Much Ado About Dubai

The panic over its debt problem tells us more about investors than it does about the emirate.

By ZACHARY KARABELL

Global markets sank sharply at the end of last week on fears that Dubai World, a subsidiary of the government of Dubai, was on the verge of defaulting on approximately $60 billion of the emirate's $80 billion in total debt held by creditors world-wide. The rush of news stories added to the wildfire of panicky speculation, with headlines ranging from "Dubai Default Risk May be Big US Bank Problem," to "Dubai Shows Limits of Government Rescues."
The mini-panic, however, has little to do with Dubai and everything to do with the tenuous psychology of global investors still skittish after the financial crisis that hit in the fall of 2008.
The challenges that Dubai faces are both well-known and at least a year old. In the wake of the global financial crisis, Dubai's debt was seen as one of many international soft spots, especially since most of the debt was tied to the assumptions that oil would stay above $145 a barrel, and that Dubai would continue to make the fantastic real-estate gains that had characterized the previous years.
The much-lauded and debated Dubai development model depended in part on a well of capital secured by oil and buoyed by the confidence of the emerging world. That confidence led to the creation of man-made islands, ski slopes in the desert, and some of the world's tallest buildings. It also led to aggressive foreign investments in a portfolio that included luxury stores such as Barney's and frivolities such as Madame Tussaud's wax museums.
What led to Dubai's rise was a vision of Arab entrepreneurialism, easy credit, and anything-is-possible attitude that epitomized the "if you build it they will come" philosophy. It was and is a dynamic materialistic outpost in a corner of the world more identified with religious and ethnic strife, and for a time it seemed to break free of the mooring of history. If nothing else, Dubai is the shopping mall and nightclub for much of the region.
Its obituary was written in the aftermath of the financial crisis as yet another icon of hubris. But Dubai is part of a United Arab Emirates confederation that includes Abu Dhabi and Sharjah, which have oil wealth that Dubai lacks.
As Dubai's ruling family preened, the neighboring emirs sulked, and when Dubai's debts came due prematurely, they swooped in, replete with the scolding I-told-you-so's and armed with billions in oil dollars. Unique model aside, Dubai was always a story of wealth expatriated from Abu Dhabi, Saudi Arabia, Kuwait, and, more opaquely, Iran. If there was ever an example of too big to fail, Dubai was it.
Dubai will not default on its debts—its neighbors simply will not allow it and as of yesterday they have pledged not to. They can well afford to bail out their cousin, though not without extracting a price for the infusion of funds. At one point early this year, with oil heading to $30 a barrel, it was possible the money wouldn't be there. But with oil near $80, the sovereign wealth funds of Abu Dhabi that have been conspicuously silent of late have their hundreds of billions.
Dubai is central to the fate of those who will bail it out. Rich-as-Croesus neighbors, whose conservative culture precludes the carefree amoral opportunities offered by Dubai, use the country as an escape valve. More important, Dubai remains a vital hub of banking, financial markets, deal-making and real estate development that is not about to pass quietly into that good night.
The panic in global markets, as absurd as it was, indicates a fragile state of mind that can do damage. If Dubai had defaulted, it's not as if all $80 billion owed would be written-off like some foreclosed subdivision in central Florida. There is still cash-flow, and no sane bank would willingly forgo that and refuse to renegotiate the loans.
Even a doomsday scenario for Dubai—complete default—wouldn't be a global disaster. While $80 billion is a lot of money, it is still $100 billion shy of what the U.S. government paid to keep American International Group afloat, and it is a pittance in the pool of tens of trillions in bonds world-wide.
So why did markets react as they did? Panic is the easy answer, and global investors do at regular intervals overreact. More disturbing is the possibility that investors in the traditional financial capitals of Europe, the United States and Asia have no better understanding of the world now than they did before last year's crisis.
The old centers—New York, London, Frankfurt, Tokyo—fear risk in parts of the world they deem emerging and underplay the risks in the offices next to them. They view the Dubais, the Shanghais and the Rios with suspicion and with errant conviction that their models are built on foundations of sand, ready to collapse, when it was their own foundations that have proved to be weak. Judging from the misguided reaction to Dubai's challenges, the past year hasn't changed those attitudes. That should make us worried, very worried, but not about Dubai.
Mr. Karabell is president of River Twice and author most recently of "Superfusion: How China and America Became One Economy" (Simon & Schuster, 2009).

 

Bernanke Says Limiting Fed Independence Would ‘Impair’ Economy

Nov. 29 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke said curbing the central bank’s authority to supervise the banking system and tampering with its independence would “seriously impair” economic stability in the U.S.
“A number of the legislative proposals being circulated would significantly reduce the capacity of the Federal Reserve to perform its core functions,” the Fed chairman said in a commentary in today’s Washington Post. The measures “would seriously impair the prospects for economic and financial stability in the U.S.”
Bernanke has presided over the most expansive use of Fed powers since the Great Depression. While the 55-year-old Fed chairman has said he averted a financial meltdown, lawmakers have voiced concern about taxpayer-sponsored bailouts and proposed the most sweeping dismantling of Fed authority since the creation of the institution in 1913.
Bernanke’s commentary is his first comprehensive answer to proposals in the House and Senate that would limit the Fed’s supervisory powers and exert more political oversight in the setting of interest rates. The issues are likely to be discussed when he faces the Senate Banking Committee on Dec. 3 for a hearing on his nomination to a second term as chairman.
“In the current environment with so much borrowing by the government, the political pressure on the Fed is out there,” said James Glassman, senior economist at JPMorgan Chase & Co. “I don’t think you can totally dismiss it.”
Lax Supervision
Senate Banking Committee Christopher Dodd, a Democrat from Connecticut, has criticized the central bank for lax supervision and introduced legislation this month that would strip bank oversight from the Fed and create a single bank regulator. Dodd would also limit the central bank’s ability to loan to individual companies.
“There is a strong case for a continued role for the Federal Reserve in bank supervision,” Bernanke said. “Because of our role in making monetary policy, the Fed brings unparalleled economic and financial expertise to its oversight of banks.”
The Fed chairman pointed to capital adequacy tests the Fed performed in May which helped restore confidence in the banking system. The Standard and Poor’s 500 Financials Index has increased 34 percent since May 1, outperforming the S&P 500 by about 10 percentage points.
Market Recovery
“The Fed has done a very remarkable job managing the financial crisis and the recovery of the financial markets is a testimony to that,” Glassman said. “Of all the things to ‘fix,’ why would we tamper with the one that actually has worked well?”
Dodd and Representative Barney Frank, chairman of the House Financial Services Committee, want to take away the Fed’s rule- writing power on consumer financial products and give it to a new Consumer Financial Protection Agency.
“The Federal Reserve, like other regulators around the world, did not do all that it could have to constrain excessive risk-taking in the financial sector in the period leading up to the crisis,” Bernanke said. The Fed has reviewed its performance and “moved aggressively to fix the problems,” he added.
As the subprime mortgage crisis began to trigger losses in bank portfolios, Bernanke used emergency authority last year to purchase securities from Bear Stearns Cos. and facilitate its merger with JPMorgan Chase & Co.
Necessary Actions
The Fed chairman said that the government’s actions, while in some instances “distasteful and unfair,” were necessary to prevent “a global economic catastrophe that could have rivaled the Great Depression in length and severity.”
Bernanke pushed the Fed’s backstop lending beyond banks, setting up programs to support the commercial paper and asset- backed securities markets. The Fed Board approved the bank- holding-company applications of Goldman Sachs Group Inc. and Morgan Stanley, giving them access to the Fed’s loan window.
The former Princeton University economist and Great Depression scholar has more than doubled the Fed’s assets to $2.21 trillion and become the lender of last resort to government bond dealers, banks, Wall Street firms and U.S. corporations. The central bank has also propped up markets for mortgage-backed and asset-backed securities that support credit to consumers, small businesses and commercial real estate.
Support for Attack
“Congress has a lot of public support for an attack on the Fed,” Allan Meltzer, a Fed historian and professor at Carnegie Mellon University in Pittsburgh, said in an interview Nov. 23. “They bailed out everybody in sight.”
A financial regulatory reform bill proposed by Frank, a Democrat from Massachusetts, would limit Fed emergency lending to broadly available credit programs.
The Frank bill preserves the Obama administration’s proposal to make the Fed the lead regulator of risk across the financial system.
The central bank’s independence is also under fire from both chambers of Congress. Frank’s committee advanced a proposal this month to remove a three-decade ban on congressional audits of Fed interest-rate decisions. The proposal was offered by Representative Ron Paul, a Republican from Texas, and based on a bill with more than 300 co-sponsors.
Less Independent
Bernanke said studies show that central banks independent of political influence tend to keep inflation and interest rates lower than their less independent counterparts.
“The general repeal of that exemption would serve only to increase the perceived influence of Congress on monetary policy decisions, which would undermine the confidence the public and the markets have in the Fed to act in the long-term economic interest of the nation,” Bernanke said.
Under the proposal by Dodd, commercial banks would lose their power to appoint directors of the 12 regional Fed banks. Instead, directors would be chosen by the Fed’s Senate-confirmed governors, and each board chairman would be appointed by the president of the United States and subject to Senate approval.
The proposal would increase political oversight of the Fed bank presidents, who are among the most vocal proponents on the Federal Open Market Committee for keeping inflation low.
“Now more than ever, America needs a strong, nonpolitical and independent central bank with the tools to promote financial stability and to help steer our economy to recovery without inflation,” Bernanke said.
Policy makers cut the benchmark lending rate to a range of zero to 0.25 percent almost a year ago and this month reiterated a pledge to keep the policy rate low for “an extended period.”
While the economy expanded at a 2.8 percent annual pace in the third quarter, unemployment jumped to 10.2 percent in October. The Fed’s challenge is to support growth without unleashing expectations of higher inflation prompted by aggressive monetary stimulus.
“The ultimate goal of all our efforts is to restore and sustain economic prosperity,” Bernanke said. “Our ability to take such actions without engendering sharp increases in inflation depends heavily on our credibility and independence from short-term political pressures.”
To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net.

