Archive for the ‘global macro’ Category

country; nominal interest rate; date; official CPI; last update; real interest rate
China 7.47% 06/13/08 7.70% 05/31/08 -0.23%
Hong Kong 3.50% 06/13/08 5.40% 04/30/08 -1.90%
India 8.00% 06/11/08 8.75% 05/31/08 -0.75%
Indonesia 8.50% 06/13/08 10.38% 05/31/08 -1.88%
Japan 0.50% 06/13/08 0.80% 04/30/08 -0.30%
Malaysia 3.50% 06/12/08 3.00% 04/30/08 0.50%
Pakistan 12.00% 05/23/08 19.27% 05/31/08 -7.27%
Philippines 5.25% 06/05/08 9.60% 05/31/08 -4.35%
South Korea 5.00% 06/30/08 4.88% 05/31/08 0.12%

Sri Lanka 10.50% 06/06/08 26.20% 05/31/08 -15.70%
Taiwan 3.50% 03/28/08 3.71% 05/31/08 -0.21%
Thailand 3.25% 05/21/08 7.60% 05/31/08 -4.35%
Vietnam 14.00% 06/11/08 25.20% 05/31/08 -11.20%


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There were about five pieces of news on Friday that delivered such a massive upside kick to oil.

1) Chinese oil consumption numbers came in much higher than expected.

Wall Street is still being blindsided by the impact of the Sichuan earthquake, and apparently most of it is ignorant that ~30 percent of Chinese oil/ natgas/ heating oil comes from Sichuan and Gansu (which was also thrown into chaos by the quake).

2) Shaul Mofaz rattled Kadima’s flimsy sabre at Iran, again. Anyone who took that seriously is ill-informed.

3) The dollar continued hemorrhaging. Brokers are cutting back trading with Lehman Brothers, and Bernanke will probably be called out on his fateful March 17 nationalization of banks’ default risk. He will have to throw hundreds of billions of dollars in Treasuries at Lehman’s crippled balance sheet, further debasing Treasuries specifically and US financial credibility generally.

4) Morgan Stanley said oil would go to $150.

5) The USD and EUR are both heavily overvalued. As long as China keeps its currency peg alive, the dollar and euro will both be overvalued. The only other large currency alternative is commodities, so that’s where money is going.

As I have said many times, government witch hunts against “speculators” never signal the top of a bull market.

Israel’s saber-rattling might have been good for 1 percent of oil’s gain. Obama’s triumph in the US presidential primaries multiplied that, for a total of maybe 3 percent.

In the meantime, Asia’s cracking currency regimes are effectively increasing their subsidies of fuel.

HONG KONG: Buckling under the weight of record oil prices, several Asian countries have cut or are thinking of cutting their fuel subsidies, which raises a pressing question for Beijing: Can China afford its own oil subsidies at a time when it is spending billions on post-earthquake reconstruction?

The short answer is yes, because China is blessed with both large trade account and fiscal surpluses. The reconstruction cost is projected to amount to about 1 percent of China’s gross domestic product, while the fuel subsidies account for another 1 percent, JPMorgan estimates.

Remember that China had a fiscal surplus of 0.7 percent of gross domestic product last year, or $174 billion. So even if spending on post-earthquake rebuilding and fuel subsidies were to cause a 1 percent fiscal deficit, that would still be very manageable.

But here is a more important question: Why should China keep domestic fuel prices at about half of the global average?

The usual answers are to keep inflation in check and stave off social instability that could result if prices were to rise too quickly.

But by distorting fuel prices, China is encouraging fuel consumption and discouraging the use of new energy. Since the Chinese still live in an $80-a-barrel oil environment, demand for anything from cars to chemical products will spiral higher and raise the risks of economic overheating.

Increasing subsidies on fuel will crowd out more investment in other areas, such as education or health care, to name two possibilities.

What’s more, a worsening fiscal situation might put downward pressure on the yuan. Fuel subsidies have exaggerated inflation in the developed world, while understating inflation in the developing world. China’s inflation could well hit 15 percent if Beijing were to free up caps on energy prices, Morgan Stanley estimates.

“If China is not able to take away the subsidy and cut down its demand, it will have huge implications for the world,” said Shikha Jha, a senior economist at Asian Development Bank.

Countries like China and India, along with Gulf nations whose retail oil prices are kept below global prices, contributed 61 percent of the increase in global consumption of crude oil from 2000 to 2006, according to JPMorgan.

Other than Japan, Hong Kong, Singapore and South Korea, most Asian nations subsidize domestic fuel prices. The more countries subsidize them, the less likely high oil prices will have any affect in reducing overall demand, forcing governments in weaker financial situations to surrender first and stop their subsidies.

