the first place". Too late now.



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