Dubai in deep water as ripples from debt crisis spread

Work has been halted on the artificial islands

Fears of a dangerous new phase in the economic crisis swept around the globe yesterday as traders responded to the shock announcement that a debt-laden Dubai state corporation was unable to meet its interest bill.
Shares plunged, weak currencies were battered and more than £14 billion was wiped from the value of British banks on fears that they would be left nursing new losses.
Nervous traders transferred the focus of their anxieties from the risk of companies failing to the risk of nation states defaulting. Investors owed money by Mexico, Russia and Greece saw the price of insuring themselves against default rocket.
Although the scale of Dubai’s debts is comparatively modest at $80 billion (£48 billion), the uncertainty spooked the markets, with no one sure who its creditors are. Several banks rushed out statements to reassure investors that their exposure was small.
The FTSE 100 plunged by 171 points to 5,194 — its biggest one-day fall in eight months in one of the most jittery days in the financial markets since the depths of the banking crisis.
The Treasury, the Bank of England and the Financial Services Authority were monitoring events closely and are demanding figures from UK banks on their loan exposures to Dubai.
According to a senior government official, Dubai’s crisis is regarded as modest and manageable for Britain, but there were growing fears that Abu Dhabi, the oil-rich neighbouring emirate that has in the past given rescue loans, would leave Dubai to its fate.
Dubai World, the state-owned corporation that began the panic on Wednesday by demanding a standstill on its interest payments, worsened the mood when it postponed a teleconference for its bond holders, saying the phone lines were overwhelmed.
Gerard Lyons, chief economist with Standard Chartered, said: “The market reaction shows how vulnerable some economies are to the aftermath of the debt binge. This highlights how fragile confidence is.”
The Eid al-Adha religious holiday in the Middle East, and the closure of financial markets in the United States for Thanksgiving, exacerbated the sense of uncertainty in markets that were open for business.
A computer crash at the London Stock Exchange, which by coincidence is 21 per cent owned by the Dubai Government, left dealers unable to trade for three and a half hours.
Shares in HSBC slumped by 5 per cent, wiping £6.2 billion from its value. According to the United Arab Emirates Banks Association, HSBC has £11 billion of loans outstanding to the UAE, of which Dubai is one of seven emirates. HSBC declined to comment.
More than £2.6 billion was slashed from the value of Barclays, while Lloyds and Royal Bank of Scotland, both partly owned by the taxpayer, saw their values fall by £1.7 billion and £1.5 billion respectively.
One analyst said that the fears were overdone because Abu Dhabi would eventually come to the rescue to save the UAE from embarrassment. Dubai World has liabilities of £36 billion, about three quarters of Dubai’s total state debt. Its subsidiary Nakheel built The Palm Islands development, but the property bubble in the emirate burst a year ago, leaving buildings unfinished, debts unpaid and paper fortunes erased.

Will The World Go Shopping?

 


Nouriel Roubini, 11.26.09, 12:01 AM EST

The wobbly holiday retail outlook in North America and Europe.