That is what happened over the past two weeks. Indonesia, Taiwan, Sri Lanka, Bangladesh, India and Malaysia have either raised regulated fuel prices or pledged that they will.

Actions taken by those countries will not be able to tame a rally in prices though unless China, the second-largest oil user in the world, changes its policy. While the West is critical of China’s energy policy, there is little outcry for change within the country, except for complaints from two loss-making refineries.

By contrast, Indonesia has convinced its people that fuel subsidies benefit the rich more than the poor, because rich people drive more and consume more electricity. Jakarta rolled out a $1.5 billion cash subsidy program to help low-income Indonesians cope with higher prices. Although no country wants to build a system on subsidies, the cash subsidy at least makes fuel subsidy cuts politically feasible.

“The people need to wonder, who pays for the subsidies?” said Louis Vincent Gave, chief executive of GaveKal, a research and asset management company. “Most Asian countries are printing money to pay for them.”

Fuel subsidies compromise countries’ ability to control their own budget spending. If China and India can cut their subsidies, they would be able to spend more on infrastructure and education.

While Asian governments dole out cheap food and cheap energy, Asian currencies settle the bill. Morgan Stanley expects some emerging market currencies to face downward pressure, probably for the first time in a decade, as those countries unwind their fuel subsidies and domestic inflation shoots up.

China’s domestic fuel prices are among the lowest in the world, equal to about 61 percent of prices in the United States, 41 percent of Japan and 28 percent of England. The longer it waits, the more painful it will be when it tries to remove the subsidy.

China actually doesn’t have much freedom to splash dollars for fuel. Its entire macroeconomic policy can be summarized as “long USD, short RMB.” Not a good trade.

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Setser on the PBOC:

What cann’t go on still hasn’t slowed, let alone stopped (Chinese reserve growth)

… Back in 2004, it was considered rather stunning when China added close to $100 billion to its reserves ($95 billion) in a single quarter, bring its total reserves up to around $600 billion.. The dollar’s fall against the euro (and associated rise in the dollar value of China’s euros) explains around $15 billion of the rise. But at the time, $80 billion was considered a very large sum for China to have added to its reserves.

Now China has $1756 billion in reserves, after a $74.5 billion April increase. The dollar rose against the euro in April, so the underlying pace of increase – after adjusting for valuation changes – was more like $82 billion.

In a month.

And not just any month – in a month when oil topped $100 a barrel.

$82 billion a month, sustained over a year, is close to a trillion dollars. A trillion here, a trillion there and pretty soon you are talking about real money. If a large share of China’s reserves is going into dollars, as seems likely, this year’s increase in China’s dollar holdings could be almost as large as the US current account deficit.

The fact that one country’s government – and in effect two institutions (SAFE and the CIC) – are providing such a large share of the financing the US needs to sustain large deficits (particularly in a world where Americans want to invest abroad as well as import far more than they export) is unprecedented.

The real surprise in some sense is that the increase in China’s April preserves isn’t that much of a surprise. At least not to those who have been watching China closely.

Wang Tao – now of UBS – estimated that China added $600 billion to its foreign assets in 2007, far more than the reported increase in China’s reserves. Logan Wright (as reported by Michael Pettis) and I concluded that Chinese foreign asset growth – counting funds shifted to the CIC – could have topped $200 billion in the first quarter.

China hasn’t disclosed how much it shifted to the CIC, let alone when it shifted funds over to the CIC. But it seems likely that the surprisingly low increase in China’s reserves in March stems from a large purchase of foreign exchange by the CIC. Indeed, the CIC’s March purchase may have used up all of the RMB 1.55 trillion the CIC initially raised.

As a result, all of the increase in the foreign assets of China’s government seems to have showed up at the PBoC in April. Or almost all. China raised its reserves requirement in April, and the banks may have been encouraged to meet that reserve requirement by holding foreign exchange.

China’s current account surplus – adding estimated interest income to its trade surplus – was no more than $25 billion in April. FDI inflows were around $7.5 billion. Sum it up and it is a lot closer to $30 billion than $40 billion. Non-FDI capital inflows – hot money – explain the majority of the increase.

No wonder Chinese policy makers were so focused on hot money this spring. Hot money flows seem to have contributed to their decision to stop the RMB’s appreciation in April. But interest rate differentials still favor China – so it isn’t clear that a slower pace of appreciation will stem the inflows.

It certainly though helps to sustain the underlying imbalance that has given rise to massive bets on China’s currency.