Roughly one year ago, around the Thanksgiving festivities, the National Bureau of Economic Research announced that the U.S. recession started in December 2007. One year later, though the U.S. economy is in recovery mode, retailers are approaching the holiday season--which accounts for slightly less than one- fifth of yearly U.S. retail sales--with some concern.
A sharp collapse in U.S. consumer spending since mid-2008 led to a particularly dismal 2008 holiday retail season. As per U.S. Census Bureau estimates, core retail sales (which exclude autos, gasoline and building supplies) fell by 1.1% year on year during November and December 2008, compared to an average 4.6% year-on-year increase in holiday season sales over the past decade. Total retail sales suffered a larger collapse, falling 9.5% year on year. After collapsing in 2008, retail sales showed signs of stabilizing over the summer of 2009. While auto sales have fluctuated sharply during recent months due to the government's "cash for clunkers" initiative, core retail sales have risen for three consecutive months as of October 2009, creeping up at a pace of about 0.5% month on month. Entering the 2009 holiday season, the recent uptick in core sales offers hope for better than anticipated holiday retail sales.
Economic indicators, however, suggest a note of caution. The renewal in U.S. consumer confidence over the first half of 2009 faded. Successive grim reports on the employment situation revealed no quick end to labor market woes, lowering consumers' income expectations. According to the October Reuters/University of Michigan Survey of Consumer Sentiment, in October 2009, consumers reported worsening personal finances for the 13th consecutive month, the "longest and deepest decline in the 60-year history of the surveys."
The poor state of personal finances has driven consumers to reduce debt at an accelerated pace. In September, consumer credit fell for the eighth consecutive month at an annualized pace of 7.2%. The poor health of personal finances, labor market uncertainty and the ongoing household balance- sheet repair will continue to promote frugal behavior by U.S. consumers. The Conference Board consumer confidence surveys tell a revealing story: Consumers' plans to purchase big-ticket appliances have declined in the run-up to the 2009 holiday season. This is a bit unusual as plans to buy big-ticket appliances usually display a sinusoidal pattern, with a trough in the month of October and a peak sometime the following spring.
A measure of weekly retail sales released by the International Council of Shopping Centers and Goldman Sachs ( GS - news - people ) indicates that same-store sales flattened over the first three weeks of November, though compared to 2008, sales are up by a promising average pace of 2.9%. The National Retail Federation projects retail sales will fall 1% during this holiday season, compared to an average 3.4% annual gain in holiday sales over the past decade. After the sharp slide in 2008, a decline of "only" 1% or even a small positive gain in 2009 holiday sales may seem like a welcome number; however, accounting for the base effects of a dismal 2008 season, the underlying reality for retailers remains grim for this holiday season. Here is our outlook for Canada and Europe.
Canada
North of the border, Canadian retail sales have recovered, consistent with a resilient domestic demand and the revived housing market. However, despite climbing for seven out of the last nine months, the improvement has not yet been robust and sales remain over 3% lower than in September 2008. Canadian domestic demand has been restrained by a still-weak labor market, where job gains have been mostly in part-time work, which along with a weak external sector have kept Canadian output roughly flat this quarter. As tax incentives on retrofitting houses have expired, some of the related purchases may soften in coming months. Moreover, consumer confidence has weakened going into the holiday season and consumer surveys suggest lower holiday spending than in 2008, when Canada was just entering recession.
United Kingdom
Uncertainty surrounds the U.K. retail sales outlook. With unemployment continuing to rise, credit conditions remaining tight and economic confidence subdued, the forecast for holiday sales is not overly optimistic. However, retail sales figures for October rose 0.4% while September's data enjoyed an upward revision of the same amount. Clothing and household goods proved to be the foundation for the increased retail activity amid hopes that the holiday sales period can continue to experience improvements in retail figures despite constrained domestic demand.
Spain
The Spanish retail outlook is extremely constrained. One in five workers could be unemployed by the end of the year and household consumption is severely dampened by depressed economic sentiment. Disposable income has fallen and will continue to fall while precautionary saving has risen significantly. Retail discounts are ongoing and are likely to continue as fierce price wars persist into the new year. Yet consumer confidence is likely to curtail any significant impact this could have on retail figures.
Greece
In Greece, the economy failed to escape the recession and is particularly affected by deteriorating labor figures. With the true extent of Greece's problem unknown until into the fourth quarter of 2009, unemployment had risen only mildly, but that is likely to accelerate as the holiday season approaches. With a 2% rise in unemployment likely to take the rate to 10% by year end, retail sales are likely to feel the pinch of dampened household expenditure. A yearly rise is still likely from 2008 figures, but a smaller increase than first hoped will probably be the outcome of a deteriorating economic picture in Greece.
Portugal
Portugal has not witnessed the same fall in private consumption as some of its counterparts. Its decline has been relatively contained to less than a 1% fall in 2009, and retail sales are likely to rise as the holiday period approaches. The relative insulation of the Portuguese consumer from the effects of the global depression can be traced to the constrained increase in unemployment and the rigidity of the labor market. Nominal wages have grown in 2009 and consumer confidence has not plummeted as heavily as for example in Spain or Ireland.
Ireland
The recession in Ireland has been exacerbated by a collapse in domestic demand with private consumption expected to fall by over 7.5%. Labor market conditions have deteriorated, as have retail sales figures, and little change in circumstance is expected before the holiday period. A yearly rise in retail figures is unlikely despite the poor performance in 2008 as Ireland struggles to contain its collapsing household consumption levels. Consumer confidence has fallen as jobs continue to be cut across the fragile economy.
Germany
During recent months, private consumption unexpectedly helped stabilize the German economy--a trend that is likely to continue during the 2009 holiday sales season which contributes almost 20% to annual retail sales. Despite the sharp contraction of the German economy, nominal retail sales only declined 2% year on year in the first nine months of 2009, and retailers still expect that "Christmas Business" in November and December will bring in an additional 73 billion euros. While workers expect to be affected adversely in the coming months due to rising unemployment and declining wages, consumer sentiment has recovered substantially from a year ago.
Unemployment has been kept in check so far with the help of government subsidized short-work schemes. Disposable income has been boosted by the German welfare state's extensive economic stabilizers as well as by the favorable inflationary environment. Still, Christmas retail sales are unlikely to exceed their 2008 levels since the expiration in September of the cash for clunkers program will act as a drag on sales in the coming months. Mark-ups will remain under pressure as retailers are trying to attract more business through discounting.
France
The French consumer has been remarkably resilient during the current economic downturn and French holiday sales in the November-December period might even exceed results from previous years. Despite a sizable increase in the unemployment rate, retail sales are unlikely to suffer significantly during the 2009 holiday sales period due to the supportive effect of France's extensive automatic stabilizers and low inflation. Consumer confidence staged a comeback in recent months and bounced back to its January 2008 level. Moreover, French retail sales will continue to benefit substantially from France's cash for clunkers program, which will only expire in 2010. While traditionally the French winter sales season kicks off in the second week of January, a new law now allows for more flexibility on the timing of sales. As a result, retailers are likely to offer steep discounts in an effort to attract additional business in the pre-Christmas period.
Italy
Holiday retail sales in Italy make such a substantial contribution to annual turnover that many retailers only manage to post profits due to sales made in the last two months of the year. Traditionally, Italian retail sales in the November-December period are more than 30% above the average of the ten preceding months, even though the official sales season does not start until after Jan. 6. The 2009 holiday retail sales are likely to disappoint compared to previous years due to the ongoing economic uncertainty. As a result, consumers are still too worried about rising unemployment and are saving a larger percentage of their incomes. Not even the favorable inflationary environment is expected to boost retail sales, which have been contracting for the past 30 months. Tax incentives for durable goods and subsidies, in particular the cash for clunkers program, are expected to have a positive impact on retail sales in the coming months. Italy registered the greatest deterioration in retail margins in the eurozone, indicating that only aggressive discounts prevented an even larger fall in sales.
Nouriel Roubini, a professor at the Stern Business School at New York University and chairman of Roubini Global Economics, is a weekly columnist for Forbes. (Read all of his columns here.) RGE analysts assisted in the writing of this column.

 

The Uncertainty Economy

Tim Geithner is not the Democrats' biggest problem.

Preparing to write about yesterday's downward revision in third-quarter GDP, we were tempted to say the Obama Administration has hit a speed-bump on its promised exit out of the recession. But it is the American economy that has hit a speed bump, and on the evidence of the policy mix emerging now from Democratic Washington, the road ahead for the economy is bump, bump, bump, bump, bump. Other than a few lucky banks, few seem be enjoying the ride.

What last month had appeared to be third-quarter growth of 3.5% in gross domestic product turns out to have been a more modest 2.8%. Consumer spending was pared back to 2.9% from 3.4%. The cash-for-clunkers subsidy produced fewer new-vehicle purchases than first estimated. In short, we aren't getting much bang for our $787 billion stimulus bucks. But you already knew that.

The frustrated Congressional Democrats who designed and enacted the stimulus seem more surprised, and they are now circling the wagons and starting to look for someone else to blame.

The Democrat catching most of the bullets is Treasury Secretary Timothy Geithner. Democratic Congressman Peter DeFazio of Oregon last week called on Mr. Geithner to resign. No surprise there. More noteworthy was that not a peep of support emerged for Mr. Geithner from the Obama White House. We've had our differences with the Treasury secretary, but how throwing Mr. Geithner off the wagon train would turn around the unemployment rate is, to put it mildly, far from clear.

The panicked Democrats' biggest problem is that Congress and the President have erected the biggest overhang of economic policy uncertainty that anyone can remember.

One big difference between Washington and private markets is that politicians think everything they do is free-standing. Markets, however, combine all the potential costs of Washington's policies and then decide whether to invest, or not. Consider what private decision-makers see in their future:

A 2,074-page, trillion-dollar health-care bill to redesign 17% of the U.S. economy. A carbon tax—cap and trade—that remains an Obama priority ahead of the Copenhagen climate summit next month. A falling dollar and gyrating commodity prices, with no idea where those prices will go next.

Democratic liberals are talking about an income tax surcharge to pay for any commitment in Afghanistan. Card check, to expand unionization of the private economy, remains a priority. Domestic discretionary spending in fiscal 2010 is set to rise at 12.1%, with inflation near zero.

Nurturing a fragile economic recovery into a durable expansion requires policies that restore public confidence and reassure investors, risk-takers and employers. The Democratic agenda is doing precisely the opposite, which is how you get subpar growth and fewer new jobs.

Heed the danger of asset bubbles

By Robert Zoellick
Published: November 24 2009 20:03 | Last updated: November 24 2009 20:03
As the world begins to recover from the worst downturn since the Great Depression, the conventional wisdom is that we have employed lessons of the past effectively: a flood of money; a dose of fiscal stimulus; and an avoidance of the worst trade protectionism. We even have Ben Bernanke, a scholar of the Depression, at the helm of the US Federal Reserve. So what could we be missing?
The old playbook may have new, unintended consequences. Last year, when governments faced financial markets paralysed by possible failure of counterparties, they used the tools they had, even if an imperfect fit. To keep credit flowing, central banks opened the money spigots. When traditional monetary tools were insufficient, they invented new ones to buy or lend against assets. And it worked.
Of course, governments knew these dramatic actions would have consequences. Central banks have been watching carefully for early signs of the traditional danger – inflation. Yet in a new era of global competition, companies are unlikely to have the pricing power that led to “demand pull” inflation in decades past; nor are unions likely to be able to make wage demands that contributed to “cost-push” stagflation. Walmart and the developing world’s labour force have changed the paradigm.
Yet the revival of John Maynard Keynes should not lead us to ignore Milton Friedman: where will all that money go? For a hint of the future, look to Asia, where a new risk is emerging: asset bubbles.
Asia is now leading the world economy with increases in industrial production and trade, partly reflecting the growth in China and India. This welcome economic upswing is accompanied by rising equity and property prices. House prices in China jumped in October by the biggest amount in 14 months, with a recent auction in Shanghai attracting record bids to a commercial property that drew none last year. Elsewhere in Asia, equity markets have surged and property prices are on the rise, notably in Hong Kong and Singapore. Gold is rising and the prices of other commodities are likely to rise too. The combination of loose money, volatile commodity markets and poor harvests – such as occurred recently in India – could make 2010 another dangerous year for food prices in poor countries. Asset bubbles could be the next fragility as the world recovers, threatening again to destroy livelihoods and trap millions more in poverty.
Unfortunately, the chapters in the history books about how to deal with asset bubbles usually precede tales of woe. Asset bubbles can be more insidious than traditional product inflation, because they seem to be a sign of health: higher values lift the real economy, which in turn can send the bubbles higher. Jaw-boning irrational exuberance has not worked well against asset or product price inflation. Waiting for bubbles to burst and then cleaning up the aftermath is now a new lesson of what not to do. But tightening interest rates too abruptly – especially where recoveries are weak, such as in the US and Europe – could trigger another downturn.
Australia, with its ties to the Asian economies, has already raised interest rates. Asian countries, which traditionally follow the US Fed’s monetary policy, will be under pressure to follow. But raising rates while the Fed keeps its rates close to zero would cause Asian currencies to appreciate. This would make their exports more expensive and decrease overseas sales, hurting recoveries based on exports. More­over, there is competition from China. The renminbi is tied to a declining US dollar that makes Chinese goods cheaper to buy than those of Asian rivals.
Some policymakers in Asia are testing alternative approaches. In Singapore, the 16 per cent surge in property prices during the third quarter of this year led the authorities to release more land for development and to take steps to stop borrowers from deferring payments. Other more focused measures include setting targets for the overall rate of growth of bank credit, imposing caps on the share of bank lending for real estate and portfolio investments, or higher capital requirements for riskier lenders. In developed countries, where central banks want to keep rates low, regulators should be considering supplementary tools such as raising margin requirements on stock, bond and futures transactions, or raising down-payment requirements on commercial or speculative real estate deals.
It would also help if North America and Europe took a closer look at the agenda that Australia and many Asian countries are starting to pursue. To build confidence and opportunity for the private sector, the Asia-Pacific countries are advancing structural reforms – including in service sectors – to boost productivity and potential growth. These reforms will help them to compete even if their currencies appreciate.
Perhaps the primary lesson from history is for countries to co-operate in making assessments that distinguish their situations, avoiding one-size-fits-all “exit strategies”, and cautioning against currency or trade protectionism. Debates about new financial regulatory structures should not distract governments from using tools they have to counter these emerging risks. These will be the challenges for the Group of 20 nations in 2010. The G20 had better put asset price bubbles and new growth strategies on its agenda. Otherwise, the solutions of 2008-09 could plant the seeds of trouble in 2010 and beyond.

The writer is president of the World Bank Group

Economy's rebound not as strong as first thought

By JEANNINE AVERSA

WASHINGTON (AP) - The economy grew at a 2.8 percent pace last quarter, as the recovery got off to a slower start than first thought.
The Commerce Department's new reading on gross domestic product wasn't as energetic as the 3.5 percent growth rate for the July-September period estimated just a month ago.
The main factors behind the downgrade: consumers didn't spend as much, commercial construction was weaker and the nation's trade deficit was more of a drag on growth. Businesses also trimmed more of their stockpiles, another restraining factor.
The new reading on GDP, which measures the value of all goods and services produced in the United States - from machinery to manicures - was a tad weaker than the 2.9 percent growth rate economists surveyed by Thomson Reuters had expected.
Still, the good news is that the economy finally started to grow again, after a record four straight losing quarters. The bad news is that the rebound, now and in the months ahead, probably will be lethargic.
The worst recession since the 1930s is very likely over, but the economy's return to good health will take time, Fed officials and economists say.
Growth probably won't be strong enough to quickly drive down the nation's unemployment rate, currently at 10.2 percent. It's only the second time in the post-World War II period that unemployment has topped 10 percent.
Some economists think economic growth will slow to around a 2.5 percent pace in the current quarter, although others say it could clock in at about 3 percent if holiday sales are better than expected.
Most say they think the economy will weaken again next year, with growth at a pace of around 1 percent as the impact of the $787 billion stimulus package fades and consumers keep tightening their belts under the strain of high unemployment and hard-to-get credit.
Much of the economy's return to growth last quarter reflected federal support for spending on homes and cars.
But Tuesday's report shows that some of that spending was a bit less robust than initially thought.
Spending on homes and other residential projects soared at an annualized pace of 19.5 percent last quarter, a little slower than the 23.4 percent rate first estimated. Spending on big-ticket "durable" goods - including cars - jumped at a pace of 20.1 percent, down from 22.3 percent.
Even with the downward revisions, it was notable that such spending grew, after falling in the previous quarter.
In the third quarter, the popular Cash for Clunkers rebates and an $8,000 tax credit for first-time homebuyers juiced up sales of cars and homes. The clunkers program ended in August, but the tax credit has been extended and expanded beyond first-time buyers.
What's not clear is whether the recovery can continue after government supports are gone.
If consumers clam up, the economy could tip back into recession. President Barack Obama recently cautioned that the economy could suffer a "double dip" downturn.
Fed Chairman Ben Bernanke, however, says he doesn't think that will happen. But last week the Fed chief did warn the recovery faces "important headwinds," such as tight credit and a weak job market that will make consumers cautious in their spending.
Those factors "likely will prevent the expansion from being as robust as we would hope," Bernanke said.
Tuesday's report showed that overall consumer spending - a major shaper of national economic activity - grew at a pace of 2.9 percent last quarter. That was down from a 3.4 percent growth rate first estimated, but still marked the best showing since early 2007.
On the business side, companies cut back spending on commercial construction - a weak spot in the economy - at 15.1 percent annualized pace. That was deeper than the 9 percent annualized cut back first estimated.
Businesses also trimmed stockpiles of goods by $133.4 billion last quarter, slightly more than initially estimated.
And the nation's trade deficit ended up shaving 0.83 percentage point off GDP last quarter, more than first thought.
Unlike past rebounds that were driven by the spending of everyday Americans, this one appears to hinge on spending by businesses, foreigners and - until it runs out - the government.
In an encouraging note on that front, businesses after-tax profits grew at a 13.4 percent pace last quarter, up from a 0.9 percent pace in the prior period, Tuesday's report showed.
In 1980, businesses led an economic recovery. It quickly fizzled, and the economy fell into a severe recession in 1981 and 1982. The unemployment rate climbed to 10.8 percent, the post-World War II high.
The government makes three estimates of economic activity for any given quarter. Each is based on more complete data. Tuesday's was the second reading of the third-quarter GDP data.
The return of economic growth puts the White House in a delicate position: Obama wants to take credit for ending the recession, but unemployment is still causing pain and anxiety nationwide.
Millions have yet to feel a benefit from the recovery in the form of a new job or even an easier time getting a simple loan. Even those with jobs are reluctant to go on a spending spree. The values of their homes and 401(k)s have not fully recovered.
Some economists think the jobless rate could climb as high as 11 percent by the middle of next year before making a slow descent. It could take at least four years for the unemployment rate to drop back down to more normal levels.
"The best thing we can say about the labor market right now is that it may be getting worse more slowly," Bernanke said last week.
Against that backdrop, Obama said he's weighing tax breaks that could encourage businesses to hire again.