The scale of China’s reserve growth suggests that China’s government is no longer just lending the US what it needs to buy Chinese goods. And it is now lending the US – and indeed the world – far more than the world needs to buy Chinese goods. Vendor financing is a fair description for China’s reserve growth in 2003 or 2004, but not now.

China’s government is increasingly acting as an international as well as a domestic financial intermediary. It has long borrowed — whether through the sale of PBoC bills of Finance Ministry bonds to fund the CIC – rmb to buy dollars, effectively taking the foreign currency domestic Chinese savers do not want to take. Now though it is borrowing from the rest of the world to lend to the rest of the world.

Most intermediaries though make money. Or at least try to. By contrast, China’s government is almost sure to lose money on its external financial intermediation. Selling RMB cheap to buy expensive dollars and euros is not a good business model.

China cannot be entirely comfortable with all the money that is pouring into China. But it isn’t at all clear that Chinese policy makers are willing to take the steps needed to shift decisively toward a new set of policies. It is clear that the costs of China’s current policies are rising.

Remember, China looses [sic] money on its reserves. More isn’t better.

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… underwritten by PIMCO’s Bill Gross.

Just in time for the huge TIPS burp a couple of nights ago, when massive buying pushed the 5-year TIPS yield down to -.77.

I’ve been a huge fan of the SS hypothesis for a long time, so it’s good to see the world’s biggest fixed income guru practically copy-paste from the Shadow Stats website for his latest letter.

Without further ado:

What this country needs is either a good 5¢ cigar or the reincarnation of an Illinois “rail-splitter” willing to tell the American people “what up” – “what really up.” We have for so long now been willing to be entertained rather than informed, that we more or less accept majority opinion, perpetually shaped by ratings obsessed media, at face value. After 12 months of an endless primary campaign barrage, for instance, most of us believe that a candidate’s preacher – Democrat or Republican – should be a significant factor in how we vote. We care more about who’s going to be eliminated from this week’s American Idol than the deteriorating quality of our healthcare system. Alternative energy discussion takes a bleacher’s seat to the latest foibles of Lindsay Lohan or Britney Spears and then we wonder why gas is four bucks a gallon. We care as much as we always have – we just care about the wrong things: entertainment, as opposed to informed choices; trivia vs. hardcore ideological debate.

It’s Sunday afternoon at the Coliseum folks, and all good fun, but the hordes are crossing the Alps and headed for modern day Rome – better educated, harder working, and willing to sacrifice today for a better tomorrow. Can it be any wonder that an estimated 1% of America’s wealth migrates into foreign hands every year? We, as a people, are overweight, poorly educated, overindulged, and imbued with such a sense of self importance on a geopolitical scale, that our allies are dropping like flies. “Yes we can?” Well, if so, then the “we” is the critical element, not the leader that will be chosen in November. Let’s get off the couch and shape up – physically, intellectually, and institutionally – and begin to make some informed choices about our future. Lincoln didn’t say it, but might have agreed, that the worst part about being fooled is fooling yourself, and as a nation, we’ve been doing a pretty good job of that for a long time now.

I’ll tell you another area where we’ve been foolin’ ourselves and that’s the belief that inflation is under control. I laid out the case three years ago in an Investment Outlook titled, “Haute Con Job.” I wasn’t an inflationary Paul Revere or anything, but I joined others in arguing that our CPI numbers were not reflecting reality at the checkout counter. In the ensuing four years, the debate has been joined by the press and astute authors such as Kevin Phillips whose recent Bad Money is as good a summer read detailing the state of the economy and how we got here as an “informed” American could make.

Let me reacquaint you with the debate about the authenticity of U.S. inflation calculations by presenting two ten-year graphs – one showing the ups and downs of year-over-year price changes for 24 representative foreign countries, and the other, the same time period for the U.S. An observer’s immediate take is that there are glaring differences, first in terms of trend and second in the actual mean or average of the 2 calculations. These representative countries, chosen and graphed by Ed Hyman and ISI, have averaged nearly 7% inflation for the past decade, while the U.S. has measured 2.6%. The most recent 12 months produces that same 7% number for the world but a closer 4% in the U.S.