Democrats push $150B stock tax on Wall Street

By Silla Brush - 11/24/09 12:05 PM ET

A House bill still being drafted aims to raise $150 billion each year to pay for new jobs.
Under a bill being drafted by Democratic Reps. Peter DeFazio (Ore.) and Ed Perlmutter (Colo.), the sale and purchase of financial instruments such as stocks, options, derivatives and futures would face a 0.25 percent tax.

The bill, a copy of which was obtained by The Hill, is titled the “Let Wall Street Pay for the Restoration of Main Street Act of 2009.”

Half of the $150 billion in tax revenue would go toward reducing the deficit, while the other half would be deposited in a “Job Creation Reserve” to support new jobs.

The job fund would be available to offset the additional costs of the 2009 highway bill and other legislation that creates jobs.

The Obama administration and congressional Democrats are looking for ways to create jobs after the nation’s unemployment rate hit 10.2 percent in October and job losses are expected to rise.

House leaders have mentioned the possibility of a tax on stock transactions, but House Speaker Nancy Pelosi (D-Calif.) appeared to raise questions about the approach last week. Pelosi said such a move would need to be done in conjunction with efforts in other countries.

“Obviously, we have to work with leadership on this,” said Leslie Oliver, spokeswoman for Perlmutter. “It has a long way to go, but the idea is to stir debate … We think this is one idea that makes a lot of sense.”

The stock tax measure specifies that tax revenue would need to support jobs that pay at least the median wage in the United States, promotes manufacturing jobs and prohibits any recipient of the $700 billion financial bailout from directly benefiting from the job reserve fund.

The bill aims to exempt retirement accounts from the impact of the tax.

A group of consumer watchdog organizations and labor unions sent DeFazio a letter this week supporting the tax bill.

“Your bill would put Wall Street to work for the public good, by placing a modest securities transaction tax on trades of stocks, options and swaps. A tax on these trades has little impact on the average investor or pension fund because they hold their investments for the long term, but it does disincentivize Wall Street gambling and high-volume short-term speculative trading,” the organizations wrote.

The groups include: Americans for Financial Reform, Public Citizen, the Service Employees International Union (SEIU) and the AFL-CIO, among others.

Government Deficits and Private Growth

Future living standards will take a hit as federal borrowing balloons and bank lending to business shrinks.

 

By GEORGE MELLOAN

For anyone who wondered if last winter's federal seizure of the financial services industry would have adverse economic consequences, an answer is now available. The credit market has been tilted to favor a single borrower with a huge appetite for money, Washington. Private borrowers, particularly small businesses, have been sent to the end of the queue.
The Federal Reserve, which supervises some 7,000 banks, has been telling bankers that they must cut risk. The most spectacular step in that effort was the Fed announcement last month that it will evaluate the salaries of bank officers on how carefully they manage risk.

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David Gothard 

By official definition, Treasury securities are risk-free, so how better to manage risk than to pad your bank's portfolio with Treasury securities, which is what bankers are doing. Under the new management from Washington, bankers who take a flyer on a venture that might some day become an Apple, Microsoft or Google will risk not only their depositors' money but a possible pay cut. Banking has been captured by the nanny state, which means that its potential for contributing to economic growth and job creation has been sharply curtailed, even as its potential contribution to government growth has been expanded.

The federally dictated risk-aversion was underway even before the Fed began monitoring banker paychecks. According to the Fed's September flow of funds report, commercial banks were net buyers of Treasury securities to the tune of $25 billion on an annualized basis in the second quarter. They were net buyers of federal agency paper—think Fannie Mae and Freddie Mac—at an annualized rate of a whopping $185 billion, contributing mightily to federal efforts to keep these miscreants afloat. Meanwhile, private lending, which once was the mainstay of banking, was shrinking at a $392 billion annual rate.
Economist David Malpass detailed the squeeze on lending to small business in a recent post on his Encima Global blog. He noted that a member survey by the National Federation of Independent Businesses in May found that 16% of respondents were reporting loans hard to get, the worst reading since the 1980-82 recession. The Federation's October report showed only a small improvement. Mr. Malpass predicted further tightness through the third and fourth quarters.
Washington hasn't been able to milk the taxpayers sufficiently to finance its massive deficit. The Chinese are getting skittish as well. So tapping bank deposits is yet another avenue to a big pot of cash. As for the bankers, they've been awarded an easy life. Thanks to the Fed's zero interest-rate policy, they can make a decent profit on "safe" Treasury and agency securities yielding 3% or more. The too-big-to-fail banks like Citi and Bank of America can draw on their big shareholder, the U.S. Treasury, if their capital needs further supplements. Bankers don't have to worry about making risk judgments because they've been ordered to not take risks. So maybe the Fed is justified in cutting their salaries, since whatever banking skills they had—meaning the ability to assess risk—are no longer needed or wanted. An office boy could buy government bonds.
There is a plentiful supply. The reported federal deficit for the fiscal year ended Sept. 30 was $1.4 trillion. That is a whale of a deficit in itself, but the primitive cash-flow accounting from which it is derived understates the real red ink. As former Treasury official Peter Wallison says, it's the way a mom and pop grocery does accounting: cash in versus cash out. It would not pass muster under the accounting rules corporations are required by the Securities and Exchange Commission to follow, in that it takes no account of such huge contingent liabilities like Medicare and the Enron-style off-budget agencies.
A number more relevant to what the government is actually demanding from the capital markets is the Treasury's financing requirement. At a recent Chartered Financial Analyst Institute conference, Treasury official Karthik Ramanathan proudly described the prodigious fund-raising task he and his colleagues pulled off in the fiscal year, what one might call a borrowing feat unparalleled in human history: "In the course of 291 auctions in 251 business days, Treasury issued nearly $7 trillion in gross Treasury marketable securities to raise approximately $1.7 trillion to finance the government."
But the Treasury Borrowing Advisory Committee on Long-term Finance was less than thrilled. In its August report to Secretary Timothy Geithner, the committee said: "This year's double-digit-as-a-percent-of-GDP budget shortfall [the federal deficit] is unsustainable. Moreover, there is little support for a marked shrinking in the deficit in the year ahead, as revenue trends likely will remain sluggish amid high unemployment and lingering capital losses and public spending will remain elevated as a share of the economy. Various policy efforts under discussion by the Administration and Congress also probably would add to the deficit and public debt on a net basis."
Needless to say, the Obama administration and Congress aren't heeding such warnings. More big spending programs on health care and green energy are getting teed up.
Fed Chairman Ben Bernanke said at a Richmond Fed market symposium last April that the Fed was attempting to "avoid both credit risk and credit allocation in our lending and securities purchase programs." The "attempt" has hardly been obvious and clearly is not succeeding, particularly with regard to credit allocation. Aside from the not-so-subtle efforts to enlist the banks in a government bond drive, there are the direct allocations of credit that have been practiced by the Fed and Treasury since the banking crisis a year ago. Infusions to Citigroup, Bank of America, JP Morgan Chase for the takeover of Bear Stearns, Fannie, Freddie, AIG, GM, Chrysler, the commercial paper industry, money market funds, etc., have clearly been credit allocation, big time.
James Hamilton of the University of California at San Diego wrote in his "econbrowser" blog on March 29 that, "the new Fed balance sheet represents a fundamental transformation of the role of the central bank." He noted that for many years the Fed had pumped money into the economy with no attempt to direct which borrowers would receive credit. The whole idea behind the Fed's open market operations is to make the process of creating new money completely separate from the decision of who receives any fiscal transfers.
"In a traditional open market operation," Mr. Hamilton writes, "the Fed buys or sells an existing Treasury obligation for the same price anyone else would pay for the security. As a result, the operation itself does not involve any net transfer of wealth between the Fed and the private sector. The philosophy is that the Fed should base its decisions on economy-wide conditions, and leave it entirely up to the market or fiscal authorities to determine where those funds get allocated.
"The philosophy behind the pullulating new Fed facilities is precisely the opposite of that traditional concept. The whole purpose of these facilities is to redirect capital to specific perceived priorities."
Yes, things have changed in a year. Feeding the government and starving free enterprise looks like a prescription for long-term economic stagnation. It's not unlike what we witnessed in the depression of the 1930s.
Mr. Melloan, a former columnist and deputy editor of the Journal editorial page, is author of "The Great Money Binge: Spending Our Way to Socialism," published last week by Simon & Schuster.

One in Four Borrowers Is Underwater

By RUTH SIMON and JAMES R. HAGERTY

The proportion of U.S. homeowners who owe more on their mortgages than the properties are worth has swelled to about 23%, threatening prospects for a sustained housing recovery.
Nearly 10.7 million households had negative equity in their homes in the third quarter, according to First American CoreLogic, a real-estate information company based in Santa Ana, Calif.

Underwater Mortgages

State-by-state details on underwater home loans

• More interactive graphics and photos
• Developments: So You're Underwater, What's Next?

These so-called underwater mortgages pose a roadblock to a housing recovery because the properties are more likely to fall into bank foreclosure and get dumped into an already saturated market. Economists from J.P. Morgan Chase & Co. said Monday they didn't expect U.S. home prices to hit bottom until early 2011, citing the prospect of oversupply.
Home prices have fallen so far that 5.3 million U.S. households are tied to mortgages that are at least 20% higher than their home's value, the First American report said. More than 520,000 of these borrowers have received a notice of default, according to First American.
Most U.S. homeowners still have some equity, and nearly 24 million owner-occupied homes don't have any mortgage, according to the Census Bureau.
But negative equity "is an outstanding risk hanging over the mortgage market," said Mark Fleming, chief economist of First American Core Logic. "It lowers homeowners' mobility because they can't sell, even if they want to move to get a new job." Borrowers who owe more than 120% of their home's value, he said, were more likely to default.

Journal Community

• Discuss: How much of your home's value do you owe on your mortgage?

Mortgage troubles are not limited to the unemployed. About 588,000 borrowers defaulted on mortgages last year even though they could afford to pay -- more than double the number in 2007, according to a study by Experian and consulting firm Oliver Wyman. "The American consumer has had a long-held taboo against walking away from the home, and this crisis seems to be eroding that," the study said.
Just months after showing signs of leveling off, the housing market has thrown off conflicting signals in recent weeks. Jittery home builders and bad weather led to a 10.6% drop in new home starts in October, and applications for home-purchase mortgages have dropped sharply in recent weeks.
These same falling prices have boosted home sales from the depressed levels of last year. The National Association of Realtors reported Monday that sales of previously occupied homes in October jumped 10.1% from September to a seasonally adjusted annual rate of 6.1 million, the highest since February 2007.
The bump in sales was ahead of forecasts, spurred by falling prices, low mortgage rates and a federal tax credits for buyers. Congress recently expanded and extended the tax credits.
The latest First American data aren't comparable to previous estimates because the company revised its methodology. First American now accounts for payments made by homeowners that reduce principal, and it no longer assumes that home-equity lines of credit have been completely drawn down.
The changes reduced the total number of borrowers under water -- although both old and new methodology show increases from the previous quarter. Using the old methodology, the portion of underwater borrowers would have increased to 33.8% in the third quarter.

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Reuters 

 

Homeowners in Nevada, Arizona, Florida and California are more likely to be deeply under water, according to the analysis. In Nevada, for example, nearly 30% of borrowers owe 50% or more on their mortgage than their home is worth, said First American.

More than 40% of borrowers who took out a mortgage in 2006 -- when home prices peaked -- are under water. Prices have dropped so much in some parts of the U.S. that some borrowers who took out loans more than five years ago owe more than their home's value.
Even recent bargain hunters have been hit: 11% of borrowers who took out mortgages in 2009 already owe more than their home's value.
Andrew Lunsford put 20% down when he bought his home in Las Vegas for $530,000 in 2004. Now, he said, his home was worth less than $300,000.
"I'm to the point where I feel I will never get my head above water," said Mr. Lunsford, a retired state trooper who works for an insurance company. He said his bank won't modify his loan because he can afford his payments, and he's unwilling to walk away, he said: "We're too honest."
Borrowers with negative equity are more likely to default if they live in a state where the bank can't pursue their assets in court, according to a study by the Federal Reserve Bank of Richmond.
But borrowers who are less than 20% under water are likely to maintain their mortgage if their loan is modified and the payments reduced, said Sanjiv Das, head of Citigroup's mortgage unit. "Beyond 120%, the most effective modification is a complete loan restructuring, including a principal reduction."
Mortgage companies have been reluctant to reduce mortgage principal over worries about "moral contagion, with people not paying their mortgage or redefaulting because they believed the bank would reduce their principal," Mr. Das said.

Related Article

• Distressed Homeowners Ponder Whether to Stay or Go

Many borrowers are so deeply under water that they can't take advantage of lower rates and refinance their mortgage. "We're declining hundreds of loans each month," said Steve Walsh, a mortgage broker in Scottsdale, Ariz. "The only way we will make headway is if we allow for a streamlined refinance where the appraisal is irrelevant."
Realtors reported that home sales in October were up 24% from a year earlier. The number of homes listed for sale nationwide was 3.57 million at the end of October, down 3.7% from a month earlier, the trade group said. But that inventory could rebound next year as banks acquire more homes through foreclosure.
About 7.5 million households were 30 days or more behind on their mortgage payments or in foreclosure at the end of September, according to the Mortgage Bankers Association. Many of those homes will be lost to foreclosure, adding to the supply of homes for sale.
A recovery could pay off for the roughly 30% of underwater borrowers who owe 110% or less of their home's value and are able to endure the slump. "Most people prefer to stay in their home" even if the value of their property has declined, said John Burns, a real-estate consultant based in Irvine, Calif.
—Nick Timiraos contributed to this article.

Seven Big Lies about the Stimulus

The difference between 450 jobs and six.

By Stephen Spruiell

There have been dozens of news reports exposing tens of thousands of stimulus jobs as frauds — David Freddoso and Mark Hemingway of the Washington Examiner put the number of phony jobs at about 75,000. They found more than 100 separate incidents, but these incidents can be grouped into seven categories, representing the seven biggest lies the administration is telling you about the stimulus:



1. Raises = jobs: This one turns out to be pretty common. For example, the Associated Press reported that one nonprofit in Georgia used stimulus money to give its employees raises, then multiplied its total number of employees (508) by the percentage points of the raises (1.84) and told the White House that the stimulus had saved 935 jobs. (Its directors said they were just following instructions they received from the White House.) Other nonprofits did the same. According to the AP, this fraud exaggerated the number of jobs created or saved by 9,300.



2. Number of people who might benefit = jobs: According to the AP, East Central Technical College in Georgia used more than $200,000 in stimulus money to buy “trucks and trailers for commercial driving instruction, and a modular classroom and bathroom for a health education program.” Officials at the college reported that the spending created or saved 280 jobs, at a cost of $715 for each one. That’s miraculous — and impossible. As it turns out, “The 280 were not jobs, but the number of students who would benefit” from the spending.