This, dear reader, looks a mite suspicious. Sure, inflation was legitimately much higher in selected hot spots such as Brazil and Vietnam in the late 90s and the U.S. productivity “miracle” may have helped reduce ours a touch compared to some of the rest, but the U.S. dollar over the same period has declined by 30% against a currency basket of its major competitors which should have had an opposite effect, everything else being equal. I ask you: does it make sense that we have a 3% – 4% lower rate of inflation than the rest of the world? Can economists really explain this with their contorted Phillips curve, output gap, multifactor productivity theorizing in an increasingly globalized “one price fits all” commodity driven global economy? I suspect not. Somebody’s been foolin’, perhaps foolin’ themselves – I don’t know. This isn’t a conspiracy blog and there are too many statisticians and analysts at the Bureau of Labor Statistics (BLS) and Treasury with rapid turnover to even think of it. I’m just concerned that some of the people are being fooled all of the time and that as an investor, an accurate measure of inflation makes a huge difference.

The U.S. seems to differ from the rest of the world in how it computes its inflation rate in three primary ways: 1) hedonic quality adjustments, 2) calculations of housing costs via owners’ equivalent rent, and 3) geometric weighting/product substitution. The changes in all three areas have favored lower U.S. inflation and have taken place over the past 25 years, the first occurring in 1983 with the BLS decision to modify the cost of housing. It was claimed that a measure based on what an owner might get for renting his house would more accurately reflect the real world – a dubious assumption belied by the experience of the past 10 years during which the average cost of homes has appreciated at 3x the annual pace of the substituted owners’ equivalent rent (OER), and which would have raised the total CPI by approximately 1% annually if the switch had not been made.

In the 1990s the U.S. CPI was subjected to three additional changes that have not been adopted to the same degree (or at all) by other countries, each of which resulted in downward adjustments to our annual inflation rate. Product substitution and geometric weighting both presumed that more expensive goods and services would be used less and substituted with their less costly alternatives: more hamburger/less filet mignon when beef prices were rising, for example. In turn, hedonic quality adjustments accelerated in the late 1990s paving the way for huge price declines in the cost of computers and other durables. As your new model MAC or PC was going up in price by a hundred bucks or so, it was actually going down according to CPI calculations because it was twice as powerful. Hmmmmm? Bet your wallet didn’t really feel as good as the BLS did.

In 2004, I claimed that these revised methodologies were understating CPI by perhaps 1% annually and therefore overstating real GDP growth by close to the same amount. Others have actually tracked the CPI that “would have been” based on the good old fashioned way of calculation. The results are not pretty, but are undisclosed here because I cannot verify them. Still, the differences in my 10-year history of global CPI charts are startling, aren’t they? This in spite of a decade of financed-based, securitized, reflationary policies in the U.S. led by the public and private sector and a declining dollar. Hmmmmm?

In addition, Fed policy has for years focused on “core” as opposed to “headline” inflation, a concept actually initiated during the Nixon Administration to offset the sudden impact of OPEC and $12 a barrel oil prices! For a few decades the logic of inflation’s mean reversion drew a fairly tight fit between the two measures, but now in a chart shared frequently with PIMCO’s Investment Committee by Mohamed El-Erian, the divergence is beginning to raise questions as to whether “headline” will ever drop below “core” for a sufficiently long period of time to rebalance the two. Global commodity depletion and a tightening of excess labor as argued in El-Erian’s recent Secular Outlook summary suggest otherwise.

The correct measure of inflation matters in a number of areas, not the least of which are social security payments and wage bargaining adjustments. There is no doubt that an artificially low number favors government and corporations as opposed to ordinary citizens. But the number is also critical in any estimation of bond yields, stock prices, and commercial real estate cap rates. If core inflation were really 3% instead of 2%, then nominal bond yields might logically be 1% higher than they are today, because bond investors would require more compensation. And although the Gordon model for the valuation of stocks and real estate would stress “real” as opposed to nominal inflation additive yields, today’s acceptance of an artificially low CPI in the calculation of nominal bond yields in effect means that real yields – including TIPS – are 1% lower than believed. If real yields move higher to compensate, with a constant equity risk premium, then U.S. P/E ratios would move lower. A readjustment of investor mentality in the valuation of all three of these investment categories – bonds, stocks, and real estate – would mean a downward adjustment of price of maybe 5% in bonds and perhaps 10% or more in U.S. stocks and commercial real estate.

A skeptic would wonder whether the U.S. asset-based economy can afford an appropriate repricing or the BLS was ever willing to entertain serious argument on the validity of CPI changes that differed from the rest of the world during the heyday of market-based capitalism beginning in the early 1980s. It perhaps was better to be “entertained” with the notion of artificially low inflation than to be seriously “informed.” But just as many in the global economy are refusing to mimic the American-style fixation with superficialities in favor of hard work and legitimate disclosure, investors might suddenly awake to the notion that U.S. inflation should be and in fact is closer to worldwide levels than previously thought. Foreign holders of trillions of dollars of U.S. assets are increasingly becoming price makers not price takers and in this case the price may not be right. Hmmmmm?

What are the investment ramifications? With global headline inflation now at 7% there is a need for new global investment solutions, a role that PIMCO is more than willing (and able) to provide. In this role we would suggest: 1) Treasury bonds are obviously not to be favored because of their negative (unreal) real yields. 2) U.S. TIPS, while affording headline CPI protection, risk the delusion of an artificially low inflation number as well. 3) On the other hand, commodity-based assets as well as foreign equities whose P/Es are better grounded with local CPI and nominal bond yield comparisons should be excellent candidates. 4) These assets should in turn be denominated in currencies that demonstrate authentic real growth and inflation rates, that while high, at least are credible. 5) Developing, BRIC-like economies are obvious choices for investment dollars.

Investment success depends on an ability to anticipate the herd, ride with it for a substantial period of time, and then begin to reorient portfolios for a changing world. Today’s world, including its inflation rate, is changing. Being fooled some of the time is no sin, but being fooled all of the time is intolerable. Join me in lobbying for change in U.S. leadership, the attitude of its citizenry, and (to the point of this Outlook) the market’s assumption of low relative U.S. inflation in comparison to our global competitors.

William H. Gross
Managing Director

The SS hypothesis extends to unemployment statistics, as well. In most European economies, anyone unemployed between 19 and 55 years of age is apparently counted as unemployed. The massive graduate education and “nonprofit” apparatus in the United States (Peace Corps, Teach for America, etc) means that many Americans who are effectively unemployed — and who often use such institutions to say that they “have something to do” — are not counted as such.

When you add up all the American distortions, the US economy expressed in European metrics comes to approximately 7 percent inflation, 8 percent unemployment, and very low growth.

Which begs the question of what European governments do to cook their own books, which is something I can’t know. Gold-buggery seems to be an overwhelmingly American phenomenon, and virtually all research into effective gold price support has come from Americans, which means that the CPI-skeptic worldview is very familiar with the nuances of American book-cooking, but not at all familiar with European equivalents.

However, European bonds are not nearly the economic anchor that American fixed income and equities prices are.

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The entire economy of Iceland has come under massive speculative assault in the past several months, as the most ludicrous example of an overextended, overleveraged, underfunded European economy.

As of December 2006, its rolling annual trade deficit was 26 percent of GDP. That has come down to “only” 15 percent as of January 2008.

However, Iceland’s currency has bled 26 percent in the interim. Because Iceland is a tiny economy, adverse shifts in foreign exchange are telegraphed extremely rapidly to every corner of the economy.

The central banks in Denmark, Norway and Sweden have offered a $2.3 billion loan to Iceland to bolster its faltering currency, the krona, which has lost some 26 percent of its value since January amid concerns that Iceland’s banks carry too much foreign debt, Bloomberg reported May 16. The currency rose 3.7 percent versus the euro on the news. Inflation in Iceland hit 11.8 percent in April, the highest level in nearly two decades, despite a key interest rate set at 15.5 percent.

This is small-scale proof that currency implosion today equals consumption implosion tomorrow. The only variables are the relative size of the country’s economy (smaller economy = faster price realignment in line with forex fluctuations), the size of the country’s trade deficit as a percentage of GDP (larger deficit = sharper adjustment), and the absolute size of the country’s trade deficit relative to all other national trade deficits.

Turning points in the global economic cycle usually hit the smaller, more vulnerable economies first. The big boys get hit last, but hardest.

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􀁘 Removing gasoline sales, which have been strongly influenced by the sharp rise in
prices in recent months, allows a better measure of real or inflation-adjusted sales
to be examined. Alternative measures of the so-called ‘control group,’ included in
real consumer spending as measured by the BEA, rose about 0.5% in April,
following a revised increase of about 0.3% in March (revised from 0.1%).
Moreover, January ‘control group’ sales are now estimated up 0.3%, about double
their previously estimated rise.
􀁘 Categories showing improvement in April included electronics and appliance store
sales which rose 1.4%, food service and drinking place sales up 0.9%, clothing and
accessories store sales up 0.7% for a second consecutive month, general
merchandise stores up 0.5% and health and personal care stores up 0.4%.
􀁘 While consumers remain under strain from weak employment conditions, falling
home values, high energy costs, and tight credit conditions, today’s retail sales
results point to stronger spending emerging this quarter, especially as the ongoing
tax rebates are more fully distributed this month and next. Moreover, some modest
upward revision to 1Q consumption is also likely.

In other words, non-inflating retail is doing well. Large discrete expenses (cars) and rapidly inflating sectors (gas) aren’t.

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