3. Stimulus Money/Average Salary = jobs: The number of jobs the stimulus allegedly saved or created in Nevada was overstated by at least 4,000, according to a report in the Las Vegas Sun. The report states that local-government officials were told to “take the amount of stimulus money they received and divide it by $92,000, the theoretical average wage and benefits of a job.” As if this weren’t sketchy enough, officials actually divided by lower numbers — $66,681 for K–12 employees and $45,000 for higher-ed workers. In fact, the teachers’ jobs were probably secure — “I don’t for a moment believe that 4,000 teachers would have been laid off if not for the stimulus,” said Republican state senator Bill Raggio. The money allowed the state to avoid making cuts elsewhere.



4. Jobs funded by other federal programs = jobs: The Boston Globe reported that it found several cases in which “federal money that recipients already receive annually — subsidies for affordable housing, for example — was reclassified this year as stimulus spending.” Property companies in Massachusetts reported that such spending saved approximately 430 jobs, but an official at one of these companies admitted, “There were no jobs created. It was just shuffling around of the funds.” USA Today discovered that the Teach for America program misattributed 1,300 jobs to the stimulus; in fact, an unrelated government grant had funded the positions. And the Wall Street Journal found that “some low-income housing landlords whose decades-old contracts with the federal government were funded by the stimulus this year reported a total of 6,463 employees as having jobs linked to the stimulus package.” Those three examples alone account for over 8,000 phony jobs.



5. Whoops! = jobs: Many of the jobs reported as created or saved are nothing more than paperwork errors. In Blooming Grove, Texas, a local housing authority reported that “it created 450 jobs with a $26,174 grant to repair roofs on five apartment buildings,” according to the Dallas Morning News. The project actually involved six workers. And the AP reported that a company in Ohio used the same workers for two stimulus contracts and counted the workers twice. The AP found numerous other instances of double-counting, accounting for 1,350 phony jobs.



6. Summer jobs = jobs: The Dallas Morning News also found about 5,100 jobs that were summer positions for people 24 and younger. A spokesman for the program that placed the workers said that “a couple of handfuls, maybe 25” saw their summer jobs turn into permanent employment. Similarly, around 3,000 “jobs” in Michigan were seasonal. And the AP found a company that claimed to have created 4,300 jobs using stimulus money, 3,000 of which lasted about a month.



7. Phantom layoffs = jobs: State education departments proved to be the biggest source of exaggerated stimulus jobs. As mentioned above, some simply divided the amount of stimulus money they received by some number representing an average teacher salary. Other cases were even more egregious: In Washington State, government officials said that stimulus money saved the jobs of 24,000 teachers who were already under contract to finish out the school year. And in California, the California State University system reported that stimulus funds saved 26,000 jobs — over half of its work force. A CSU spokesman admitted, “This is not really a real number of people. It’s like a budget number.”



Under pressure to produce results, the administration has put forward a set of loose guidelines that invite stimulus recipients to exaggerate the number of jobs the stimulus has created or saved. It is a political metric — not a measure of something measurable — and it is starting to backfire on the administration. The more people question the administration’s job data, the more they might start wonder whether the stimulus has created any jobs at all.



— Stephen Spruiell is an NRO staff writer.

Gold Jumps to Record as Slumping Dollar Spurs Investment Demand

By Nicholas Larkin and Pham-Duy Nguyen

Nov. 23 (Bloomberg) -- Gold jumped to a record price as the slumping dollar boosted bullion’s appeal as an alternative asset. Silver also gained.
Gold futures touched an all-time high of $1,174 an ounce in New York, after the dollar fell as much as 0.9 percent against the euro. Gold has posted records during nine sessions this month, and is up 32 percent this year as investors and central banks increased their holdings of the metal to preserve wealth. Russia’s central bank said it bought more bullion last month.
“All this buying shows no confidence in the dollar,” said Bernard Sin, the head of currency and metals trading at bullion refiner MKS Finance SA in Geneva.
Gold futures for December delivery rose $17.90, or 1.6 percent, to $1,164.70 an ounce on the New York Mercantile Exchange’s Comex division, the biggest gain in a week.
In London, bullion for immediate delivery climbed $13.73, or 1.2 percent, to $1,164.33 an ounce at 7:43 p.m. local time after earlier touching a record price of $1,174.
Gold may surge to $1,500 an ounce over the next 18 months, Bank of America Merrill Lynch analysts said today in a report.
The U.S. Dollar Index, a six-currency gauge of the greenback’s value, slid on speculation that the Federal Reserve will hold U.S. interest rates at historic lows indefinitely. The Fed cut the target range for its benchmark lending rate to zero percent to 0.25 percent in December. The dollar index is down 7.6 percent this year.
Russia’s central bank increased its gold holding to 19.5 million ounces last month from 19 million ounces in September, Bank Rossii said on its Web site.
Government Buying
Governments, the biggest holders of gold, have been expanding their bullion reserves, helping to spur an 8.3 percent rally in the metal’s price from Oct. 20 to Nov. 20. India’s central bank bought 200 metric tons from the International Monetary Fund in October. Mauritius and Sri Lanka also have been buying gold. The IMF still has about 200 tons left to sell.
“Any given emerging-market central bank cannot hedge against further U.S. dollar weakness by buying euros or sterling,” Bank of America Merrill Lynch said, citing the likelihood of rate moves by the European Central Bank and the Bank of England. “This is because there is a significant probability that the ECB and the BOE will have to follow any monetary policy moves by the Fed.”
The ECB’s benchmark lending rate is at 1 percent and the Bank of England’s main rate is at 0.5 percent.
Non-Dollar Purchases
Dennis Gartman, an economist and the editor of the Gartman Letter in Suffolk, Virginia, told investors to buy gold denominated in other currencies.
“Owning gold across the currency spectrum has effectively hedged the dollar exposure,” Gartman said in a note to clients.
Holdings in the SPDR Gold Trust, the biggest exchange- traded fund backed by bullion, were unchanged for a second day at 1,117.49 tons as of Nov. 20, according to its Web site. The fund’s cache reached a record 1,134 tons on June 1.
Sales of American Eagle gold coins by the U.S. Mint jumped 88 percent this year through October, to 1.07 million ounces, from the first 10 months of last year, data on the mint’s Web site shows. The mint lists November sales at 99,500 ounces of the coins. The U.K.’s Royal Mint said last week that it quadrupled output of gold coins in the third quarter.
Gold is in the second stage of a rally to $1,500 that began with the credit crisis in August 2007, Bank of America Merrill Lynch said. The second stage is marked by dollar weakness. In the third stage, a recovery in energy and commodity prices will boost investment into precious metals, the bank said.
Silver futures for December delivery climbed 17 cents, or 0.9 percent, to $18.61 an ounce, after touching a 16-month high of $18.935 earlier. The metal is up 65 percent in 2009.
To contact the reporters on this story: Pham-Duy Nguyen in Seattle at pnguyen@bloomberg.net; Nicholas Larkin in London at nlarkin1@bloomberg.net.

Analysis: Fed under fire as public anger mounts

Analysis: Fed under fire as public anger mounts
Tom Raum

Suddenly the Federal Reserve is everybody's punching bag.

Strip the Fed of its bank regulation powers, some in Congress are demanding. Get probing audits of its behind-the-scenes operations, others say.

The chairman of the Federal Reserve Board is always fair game for criticism and second-guessing, usually over interest rate actions. But this year the criticism is much broader as Congress responds to widespread public anger that the Fed bailed out Wall Street but not ordinary Americans, and with unemployment in double digits.

Former Fed Chairman William McChesney Martin Jr. famously said that the central bank's job was to yank away the punchbowl just when everybody is starting to party. And while Fed Chairman Ben Bernanke has signaled the Fed will keep interest rates low for now, a round of higher rates inevitably will come.

The Fed finds itself both the punchbowl keeper and the punching bag. Imagine the outcry when it does begin to crank up rates — perhaps just ahead of next year's midterm elections.

Fireworks seem likely at Senate confirmation hearings early next month on President Barack Obama's nomination of Bernanke to a second four-year term as chairman.

Many economists and Fed watchers say congressional efforts to rein in the Fed's powers could interfere with the central bank's ability to help guide the fragile economy to recovery.

The Fed's very independence and its unique ability among U.S. institutions to create money out of thin air enabled it to act quickly to stabilize the nation's financial system after it froze up last September after the bankruptcy of the Lehman Brothers investment house, Fed backers say.

"It might have been the Fed's finest moment when it had to jump into the market," said David M. Jones, a former Fed economist and president of DMJ Advisors, a Denver-based consulting firm. "We still have to wait to see how effective the Fed is in its exit strategy and whether it can keep inflation in check. But this badgering by Congress, even if there is populist sentiment, is inappropriate."

The Fed's aggressive intervention also set the stage for the current criticism. Many lawmakers question whether the Fed's money machine has mainly benefited financial markets and not the broader economy. Lawmakers are also peeved that the central bank acted without congressional involvement when it brokered the 2008 sale of failed investment bank Bear Stearns and engineered the rescue of insurer American International Group.

Bernanke, first appointed by President George W. Bush, has worked closely with both Treasury Secretary Timothy Geithner and Bush Treasury Secretary Henry Paulson in confronting the worst financial crisis in decades. Geithner also has gotten his share of congressional wrath, mainly for his administering of the $700 billion bank bailout fund.

"In the past, the Federal Reserve was held in very high esteem," said Rep. Ron Paul, R-Texas, a libertarian who twice ran quixotic presidential campaigns and remains a darling of skeptics of Washington. Now, it's "the source of our problem," suggests Paul, author of the best-seller "End the Fed."

Usually an outlier, Paul suddenly has found an army of at least 307 House colleagues and 30 senators marching behind his legislation to subject the Fed to intense scrutiny by Congress' Government Accountability Office. The House Financial Services Committee endorsed Paul's approach 43-26 last week over objections from its chairman, Rep. Barney Frank, D-Mass.

The bill would authorize Congress to audit not only the Fed's lending programs but its basic decisions to set monetary policy by raising or lowering interest rates. Paul has been introducing a version every year since the early 1980s, but this is the first time it has garnered any serious attention.

Senate Banking Committee Chairman Chris Dodd, D-Conn., who will preside over Bernanke's confirmation hearings, has proposed legislation that would strip the Fed of its bank-regulation authority and give the Senate a role in selecting the 12 regional Federal Reserve bank presidents.

Dodd says his measure would return the Fed to its core mission of setting monetary policy, claiming it proved itself "an abysmal failure" by not cracking down on risky lending practices that led to the financial meltdown.

Dodd is in an extremely tight battle for re-election, even though he has served in Congress for 35 years.

"I don't think it ever hurts to have a member of Congress stand up and denounce the Fed. There is a lot of anger out there, and this is basically a therapeutic gesture," said Ross Baker, a political scientist at Rutgers University.

Still, Baker said, it probably isn't wise to tamper with the formula that makes the Fed "very much an anomaly in American government. It's independent, it has to be. You don't want the Fed to be under the control of the president. And it kind of sits out there — not in the executive branch, not in the legislative branch, not in the judicial branch. Sort of its own little element in the separation-of-powers constellation."

While the Fed is subject to some congressional oversight, its decisions don't have to be ratified by the president or Congress. Fed officials are not paid with money appropriated by Congress.

Should Bernanke be worried?

"Not only should be worried, he's clearly ratcheted up his game in terms of his communications with Congress," said Norman Ornstein, a senior fellow at the American Enterprise Institute.

Ornstein said the Fed bashing this time is different from before, with "a broader base of support. And it's coming from people who in the past would not have hit the Fed. There's a lot of populist anger out there — on the left, in the center and on the right. And politicians are responsive to that."

___

EDITOR'S NOTE: Tom Raum covers economics and politics for The Associated Press.

The 'Real' Jobless Rate: 17.5% Of Workers Are Unemployed

By: Jeff Cox
CNBC.com

As experts debate the potential speed of the US recovery, one figure looms large but is often overlooked: nearly 1 in 5 Americans is either out of work or under-employed.

According to the government's broadest measure of unemployment, some 17.5 percent are either without a job entirely or underemployed. The so-called U-6 number is at the highest rate since becoming an official labor statistic in 1994.

The number dwarfs the statistic most people pay attention to—the U-3 rate—which most recently showed unemployment at 10.2 percent for October, the highest it has been since June 1983.

The difference is that what is traditionally referred to as the "unemployment rate" only measures those out of work who are still looking for jobs. Discouraged workers who have quit trying to find a job, as well as those working part-time but looking for full-time work or who are otherwise underemployed, count in the U-6 rate.

With such a large portion of Americans experiencing employment struggles, economists worry that an extended period of slow or flat growth lies ahead.

"To me there's no easy solution here," says Michael Pento, chief economist at Delta Global Advisors. "Unless you create another bubble in which the economy can create jobs, then you're not going to have growth. That's the sad truth."

Jeff Cox
Staff Writer
CNBC.com

Pento warns that forecasts of a double-dip ("W") or a straight up ("V") recovery both could be too optimistic given the jobs situation.

Instead, he believes the economy could flatline (or "L") for an extended period as small businesses struggle to grow and consequently rehire the workers that have been furloughed as the U-3 unemployment rate has doubled since March 2008.

As that trend has happened, the U-6 rate has expanded at an even more dramatic pace. Economists cite several reasons for the phenomenon.

For one, more workers are becoming discouraged as real estate—the focal point for the expansion in the earlier part of the decade—has collapsed and taken millions of directly related and ancillary jobs with it.

Many workers believe those jobs aren't coming back, and have thus quit looking and added themselves to the broader unemployment count.

"In the earlier part of this decade, 40 percent of all new jobs created were in real estate. Attorneys, mortgage brokers, agents, construction—they were all circled around housing," Pento says. "We've had a jobless recovery in the last two recessions. This is going to be the third jobless recovery in a row."

Another factor that may be leading people onto the rolls of those no longer looking for jobs is the government's accommodative extensions of jobless benefits.

"Workers are unemployed for a much longer span than we've seen historically," says David Resler, chief economist at Nomura Securities International in New York. "Part of that may be affected by the longer availability of benefits. It reduces the incentives for an urgent job search."

The U-6 rate debuted in January of 1994 at 11.8 percent, while the U-3 was at 6.6 percent. The measure hit a low of 6.9 percent in April 2000 while U-3 sat at 3.8 percent.

While the current methodology only dates back 15 years, a former U-6 gauge was in existence previously and peaked at 14.3 percent in 1982. Economists predict the current measure would fall just below that number using the same methodology.

"We're in the process of discovering how severe this recession and the long-run impact on certain industries will be and what that will do to overall employment," Resler says. The U-6 rate "portends a very slow, sluggish recovery."

If that holds and the US economy stays weak, that presents challenges for investors.

"People focus too much on that 10 percent number and not on the larger number," says Kevin Mahn, chief investment officer at Hennion & Walsh in Parsippany, N.J. "There's a humongous inventory of people out there looking for work and have been looking for work for a long time. Where are those jobs going to come from?"

High unemployment and the resulting pressure on consumers is driving many investors to look for opportunities overseas and in other assets.

Walsh says that trend is going to continue, with clients going to foreign markets, real estate investment trusts, certain bonds—anywhere that can offer profits above the slow-growth mire of US-based investments.

"If full employment is 4 percent, people are wondering how we're going to get from 10 (percent) to 4. Well, try getting from 17 to 4. We may not get back to full employment for a decade," Mahn says. "As an investor, that causes me to look for different places now. Maybe you can't just put money in US large caps and ride out this recovery."

• Slideshow: Where the Jobs Are